Week 3 MBA 503- Managerial Decision Making Final Fall 2012

What choices does a manager make with respect to Accounting? Is it limited to policies? Also decides on estimates & disclosure


Enron, Worldcom- examples of direct manipulation of accounting information to deceive- outside of the rules Flexibility of GAAP with Professional judgment leads to legal earnings management.

Recognition that a previously recorded Accounts receivable will not provide a future benefit due to the fact we will not collect it, or will we??? Didn’t the rules of revenue recognition require us to determine if collection is reasonably assured???
Situation #
Situation 1
Fiscal 2010 Fiscal 2011 Fiscal 2012
Rogers receives Rogers ships large order from order to customer corp customer and receives cash Receives large order from customer Receives large order Ships order Receives cash on delivery Ships order Receives cash from customer
Situation 2
Situation 3
When do we record the revenue and why?


Performance has occurred The amount of revenue can be reasonable measured Collection of payment is reasonably assured Sounds easy?
Net cash provided by operating activities Net cash used for investing activities Net cash provided by financing activities Net decrease in cash Cash balance, December 31, 2005 Cash balance, December 31, 2006

Common methods of Bad Debt calculation
1) Direct Write Off 2) % of Sales 3) Aging of A/R balances
Subject
Revenue Recognition
Policies
When to recognize revenue?
Estimates
Bad Debts Returns Discounts
Other
Inventory
Valuation- FIFO,LIFO, average cost What is included in inventory cost?
Operating
–day to day
Investing
– Long term assets
Long term liabilities shareholders
Financing-
and transactions
Cash Flow Statement (Indirect Method) For the Year Ended December 31, 2006 (In thousands)



Rules vs Guidelines? Government vs Self Policing? Professional judgment? Do laws against speeding and theft stop those activities? Be vigilant- consider the source/objectives of all information If it doesn’t make sense, question it!
Is there a difference between revenue and the receipt of cash?
Is timing important?
Must there be agreement between the two parties as to whether or not something is earned?
industry risk customers contracts ownership demands need for financing moral/ethical considerations taxation

Accounts receivable balances Accounting for returns/discounts Bad debt expense & allowance for doubtful accounts
GAAP says that we record Revenue when it is earned
What happens when revenue is earned? Assets increase Revenues increase
The big question is: When is revenue earned??

Even in the US, GAAP allows for flexibility in the choice of:
Accounting Policies- more than 1 allowable option Accounting Estimates- professional judgment Disclosure- no required wording

GAAP Auditors Report- fair representation Fraudulent Activities Basic Financial Analysis
◦ Management by exception ◦ Expectations/Comparisons

Interconnection between Accounts





Meet investors expectations Maintain stock price Meet budget goals Obtain best terms for loans Avoid violation of debt covenants Obtain grants from government Minimize taxes Generally influence decisions arising out of accounting information
Amortization Method Capitalization policies
Leases When to recognize liabilities
Write-downs of obsolete and damaged inventory, Net Realizable Value
Useful lives, Write downs and write offs Salvage values
Warranty provisions Pensions Accruals
Capital Assets
Liabilities
Assets vs Expenses
Other
Capitalization policies
Expensing assets Classifications Long/Short term, ordinary, unusual, extraordinary Disclosure of contingencies

Defn: “Amounts owed to an entity by customers for goods and services provided on credit”
John Friedlan, Financial Accounting, 2nd edition, McGraw Hill, 2007





Management InfluenceGoals/Motivations/Objectives Earnings Management Generally Accepted Accounting Principles (GAAP) Inter-connection between Accounts Revenue Recognition and Accounts Receivable
$ 68 (255) 167 $ (20) 42 $ 22
Free cash flow is the amount of cash available from operations after paying for planned investments in capital, equipment, and other long-term assets. Free cash flow = Net cash flow from operating activities – Cash outflow earmarked for investments in capital, equipment (long term assets) and required dividends