Question

1) Identify activities/transactions associated with companies engaged in the development stage.

2) Identify activities/transactions associated with companies engaged in the launch stage.

3) Identify activities/transactions associated with companies engaged in the growth stage.

4) Identify activities/transactions associated with companies engaged in the maturity stage.

5) Identify activities/transactions associated with companies engaged in the decline stage.

6) Explain how companies can be engaged in activities associated with more than one stage.

7) Explain the difference between a) investments/marketable securities, b) equity method investments or joint ventures and c) consolidated entities.

8) Discuss the differences between US GAAP and IFRS in accounting for intercompany investments.

Answer 1

1) Identify activities/transactions associated with companies engaged in the development stage:

This is the very beginning of the business lifecycle, before your startup is even officially in existence. You’ve got your business idea and you are ready to take the plunge. But first you must assess just how viable your startup is likely to be.

At this stage, you should garner advice and opinion as to the potential of your business idea from as many sources as possible: friends, family, colleagues, business associates, or any industry specialists you may have access to. Ultimately the success of your business will come down to many factors– including your own abilities, the readiness of the market you wish to enter and, of course, the financial foundation in place (how are you going to finance your launch?).

In some ways, this is the soul-searching phase. It’s where you take a step back and consider the feasibility of your business idea, and also ask yourself if you have what it takes to make it a success.

2) Identify activities/transactions associated with companies engaged in the launch stage.:

Once you have thoroughly canvassed and tested your business idea and are satisfied that it is ready to go, it’s time to make it official and launch your startup. Many believe this is the riskiest stage of the entire lifecycle. In fact, it is believed that mistakes made at this stage impact the company years down the line, and are the primary reason why 25% of startups do not reach their fifth birthday.

Adaptability is key here, and much of your time in this stage will be spent tweaking your products or services based on the initial feedback of your first customers. It can even get to the point where you are making so many changes to your offering that you start to feel a bit of confusion. That’s just noise, and the main advice here is to power through the blurriness, because extreme iterations upfront will naturally seem confusing. Rest assured the clarity will once again come.

3) Identify activities/transactions associated with companies engaged in the growth stage.

If you’re at this stage, your business should now be generating a consistent source of income and regularly taking on new customers. Cash flow should start to improve as recurring revenues help to cover ongoing expenses, and you should be looking forward to seeing your profits improve slowly and steadily.

The biggest challenge for entrepreneurs in this stage is dividing time between a whole new range of demands requiring your attention– managing increasing levels of revenue, attending to customers, dealing with the competition, accommodating an expanding workforce, etc.

It is essential that you start to come into your role as head of the company in this stage. While you’ll still be on the front lines often enough, you need to be aware of how your expanding and highly qualified team is going to be taking over a great deal of the responsibilities that were previously tightly under your control. It is your job now to start establishing real order and cohesion as you mobilize the teams according to clearly defined and communicated goals.

4) Identify activities/transactions associated with companies engaged in the maturity stage.:

At this stage you might feel there is almost a routine-like feel to running your business. Staff is in place to handle the areas that you no longer have the time to manage (nor should you be managing), and your business has now firmly established its presence within the industry. Here you might start to think about capitalizing on this certain level of stability by broadening your horizons with expanded offerings and entry into new geographies.

Businesses in this stage often see rapid growth in both revenue and cash flow as the blueprint has now been established, but be warned about getting too comfortable. In business, if you are not moving forward you are moving backwards, and without a constant, almost nervous itch or desire to expand, complacency can set in, and you might get caught off guard.

There are, of course, two sides to this coin, with the other involving a risk of expanding too carelessly. While there is no crystal ball and it is very hard to get an idea of what will be the results of your undertakings, you can give yourself the best possible chance of continued success through careful planning. Look at your resources, be realistic about the effort and cost and potential returns, and always keep an expert eye on how expansion might impact the current quality of service you provide your existing customers.

Remember, while having a successful business model behind you is undoubtedly an advantage, it is not a guarantee that it will work elsewhere within other markets, or that new offerings will result in the same success. The business graveyard is littered with organizations that took on too much and failed. Your task is indeed to take on new challenges as you look to constantly expand, but measure your risk and do your best to secure the company for all eventualities.

5) Identify activities/transactions associated with companies engaged in the decline stage.:

Having navigated the expansion stage of the business lifecycle successfully, your company should now be seeing stable profits year-on-year. While some companies continue to grow the top line at a decent pace, others struggle to enjoy those same high growth rates.

It could be said that entrepreneurs here are faced with two choices: push for further expansion, or exit the business. If you decide to expand further, you will need to ask yourself the same questions you did at the expansion stage: Can the business sustain further growth? Are there enough opportunities out there for expansion? Is your business financially stable enough to cover an unsuccessful attempt at expansion?

And, perhaps most importantly, are you the type of leader who is up for the task of further expansion at this stage? In fact, many companies change leadership here, bringing in a seasoned CEO who is more fit to navigate the new challenges.

Many at this stage also look to move on through a sale. This could be a partial or full sale, and of course depending on the company type (for example, public or private), the negotiation may be a whole new journey in itself.

6) Explain how companies can be engaged in activities associated with more than one stage.:

Not all businesses will experience every stage of the business lifecycle, and those that do may not necessarily experience them in chronological order. For example, some businesses may see astronomical growth right after startup, and the founders may decide to cash out right away, jumping straight to that “exit” stage.

For many companies, though, there will be some sort of resemblance to the stages defined above, and awareness may help you anticipate what is coming next and how you can best prepare yourself and your team to maximize your chance of success. Making the right decisions at each stage is another thing altogether, however, and that will require your usual mix of gut instinct and practical business sense.

7) Explain the difference between

a) Investments/marketable securities:

Marketable securities are securities or debts that are to be sold or redeemed within a year. These are financial instruments that can be easily converted to cash such as government bonds, common stock or certificates of deposit.

b) Equity method investments:

The equity method of accounting is used to account for an organization’s investment in another entity (the investee). This method is only used when the investor has significant influence over the investee. Under this method, the investor recognizes its share of the profits and losses of the investee in the periods when these profits and losses are also reflected in the accounts of the investee. Any profit or loss recognized by the investing entity appears in its income statement. Also, any recognized profit increases the investment recorded by the investing entity, while a recognized loss decreases the investment.

c) Consolidated entities:

To consolidate is to combine assets, liabilities, and other financial items of two or more entities into one. In the context of financial accounting, the term consolidate often refers to the consolidation of financial statements, where all subsidiaries report under the umbrella of a parent company.

8) Discuss the differences between US GAAP and IFRS in accounting for intercompany investments.

Intercorporate investments (investments in other companies) can have a significant impact on an investing company’s financial performance and position. Companies invest in the debt and equity securities of other companies to diversify their asset base, enter new markets, obtain competitive advantages, and achieve additional profitability. Debt securities include commercial paper, corporate and government bonds and notes, redeemable preferred stock, and asset-backed securities. Equity securities include common stock and non-redeemable preferred stock. The percentage of equity ownership a company acquires in an investee depends on the resources available, the ability to acquire the shares, and the desired level of influence or control.

Convergence between IFRS and US GAAP makes it easier to compare financial reports because the accounting is the same or similar for many transactions. However, differences still remain. When differences exist, there is generally enough transparency in the disclosures to allow financial statement users to adjust for the differences. Understanding the appropriate accounting treatment for different intercorporate investments and the similarities and differences that exist between IFRS and US GAAP will enable analysts to make better comparisons between companies and improve investment decision making. The terminology used in this reading is IFRS oriented. US GAAP may not use identical terminology, but in most cases the terminology is similar.

Intercompany investments play a significant role in business activities and create significant challenges for the analyst in assessing company performance. Investments in other companies can take five basic forms: investments in financial assets, investments in associates, joint ventures, business combinations, and investments in special purpose and variable interest entities. Key concepts are as follows:

IFRS and US GAAP treat investments in financial assets in a similar manner.    

• Investments in financial assets are those in which the investor has no significant influence. They can be measured and reported as
  • Fair value through profit or loss.
  • Fair value through other comprehensive income.
  • Amortized cost
• Investments in associates and joint ventures are those in which the investor has significant influence, but not control, over the investee’s business activities. Because the investor can exert significant influence over financial and operating policy decisions, IFRS and US GAAP require the equity method of accounting because it provides a more objective basis for reporting investment income.
  • The equity method requires the investor to recognize income as earned rather than when dividends are received.
  • The equity investment is carried at cost, plus its share of post-acquisition income (after adjustments) less dividends received.
  • The equity investment is reported as a single line item on the balance sheet and on the income statement.
• Current IFRS and US GAAP accounting standards require the use of the acquisition method to account for business combinations. Fair value of the consideration given is the appropriate measurement for identifiable assets and liabilities acquired in the business combination.
• Goodwill is the difference between the acquisition value and the fair value of the target’s identifiable net tangible and intangible assets. Because it is considered to have an indefinite life, it is not amortized. Instead, it is evaluated at least annually for impairment. Impairment losses are reported on the income statement. IFRS use a one-step approach to determine and measure the impairment loss, whereas US GAAP uses a two-step approach.
• If the acquiring company acquires less than 100%, non-controlling (minority) shareholders’ interests are reported on the consolidated financial statements. IFRS allows the non-controlling interest to be measured at either its fair value (full goodwill) or at the non-controlling interest’s proportionate share of the acquiree’s identifiable net assets (partial goodwill). US GAAP requires the noncontrolling interest to be measured at fair value (full goodwill).
• Consolidated financial statements are prepared in each reporting period.
• Special purpose (SPEs) and variable interest entities (VIEs) are required to be consolidated by the entity which is expected to absorb the majority of the expected losses or receive the majority of expected residual benefits.