Accounting decisions
Case: Accounting at MacCloud winery
Accounting at McCloud Winery
Methodological note
We want to distinguish between Economic “facts/data”
– No need to discuss them– Taken for granted
Accounting “issues”– The topic of our discussion– We will follow the order of the case questions
Accounting at McCloud Winery
The MacCloud winery 5 acres of land One building
Accounting at McCloud Winery
1: The building Worth $32,000 Leased for 10 years for $5,000 per year How do we account for it?
Accounting for a lease Capital lease
– Treated as an acquisition of the asset financed by a loan Operating lease
– Treated as a rental agreement A leas is a capital lease if
1. There exists a bargain purchase option at the end of the lease2. The lease covers more than 75% of the economic life of the asset3. The PV of future lease payments is at least 90% of the market value
of the asset– Only one condition is sufficient– In this case condition 3. tells that that it should be treated as a
capital lease (see related excel file)
Accounting at McCloud Winery
Accounting at McCloud Winery
2: The bank loan $180,000 3 years maturity $ 10,000 annual repayment 10% interest rate
Accounting for the loan
See the related excel file
Accounting at McCloud Winery
Accounting at McCloud Winery
3: The land and the grapevines The vineyard is certainly an asset Cost of this asset? Depreciation?
Cost (initial value) of an assets You can include in the cost (initial value) of
an assets all the costs necessary to put the asset into its productive use
So, in this case, it can be argued that all the expenses incurred in the first 5 years are part of the initial cost of the asset
Also the transportation cost can be included in the initial cost of the asset
Accounting at McCloud Winery
Accounting at McCloud Winery
4: Vines’ diseases
Highly damaging event Possible, but not certain How do we account for this?
Phylloxera Pierce’s disease
Provisions Provisions are “accounting funds” that are set
aside in the liabilities side of the balance sheet in order to be used in the future to cover for possible future costs
A provision can be created if1. The future event is sufficiently likely2. The future damage can be reasonably estimated– Both conditions are necessary
It is open to discussion whether in this case the two conditions are met
Accounting at McCloud Winery
Accounting at McCloud Winery
5: The oak barrels Two types
– High quality (5 + 10 years of economic life)– Low quality (10 years of economic life)
Is it an asset? Depreciation?
Depreciation
Depreciation is the accounting way to spread the cost of an investment in a fixed asset throughout the economic life of the asset
The depreciation method should reflect the usage and the loss in productive value of the asset
It is open to discussion, which is the best way to depreciate the oak barrels
Accounting at McCloud Winery
Accounting at McCloud Winery
General questions that we have tackled today
1. What do we mean by “accounting decisions”?
2. Why is it necessary to make accounting decisions?
3. What are the consequences of these decisions?
1. What do we mean by “accounting decisions”?
In every of the issues analyzed in the case the management of the vinery has to make an “accounting decision”
Accounting decision = the choice of one among the various possible accrual representations of the cash flow of the transaction
Accounting at McCloud Winery
2. Why is it necessary to make accounting decisions?
Because in the real world we have uncertainty
Better explained by the “Accounting for a business project” case
Accounting at McCloud Winery
3. What are the consequences of accounting decisions?
By choosing a certain accrual representation of the cash flow of the transaction we choose one– Income statement– Balance sheet
These two financial statements depend crucially on the accounting decisions taken by the management
Accounting at McCloud Winery
Accounting at McCloud Winery
The accrual principle: do you remember the example?
Begin. day 1 End of day 1 End of day 2
I/S day 1Wealth
300
BalanceSheet
I/S day 1
BalanceSheet
Wealth
350
BalanceSheet
Wealth
360
Cash flow day 1
Cash flowday 2
Cash
0
Cash
250
Cash
360
Profit = 50 Profit = 10
Cash increase = 250 Cash increase = 110
Cash flow logic
Accrual logic
Different!
Accounting at McCloud Winery
Accounting and Financial Analysis
Raw dataAccounting decisions
FinancialStatements
FinancialAnalysis
Double-entry
Accounting at McCloud Winery
Summing up
The need to make accounting decisions because of– Accrual principle– Uncertainty
Accounting standards guide these decisions, but never eliminate them
Financial statements are “chosen”– Ethical issues– Communication strategy