Income Statements » What’s Behind the Numbers » Income Recognition Decisions and Entries » Exercises
www.navigatingaccounting.com
S O L U T I O N S
is.wbn.is.bse.060 Connecting what you see to events behind income statements
(Starbucks)
Answer these questions using the excerpt on the next page from Starbucks’ 2010 Annual
Form 10-K Report disclosing some of the company’s accounting policies.
(a) First, assume Starbucks recognizes revenues at the point-of-sale when they sell $10 of
coffee. Ignoring the cost of the coffee, how is the revenue from the sale reflected in the
balance-sheet equation? Do net assets increase? If so, why?
First, a time line of the event would simply show that the sale and collection of cash happened at the same time. Then ask:
• Should an asset be recognized? Yes, $10 cash collected from the customer.
• Should an asset be de-recognized? No.
• Should a liability be recognized? No. Starbucks has no other obligation for this event.
• Should a liability be de-recognized? No.
Net assets increase by $10 and thus owners’ equity increases. Starbucks would recognize
$10 of revenue.
(b) Suppose coffee beans cost Starbucks $2 to purchase and $1 to roast. Assume the coffee
beans are purchased on account and a third party roasts the beans in exchange for cash.
How is net assets affected when Starbucks purchases coffee beans? How is net assets
affected when the coffee beans are roasted? How are net assets affected when the coffee
is sold?
When the coffee beans are purchased:
•
Should an asset be recognized? Yes, $ 2 increase in inventory.
• Should an asset be de-recognized? No.
• Should a liability be recognized? Yes, $ 2 increase in accounts payable.
• Should a liability be de-recognized? No.
Net assets have zero effect from purchasing the coffee beans on account.
When the coffee beans are roasted:
•
Should an asset be recognized? Yes, $ 1 increase in inventory.
•
Should an asset be de-recognized? Yes, $ 1 decrease in cash to pay for the roasting.
• Should a liability be recognized? No.
• Should a liability be de-recognized? No.
Net assets have zero effect from roasting the coffee beans in exchange for cash.
You may customize this work, as long as you credit G. Peter & Carolyn R. Wilson and respect the Creative Commons
Attribution-Noncommercial-Share Alike United States license. © 1991–2012 NavAcc LLC.
www.navigatingaccounting.com
2
NAVIGATING ACCOUNTING®
When the coffee was sold:
•
Should an asset be recognized? No. Cash was recognized earlier in part (a).
•
Should an asset be de-recognized? Yes, $ 3 decrease in inventory ($2 + $1).
• Should a liability be recognized? No.
• Should a liability be de-recognized? No.
Net assets decreased $3 from selling the coffee. Starbucks would recognize $3 cost of sales.
(c) Why report $10 of revenue and $3 of expenses rather than simply $7 of net income?
Investors and other users of financial reports want to know how the company performed
during the reporting period and whether the past performance is useful for predicting
future performance. The line items, such as revenue and cost of sales expenses, help users
better interpret the company’s performance. Importantly, investors’ demand for disclosures
on the financial statements or in footnotes influence standard setters when they’re deciding what disclosures to require. Companies may also voluntarily disclose more information
than what is required, balancing this against the need to protect sensitive information from
competitors. Investors can influence companies to voluntarily disclose more information
and this can result in common disclosures across an industry.
(d) Now, suppose that the gross margin decreases from $7 to $6. Why do we care whether
this decrease is due to a decrease in revenues, an increase in expenses, or some combination of changes to revenues and expenses?
Investors and other users care a great deal about the components of gross margin. This
helps them interpret whether the company is facing pricing pressures from customers, rising
costs from suppliers, or a combination. This would also help in predicting future performance.
(e) Next, assume a customer pays $10 for a Starbucks value card up front and then uses the
card over time until the balance is depleted to zero. In this case, the value card is swiped
through a machine each time coffee or another Starbucks product is sold, rather than
collecting cash from the customer. Should Starbucks recognize revenue when the value
card is sold? If not, why not? If not, when should the revenue be recognized? Assume a
customer uses the value card to purchase coffee for $3. How is net assets affected when
the coffee is sold (ignoring costs)?
See Example 3 in Scenic video: What’s Behind the Numbers » Income Statements »
Revenues
www.navigatingaccounting.com/video/scenic-revenues-bse-je
First, a time line of the event would show that the sale of the value card and collection of
cash happened at the same time. However, at that point, Starbucks had an obligation to
perform in the future. At the time of the value card sale, ask:
When the value card was sold:
• Should an asset be recognized? Yes, $10 cash collected from the customer.
• Should an asset be de-recognized? No.
• Should a liability be recognized? Yes. Starbucks has an obligation to provide coffee or
other products in the future.
• Should a liability be de-recognized? No.
Net assets have zero effect from selling the value card. Thus, no increase in owners’ equity
and no increase in revenue. Revenue is recognized when Starbucks meets its obligation in
the future.
© 1991-2012 NavAcc LLC, G. Peter & Carolyn R. Wilson
EXERCISE
When a customer uses the value card to purchase $3 coffee (ignoring costs):
• Should an asset be recognized? No, cash was collected from the customer when the value card was sold
earlier.
• Should an asset be de-recognized? No (ignoring costs)
• Should a liability be recognized? No.
• Should a liability be de-recognized? Yes. Starbucks has an met $3 of its obligation to provide coffee or
other products in the future.
Net assets increase by $3 and thus owners’ equity increases. Starbucks would recognize $3 of revenue.
(f) What risky events or circumstances could occur between the time Starbucks sells a value card and the customer uses it that could prevent Starbucks from earning related income?
The customer could lose the value card or otherwise not use the card. Thus, Starbucks could not meet its obligation in the future.
(g) What are Starbuck’s revenue-recognition policies associated with value cards?
See the related figure. “While we will continue to honor all stored value cards presented for payment, management may determine the likelihood of redemption to be remote for certain cards due to, among other things,
long periods of inactivity. In these circumstances, if management also determines there is no requirement for
remitting balances to government agencies under unclaimed property laws, card balances may then be recognized in the consolidated statements of earnings, in net interest income and other.”
(h) Assume Starbucks incurs $15 of cost to advertise in a newspaper this year. The costs will be paid in the
future. When will Starbucks recognize related advertising expense?
When the advertisement cost is incurred:
•
Should an asset be recognized? No. The future benefit of the advertisement can’t be measured reliably.
• Should an asset be de-recognized? No.
• Should a liability be recognized? Yes, $ 15 increase in accounts payable.
• Should a liability be de-recognized? No.
Net assets decreased and thus, and expense would be recognized. Starbucks would recognize the expense this
year, even if it expects to receive benefits in the future. This is consistent with their stated policy “We expense
most advertising costs as they are incurred...” See the related figure.
(i) Now assume that Starbucks incurs $25 of cost this year to produce an advertisement that will run for the
first time next year. The cost is paid in cash when incurred this year. The advertisement will likely benefit
sales for a few years. When will Starbucks recognize the related advertising expense?
Starbucks’ stated policy is “We expense most advertising costs as they are incurred, except for certain production costs that are expensed the first time the advertising campaign takes place.” See the related figure.
Thus, at the time of the advertisement costs is incurred, ask:
• Should an asset be recognized? Yes, $25 prepaid expense.
• Should an asset be de-recognized? Yes, $25 cash.
• Should a liability be recognized? No.
• Should a liability be de-recognized? No.
Net assets have zero effect from advertisement costs.
© 1991-2012 NavAcc LLC, G. Peter & Carolyn R. Wilson
3
4
NAVIGATING ACCOUNTING®
Thus, at the time of the advertisement is ran in the following year, ask:
• Should an asset be recognized? No.
• Should an asset be de-recognized? Yes, $25 prepaid expense.
• Should a liability be recognized? No.
• Should a liability be de-recognized? No.
Net assets decreased $25, thus, owners’ equity decreased and $25 of expense is recognized.
© 1991-2012 NavAcc LLC, G. Peter & Carolyn R. Wilson
are recorded in cost of sales including occupancy costs, general and administrative expenses, or restructuring
charges.
5
EInsurance
X E R C I S E Reserves
S
We use a combination of insurance and self-insurance mechanisms, including a wholly owned captive insurance
entity and participation in a reinsurance treaty, to provide for the potential liabilities for certain risks, including
Figure:
Excerpt from Starbucks’ Summary of Significant Accounting Policies Footnote
workers’ compensation, healthcare benefits, general liability, property insurance, and director and officers’ liability
insurance.
associated
with
the risks that
are retained
us are not
discounted
are estimated,
This
figureLiabilities
is an excerpt
from
Starbucks’
2010
annualby Form
10-K
report,and
pages
46-48. in part, by
considering historical claims experience, demographic factors, severity factors and other actuarial assumptions.
Revenue Recognition
Consolidated revenues are presented net of intercompany eliminations for wholly owned subsidiaries and investees
controlled by us and for licensees accounted for under the equity method, based on our percentage ownership.
Additionally, consolidated revenues are recognized net of any discounts, returns, allowances and sales incentives,
including coupon redemptions and rebates.
Stored Value Cards
46
Revenues from our stored value cards, such as Starbucks Cards, are recognized when tendered for payment, or upon
redemption. Outstanding customer balances are included in deferred revenue on the consolidated balance sheets.
There are no expiration dates on our stored value cards, and we do not charge any service fees that cause a
decrement to customer balances.
While we will continue to honor all stored value cards presented for payment, management may determine the
likelihood of redemption to be remote for certain cards due to, among other things, long periods of inactivity. In
these circumstances, if management also determines there is no requirement for remitting balances to government
agencies under unclaimed property laws, card balances may then be recognized in the consolidated statements of
earnings, in net interest income and other. For the fiscal years ended October 3, 2010, September 27, 2009 and
September 28, 2008, income recognized on unredeemed stored value card balances was $31.2 million, $26.0 million
and $13.6 million, respectively.
Customers in the US who register their Starbucks Card are automatically enrolled in the My Starbucks Reward
program and earn points (“stars”) with each purchase. A free beverage coupon is issued to the customer once 15
points have been accumulated. The value of points earned by our program members is included in deferred revenue
and recorded as a reduction in revenue at the time the points are earned, based on the value of points that are
projected to be redeemed.
Retail Revenues
Company-operated retail store revenues are recognized when payment is tendered at the point of sale. We maintain a
sales return allowance to reduce retail revenues for estimated future product returns based on historical patterns.
Retail store revenues are reported net of sales, use or other transaction taxes that are collected from customers and
remitted to taxing authorities.
Specialty Revenues
Specialty revenues consist primarily of product sales to customers other than through company-operated retail
stores, as well as royalties and other fees generated from licensing operations. Sales of coffee, tea and related
products are generally recognized upon shipment to customers, depending on contract terms. Shipping charges
billed to customers are also recognized as revenue, and the related shipping costs are included in cost of sales
including occupancy costs on the consolidated statements of earnings.
Specific to retail store licensing arrangements, initial nonrefundable development fees are recognized upon
substantial performance of services for new market business development activities, such as initial business, real
estate and store development planning, as well as providing operational materials and functional training courses for
opening new licensed retail markets. Additional store licensing fees are recognized when new licensed stores are
opened. Royalty revenues based upon a percentage of reported sales and other continuing fees, such as marketing
and service fees, are recognized on a monthly basis when earned. For certain licensing arrangements, where we
intend to acquire an ownership interest, the initial nonrefundable development fees are deferred to other long-term
liabilities on the consolidated balance sheets until acquisition, at which point the fees are reflected as a reduction of
our investment.
Other arrangements involving multiple elements and deliverables as well as upfront fees are individually evaluated
for revenue recognition. Cash payments received in advance of product or service delivery are recorded in deferred
revenue until earned.
Advertising
We expense most advertising costs as they are incurred, except for certain production costs that are expensed the
first time the advertising campaign takes place.
Advertising expenses, recorded in store operating expenses, other operating expenses and general and administrative
47
expenses on the consolidated statements of earnings, totaled $176.2 million, $126.3 million and $129.0 million in
fiscal 2010, 2009 and 2008, respectively. As of October 3, 2010 and September 27, 2009, $5.6 million and
$7.2 million, respectively, of capitalized advertising costs were recorded on the consolidated balance sheets.
Store Preopening Expenses
Source: www.starbucks.com
Costs incurred in connection with the start-up and promotion of new
store
openings are expensed
incurred.
See
accompanying
notes inasannual
report
Operating Leases
We lease retail stores, roasting, distribution and warehouse facilities, and office space under operating leases. Most
lease agreements contain tenant improvement allowances, rent holidays, lease premiums, rent escalation clauses