Command Palette
Search for a command to run...
Accounting
Accruals & Revenue Recognition
Understanding the timing difference between cash and economic events
Overview
This module explores the fundamental difference between cash-basis and accrual accounting. The core insight is that change in wealth ≠ change in cash. Accrual accounting captures economic reality by recognizing income when earned and expenses when incurred, regardless of when cash changes hands.
Key Concepts
The Timing Mismatch
Cash flows and economic events rarely occur simultaneously. Accrual accounting bridges this gap by creating assets (receivables, prepayments) and liabilities (payables, unearned revenue) to track economic value.
Four Accrual Categories
Master these four scenarios: (1) Accrued Liabilities - expense before cash out, (2) Accrued Revenue - revenue before cash in, (3) Prepayments - cash out before expense, (4) Unearned Revenue - cash in before revenue.
Revenue Recognition Triggers
Revenue is recognized when performance obligations are satisfied, NOT when cash is received. Under IFRS 15, contracts must be analyzed for separate performance obligations.
The Five-Step Model (IFRS 15)
Identify contract → Identify obligations → Determine price → Allocate price → Recognize revenue. This unbundling can significantly change WHEN revenue hits the income statement.
Events After Reporting Period
Adjusting events (conditions existed at year-end) require financial statement changes. Non-adjusting events (arose after year-end) only need disclosure if material.
Key Formulas
Interest = Principal × Rate × (Days/365)Revenue per period = Total prepayment × (Period used / Total period)Key Takeaways
- •Cash accounting is simple but misleading - it fails to show true economic performance
- •Accrual accounting creates balance sheet items (assets/liabilities) to track timing differences
- •Revenue recognition has become more complex under IFRS 15 - always look for multiple performance obligations
- •The income statement and cash flow statement serve different purposes and rarely match
Common Mistakes
- •Recording revenue when cash is received instead of when earned
- •Forgetting to accrue expenses at year-end (wages, utilities, interest)
- •Not unbundling contracts with multiple performance obligations
- •Confusing adjusting vs non-adjusting events after year-end
Fixed Assets & Depreciation
Capitalisation decisions and cost allocation over time
Overview
This module covers how to account for long-lived tangible assets. The key decisions are: (1) Should we capitalise or expense? (2) How do we allocate the cost over time? Remember: depreciation is cost allocation, NOT valuation. The book value of an asset rarely equals its market value.
Key Concepts
Capitalise vs Expense Decision
Capitalise if: (1) benefit is quantifiable, AND (2) from past transactions. Capitalisation increases assets and spreads expense over time. Expensing reduces current profit immediately.
What Goes Into Asset Cost
Include ALL costs to acquire and prepare the asset: purchase price + transportation + installation + testing. For self-constructed assets, capitalize interest on construction debt.
Depreciation Is NOT Valuation
Depreciation allocates cost over useful life - it doesn't track market value. Net Book Value = Cost - Accumulated Depreciation. This is an accounting number, not what you could sell it for.
Method Choice Matters
Straight-line = constant expense. Accelerated (DDB, SYD) = front-loaded expense. Units of production = usage-based. Same total expense over life, but different timing affects ratios and comparability.
Impairment Asymmetry
US GAAP: Write down if impaired, NO reversal allowed, NO upward revaluation. IFRS: Write down if impaired, reversals possible, upward revaluation to equity reserve permitted.
Key Formulas
Depreciation = (Cost - Salvage) / Useful LifeDepreciation = NBV × 2 × (1 / Useful Life)Gain/Loss = Proceeds - Net Book ValueAge ≈ Accumulated Depreciation / Annual DepreciationKey Takeaways
- •Companies prefer capitalisation because it increases current profits (expense is spread out)
- •Depreciation method and estimates (life, salvage) involve management judgment - be skeptical
- •Total P&L impact over asset life = Original Cost - Proceeds, regardless of depreciation method
- •Impairment charges are often a sign of overly optimistic prior assumptions
Common Mistakes
- •Thinking depreciation represents the asset's decline in market value
- •Forgetting to stop depreciating when NBV reaches salvage value (for DDB)
- •Not updating estimates when circumstances change
- •Ignoring the impact of depreciation policy differences when comparing companies
Intangible Assets & Cash Flows
The hidden value problem and understanding cash generation
Overview
Intangible assets often drive the most value in modern companies (think Apple, Google), yet accounting rules make most of them invisible on the balance sheet. This module explains why internally-generated intangibles are NOT recognized, how goodwill arises from acquisitions, and how to read and prepare cash flow statements.
Key Concepts
The Intangibles Paradox
90% of S&P 500 market value is intangible, but most doesn't appear on balance sheets. Why? Internally-generated intangibles (R&D, brands, talent) fail the reliability test - cost ≠ value.
Internal vs External Recognition
Externally ACQUIRED intangibles → Recognized at cost. Internally GENERATED intangibles → Generally expensed (exceptions: IFRS development costs, software post-feasibility).
Goodwill = The Plug
Goodwill = Purchase Price - Fair Value of Net Identifiable Assets. It represents synergies, reputation, market position - things we can't separately value. Only exists when acquired.
Definite vs Indefinite Life
Definite life → Amortise over useful life. Indefinite life (brands, goodwill) → No amortisation, but annual impairment testing required.
Cash Flow Statement Structure
Operating (core business) + Investing (long-term assets) + Financing (debt & equity) = Change in Cash. The indirect method starts with Net Income and adjusts for non-cash items.
Key Formulas
Goodwill = Purchase Price - FV of Net Assets AcquiredNet Income + Depreciation ± Δ Working Capital = CFOCash from Customers = Sales - Δ ReceivablesKey Takeaways
- •Book value is increasingly disconnected from market value due to unrecognized intangibles
- •Acquisitions are the main way intangibles get on the balance sheet (as goodwill)
- •Large goodwill balances mean the company paid a premium - watch for future impairments
- •Cash flow from operations is often more reliable than net income for assessing performance
Common Mistakes
- •Assuming book value represents what the company is worth
- •Forgetting that R&D expense today could be tomorrow's valuable patent
- •Ignoring that goodwill impairment is a lagging indicator of overpayment
- •Confusing operating vs investing cash flows for interest and dividends
Liabilities & Debt
Understanding obligations and the time value of money
Overview
Liabilities represent future sacrifices arising from past transactions. This module covers the spectrum from certain obligations (bonds) to uncertain ones (contingencies), with special focus on bond accounting. The key insight: interest expense ≠ interest paid when bonds are issued at premium or discount.
Key Concepts
Certainty Spectrum
Most certain (notes payable) → Less certain (accounts payable) → Estimated (warranties) → Contingent (lawsuits). Treatment varies from full recognition to footnote disclosure to ignoring.
Contingent Liability Treatment
Remote → Ignore. Possible → Disclose only. Probable AND estimable → Recognize provision. The threshold assessment involves significant management judgment.
Bond Pricing Fundamentals
Bond Price = PV of Coupons + PV of Principal. If Coupon > Market Rate → Premium. If Coupon < Market Rate → Discount. If Coupon = Market Rate → Par.
The Effective Interest Method
Interest Expense = Market Rate × Net Book Value (NOT coupon × face). The difference between expense and cash payment amortises the premium/discount over time.
Convertible Debt Complexity
Under IFRS, split into: (1) Liability component at PV using straight debt rate, (2) Equity component as residual. This affects both balance sheet and interest expense.
Key Formulas
Price = PV(Coupons) + PV(Principal)Expense = Market Rate × Beginning NBVAmortization = Interest Expense - Cash Interest PaidGain/Loss = Net Book Value - Repurchase PriceKey Takeaways
- •Long-term liabilities are shown at present value; current liabilities at face value
- •Premium bonds → Interest expense LESS than cash paid (expense decreases over time)
- •Discount bonds → Interest expense MORE than cash paid (expense increases over time)
- •Debt covenants can significantly constrain management - always check compliance
- •Early redemption gains/losses reflect changes in interest rates since issuance
Common Mistakes
- •Using coupon rate instead of market rate to calculate interest expense
- •Forgetting that total interest over bond life is the same regardless of premium/discount
- •Not understanding that early redemption gains may come with higher refinancing costs
- •Ignoring covenant compliance when assessing financial health