4 Criteria for Recognizing Revenue

Transcription

1 What do you know?

2 E4-7 Preparing financial statements Taken from the 2008 annual report of Bristol-Myers Squibb, a world-leading drug company (dollars in millions), reconstruct the financials. Cost of goods sold $ 6,396 Net cash from operations 3,707 Accounts receivable 3,710 Restructuring expense 218 Net cash from financing (2,582) Shareholders equity 12,241 Net cash from investing 5,079 Research & dev. expense 3,585 Other noncurrent assets 9,384 Other expenses 901 Marketable securities 289 Cash and equivalents $ 7,976 Short-term borrowings 154 Adv. & product expense 1,550 Accounts payable 1,535 Long-term liabilities 10,601 Net sales 20,597 Property, plant, & equip. 5,405 Other current assets 2,788 Other current liabilities 2,085 Sell. & adm. expenses 4,792 Accrued payables 2,936

3 4 Criteria for Recognizing Revenue 1. The company has completed a significant portion of the production and sales efforts. 2. The amount of revenue can be objectively measured. 3. The company has incurred the majority of costs, and remaining costs can be reasonably estimated, and 4. Cash collection is reasonably assured.

4 ID3-7 Matching and mismatching Much has been written about accounting fraud and subsequent bankruptcy of WorldCom. The Baltimore Sun reported that the Fraud was brazen (and) easy to spot The scheme was not complicated: the company s financial officers recorded routine maintenance expenses totaling $3.9 billion as capital expenditures, which can be written off over decades rather than booked as immediate expenses. a. Explain how capitalizing an item, instead of expensing it, affects the financial statements. b. Which principle of accounting is being violated? Are other principles involved? Discuss.

5 P3-12 Revenue recognition and net income a. Assuming that Hydra recognizes revenue when the toasters are produced, how much revenue should be recognized in each of the 3 years? b. Assuming Hydra recognizes revenue at delivery, how much revenue should be recognized in each of the 3 years? c. Calculate net income for the 3 periods under each of the two assumptions above. d. If Hydra s management is paid an income-based bonus, which of the two assumptions would be preferred? Hydra sells appliances to Seasons Department Store. A recent order requires Hydra to manufacture and deliver 500 toasters at a price of $100 per unit. Hydra s manufacturing costs are approximately $40 per unit. The following schedule summarizes the production and delivery record of Hydra: Year Total Toasters produced Costs incurred $8,000 $8,000 $4,000 $20,000 Toasters delivered Cash received $10,000 $15,000 $20,000 $45,000

6

7 E3-5 Matching and Revenue recognition Cascade Enterprises ordered 4,000 brackets from McKay and Company on , for a contract price of $40,000. McKay completed manufacturing the brackets on and delivered them to Cascade on McKay received a check for $40,000 from Cascade on a. Assume that McKay and Company prepare monthly income statements. In which month should McKay recognize the $40,000 revenue from the sale? a. Justify your answer in (a.) in terms of the 4 criteria of revenue recognition.

8 E3-5 Matching and Revenue recognition Cascade Enterprises ordered 4,000 brackets from McKay and Company on , for a contract price of $40,000. McKay completed manufacturing the brackets on and delivered them to Cascade on McKay received a check for $40,000 from Cascade on c. Are their conditions under which the revenue could be recognized in a different month than the month you chose? d. Provide several reasons McKay s management might be interested in the timing of the recognition of revenue.

9 Financial Accounting Fundamentals Assumptions Economic Entity (identified and measured) Fiscal Period (periodicity) Going Concern (life indefinite) Stable Dollar (across time) Measurement Principles Objectivity (Verifiable and documented) Matching and Revenue Recognition (costs & benefits) Consistency (methods same across time) Two Exceptions Materiality little to no effect on user decisions Conservatism -understate assets, overstate liabilities, accelerate losses, and delay gains (due to legal liability) Valuation Input Market (purchase)-original, replacement Output Market (sell)-present, fair market Financial Statements: Original (Historic) Cost: Land, LT Invt Lower of Cost or Market: Inventory Net Realizable Value: net AR Net Book Value: PP&E, Intang. Face: Cash, Current liabilities Fair Market Value (sales price): ST Invt Present Value: LT NR & LTL IFRS v. US GAAP Principles based Rules based

10 E3-8 The concept of materiality All large U.S. companies have policies in which all expenditures under a certain dollar amount are expensed. Many of these expenditures are for assets, items that are useful to a company beyond the period in which they were purchased. a. Explain the proper accounting treatment for expenditures for items that are expected to generate benefits in the future. b. Explain why it might make economic sense to expense some of these items. Upon what exception to the principles of financial accounting would such a decision be based?

11 ID3-10 Income management and conservatism Whitney Tilson, a noted analyst, warns investors in an article in The Motley Fool that more than any other type of company, financial companies have immense discretion regarding what earnings to report. The key is the rate of loan losses that they expect to experience, which must be estimated at the end of every period. By changing the estimate, which in turn changes one of the largest expenses on their income statement, financial companies can manage net income. Tilson specifically cites Farmer Mac, the agency created by the federal government to provide funds in the agricultural lending market, which many analysts believe smooths it earnings across time by simply changing its estimate of loss rates. a. What does it mean to smooth earnings across time? How might a financial company practice this strategy, and why might it engage in this activity? b. Earnings smoothing has also been associated with conservatism. Why?

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

29

30