This article talks about the changes to the LIFO Accounting method, which Obama Administration is considering.

The Obama administration has scoured the tax code looking for “loopholes” to close to generate more revenue. According to, The New York Times, Barack Obama describes the “last-in, first-out” rule of inventory accounting as “arcane”. However but it will be a critical problem for businesses if the decade-long tax rule gets changed.  Instead of using the last sale price of inventory as a cost basis to determine taxable profit, the elimination of the LIFO rule will create accounting headaches that will impact smaller businesses most.

The effect of the accounting change would be significant, and in pushing for it Mr. Obama has kicked a hornet’s nest. Lobbyists from companies of all sizes are swarming around Congress to kill the proposal, which would prohibit the use of an accounting technique known as last in, first out, or LIFO which is used to determine the cost of goods sold, and therefore the income earned, by a company.

By eliminating LIFO accounting technique, Obama Administration has projected to raise $65 billion to $95 billion over 10 years. This would increase the taxable income and tax liability of companies that have been using this method of accounting for decades. Small businesses, manufacturers, wholesalers, retailers and oil companies would be especially hard hit as a result of this change.

The president’s proposal would also undo the tax benefits that companies have obtained by using the LIFO method of accounting over the years. The government would tell companies that they must go back and recalculate the tax savings they have claimed for decades. The proposal requires that tax be paid on long-deferred gains with the provision that the tax could be paid over a period of 10 years.

In moving forward with this accounting change, the administration needs to consider the overall impact it will have on the businesses and indirectly on the US economy.

Rite Aid Turns a Corner

Rite aid posted its first quarterly profit in 5½ years, as shoppers filled more prescriptions and stuck around to buy more incidentals in renovated stores. Shares jumped 18%, or 19 cents, to $1.24 in recent trading as investors were cheered by the news. Rite Aid, which also offered an improved fiscal 2013 per-share earnings target, last reported a profitable quarter in summer 2007.

The company’s firmer footing can be attributed to several factors. Rite Aid has cut costs and refinanced billions of dollars in debt. Rite Aid’s results have also been bolstered by the retailer’s loyalty program rollout and store renovations under a new format that expands clinical pharmacy services and offers more health and wellness products. Rite Aid remodeled 114 stores during the latest quarter and has in total converted 687 locations into the new wellness format. Rite Aid’s results have also been helped by a jolt in the number of prescriptions the company filled at its stores after millions of customers transferred their prescriptions when Walgreen exited pharmacy-benefits manager Express Scripts Holding Co.’s network at the beginning of 2012.

For the quarter ended Dec. 1. 2012, Rite Aid reported a profit of $61.9 million, or seven cents a share, compared with a loss of $52 million, or six cents a share, a year earlier.

Since 2007 Rite aid has recorded net losses. Rite Aid, using LIFO method, hasn’t needed to pay tax or dividends, since they haven’t had net income for a while. However, investors were not happy about Rite Aid’s performance. Due to several reasons the article previously mentioned, Rite Aid restarted to record net income instead of net loss.

http://online.wsj.com/article/SB10001424127887324461604578191231912454290.html

June 2002, Microsoft settled with the Securities and Exchange Commission regarding allegations of misstating its financial statements by managing earnings, according to the Wall Street Journal.  In this settlement, Microsoft neither denied nor admitted to any wrong doings but agreed to abide by the S.E.C. rules going forward; and the company did not face any fines.  The S.E.C. investigation, which started in 1999, was focused on the company’s reserve practices during fiscal year 1994 to 1998 that may have materially  misrepresented its earnings, the so-called “cookie jar” accounting.

“Cookie jar” accounting is a non-GAAP accounting method which allows management to manipulate the company’s bottom line to smooth out the earnings from period to period by using reserves.  Although there are strict guidelines for when and how to recognize revenues, there are also flexibilities to the rules that the managers can manipulate in order to maintain smoother earnings trend.  Specifically for Microsoft, setting higher reserves for returned software or bad debt accounts during well performing quarter (understating earnings) and then reversing the reserves during an underperforming quarter (overstating earnings) can result in a smoother upward trend of earnings.

Moreover, due to Microsoft’s multifaceted nature of licensing agreements, revenues from these licensing business are deferred to match the life time of the agreements.  Since Microsoft had billions of dollars of unearned revenue in its liabilities accounts, the company can understate or overstate its revenues if revenue recognition methods used are not compliant to GAAP.

These types of illegal accounting practices are usually serious violations which can result in large fines and other disciplinary measures for fraud.  However, the S.E.C. did not allege fraud for Microsoft because, unlike other cases, the company had understated its earnings.  Additionally, the investigation was unable to find any evidence of intent to reverse the reserves to overstate its earnings.  One example of a company charged with fraud under the same “cookie jar” accounting method is Xerox.  In 2002, Xerox was fined $10 million and revised its financial statements back to 1997.  The S.E.C. charged Xerox of setting high reserves during better performance years and then reversed the reserves to overstate its earnings during lower performance years which artificially inflated its revenues by $2 billion since 1997.

These types of violations of accounting rules will always be difficult to identify because the estimates of, say, bad debt or returned merchandise, are, to a large extent, subjective judgment calls by the management.  Thinking about accounting in this way makes accounting much more complex than just a quantitative study of transactions as would a beginning student of Accounting may have supposed.

Microsoft continues to branch out of the PC world; a new Xbox is due to be released for the holidays and the new Surface Pro will ship in March.  Yet, the WSJ recently described a new product, created by Microsoft and the NYPD designed to fight crime! (NYPD, Microsoft create crime-fighting tech system).

This futuristic Person of Interest style system uses over 3,000 security cameras, license plate records, portable radiation detectors, 911 calls, and arrest records to give police real-time information of the crime scene they are running towards.  In fact, it was already successfully used last August when a gunman opened fire outside the Empire State Building.  Without the system providing data suggesting only one shooter, the police would have initially concluded there were multiple gunman, based on 911 calls, and would have approached the situation differently, which is a life or death decision.

The NYPD has been working with Microsoft since 2009 to create the system, at a cost of $30-$40 million dollars.  However, if Microsoft can identify a target market, New York City would get 30% of every sale.

What is interesting to me (besides the obvious fact of science-fiction again becoming reality), is how we will have to start comparing Microsoft’s earnings once this super-hero computer system hits the market.  Assuming analysts’ trepidation is proved foolhardy, this system could provide extremely large revenues per individual sale, whether to major cities, smaller municipalities, or even large stadiums that routinely house sporting events and concerts.  Adjusting Microsoft’s earnings with non-GAAP adjustments will become imperative to see the true impact of this system (and the new Xbox and Surface tablet) has on their bottom-line.  As time goes on, and these products become part of their normal operations, adjustments will become less necessary, but for now and the immediate future, it will be difficult ascertain Microsoft’s normal operating results with the launch of new (and unusual) products.

That and it’s just flat out cool.

Revenue Recognition:

Revenue recognition is one of the four main principles in the US Generally Accepted Accounting principles (GAAP) which refers to how revenue is treated or recognized. Every company has to report their revenues. So what is revenue? Revenue is the total money, which a company receives for the goods or services it provides.  So revenue is calculated by multiplying the price at which goods or services are sold by the number of units or amount. There few conditions under which revenue can be recognized. However, the two primary conditions are 1) The goods have been sold or a service has been rendered 2) There is some kind of assurance of the payment

In cash accounting, revenues are recognized as soon as the cash is received because cash is the only form of revenue that is possible. In accrual accounting, revenues are recognized as soon as the sale is made even if the cash is not received upfront. Generally the accrual accounting method is used by most of the companies as the cash is not received immediately after the sales are made.

There are two ways to report your revenues. The first one is the Gross Revenue Method. Calculating the revenue at gross means that you are actually recording all the revenues of the company on the income statement. In this method, the cost of sales and the cost of goods are reported separately. For example, if a company sells 10 pieces of a product for $100 each, then the revenues reported by the company by using the gross method will be $1000. Companies can also report the revenues by using another method called the Net Revenue Method. Calculating revenue means that you are actually recording only a commission on your net amount on your income statement. Even if there is no commission as such, a company can still report revenues at net by netting the amount sold to customers against the amount paid to the suppliers. Obviously, as only the net amount is shown in the second method, revenues reported by Net method will always be lower than revenue reported by Gross method for the same company. No matter which method a company chooses to report its revenues, its Net Income will be the same. Just the top line revenue figures of the company will be different.

The SEC has given some guide lines which the companies should use in deciding whether they should report their revenues by Gross method or by Net method. But these are just guidelines and not obligations. So companies are free to choose the way in which they report their revenues on the income statement. Due to this, analysts are having a hard time comparing companies in the same business as they use different methods of reporting revenues. One has to be really careful while looking at revenues of a company, as the revenues can be overstated by using a particular method which may be miss leading to an investor.

Reference:  http://en.wikipedia.org/wiki/Revenue_recognition,

http://www.buzzle.com/articles/gross-vs-net-revenue.html

Hi Everyone,

Not sure if any of you have heard of the Planet Money podcast, but I’m a bit obsessed. I heard a great episode the other day about the Birth of Accounting and thought you might enjoy. It has definitely given me a new appreciation for double-entry accounting.

http://www.npr.org/blogs/money/2012/09/28/161948981/episode-407-a-mathematician-the-last-supper-and-the-birth-of-accounting

Enjoy,

Karen

A recent Wall Street Journal article,  explained that more than 65% of mobile-equipped travelers waited until 2:00pm on December 31st to book a New Year’s Eve hotel room. Out of these travelers who used the Priceline.com mobile app to snag a hotel room on New Years’s Eve, 42% waited until 5:00pm, while a remaining 13% risked the wait and booked after 9:00pm.

These numbers come from a Priceline.com study which suggests that many travelers, often who are already in their destination cities, will use their mobile devices to make travel reservations in the last minute.

John Caine, priceline.com’s Chief Product Officer says that, “Travel apps like Priceline can be game changers for hotels on holidays like New Year’s. It gives them that one more shot at selling last-minute rooms to mobile-equipped travelers who already may be in, or close to town, having dinner, clubbing, or watching the fireworks.”

Priceline.com gathered their data by looking at bookings made through its Priceline app and its Tonight-Only Deals service for the app. This app allows travelers to find hotel discounts up to 35% or more for check-in that night. This service differs from Priceline’s Name Your Own Price, since every Tonight-Only Deal shows the exact hotel one can book, along with the specific location and pictures.

This is great advice for anyone looking to book a cheaper hotel room and is willing to take a little risk.

For more information check out the article, “Now That’s Last Minute: New Priceline.com Study Shows That Almost Half Of Mobile-Equipped Travelers Waited Until After 5:00 P.M. To Book Their New Year’s Eve Hotel Rooms” at http://online.wsj.com/article/PR-CO-20130128-909129.html?mod=crnews

On Wednesday, February 13th my group discussed Priceline.com, its main businesses and the way this company chooses to report its revenue. During our presentation we mentioned regulations and guidelines provided by the SEC on the matter of what methods could be used when it comes to the revenue recognition. I decided to write a blog in regards to the recent developments in the new regulation implementations. After reading an article “Revenue recognition: time for early-stage planning”, I would like to share with the rest of you some recent developments in regards to the revenue recognition regulations.
According to the article, even though the final corrections to the current rules haven’t become official yet, it is important that the company across all industries begin preparations for the upcoming changes by reviewing its existing long-term contracts, studying new models and figuring out potential implementations on the business, as well as planning for the potential expenditures that the new regulations may bring.
In accordance with the FASB new proposal, “The standard is being designed to facilitate global comparability as well as consistency in reporting between industries. It also will result in a significant decrease in the industry-specific guidance that U.S. companies are used to”. The article mentions potential benefits and flaws the new regulations bring to the table. In my opinion, while it will be easier for the financial analyst to find his way around the statements provided by the companies across multiple sectors due to lack of diversity in reporting, it will become more difficult to recognize specific features that a particular sector may possess.
The article mentions a perfect example, which supports my concern. Currently, telecommunication companies across the board offer discounted handsets when the customer resigns the membership contract and/or is eligible for an early device upgrade. At this stage, the way the revenue gets reported should contrast the way it would get reported should the company sell the device at full price. While the editor of this article believes that the upcoming changes are inevitable and the companies should just prepare for them accordingly, I believe that a strong case may be made in support of introducing general regulations within each sector instead of applying them across all of the industries. That way it will become easier to compare similar companies without affecting the reporting for companies in other sectors.
For those that are interested in pursuing future career opportunities within the accounting firms it may be useful to keep up with the developments regarding revenue recognition regulations considering that those changes should affect an entire industry. I hope that this article will help shed some light on the revenue recognition rules for those of us that would like to stay up to date on this important aspect of financial accounting. The link for the article can be found below.

Article: http://www.journalofaccountancy.com/News/20137165.htm

“The Price Isn’t Right” by Detlef Schoder (http://online.wsj.com/article/SB10001424052970203922804578080693320969644.html?mod=WSJ_qtnews_wsjlatest) is a very interesting article regarding online retailers profit model and how it can be taken advantage of via extreme bargain hunters.

The article concedes that every consumer is looking for the best bargain possible, which isn’t exactly breaking news but Schoder puts an interesting spin on current retail or deal sites like Priceline which is the rise of deal site deal sites. No, that was not a typo. These are sites specifically for consumers to point out the best deals on other deal sites. Sites like SlickDeals, DansDeals and even Kayak that track the best deals on the net and post them to their following base. This poses an interesting situation for sites such as Priceline whose profitability resides in the margins (which would be cut into if algorithmic models for best deals are made public).

Schroder poses eight potential solutions to this problem:

One would be to actively monitor sales/transaction data, so if you see a spike in one of your offerings you may be able to tie it to a Deal Site Deal Site posting and squash the deal.

Two,  ’embrace but try to limit these bargain hunter’s’.

Three, bundle different services making price gauging more difficult due to the inability of the consumer to determine the price of each individual good. Which I think is probably the best route to decrease extreme bargain hunters.

Four, ‘Control the Sales Network’. Priceline has no advantage here. If somebody else (Orbitz, Expedia) isn’t going to sell Delta’s tickets another Delta will themselves.

Five, ‘Ban online customers who repeatedly eat into your profit margin’. This may seem like a good idea for a site like Priceline but would most definitely aggravate their customer base and go against their business model about being a site for deal seekers.

Six, ‘Clear the Market’

Seven, ‘Offer Discounts Through Intermediaries Who Hide The Brand’. This is what Marriot, Delta, and Avis use Priceline for; not the other way around.

Eight, ‘Reshape the Landscape’, this is where Schroder goes into detail about how Priceline routinely switches up its zoning of hotels for the name your own price feature making it difficult for consumers to ‘crack the code’ and find the best possible deal. The spokesman for Priceline acknowledges that they are not trying to discourage users from getting great prices but that they must protect their other customers, the hotels, at the same time. This puts Priceline right in the middle as to whom to best cater. It makes sense to ride the middle here so that your customer base can still get great deals but that the best deals may be hard to find so as a company you don’t alienate your wholesalers and you also continue to make a profit.