Saturday, June 28, 2014

Appreciation for Depreciation




The concept and application of Depreciation in the design of an organization’s Accounting picture, is an essential element to understand and recognize, when responsible for the design or rendering of the company’s financial pictorial representation or when re-performing or further analyzing and interpreting the entity’s financial position.

Depreciation is a term used to cause for two main accounting principles.  These principles include: (1) Cost allocation:  When a company makes a major purchase, such as the purchase of a fixed asset, the company is anticipating utilizing that asset over a period of time, and in utilization of that asset, to generate revenues or reduce threats of potential liabilities.  For example, a pupil transportation company, will purchase school buses and particularly school buses of certain quality so as to ensure the efficient, safe and reliable transportation of its riders to and from school each day.  The company, we will call: Bunny Transportation (When walking my dog, I saw a mother bunny and its babies, so as such I came up with Bunny Transportation).  Bunny Transportation expects to utilize those school buses over a period of 10 years and as such will generate revenue from the use of those buses.    Depreciation allows and GAAP requires the company to allocate the cost of the purchase over the term in which the company anticipates it will generate revenue from that asset.  In our example above, Bunny Transportation will allocate the cost of the school bus purchase over 10 years.  Assuming Bunny purchased a bus for $100,000.00, Bunny would then allocate an expense of $10,000 toward that bus each year, for a period of 10 years.

NOTE:

As you can probably can tell right now, Depreciation ( as with many other accounting concepts and GAAP principles ) is based off of guesses.  Guesses in the world of accounting are called: Estimates.  As with guesses, estimates are merely calculated guesses and as such, the same could be wrong or unexpectedly changing.  This is not cause to PANIC !!!.  There are processes and procedures to adjust and correct these estimates as future events become recognized in the present, or in other words, “as stuff happens”.

The other main accounting principle Depreciation attempts to recognize, (2) is the decreasing value over time, of the asset that was purchased.  As Fixed Assets inherently decline in value over time, due to obsolescence, wear – tear, use, depletion, etc, Depreciation is used to record this decline in value, each period ( year, month, or any other measurable period, including non-calendar based periods, such as usage periods ).  Going back to Bunny Transportation:  Bunny’s purchase of a school bus for $100,000.00 will not be worth the same $100,000, not even the day the vehicle leaves the dealer’s lot and certainly less with each passing month, year and / or mile added to odometer.  Depreciation, therefore, not only recognizes the allocation of a respective asset’s cost over time, it also (and with the same stroke) attempts to reflect the decrease in the asset’s value.  

How is Depreciation Calculated ?:

Depreciation can be calculated utilizing a variety of different methods, while accounting for even more influencing factors.  Depreciation can be calculated on a steady and consistent basis over time ( such as over the months or years of the asset’s life {economic life} or Depreciation can be calculated over the basis for which it will generate revenue (for example, the number of miles on the vehicle, number of hours of the machine, etc.) or Depreciation can be calculated utilizing an accelerated method of cost allocation and value depletion.  Accelerated methods are not only commonly used for financial reporting purposes, but are also standard procedures for corporate tax return preparations.    Furthermore, Depreciation can become influenced by many other factors, such as residual values, impairment, disposition of assets, asset groupings, etc. 

I will give the first blogger to post the correct answer to this question, a free copy of my book, whenever, I decide to write one.

Why would the IRS encourage accelerated cost recovery (Depreciation methods) ?

In closing:  Due to Depreciation’s two fold purpose:  I appreciate a Fixed Asset as it Depreciates !



Tuesday, June 17, 2014

Sponge up your Costs !


In a manufacturing environment, Accountants and Financial Analysts are delegated and burdened with the responsibility of calculating the cost associated and accompanied with the manufacturing of the product for which their company produces.


               This is known as Cost- Accounting and is considered a specialized field or area of study for accountants.  Just as a Doctor could specialize in pediatrics, or pathology, or cardio vascular diseases, Accountants too can specialize in various areas of accounting, one being Cost-Accounting.  Cost Accounting can be viewed as the cardio-vascular system of a Manufacturer's financial position.  In other words, it is the heart and lungs; the life support of a manufacturer.  

What really goes into cost - accounting ?

               As with all accounting basis and specialties, cost-accounting can be conducted and proceeded in accordance with GAAP, NOT or in some type of hybrid method of being right and wrong.  [ GAAP stands for Generally Accepted Account Principles.  GAAP is the framework of standards for financial reporting.  Meaning that financial statements and the financial reporting of transactions and valuation calculations of those transactions should be recorded in accordance with this framework.  Unfortunately, just as the strike zone on a batter is quite broad, so is the framework at times, across different topics.  A financial statement, therefore, can claimed to be reported in accordance with GAAP and still defy consistency and be found with questionable reporting practices. ]

The GAAP recognized Cost-accounting method is known as Full Absorption Costing or Full Costing. 

               Cost-accounting involves identifying and recognizing the varying pieces and the cost (or value) of those pieces in the manufacturing of a product. 

               For example, a company makes Cheeseburgers {Why cheeseburgers ? - Because I'm hungry and I like cheeseburgers, plus I could have picked anything, like microwave ovens, copy machines, cars, interplanetary space modules, but you can't eat any of those - perhaps my discussion and visualization of a cheeseburger will cause me to be satisfied with a healthy leafy salad tonight for dinner - I will let you know}  Ok, a Cheeseburger, consists of a variety of different pieces, such as :

a.      Ground beef

b.      Hamburger Bun

c.      Cheese

d.      Lettuce, Tomato, Onion

e.      Salt, Pepper

f.       Ketchup (or Catsup) - Don't understand why we need two words saying the same exact thing - And people say Accounting can be confusing - Teach a foreigner how to spell the red sauce poured on fries or hamburgers.

              

               Each one of these pieces and the unique quantity of those pieces cost (or are valued) at a certain sum.  The company manufactures cheeseburgers and holds them as inventory until sold.  The company values those CB at the cost incurred for those 5 raw materials. 

Is this in accordance with GAAP ? Is this full absorption costing ?

NO !

               Although a product has pieces of raw materials used in the manufacturing of that product, the sum of those pieces independently do not make up the final product's ending valuation, at least in accordance with GAAP. 

Well WHY NOT ?

               Because …. What else did we forget to add when calculating the cost to make the cheeseburger ?  We forget to compute the cost of labor for the employees used to make the cheeseburger, we also did not calculate the cost of the energy used to cook the hamburger or the materials used to wrap up and seal the hamburger. 

So would that complete the costing in accordance with GAAP ?

NO !

               GAAP requires Full absorption costing in the valuation of a manufactured product being sold by a Company.  Full absorption costing requires that all costs associated with a product are calculated in the valuation of that product.  ALL Costs, mean ALL Costs.  All costs consist of the variable costs associated with the product such as the raw materials and the variable labor.  {Variable costs are those costs that vary or change depending on the quantity of the products that are manufactured.}.  All costs also consist of the fixed costs of the property and plant used and needed to manufacture the product.  {Fixed costs are those costs that do not change, they are FIXED, regardless as to the quantity or number of products that are manufactured.}  Fixed costs consist of those costs such as rent, overhead, fixed labor costs, etc.

               In conclusion:  GAAP Cost-Accounting requires Full Absorption Cost Valuation, in which Inventory is valued with Fixed and Variable costs in its computation.  Just as a sponge absorbs all liquid around it, so does the product that is being manufactured and for that reason, GAAP recognizes this method as the standard for a manufacturing environment.

So Manufacturers, manufacturer away, just make sure you have an Accounting professional that is knowledgeable of these standards and methods.  If Not, you may get Sponged !

Sunday, June 15, 2014

Starting a New Business ? - Good News !


Do you have a company that has not been able to get off the ground ? 

Do you have an entity that is still in its developmental stages ? 

If you said "Yes", then I have good news for you. 

FASB is going to make your life a little easier.

What does that mean ?  and Who is FASB ?

               FASB or the Financial Accounting Standards Board is the designated organization for establishing financial accounting and reporting standards in the private sector.  The standards that FASB sets are those in which accountants should follow, particularly for companies that do not offer investments to the public sector.  FASB continually reviews their standards during internal audit, or upon technical or general inquiries.  On June 10, 2014 * YES - 5 Days Ago * FASB announced that they have issued a new standard.  A standard that will revise and improve financial reporting for development stage entities.

               A Developmental Stage Entity (DSE) is defined by FASB as an entity that devotes substantially most of its time, and efforts to establishing a new business and for which its planned operations have not started or have not generated significant revenue.  Most companies or entities that are starting up, fall into this definition.  FASB recognizes that when issuing financial reports for an entity in this position, certain disclosures should be made to advise and almost forewarn the reader and end-user of the financial statements that the company is inherently at greater risk because of its stage of existence.  Most organizations; however, in this stage of existence, are not necessarily aware of this accounting standard, nor are most accountants, as financial statements are not typically issued.

So why care ?

               Care, because with this new standard, your start-up organization can issue a financial statement, seek funding, seek investors, submit bids, RFPs, grants, government contracts, etc. and not face the struggles once required for a developmental stage entity. 

Let's back up one second:  What is an entity ?  An entity, does not mean that your business has to be incorporated or officially formed with the Secretary of State.  An entity can be you !.  Yes, YOU with an idea to start a business.  An entity is an individual, or a company.  So remember that when considering your start up organization.

So what are the main provisions of this new standard ?  What do I need to do or to become aware ?

Prior to this amending standard: Developmental stage entities needed to, and were supposed to:

1) Present inception-to-date information in all statements, income, cash-flows and equity.

2) Label each financial statement as a "Development Stage Entity"

3) Describe the activities in which the entity was engaged during this time

and

4) Disclose, after it is no longer a development stage entity, that it is no longer a development stage entity that in prior years it has.

 

These disclosures and requirements have now been washed away;  and for that, you can be thankful.  Those financial reporting requirements would be quite burdensome to track, maintain and report upon and furthermore, expect an loan, investor or acceptance to your RFP. 

 

The new standards require the following:

1) Within the standard footnotes of an entity's financial statement, the entity shall disclose the nature of its operations by describing the major products or services it offers and the locations where it offers those products or services.  This disclosure is required for any leveled organization.

-AND-

2) Verbatim "An entity that has not commenced principal operations shall provide disclosures about the risks and uncertainties related to the activities in which the entity is currently engaged and an understanding of what those activates are being directed toward"

FASB has provided examples on how an entity can clearly comply and disclose this information.  More information, sources and relevant information can be found on their website : http://www.fasb.org

 

               So in closing, if you are starting a new business and would like to issue financial statements prior to fully commencing operations for purposes of funding, etc.,  understand these new rules, becoming effective 12/2014. 

               More questions, seek out a qualified and competent accounting professional !

 

Saturday, June 14, 2014

The Unification of Many


The unification of multiple statements in a financial statement presentation.


The varying financial statements in a financial binder, close or even managerial report, although very different in their presentation and intent, should all flow and sing as harmoniously as Angelic as Heaven itself.  A typical and ordinary financial statement close package for external provision (for a private, for-profit organization), regardless as to whom the end-user may be, consists of the following:

               Balance Sheet:      A Balance sheet is a financial statement with the purpose and intent of identifying all of a company's assets, liabilities and equity as of a date in time.  Although the Balance sheet depicts an entity's position as of a fixed date, a reasonable person can make assumptions as to the events that led up to that date and furthermore, assumptions extending beyond that date in time.  A Financial analyst, auditor, loan broker, CFO, fraud examiner, and many others will look at a balance sheet, make reasonable and logical assumptions and therein test such assumptions through requests, inquiries, etc.

               Income Statement:  Also known as a Profit & Loss Statement, Statement of Income & Expenses, an Income Statement, is a financial statement with the purpose and intent of identifying all of a company's revenue and costs associated in generating that revenue. (Discussion of Cash vs. Accrual based accounting will be held at a different time).  The Income statement is represented for a period of time.  While a Balance sheet presents a date in time, an Income statement is reporting a period of time - such as a Month, Quarter, Year, etc.  The income statement results in presenting a Net Profit. 

       Cash Flow Statement:     A Cash flow statement presents, categorizes and reconciles the generation and use of cash through the Income statement and the balance sheet.  The Cash flow statement, as with the Income Statement, presents the activity across a period of time.

               Footnotes:   Footnotes are written discussion of relevant and applicable areas of the financial statements that need specific attention for the end-user to fully comprehend the activity that has taken place within the statements identified above.  Footnotes, are like the choir director.  They are there, just in case the Statements starting singing off-key a little. 

               Consider this, an Accounting professional who prepares a Financial statement package that does not unify and omits footnotes, is deliberately and intently hoping that you are unable to hear the horror of an off-key choir. 

    Ok, so how do these multiple and different statements harmoniously sing as one choir…

All Financial Statements sing in unison and if they do not, they were not prepared in an ethical or at least, reliable and accurate manner.  As Accounting lives in the world of debits, credits, and dual entry, all transactions will flow through the statements in a balance, while effecting accounts across different statements.  Let's look at some examples:

               Depreciation: Depreciation is expensed each month or respective period and therefore influences the Income statement.  Depreciation is a Non-cash expense and therefore would affect the cash flow statement.  Further depreciation, accumulates and is recorded as a reduction in the value of a fixed asset, which therein effects the balance sheet.

               Cash:  The mighty KING.  Cash is KING and Cash as you can clearly tell will effect and influence every statement.  Cash is generated from revenue and reduced with the payment of expenses : Effects Income Statement.  Cash is also generated by collection and reduced by payment of payables: Effects Balance sheet.  Cash is the primary factor in a Cash flow statement.

               Notes:  As loan payments are made, cash is disbursed, which would clearly be identified on a cash flow statement and a balance sheet (for both the Note and the cash), but how about the income statement.  Notes are loans and loans charge interest.  Interest is an expense and expenses are categorized, where ?  Yes, the income statement.

               I can visualize,... now you are now beginning to see ….. A ha !..... So… what are some other ways in which these financial statements can sing in harmony.  There are many, many other ways.  One way, which is most obvious, I have left for you to comment.  You tell me, so I can stop typing and drink my root-beer. 
 

Warning:
Untrained eyes may find some discrepancies in the ways financial statements are supposed to sing; however, it often requires the expertise or competency of an experienced Accounting professional.  Do not rely on the untrained, rely on the reliable.  Call me to audit, prepare, or advise you on your Accounting reliability.: WMORANMAFM@GMAIL.COM: 862-216-8196

 

Friday, June 13, 2014

Your intentions are meaningful....


One critical subject when presenting and discussing The Accounting Picture of a company is:


Intent.

An entity's accounting picture is drawn by and through its transactions; however, Intent of a transaction plays a clear and crucial role in the drawing of an Accounting Picture.  Intent can be identified as the "real" plan, purpose or state-of-mind when a certain transaction or series of transactions occur and become recognized or recorded.  When the Intent of a transaction is not in-line with the recognition of the transaction, the Accounting Picture could (and most likely will) become skewed and misleading.  Certainly, as we have discussed previously, an entity's accounting picture should be objective in nature.  It should not be drawn by a designer, but rather drawn through actual transactional occurrences as recorded an independent, ethical and objective accounting professional; however, Intent is often an area where principals will attempt to manipulate for purposes of reflecting and representing a better picture. 

Intent does not and cannot materially affect every accounting transaction or every type of accounting transaction; however, the transactions for which Intent does apply, are typically the features in a company's accounting picture that are desired to be reflected in a different manner.  For example, the intent of a company to purchase merchandise for business purposes would not influence the recognition of the transaction; however, the intent of a Loan, whether the loan is received or lent, would indeed be an area, subject to the great Intent Debate.

The types of transactions that generally become materially affected by Intent are those transactions involving the disbursement or receipt of funds to and / or from company officers, employees or principals.  Funds disbursed or received by these members of an organization should be recorded in a manner based on their intent - their real plan or purpose - at the time of the transaction.  For example, amounts disbursed to a company officer without a prior arrangement of a clear repayment plan and interest accrual, without board of director approval, and / or without any intent (real intent) of being paid back, should NOT be recorded as a LOAN to the officer, as a Loan is not the intent of the transaction.  The Company does not expect to receive the amount to be paid back and the officer does not intend to repay the money.  Therefore, the transaction should not be recorded as a LOAN.

Intent, for clarification and redundancy purposes, is the real, honest, truthful, and ethical intent, plan, purpose and / or state-of mind at the time the transaction occurs.  For example, applicable intent occurs when the money was disbursed to the company officer - NOT when the IRS audits - NOT when preparing financial statements.  Intent of a transaction is NOT a belief that one day, the officer will repay the loan.   Would a bank loan money without a loan agreement or approval ?, neither should a  company, regardless as to the size, extent or capacity of the officer, the company or the transaction itself.

We are building real Accounting Pictures through this blog and therefore….

Intent is REAL & TIMELY

Intent applies to all transactions

Intent is material

 

Thursday, June 12, 2014

When is an Expense considered and recorded as an Asset ?


 

When the Expense is pre-paid or paid in advance.


When a company pays an amount in advance, in anticipation of receipt of future goods or services, the company recognizes this purchase as an ASSET and not as an EXPENSE.   The purchase is recognized as a  Prepaid Expense (an Asset: typically a current asset )

But why  ?


Four Reasons: (that I can think of….. if you know of any others … please post in comments below)

Reason 1) The Company has paid for something of value, whether that be a SERVICE, such as a utility, a RIGHT, such as insurance or rent and / or a GOOD, such as a product or merchandise; however, that SERVICE, RIGHT OR GOOD has not yet been received or earned.  As a result, since, the service, right or good has value through its future receipt, then that value is considered an asset for the company.  Just as something that is owed, is of value to the company, we can identify Prepaid Expenses in the same light.  A Prepaid Expense can be viewed as a receivable in a way, not of money, but rather of a service, goods or rights, and not that of a customer but rather from a vendor or supplier.  To clarify, a prepaid expense is an Asset, due to the future value it holds pending receipt of the same. 

Example 1:

A company pays for an insurance policy in full for the year 2015 on 12/31/2014.  That entity has therefore incurred the cash outlay for the purchase of the policy, but has not fully enjoyed the benefit of the rights of an insured member.  The payment made on 12/31/2014 would, therefore, be recorded as a Prepaid Expense, as of that date.  The pro-rata portion of the insurance policy will be expensed and credited from the Prepaid Expense Asset account each month as the company earns or enjoys the benefit of the insurance policy.  When the period elapses, the Prepaid Expense also declines, as the Expense has been earned by the vendor and the Service has been Received by the Company. 

Reason 2) Since the Company has paid for something of value, but has not yet received that something, the implicit understanding is that the company can cancel the order prior to receipt of the goods, services or rights and therein receive a full refund of the cash actually disbursed.  In this outlook, prepaid expenses are more viewed as a secured cash account instead of a vendor receivable of service.  Regardless the reigning tone holds that the company has paid for something of value and has not yet received that "something". 

Example 2:

The company pays for the insurance policy for 2015 in full on 12/31/2014; however, on 1/1/2015, the company finds a cheaper policy, cancels the existing one and anticipates a full (or nearly full 364/365) refund. 

Reason 3) One word: Matching.  When recognizing a payment which creates a Prepaid Expense, and even more particular, when recognizing the receipt of the good, service or right that was paid in advance as it becomes earned, an Accountant is careful to draw the accounting picture of the entity, to match expenses as they become incurred or accrued and not when they are actually paid.  An expense is not necessarily incurred when it is paid and in the light of prepaid expenses, the expense is certainly not incurred when it is paid, as it is paid in advance.  Prepaid Expenses allow for proper matching of expenses in the time period for which they are applicable.

Example 3:

The company pays $1200 for a 2015 insurance policy on 12/31/2014.  If the accountant or bookkeeper did not care for matching, the company would recognize a $1200 insurance expense in December 2014 and no insurance expense in 2015.   This is obviously not an accurate representation of the effective transaction.  Insurance would be overstated in 2014 and understated or omitted completely in 2015.  Instead with the matching principle, and applying the same insurance example utilizing the earning of expense through a prepaid expense asset account, the accountant would reflect a $100.00 insurance expense each month of the year in 2015 as appropriate.   

Reason 4)  A Prepaid expense represents the payment in advance for a good, service or right and therein by its nature represents an economic resource through its causation effect by reducing the use of future assets.  A reduction of a future liability or the reduction or elimination of the use of a future resource or asset is often referred to as an Asset. 

               Example 4:

               The company paid for an insurance policy in full for the effective year 2015, on 12/31/2014.  The company will not need to use resources or assets in the future to pay for this policy.  The company has paid this policy in full for the entire year.  Due to its inherent nature that the payment reduces the future use of resources, this transaction further is reason to create an asset, a Prepaid Expense Asset.

Some questions for comment ….


          Can anyone think of any other basis or reason for why an advance payment creates an asset ?

          Can anyone provide an example of a long-term prepaid expense ?

          How does the vendor recognize the payment ?   

          What does a prepaid expense say about a company ?

           How does it present a company's accounting picture ?

 

Thursday, June 5, 2014

Intangible Assets


 

Blessed are those who believe and do not see...



               The concept of Intangibility can be defined by Webster as the absence of Tangibility; however, that does not necessarily provide clarification or association solely through its definition.  We understand that Tangibility is associated with things that are material in nature.  Those things that can be physically touched, held, and moved, therefore, Tangible Assets are those items that, can be physically touched, held, moved, etc.   such as Equipment, Vehicles, Property, Buildings, etcetera, etcetera.  Directly linking this definition to Intangible Assets, we would then define them as items or Assets that cannot be touched, or held.  What is that ? Is that True ? 

What value could an asset hold, if the asset cannot be held ?

The answer to that question is GREAT VALUE !.


               Intangible Assets are not necessarily assets that cannot be held, but rather are assets that are associated with other assets with tangibility.  For example, Customer Lists, Patents, Trademarks, Copyrights or Goodwill, Licenses, or Rights.  Intangible Assets are assets that derive and recognize their value through their potential to maintain, protect and / or enhance the value of another asset, the company or entity as a whole, and / or the ability to generate, or protect revenue of the company.   Patents, for example, protect machinery or inventions from being infringed upon and copied by competitors and as such Patents maintain and protect the value of the equipment and the Company's ability to generate revenue from that equipment.  Goodwill, as mentioned in a previous post, is the value paid for another entity or organization in excess of the fixed assets value purchased in the transaction.  This Intangible Asset therefore is attached to the value of the company, as the value is believed to be held within the generation of future revenue through this acquisition.  As no company would pay in excess of the value of the assets of the company, unless such excess actually produces or provides something. 

               The value of the reported Intangible Asset; however, is not the value of the potential revenue it will generate or protect, but rather reported as the cost to acquire the intangible asset :

·        The cost to obtain a patent, or trademark

·        The cost in excess of fixed assets paid for the acquisition of another entity (goodwill)

·        The cost to acquire a license or right.

               If there was no cost to obtain an intangible asset, then according to the company's accounting picture, the intangible asset does not exist, and would never become recorded unless that intangible asset gets purchased by another entity and would then be recognized on that company's accounting picture.

               Follow Up - Inquisitive Question - Can an Intangible asset's value change after it has been acquired ?  - Who is of Accounting Picture Mind to answer….. Anyone ?