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Accounting Policy Analysis Junichi Hara

Accounting Policy Analysis Junichi Hara. Agenda. R&D Policy Depreciation Policy. Conclusion. Accounting policy should not change value (If it could, we could fix global poverty) But need to be… Aware of “steady state” Careful that assumptions are correct. Conclusion. Need to:

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Accounting Policy Analysis Junichi Hara

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  1. Accounting Policy AnalysisJunichi Hara

  2. Agenda • R&D Policy • Depreciation Policy

  3. Conclusion • Accounting policy should not change value • (If it could, we could fix global poverty) • But need to be… • Aware of “steady state” • Careful that assumptions are correct

  4. Conclusion • Need to: • Understand the models • Understand the business

  5. 1. R&D Policy

  6. Part a

  7. Expense Method Situation 1: Expense? Situation 2: Capitalize?

  8. Projection: Expense

  9. Projection: Expense

  10. Part b

  11. Capitalize Method Situation 1: Expense? Situation 2: Capitalize? Amortize R&D expense over five years

  12. Projection: Capitalize

  13. Projection: Capitalize

  14. Part c

  15. What’s going on?

  16. Residual Enterprise Income

  17. Residual Enterprise Income Extra: $100 capitalized - $20 amortization Avoided: $100 capitalized * 10% r

  18. Residual Enterprise Income • After 5 yrs R&D = Amortization ($100) • NEA higher by $300 • Represents $300 of R&D expense avoided • Almost like “head start”

  19. The “head start” $300 “head start” (expenses avoided and capitalized)

  20. RNEA

  21. RNEA • Negative due to negative EPAT • Incurring entire R&D expense • While getting <5 R&D years worth of sales

  22. RNEA • Getting sales from 5 years of R&D • NEA unchanged

  23. Part d

  24. Projecting to 2020 • Same as 2018 • Reached “steady state” • Expensing method “caught up” with capitalizing method • But, still $300 of R&D expenses (“head start”) stuck in NEA

  25. Projecting to 2020 • To get accurate valuation need to have terminal value start 2018

  26. Part e-f

  27. Valuation comparison Terminal value based on 2016 REI Expense method: -$16 Capitalize method: $4

  28. Valuation comparison Valuations equal! Why?

  29. Taking a closer look

  30. Taking a closer look Catch up to $300 “head start” through terminal value

  31. REI Is Source of Difference Everything else in equation is same for both methods

  32. NEA Is Source of Difference

  33. TV Captures NEA Difference • Difference in terminal REI is $30 • Terminal value captures $300 of unexpensed R&D (the “head start”)

  34. Wrap up Capitalize $100 Extra NEA $200 Extra EPAT Expense $300 Extra TV $100 $200 $300

  35. Wrap up Residual Enterprise Income Model corrects for time value $100 $200 $300

  36. Part g

  37. What if R&D is cut? • Cut R&D by $20MM every year • Starting 2016 • Eventually no R&D by 2019 • Sales should decrease and eventually dissappear

  38. Cut R&D

  39. No cuts

  40. Why does RNEA go up? • Cuts start 2016 • But R&D provides sales for 5 years • Still get benefits while cutting costs • Denom. stays same while num. increases • Effect wears off after 5 years

  41. Cut R&D

  42. No cuts

  43. Hidden Reserve • Shows that management can temporarily increase margin • R&D is like an asset that provides turnover • If unaware of relationship could project inflated TV

  44. 2. Depreciation Method

  45. Part a

  46. Three year depreciation

  47. Five year depreciation

  48. Part b

  49. Five year looks more profitable • Three year accelerates depreciation • Already fully expensed 2014’s CAPEX by 2017 • Recent and higher CAPEX depreciated too

  50. Part c

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