Cases Summaries - Accy 401, Emba - Verona Springs Mineral Water

The University of Illinois Executive MBA

Case Summaries

Accy 401, EMBA; Fall 2000

Accounting courses are usually separated into five general categories. Two, taxes and auditing, are usually quite technical and often focus on CPA preparation. The other three categories are more general:

1. Financial accounting deals almost strictly with financial statement preparation. It focuses on pronouncements issued by the Financial Accounting Standards Board (FASB) and the SEC, and on accounting concepts such as materiality, matching revenues and expenses, relevance, and consistency. It also considers highly technical details about consolidated financial statements, leases, pensions, income taxes, and inventory valuation methods that are often found on the CPA exam.

2. Financial accounting from a management perspective covers many of the same topics as financial accounting but it does so from the view of a manager using financial accounting information to help make decisions or to report an organization's performance to others. This is the typical focus of an MBA financial accounting course, or a financial accounting course in a non-degreed program for executives. It is the primary focus of Accy 401, EMBA.

3. Cost and managerial accounting deals almost exclusively with accounting as a tool to help manage and understand a business. These courses focus on areas such as fixed and variable costs, how costs behave over time (e.g., the learning curve), cost systems, and ways to allocate fixed costs to products or product lines.

These courses also consider how cost information influences organizations. For example, firms with multiple divisions often sell products between divisions. The price one division charges another, the transfer price, has a major effect on how each division operates. Transfer prices are a common source of friction between divisions. There is no ideal transfer pricing system, but some are far worse than others.

This course deals with financial accounting from a management perspective; your next accounting course deals almost exclusively with cost and managerial accounting. Many of the financial accounting cases, however, are broad enough to cover more than one aspect of cost or managerial accounting. The following case summaries separate the topics each case covers into the above three categories

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Verona Springs Mineral Water

Financial Accounting:

This case demonstrated the basics of double entry bookkeeping. That topic includes journal entries and how journal entries are used to create a ledger of the firm's accounts. The case also demonstrates how the two basic financial statements, the income statement and balance sheet, are prepared from the ledger. It then covered how the statement of cash flows is prepared from the balance sheet.

The case covered the idea that costs can either be capitalized or expensed. It also covered the idea that most capitalized costs are eventually expensed, with land being the typical exception). It also introduced the idea that by expensing and item rather than capitalizing the item, a firm lowers its net income in the current period. By capitalizing the item, a firm would show higher net income in the current period, but lower income in each of the future periods when the capitalized expense is depreciated (fixed assets), amortized (intangible assets), or depleted (mineral assets such as oil or gold).

When considering whether to capitalize or expense an item, we considered two accounting concepts: the concept of matching revenues with expenses and the concept of materiality. For example, the well was clearly an asset that would have future value, but its value was low enough that it was reasonable to expense so as to avoid record keeping costs.

Financial Accounting from a management perspective:

The case is primarily a technical introduction to financial accounting, but it did introduce the idea that the user should look at accounting numbers with some skepticism. For example, the income statement did not include any cost for setting up the company, no costs for utilities, and no cost for the owner's salary. In addition, the income statement included interest expense for two months expense even though the firm had only operated its equipment for one month. In addition, the income statement included the cost of drilling a well that would last for ten years.

Cost accounting and managerial accounting:

The case introduced fixed and variable costs. For example, depreciation expense and interest expense are fixed costs that only change if there is a major change in production volume. Thus, if the firm doubled its sales its income would more than double. That is, revenue would double, variable costs such as supplies, labor, and shipping would double, but fixed costs would remain unchanged.

This case introduced the idea of account numbers that can be used to separate revenues and costs into great detail without much work on the part of accountants, so long as a well-designed system is in place. That is, a company may record its travel and entertainment expenses in account number 2118. Suppose the expense is incurred at the company's speed switch subsidiary (subsidiary 18), at the Dallas office of that subsidiary (location 05), by a salesperson whose code is 16. The company might debit account 18-10-16-2118. With a well-designed accounting system, the company could then determine travel and entertainment expenses by individual, by location, by subsidiary, or for the entire company.

Chemalite

Financial Accounting:

This case again demonstrated the basics of double entry bookkeeping and how financial statements are prepared from journal entries. It also introduced the idea of research and development costs. Since 1971 the FASB has required that companies expense R&D costs. As with Verona Springs,

This case also briefly introduces revenue recognition. Chemalite has a firm order in hand but has not yet shipped the goods and wonders whether to recognize revenue. We discussed the idea that a firm must have completed the process by which it adds value to it product, which usually, but not always, includes shipping the good to a customer or completing the service. It must