1. Financial Statement Analysis Case
Nokia (FIN) provided the following disclosure in a recent annual report.
Use of Estimates (Partial). The preparation of financial statements in conformity with IFRS requires the application of judgment by management in selecting appropriate assumptions for calculating financial estimates, which inherently contain some degree of uncertainty.... are areas requiring significant judgement and estimation that may have an impact on reported results and the financial position.
Revenue Recognition. Sales from the majority of the Group are recognized when the significant risks and rewards of ownership have transferred to the buyer, continuing managerial involvement usually associated with ownership and effective control have ceased, the amount of revenue can be measured reliably, it is probable that economic benefits associated with the transaction will flow to the Group and the costs incurred or to be incurred in respect of the transaction can be measured reliably. Sales may materially change if management’s assessment of such criteria was determined to be inaccurate. The Group makes price protection adjustments based on estimates of future price reductions and certain agreed customer inventories at the date of the price adjustment. Possible changes in these estimates could result in revisions to the sales in future periods.
Revenue from contracts involving solutions achieved through modification of complex telecommunications equipment is recognized on the percentage of completion basis when the outcome of the contract can be estimated reliably. Recognized revenues and profits are subject to revisions during the project in the event that the assumptions regarding the overall project outcome are revised. Current sales and profit estimates for projects may materially change due to the early stage of a long-term project, new technology, changes in the project scope, changes in costs, changes in timing, changes in customers’ plans, realization of penalties, and other corresponding factors.
Instructions
(a) Briefly discuss how Nokia’s revenue recognition policies are consistent with the revenue recognition principle. Evaluate both: 1. Sales. 2. Revenue from contracts.
Answer : 1. Sales
Nokia’s revenue recognition policies are consistent with the revenue recognition principle because Sales from the majority of the Group are recognized when the significant risks and rewards of ownership have transferred to the buyer and the amount of revenue can be measured reliably.
2. Revenue from contracts
Revenue from contracts involving solutions achieved through modification of complex telecommunications equipment is recognized on the percentage of completion basis when the outcome of the contract can be estimated reliably. Revenue Recognition Principle is when a company agrees to perform a service or sell a product to a customer and the company satisfies this performance obligation, it recognizes revenue.
(b) Briefly discuss how estimates inherent in Nokia’s revenue recognition policies can result in reported revenue numbers that are not relevant and faithful representations.
Answer :
Revenue recognition policies at Nokia are based on estimates of future price reductions, customer inventories, and project outcomes. In the future, these estimates may change, which could result in revisions to the previous period’s sales. This could make the reported revenue numbers less relevant, since they may not accurately reflect the economic reality of the transactions. The revenue estimates used to recognize revenue may also not be reliable, resulting in an inaccurate representation of the underlying transactions in the reported revenue numbers
(c) Assume that Nokia’s competitors use similar revenue recognition policies for their sales. What are some of the judgments inherent in applying those policies that could raise concerns with respect to the qualitative characteristic of comparability?
Answer :
There are some judgements inherent that could raise concerns about the qualitative characteristic of comparability, such as : current sales and profit estimates for projects may materially change due to the early stage of a long term project, new technology, changes in the project scope, changes in costs, changes in timing, changes in customers’ plans, realization of penalties, and other corresponding factors.
- Determination of the cost of product in order to determine the cost of goods sold - Research on competitors' selling prices for products with the same qualifications - Determination the profit margin level of the products to be sold
- Application of discounts for products sold - Timing of sale
Depending on these judgments, different revenue recognition methods can be used by competitors, which can affect financial statement comparability
2. The Caddie Shack Driving Range
William Murray achieved one of his life-long dreams by opening his own business, The Caddie Shack Driving Range, on May 1, 2015. He invested $20,000 of his own savings in the business.
He paid $6,000 cash to have a small building constructed to house the operations and spent $800 on golf clubs, golf balls, and yardage signs. Murray leased 4 acres of land at a cost of $1,000 per month. (He paid the first month’s rent in cash.)
During the first month, advertising costs totalled $750, of which $150 was unpaid at the end of the month. Murray paid his three nephews $400 for retrieving golf balls. He deposited in the company’s bank account all revenues from customers ($4,700). On May 15, Murray withdrew
$800 in cash for personal use. On May 31, the company received a utility bill for $100 but did not immediately pay it. On May 31, the balance in the company bank account was $15,100.
Murray is feeling pretty good about results for the first month, but his estimate ofprofitability ranges from a loss of $4,900 to a profit of $2,450.
Accounting
Prepare a statement of financial position at May 31, 2015. (Murray appropriately records any depreciation expense on a quarterly basis.) How could Murray have determined that the business operated at a profit of $2,450? How could Murray conclude that the business operated at a loss of
$4,900?
Answer :
1. Statement of Finansial Position May 2015
Caddie Shack Driving Range Statement of Finansial Position
May 2015
(In US Dollar)
Assets Equity
Cash 15,100 Capital 20,000
Building 6,000 Retained Earnings 1,650
Equipment 800
Liabilities
Ads. Payable 150
Utilities Payable 100
Total Assets 21,900 Total Equity +
Liabilities 21,900
*Retained Earnings = Accrual income – Dividend
= (4,700 – (1,000 + 750 + 400 + 100)) – 800
= 2,450 – 800
= 1,650 2. Murray Measurement of Profit $2,450
- Revenue $4,700
- Expenses
1. Land Rent $1,000 2. Ads Expense $750 3. Salary Expense $400 4. Utilities $100
Total $2,250
- Profit $2,450
3. Murray Measurement of Loss $4,900
- Revenue $4,700
- Expenses
1. Building $6,000 2. Equipment $800
3. Land $1,000
4. Ads Expense $600 5. Salary Expense $400 6. Personal Use $800
Total $9,600
- Loss $4,900
Analysis
Assume Murray has asked you to become a partner in his business. Under the partnership agreement, after paying him $10,000, you would share equally in all future profits. Which of the two income measures above would be more useful in deciding whether to become a partner? Explain.
Answer :
The income measure of $2,450 is most relevant for assessing the future profitability and hence the payouts to the owners. For example, charging the cost of the building and equipment to expense in the first month of operations understates income in the first month. These costs should be allocated to future periods of benefit through depreciation expense. Similarly, although not paid, the utilities were used to generate revenues, so they should be recognized when incurred, not when paid.
Principles
What is income according to IFRS? What concepts do the differences in the two income measures for The Caddie Shack Driving Range illustrate?
Answer :
IFRS income is the accrual income computed above as $2,450 (excluding depreciation expense.) The key concept illustrated in the difference between the loss of $4,900 and profit of $1,650 is the expense recognition principle, which calls for recognition of expenses when incurred, not when paid. Excluding the cash withdrawal from the measurement of income [the difference between income measures in parts (c) and (d)]
is an application of the definition of basic elements. Cash withdrawals are distributions to owners, not an element of income (expenses or losses).
Name : Aisyah Nuralam NIM : 29123362
