Glencoe Accounting

Unit 5: Accounting for Special Procedures

WebQuest Internet Project

A company can pay millions of dollars for an office building. A small business might buy just a used truck and a computer, as Roadrunner Delivery Service did in Unit 2. In this project you will find out how to use the matching principle to assign asset costs to the revenue those assets generate.

The saying "It takes money to make money" is especially true when it comes to running a business. When a business spends money on assets like equipment, vehicles, or inventory, it does so with the ultimate aim of earning revenues. While some assets may only benefit the company for a few months, others will contribute toward revenue-generating activities for years. In this WebQuest project, your task is to report the asset management policies of Dell Computer, the largest provider of PCs worldwide. An asset management policy might address these questions regarding plant assets:

• How much should we spend on new plant assets?
• What benefits does the company expect to receive from those plant assets?
• How will we allocate the expense of these purchases?
• Effective asset management will also address issues such as these:
• How much cash should we tie up in inventory?
• Are inventory quantities sufficient to fill customers orders on time?
• How well do our assets generate revenue?

Your report should discuss ways in which Dell purchases and expenses plant assets and how the company handles its inventory costing. You will also examine how the company's business strategy affects its accounts receivable.

To successfully prepare your presentation you will need to complete the following items.

• Review Management's Discussion and Analysis of Financial Condition and Results of Operations (Item 7) in Dell's Form 10-K for the year ended Jan. 28, 2005. www.dell.com/downloads/global/corporate/sec/10k-fy05.html#tocPay special attention to these sections: Gross Margin; Operating Expenses; Selling, General, and Administrative; Research, Development, and Engineering; Capital Expenditures. Also review the Financial Statements and Notes to Consolidated Financial Statements in the same document.
• Identify the major points of asset management discussed in the article "Asset Management" at www.fool.com/school/returnonequity/ReturnOnEquity03.htm
• List the ideas central to Dell's inventory strategy found in the article "Living in Dell Time" at www.fastcompany.com/magazine/88/dell.html
• Find out how return on assets (ROA) is calculated and what this ratio measures, using this Web resource: www.investopedia.com/terms/r/returnonassets.asp
• Make a list of Dell's primary revenue generating activities.
• Make a list of the kinds of assets that Dell might purchase to generate revenues.

• What depreciation method does Dell Computer use? Explain how depreciation of assets satisfies the matching principle.
• What amount of property, plant, and equipment is reflected on the balance sheet?

• Make a list of the general kinds of inventory needed for Dell operations.

• Describe Dell's basic inventory strategy, and identify how it differs from other schools of thought on inventory management.
• Identify the amount of inventory reflected on the balance sheet.
• What method is used to determine the cost of inventories?

• Based on the information found in the Critical Accounting Policies section of Dell's annual report, what method is used to estimate uncollectible or doubtful accounts?
• Identify the amount of accounts receivable reflected on the balance sheet. Has this figure been adjusted for uncollectibles? How can you tell?

• Calculate Dell's return on assets ratio.
• Consider organizing your report into five sections: (1) Dell's general business strategy and revenue-generating activities, (2) Plant assets and depreciation issues, (3) Inventory methods and strategies, (4) Accounts receivable and uncollectibles, (5) Return on assets.

To improve your report, consider the following questions and suggestions:

1. Describe how the purchase of new technologies might contribute to revenue generation at Dell.
2. Since Dell requires payment from customers when an order is placed, consider how this policy impacts accounts receivable.
3. Explain what Dell's return on assets ratio demonstrates to investors.
4. Is there a downside to Dell's inventory strategy? If so, what is it?

Here are some suggestions for finishing your report:

• Create a visual depiction of the matching principle. Include these elements: Revenues, Purchase of Plant Assets, Depreciation, Expenses, and Net Income. How do these elements relate to each other?

• Order a hard copy of the Dell Computer 2004 Annual Report from the company. Use pages from the annual report to illustrate points from your report.
• Talk to friends or family about experiences ordering products from Dell.

• Assume that Dell Computer Co. purchases a piece of manufacturing equipment for $500,000. Management expects the equipment to benefit the company for ten years with a residual value of $15,000. How should the purchase be recorded? Using straight-line depreciation, what is the annual depreciation expense?

• If companies do not match expenses to the revenues they generate, what situation results?
• What is the difference between a plant asset and a current asset? List examples of each kind of asset.
• Assume that Dell Computers decided to use the percentage of net sales method to estimate uncollectibles. Net sales in 2005 were $49,205 million. Using a percentage of 0.2%, what is the uncollectible expense for 2005?
• Which inventory costing method results in the highest gross profit on sales in times of rising inventory prices?

Companies use a variety of depreciation methods. Hewlett-Packard uses the straight-line and accelerated methods for its assets. IBM uses the straight-line method. Each method assigns the cost of an asset to the periods in which the asset contributes to revenue-generating activities.

Question:

• What information is needed when calculating annual depreciation for a plant asset using the straight-line method?

The level of uncollectibles for businesses may differ dramatically due to the types of payments they receive from customers. A company like Wal-Mart accepts primarily cash and credit cards from its customers. Therefore its uncollectible expenses are low. Conversely, a food wholesaler that sells to local grocery stores may extend credit to its customers. The probability of uncollectible accounts for the wholesale is higher because customers may default on payments due. To account for uncollectible accounts receivable in accordance with Generally Accepted Accounting Principles (GAAP), these expenses are estimated and recorded to match revenue and expense in the month of the sale. This entry should be done so that the income statement and balance sheet are fairly stated at the amount expected to be collected in receivables, satisfying the matching principle.

Question:

• What accounts are involved when companies record the estimated uncollectible expense for a period using the allowance method?

As you learned in the case of Dell Computers, inventory is a fast-moving commodity and requires little to no storage. In other businesses, inventory items are stored in facilities until they are to be sold or placed in retail locations. As items move out of storage and are sold, it is important that a consistent cost flow assumption is applied.

Question:

• If a company uses the LIFO costing method, which items in inventory are used to assign a cost to the inventory? Explain your answer.