Discount Stores Limited
Accounting measures and treatments have been used to properly determine the profitability and financial position of a business entity. In the case of Discount Stores Limited, they have suffered significant losses especially in the first few years of operations. After hiring Harry Highpaid as the chief executive officer, though still suffering from a small loss, Discount has made significant improvements in its business operations.
Now for the owners Ruth and Irving Bogan, employing various methods to account for advertising costs, inventory and company receivables, which have been used by Highpaid, is still subject to either approval or modification. These three aspects and how it contributes to the net profit or net loss of Discount would be the primary accounts and methods under inquiry. Case Study: Discount Stores Limited Discount Stores Limited is a chain of retail stores located in Ontario, Canada selling clothing and household items.
The owners Ruth and Ivan Bogan use the income they get from Discount to provide for their personal living. However, the Bogans are worried because of they may possibly lose their primary source of income due to the business’ unprofitable years. It is nothing but normal for a new business establishment to suffer losses during its first few years of operation. However, these annual losses must, of course, be regained by increasing income for the years thereafter. For the owners, hiring an excellent manager, Harry Highpaid, became a venue for Discount to recover from the significant losses that they have incurred.
Improvements have been flowing to Discount, and the owners are confident of the potential success of their business. Having been presented with the current year financial statements, the owners are concerned of some accounting treatments that Highpaid had employed in terms of advertising costs, slow-moving inventory and credit to customers. With regards to advertising costs, Highpaid has utilized extensive advertising campaigns to make their products known to the public, to attract new customers and to gain a bigger market share.
This marketing strategy, according to Highpaid, has been a success and significantly contributed to increase in interested customers and eventually, increase in their gross profit. Highpaid had capitalized Discount’s advertising cost, believing that these will benefit the store for more than a year, and amortizing them over a period of five years. This is contradictory to Discount’s previous treatment of advertising costs, which is to expense them as incurred. Advertising costs are generally expensed in the period it is incurred.
Proponents of this concept argue that future benefits that may be derived from advertising expenditures are uncertain (cited in Flesher, 1991). However, others believe these advertising costs must be capitalized for future economic benefits from these are identifiable and measurable. Plus, capitalization of this kind of cost could maximize long-term profits, not just short-term. Discount’s capitalization of 50% of its advertising costs would indeed contribute to bigger profits since the expenses it would incur will be lesser.
Also, this gives rise to an intangible asset. Proof that capitalization of this cost would benefit future periods is that customers’ advertising impressions may build up overtime and it would be instrumental in introducing Discount’s product to customers who may possibly develop brand loyalty. Expensing the other half of it would be the proper treatment for those advertising costs, which do not necessarily benefit future periods, or benefit the current period alone. Moreover, this would serve as an immediate tax shelter, decreasing the potential taxable income.
Determination which of these costs must be capitalized and which must be expensed actually depends on several factors such as the industry Discount is in and the extensiveness of advertising that they are employing. Advice is to maintain capitalizing the identifiable and measurable costs which would benefit future periods and expense those which would not, having already proven its considerable contribution to Discount’s increase in income. Every shop selling furniture or household items runs into the problem of having slow-moving inventory.
This unsalable merchandise may be the bane of businesses no matter what the products are. Therefore, it is no longer extraordinary for Discount to have a low turnover of its inventory. Discount used to write off slack inventory, which has been on hand for six months or more, at the end of each fiscal year. These products with sporadic sales were discontinued and liquidated. But Highpaid has employed a slightly different term of writing off these inventories. He now writes off only inventories, which he thinks could no longer be sold. What discount must first do is to set up a system of managing its inventories.
It must be able to know and identify which items are moving, and which are dragging sales down so that it can make better buying decisions, diminish slack inventories, and eventually increase profit margins. It must consistently track these inventories, which are selling more and which are not. Purchase bigger quantities of those products highly demanded by the customers. This is to avoid or lessen slow-moving inventory at the end of the operating period. Highpaid’s new inventory write-off strategy is better than Discount’s previous treatment of completely liquidating all sporadic products.
This is due to the fact that Discount must “maintain a stock of some slow-moving products, and even products that have never been sold, in order to maintain a high level of customer service and enhance their corporate profitability” (Screibfeder, p. 1). Concentrate on ensuring you have the optimal quantities of those items that have the most dollars flowing through the shop. Offering credit to customers is a very helpful and widely used business tool. Making sales on credit generally allows the store to increase its sales.
The downside is that it brings with it the risk of late payments, or worse, uncollectible payments or the so-called bad debts. To appropriately comply with the accepted accounting principles, Discount must record the portion of its receivables that can no longer be collected. These bad debts must be recorded in the period it is incurred. Since there is an inherent risk that clients might default or incur delay on payment, Discount’s receivables must then be recorded at its net realizable value, or its gross accounts receivable less the allowance for doubtful accounts or the portion of the credit estimated to be doubtful of collection.
The actual amount of Discount’s uncollectible receivable is written off as an expense from Allowance from Doubtful Accounts to the income statement account known as the Bad Debts Expense. This way, Discount would be able to fully account for the customers’ collectible credit and correctly diminish its income with the portion of the receivable, which will be uncollectible.
To protect Discount’s cash flow, it is essential to credit check new customers before giving credit and continue monitor their payment practices throughout the business relationship. It may also be advantageous to provide for cash discounts to credit customers to encourage faster payment of debt. Proper and close monitoring of Discount Stores Limited’s accounting policies would greatly contribute to the profitability and to the stability of its financial condition.