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Accounting decisions

Accounting decisions. Case: Accounting at MacCloud 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.

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Accounting decisions

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  1. Accounting decisions Case: Accounting at MacCloud winery

  2. 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

  3. The MacCloud winery • 5 acres of land • One building Accounting at McCloud Winery

  4. 1: The building • Worth $32,000 • Leased for 10 years for $5,000 per year • How do we account for it? Accounting at McCloud Winery

  5. 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 • There exists a bargain purchase option at the end of the lease • The lease covers more than 75% of the economic life of the asset • 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

  6. 2: The bank loan • $180,000 • 3 years maturity • $ 10,000 annual repayment • 10% interest rate Accounting at McCloud Winery

  7. Accounting for the loan • See the related excel file Accounting at McCloud Winery

  8. 3: The land and the grapevines • The vineyard is certainly an asset • Cost of this asset? • Depreciation? Accounting at McCloud Winery

  9. 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

  10. 4: Vines’ diseases • Highly damaging event • Possible, but not certain • How do we account for this? Pierce’s disease Phylloxera Accounting at McCloud Winery

  11. 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 if • The future event is sufficiently likely • 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

  12. 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? Accounting at McCloud Winery

  13. 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

  14. General questions that we have tackled today • What do we mean by “accounting decisions”? • Why is it necessary to make accounting decisions? • What are the consequences of these decisions? Accounting at McCloud Winery

  15. 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

  16. 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

  17. 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

  18. The accrual principle: do you remember the example? Balance Sheet Balance Sheet Balance Sheet Profit = 50 Profit = 10 Accrual logic Wealth 300 Wealth 350 Wealth 360 I/S day 1 I/S day 1 Different! Begin. day 1 End of day 1 End of day 2 Cash flow logic Cash flow day 1 Cash 0 Cash 250 Cash 360 Cash flow day 2 Cash increase = 250 Cash increase = 110 Accounting at McCloud Winery

  19. Accounting and Financial Analysis Accounting decisions Raw data Double-entry Financial Analysis Financial Statements Accounting at McCloud Winery

  20. 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 Accounting at McCloud Winery

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