Daphne Koller provides some very strong evidence that the future of university-level education must incorporate online components. There has been so many recent announcements about MOOCs (Massive Open Online Courses) and universities collaborating with Coursera, EdX and Udacity amongst others that university faculty really do need to wake up and pay attention.
There’s been a lot of movement recently around how higher education can deliver more efficient and effective education. While I am a big proponent of in-class, face-to-face education the reality is is that we’re using that valuable time very poorly in most cases. We must rethink how we use that time with students to really develop skills and knowledge that they cannot learn on their own with the appropriate support including video, textbooks etc. Sal Khan demonstrates exactly this. If you’re interested in seeing where education in general is headed have a watch. I would love to hear your comments about this as well. Do you think this is the next wave or some ill-guided fad?
In BC there was a significant announcement in the last few months that a new ski resort had received final governmental approval. Jumbo Glacier Resort has been in the works for almost twenty years but has received plenty of bad press from environmentalists and other stakeholders that felt the resort was inappropriate for that location. I don’t necessarily agree or disagree with those views, however I have always been shocked that someone was willing to throw $900 million into the project. Skier visits are decreasing all across North America, a combination of demographic shifts, economic conditions, and weather patterns. WhistlerBlackcomb’s skier visits are shown below, its hardly what you would call a “growth industry”. Is there really consumer demand for another provider? I suppose if Jumbo was to offer something unique then perhaps there would be a business case for it. What does Jumbo have going for it? Great snow, lots of terrain. Downsides? Location. Its not easy to get to. WhistlerBlackcomb claims to be within five hours drive for seven million people. How many people live five hours way from Jumbo? Substantially less than two million.
There are two accounting lessons that can be learned by looking at this situation. First, non-financial information is vital to understanding and analysing a business. In the case of ski resorts, skier visits and convenience are obviously critical. For grocers, you may find managers talking about inventory turnover and inventory transit time. As a financial statement user, don’t forget the power of the non-financial information. That information is not always easy to find but is necessary to complete the picture the financial statements begin to paint.
Second, understand the demographics of the business’ consumer. The first time I really considered demographics was reading David Chilton’s Wealthy Barber 20 years ago. If you haven’t ever read that and want to understand how important demographics are to businesses I highly recommend his books. What do we know about North American demographic trends? The population is aging as the picture below clearly indicates. I’d hazard a guess that older people ski less than young people so I don’t see a huge turnaround in the key skier-visit statistic. Where does that leave the new Jumbo ski resort? Lots of terrain, great snow, an inconvenient location, and decreasing demand. My guess is that someone, somewhere in the Jumbo organization will realize that there are easier ways to waste $900 million and the project will be dramatically changed before it gets started. If you’re interested in skiing or the resort business and disagree, I’d love to hear your comments below.
Note: this blog was originally posted on my site hosted by Pearson Education (http://php2.pearsoncanada.ca/highered/inthenews/accounting_in_the_news/)
If you are a late 80’s movie buff or a Kevin Costner fan you may have seen the movie Field of Dreams where Kevin Costner plays a character who builds a baseball field in the middle of a corn field because he believes that the baseball-great Shoeless Joe Jackson will come back as a ghost and play baseball in his field. An odd premise for a movie to be sure but it spawned the relatively famous quote, “If you build it he will come.”
It turns out that you can build something and have no one show up; that’s exactly what is happening at Research In Motion (RIM), the maker of the once-revolutionary Blackberry smartphone. Like any wholesaler or retailer, RIM carries a certain amount of pre-built inventory on hand, ready to sell at a moments notice. Grocery stores need milk and eggs, clothing stores need clothes, gas stations need gas. These are all inventory – product that is intended to be resold. Inventory is usually a current asset shown on the balance sheet. Inventory management, that is, determining the correct amount of inventory to carry at any one time is a critical business skill. Carry too much and the milk goes bad before you can sell it. Don’t carry enough and you’ll have angry customers that purchase their milk at your competitor’s store.
In RIM’s latest annual financial statements, inventory has grown from $618 M to $1,027 M, a 66% increase. That by itself is not necessarily bad. Businesses experiencing or about to experience strong growth and expansion would likely have similar inventory growth. In RIM’s case though, the inventory increase is NOT due to growth but completely the opposite. Inventory increases can also indicate slow-moving inventory; that is, no one is buying your stuff. RIM’s rapid decrease in the smartphone market share is no secret. If people stop buying Blackberrys and Playbooks but RIM continues to manufacture them, inventory must grow.
Another way to consider this is with the inventory equation: Closing Inventory = Opening Inventory + Units Manufactured – Units Sold. If Units Sold decreases faster than Units Manufactured, Closing Inventory will be higher than Opening Inventory.
So, point #1: Inventory growth can be a sign of an unhealthy business. This is certainly the case for RIM.
Point #2? Obsolete or slow-moving inventory may actually require a write down. That is, the value recorded on the financial statements ($1,027 M for RIM) may be too high. If RIM needs to decrease the selling price to encourage sales and that sales price is lower than the manufacturing costs, a write down is likely required. Why does that matter? Well for one, RIM’s assets would be smaller than currently shown on the financial statements and two, the write down is also an expense which would further decrease RIM’s net income (loss).
What’s the quick lesson here? When you read a set of financial statements, look carefully at inventory trends. If inventory is rapidly increasing and there is no planned business growth in the short term, that inventory growth may indicate that customers don’t like what that company sells. Never a good position to be in.
Note: this blog was originally posted on my site hosted by Pearson Education (http://php2.pearsoncanada.ca/highered/inthenews/accounting_in_the_news/)
I had the great pleasure of attending two Shakespeare plays this week at Bard on the Beach in Vancouver, Taming of the Shrew and MacBeth. Very different plays for sure but what an incredible experience. My motivation for attending was partly as a result of seeing Christopher Gaze live at TEDxVancouver last fall. Christopher is the artistic director of Bard but really is the life and blood of that organization. Almost 25 years ago he was a critical part of getting the Bard up and running and its amazing to see where he and many other directors, actors and volunteers have taken it. If you’re out on the west coast of Canada this summer I highly recommend the experience.
Anyway, here is the TEDx talk that motivated me to begin with. Whether you like Shakespeare or not, you will agree that Christopher is a fabulous public speaker, an entertainer and educator at heart. Lessons for any teachers, students, or lovers of culture – enjoy!
Elyn Saks takes us through her journey, her nightmare with schizophrenia. One of the most honest looks at this mental illness I have ever seen. Elyn is a law professor at USC and talks about the importance of mental health research, supportive family and supportive work places. If you’ve ever wondered what schizophrenia is or is not, watch this.
Continued from part 1
In part 1 we reviewed the basics for accounting for liabilities. Nortel uses the term “reserve” instead of liabilities, but the same principles hold true. Nortel is currently under legal discussions about their accounting for reserves. If you haven’t read Part 1 and want a quick review of what liabilties are and how to account for them, read that first.
So Nortel has gone ahead and set up these reserves and now wants to reverse them. The reversing entry will definitely increase income (again, see Part 1 for the reasons). Nortel executives argue that the liability no longer exists and therefore the reserve must be reversed. The auditors aren’t so sure that the liability has been fully settled and would prefer to leave the liability on the balance sheet. Leaving the liability there would have no effect on net income.
It possible that the Nortel execs are telling the truth or maybe they are trying to manipulate net income. These types of financial reporting decisions are never transparent and the small shareholder is always at an information disadvantage. Perhaps you are starting to see the potential conflict of interest – Nortel execs had plenty of motivation for wanting to improperly reverse the reserves. I’m not saying that what they did was wrong, the courts will decide that. I am saying that they had lots of incentive for doing the wrong thing.
What incentives? Well after Nortel profitability fell dramatically in the early 2000’s, the board of directors introduced a new bonus plan referred to as “The Return to Profitability”. Seems like a good idea. Nortel needed management to bear down and focus on making sure that the company turned the corner to being a profitable business again. Providing incentives to management for successfully accomplishing that seems like common sense. The problem with so many of these bonus plans is that they focus on accounting profitability as a pseudo-measurement of true, economic profitability. That too makes sense – economic profitability is rarely known, accounting profitability when done properly is a reasonable (but not perfect) proxy.
But, and this is a big BUT … accounting profitability is subject to manipulation or massaging. And when you have the ability to earn a substantial bonus, you definitely have incentive to mess around with the accounting. I’m sure there are very ethical people out there that would never fall into that trap but history has shown that many people choose the dark side when faced with this issue.
Rewind to 2002-2003: Nortel exec’s are sitting around wishing they could get their bonuses when they look at the financial statements and see these reserves (liabilities) sitting on the balance sheet. They think to themselves, “hey, if we reverse those we can quickly increase net income, triggering the bonuses”. The auditors disagree or at least try to disagree but the reserves get reversed, net income gets an upward pop, bonuses get triggered, executives spend lavishly.
Bad accounting? Sure, but it is just one more example of well-intentioned incentive plans back firing. When you create bonus plans and incentives for managers, be careful that you eliminate or reduce their motivation to improperly trigger those bonuses. That’s not easy to do but the downside of not carefully developing the bonus plan and monitoring the accounting process is, well – Nortel. You don’t want that.
What’s the lesson here: financial reporting is not perfect; use financial statements carefully!
Although I wrote about Nortel a few posts ago, it really is the never-ending financial reporting story in Canada. A recent Globe and Mail article outlines the argument (no, that’s too strong… ‘discussion’) that occurred between Nortel executives and their auditors, Deloitte & Touche. The issue at the core of the article and current legal discussions involves when Nortel should have undone some of their “reserves.” This is a complex topic for anyone that hasn’t completed a few accounting courses. I doubt that 5% of the people on the street have a grasp of what went on at Nortel. At the risk of over-simplifying, let me try to explain it here.
The reserves they refer to in the article are actually liabilities, which would be sitting there on the balance sheet as credit balances. The term “reserve” has a slightly different meaning under different GAAP, so lets clear that up now. Under IFRS (Conceptual Framework, para 4.20), reserves are actually an equity item and mean something different than what we’re discussing here. Nortel reported under US GAAP (despite being a Canadian company). In US GAAP, “reserves” refer to liabilities with uncertain timing or uncertain amounts. Under IFRS, these are called “provisions” (IAS 37).
Getting back to the stuff in the recent news—what Nortel referred to as “reserves” were liabilities. Nortel execs and the auditors were arguing about when to remove those credit balances from the balance sheet. These reserves are no different than regular liabilities. Nortel believed that they owed someone some amount of money or future service. There are essentially two options when dealing with these types of liabilities: 1) Nortel could have settled the liability by paying the other party or providing the expected service (this is the normal course of action), or 2) Nortel could have decided it was no longer responsible for settling the liability and removed the credit balance from its balance sheet. Let’s quickly walk through examples of each of these options.
Assume that Nortel offers a customer a special warranty to fix a specific piece of equipment if it breaks in the next three years. This warranty meets the definition of a liability. Therefore, on the date of the sale Nortel books a special warranty liability related to the piece of equipment. The journal entry on the sale date should be:
Dr Warranty Expense $X
Cr Special Warranty Liability $X
This would reduce net income immediately and create a liability.
Case 1: Over the next three years, the equipment breaks and requires service. Nortel provides the service and parts necessary. Assuming that Nortel pays cash for the workers and parts, the journal entry on the date of the repair would be:
Dr Special Warranty Liability $Y
Cr Cash $Y
This would have no impact on net income.
Case 2: Over the next three years, the equipment performs flawlessly and requires no warranty service. At the end of the three years, Nortel would still have that original Special Warranty Liability on its balance sheet for $X, but since the warranty will have expired it would no longer owe anything and wouldn’t have a true liability. Therefore, it should reverse the liability:
Dr Special Warranty Liability $X
Cr Warranty Expense** $X
Note that this journal entry actually increases net income at the end of the third year. What Nortel is in trouble for is Case 2, reversing the liability (“reserve”) at a potentially inappropriate time. Notice the substantial difference between Case 1 and Case 2: the first does NOT impact net income, the second does. If Nortel wanted to inflate its income, reversing a liability would definitely accomplish that. In some cases, reversing the liability is completely justified. The question is, did Nortel have the proper justification? In the next part, we’ll look at the reserve leading up to the time Nortel reversed it and examine some potential incentives that Nortel had to artificially increase net income.
** While it may seem unusual or wrong to credit (Cr) an expense account it is acceptable. It is unlikely that the Cr to Warranty Expense would create a negative expense. Since there would have been other Dr entries to that same account during the year, the Cr only reduces the expense rather than making it negative.