Problem-based Learning. Learning by doing strategy Student centered vs. instructor centered Course is organized around a “real” business problem Begin with the problem Goal of learning activity is to develop, explain, and defend response to the problem
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Critique each other’s work
Explore applications of concepts together
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Collaborate in solving problemsInteraction brings new challenges and perspectives
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Analysis of Financial Statement Impact of Capitalization and Expense Decisions at Stearing-Harp Water
Property, Plant and Equipment
Stearing-Harp Water (S-H) is currently using an accelerated depreciation method for depreciating the cost of its property, plant and equipment, which causes net income to be lower in the earlier years of an asset’s life, as compared to straight-line depreciation, which would evenly allocate the expense of the asset over its life. For tax purposes, this results in a lower tax liability as well.
This is not a real “cash” charge, and affects “paper profit” only, in that it attempts to match the costs of assets to the periods in which they will provide benefits. This method is appropriate if the assets wear out quickly in the beginning years of their lives; however, as most companies use straight line depreciation for financial statement purposes, it is questionable whether this method should be used for S-H, especially as the assets in question are of a type that do not seem to wear out more quickly than normal and have fairly long useful lives.
With respect to the carrying value of company assets, the impairment value charge that was taken for the destruction of the delivery trucks was appropriate, as they will not be providing a benefit to S-H in future periods. It was also required by US GAAP (Generally Accepted Accounting Principles) and management did not have latitude in making this decision; their only judgment call was the extent of the impairment. Depending on the facts and circumstances surrounding the impairment of the trucks, this “writedown” may or may not be deductible for tax purposes until the actual disposal of the trucks takes place.
Good summary. You recognize the effect of the change to the financial statements that took place at SH and have considered its validity as well.
Internally Developed Software
S-H’s adoption of SOP 98-1 would allocate the costs associated with the software to the periods to which it will provide benefits, by creating an asset equal to the costs incurred to develop it and amortizing this asset ratably over its life. This would increase the assets reported on the balance sheet and decrease the amount of expense charged through the income statement (as compared to the method used prior to adopting this accounting method, which presumably was to directly expense all costs as incurred). This would improve earnings and cause the earnings to be of a higher quality, as the costs incurred to produce the benefits generated by the software would be matched to the periods in which the benefits are realized.
Good. I agree that assets would be higher, as would retained earnings, as less expense is recognized.
These charges are being directly expensed through the income statement; it is assumed that they are not creating a future benefit and accordingly, no asset is being created on the balance sheet. For tax purposes, these costs may or may not be able to be expensed, depending on certain criteria, so these costs may reduce financial statement income without providing a correspondent tax benefit (or the benefit might have to be allocated over more than one year for tax purposes).
Based on the info we are given, I agree that we can infer that the costs do not benefit a future period.
Under US GAAP, S-H is required to expense the costs of advertising campaigns as the costs are incurred, as it is difficult to quantify the benefits gained and allocate them to accounting periods. No asset will be created on the financial statements (as opposed to the previous method, under which the costs were capitalized and amortized) and net income will be lower under the new (correct) method. Management did not have the option to continue using the prior method, as the financial statements must be in accordance with GAAP.
Yes, GAAP must be followed when preparing financial statements. The old method was incorrect, and the correct method had to be adopted. Lower net income will be the result as well as lower assets and retained earnings.
Lease payments made under operating leases to which S-H is a party must be expensed as rent in the periods to which the payments relate; in contrast, the present value of lease payments to be made under capital leases (assuming the leases would be classified as capital leases for accounting purposes under the four part test that exists under US GAAP) must be capitalized, which causes an asset to be created on the financial statements which is amortized over the life of the lease(s). If more payments are made under capital leases than operating leases, net income will be higher (because less of the lease payments are being expensed) than if the reverse applied.
Actually, under capital leases the assets are amortized in each period, and interest expense is also recorded. We can’t say for sure which would bring a lower expense on the books without more information about the specifics of the leases.
You have a good grasp of the types of accounting changes that occurred at SH over the past year and how they affected the company. Were the new changes more or less conservative than the old methods?
Overall Assessment: Mastery
Accounting exists because there are differences between cash flow and wealth flow. Describe this difference using the personal scenario of working and getting paid for your work. Please try to limit your response to no more than six sentences.
After I finish my work at UNext, I’ll get my paycheck and head to the bank. Now…am I wealthy? If I cash the check and stuff it all in my wallet, I appear to be wealthy because I have so much cash on hand. If I deposit 95% of my check in my bank account and put the remaining 5% in my wallet as cash, I appear to not be as wealthy as if I cashed the entire check. We must look at more than just the cash on hand at the time I get paid, as cash flow does not equal wealth flow. The wealth equation is Resources – Obligations = Wealth. The real answer to whether I am wealthy is determined by my obligations ( my UNext check ( + other income sources, assets, bank account ) – my rent, expenses, etc. ) = my wealth.