Accumulated Depreciation Accounting

The basic theory of depreciation accounting is unarguable: The amount
of capital a business invests in a fixed asset, less its estimated future
residual (salvage) value when it will be disposed of, should be allocated
in a rational and systematic manner over its estimated useful life to the
business.

A fixed asset’s cost shouldn’t be charged entirely to expense in the year
the asset’s acquired. Doing so would heavily penalize the year of acquisition
and relieve future years from any share of the cost. But the opposite approach
is equally bad: The business shouldn’t wait until a fixed asset is eventually
disposed of to record the expense of using the asset. Doing so would heavily
penalize the final year and relieve earlier years from any share of the fixed
asset’s cost.

Essentially, cost less residual value should be apportioned to every year
of the fixed asset’s use. (Land has perpetual life, and therefore, its cost
isn’t depreciated.) The theory of depreciation is relatively simple, but
the devil is in the details. And, I mean details!

Frankly, there’s not much point in discussing the finer points of
depreciation accounting. I could refer you to many books written
by accounting scholars on depreciation. But as a practical matter the
federal income tax law dictates the depreciation methods and practices
used by most businesses. The IRS publication “How To Depreciate
property” (2005 edition) runs 112 pages. You ought to read this
pamphlet— if you have the time, and the stamina.

Let me step on the soapbox for a moment. The depreciation
provisions in the income tax law are driven mainly by political
and economic incentives, to encourage businesses to upgrade
and modernize their investments in long-term operating assets.
By and large, businesses follow income tax regulations on
depreciation. As the result, useful lives for depreciating
fixed assets are too short, salvage value is generally ignored,
and depreciation is stacked higher in the early years. In
other words: fixed assets generally last longer than their income
tax depreciation lives; when disposed of fixed assets often have
some salvage value; and, a strong case can be made for allocating
an equal amount of depreciation to each year over the useful life
of many fixed assets. In short, actual depreciation practices
deviate from depreciation theory. Okay, I’m off my soapbox now.

The cost of land is not depreciated. Land stays on the books at
original cost as long as the business owns the land. Ownership
of land is a right in perpetuity, which does not come to an end.
Land does not wear out in the physical sense, and generally holds
its economic value over time. Buildings, machines and other fixed
assets, on the other hand, wear out with use over time and generally
reach a point where they have no economic value. Assume the business
decides to maximize the amount of depreciation recorded in the year,
according to the provisions of the income tax law.

Sample Of Credit Policy,How To Create And Maintain Credit Policy

Today we talk about sample credit policy and how to maintain it,

One of the chief causes of confusion not only within the credit

department but also between the credit and sales departments

is the lack of consistency in dealing with customer credit issues.

This includes who is responsible for credit tasks, what logical

structure is used to evaluate and assign credit, what terms of sale

are used, and what milestones are established for the collection process.

Without consistent application of these items, customers never

know what credit levels they are likely to be assigned, collection

activities tend to jolt from one step to the next in no predetermined

order, and no one knows who is responsible for what activities.

Establishment of a reasonably detailed credit policy goes a

long way toward resolving these issues. The policy should

clearly state the mission and goals of the credit department,

exactly which positions are responsible for the most critical

credit and collection tasks, what formula shall be used for

assigning credit levels, and what steps shall be followed

in the collection process. Further comments are as follows:

Mission. The mission statement should outline the general

concept of how the credit department does business: Does it

provide a loose credit policy to maximize sales, or work toward

high-quality receivables (implying reduced sales), or manage

credit at some point in between? A loose credit policy might

result in this mission: ‘‘The credit department shall offer credit to

all customers except those where the risk of loss is probable.’’

Goals. This can be quite specific, describing the exact performance

measurements against which the credit staff will be judged.

For example, ‘‘The department goals are to operate with no

more than one collections person per 1,000 customers, while

attaining a bad debt percentage no higher than 2 percent of

sales, and annual days sales outstanding of no higher than 42 days.’’

Responsibilities. This is perhaps the most critical part of the policy,

based on the number of quarrels it can avert. It should firmly state

who has final authority over the granting of credit and the assignment

of credit hold status. This is normally the credit manager, but the policy

can also state the order volume level at which someone else, such as

the CFO or treasurer, can be called upon to render final judgment.

Credit level assignment. This section may be of extreme interest to

the sales staff, the size of whose sales (and commissions) is based on it.

The policy should at least state the sources of information to be used

in the calculation of a credit limit, such as credit reports or financial

statements, and can also include the minimum credit level automatically

extended to all customers, as well as the criteria used to grant larger limits.

Collections methodology. The policy can itemize what collection steps shall be

followed, such as initial calls, customer visits, e-mails, notification of the sales

staff, credit holds, and forwarding to a collections agency. This section can be

written in too much detail, itemizing exactly what steps are to be taken after a

certain number of days. This can constrain an active collections staff from

taking unique steps to achieve a collection, so a certain degree of

vagueness is acceptable here.

Terms of sale. If there are few product lines in a single industry, it is useful to

clearly state a standard payment term, such as a 1 percent discount if paid in

10 days; otherwise full payment is expected in 30 days. An override policy can

be included, noting a sign-off by the controller or CFO. By doing so, the

sales staff will be less inclined to attempt to gain better terms on behalf

of customers. However, where there are multiple industries served with

different customary credit terms, it may be too complicated to include this

verbiage in the credit policy.

Company management can experience significant losses if it loosens the

credit policy without a good knowledge of the margins it earns on its products.

For example, if it earns only a 10 percent profit on a product that sells for $10

and extends credit for one unit on that product to a customer who defaults,

it has just incurred a loss of $9 that will require the sale of nine more units

to offset the loss. On the other hand, if the same product had a profit of

50 percent, it would require the sale of only one more unit to offset the loss

on a bad debt. Thus, loosening or tightening the credit policy can have a

dramatic impact on profits when product margins are low. Consequently,

always review product margins before altering the credit policy.

When economic conditions within an industry worsen, a company whose

credit policy has not changed from a more expansive period will likely

find itself granting more credit than it should, resulting in more bad

debts. Similarly, a restrictive credit policy during a boom period will result

in lost sales that go to competitors. This latter approach is particularly

galling over the long term, since customers may permanently convert to

a competitor and not come back, resulting in lost market share. To

prevent these problems, schedule a periodic review of the credit policy

to see when it should be changed to match economic conditions. A

scheduled quarterly review is generally sufficient for this purpose.

To prepare for the meeting, assemble a list of leading indicators for

the industry, tracked on a trend line, that show where the business

cycle is most likely to be heading. This information is most relevant

for the company’s industry, rather than the economy as a whole,

since the conditions within some industries can vary substantially from

the general economy. If a company has international operations, then

the credit policy can be tailored to suit the business cycles of specific

countries.

If a company’s products are subject to rapid obsolescence, a tight

credit policy can result in limited product sales that leave excess

quantities on hand that will be scrapped. In such cases, loosen the

credit policy on those inventory items most likely to become obsolete

in the near term. The logic is that, even if inventory is sold to

customers with a questionable ability to pay for the goods, this at

least presents higher odds of obtaining payment than if the

company throws away the goods. To implement this approach,

keep the credit department informed of the obsolescence status of

inventory items, usually by having the sales, marketing, and logistics

staffs flag potentially obsolete items in the inventory database

and giving the credit department online access to this information.

When customers send in orders, the credit staff

accesses this information, verifies the obsolescence status

of the items ordered, and modifies the credit policy as needed.

Tags: sample credit policy