economics 4 / management 4 financial accounting · 1) purchase three periods of advertising for $33...
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Economics 4 / Management 4 Financial Accounting
Ugly Puppy Periods 1 - 3
Updated 05/07/16
Analyzing Accounting Choices Analysis is a systematic process of comparison. • We will compare the financial reporting
results of two separate sets of accounting policies for …
• … one set of business events. • This will clearly demonstrate FORM (two
sets of financial reports) over SUBSTANCE/REALITY (one series of transactions)
Start w/ a business enterprise with several profit centers.
1. Consulting.
2. Retail Sales.
3. Celebrity appearances and, maybe …
4. … an Instagram Account
What is the role of a Policy?
Policies are guidelines for dealing with the stuff that happens ( I apologize if that doesn’t sound very fancy). Policies tell us what to do if shit happens, or not:
What is the role of an Accounting Policy?
Accounting policies are guidelines for:
a) making estimates;
b) analyzing & interpreting transactions;
c) communicating contingencies;
d) recognizing revenues & expenses.
What does this mean?
The accounting policies adopted by management
will influence the firm’s financial reports,
particularly reported profits, plus assets, and
liabilities.
Two firms with different accounting policies,
experiencing the same business activities and
transactions, will look different to investors.
but …. are they different?
In form but not in substance.
What Accounting Policies?
1) Costs that are capitalized or expensed.
2) How “capitalized costs” are amortized.
3) How “inventory costs” flow through COGS.
4) How “contingencies” are reported.
5) How strictly the earnings process is measured.
6) How “bad” things get reported, and
7) … all of the implications that go along with the above.
Period 1 1) Issue 200 shares of stock for $1 each. 2) Acquire an Ugly Puppy for $100, cash. 3) Buy T-shirts in three successive cost layers as: 4) 10 shirts @ $1 each, cash. 5) 10 shirts @ $2 each, cash. 6) 10 shirts @ $3 each, cash. 7) Consult 40 clients and 30 pay the $1 each; 10
promise to pay later. 8) Sell 10 T-shirts at $5 each, cash.
Capitalizing and amortizing the Puppy’s Cost
• Cost is $ 100. • Expected recovery of that cost is $ 0, thus • Amortizable Basis is $ 100 - $ 0 = $100.
• AGG gives the amortizable basis a three-period
life while the CON gives it a two-period life. • Depreciation Schedules: • Period 1 2 3 4
1. AGG $ 33 $ 33 $ 34 $ 0
2. CON $ 50 $ 50 $ 0 $ 0
• Use FIFO as the Aggressive choice. • The $ 1 cost layer goes to COGS first, thus • The $ 2 and $ 3 layers are LISH as EI. • Use LIFO as the Conservative choice. • The $ 3 cost layer goes to COGS first, thus • The $ 1 and $ 2 layers are FISH as EI.
Inventory Cost Flow Decisions: FIFO versus LIFO
When a firm sells on-account, it is holding a customers debt. • Will the customer repay the debt? • All of it or just a portion? • When? How should the firm communicate this to creditors and investors?
Reporting (or not) Contingencies - the reality of holding
someone’s debt.
Color Code for Policy Effects
Amortization effects
Cost flow choice and “COGS”
Contingencies “bad debt expense”
Revenue recognition
Layer COGS Layer COGS
$ 10 ( $ 10) $ 10
$ 20 $ 20
$ 30 $ 30 ( $ 30)
Inventory Cost Flows AGG CON
FIFO / LISH LIFO/FISH
The 1st Period - Aggressive policies Starting Rev 90 COGS (10) GP 80 G&A ( 0) EBITDA 80 DA (33) EBIT 47 I ( 0) EBT 47 T ( 0) NI 47
200
0
( 0)
0
0
0
0
(0)
0
0
0
0
200
0
120
10
( 0)
50
0
0
100
(33)
0
0
0
0
200
47
The 1st Period - Conservative policies Starting Rev 90 COGS (30) GP 60 G&A (10) EBITDA 50 DA (50) EBIT 0 I ( 0) EBT 0 T ( 0) NI 0
200
0
( 0)
0
0
0
0
(0)
0
0
0
0
200
0
120
10
(10)
30
0
0
100
(50)
0
0
0
0
200
0
Comparisons
• Period #1
Profits Assets Liabilities
Aggressive $ 47 $ 247 $ 0
Conservative $ 0 $ 200 $ 0
A Few Observations
• Two sets of Financials.
• One business.
• We have created a reporting form
• Different from the substance of events.
• The one reported item that cannot be altered by
Accounting Choices is CA$H.
Period 2 1) Acquire a 2nd Ugly Puppy for $100 cash 2) Borrow $100 @ 7% interest on an interest-only
basis with interest due in subsequent periods 3) Purchase 10 T-shirts @ $4 each, on-account. 4) Purchase ten 10# bags of dog food for $5 each,
$50 total cash. 5) Take both puppies to a Vet and pay $24 cash. 6) Consult 40 clients and 30 pay $1 each; 10
promise to pay later. 7) Sell 20 T-shirts at $5 each, cash.
Capitalizing or Expensing the Vet & Trainer Costs
Cost is $ 24. An accessory to the L.L.A “puppy” but what type: betterment or repair? Betterment gets capitalized and amortized; repair gets expensed. If capitalized, then • What amount of the cost is recoverable? • What life do we give the cost?
AGG Capitalizing the Costs • Give the 2nd puppy’s cost a 3 period life. • Give the Vet cost a 3-period life.
• AGG Depreciation Schedule: • Period 1 2 3 4
$ 100 $ 33 $ 33 $ 34 $ 0 $ 0
$ 100 $ 33 $ 33 $ 34 $ 0
$ 24 $ 8 $ 8 $ 8 $ 0
Total $ 33 $ 74 $ 75 $ 42
CON Capitalizing & Expensing the New Costs
• Give the 2nd puppy’s cost a 2 period life. • G&A Expense the Vet.
• CON Depreciation Schedule: • Period 1 2 3 4
$ 100 $ 50 $ 50 $ 0 $ 0 $ 0
$ 100 $ 50 $ 50 $ 0 $ 0
Total $ 50 $100 $ 50
Inventory Cost Flows AGG CON
FIFO / LISH LIFO/FISH
Layer COGS Layer COGS $ 10
$ 20 ( $ 20) $ 20 ( $ 20) $ 30 ( $ 30) $ 40 $ 40 ( $ 40)
The 2nd Period - Aggressive Starting Rev 140 COGS (50) GP 90 G&A ( 10) EBITDA 80 DA ( 74) EBIT 6 I ( 7) EBT ( 1) T (0) NI ( 1)
120
10
( 0)
50
0
0
100
(33)
0
0
0
0
200
47
176
20
( 0)
40
0
40
224
(107)
0
40
7
100
200
46
The 2nd Period - Conservative Starting Rev 140 COGS (60) GP 80 G&A (44) EBITDA 36 DA (100) EBIT (64) I ( 7) EBT (71) T ( 0) NI (71)
120
10
(10)
30
0
0
100
( 50)
0
0
0
0
200
0
176
20
(20)
10
0
40
200
(150)
0
40
7
100
200
( 71)
Comparisons
• Period #2
Profits Assets Liabilities
Aggressive ($ 1) $ 393 $ 147
Conservative ($ 71) $ 276 $ 147
Prelude 3nd Period Events • Several things should or will likely happen: Pay the Bank $ 7 owed from the 2nd period [should]. Pay or delay the $ 40 Payable [likely]. Recognize scheduled depreciation regardless of any other activities [must]. Collect outstanding Receivables [hope]. Carry-forward certain account balances [must].
• What might happen? Activities related to the Working Capital accounts – purchase Inventory, pay Payables. Additional Capital Expenditures (“CAPEX”)? Recognize uncontroversial SG&A-type expenses? Recognize controversial SG&A-type expenses?
Period 3 Pay the Payable and the Accrued Interest. 1) Purchase three periods of Advertising for $33
cash; 2) Purchase 10 T-shirts @ $4 each, cash. 3) Consult 40 clients and all pay $1 each, cash. 4) Collect $10 in outstanding Receivables. 5) Sell 20 T-shirts at $6 each, cash. 6) Purchase 10 T-shirts @ $5 each, cash. 7) Encounter a person who agrees to $100 for a
celebrity Puppy appearance – next period – and pays $50 cash now with balance due on performance.
8) Declare $100 in dividends.
The 3rd Period - Aggressive Starting Rev 210 (50) COGS (80) GP 130 G&A ( 21) EBITDA 109 DA ( 75) EBIT 34 I ( 7) EBT 27 T (0) NI 27
176
20
( 0)
40
0
40
224
(107)
0
40
7
100
200
46
226
10
( 0)
50
22
30
224
(182)
0
0
7
100
100
200
(27)
The 3rd Period - Conservative Starting Rev 160 COGS (90) GP 70 G&A (11) +10 EBITDA 59 DA (50) EBIT 9 I ( 7) EBT 2 T ( 0) NI 2
176
20
(20)
10
0
40
200
(150)
0
40
7
100
200
(71)
226
10
(10)
10
22
30
200
(200)
50
0
7
100
100
200
(169)
Layer COGS Layer COGS $ 10
$ 40 ( $ 40) $ 40 ( $ 40) $ 40 ( $ 40) $ 50 $ 50 ( $ 50)
Inventory Cost Flows AGG CON
FIFO / LISH LIFO/FISH
Comparisons
• Period #3
Profits Assets Liabilities
Aggressive $ 27 $ 380 $ 207
Conservative $ 2 $ 288 $ 257