- Often, the most difficult aspect of accounting
is determining which events are to be reflected
in the accounting records, and which are not.
Suppose, for example,
that Burger King introduced a new
Big Mac clone at half the Big Mac price.
The proliferation of these Big Mac clones
can have a serious impact on the future of McDonald's.
However, events that cannot be
reliably measured in monetary terms
will not be reflected in the financial statements.
Since it would be virtually impossible
to quantify the impact of the Big Mac clones
on the future profitability of McDonald's,
that information will be excluded
from the financial statements.
While there is an obligation
to inform financial statement users
about this attack on the Big Mac,
the financial statements are not the place to do it.
The financial statements are only one part
of the information provided to users.
Information relating to the competitive environment,
product development, and marketing and sales efforts,
it's included in the company's annual report to stockholders
but not as part of the accounting information.
Now, once we've determined that we have
a transaction that needs to be included
in the accounting records,
the event must be analyzed
to determine if an arm's length transaction has occurred.
Accounting is concerned primarily with reflecting
the effects of transaction between two independent parties.
Delta Air Lines signing a contract with Boeing
to purchase airplanes in the future
would not be reflected in the financial statements
until the airplanes are manufactured and delivered
and Delta has agreed to pay for them.
While many transactions
between independent parties are routine,
some business events are quite complex
and require a comprehensive analysis to determine
how the event should be reflected
in the financial statements.
Consider the following:
a company buys a building.
In addition to paying $20,000 in cash,
the company agrees to pay $10,000 per year
for the next 10 years.
The company will also pay a $2,000 property tax bill
associated with the building from last year.
As part of the purchase,
the company gave the former owners of the building
500 shares of stock.
Finally, the building will require $23,000 worth of
repairs and renovations before it could even be used.
Now, how much should be recorded
as the cost of the building?
Transactions like this can become quite complex,
but the framework introduced in this topic
will allow you to break complex transactions
into manageable pieces,
and provide you with a self-checking mechanism
to ensure that you haven't forgotten anything.