Reading: Lesson 9 - Summary of significant accounting policies

As part of their annual reports, companies include summaries of significant accounting policies. These policies assist users in interpreting the financial statements. To a large extent, accounting theory determines the nature of these policies. Companies must follow generally accepted accounting principles in preparing their financial statements. The accounting policies of The Walt Disney Company, one of the world's leading entertainment companies, as contained in a recent annual report follow. After each, the chapter of this text where we discuss that particular policy is in parentheses. 

Significant accounting policies

Principles of consolidation - The consolidated financial statements of the Company include the accounts of The Walt Disney Company and its subsidiaries after elimination of inter-company accounts and transactions.

Accounting changes - The Company changed its method of accounting for pre-opening costs (see Note 12). These changes had no cash impact.

Revenue recognition - Revenues from the theatrical distribution of motion pictures are recognized when motion pictures are exhibited. Television licensing revenues are recorded when the program material is available for telecasting by the licensee and when certain other conditions are met. Revenues from video sales are recognized on the date that video units are made widely available for sale by retailers.

Cash, cash equivalents and investments - Cash and cash equivalents consist of cash on hand and marketable securities with original maturities of three months or less. SFAS 115 requires that certain investments in debt and equity securities be classified into one of three categories. Debt securities that the Company has the positive intent and ability to hold to maturity are classified as "held-to-maturity" and reported at amortized cost. Debt securities not classified as held-to-maturity and marketable equity securities are classified as either "trading" or "available-for-sale", and are recorded at fair value with unrealized gains and losses included in earnings or stockholders' equity, respectively.

Merchandise inventories - Carrying amounts of merchandise, materials and supplies inventories are generally determined on a moving average cost basis and are stated at the lower of cost or market.

Film and television costs - Film and television production and participation costs are expensed based on the ratio of the current period's gross revenues to estimated total gross revenues from all sources on an individual production basis. Estimates of total gross revenues are reviewed periodically and amortization is adjusted accordingly. Television broadcast rights are amortized principally on an accelerated basis over the estimated useful lives of the programs.

Theme parks, resorts and other property - Theme parks, resorts and other property are carried at cost. Depreciation is computed on the straight-line method based upon estimated useful lives ranging from three to fifty years.

Other assets - Rights to the name, likeness and portrait of Walt Disney, goodwill and other intangible assets are amortized over periods ranging from two to forty years.

Risk management contracts - In the normal course of business, the Company employs a variety of off-balance-sheet financial instruments to manage its exposure to fluctuations in interest and foreign currency exchange rates, including interest rate and cross-currency swap agreements, forward and option contracts, and interest rate exchange-traded futures. The company designates interest rate and cross-currency swaps as hedges of investments and debt, and accrues the differential to be paid or received under the agreements as interest rates change over the lives of the contracts. Differences paid or received on swap agreements are recognized as adjustments to interest income or expense over the life of the swaps, thereby adjusting the effective interest rate on the underlying investment or obligation. Gains and losses on the termination of swap agreements, prior to the original maturity, are deferred and amortized to interest income or expense over the original term of the swaps. Gains and losses arising from interest rate futures, forwards and option contracts, and foreign currency forward and option contracts are recognized in income or expense as offsets of gains and losses resulting from the underlying hedged transactions. 

Cash flows from interest rate and foreign exchange risk management activities are classified in the same category as the cash flows from the related investment, borrowing or foreign exchange activity.

The Company classifies its derivative financial instruments as held or issued for purposes other than trading.

Earnings per share - Earnings per share amounts are based upon the weighted average number of common and common equivalent shares outstanding during the year. Common equivalent shares are excluded from the computation in periods in which they have an antidilutive effect. As you proceed through the remaining chapters, you can see the accounting theories introduced in this chapter being applied. In Chapter 6, for instance, we discuss why sales revenue is recognized and recorded only after goods have been delivered to the customer. So far, we have used service companies to illustrate accounting techniques. Chapter 6 introduces merchandising operations. Merchandising companies, such as clothing stores, buy goods in their finished form and sell them to customers.