A question from the Audience, paraphrased:
How to amortize plant costs in COGS: You say we should amortize over time, but we use a per book cost. For example: if our development costs are $5,000 and we expect to sell 5,000 books, we amortize the costs at the rate of $1.00 per book. That way, we more closely match revenue and expenses. However long it takes to sell those books, that’s the time we use to amortize the cost. While GAAP may suggest your version, is there any problem with this?
I see two potential difficulties, both of which can be handled:
1. You may never sell all the copies you expect.
Handle this by having a reserve against that eventuality. When it happens, you write off the balance against that accumulated reserve, rather than taking a then-current expense. This restores the matching.
2. It’s awfully tempting when considering some sort of incremental deal to include the per book plant cost. This is very wrong. The plant cost is a cost of producing the book in the first place, and is not at all changed whether or not you make the special deal. (I see it all the time, and it makes people turn down deals that have only a small profit margin on each book, but huge volume, and huge profits in total. Not good.)
You handle this by being sure to do a total cost and profit worksheet on the book with the deal and without the deal, in order to decide if you’re better off doing it. That’s a lot more work, and most folks make errors somewhere in that as well.
You can, of course, change your amortization pattern to reflect the expected speed of sale, rather than using a straight line. And that would do a pretty good job of restoring the matching of revenue and sales. (In fact, it has an even better effect: it matches your intended revenue when you planned the project to the expenses you incurred based on that planning: much better feedback, even if not quite the same as the reasoning underlying GAAP!)
So, we’ve beaten this issue into the ground. You amortize plant costs somehow, and they don’t go into Inventory. But how do you get them into COGS on your Income Statement? Most accounting programs compute your COGS straight from your change in inventory.
You can’t use the pre-programmed Income Statement report, but must write a custom report to replace it. I know that sounds scary, but there’s just no way around it.
In this custom report, your copy the Income Statement, with the one exception that your Plant Cost Amortization and your Royalty Expense accrued are included in COGS rather than in Operating Expenses.
Some accounting programs will pull anything into COGS that’s in a pre-programmed range of account numbers. That’s not common, though, so you will almost certainly have to bite the bullet, and read the manual, and learn how to write a custom report.
Is there any way around this? No. Even if you treat Plant Costs as part of the inventory value of your first print run, which I do NOT recommend, you still have to write a custom report in order to include your royalty expense. Could you include royalty expense as part of the inventory value of your books? No, not for tax purposes, not according to any type of financial accounting standards, nor according to any other set of standards I know. These rules are based upon the practical consequences of the way you record your information, but that’s a little complex to go into here. Just, please, believe me. This is a bad idea that tends to come back and bite you. Hard.
Now, who is confused by this entry? Don’t be shy, ask. This is complicated stuff, and I’m not a writer. (Well, duh. Apologies to all you editors out there who must be itching for a blue pencil as you read this!)