Skip to main content

Accounting Issues: Part VI


The other central document of accounting is an income statement.  This represents a period of time, rather than the moment-in-time of the balance sheet. If all is working properly, the income statement should give investors an idea of the underlying processes that have made the present condition of the company what it is.

 

We won’t spend a lot of time on the income statement, simply because much of what we might say about it we’ve already said. The issues that arise in compiling an income statement look familiar to anyone who understands the latest balance sheet. 

For example, the expenses part of an income statement should indicate the costs of goods sold (COGS), that is, the costs directly attributable to such of the goods that have gone out the door in the hands of a customer over the past year or quarter, separately from all the other costs, especially the “general and administrative expenses.”

The issues that arise when valuing COGS are the same issues that arise when valuing  inventory in the preparation of the balance sheet, and we’ll say no more about them here.

Likewise, the issues that arise when we try to determine the amount of a year’s or quarter’s depreciation, in the expenses portion of the balance statement, are the same issues that we mentioned when we discussed the value of the equipment itself, as an asset on the balance sheet.

Then there is the bad debt expense. Some of the people to whom I extended store credit will never pay me back. I could hire a collection agency, but that may in many cases be a larger expense than it’s worth. So, suppose I just write them off after a certain period of time has passed. That’s a bad debt expense on the income statement, and it is a charge to the receivables account on the balance sheet.

I should be recovering my overhead costs from the pricing of my product. If I’m not, then I’m running a going-out-of-business sale. But if I am recovering the costs of overhead (our conveyor belt), I am liquidating that conveyor belt. It is turning year by year from a tangible asset into cash: enough cash to be used to buy another conveyor belt in due course.

Expenses (and losses) raise some convoluted issues of recognition and valuation. A critical point is that a business can’t wait until it has to pay some sum of cash before it records an expense. The expense may be incurred long before that, or it may not be incurred until sometime thereafter.

Because expenses may be incurred (they may accrue) before any payment must be made, accountants have to live with uncertainty.
Labels:

Comments

Post a Comment

Popular posts from this blog

A Story About Coleridge

This is a quote from a memoir by Dorothy Wordsworth, reflecting on a trip she took with two famous poets, her brother, William Wordsworth, and their similarly gifted companion, Samuel Taylor Coleridge.   We sat upon a bench, placed for the sake of one of these views, whence we looked down upon the waterfall, and over the open country ... A lady and gentleman, more expeditious tourists than ourselves, came to the spot; they left us at the seat, and we found them again at another station above the Falls. Coleridge, who is always good-natured enough to enter into conversation with anybody whom he meets in his way, began to talk with the gentleman, who observed that it was a majestic waterfall. Coleridge was delighted with the accuracy of the epithet, particularly as he had been settling in his own mind the precise meaning of the words grand, majestic, sublime, etc., and had discussed the subject with William at some length the day before. “Yes, sir,” says Coleridge, “it is a maj...
9 comments
Read more

Searle: The Chinese Room

John Searle has become the object of accusations of improper conduct. These accusations even have some people in the world of academic philosophy saying that instructors in that world should try to avoid teaching Searle's views. That is an odd contention, and has given rise to heated exchanges in certain corners of the blogosphere.  At Leiter Reports, I encountered a comment from someone describing himself as "grad student drop out." GSDO said: " This is a side question (and not at all an attempt to answer the question BL posed): How important is John Searle's work? Are people still working on speech act theory or is that just another dead end in the history of 20th century philosophy? My impression is that his reputation is somewhat inflated from all of his speaking engagements and NYRoB reviews. The Chinese room argument is a classic, but is there much more to his work than that?" I took it upon myself to answer that on LR. But here I'll tak...
17 comments
Read more

Recent Controversies Involving Nassim Taleb, Part I

I've written about Nassim Taleb on earlier occasions in this blog. I'll let you do the search yourself, dear reader, for the full background. The short answer to the question "who is Taleb?" is this: he is a 57 year old man born in Lebanon, educated in France, who has been both a hedge fund manager and a derivatives trader. He retired from active participation from the financial world sometime between 2004 and 2006, and has been a full-time writer and provocateur ever since. Taleb's writings for the general public began where one might expect -- in the field where he had made his money -- and he explained certain financial issues to a broad audiences in a very dramatic non-technical way. Since then, he has widened has fields of study, writing about just about everything, applying the intellectual tools he honed in that earlier work. As you might have gather from the above, I respect Taleb, though I have sometimes been critical of him when my own writing ab...
4 comments
Read more