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04/18/2012

Financial Accounting


Financial Accounting

 

Question 1: Cherry Limited

A. Revenue and Interest

Revenue or sales is measured in terms of the value of the products or services being exchanged in an arm’s-length transaction, which represents either the net cash equivalent or the current discounted value of the money that are received or to be received in exchange for the products or services that the company had transferred to the customers (Riahi-Belkaoui 2004). In connection, revenue or sales recognition involves decisions of both timing (when to recognize revenue) and measurement (the amount of revenue to measure) (Stickney & Weil 2009). There are two types of recognition for revenue: the completion-of-production basis for recognition and the payment of basis. These two factors are applicable to the company. First, because Cherry is offering kitchen appliances which has a high rate of product returns, the revenue should only be recognized after the return period expires, with this, the company had done all that has promised to the customers (Epstein & Jermakowicz 2008). Furthermore, it is also important to consider the current financial condition of the company. With this, if the company wants to cover the fact of having a bad performance in terms of sales, it can recognize the income that has not yet been collected as its revenue to improve the sales revenue for the year.

However, it is important to consider that the company is implementing a new discounting scheme, where in those customers that will pay within 450 days after the purchase will no longer have to pay the interest. With this, it is important to consider the amount of the interests paid in the financial statement of the company.

            On the other hand, regarding the issue of the interest, it is important to focus on the issue if the interest be accrued for sales. The interest is recognized when it shows certainty on the economic benefit flow to the enterprise and if it can be measured reliably. In the case of the Cherry, because of its new scheme, it will be inappropriate to accrue the interest to the sales because if the customers paid within the given period of time, they will no longer have to pay for the interests. Thus, the necessary computation for the said interest’s receivable will only be computed after that, and it will be decided who among the customers will have to pay 12% annually. With this, it can be said that the new scheme developed some complications in the computation process.

B. Calculation

            Impairment loss is the difference between the recorded value of an asset in the financial statement and its value in the market, when the market value is lower than the carrying value (Reed & Lajoux 2007). The impairment loss for an asset that the company intends to hold and use is the difference between the book value of the asset and the fair value. The fair value is the amount at which the asset could be sold in a present transaction between the market participants (Nikolai & Bazley 2009). The table below shows the computation of impairment loss of Cherry. Consistency requires that if the obligation is included in the entire evaluation of the recoverable amount, it is the net carrying value with which this recoverable amount must be compared in order to determine whether an impairment loss does exist. There are two main problems that must be considered including the goodwill and the corporate assets. The goodwill does not produce cash flow in independent manner from other assets or groups of assets, thus, the recoverable amount of the goodwill as an individual asset cannot be established. As a result, if there is an indication that goodwill may be impaired, the recoverable amount is established for the cash-generating unit where in the goodwill belongs. The said amount will then be compared to the carrying amount of the said cash-generating unit as well as of any impairment loss is recognized (Alexander & Britton 2007).

Carrying Amount

 

Industrial Division (IND)

Domestic Division (DOM)

Property, Plant and Equipment

40,000,000

32,000,000

Other Relevant Assets

24,000,000

24,000,000

Office Space

 

8,800,000

Total Carrying Amount

76,400,000

74,600,000

 

 

 

Impairment Loss

 

Industrial Division (IND)

Domestic Division (DOM)

Recoverable Amount

72,400,000

61,000,000

Value in Use

 

 

Total Impairment Loss

4,000,000 (note 1)

13,600,000 (note 2)

 

Note 1: Total carrying amount – recoverable amount = 76,400,000 – 72,400,000 = 4,000,000.00

Note 2: Total carrying amount – recoverable amount = 74,600,000 – 61,000,000 = 13,600,000.00

In allocating impairment loss the carrying amount of the asset should not be reduced below the highest of: (a) its fair value less costs to sell; (b) its value in use; and (c) zero. The amount of the impairment loss that would otherwise have been allocated towards the asset must be allocated to other assets of the unit on the prorate basis. In connection, a liability must be recognized for any remaining amount of the impairment loss for a cash-generating unit, if and only if, this is being required by other accounting standards. With this, it is important to fist abolish goodwill, but ensure that the carrying amount o any individual asset is not being reduced in order to create a figure not economically relevant to the said asset (Alexander & Britton 2007).

C. Depreciation Policy

            Depreciation is defined as the process of allocating the cost of a long-term tangible asset over its useful life (Porter & Norton 2009). Thus, it is considered as vital accounting information. Accounting information must have qualitative characteristics in order to become useful in the decision-making process (Hermanson & Edwards n.d.). This is the primary reason of Cherry in choosing and applying its depreciation method, thus its objectives are: consistency, comparability, reliability and relevance. Consistency pertains on the ability to compare with the prior or past years; comparability enables to compare with other companies; reliability enables to rely on the information and relevance focuses on the impact of the information towards the decision (Porter & Norton 2009). Among all these qualities, consistency is linked closely to comparability. This is because the two qualities focus on having the same standard in consistent manner. However, Cherry Company is having a problem with its depreciation method and policy because of the objectives that it is implementing. It is important to consider that there are some aspects of the objectives that are conflicting with each other. Reliability and relevance often conflict with one another (Strawser & Strawser 2002). This is because when the consistency carried too far, reliability will adversely affect relevance.

            Reliability tends to come into conflict with the relevance because relevance would favor the adoption of current subjective values whereas the reliability would gravitate towards the adaptation of historic and more objective costs (Kirk 2005). Based on this, it is important to consider that these conflicts can affect the overall financial statement or transaction of the business. It is important to consider that all of the said objectives of the company are connected to the accounting standards being implemented in different countries. With this, it is important to maintain these. However, because of the company is already experiencing impacts on the earnings and EPS due to its excessively conservative method of accounting for depreciation, it will be important to implement a loose policy in depreciation accounting like its competitors.

            The fist factor to consider is the consistency, where in, it is vital for the company to use the same depreciation method used from the past. With this, the company can implement change by using the appropriate depreciation method based on the current performance of the company, at the same time, focuses on the specific current need of the company in that given time. On the other hand, it is vital to maintain comparability, because it is important for all the stakeholders who will view the financial statement. This is the same with the relevance, because it is important aspect in the decision-making process of the company. Therefore, it is just vital to focus on removing the objective of consistency, but maintain the good level of the remaining accounting information quality.

Question 2: John Limited

A. The Licenses

            Intangible assets include patents, copyrights, trademarks, trade names, franchise licenses, government licenses, goodwill and other items that are lack with physical substances, but still offer long-term benefits towards the company. It is important to consider that like other companies, John Limited also accounts for the intangible assets as much as they account for depreciable assets as well as natural resources. This is because of the fact that the cost of the intangible assets is systematically billed to expense during the useful life or legal life of the asset, whichever is shorter (Cliffs Notes n.d.). There are different factors that must be considered in the tangible assets. Before choosing the suitable measure of economic income to quantify, the analyst should focus on considering how the intangible asset of the subject will produce that particular income. It is important to note how an intangible asset can produce incomes, which are the following: (1) the use of the intangible, (2) the ownership of the intangible and (3) the forbearance of use of the intangible (Reilly & Schweihs 1999). In the case of the John Limited, it is using the government license. It is important to consider that the purchaser and owner of the government license receive the right to engage in regulated business activities. The company is required to broadcast on a given or particular frequency and transport a given material (Cliffs Notes n.d.). Furthermore, the company also has its partnership with the telecom company. Because the company’s value is directly dependent on the value of the assets owned by the company (both tangible and intangible), it is important to focus on the use of asset-based approach. With this, it is important to rely on the basic and essential principle that assets minus liabilities are equal to equity. In implementing this method, it will be important to use approach including asset accumulation method where in the analyst will convert the asset and liabilities of the company to the appraised value that are all based on the suitable standard of value (Reilly & Schweihs 1999). It is important to consider that the value of the intangible asset is made up of important aspects which include: amortizable identified asset value, nonamortizable identified asset value and goodwill. These three factors are vital because of tax reasons, because it will have a vital influence over the cash flows. With this, it is important to focus on amortizable which means that the intangible assets is can be deducted with taxable income, just like the way tangible assets are being depreciated (Rezaee 2001).

B. Network

            Extending the network of John Limited is a good step or action for the company because it can help in order to improve its current position in the market. However, it is important to consider the different additional cost that it will create. Thus, the company will have to focus on both the tangible and intangible assets, particularly focusing on the Property, Plant and Equipment (PPE), together with the additional licenses that must be paid in order to maintain the operation.

            PPE are tangible assets that are held by the company for use in the production or supply of goods or services, for rentals to others, for administrative purposes and are expected to be used during more than one period (Kirk 2005). Furthermore, it is also vital to focus on the model to be applied on the policy regarding the entire class of PPE. This includes cost model and revaluation model. The cost model focuses on the PPE to be carried at cost less any accumulated depreciation and impairment losses to date, while the revaluation model focuses on the property to be carried at fair value at date of revaluation less any subsequent accumulated depreciation and impairment losses. With this, the revaluation process should happen in efficient and adequate manner in order to ensure that the amount does not different from the fair value at the balance sheet date in material manner (Kirk 2005). In connection, it is also important to consider the depreciation of PPE. The depreciable amount of the PPE should be allocated on the systematic basis over its useful life, together with the method that are being adopted that must reflect the pattern where in the future economic benefits of the assets are all expected to be consumed. With this, the depreciation should normally recognize as an expense (Kirk 2005). Therefore, it is important to focus on how the depreciation can affect the overall financial flow of the company. In connection, it is important to focus on the maintenance cost that must be spent in order to maintain the quality or the performance of the PPE of the company. This is important because the condition of PPE can directly influence or affect the overall quality of the products or services to be offered by the company.

            In connection, it is also important to focus on the amortization. As have mentioned, the term amortization is very similar with the depreciation of PPE. This involves allocating the acquisition cost of an intangible asset to the periods benefited by the use of asset (Porter & Norton 2009). With this, it is important to focus on the impact of amortization of the licenses and other intangible assets of the company that will add up with the cost to be spent by the company.

            Above all, it is important to focus on the $300,000 to be paid to the government as the company’s operating lease. It is important to note that operating lease is a regular rental of property. Thus, as rental payments become payable, rent expense is debited and cash and/or payables are credited, the rent expense is reflected on a straight-line basis and accrual basis accounting is followed (Siegel & Dauber 2008). With this, the company will have additional allocation for a long period of 12 months.

C. Handset Inventory

            It is important to focus on the purchase of handsets and recognition of the revenue from the customers and dealers. First, it is important to focus on the revenue recognition. Revenue is measured by the value of the products or services that are being exchanged in an arm’s length transaction, which correspond to the net cash equivalent as well as the current discounted value of the money that are all being received or to be received in exchange for the products or services that the company had transferred towards the customers (Riahi-Belkaoui 2004). To explain further, there are two types of recognition for the revenue, which include the completion of production basis for recognition and the payment basis. In the case of the John Limited the revenue is not recognized when sales to dealer, but when service is rendered. With this, it can affect how the financial statement will be presented by the company. Thus, it can affect the overall financial image of the company. First, it is important to consider that the recognition of the revenue is an important factor for the company. This is particularly because of the fact that there is a possibility of the return of goods, which will affect the overall operation of the company. In connection, it is important to focus on the cost of the handset which is $200 together with the payment of $130 to dealer is intangible asset to be amortized.

 

References

Alexander, D, Britton, A & Jorissen, A 2007, International Financial Reporting and Analysis, Cengage Learning EMEA.

Cliffs Notes, Intangible Assets, http://www.cliffsnotes.com/ [Accessed on April 6, 2010].

Epstein, B & Jermakowicz, E 2008, Wiley IFRS 2008: Interpretation and Application of International Accounting and Financial Reporting Standards, John Wiley and Sons.

Hermanson, Edwards & Maher, Accounting Principles, 8th Edn, Freeload Press.

Kirk, R 2005, International Financial Reporting Standards in Depth: Theory and Practice, Elsevier.

Nikolai, L, Bazley, J & Jones, J 2009, Intermediate Accounting, Cengage Learning.

Porter, G & Norton, C 2009, Using Financial Accounting Information, Cengage Learning.

Reed, S F, Lajoux, A R & Nesvold, H P 2007, The Art of M&A, a Merger, Acquisition and Buyout Guide, McGraw-Hill Professional.

Reilly, R & Schweihs, R 1999, Valuing Intangible Assets, McGraw-Hill Professional.

Rezaee, Z 2001, Financial Institutions, Valuations, Mergers and Acquisitions: The Fair Value Approach, John Wiley and Sons.

Riahi-Belkaoui, A 2004, Accounting Theory, Cengage Learning EMEA.

Siegel, J, Dauber, N & Shim, J 2008, The Vest Pocket CPA, John Wiley and Sons.

Stickney, C, Weil, R & Schipper, K 2009, Financial Accounting: An Introduction to Concepts, Methods and Uses, Cengage Learning.

Strawser, R, Strawser, J & Strawser, J 2002, Financial Accounting and Reporting, Dame.

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