Singapore Shipping Corp

[Yoyo]

Matching principle
http://www.accountingtools.com/matching-principle
 
The matching principle requires that revenues and any related expenses be recognized together in the same period. Thus, if there is a cause-and-effect relationship between revenue and the expenses, record them at the same time. If there is no such relationship, then charge the cost to expense at once.
 
Here are several examples of the matching principle:

• Commission. A salesman earns a 5% commission on sales shipped and recorded in January. The commission of $5,000 is paid in February. You should record the commission expense in January.
  
• Depreciation. A company acquires production equipment for $100,000 that has a projected useful life of 10 years. It should charge the cost of the equipment to depreciation expense at the rate of $10,000 per year for ten years.
  
• Employee bonuses. Under a bonus plan, an employee earns a $50,000 bonus based on measurable aspects of her performance within a year. The bonus is paid in the following year. You should record the bonus expense within the year when the employee earned it.
  
• Wages. The pay period for hourly employees ends on March 28, but employees continue to earn wages through March 31, which are paid to them on April 4. The employer should record an expense in March for those wages earned from March 29 to March 31.
  

Recording items under the matching principle typically requires the use of an accrual entry. An example of such an entry for a commission payment is:

Debit    Commission expense   5,000
Credit   Accrued expenses  5,000

In this entry, the commission expense is charged before the cash payment to the salesperson actually occurs, along with a liability in the same amount. In the following month, the company pays the commission, and records the following entry:

Debit    Accrued expenses  5,000
Credit   Cash  5,000

The cash balance declines as a result of paying the commission, which also eliminates the liability.
 
Because use of the matching principle can be labor-intensive, company controllers do not usually employ it for immaterial items. For example, it may not make sense to create a journal entry that spreads the recognition of a $100 supplier invoice over three months, even if the underlying effect will impact all three months. Instead, such small items are charged to expense as incurred.
 
If you do not use the matching principle, then you are using the cash method of accounting, where revenue is recorded when cash is received and expenses when they are paid.
 
Thus   cause-and-effect relationship between revenue and the expenses
 
Salesman needed to generate sales.  We can directly relate / match the sales (revenue) to these items – products cost (COGS), Salesman salary, Salesman bonus, Salesman Commission, Depreciation on delivery truck (in the case of SSC – depreciation on vessels), etc.
 
 
Source of Fund (Financing)
 
Loan Financing for the acquisition of revenue generating assets (such as plant and machinery, vessels) is not related to the sales process.  It is a choice of financing/funding.  In the purchase of these fixed assets, to use internal funding or to use external sources.  Internal funding does not entail additional business cost, such as existing cash resources and right issue of shares. External sources in the form of bank loan or loan stock/debenture do have interest element.

Cost of fixed assets is but financing of fixed assest is not related to the matching of revenue.  Hope this helps and not confusing more.

[valuebuddies]

I think for company like SSC which acquires assets solely for the purpose of leasing, the interest could be consider as direct COGS for financing the CGU. The question here is whether it is possible to apply straight-line method in recognizing the interest, which the auditor has not suggested, I guess due to the following reasons:

1. the LTV ratio is low and thus cannot justify that the loan is obtained exclusively for acquiring the vessel or vice-versa,
2. due to the present low interest rate, the impact of applying straight-line method to account the interest would not change the true and fairness of the financial results,
3. due inability to reasonably predict the future interest rate, it is therefore not possible to apply the straight-line method to account for the total interest,

However, I do agree with the deceleration in recognizing the revenues and depreciation. Auditor might disagree owing to the usual "prudent" reason.

[ksir]

I think for company like SSC which acquires assets solely for the purpose of leasing, the interest could be consider as direct COGS for financing the CGU. The question here is whether it is possible to apply straight-line method in recognizing the interest, which the auditor has not suggested, I guess due to the following reasons:

1. the LTV ratio is low and thus cannot justify that the loan is obtained exclusively for acquiring the vessel or vice-versa,
2. due to the present low interest rate, the impact of applying straight-line method to account the interest would not change the true and fairness of the financial results,
3. due inability to reasonably predict the future interest rate, it is therefore not possible to apply the straight-line method to account for the total interest,

However, I do agree with the deceleration in recognizing the revenues and depreciation. Auditor might disagree owing to the usual "prudent" reason.

Very well reasoned!!
Point3 is probably the killer.

[ksir]

Related to the point on step-down rates, I quoted below from 2016 AR:
Why did you build in step-down rates in your charter contracts?

The initial rates under a long term charter are higher due to higher interest rates under the financing arrangements. Further, as a vessel ages, it will naturally command a lower charter rate.

For illustrative purposes, it is not uncommon for the first 5 years of the rates to be agreed at S$10,000 per day (as an example), with rates stepping down to S$5,000 per day for the 5 years thereafter. In our view, such rates should be accurately reflected accordingly in the accounts, as was done in previous years. However, in May this year, it was foisted on us that we should adopt a straight-line basis which means (if based on the example above), we would only record S$7,500 as revenue a day even though the full S$10,000 is earned.

My comment: it's mentioned that the step-down rate as the vessel ages.
So isn't it more relevant to set decelerating depreciation instead?

Now, they are finding the auditor who could more understand their business model?

<vested>

[Contrarian]

> My comment: it's mentioned that the step-down rate as the vessel ages.
> So isn't it more relevant to set decelerating depreciation instead?

This is a good question. The AR shows that they try a lot to explain with much clarity.

I think best to ask for clarity on the revenue rates and depreciation.

On the operating lease commitment, the amount actually increased. Is that a result of the revised revenue recognition rules that lead to slightly high operating lease future revenue?

[valuebuddies]

Isn't auditor already proposed a straight-line approach in accounting the revenue and depreciation? What else need to be clarified?

In accounting, the word "prudent" is very important. If a liability is POSSIBLE, you should recognise it, but for assets you can only take into your book when it is PROBABLE.

For landlord's accounts (like reits), the acceleration method is more prudent than the straight-line method. For SSC, the straight-line method is more conservative than the deceleration approach.

Setting aside some deferred income is also good as an insurance against unforeseen events (eg. bad debts, breach of lease, downturn in RORO market, impairment on vessel and etc)

[Yoyo]

We all agreed that the early part of the shelf-life of Fixed Assets such as Plant and Machinery, Motor Vehicles, are most productive, less prone for breakdown, contributing the prime part of its values, so why is the straight line depreciation method commonly used in the preparation of financial statement?  In time where the currency registered wide fluctuation, arguable MYR, IDR, the financial statement is prepared under historical cost instead of the current cost.  Companies that are heavily in debt, had their financial statement prepared on a going concern basis. 

However we feel (we investors can have no influence), these financial statement are prepared and vetted based on the generally accepted accounting principles (GAAP) and the local accounting standards.  These standards evolve over times, giving raise to change in intepretation, treatement, adjusting to a ever changing business complexities, etc. 

I remember some VBs mentioned that it is more important not to take the financial figures at face value, but to read in its context.  A gift of SGD1,000 may be nothing now, but think about receiving the same 50 years ago.

[brattzz]

also meant that previous revenues are overstated?
suddenly come back to straight-line method is more conservative?

no wonder must change auditor...

[specuvestor]

There are generally 3 types of accounts: Financial Accounting, Tax Accounting and Management accounting and each with their own purposes. The principle of matching is very important in all 3 but their application is different.

Simple straight line depreciation is path of least resistance cause generally people don't question this simple methodology. If one uses accelerated recognition then it deviates from this baselline and the prerogative is on one to explain why. Problem is straight line might not match the revenue recognition and cashflow. In the event one smoothens the revenue and cost, then one inevitably understated the cost and revenue upfront as per Ksir example. This mismatch between numbers and reality effectively created an "off balance sheet suspense account" that can only be reversed over time. Problem is nobody see this suspense account and crap starts when the expected contract was not fully fulfilled or there are significant changes in cost or revenues due to industry dynamics or FX.

It can be deadly if one just revalues liabilities without the asset side and vice versa ie there is no corresponding matching. The recent GFC are of such nature and more an accounting crisis rather than a cashflow crisis. IIRC Bear Sterns and Lehman didn't default YET but the accounting crisis caused a run on confidence. But whether it is AFC or South America debt problem (which is more a cashflow crisis due to devaluations etc) or GFC, the key denominator is overleverage.

End of Day Accounting is an Art, rather than science which many are led to believe. That's why it is GENERALLY ACCEPTED principles for application. IFRS and IAC is more an international standard created so that one can compare across different jurisdictions, but in so doing it is misleading that accounting is standardised and mechanical.

And then there is the real world where cashflow is king... not accounting. Finance is interesting cause it straddles between the real world and the numbers world of accounting

SSC has been leveraging only these past 2 years to buy ships. Any change in accounting should not be that significant as long it had been matching but the industry dynamics and FX could.

[brattzz]

ok fair enough, thanks specuvestor for the class...