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