Question

Case 6B: Accounting Policy Choices

Shown below is an extract from an article in the Southern Times Financial Review on 15 August 2012. There are a few items in the article we have not covered, but you should be able to comprehend the key elements. Note 1 from the 2008 accounts of Simons’ Harbour Casino Holdings Limited notes that ‘Pre-opening expenses consist primarily of set-up costs, establishment costs and the costs associated with the organization of the Casino license, share issuance and finance costs. The policy has been that Pre-opening expenses have been written off as incurred’.

Simons’: We're as good as Crown

Simons’ Harbour Casino Holdings Ltd recorded a mere $1 million net profit for its first full six months of operations, falling well short of both prospectus forecasts and its booming Portland counterpart.

But Chairman Mr. Bick Burton yesterday rejected suggestions that Portland's Crown Ltd was outperforming the Simons’ gaming house, saying the better bottom line at Portland's Crown Ltd was largely a function of accounting methods and had very little to do with real business operations.

Simons’ Casino has chosen to account for large chunks of its expenses as they occur – rather than follow GAAP and capitalize those costs – leaving the company with large abnormal losses.

‘When you get such a significant difference in accounting practices, it skews the results,’ Mr. Burton told reporters. ‘What we're just trying to point out is that when you put it on a like-to-like basis, you'll see our result is exceptionally good.’

Mr. Burton produced a string of numbers to show that when indicators other than bottom-line profit were used, Simons Casino's position was equal to or better than its competitor.

He said Portland was a bigger casino – with 2820 ‘gaming spaces’ available against Simons Casino's 1700 – and as such was always expected to show bigger overall numbers.

However, on a win-per-table or win-per-visitor basis, Simons Casino was trading more strongly than Portland, he said.

For example, Mr. Burton said Simon Casino's pre-abnormal $24.8 million results were wiped out by $22 million in pre-opening costs and amortization of pre-paid rentals.

Before accounting for interest, tax, abnormals, depreciation, and amortization, earnings were $47 million – a result that Mr. Burton said confirmed the company was performing exceptionally well in a competitive market.

However, the result was well short of prospectus forecasts. Revenue for the 2008 financial year came in 22 percent weaker than prospectus forecasts: the casino pulled in $303 million against a promised $387 million.

Also, it predicted a net profit of $37 million, based on an operating profit of $67 million. Instead, its year to June result was a $4.7 million net loss and an operating profit of just $48.5 million.

The casino also renewed its call for a new, lower tax rate for high-roller gamblers, saying it would bring in millions more in revenue to government coffers.

Required:

1. Explain, as simply as possible, what is included in pre-opening costs.
2. How does the accounting treatment for pre-opening costs differ between the two casinos? What effect do the differences have on both profit and the balance sheets of the two companies?
3. Why might Sydney Casino have chosen to account for pre-opening costs in this way?
4. Is the choice of accounting method an excuse for not reaching profit forecasts?

Answer 1

a) Meaning of Pre Opening Cost

It includes one-time activities related to opening a new facility, introducing a new product or service, conducting business with a new class of customer or beneficiary, initiating a new process in an existing facility, or commencing some new operation.

b) How does the accounting treatment for pre-opening costs differ between the two casinos?

Simon Casino is expensing the pre-opening cost as incurred.It is showing all the one time pre opening cost in its profit and loss as and when they incur.

On the other hand, Portland Casino is capitalising the pre opening cost and then they will amortize it over number of years.

What effect do the differences have on both profit and the balance sheets of the two companies?

When an entity choose to expense the pre-opening cost as when they incur it will impact the profit of the company i.e. actual profit will get reduced. When pre opening cost are expensed it will have no impact on balance sheet it will affect profit and loss only.

However, when an entity choose to capitalise pre opening cost and then amortise it over several years it will impact both balance sheet as well as profit and loss.There will be increase in profit due to proportionate charge of pre opening cost in profit and loss statement.In balance sheet the unamortised pre opening cost will be shown as asset.

c)Why might Sydney Casino have chosen to account for pre-opening costs in this way?

It might have chosen to account in this way to present its financial statement in accordance with GAAP and to show true and fair view to the users of financial statement.Other views are it might have chosen to acount it in this way in order to mask its failure to reach it profit forecast and shift the blame on huge pre opening cost.

d)Is the choice of accounting method an excuse for not reaching profit forecasts?

The short answer to this question is 'Yes'.Accounting Policy choices are very important to the interpretation and analysis of financial statements.Here management chose accounting policy that does not depict actual performance of the casino as the operating profit got wiped out due to huge pre opening cost.To overcome this, management may present a supplementary statement showing hwo far it has achieved its budget it will help the investors in knowing correct financial position.