Kenneth Boyd's Blog, page 44
December 20, 2019
The Real Real Merchandise Scandal: Inventory and Consignment Sales
Is that luxury item you purchased the genuine article?
If not, you’ve overpaid by a wide margin.
That’s the recent scandal at The Real Real, world’s largest online consumer marketplace for luxury items. The company website states that the firm “is the leader in authenticated luxury consignment. Every items we sell is 100% authenticated by an expert.”
The company’s value proposition is that, when we sell you something, it’s the real thing.
Unfortunately, that’s not always the case. The resulting scandal is a great tool to explain accounting for inventory.
What happened
A CNBC investigation found that: “many of the items on the site were being authenticated by copywriters with limited training, leading to mistakes.” In fact, the company produced an internal report, called “Copywriting Faux and Tell,” that served as a “weekly recap of TRR published and returned counterfeits.”
Ouch.
In the last six months, the firm’s stock price has declined by over 35%.
The Real Real operates on a consignment basis. What does that mean?
Consignment accounting
Accounting Tools defines consignment:
“A consignment occurs when the owner of goods leaves them with another party to be sold. When the goods are eventually sold, the consignee retains a commission and pays the consignor the residual amount. Consignment arrangements are relatively common for certain types of retail sales. Online auction sites are a form of consignment arrangement, since a third party is undertaking the sales role.
In a consignment arrangement, the consignor continues to own the goods until they are sold, so the goods appear as inventory in the accounting records of the consignor, not the consignee.”
An example
Let’s assume that Upscale Clothing has 500 Kate Spade purses that are consigned to The Real Real (TRR). The two parties agree that the purses will be priced at $100 each, and Upscale sends the purses to TRR.
In accounting terms, Upscale is the consignor (the party providing the goods), and TRR is the consignee.
Assume that Upscale Clothing’s cost per purse is $70, and that TRR agrees to sell the purses for $100 in cash. Upscale will pay TRR a $10 commission for each purse sold.
Upscale still owns the inventory, and no sale has taken place. However, TRR now has possession of goods owned by someone else. If the goods are not sold, they must be returned.
TRR needs to post a liability for the consigned goods received:
Debit consigned inventory-purses $50,000 ($100 X 500 purses)
Credit accounts payable $50,000
Note: Consigned inventory is not an asset account on TRR’s books, it’s a “holding place” to account for goods held for another party.
Recording a sale
Here are the entries when the 100 purses are sold for cash:
Upscale’s books
The inventory balance is reclassified to cost of sales:
Debit cost of sales $35,000 ($70 cost X 500 purses)
Credit inventory-purses $35,000
A sale is recorded, along with a commission expense.
Debit accounts receivable $45,000
Debit commission expense $5,000 ($10 commission X 500 purses)
Credit sales $50,000 ($100 sale price X 500 purses)
The profit to Upscale is:
$50,000 sale – $35,000 cost of sales – $5,000 commission = $10,000
TRR’s books
#1 TRR receives cash and records a sale
Debit cash $50,000
Credit sales $50,000
#2- TRR moves reclassifies the consigned goods balance to cost of sales:
Debit cost of goods sold $50,000
Credit consigned inventory-purses $50,000
#3- TRR pays Upscale, less the commission amount earned, and removes the liability balance:
Debit accounts payable $50,000
Credit commission income $5,000
Credit cash $45,000
The profit to TRR is:
$50,000 sale + $5,000 commission – $50,000 cost of sales = $5,000
TRR’s profit is only the commission received on the consigned goods.
My next book, 50 Stories That Explain Accounting, will be out in 2020. More info to follow.
For live CPA exam prep and accounting classes, join Conference Room for free. Members will be notified of course dates, times, costs, and how to attend these courses.
Get your questions answered to pass the CPA exam, and to learn accounting concepts.
Go to Accounting Accidentally for 300+ blog posts and 450+ You Tube videos on accounting and finance:
Good luck!
Ken Boyd
Author: Cost Accounting for Dummies, Accounting All-In-One for Dummies, The CPA Exam for Dummies and 1,001 Accounting Questions for Dummies
(email) ken@stltest.net
(website and blog) http://www.accountingaccidentally.com/
The post The Real Real Merchandise Scandal: Inventory and Consignment Sales appeared first on Accounting Accidentally.
December 19, 2019
How to Avoid the Financial Impact of an Accident
Staying healthy isn’t easy–nor is it cheap.
The average costs of healthcare in the country are almost double what it was 40 years ago. As such, there’s a huge financial impact with every accident that you might end up in. Whether it’s a car collision, a work-related injury, or even something that happened while playing sports, you should be careful if you ever suffer from some kind of accident.
What do the costs boil down to?
The costs of an accident are varied and will depend on your individual circumstances.
For example, an accident typically means that you need to pay large costs, even if you have health insurance. It also means that your main source of revenue will be cut off if you’re unable to work. There are circumstances where you’ll be entitled to sick pay, but those situations will generally depend on your employer.
If you’ve had a financial setback, this article can help.
You also need to think about the costs of hiring a lawyer, especially if the accident involved other people or their property.
For example, a DUI charge could evolve into a full-on injury or accident claim if someone else was hurt. In a situation like this, you’ll want to speak to criminal law professionals such as The Law Offices of Morgan Fletcher Benfield, PLLC to help you reduce any punishment you might receive, and also help with the financial side of things.
As you can see, most of the costs boil down to two things; ensuring that you’re healthy again and dealing with the potential aftermath of being in a hospital or spending time away from work.
Avoiding the costs of an accident
There are two things to focus on; lowering the costs and recuperating afterwards.
When avoiding the costs, try and think about how you can lower your health insurance premiums. If you’ve been particularly healthy the past couple of years then you can speak to your health insurance company and ask about lowering your premium.
This step can help you save a lot of money in the long run, but if your company offers some kind of health plan or an alternative which saves you from paying for it yourself, you should also take advantage of those benefits.
If you work as a freelancer, this article can help.
In terms of recuperating your costs, we suggest making a claim if the accident wasn’t your fault. This is why it’s vital to speak to a lawyer immediately after your accident, so that you can claim not just insurance money, but potentially sue someone else if they’ve caused you a lot of harm or grief due to the accident. You can even sue a company if they did something that could have resulted in you being injured or in an accident.
Lastly, we suggest always having a large amount of savings available for situations like this. These kinds of situations are unpredictable and will generally lead to expensive healthcare and legal costs. Make sure you save up plenty of money for a rainy day and you’ll never have to worry about the financial impact of an accident ever again.
My next book, 50 Stories That Explain Accounting will be out in 2020. More information to follow.
For live CPA exam prep and accounting classes, join Conference Room for free. Members will be notified of course dates, times, costs, and how to attend these courses.
Get your questions answered to pass the CPA exam, and to learn accounting concepts.
Go to Accounting Accidentally for 300+ blog posts and 450+ You Tube videos on accounting and finance:
Good luck!
Ken Boyd
Author: Cost Accounting for Dummies, Accounting All-In-One for Dummies, The CPA Exam for Dummies and 1,001 Accounting Questions for Dummies
(email) ken@stltest.net
(website and blog) http://www.accountingaccidentally.com/
The post How to Avoid the Financial Impact of an Accident appeared first on Accounting Accidentally.
December 18, 2019
Protecting Your Business: Are You Doing Enough?
Building a successful company is hard work.
So, when you do achieve your short-term goals, it’s vital that you take the right steps to ensure that the venture continues to hit its targets for many years. Protecting the business from threats and potential pitfalls is vital.
Every entrepreneur appreciates the need to install computer firewalls. However, your commitment to protecting the company’s future should incorporate a host of other features.
If you’ve had a financial setback, this article can help.
Here are some of the key issues you must take into account.
Preventing Intellectual Theft
You are all too familiar with the threat of physical theft related to cash. However, you must also pay attention to the threat of intellectual theft. Otherwise, you could see major damage to your reputation as well as the loss of clients.
Fraudsters may attempt to make money off the name of your brand through counterfeit goods. A bigger concern, however, revolves around ex-employees stealing your leads and clients. Non-disclosure agreements are a great tool for avoiding this danger. Use them wisely.
If you give outsiders a chance to steal some of your success, they will. Putting up the right barriers regarding copyright is vital.
If you work as a freelancer, this article can help.
Protecting Your Finances
The harsh reality is that only 1 in 3 businesses will surpass the 10-year mark.
A lack of financial controls through the difficult opening years is usually the chief reason behind the failure. Therefore, protecting your firm’s working capital is essential.
Most inexperienced businesses fall into the trap of focusing solely on revenue. In reality, learning to reduce spending is an equally beneficial task that will lead a company to a far brighter outcome. If nothing else, it’s the ideal tool to maximize profit margins.
Good organization is equally crucial. A greater sense of clarity regarding company finances will move a brand to greatness.
Staying Productive
It’s one thing to build a business that succeeds when things run smoothly. However, knowing that the company will continue to perform in the face of adversity is where you will find true success. This is especially true, given that unforeseen circumstances can occur at any time.
Backup power generators can keep the business running when power lines are damaged. Being forced to take a break due to injuries suffered on a supplier’s site could disrupt everything too. Experts at Jones law firm can help you gain compensation in a potential legal matter.
Still, you also need contingencies.
Protect yourself, the staff, and all facilities for optimal results. The peace of mind can help you work with a clearer mindset.
Evolving With The Times
It would be easy to assume that short-term success guarantees that clients will be behind your products and services forever. In reality, client expectations evolve at a rapid rate. If your business does not progress alongside them, disaster could follow.
You can conduct endless research into the right tools and techniques that may be used. In truth, though, the most effective step is to analyze your performance. Experts at SEM Rush can run an audit into your online marketing elements. Meanwhile, check your automated analytics to review client trends.
As long as the business continues to keep the needs of the client in mind, positive results are sure to follow.
My next book, 50 Stories That Explain Accounting will be out in 2020. More information to follow.
For live CPA exam prep and accounting classes, join Conference Room for free. Members will be notified of course dates, times, costs, and how to attend these courses.
Get your questions answered to pass the CPA exam, and to learn accounting concepts.
Go to Accounting Accidentally for 300+ blog posts and 450+ You Tube videos on accounting and finance:
Good luck!
Ken Boyd
Author: Cost Accounting for Dummies, Accounting All-In-One for Dummies, The CPA Exam for Dummies and 1,001 Accounting Questions for Dummies
(email) ken@stltest.net
(website and blog) http://www.accountingaccidentally.com/
The post Protecting Your Business: Are You Doing Enough? appeared first on Accounting Accidentally.
December 12, 2019
Protect Your Financial Bubble
There are few places better in the world than home.
It’s the place where you and your family can feel completely safe from the outside world. The place where you make memories and grow closer together through the time that you spend with each other. It can often feel as though you’re living in your own little bubble, safe from anything that’s going on in the outside world.
When something happens that might pop that bubble, it can be an incredibly difficult and stressful time for you and your family. However, that doesn’t mean that it needs to be the end of the world.
There are plenty of things that you can do to keep your home and your family safe at all times. Here are a few things that you can do in order to protect your bubble.
If you’ve had a financial setback, this article can help.
Plan for the worst
No one likes thinking about the terrible things that could potentially happen to them or their family.
After all, it’s much nicer to only ever think about positive things. However, just because you refuse to think about them that doesn’t mean bad things aren’t going to potentially happen to you. All that you really do by ignoring those kinds of things is to set yourself up for a seriously nasty surprise.
Make sure that you’re always planning for the worst well in advance. Things, like having the right insurance policy as well as setting up security measures in your home, might seem like overkill to some, but the reality is that it’s always better to be safe than sorry.
Here are some useful tips, if you want to become a freelancer.
Keep financially stable
If there’s one thing that can impact the quality of life for both you and your family, it’s money.
The saying that money makes the world go round might seem dramatic, but there’s certainly a decent amount of truth to it. If you’re not taking care of your finances, then you’re opening yourself up to some seriously dangerous situations.
Whether you have to pay large sums of money to fix something in your home or medical bills that leave you in a scary financial position, it’s important to think carefully about how to handle these situations. One of the ways to deal with it is to take out personal loans which can offer you at least a little bit of short-term relief. Of course, you don’t want to lean on this as a long-term solution since cash loans often come with some pretty high-interest rates.
Work together
One of the most difficult things is feeling as though you’re trying to keep your family safe all by yourself.
Of course, you can’t really rely on the kids to take care of things, and nor should you, but you’re definitely within your rights to ask your partner for some help and support. There are few better ways to find yourself completely burning out and becoming exhausted than trying to run a household all on your own.
Whether it’s dividing up tasks or having your partner take over things like the finances for a while in order to give you break, the best way to make a problem less significant is to share it between you both.
Planning for your financial future is essential even if things are going fine. Putting money aside in a savings account and keeping a close eye on your finances will not only make it easier to deal with disaster but it will also help make sure that you feel more comfortable on a day-to-day level.
For live CPA exam prep and accounting classes, join Conference Room for free. Members will be notified of course dates, times, costs, and how to attend these courses.
Get your questions answered to pass the CPA exam, and to learn accounting concepts.
Go to Accounting Accidentally for 300+ blog posts and 450+ You Tube videos on accounting and finance:
Good luck!
Ken Boyd
Author: Cost Accounting for Dummies, Accounting All-In-One for Dummies, The CPA Exam for Dummies and 1,001 Accounting Questions for Dummies
(email) ken@stltest.net
(website and blog) http://www.accountingaccidentally.com/
The post Protect Your Financial Bubble appeared first on Accounting Accidentally.
December 11, 2019
Streamline Your Business and Improve Your Results
Founders need to balance their need to control with the ability to focus on tasks that grow the business.
You can meet both objectives when you streamlining your business.
Streamlining operations is a lot like cleaning out a closet. There’s less to look at, and the items that remain are the most important, and easy to see. De-clutter your business, and you’ll be able to focus on tasks that matter.
Changes in tech have made outsourcing much easier for business owners.
Marketing
Outsourcing is a great tool to simplify your business.
When you outsource, you hand off tedious, routine work to an outside party, and the strategy frees up your time. One of the best areas to outsource here is marketing.
There will always be an internet marketing company out there that has more skills, time, and experience than you do.
If you’re not an accounting expert, find someone who can fill that role for you.
Accounting
Every business owner must understand the basics of accounting, in order to post transactions and to generate financial statements.
Accounting is a cycle that starts with gathering source documents (invoices, receipts) and ends with the financial statements. The cycle repeats every month and year.
Chart of accounts
The chart of accounts is listing of each account and the account description, and your accounting software will provide a standard chart of account that you can change as needed.
Journal entries
Accounting transactions are posted using debits and credits, which you can read about in detail here. A journal entry records all of the needed detail about a particular transaction, including the dollar amount, the accounts used, the date, and a brief description of the transaction.
Trial balance, adjustments, financial statements
A trail balance is a list of every account and its balance as of a certain date. Accountants generate a trial balance to review the impact of transactions, and to assess the overall financial status of a company.
At the end of each month, accountants post adjustments to the trial balance, and the adjusted report is used to generate the financial statements.
You can find bookkeepers and accountants who can perform these tasks for you.
As more of your business tasks are automated, you need a reliable IT system to operate productively.
Technology
Another area will always be IT. Because unless you are an IT whizz yourself and this is an area that you want to be working on, then you will want to make sure that you outsource this.
Letting IT issues slow you down can cost money, so it’s much easier for you to leave it to the experts and focus on your own strengths.
Administration
If there’s one thing that you’re going to find that you keep on doing, it’s admin. We all have admin and it always seems to pile up. But, when it comes to being able to push things forward, you can’t let yourself wrap yourself up in everything like this. Instead, you have to make sure that you hire admin help and allow you to push the business and for you to focus on the future.
Ultimately, your most important job is to serve customers.
Customer Service
It’s important to have great customer service when you’re running your own company. And if you’re struggling to stay on top of it yourself, then it’s a good idea to call in some help. Hiring a member of staff to help you can work, but even then you may struggle. And so, it can be more beneficial to your business if you can outsource your customer service to a team that can handle it.
Put these systems in place to increase productivity, and to grow your business.
For live CPA exam prep and accounting classes, join Conference Room for free. Members will be notified of course dates, times, costs, and how to attend these courses.
Get your questions answered to pass the CPA exam, and to learn accounting concepts.
Go to Accounting Accidentally for 300+ blog posts and 450+ You Tube videos on accounting and finance:
Good luck!
Ken Boyd
Author: Cost Accounting for Dummies, Accounting All-In-One for Dummies, The CPA Exam for Dummies and 1,001 Accounting Questions for Dummies
(email) ken@stltest.net
(website and blog) http://www.accountingaccidentally.com/
The post Streamline Your Business and Improve Your Results appeared first on Accounting Accidentally.
December 8, 2019
What the Schwab/ TD Ameritrade Merger Teaches Us About The Cost-Volume-Profit (CVP) Ratio
Why would two large companies decide to merge?
In many cases, it has to do with huge changes in how both firms generate revenue and profits. As a business owner, you can use the cost-volume-profit (CVP) formula to make decisions about the direction of your business.
As this great article explains, Charles Schwab is merging with TD Ameritrade, two companies that control 11% of client assets in the retail financial services market. If you’re an investor, particularly a self-employed person who is funding retirement, you may have an account with one of these firms.
Both firms are well established in the investment industry.
Prior Success
Schwab has $3.8 trillion in client assets and over 12 million customer accounts. Similarly, TD Ameritrade has $1.3 trillion in client assets and 12 million customer accounts. Both companies are successful, and have national brand awareness.
So why pursue a merger?
The Revenue Issue
A major source of revenue is disappearing for both firms: fees from online trades.
Facing pressure from new competitors, like Robinhood, Schwab took the plunge and eliminated fees for online trades.
What happens when you give away something for free?
More people want it.
Sure enough, clients opened 142,000 new trading accounts in the first month alone.
The result? Schwab must now spend money to service 142,000 new accounts- and not earn any online trading fees.
Now, sure- Schwab is trying to bring more customers in the door, so the business can sell other products and services. But in the short term, it’s a money loser.
So, how do you maintain profitability when a major source of revenue goes away?
Merge, and cut expenses by eliminating duplicate costs.
The Merger
Combining firms allows the two companies to reduce both variable and fixed costs.
Tax expense, for example, is a variable cost that changes with the amount of profit a firm generates.
Schwab and TD Ameritrade will operate out of a single headquarters in Westlake, TX. Charles Schwab will stop paying the California corporate income tax, currently 8.84%, and operate in Texas, which has a 1% corporate income tax rate.
For most businesses, the biggest fixed cost is payroll.
The combined firms can eliminate duplication. Legal, accounting, and administrative jobs will certainly be reduced as two headquarters and combined into one.
Revenue for online trades has been eliminated, but the merger allows both firms to reduce fixed and variable costs.
The cost-volume-profit formula is a great tool to make similar decisions about revenue and costs.
Cost-Volume-Profit
Here’s cost-volume-profit (CVP) formula:
Profit = revenue less variable costs less fixed costs
Revenue is falling. One way for the merged firms to maintain (or even increase) profits is to lower variable costs and fixed costs.
You can also use the CVP formula to calculate breakeven:
In this case, assume that “X” represents units sold to reach breakeven. You’re selling a product for $50 a unit, your variable costs are $20 per unit, and fixed costs total $3,000. Set the profit to $0:
$0 Profit = $50X – $20X – $3,000
$3,000 = $30X
X = 100 units
If you sell 100 units at $50 per unit, you cover all of your costs.
You can also set the profit formula to reach a certain net income:
$3,000 Profit = $50X – $20X – $3,000
$6,000 = $30X
X = 200 units
To earn a $3,000 profit, you need to sell 200 units at $50 per unit.
The Lesson
CVP is a simple, “back of a napkin” tool you can use to perform what if analysis on your revenue, units sold, and costs.
My next book, 50 Stories That Explain Accounting, will be out in 2020. More info to follow.
For live CPA exam prep and accounting classes, join Conference Room for free. Members will be notified of course dates, times, costs, and how to attend these courses.
Get your questions answered to pass the CPA exam, and to learn accounting concepts.
Go to Accounting Accidentally for 300+ blog posts and 450+ You Tube videos on accounting and finance:
Good luck!
Ken Boyd
Author: Cost Accounting for Dummies, Accounting All-In-One for Dummies, The CPA Exam for Dummies and 1,001 Accounting Questions for Dummies
(email) ken@stltest.net
(website and blog) http://www.accountingaccidentally.com/
The post What the Schwab/ TD Ameritrade Merger Teaches Us About The Cost-Volume-Profit (CVP) Ratio appeared first on Accounting Accidentally.
What the Schwab/ TD Ameritrade Teaches Us About The Cost-Volume-Profit (CVP) Ratio
Why would two large companies decide to merge?
In many cases, it has to do with huge changes in how both firms generate revenue and profits. As a business owner, you can use the cost-volume-profit (CVP) formula to make decisions about the direction of your business.
As this great article explains, Charles Schwab is merging with TD Ameritrade, two companies that control 11% of client assets in the retail financial services market. If you’re an investor, particularly a self-employed person who is funding retirement, you may have an account with one of these firms.
Both firms are well established in the investment industry.
Prior Success
Schwab has $3.8 trillion in client assets and over 12 million customer accounts. Similarly, TD Ameritrade has $1.3 trillion in client assets and 12 million customer accounts. Both companies are successful, and have national brand awareness.
So why pursue a merger?
The Revenue Issue
A major source of revenue is disappearing for both firms: fees from online trades.
Facing pressure from new competitors, like Robinhood, Schwab took the plunge and eliminated fees for online trades.
What happens when you give away something for free?
More people want it.
Sure enough, clients opened 142,000 new trading accounts in the first month alone.
The result? Schwab must now spend money to service 142,000 new accounts- and not earn any online trading fees.
Now, sure- Schwab is trying to bring more customers in the door, so the business can sell other products and services. But in the short term, it’s a money loser.
So, how do you maintain profitability when a major source of revenue goes away?
Merge, and cut expenses by eliminating duplicate costs.
The Merger
Combining firms allows the two companies to reduce both variable and fixed costs.
Tax expense, for example, is a variable cost that changes with the amount of profit a firm generates.
Schwab and TD Ameritrade will operate out of a single headquarters in Westlake, TX. Charles Schwab will stop paying the California corporate income tax, currently 8.84%, and operate in Texas, which has a 1% corporate income tax rate.
For most businesses, the biggest fixed cost is payroll.
The combined firms can eliminate duplication. Legal, accounting, and administrative jobs will certainly be reduced as two headquarters and combined into one.
Revenue for online trades has been eliminated, but the merger allows both firms to reduce fixed and variable costs.
The cost-volume-profit formula is a great tool to make similar decisions about revenue and costs.
Cost-Volume-Profit
Here’s cost-volume-profit (CVP) formula:
Profit = revenue less variable costs less fixed costs
Revenue is falling. One way for the merged firms to maintain (or even increase) profits is to lower variable costs and fixed costs.
You can also use the CVP formula to calculate breakeven:
In this case, assume that “X” represents units sold to reach breakeven. You’re selling a product for $50 a unit, your variable costs are $20 per unit, and fixed costs total $3,000. Set the profit to $0:
$0 Profit = $50X – $20X – $3,000
$3,000 = $30X
X = 100 units
If you sell 100 units at $50 per unit, you cover all of your costs.
You can also set the profit formula to reach a certain net income:
$3,000 Profit = $50X – $20X – $3,000
$6,000 = $30X
X = 200 units
To earn a $3,000 profit, you need to sell 200 units at $50 per unit.
The Lesson
CVP is a simple, “back of a napkin” tool you can use to perform what if analysis on your revenue, units sold, and costs.
My next book, 50 Stories That Explain Accounting, will be out in 2020. More info to follow.
For live CPA exam prep and accounting classes, join Conference Room for free. Members will be notified of course dates, times, costs, and how to attend these courses.
Get your questions answered to pass the CPA exam, and to learn accounting concepts.
Go to Accounting Accidentally for 300+ blog posts and 450+ You Tube videos on accounting and finance:
Good luck!
Ken Boyd
Author: Cost Accounting for Dummies, Accounting All-In-One for Dummies, The CPA Exam for Dummies and 1,001 Accounting Questions for Dummies
(email) ken@stltest.net
(website and blog) http://www.accountingaccidentally.com/
The post What the Schwab/ TD Ameritrade Teaches Us About The Cost-Volume-Profit (CVP) Ratio appeared first on Accounting Accidentally.
November 25, 2019
What Delta Airlines News Teaches Us About Accounting For Leases
Some companies, such as banks, large manufacturers, and airlines, have to make a big investment in assets to operate.
Delta Airlines, for example, has to lease gates and ticket counters at over 300 airports. How a business accounts for this type of spending has a big impact on company profit.
This excellent article from the Wall Street Journal explains how accounting for leases has changed, and the impact on the financial statements of airlines like Delta.
To understand leases, think about your car.
Leasing vs. Buying
Many of us have considered whether it’s make economic sense to lease a car rather than buy it.
Buy a car: If you purchase a car, you own the assets once the loan is paid off.
Lease a car: A lease means that you’re essentially renting a car. You don’t own an asset at the end of the lease period. Sure, the lease may include an option to buy the leased car, but you can decline that offer and simply turn the car over when the lease ends.
Accounting for leases is similar.
Lease Accounting
To account for leases, you designate a lease as an operating lease or a finance lease, but there’s been a big change.
Here’s how the AICPA explains it:
“The core principle of the new leases standard is that lessees should recognize assets and liabilities arising from all leases, except for leases with a lease term of 12 months or less.”
An example
Let’s assume that the Riverside Café decides to lease some large refrigerators for the restaurant.
An operating lease means that the cost of the lease is simply expensed. Riverside debits an expense account, Refrigerator Lease Expense, and credits Cash for each lease payment. This would only apply if the lease term was for 12 months or less.
A finance lease is different.
If Riverside chooses to treat the lease as a capital lease, the restaurant creates an asset account, and sets up a liability account for the payments. In essence, the restaurant is taking out a loan from the lessor to purchase the asset (refrigerators).
How is the dollar amount of the asset and the liability determined?
Present value
Riverside uses the present value of the leased asset, using a discount rate that is typically the interest rate expected on a loan.
Let’s say that Riverside is leasing refrigerators at a cost of $10,000 for 5 years. The current interest rate for a 5-year loan is 8%. This present value calculator indicates that the present value is $6,806 (with rounding).
Riverside debit Refrigerator Lease (asset account) for $6,806, credits Refrigerator Lease Liability (liability account) for $6,806.
Each time that Riverside makes a lease payment, some of the payment is posted to reduce the lease liability, and a portion is recorded as interest expense. It’s the same process that is used when you make a payment on your home loan.
What’s the impact of recording far more leases with an asset and liability account?
Balance Sheet Impact
The Wall Street Journal makes this comment:
“Under the new rules, the interest rates companies pay on their debt can be used to discount the future value of their leases. Risky companies pay higher rates, and so benefit more than safer companies in discounting their leases, thereby reducing their reported liabilities.”
To understand this concept, think about two people want to borrow $10,000 to buy a car.
Two borrowers
Borrower A has good credit, and can borrow at the 5-year, 8% interest explained above. The present value of $10,000 at 8% for 5 years is $6,806.
However, Borrower B has poor credit, and must borrow at 12% for 5 years. Using the same present value calculator, the present value of $10,000 is only $5,674.
The 4% higher interest rate decreases the present value by over $1,000.
The irony?
Companies with poorer credit ratings now post lower liability balances for leases.
Does it matter?
Quite a bit, actually.
Moody’s and Standard and Poors (S&P) rate companies, based on creditworthiness. Here’s how they changed their analysis of Delta.
“Ratings firm Moody’s Corp. cut Delta’s operating-lease liabilities almost in half, from $11.2 billion to $6.8 billion, when the airline adopted the new accounting rule for its end-2018 balance sheet. Rival ratings firm S&P Global Inc. lowered Delta’s lease liability from $10.6 billion to $7.2 billion.”
These changes dramatically improve some of Delta’s financial ratios- ratios that analysts use to judge performance.
An important ratio
One of the most popular tools to measure financial performance is EBITDA. This ratio takes company earnings and adds back some items, including interest expense and tax expense.
You can assess a company’s debt load reviewing the ratio: (Debt) / (EBITDA). If a business is growing earnings (in the denominator), debt could increase and the ratio may stay the same.
Here’s how Delta’s ratio looks now:
“Moody’s adjusted Delta’s leverage ratio—or debt compared to earnings before interest, tax, depreciation and amortization—from 3 to 2.5.”
The Lesson
Most balance sheet now a have much larger balance for leases than in the past. Lease liabilities are adjusted to present value, and the interest rate assumption has a big impact on the dollar amount of the lease liability.
My next book, 25 Intermediate Accounting Spreadsheets (and How to Use Them) will be out in 2020. The format will include a written discussion of a spreadsheet, with spreadsheet images, and a related video.
To learn more and get sample chapters of the book, watch this video.
For live CPA exam prep and accounting classes, join Conference Room for free. Members will be notified of course dates, times, costs, and how to attend these courses.
Get your questions answered to pass the CPA exam, and to learn accounting concepts.
Go to Accounting Accidentally for 300+ blog posts and 450+ You Tube videos on accounting and finance:
Good luck!
Ken Boyd
Author: Cost Accounting for Dummies, Accounting All-In-One for Dummies, The CPA Exam for Dummies and 1,001 Accounting Questions for Dummies
(email) ken@stltest.net
(Image) Airplane by muffinmax71xx
(website and blog) http://www.accountingaccidentally.com/
The post What Delta Airlines News Teaches Us About Accounting For Leases appeared first on Accounting Accidentally.
November 14, 2019
What Mattel’s Accounting Mistake Teaches Us About Material Weakness and Deferred Taxes
Who knew that Thomas the Tank Engine could stir up so many problems?
Mattel, the owner of the toy brand and PwC, Mattel’s external auditor, did not take proactive steps to correct an accounting error.
The company and the auditor have paid a heavy price.
This excellent article from the Wall Street Journal, “Mattel and PwC Obscured Accounting Issues, Former Executive Says”, lays out a great example to explain a material weakness, and how deferred taxes work.
The story begins when an error is discovered.
What is a Material Weakness?
Mattel is a public company, so it makes sense to refer to the Public Company Accounting Oversight Board (PCAOB). The Board was created after the Enron collapse, in an effort to improve the amount and timeliness of accounting disclosure.
Here’s how PCAOB defines a material weakness in Auditing Standard 5:
“A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis.”
Let’s break that down, starting with materiality.
Materiality
The term “material” refers to a dollar amount that is large enough to change the opinion of a financial statement reader. The level of materiality is a judgment call. A $5 error in a $2 million inventory balance isn’t material, but a $10,000 mistake is probably material.
Firms needs controls in place to prevent material errors.
Internal controls
A business needs controls in place over inventory, including physical inventory counts.
During the count, the internal auditors compare items in the detailed inventory listing to the physical items in the warehouse. This procedure is the strongest evidence that the inventory exists.
Companies also need to control how goods move in and out of the warehouse, so that accurate records are maintained.
If controls are weak, the company will not report the inventory balance accurately. A material weakness means that a firm’s accounting system does not produce reliable reporting.
Timing is particularly important.
Timely basis
When you find a material error, you need to disclose it and correct it right away.
But that’s potentially embarrassing- and may change how investors view your firm. Which brings us back to Mattel and PwC.
Why an Earnings Restatement is a Disaster
Here’s a quote from the article:
“The accounting problem was tied to Mattel’s ownership of Thomas & Friends, an animated children’s show about talking trains. The finance team discussed fixing the problem and restating earnings, with the expectation that Mattel would have to admit to shortcomings in its accounting and reporting procedures…”
Ouch.
Restating earnings is a PR problem, for two reasons:
Analysts and investors will have less confidence in Mattel’s management
PwC (the auditor’s) reputation will be damaged, as well as the firm’s reputation with the client (who they’ve audited for decades)
So, what did Mattel and PwC do?
“… senior finance executives and Mattel’s auditor, PricewaterhouseCoopers, decided to change the accounting treatment of the Thomas asset, effectively burying the problem, according to Mr. Whitaker and documents reviewed by The Wall Street Journal. The executives agreed not to tell Mattel’s then-chief executive or its board of directors, an internal investigation found.”
They buried the problem- so the public (and particularly investors) didn’t know about the mistake right away.
There was a great deal of fallout. The Mattel CFO left the firm, and the PwC partner was put on administrative leave and is expected to leave the audit firm.
Let’s shift gears and talk about intangible assets, and the accounting error itself.
Reviewing Intangible Assets
Intangible assets include patents, copyrights, and other assets that are not physical.
Goodwill is a common intangible asset category. If you pay more than the book value for a company, some of the purchase price may be posted to goodwill. This video explains accounting for goodwill.
Intangible assets are amortized, which reclassifies the asset balance into amortization expense over time. It’s similar to depreciation expense for physical assets.
When Mattel buys an intangible asset, the company has to review the asset for possible impairment.
Impairment
GAAP requires that intangible assets must be evaluated each year for impairment.
If the fair value of the intangible asset is less than the unamortized balance in the intangible asset account, the asset is impaired.
Here’s an example:
Let’s assume that you buy a copyright for a book that generates $100,000 in sales a year. Time goes by, and the annual revenue for the book declines to $30,000 a year. Obviously, the value of the copyright has declined.
But by how much?
Estimating the fair value of an intangible asset is a complicated issue. This blog post from the CFA Institute goes into detail on the valuation process, if you want to know more.
Writeoff
If an intangible asset is impaired, you must write off the impairment amount to expense.
That’s consistent with other areas of accounting. We never want an asset on the books to be overstated. If an asset is overvalued, we generally expense the overage amount.
Here’s the Mattel accounting issue:
“The accounting error was tied to a $562 million valuation allowance—a reserve for a potential loss in value—that Mattel created against its deferred tax assets in September 2017.”
Reserve for Potential Loss
Reserve accounts help a business comply with the principle of conservatism.
This principle states that, when in doubt, choose the accounting method that generates less net income.
So, if Mattel considered that an intangible asset may be worth less in the future, why not set aside some dollars now to address the issue?
That’s taking a conservative approach.
Banks use reserve for loan loss accounts to set money aside for potential loans that may not be paid back. In fact, the amount of a bank’s loan loss can be an area of dispute between bankers and their external auditors.
Let’s talk about deferred taxes.
Deferred Tax Asset
The concept of deferred taxes is one of the toughest topics in accounting. This video and the video here both explain the topic.
The journal entry for the Mattel error was a debit to Deferred Tax Asset and a credit to a Reserve for Loss account.
A deferred tax asset means that you have a tax expense in the future, which reduces your tax liability in the future.
Depreciation expense can be different between book (accounting records) and the tax return. These temporary differences create deferred tax assets.
Let’s say that you have $30,000 more in depreciation for taxes than book depreciation in 2021. Higher expenses means less net income- and a lower tax liability.
You would have a $30,000 deferred tax asset.
A deferred tax liability means that you have a higher tax liability in future years.
So what, exactly, was the big problem with the Mattel accounting?
How Mattel Made a Mistake
“The allowance was reduced by $109 million, which came from deferred tax liabilities related to the company’s 2011 acquisition of HIT Entertainment Ltd., which included Thomas & Friends, Barney & Friends, and Bob the Builder. Reducing the allowance lowered Mattel’s loss for the quarter.
Soon after, the company did an internal review of its intangible assets. Finance executives discovered that because of the way the HIT liability had been categorized, it shouldn’t have been used to reduce Mattel’s loss …”
Mattel mixed apples and oranges.
The reserve for potential loss for “A” should not have been reduced by an event from acquisition “B”. Events A and B were not related to each other.
My next book, 25 Intermediate Accounting Spreadsheets (and How to Use Them) will be out in 2020. The format will include a written discussion of a spreadsheet, with spreadsheet images, and a related video.
To learn more and get sample chapters of the book, watch this video.
For live CPA exam prep and accounting classes, join Conference Room for free. Members will be notified of course dates, times, costs, and how to attend these courses.
Get your questions answered to pass the CPA exam, and to learn accounting concepts.
Go to Accounting Accidentally for 300+ blog posts and 450+ You Tube videos on accounting and finance:
Good luck!
Ken Boyd
Author: Cost Accounting for Dummies, Accounting All-In-One for Dummies, The CPA Exam for Dummies and 1,001 Accounting Questions for Dummies
(email) ken@stltest.net
(website and blog) http://www.accountingaccidentally.com/
The post What Mattel’s Accounting Mistake Teaches Us About Material Weakness and Deferred Taxes appeared first on Accounting Accidentally.
November 7, 2019
Why Using a Logistics Firm Can Grow Your Business
People don’t often consider logistics to be an interesting topic.
But getting logistic right can make or break your business.
Logistics may be viewed as a way to get products from point A to point B, but there is much more to it than that. For a lot of businesses, getting the right fleet management company can be the difference between delivering on time and within budget, or being late and missing deadlines.
Logistics are more complicated than ever, because of technology and global trade. To stay competitive, you need to use the latest tools and techniques for logistics.
If you’re recovering from a financial setback, this article can help.
Consider these ideas.
Outsourcing
Every business knows that outsourcing is an area where firms can save the most money. Outsourcing logistics is one service where third party logistics (3PLs) make a significant impact on the bottom line. Of course, the costs will depend on the services you choose, but you can save money in these areas:
Warehousing
Reverse Logistics
JIT delivery
Fulfillment
3PLs find the most cost-effective way to manage all of these tasks, and offer them as a complete service.
Big Money
If you consider the entirety of your supply chain, shipping might not seem like the most significant component.
However, the shipping industry is a trillion-dollar industry. There has been a sharp increase in revenue as people increase online purchases. As a result, more businesses are willing to increase spending on fast and reliable shipping firms.
If you’re considering a career as a freelancer, read this.
Sustainability
Logistics firms are moving toward a more sustainable business model.
Trucks, which are still the most-used shipping method, are becoming more environmentally friendly. When you combine that with a more efficient supply chain, there will be, by default, fewer emissions.
Types
There are more different types of logistics than you might think! There are 1PL, 2PL, 3PL, 4PL, and 5PL. The PL stands for party logistics, and the most common is 3PL. In a typical 3PL working relationship, the 3PL finds ways to make the supply chain more efficient, while the shipper maintains control of the supply chain.
Big Employment
When an industry is worth a trillion and growing, the employment is going to increase. In the US alone, there are over 5 million people employed in transport and warehousing. The industry is growing at a rapid rate, and employment is increasing.
Wheels Win
There are more options now when it comes to shipping, as we see airplanes and drones come into their own.
However, these services aren’t a complete replacement for trucks. Trucking as a standalone is worth $721 billion as an industry. And it currently accounts for 63% of all freight in some areas. Trucks are one of the most affordable and reliable ways to ship goods, and with strides being made in sustainability, they are an attractive option.
Do Your Homework
Before you hire a logistics company, do your homework.
Your customers need to receive a quality product that is safely delivered on time. The logistic company represents your firm, and they have to be competent and professional.
Find a reliable logistics company, and operate your business with confidence.
Good luck!
Ken Boyd
Author: Cost Accounting for Dummies, Accounting All-In-One for Dummies, The CPA Exam for Dummies and 1,001 Accounting Questions for Dummies
(email) ken@stltest.net
(website and blog) http://www.accountingaccidentally.com/
The post Why Using a Logistics Firm Can Grow Your Business appeared first on Accounting Accidentally.
