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!)
Who created accounting principles? Who sets and revises accounting standards? What if you don’t follow all the rules, do you go to jail? Is there an accounting police force that investigates and arrests violators? It would seem that there must be some regulatory force to make sure that providers of financial statements conform to the rules.
Accounting principles were created by accountants over centuries, but are codified by the Financial Accounting Standards Board (in the US — there are other orgs in other countries). FASB regs are then used as the basis of many rulings by the SEC and the IRS. So, no, you don’t go to jail if you don’t follow the FASB regs, but you may ALSO be violating laws relating to securities (if you have company debt or have sold stock), or in filing your taxes based upon your accounting records.
And, of course, you’re probably doing yourself harm, because those regs are there for a reason, and those reasons apply to most businesses.
I just recently found this blog and have forwarded the link on to others. Lots of great info here. Thanks for your time and effort.
We’ve been niche publishing for 10 years, though most of that time very small and operating as a Sole Prop, during which time we accounted for the Plant costs in precisely the WRONG way. This year we have incorporated and are trying to bring everything to the next level and do it all RIGHT (or as close as possible anyhow).
Since we can keep our titles “in stock” (potentially) perpetually thanks to short-run and POD printing (and via direct sales to the niche), what is a reasonable length of time to amortize the Plant costs? Has anyone determined a Best Practices length of time to account for the impacts these emerging technologies have on the business?
I’m in Grenada this week, but check back next week and we’ll talk.
I don’t believe that there’s a best practice set for either tax or financial accounting. But I do think that you might want to use something like the depreciation structure for a durable fixed asset.
Personally, I’ve always used straight line depreciation, with a life of one year for normal front list trade non-fiction, and three years for an evergreen backlist title. That seems to be a good compromise.
You could, I think, use MACRS instead of straight line, but I see no real reason to go to the extra effort. It might give you a gain in the first year or two that you use it, but after that, you’re in a steady state, and there’s no gain for the extra labor cost to do the calculations.
Hope that helps.
It does, thanks… Metrics suggest that sales on most of our titles peter out to the background level after two or three years or so, barring any new releases that spur backlist sales pulses. So, three years was what I was already contemplating as a common-sense number for us.
Thanks again for the input. Very helpful!
Glad you liked it. In most cases, you can make a case that you’re representing reality as closely as possible, when you do have to challenge a standard accounting rule of thumb.