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Recognition and measurement per US GAAP

US GAAP guidance on recognition identifies whether an element should be included in the financial statements and measurement determines the value at which it should be included in the financial statements.

The matching principle which requires that revenues are recognized when they are earned and expenses are recognized when they are incurred  is commonly known.

Other recognition and measurement criteria for assets and liabilities are also established.

PPE and most inventories are measured at historical cost – which is the amount of cash paid to acquire the asset

Some inventories are reported at current cost – amount that would have to be paid if that asset was acquired currently

Investments in marketable securities are reported at current market value which can be obtained by selling an asset in liquidation

Short term receivables and some inventories are measured at Net realizable value which is the non-discounted amount of cash into which an asset is expected to be converted after direct costs incurred

Long term payables are reported at present or discounted values of future cash flows

A distortion in either of these will result in misrepresenting the assets and liabilities.

Groupon is a recent  example of a company that got into trouble with revenue recognition. An extract from a blog that analyses this. Quote from an article that discusses this to great detail “It counted revenues from its new customers (as it should), and used that revenue to show growth, but did not show customer-acquisition costs as operating costs.” (Source : http://expertlywrapped.wordpress.com/2011/10/27/in-depth-on-groupons-accounting-practices/)

Assets at fair value on the balance sheet : 1. Marketable securities

Marketable securities are investments held for sale. These investments are estimated  at fair value on the balance sheet. Any unrealized gains or losses on these securities (net of tax) are carried to accumulated other comprehensive income  in stockholders equity. Unrealized losses are charged against other income (expense), net when a decline in fair value is determined to be other-than-temporary.

Is D&A part of COGS

Depreciation expense for a manufacturing company is allocated between COGS and operating expense based on the source of this expense. For a manufacturing company, depreciation on the manufacturing equipment and facilities is a manufacturing overhead and thus included in COGS. Whereas depreciation on non-manufacturing equipment is included in operating expenses.

It is interesting to note how various companies in the Internet Publishing and Broadcasting and Web Search Portals (NAICS  519130)  are treating depreciation expenses and what is the reason behind this.  

Facebook, Linkedin and Google are all under the same NAICS as mentioned above. Facebook and Google include depreciation associated with operation of data centers and amortization of intangible assets in cost of revenues whereas Linkedin reports D&A separately on the income statement. Since maintaining data center equipment and technology infrastructure is directly related to delivery and distribution of products and services of these companies this treatment is reasonable. These costs are similar to the depreciation on manufacturing equipment being included in COGS by a manufacturer.

For Linkedin D&A expenses include depreciation on computer equipment, software, leasehold improvements, capitalized software development costs and amortization of purchased intangibles. The cost of revenues does include data center equipment maintenance expenses. This could imply that depreciation related to data center equipment is included in cost of revenue and all other D&A is reported separately on the income statement.

For Target and Radioshack which are retailers D&A are a part of the operating expenses.

While modeling financial statements for Facebook and Google D&A need to be identified and separated from the COGS or it might lead to D&A expenses being double counted and resulting in an understatement in operating income. The alternative to this adjustment is to not have D&A as a separate line item in the income statement just as it is presented in the financial statements.

 

 

Open up to accounting and edge up to finance

yawn… accounting . Really! Accounting is where all the finance starts, all the scandals and yes all the RULES.  Finance is where all the glitz and glamour belongs right?  Certainly more exciting it is ..to analyze financial statements, to build financial models, to pick stocks, to buy and sell companies..isnt this just the thing you need to jazz up that linkedin profile and how about topping it off with being a management consultant.. well whats next a vacation in Hawaii for starters may be . If all the geeky words in annual reports are deciphered and intent behind all disclosures understood theres a lot more talking to the future and a lot more skill!

Welcome to the bridge then.. open up to accounting and edge up to finance.  Happy reading!

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