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Accounting Report FINAL Japan Food Holdings
Accounting Report FINAL Japan Food Holdings
Accounting Report FINAL Japan Food Holdings
ACCOUNTING REPORT
Contents
Contents ...............................................................................................................................................2
Executive Summary .............................................................................................................................3
1. Introduction......................................................................................................................................4
2. Inventories .......................................................................................................................................4
2.1 Changing of Inventory Method .........................................................................................4
2.2 Inventory Write-Off ...........................................................................................................6
3. Depreciation.....................................................................................................................................6
3.1 Straight-line Method vs. Double Declining Method .........................................................6
3.2 Useful Life / Salvage Value ...............................................................................................8
4. Conclusion .......................................................................................................................................8
5. Appendix..........................................................................................................................................9
6. References......................................................................................................................................12
ACCOUNTING REPORT
Executive Summary
This report summarizes the effects of earnings management and how Japan Food Holdings (JFH)
can adopt various methods and techniques to put the company in a better financial position.
Headquartered in Singapore, JFH operates in the food and beverage industry, specializing in
authentic Japanese Cuisines. Even though JFH has been demonstrating strong financial
performance, we feel that they should be conservative by increasing their earnings so as to prepare
themselves for tougher times ahead. Using information from its financial statements, we have
identified 2 accounts, namely inventory and depreciation expenses, which are closely related to the
core business of JFH, which we believe, can help them manage their earnings. We propose that
JFH should change their current method used to measure the cost of inventory, as well as their
method of depreciation. We believe that this will not only smoothen their earnings but also puts
them at a competitive edge over other companies.
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1. Introduction
Japan Food Holdings (JFH) is one of the leading Food & Beverage groups in Singapore,
specializing in authentic Japanese cuisine. It has several franchise brands including the popular
Ajisen Ramen, Udon King, and also overseas joint ventures like Menya Musashi. In addition to this
booming performance, we feel that JFH can potentially manage their earnings to match a predetermined target. (Investopedia ULC, 2012)
JFH can manage their earnings through the Inventories Account. Taking advantage of the different
inventory methods and the legitimate flexibility of when and how much to record inventory
obsolesces, JFH can deliberately smooth their earnings to meet the companys objectives. Also,
second to employee compensations and rental, purchase of inventories takes up the bulk of JFHs
expenses (Refer to Appendix 1). This makes managing earnings through inventory more attractive
and effective.
JFH opened many new outlets both Singapore and abroad. This resulted in a stark increase in
Assets and Revenue over the last year, especially in renovation (PPE). The Depreciation of PPE
Account is also one of the highest expense accounts (Refer to Appendix 1). Hence, our group feels
that the effects of managing this account are largely substantial.
2. Inventories
2.1 Changing of Inventory Method
Depending on JFHs objective, different inventory methods can be used to manipulate the earnings,
namely First In First Out (FIFO), Last In First Out (LIFO), Specific Identification, and Weighted
Average (WA). However, under FRS 2:IN13 (Refer to Appendix 2) (Accounting Standards
Council, 2013), LIFO is prohibited as a method to measure the cost of inventory. Also, mentioned
in FRS 2:23 and FRS 2:24 (Refer to Appendix 3 and 4), specific identification is inappropriate
when there are large numbers of items in inventory that are ordinarily interchangeable, and such
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method is usually used for luxury items. Hence, based on FRS 2:25 (Refer to Appendix 5) this
leaves us the option of only FIFO or WA.
JFH currently adopts the FIFO inventory system. Our proposed strategy is for JFH to change their
inventory method to WA. It is often consistent with the general rule that LIFO produces the lowest
income assuming that food cost rises (Department of statistics, 2014), FIFO the highest and WA an
amount in between. Even though WA depresses earnings, it produces a lower tax bill due to income
tax considerations. Having incurred S$1.5 million tax expense in 2013 at the corporate tax rate of
17%, changing the inventory method to WA could possibly reduce the tax expense. In addition,
when compared to FIFO, WA ensures that JFH will not be as badly affected by changes in
economic cycle such as sudden increase in inventory costs, new legislation or seasonal changes and
do not experience sudden fluctuated earnings. Instead, it can consistently report stellar periodical
earnings over a long period of time, boosting investors confidence.
Furthermore, given the recent increase in number of natural disasters, particularly in Southeast Asia
due to the increased threat of global warming, food costs are more likely to increase as food crops
are destroyed (Nika, 2013). In the 2011 Thailand Flood, the export price of rice increased
exponentially by 9% (Ang, 2011) (Thecropsite, 2013). Due to the supply shock, analysts predicted
that prices of rice and other related commodities will rise by 10% this year (Thecropsite, 2014).
The F&B sector is likely to be the most affected, relying heavily on imports for inputs (Wenzlau,
2013). In the case of JFH, they rely heavily on Thailand for rice imports for their sushi and on
Canada for wheat and flour for the ramen in their outlets, especially Ajisen Ramen, the main bulk
of their business. Since FIFO takes into consideration the previous (lower) cost of ingredients as
the expense for current period, the WA would be a more faithful representation of cost of goods
sold, enhancing the quality of report. Under the International Accounting Standards Board,
information presented in the financial statements should faithfully represent transaction and events
occurring during that period. Transactions should be accounted for in a manner that represents their
true economic substance rather than mere legal form.
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3. Depreciation
When assets are acquired, the cost is placed as an asset in the balance sheet. FRS 16:61 (Refer to
Appendix 7) (Accounting Standards Council, 2013) requires all depreciable assets to be subject to
depreciation accounting. These are assets which are expected to be used over a year, have a limited
useful life, and are held by JFH for use in their main operations, rental and administration.
Over time, this cost is then expensed out, in line with the Matching Principle from generally
accepted accounting principles (GAAP), which states that expenses are recorded in the same
accounting period as the revenue earned as a result of those expenses. Therefore, the magnitude of
the depreciation will have a direct effect on the rate of return on PPE, added to total expenses, and
will influence the profitability ratios.
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method is further divided into 2 categories, double declining balance method and sum-of-the-digit
method. Using the accelerated method, the depreciable amount will be allocated proportionately to
the earlier part of the assets useful life. This also means that the depreciation expense for the first
few years of the assets useful life will be higher, but will be much lower near to the end of the
assets useful life.
FRS16:60 (Refer to Appendix 8) states that the depreciation method used should reflect the usage
pattern in which the assets economic benefits are consumed by the entity. Due to rapid
advancement in technology, many of the PPE such as the kitchen and office equipment will become
obsolete in a few years time. Thus, equipment is likely to be maximally utilized in the earlier years
of its useful life. On top of that, with the increase in competition in the industry, the management
would need to invest more in new PPE to ensure that its assets are efficient in producing the
required output. Therefore, older PPE will be used less often in the later part of its useful life. It is
more appropriate for JFH to adopt the double declining method and assign a higher depreciation
charge in the first few years of the assets useful life based on FRS16:60 (Refer to Appendix 8). By
using the double declining method, this would mean that the rate of depreciation is double than the
usual rate given that the company adopts the straight-line method.
The example in Appendix 9 illustrates how the depreciation expense is allocated throughout the
useful life of the kitchen equipment by adopting the double declining method. The financial
statements indicated a cost of $6,943,000 (Refer to Appendix 10), with an estimated useful life of 5
years, assuming salvage value = 0.
As seen from the illustration, using the double declining method, the company will have a higher
depreciation expense for the first and second year as compared to using the straight-line method.
However, the depreciation expense for the third, fourth and fifth year is lower which allows them to
attain a higher profit for the year, especially when depreciation expense is a rather high expense
account. Thus, in view of tougher times ahead, the company would be able to increase their profits
to achieve a better financial position, which puts them at an advantage over other companies.
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4. Conclusion
Given the booming financial performance over the last 5 years, it is crucial for JFH to carefully
manage their earnings in preparation for a possible cyclical recession in the near future.
Furthermore, international relations all over the world make JFH especially sensitive to fluctuations
in the global economy. However, they must practice earnings management with caution to smooth
out their earnings moderately.
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5. Appendix
Appendix 1 : Expenses by nature
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ACCOUNTING REPORT
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Straight-line Method
Year
of PPE ($000)
expense ($000)
PPE ($000)
($000)
6,943
6,943*40%=2,777
6,943
20%*6,943=1,388.60
4,166
4,166*40%=1,666
5,554.40
20%*6,943=1,388.60
2,500
2,500*40%=1,000
4,165.80
20%*6,943=1,388.60
1,500
1,500/2=750
2,777.20
20%*6,943=1,388.60
750
750
1,388.60
20%*6,943=1,388.60
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6. References
Acounting Standards Council. (2013). Retrieved 25 February, 2014, from
http://www.asc.gov.sg/frs/Frs_16.htm
Accounting Standards Council. (2013). Retrieved 25 February 2014, from
http://www.asc.gov.sg/frs/Frs_2.htm
Ang, S. (2011). Thailand Floods Disrupt Supply Chains & Raise Inflationary Risks. Retrieved 1
March, 2014, from http://www.sharesinv.com/articles/2011/11/04/thailand-floods/
Department of Statistics, Singapore. (2014). Import & Export Price Indices. Retrieved 28 February,
2014, from http://www.singstat.gov.sg/publications/publications_and_papers/prices/ipijan14.pdf
Investopedia ULC. (2012). Investopedia. Retrieved 3 March, 2014, from
http://www.investopedia.com
Nika, M. Lazo Kristyn. (2013). Disasters affecting Food Prices. Retrieved 5 March, 2014, from
http://manilatimes.net/disasters-affecting-food-prices/46601/
The Crop Site. (2013). Thailand Rice Prices Increase. Retrieved 5 March, 2014, from
http://www.thecropsite.com/news/12918/thailand-rice-prices-increase
The Crop Site. (2014). Poor Rainfall Expected to Limit the 2013/14 Paddy Production. Retrieved 5
March, 2014, from http://www.thecropsite.com/news/15681/poor-rainfall-expected-to-limit-the2013-14-paddy-production
Wenzlau, S. (2013). Global Food Prices Continue to Rise. Retrieved 5 March, 2014, from
http://www.worldwatch.org/global-food-prices-continue-rise-0
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