Lesson 5 of 7 · 15 min
Accounting choices and estimates that manage earnings and the balance sheet
Accrual accounting needs judgement about timing, methods and estimates, and every judgement can be pushed in the direction management wants without breaking a rule.
In short
- Timing of revenue: FOB shipping point lets a seller recognise revenue when goods leave the dock; FOB destination delays it until arrival. End-of-period shipments can pull revenue in or push it out.
- Methods: inventory cost flow (FIFO vs weighted average), depreciation method (straight-line, accelerated, units of production) and capitalisation policy.
- Estimates: allowance for uncollectible accounts, valuation allowance on deferred tax assets, useful lives and salvage values, warranty and rebate reserves, fair values in acquisitions and goodwill impairment tests.
- Every amount capitalised is an amount not expensed this period.
- In acquisitions, a low fair value for depreciable assets cuts future depreciation and pushes more of the price into goodwill, which is not amortised.
- Warning areas: channel stuffing, bill-and-hold sales, rebates, multiple-deliverable arrangements, inventory reserves and LIFO liquidations, warranty reserves and related-party transactions.
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