Revenues & Expenses Asset accounting issues

2007/01/19International Business Program Financial Accounting 1 Revenues Investors (and other Stakeholders) place great importance on revenues in making decisions.

2007/01/19International Business Program Financial Accounting 2 Revenues Investors (and other Stakeholders) place great importance on revenues in making decisions. What is revenue?

2007/01/19International Business Program Financial Accounting 3 Revenues Investors (and other Stakeholders) place great importance on revenues in making decisions. What is revenue? Inflow of resources from the primary business activity –Marco’s bingo winnings Question 3.3, page 65

2007/01/19International Business Program Financial Accounting 4 Revenues Investors (and other Stakeholders) place great importance on revenues in making decisions. Why?

2007/01/19International Business Program Financial Accounting 5 Revenues Investors (and other Stakeholders) place great importance on revenues in making decisions. Why? The purpose of business enterprise is to sell goods and services.

2007/01/19International Business Program Financial Accounting 6 Revenue Recognition When seller or provider has done something that clearly establishes it has earned revenue Both seller and buyer have essentially completed obligation

2007/01/19International Business Program Financial Accounting 7 Revenue Recognition (continued) Seller has transferred to buyer the risks and rewards of ownership Seller has no significant control Amount of transaction can be reliably established Costs, past and future, can be measured reliably (Text pg. 89)

2007/01/19International Business Program Financial Accounting 8 Revenue recognition examples (What do we mean by word ‘example’?) Sale of goods by manufacturer, wholesaler, retailer Sale of services in professional practice No significant issues (straightforward)

2007/01/19International Business Program Financial Accounting 9 Revenue recognition examples (continued) Resources received in advance; Goods and services provided in future –Liability for unearned revenues –NB liability is not satisfied with cash –Often seller earns revenues with passage of time; no explicit activity Further discussion in textbook pp Limited to certain business and industries

2007/01/19International Business Program Financial Accounting 10 Revenue recognition examples (continued) Resources received in the future –Trade credit (majority of businesses) –Creates a valid asset – receivables –Measurement? fair value of goods or services –Diletta Ferrari pg. 86 & pg. 67

2007/01/19International Business Program Financial Accounting 11 Revenue recognition examples (continued) Resources received in the future (continued) Discounts, allowances, rebates, etc? –Reduce revenue, not expenses –Why? Text pg. 83 Exception: large amount of returns expected. What happens then?

2007/01/19International Business Program Financial Accounting 12 Revenue recognition examples (continued) Resources received in the future (continued) –Some trade credit never paid; normal risk of business –Reduce revenue or recognize expense? –Recognize at time of sale or when non- payment obvious? –Asset valuation?

2007/01/19International Business Program Financial Accounting 13 Revenue recognition examples (continued) Resources received in the future (continued) –Analytical tools Receivables turnover Days uncollected –Assess impact of financial decisions of seller

2007/01/19International Business Program Financial Accounting 14 Revenue recognition examples (continued) Long-term construction- e.g. buildings, infrastructure, aircraft, ships –What is primary economic activity measured? Proportionate completion of project? Final delivery of object? Prudence vs. matching –Current view of IAS is proportionate with exceptions

2007/01/19International Business Program Financial Accounting 15 Inventories and Cost of Sales Major element of earning revenue for many types of companies Defines business cycle for many companies Cost of sales is largest single expense for many companies. – Why? Diletta Ferrari pg. 86 & 67

2007/01/19International Business Program Financial Accounting 16 Inventories and Cost of Sales (continued) Must assign value to inventory. –Why?

2007/01/19International Business Program Financial Accounting 17 Inventories and Cost of Sales (continued) Must assign value to inventory. Why? –Match expense of selling goods against revenue earned –Reflect asset in balance sheet –Very rarely can measure directly. Why? –Accounting conventions – FIFO, AVCO NB: LIFO NOT COVERED IN COURSE

2007/01/19International Business Program Financial Accounting 18 Inventories and Cost of Sales (continued) Accounting conventions (continued) –FIFO – earliest goods purchased are ones sold –AVCO – cost of sale is average Weighted Moving (not in text) –Follow example in text pp NB: LIFO NOT COVERED IN COURSE

2007/01/19International Business Program Financial Accounting 19 Inventories and Cost of Sales (continued) Lower NRV (continued) –Sometimes replacement cost and net realizable value of inventory declines. – Why? –Give examples

2007/01/19International Business Program Financial Accounting 20 Inventories and Cost of Sales (continued) Lower NRV (continued) –Replacement cost and NRV of inventory declines. – Why? Give examples –Technology become mature or obsolete Mobile telephones Computers Memory sticks

2007/01/19International Business Program Financial Accounting 21 Inventories and Cost of Sales (continued) Lower NRV Value (continued) –When is loss of value recognized? Period when goods are held? Period when goods are sold? –Matching principle

2007/01/19International Business Program Financial Accounting 22 Inventory Misstatements Major analytical tool Direct relationship between ending inventory and profit Other things being equal: –Increase ending inventory, increase profit; and vice versa –Increase beginning inventory, decrease profit; and vice versa

2007/01/19International Business Program Financial Accounting 23 Inventory Ratios Other major analytical tools –Inventory turnover –Average days in inventory –Depends on type of business!!!!!!!!!!

2007/01/19International Business Program Financial Accounting 24 Non-current Assets and Profits Tangible – physical substance Intangible – no physical substance In concept are the same Intangibles present practical difficulties

2007/01/19International Business Program Financial Accounting 25 Non-current Assets and Profits (continued) Capital Expenditures –Future benefit –Contribute to earning revenue over time –Match against revenues when contribute Depreciation and amortisation Current expenses –Contribute to earning revenues in current period; matching WorldCom scandal

2007/01/19International Business Program Financial Accounting 26 Non-current Assets and Profits (continued) Initial cost –All costs associated with acquiring, e.g. Purchase price, taxes, less discounts, etc. Delivery, installation, etc. Professional fees for architects, lawyers, etc. Estimated future cost to dismantle Interest directly associated with acquisition Example pg. 132

2007/01/19International Business Program Financial Accounting 27 Non-current Assets and Profits (continued) Subsequent costs –If increases future benefits, capitalize –Otherwise, expense

2007/01/19International Business Program Financial Accounting 28 Non-current Assets and Profits (continued) Depreciation and amortization –Match cost of using asset against revenue earned –Based on cost (and subsequent additions) –Useful life –Residual value (may be negative)

2007/01/19International Business Program Financial Accounting 29 Non-current Assets and Profits (continued) Depreciation and amortisation methods These are not choices!!!!!!!!!!!!! –Straight-line Most commonly used. Why? –Accelerated (declining balance and sum of units) Should raise analytical questions. Why? (You do not need to know how to compute)

2007/01/19International Business Program Financial Accounting 30 Non-current Assets and Profits (continued) Disposals Straightforward; see text

2007/01/19International Business Program Financial Accounting 31 Non-current Assets and Profits (continued) Leased assets –One company has contractual right to use an asset owned by another company –Can present analytical issues –Review Definition of asset Concept of substance over form

2007/01/19International Business Program Financial Accounting 32 Non-current Assets and Profits (continued) Leased assets (continued) –If substance of transaction is equivalent to purchase, must reflect Asset – lesser issue Liability – This is the major issue! At present value of future cash flows (fair value) –Typically minimal impact on expense Why?

2007/01/19International Business Program Financial Accounting 33 Non-current Assets and Profits (continued) Intangible assets –In substance same as tangible assets –Present practical difficulties

2007/01/19International Business Program Financial Accounting 34 Non-current Assets and Profits (continued) Intangible assets (continued) –Examples in text (pg. 131) –IAS addresses practical issues Identifiable (or separable) Controlled Acquired in transaction Significant analytical issues in some industries, e.g. pharmaceuticals Special issues with R & D

2007/01/19International Business Program Financial Accounting 35 Non-current Assets and Profits (continued) Natural resources –Same concepts apply –Procedures vary slightly Depletion based on units, not time

2007/01/19International Business Program Financial Accounting 36 Non-current Assets and Profits (continued) Impairment issues –Just like inventory, some non-current assets have values that are impaired Why? –When should impairment loss be recognized? Matching –Reflect present value of future cash flows or NRV.