Accounting Minefields

Group Members:

Chandrasekhar (15F315)

Debashish (15F316)

Prateek Chaubey (15F335)

Satyabrata Pani (15F344)

Durgesh (15F416)

Minefield 1: Revenue Recognition and Measurement

It tells about how the revenue is defined and how it should be measured. Some companies define revenue as the entire amount of sale and some companies only take the commissions that are received by them as revenue. These two methods can create huge differences in the financial statement figures. Companies that are not into production business but show the entire value of sale as their revenue follow aggressive accounting practices. Generally it is followed by companies facing continuous decline in commission receipts or new companies those who want to show huge growth in revenues.

Revenue should be only measured when it has actually accrued and matching concept should be applied. That is revenue received for a period exceeding one accounting year should not be treated entirely for that year, and it should be spread over accordingly. Unearned revenues should not be treated as revenues.

Minefield 2: Provisions for uncertain future costs

Companies must make provisions for the costs or losses that may arise in the future, even if they do not have a best estimate, such as inventory obsolescence, bad-debts, product returns, restructuring costs, warranty expenses and other loyalty reward programs. Generally companies do not take these expenses into provision which gives an inflated income statement. Similarly overstated restructuring costs when reversed give a boost to the Income statement. But it is not disclosed which also is not an actual profit. The idea is to isolate the effect of non-recurring expenses in the income statement. Companies also park some profits in their statements as a reserve to offset against any decrease in earnings in the future.

Minefield 3: Asset Valuation

Companies try to revise the useful life of assets thereby altering the value of depreciation which impacts the value of the asset. Some companies also look to modify the value of assets by accelerating the write-off on R&D or accounting R&D as an investment. All these practices are carried out with the aim to project better earnings for the company.

Minefield 4: Derivatives

Derivatives are used to hedge risk & stabilize cash flows for a firm/company. But a good understanding of derivatives & the right assessment of risk involve is extremely necessary before jumping into transactions involving derivatives. On one hand where Derivatives help in hedging risk, it also can cause tremendous losses (especially Forwards/Futures) as in the case of Metallgesellschaft, who tried to hedge their future transactions (sell) using derivatives (probably forwards) but they indeed suffered huge losses as the oil prices moved in direction to opposite of what they had anticipated.