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

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 at McCloud Winery

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. 2. 3.

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

2: The bank loan

$180,000 3 years maturity $ 10,000 annual repayment 10% interest rate

Accounting at McCloud Winery

Accounting for the loan

See the related excel file

Accounting at McCloud Winery

3: The land and the grapevines

The vineyard is certainly an asset Cost of this asset? Depreciation?

Accounting at McCloud Winery

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

4: Vines diseases
Highly damaging event Possible, but not certain How do we account for this?

Phylloxera

Pierces disease
Accounting at McCloud Winery

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
1. The future event is sufficiently likely 2. 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

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

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

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?
Accounting at McCloud Winery

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

The accrual principle: do you remember the example?

Balance Sheet Profit = 50

Wealth
300

Accrual logic
Wealth
350 I/S day 1 I/S day 1

Balance Sheet

Profit = 10

Balance Sheet

Wealth
360

Begin. day 1

Different!
End of day 1

End of day 2

Cash 0

Cash flow logic

Cash flow day 1
Cash 250

Cash flow day 2

Cash 360

Cash increase = 250

Cash increase = 110

Accounting at McCloud Winery

Accounting and Financial Analysis

Double-entry Accounting decisions Raw data

Financial Statements

Financial Analysis

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
Accounting at McCloud Winery