This post was prompted by a comment from a reader. The question was where do I show the customs duty in an income statement. If we are referring to a published income statement, the answer is it is not shown. And this made me think of the items that are not visible on a published income statement. Of course, such items may be visible/shown on an internal income statement within a business.
Let me use the customs duty as an example. If the duty is paid on items of raw material/items purchased for re-sale, the duty will be included as part of the cost/expense. On internal income statements, it probably will not be shown separately, but may have its own ledger account. On a published income statement, it will be included in cost of sales.
There are many other items which we would typically not see on an income statement, even an internal one. For example, discounts are likely to be netted off against the relevant expense; or sales of waste product against sales. However, the materiality concept may kick in, if the amount is large (material) enough to merit separate disclosure. Even if material, such items will not be seen on the income statement, but in a note.
Some recent media coverage of problems in the Irish charity sector has been quite detailed. In one case, a charity founder was clearly exerting a lot of control and taking money for personal use. In another, a group of people on social media demanded detailed accounting and controls in a charity with only a single permanent staff member.
In both cases, and there seems to be a lack of accountability as regards to how money was spent. The first case was to me simply fraud, but the second case is probably more typical of the issues faced by smaller charities in Ireland and other countries. That charities be held accountable for what they spend if of course right and proper, but to do so they require accounting and contol systems. These systems do not come free of charge. For example, even to have one qualified accountant in a charity would cost in the region of €70000 per annum. This may a considerable portion of the income of a smallef charity and herein lies the conundrum – the public want accountantability, but they also want administration costs to be minimised. What’s the answer to this conundrum? Well, I am not sure, gut the answer may lie in simple economies of scale – that is, perhaps there are too many smaller charities who could consolidate. Or possible governments or some regulatory agency could provide shared service type accounting arrangements for charities.
As you are probably aware, the United Kingdom (UK) is leaving the European Union. This will have many effects on business, and in Ireland we are likely to experience the effect quite early on due to our close business ties.
Will any effects on business be revealed in the accounts of Irish (or other) businesses? The simple answer is yes, as if a company has close business ties with the UK then there is very likely to be a contingent liability or provision in the accounts. IAS 37 defines a contingent liability as:
- a possible obligation depending on whether some uncertain future event occurs, or
- a present obligation but payment is not probable or the amount cannot be measured reliably
As noted in an article in The Sunday Business Post, the outcome of Brexit is as of now uncertain, and looking at the definition of a contingent liability above, it would seem the financial statement of companies may have contingent liabilities (or even contingent assets) disclosed for some years to come. Only time will tell.
On July 14th last, it was reported on the BBC website that the total cost to BP of the Deepwater Horizon oil spill back in 2010 was totalling $61.6 billion – quite an amount. If you look back at the media websites/newspapers over the years you will see the amount rising over time.
Just out of curiosity, I had a look at the most recent financial statements of BP to see what they include on this. Two things came to mind before I looked at the accounts 1) the amounts involved here are material and 2) it spans many reporting periods, so IAS 10 Events after the Reporting Period would probably kick in. Looking at the accounts to 31.12.2015, they contain a separate note which itemises the events of the event on each of the three financial statements. You can see the accounts here – look at note 2. It is quite detailed and I do like how they have shown the effects, and the note is quite detailed. It is not very often such significant events occur, and as far as I can see BP have done a good job on this note. It certainly should provide an investor with enough information to decide whether to invest in the company or not – a key criteria of what financial statements should do.
Regulation of charities in Ireland is not as good as it could be – we have some legislation waiting to be enacted since 2009 as far as I know. But laws cannot prevent what happens within an organisation from happening; they can only penalise after the event.
So what bugs me? Well, the title of this post really – it is something I picked up from the print media in recent weeks. I am sure I have said somewhere on this blog that accounting is the language of business, so what about accounting for charities? My own opinion is that charities must have proper accounting, and there are accounting standards already in place for charities. But I often wonder should we be careful and not allow charities to become too much like a business? For example, we should be using accounting in charities to drive efficiencies, not necessarily monitor revenue and costs like in a business. Nor should we be using accounting just to get funding for a charity. In short, what I am trying to say is that we need to be careful and try to not let accounting (and other commercial sector notions) detract from what a charity should be.
On a recent research project I read an article from 1914 which was written by an “old” accountant of the time. On testing accounting students knowledge through examinations (s)he notes “we see interesting problems set out in symmetry and order”. This made me think about what has changed today.
Indeed we still use examinations in university and in professional bodies. They are a good tool to test knowledge, and increasingly examinations draw on methods such as case scenarios which are less structured in an effort to imitate real life scenarios. However, no matter what we do as teachers, we cannot replicate the real world. This is of course where professional development and on the job training come in. I do hope we at least provide the basic knowledge to help students hit the ground running when they start their careers. We can only improve the value of this basic knowledge by trying to get students to use their knowledge in an unstructured way. In an examination scenario, this means we need to use fresh ideas and new ways to ask standard material – this can be tricky sometimes, but it helps both students and us teachers to apply ourselves in a more real world fashion.
In recent years many operations – both business and public sector – have been closed or reduced in capacity to save costs. Closing an operation is one of the topics I often teach too. When I teach, the basic message is to focus on the fixed costs, and how much can be reduced or eliminated. Of course, some labour costs are increasingly seen as fixed – and this may be a more certain feature in the public sector.There may also be some hidden or unforeseen costs, which are often not included in the analysis. Let me give you two recent examples, both of which are from the public sector.
In Ireland, the government closed down 139 Garda (police) stations due to economic woes. Most of these closures were in rural areas. The total annual cost saving is estimated at just over €500,000 – see here. This is likely due to the fact that only the only savings were operating costs of the stations e.g. light and heat were the only real costs saved. Police staff and equipment simply moved to another station – where costs may have been incurred to accommodate them. There is a big hidden cost though, which is increased rural crime. While there was probably no money value on this cost in any cost estimates prepared, I’d be quite sure it is higher than closing stations. Recently, the decision to close has been reversed.
A second example comes from Lambeth council in London who closed two libraries – see here . According to a report in the Guardian, the daily security cost is higher than the cost of keeping the libraries open. There seems to have been some protests against the closure of one library in particular, which drove up the costs. This unforeseen cost, if included in the closure decision might have changed things.
Have you ever noticed how some Eco items cost more than, shall we call them traditional items? For example, eco building materials like some insulations are much more costly than the traditional materials. Or more efficient appliances such as heating boilers cost more. What bugs me a little is, if our goal to is to reduce energy consumption, reduce CO2 or live more sustainably, then why are many things that could helps us so costly?
Two reasons come to mind as a management accountant. First, there may have been some capital costs incurred by manufacturers to produce newer and more sustainable products, which are included in the price. These costs may decrease over time as economies of scale creep in. A second reason is that although the costs may be higher, there may be savings to take into account. For example, an certain insulation maybe be twice the cost, but it can seriously reduce your heating bills over the several decades.
My colleague Michael Farrell has written a nice post explaining the dodgy accounting transactions at Anglo Irish Bank – the bank that was a big part of the Irish financial crisis in recent years.
Former executives from Anglo Irish Bank (“Anglo”) and Irish Life and Permanent (“ILP”) are alleged to have conspired to mislead investors by setting up a €7.2bn circular transaction scheme to bolster Anglo’s balance sheet in 2008.
The simplified debits and credits (from Anglo’s perspective) for the “circular transaction” as it’s being called are as follows:
1) Amount put on deposit with Anglo by ILP:
Dr Cash €7.2bn
Cr Customer Deposits €7.2bn (shown as a liability)
2) Amount “lent” to ILP by Anglo:
Dr Loans and Advances to Banks €7.2bn (shown as an asset)
Cr Cash €7.2bn
Per the above, the transaction is cash neutral, so what’s the big deal? The issue is that the €7.2bn recorded as a customer deposit with the bank would be (and was) incorrectly interpreted by the bank’s wider stakeholders as a measure of customer confidence in the bank.
So where do the accounting rules stand on…
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You may know that Ireland has been marking the centenary of the Easter Rising this year. There have been many events to mark the occasion all over the country. So, for what it is worth, I decided to write this short post on what accounting was like back then.
The first thing of note is that Eamonn Ceannt, one of the signatories to the Proclamation of a Republic was in fact an accountant. He worked in the city council, and according to an article in the Irish Times dated March 14, 1916, an Accountant in such a role earned £300-450. At this time not many accountants were actually professionally qualified as today.
Second, some useful insights are provided from a report of the AGM of The Institute of Chartered Accountants in Ireland – as reported in the Irish Times of May 22, 1916. The report notes that 82 members had enlisted for active service and were fighting on the European continent. The Easter Rising was condemned. The AGM report also notes an on-going wish to have the accounting profession legally recognised – something which was attempted in 1926, when the Irish Free State had been formed and began to enact its own legislation. It would not be until much later in 2003, that actual recognition was achieved. Finally, in a related point, the report notes the role played by Chartered Accountants in the calculation of excess income taxes to be paid to support the war effort. It is noted that the government of the time will likely not question any accounts or tax calculations prepared by responsible accountants.
You have probably heard about the amount of fruit and vegetables wasted in the food supply chain. This waste “occurs” for three main reasons. First, in less developed countries, poor transport and storage can result in waste. This also happens in larger developed countries, where distances mean fruit/veg cannot survive the trip. Second, the exacting standards imposed by retailers as to the size and shape of fresh fruit and vegetables causes growers to simply dump large quantities each year. Third, end consumers throw away perfectly good food.
Personally, I grow some fruit in a small suburban garden. We never but jam, as I make enough for the household for the whole year. We have 2-3 months worth of pears and apples, and some years the “leftover” fruit become wine – blackcurrant wine is quite nice. So, from a small say 10m2 plot, I can do all this and have zero waste. On a commercial scale, things are different. The waste is immorally high, primarily due to the exacting standards of retailers. I can tell you that the apples and pears I grow may be all shapes and sizes, but they taste so much better than anything I can buy in the supermarket – and my neighbours all agree.
To give a snapshot of how much perfectly good fruit and vegetables we waste each year as a race, National Geographic (March 2016) provides some stark numbers. In total, 53% of fruit and vegetables never makes it to the market – 20% is lost at the farm due mainly to exacting standards, 19% is uneaten and discarded at home, 3% lost in transit/storage, 2% lost in processing (canning/baking) and 9% discarded by wholesales and retailers. Add to this the resources used to harvest and prepare what is wasted – 70 times the oil lost in Deep Water Horizon and enough water to fill the Volga, and that’s just one year in the US alone. To add another number, the annual total food waste (all foods) could feed 2 billion people.
From these stark numbers, what can (management) accountants do? Recently, some documentaries on British TV featured vegetable growers saying the loose perhaps £100,000 per month worth of vegetables – assuming it could be sold at market price. Nowhere is this accounted for, not in their accounts, in supermarket accounts, in our national accounts (GDP). What if these accounts included the cost of waste? I’m sure if they did, we would all stand up and take notice.
Any student of management accounting (or management accountant) will be able to tell you about the costs/revenues which are relevant to decision-making. It is not very often a clear cut example appears in the media however.
One really good example is the cost of discontinuing Irish Water – a public water utility formed three years ago in Ireland. The utility has been plagued with political interference and has become the topic of much debate in political circles.
In late February/early March of this year, the utility became a bargaining tool in the formation of a new government. Media reports started to note how much it would cost to discontinue the utility. One reasonably good media report puts the cost at up to €7 billion – see the report here The report draws on internal Irish Water figures, which include the following costs and revenues:
- paying off staff
- sunk costs of €670 million – cost such as business systems and meter installation
- over €3 billion in benefits forgone – lost revenues and future cost savings over the term of the current 5 year strategy of Irish Water.
Including the sunk costs is incorrect, as sunk costs are not relevant to a decision such as this – well maybe they are for political circles! Including the future revenues and cost savings is correct. These are future savings/incomes which will be lost if the utility is discontinued. It seems wise to continue with the utility, as otherwise a lot of money will go down the drain – excuse the pun.
A few weeks ago, the annual Academy Awards took place. At some point in the run up to the awards, I found a nice post by Cheryl Meyer in the Journal of Accountancy. The post “5 films to inspire CPAs” was not only a reminder of some great movies, but also a reminder of the varying and broad role accounting and accountants play in society.
On favourite on the list is The Shawshank Redemption. If you have never seen it, do. The lead character Andy Dufresne (Tim Robbins) makes life a little more comfortable for himself while serving time through doing tax returns for prison officers and keeping accounts of the Warden’s corrupt dealings. The good accounting allows Andy to take all the corrupt cash for himself on his escape from prison.
My second favourite is The Untouchables. The model used to imprison Al Capone in this movie is still widely used today – get the criminals on tax laws or “lack” of earning to match their lifestyle. For example, the Irish Criminal Assets Bureau uses this concept quite effectively. I’m a big Sean Connery fan too!
The above headline appeared in an article in The Times recently. There is something fundamentally incorrect in what it says, which I detail below. Let me say first that I am bashing the article author or the paper, as most papers do such things when covering firm performance.
So what is wrong with above statement? Simply, it is the application of the accruals concept in accounting. Under this concept, revenues and expenses are matched, and when cash is received/paid is not relevant – at least in the calculation of profit.
Here is a simple example. Let’s assume a business sells goods for $1,000 cash but has not paid the supplier. The goods cost $600. The profit on this is $400. If the supplier is never paid, or is paid in 10 days, the profit will not change.
While the article is incorrect in terms of the title, it’s message is solid – that you can benefit by not paying people. In the simple example above, the business has $1000 in the bank.
The question of accounting for spare parts for assets (i.e. plant and equipment) is one which needs some judgement on the part of an accountant. Before outlining some options, let me describe one experience I had. I worked for a global paper company in the past and the policy to deal with such spares was as follows:
- spares bought with machinery were capitalised as items of plant/equipment and depreciated with the asset
- all spares bought at other times were treated as inventory.
Then, the company merged with another and they had a different policy in that only spares valued over $1000 per unit were inventory, all others were expense. I can recall the month this policy changed, the accounts had a few hundred thousand dollars extra expenses as the lower value inventory items were written off to the income statement.
In IFRS terms, there may be two standards at play, IAS 2 on inventories and IAS 16 on Plant, Property & Equipment. So how is it decided whether a spare part is inventory or treated as an item of PPE? The general consensus, although not specifically stated in any IFRS, is to treat higher value items as an asset and lower value items as inventories. If an asset, then the question arises if the spare should be depreciated. There is a good logical argument that a spare should not be depreciated until it is put in use, so it remains on the books at cost value with adjustment for any impairment. Whatever is chosen, the accounting policy probably should disclosed if the value of spares is material – and in large manufacturing concerns it can be.
Just to complicate things further, from my experience, maintenance staff may still want to have an inventory of some low value, but critical spares even if expensed. I have seen SAP being used to track the quantity of spares held, but with no value attached (as they have been expensed). A good example might be a control panel for a machine. It may be for example a small touch screen worth $300, and expensed in the accounts. But the machine cannot work without it, so it is good to know if a spare is in stock and where it is – the latter being important when perhaps another plant in the group has a spare on hand.
Finally, here is a nice tutorial on accounting for spares.