Introduction

Contemporary accountancy determines the concepts of depreciation and impairment as one of the most integrally important elements of the internal and external financial environments of company (Kerrigan, 1990). Scholars unanimously accentuate the fact that if these variables are not considered while the process of the financial environment evaluation is underway, the firm risks incurring significant financial losses, which can lead to the financial collapse and bankruptcy in the long run (Bazley, 2004).

The fact that Industrial Age has passed away shall not misguide the business practitioners, since the importance of impairment and depreciation has not been reduced at all. Moreover, the advent of the technological revolution clearly conditions the necessity to elaborate new methods of impairment and depreciation calculation, since the productive facilities of the enterprises are especially vulnerable to the technological advancements (Warren, Fess, Reeve & Fess, 1996).  Constant need to update the installed technologies explains why the depreciation and impairment has become so significant today. The most contributive factor is the fully unpredictable nature of the technological breakthroughs, and therefore the financial team of an enterprise can’t timely predict what managerial concepts are to be followed to keep up with the existing market conditions.

One of the targeted company for this research are the US located JP Morgan Chase  & Co., the international financial and banking giant. The company operates in the securities trade, investments operations and retail trading.  This institution is known to be one of the biggest banking institutions in the United States of America and in 2011 it was reported to be number one.  The company provides retail and commercial banking services as well, whilst the focus of the activity is made on the investment banking.

The second researched institution is one of the closest competitors of JP Morgan Chase & Co. Goldman Sachs, the international US based firm specializing in providing  investment banking services as a principal business activity.

Overall, the objective of this research paper is to define the concepts of depreciation and impairment and to provide comparative studies thereof, to evaluate their role in the composition of  true, fair and legitimate financial statement and reports of business institutions, to speculate over the strategies and polices taken by the targeted companies on depreciation and impairment, to calculate ROR ( Return on Assets ) of the both companies for 2011 and 2012 consecutive accounting periods and to discourse over the relative profitability, to calculate ROR without depreciation and impairment and to comment accordingly. The latest parts of the report provide the calculations of the working capital ratios of the targeted companies. The paper is finalized with the summative conclusion and guidance to the management of the discussed companies and to the promising investors.

The Definitions and Comparison

The nature of depreciation is twofold: firstly, the accounting scholars and practitioners refer this issue to the reported reduction in value of the entire set of the company operational assets. The second part of the concept is the allocation of the operational expenses into the separate time periods in which the resources are utilized. 

The concept of impairment refers to the procedure conducted by the financial authorities of the company with the intent to reevaluate the fixed assets of the company in order to find out their true value (Horngen, Harrison, Bambers, 2002). 

The main disparity between the two variables is the fact that the model of depreciation is necessarily connected with the age of service of the examined fixed assets (or productive facilities of the company), while impairment procedure is conducted when such necessity arises ( for instance when the entity is merged with another entity) and is in no way linked to the age of service of the targeted assets.

The Accounting Principles and Concepts that Prescribe the Utilization and Recognition of Impairment and Depreciation for the Composition of True and Fair Financial Reports and Statements of the Business Entities

Generally, the application of the depreciation and impairment accounting models is closely connected with the five major concepts of contemporary accounting, although the latest two ones are fervently contested by the critics of the modern school (Baxter, 2005).

First and foremost, the depreciation and impairment models depend heavily on the consistency concept, which purports that since the method of accounting is chosen it must remain unchanged until the specific operation is fully completed (Kerrigan, 1990).  With regard to the present concepts, they are closely linked to this one because both they are quantative variables, and the methods of their calculation shall be the same. 

The second governing concept is the principle of going concern that sets forth that assumedly the targeted business entity will remain operative in the feasible future and will not be closed or suspended ( Baxter, 2005).   If the business is inactive, therefore there is no objective need to calculate the discussed variables and the winding up of a business unit obligatorily necessitate the application of the specific calculative strategies and methods under the common bankruptcy procedures.

The full prudence concept indicates that the accrued profits shall be calculated and considered only when they are actually accrued (not when there is a feasible opportunity that they will be accrued) and the liabilities and losses are considered when there is a reasonable and probable chance that they will be born. Depreciation and impairment costs are included into the costs of the goods sections of the financial statement and therefore can be considered as losses.

The fourth principle regulating the application of the discussed principles is the concept of full disclosure. This postulate implicates that all the relevant data shall be obligatorily exposed to the stakeholders, or those, who need this information to fulfill their industrial function, e.g. top-management or financial department of the company. The causation with the reviewed concepts is conditioned by the fact that the depreciation and impairment variables can be calculated when the information relating to them is available (Bazley, 2004).

 The concept of materiality signifies that only major and determinative accounting variables and values shall be considered by the researchers. Insignificant numbers can be disregarded, by the important ones must be fully and explicitly revealed for the stakeholders.

The Practical Examination of the Concepts

a)      The Policies of the Companies Applied to Recognize and Account for the Losses in the Category of Long-Term Assets in the Context of Depreciation and Impairment

JP Morgan Chase & Co. in 2011 was reported to possess US$ 2.359 trillion in total assets, with the net income being $ 97,234.  With regard to the methods of depreciation calculation, it has become evident that the multiple combined approach was followed by the analysts of the company to accomplish this task. In particular, the focus was made on the fusion of the straight line depreciation calculation and declining balance methods.  Moreover, the elements of the composite depreciation and group depreciation methods have been applied by the financial department of the banking institution. The process is so diverse due to the fact that the services provided by the firm are heterogeneous in there natures and hereby a great variety of different factors are to be taken into consideration to accomplish the task.  Overall , this company calculates and recognizes the profits only after the depreciation and impairment values have been fully identified and reported.

With regard to Goldman Sachs, the 2011 financial statement of the company reveals clearly that the company is using the similar methodology, which is however reinforced by the activity depreciation and units of time depreciation methods.  The performance of the company clearly suggests that the depreciation and impairment values are estimated at the beginning of the accounting years and these values are anticipated on the basis of the previous results.

b)      The Rate of Return

The most widely applied formula for the rate of return calculation is the following one:

The following figures will be applied in the course of subsequent calculations (retrieved from the annual financial statement of the targeted companies respectively):

JP MORGAN & CHASE CO.

2011

2010

Net Revenue

$ 97, 234

$ 102, 964

Net Income

$ 18,976

$ 17,370

GOLDMAN SACHS

2011

2010

Net Revenue

$ 28,811

$ 39,161

Net Income

$ 4,442

$ 8,354

Note: all values are given in the United States dollars (millions)

The obtained values clearly suggest that the fact that the companies followed different finance management approaches with regard to the issues of depreciation and impairment was objectively reflected in the financial performance demonstrated by the targeted entities.  While the 2011 was more profitable financially for Morgan & Chase, the revenues accrued by Goldman Sachs have been slightly reduced.  The reasons of these vacillations shall be inter alia sought in the depreciation and impairment strategies of the companies (Baxter, 2005). While Morgan & Chase conducts the evaluation progressively (which more expensive but at the same time considerably more accurate) Goldman Sachs calculate these values on the basis of the previous year assumptions. 

c)      Rate of Return Calculations Excluding Impairment and Depreciation Constituents

Having analyzed the 2010 and 2011 annual financial statements of the targeted companies, the following depreciation and amortization values have been retrieved

2011

2010

JP Morgan &Chase Co.

4,257

4,029

Goldman & Sachs

1,8652

1,889

The obtained figures clearly demonstrate to the targeted audience that several inferential conclusions can be made. First and foremost, the ratio of the depreciation and amortization funds the general assets is considerably bigger in the financial management of the Goldman Sachs, since the exclusion of these values from the calculation model inevitably leads to the enhancement of the Rate of Return financial indicator.  Consequently, it is possible to increase the revenues and the net income accrued by the company is means of artificial reduction of the depreciation and amortization funds of the enterprise (Bazley, 2004).

While Goldman Sachs can potentially increase their revenues by exclusion the depreciation and amortization fund, their competitors cannot launch this strategy, since it is evident that the percentage value of the depreciation and amortization fund is not significant.  Although relative profitability of the both entities is increased, in the long run this policy is detrimental to the financial environment of the company due to the fact that the total assets of the entity are devaluing and in contrast to the first situation this process is uncontrollable.

D) Working Capital Ratios Calculations

Turnover Days

This figure demonstrates the number of times the inventory is purchased by the customers of the company

For JP Morgan and Chase Co., 2010 fiscal year the Inventory Turnover days is 24, while for the  2011 accounting period it is fixed on the 24 figure.

With regard to the Grossman Sachs, 2011 was marked by 67 turnover days and 2010 by 59 inventory turnover figure.

With regard to the accounts receivable period, it took  56 days to collect all their receivable from the debtors of the banking institution in 2010 and 63 days in 2011 ( JP Morgan & Chase Co.)

As far as the accounts receivable period of Goldman Sachs is concerned, it shall be stressed that it took 78 days in 2010 and 91 days in 2011 respectively to collect.

For the both companies it can be inferred that their cash flows are heavily pressured by the  deficit of the operative cash flow.

Accounts receivable period for the Morgan & Chase Co. takes 100 days (2010) and 83 days (2011) respectively, while Goldman Sachs reported to comply with all their pending financial liabilities within 57 days in 2010 and 63 days in 2011.

This analysis clearly demonstrates that although the annual statements explicitly suggest the profitability and the liquidity of the reviewed enterprises, their capacity to handle day-to day cash-flow related operations do seem to be seriously endangered, since accounts payable and accounts receivable periods significantly exceed the normal period.

Summative Conclusion

Having recapitulated the major points of the research, several important inferences are to be drawn. First and foremost, the companies follow different strategies with regard to the management of the depreciation and amortization funds, with Goldman Sachs being more scrupulous and investment-willing to this section. Secondly, both companies do experience difficulties linked to the accounts payables and receivables funds.

Overall, the targeted companies are lucrative investment opportunities, but when the investment is made, the managers of the company are requested to follow flexible approaches in order to achieve the maximum rate of return.

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