MBA 5010 - Accounting Methods for Leaders: Training Manual for Accounting Tools and Practices (8/27/2024)

 

Business Context

 

Urban Outfitters (NYSE: URBN) began in 1970 as a small store near the University of Pennsylvania. The owners created Urban Outfitters as a boutique and community center for “creative college-aged students” (Urban Outfitters, Inc., 2024a, para. 1). Only a  few years after its opening, Urban Outfitters expanded to a department store, which opened the experience up to the greater community including restaurants, music, and other product offerings. Today, Urban Outfitters has over two hundred stores in the United States, Canada, and Europe that continue to provide a creative, inclusive place for the community and sell clothing and accessories for men, women, and housewares (Urban Outfitters, Inc., 2024a). Urban Outfitters, Inc. offers several global brands, including Anthropologie, Free People, FP Movement, Urban Outfitters, and Nuuly.  Recently, the company reported a net income of $117.5 million, earnings per diluted share of $1.24, and record-breaking operating profits for four of its brands for the second quarter of 2024 (Urban Outfitters, Inc., 2024b). However, to better understand a company’s financial standing and make financial decisions, it is imperative to learn some accounting fundamentals.

Introduction

The accounting process, which begins with a transaction between an entity or individual, such as a sale, purchase, loan, expense, interest, or other financial events, is crucial for understanding a company's financial position. Financial statements, which are records of these transactions, provide a comprehensive view of a company’s financial health, including its position, operations, and cash flow. This comprehensive view allows managers to make informed financial decisions. Understanding some essential accounting principles will allow one to interpret financial statements better. Current standards and guidelines require financial statements for the reporting period to reflect a company’s financial position, earnings, cash flows, investments, and distributions. This information is found in the company’s four primary financial statements: the balance sheet, income statement, statement of cash flows, and statement of stockholder equity changes. Financial statements account for all company funds: where funds came from, where they went, and where they are currently. Per the United States Securities and Exchange Commission (SEC), “If you can read a nutrition label or a baseball box score, you can learn to read basic financial statements”(2007, para. 1). This training will review general accounting practices, balance sheets, income statements, financial notes, advertising costs, store opening costs, and web development costs.

Balance Sheet

A balance sheet indicates what the company owns and owes during a specific period with detailed information regarding assets, liabilities, and shareholder’s equity (SEC, 2007). The assets always equal the liabilities and the shareholder equity combined. Assets provide company value. Asset examples are tangible items like property, equipment, and inventory and intangible items such as trademarks, patents, and investments. (SEC, 2007) Liabilities are debts the company owes, like loans, payroll, taxes, and contracts that have yet to be fulfilled. Shareholder’s equity is the funds that remain after the company sells all its assets and pays all its liabilities (SEC, 2007). Appendix A is an example of a balance sheet for Urban Outfitters, Inc. for April 30, 2016, and April 30, 2017. The current assets (Cash and cash equivalents, Marketable securities, Inventory, etc..) are assets the company expects to flow to cash within one year. Fixed assets, like property and equipment and deferred income taxes, will be sold later than one year, or the company does not intend to sell (SEC, 2007). The shareholders' equity details show the amount invested and the gains or losses. In the example found in Appendix A, the retained earnings for Urban Outfitters, Inc. for April 30, 2017, are 1,358,319, and the accumulated other comprehensive loss is 32,269.

Income Statement

Income statements show how much money a company made or spent during a specific period (SEC, 2007). The income statement for Urban Outfitters, Inc. for April 30, 2016, and  April 30, 2017, are in Appendix B. The primary purpose of the income statement is to explain if the company was profitable for the established period. The answer is calculated by subtracting all the company’s expenses from the reported revenue (Marshall et al., 2023). Income statements also contain the earnings per share, which is the amount shareholders would receive if the company distributed the entirety of the company’s net earnings (SEC, 2007). In Appendix B, for 2017, the net sales are 761,190; after all the expenses are subtracted from that total, the net income is 11,938.         However, most companies do not distribute the entity of these funds as they are often reinvested into the company (SEC, 2007).

Accounting Methods

The two general accounting methods are the cash basis method and the accrual basis method. The method used by a company depends on when they choose to recognize revenue and expenses. Under the cash-based approach, the company records the revenue or expense when the amount is paid or received. Under the accrual basis approach, expenses are logged when incurred (Marshall et al., 2023). Either accounting method has potential advantages and cons. Since the accrual method records accounts receivable and payables, this may better reflect a company’s profitability over time since it accounts for expected revenue. However, the accrual method does not track cash flow as quickly as the cash basis method (Morah, 2024). Cash basis accounting is simple and is often used by sole proprietorships and small businesses; however, from an investor’s point-of-view, a company using the cash basis model might appear more financially sound in December due to holiday spending and less profitable than the following January when consumer spending drops (Morah, 2024). The Financial Accounting Standards Boards (FASB) require publicly traded companies whose financial forms are audited to use the accrual method per the generally accepted accounting principles (GAAP) (Morah, 2024). Companies explain further details of their accounting practices in the notes in their financial statements.

Financial Statement Notes

Since companies may have different accounting methods, without any oversight, they may use unethical accounting practices, which is why there is a need for financial transparency and regulatory measures. Most recently, the Sarbanes–Oxley Act (SOX) of 2002 created the Public Company Accounting Oversight Board (PCAOB) to monitor and audit accountant practices (Marshall et al., 2023). Accountants and companies must disclose all accounting practices in the financial statement notes. These notes are integral to understanding the financial statements (Marshall et al., 2023). These notes clarify the content of the reports, allowing anyone to understand the information provided within. The following examples from Urban Outfitter’s 2016–2017 financial statement’s summary of significant accounting policies explain the company's criteria for recording advertising and store opening costs and in which the financial statement the information was recorded. The company’s approach to web development costs and capitalization is also noted in the financial statement’s summary of significant accounting policies.

Advertising Costs

Per the financial statement notes, Urban Outfitters, Inc.’s advertising costs include web-based marketing, printed catalogs (the paper and mailing postage), and photograph or image costs for the catalog, websites, social media ads, and mobile apps (SEC, 2017b). Per the financial statement, “the company expenses the costs of advertising when the advertising occurs, except for direct-to-consumer advertising, which is capitalized and expensed when the catalog is mailed or the content is published on the Company’s websites and mobile applications” (SEC, 2017b, p.F-12). The company will expense these as incurred if the advertising costs do not provide any future gains. The prepaid advertising costs are included on the balance sheet under “Prepaid expenses and other current assets” (SEC, 2017b., p. F-13). This is found below the “Current Assets” line in Appendix A. Advertising expenses that are not prepaid are included in “Selling, general, and administrative expenses” in the income statement (SEC, 2017b, p. F-13). This information is found in Appendix B. Therefore, Urban Outfitters, Inc. uses an accrual basis of accounting for advertising costs unless the expense will provide future benefits. This information is found in Appendix B.

Store Opening Costs

Urban Outfitters, Inc. uses an accrual method for its store opening costs. Per the financial statement notes, “The Company expenses all store opening and organization costs as incurred, including travel, training, recruiting, salaries, and other operating costs, and all such costs are included in “Selling, general and administrative expenses” in the Consolidated Statements of Income” (SEC, 2017b, p. F-13). This information is found in Appendix B.

Website Development Costs

For website development costs, “The Company capitalizes applicable costs incurred during the application and infrastructure development stage and expenses incurred during the planning and operating stage. During fiscal 2017, 2016, and 2015, the Company did not capitalize any internally generated internal-use software development costs because substantially all costs were incurred during the planning and operating stages, and costs incurred during the application and infrastructure development stage were not material” (SEC, 2017b, p. F-13). A company capitalizing costs will recognize the incurred costs over time rather than as a one-time transaction (Tuovila, 2023). This means expenses like web development can be amortized over time. In the case of Urban Outfitter Inc.’s web development costs during the development stage, the company chose to capitalize its website development costs, which are in turn then included in the company’s assets and do not take money away from the company as expenses do (Tuovila, 2023). Capitalization is the best option for web development costs since the company’s financials will not reflect a significant one-time expense during this period and will be spread out more evenly throughout the year. Also, web development is technically a long-term company asset as the company uses this platform for sales and customer relations.

Appendices 

Appendix A: Balance Sheet

 

(Urban Outfitters, Inc. condensed consolidated balance sheet by U.S. Securities & Exchange Commission, 2017a).

Appendix B: Income Statement

 

(Urban Outfitters, Inc. condensed consolidated statements of income by U.S. Securities  & Exchange Commission, 2017a).

References

 

Capella University. (n.d.). The accounting cycle [Video]. https://media.capella.edu/CourseMedia/bus3060/AccountingCycle/animation_wrapper.asp

Marshall, D. H., McManus, W. W., & Viele, D. F. (2023). Accounting: What the numbers mean (13th ed.). McGraw-Hill.

Morah, C. (2024, June 13). Accrual accounting vs. cash accounting: What’s the difference? Investopedia. https://www.investopedia.com/ask/answers/09/accrual-accounting.asp#:~:text=Key%20Takeaways,is%20actually%20received%20or%20dispensed.

Tuovila, A. (2023, May 1). Capitalized cost: Definition, example, pros, and cons. Investopedia. https://www.investopedia.com/terms/c/capitalizedcost.asp#:~:text=Key%20Takeaways,instead%20of%20being%20expensed%20immediately.

Urban Outfitters, Inc. (2024a). About us. https://www.urbn.com/our-brands/urban-outfitters/about-us

Urban Outfitters, Inc. (2024b, August 21).URBN reports record Q2 sales [Press release]. Urban Outfitters. http://investor.urbn.com/news-releases/news-release-details/urbn-reports

U.S. Securities & Exchange Commission (SEC). (2007, February 4). Beginner’s guide to financial statement. https://www.sec.gov/about/reports-publications/investorpubsbegfinstmtguide

U.S. Securities & Exchange Commission (SEC). (2017a, April 3). Urban Outfitters, Inc. Form 10-K. The fiscal year ended on January 31, 2017. https://content.edgar-online.com/ExternalLink/EDGAR/0001193125-17-108506.html?hash=c22ae7b31ae6a284cbf6aae0667837a24691aa34177e356a2203981cb255e4ef&dest=D286750DEX107_HTM#D286750DEX107_HTM

U.S. Securities & Exchange Commission (SEC). (2017b, April 30). Urban Outfitters, Inc. Form 10-K. https://www.sec.gov/Archives/edgar/data/912615/000119312517108506/d286750d10k.htm