Thursday, June 3, 2010

Some Simple yet important terms

written down value (WDV)
Net book value of an asset computed by deducting the accumulated depreciation or amortization from the value shown in the account books (the book value).

Operating Expense or "OPEX"
A category of expenditure that a business incurs as a result of performing its normal business operations.For example, the payment of employees' wages and funds allocated toward research and development are operating expenses.

Operating Revenue
Income derived from sources related to a company's everyday business operations. For example, in the case of a retail business, inventory sales generate operating revenue, whereas the sale of a warehouse does not. Instead, the latter sale is considered to be an unexpected, or "one-time", event.
Also referred to as "regular revenue".

Operating Profit
The profit earned from a firm's normal core business operations. This value does not include any profit earned from the firm's investments.
Also known as "earnings before interest and tax" (EBIT).

Calculated as:
Operating Profit = Operating Revenue - Operating Expense


Substance over form:

When an entity practice the Substance Over Form, it means that the financial statements reflect the financial reality of the entity (Substance) rather than the legal form of the transactions and events(Form) which underlie them.To put it very simply: if it is a goat but it was disguised in a legal form to look like a dog, Substance Over Form would prevail to reinstate that it is a goat and not a dog!

To be able to differentiate Substance Over Form, we need to be vigilant, have very good inner knowledge of the company’s operation and takes a more investigative in-depth approach so as to seek further evidence or proof. This is because normally these types of events or transactions are often quite complex. These events or transactions happen just around the accounting year ended. (balance sheet date)

We have seen many cases whereby many accounting fraud occur as a result of this lack of Substance Over Form.

Cases like Enron and Computer Associate are describe below:

Examples:Exchanging revenue/revenue swap:

In the Computer Associate case, the CEO of the company swap or exchange revenue with another company. What it did was CSA purchased a certain software/service from the company A and in turn company A also purchased from CSA. Its look like a sale and it being recognized as revenues in the Income Statement

In the Enron’s case we have:

Enron group’s use of over 3000 Special Purpose Entities (SPEs) structured in such a way as to enable the company to avoid including extensive debt in the consolidated financial statements of the group.

Other examples like:-
Company itself fund its own revenue

An outright purchase of capital equipment, whereas in fact the substance of the transactions is a lease of (or perhaps an option to purchase) the equipment.

Accrued and deffered cost:-

Accrued costs are costs for services or materials received, but for which payment has not been made. Example - you order 1600 cubic yards of concrete. It is delivered to your site in 16 weekly increments of 100 cubic yards. You receive a bill at the end of the 16 weeks. The accrued cost reflects the cost of concrete delivered in a reporting period prior to receiving the bill. This is money that should be set aside (and costs to balance against earned value for the material).

Deferred cost are for services or materials not yet received, but for which payment has been made. Example - you purchase a plane ticket 6 weeks before a planned trip. The cost is incurred, but reporting may be deferred until the trip is made and value is earned.

Difference b/w prepaid and deffered expenses:-

prepaid expenses are those which we pay in advance! like rent of a building , its a prepaid expense . we first pay the rent and then use the building whenever we need.
deffered expenses are those which have been accumulated and are not paid yet. for example if we do not pay the rent of the building for 5 months , so it has been deffered means accumulated!

A prepaid expense usually relates to a specific time frame, like pre-paying rent as mentioned above. Whereas a deferred expense may not have a specific time frame in which to be recognized. It might even be a partial expense which will continue to increase (whether actually paid or not) until the time comes when it will be amortized. An example might be costs associated with the acquisution of a business or product line. Those costs might continue to accrue as deferred expenses for months (or longer) until the transaction is complete and revenues begin to flow.

Gross and Net

Gross is the profit from the transaction without deduction. Net is the profit from the transaction after deducting cost of goods and cost of the sale (manpower, taxes, rent, etc.)

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