1
Q
Working Capital: what is working capital and what does it measure
A
working capital = current assets - current liabilities
measures: solvency
2
Q
Working Capital: what is the formula for the Quick Ratio
A
(cash + NET A/R + marketable securities) / current liabilities
Note: NOT inventory
3
Q
Working Capital: List the 9 common current assets
A
- cash
- trading securities
- other short-term investments (if liquidiation is anticipated within the operating cycle or one year, whichever is longer)
- trade installment receivables
- inventories
- A/R and N/R
- prepaid expenses
- cash surrender value of life insurance (if policy owner intends to surrender policy for cash during the normal operating cycle)
Note: CSV can be non-current
4
Q
Working Capital: how are premium payments that do not add to an insurance policy’s cash surrender value recorded
A
expensed
5
Q
Working Capital: define a current asset
A
resources that are reasonably expected to be realized in cash, sold, or consumed (prepaid items) during the normal operating cycle of a business or one year, whichever is longer
6
Q
Working Capital: define a current liability
A
obligations whose liquidation is reasonably expected to require the use of current assets or the creation of other current liabilities
Note: includes estimates or accrued amounts expected to be required to cover expenditures within the year for known obligations (1) when the amount can be determined only approximately or (2) where specific persons to whom payment will be made is unascertainable
7
Q
Working Capital: what are the main sources of current liabilities
A
- operating liabilities
- borrowings from banks
Note: short-term notes payable are not always an operating liability (see F7)
8
Q
Working Capital: list the 7 main types of current liabilities
A
- trade accounts and notes payable
- current portions of LT debt
- cash dividends payable (declared but not paid)
- accrued liabilities
- payroll liabilities
- taxes payable
- advances from customers (unearned revenue expected to be recognized within one year)
9
Q
Working Capital: what are the GAAP and IFRS requirements for reclassifying current liabilities to non-current liabilities
A
- GAAP: company intends to refinance the debt on a LT basis and intent is support by ability to do so as evidenced by either:
(a) actual refinancing prior to the issuance of the financial statements or
(b) existence of a non-cancelable financing agreement from a lender having the financial resources to accomplish the refinancing - IFRS: short-term liabilities must be ACTUALLY refinanced at the balance sheet date
10
Q
Working Capital: what is the journal entry to record the refinancing of short-term liabilities
A
Dr. Short-term Liability Cr. Long-term Liability --OR-- Dr. Short-term Liability Cr. Common Stock Cr. APIC
11
Q
Working Capital: define cash and cash equivalent
A
- cash: currency, demand deposits, and similar (that can be added to or withdrawn at any time without penalty)
- cash equivalent: short-term, highly liquid investments that are both readily convertible to cash and so near maturity when acquired by the entity (ORIGINAL maturity of 90 days or less from date of purchase) that they present insignificant risk of changes in value
12
Q
Working Capital: give 6 examples of cash and cash equivalents
A
- coin and currency on hand (including petty cash)
- checking accounts
- savings accounts
- money market funds
- deposits held as compensating balances against borrowing arrangements with a lending institution that are NOT legally restricted
- Negotiable paper:
- bank checks, money orders, traveler’s checks, bank drafts, and cashier’s checks
- commercial paper and T-Bills
- certificates of deposits (with original maturities of 90 days or less)
Note: NOT INCLUDED -
- time certificates of deposit (if original maturity >90 days)
- LEGALLY restricted deposits held as compensating balances against borrowings with a lending institution
13
Q
Working Capital: define restricted cash and how it is recorded
A
Restricted Cash: cash that has been set aside for a specific use or purpose (disclose nature, timing, amount in footnotes)
If associated with a current asset/liability = current asset but separate from unrestricted cash.
If associated with a non-current asset/liability = non-current asset separate from either the Investments or Other Assets section.
14
Q
Working Capital: what are the 2 general forms of bank reconciliations
A
- Simple Reconciliation
2. Reconciliation of Cash Receipts and Disbursements (4-Column Approach)
15
Q
Working Capital: list the treatment of components in a Simple Bank Reconciliation
A
- Deposits in Transit = add to bank balance
- Outstanding Checks = subtract from bank balance
- Service Charges = subtract from books
- Bank Collections = add to books
- Errors = fix it (either bank or books)
- Nonsufficient Funds (NSF) = subtract from books if not redeposited
- Interest Income = add to books
16
Q
Working Capital: what are the procedures for calculating the True Balance in a Simple Bank Reconciliation
A
Step #1: Book balance is adjusted to reflect any corrections reported by bank
Step #2: Adjusted Book Balance = True Balance
Step #3: bank balance per the bank statement is reconciled to the “true balance” determined above
17
Q
Working Capital: how are accounts receivable
A
A/R: oral promises to pay debts and generally classified as current assets
N/R: written promises to pay that can be current or non-current (depending on when collection will occur)
18
Q
Working Capital: what are the 2 types of A/R
A
- trade (from purchasers of company goods and services)
2. non-trade (from persons other than customers)
19
Q
Working Capital: how are A/R recorded
A
@ net realizable value
NRV = A/R - allowances for uncollectibles, - sales discounts - sales returns and allowances
20
Q
Working Capital: what are the 2 types of discounts considered when reporting A/R
A
- Sales or Cash Discounts
- Gross Method: if taken, DEBIT “Sales Discounts Taken” (contra-revenue) account
- Net Method: if not taken, CREDIT “Sales Discounts Not Taken” (revenue account) - Trade Discounts (quantity)
- apply SEQUENTIALLY
21
Q
Working Capital: how are Sales Returns and Allowances recorded when recognizing A/R
A
General Rule: wait until actual return
If past experience shows a material % of A/R are returned, estimate and accrue “Allowances for Sales Returns” (if reasonably estimable)
Sales Returns and Allowances account is a contra-sales account
22
Q
Working Capital: what are the 3 GAAP allowance methods for estimating uncollectible A/R accounts
A
- Percentage of Sales (I/S, emphasizes matching)
- Percentage of A/R @ yr-end (B/S) = amount calculated is the ending balance that should be in the Allowance for Doubtful Accounts account
- Aging of A/R (B/S, emphasizes asset valuation NRV) = the sum of the product for each aging category is the desired ending balance in the allowance account
Note: Tax method = direct write-off (no matching)
23
Q
Working Capital: what is the journal entry for subsequent collection of A/R previously written off under the (1) allowance method and (2) direct write-off method
A
1. Allowance method Dr. A/R Cr. Allowance for Uncollectible Accounts - and- Dr. Cash Cr. A/R
- Direct write-off method
Dr. Cash
Cr. Uncollectible accounts recovered (revenue account)
24
Q
Working Capital: define Pledging (Assignment) of Accounts Receivable
A
Pledging: company uses existing A/R as collateral for a loan
- company maintains title to the A/R
- company pledges to use proceeds from the A/R to repay the loan
- A/R is not adjusted
Dr. Cash
Cr. Note Payable
25
Working Capital: define Factoring of A/R
Factoring: company converts receivables into cash by assigning them to a "factor" either with recourse or without recourse
- with recourse: factor has option to re-sell any uncollectible receivables back to seller
- without recourse: true sale, assignee/factor assumes the risk of losses (the factor may retain proceeds to protect itself against sales returns, discounts, allowances, etc. and represents a liability to assignee)
Note: the customer may or may not be notified
26
Working Capital: what are the 2 possible treatments of A/R in a Factoring With Recourse situation
1. Considered a sale: requires ALL of the following
- (a) transferor's (seller's) obligation for uncollectible accounts can be reasonably estimated (accomplished by posting some security, "Due From Factor"
- (b) transferor surrenders control of future economic benefits of A/R to the buyer, and
- (c) transferor cannot be required to repurchase the receivables but may be required to replace the receivables with other similar ones
2. Considered a borrowing (with receivables as mere collateral)
- used when any one of the above requirements for sale recognition is NOT met
27
Working Capital: what is the objective of SFAS No. 40 addressing the transfers and servicing of Financial Assets
Each entity involved in the transaction should:
1. recognize only the assets it has control over (and the related liabilities it has incurred in the process) and
2. De-recognize those assets only when control over them has been surrendered and those liabilities only when extinguished (see F5)
- derecognition involves removing previously recognized items from the B/S
28
Working Capital: what is the Financial-Components Approach regarding the transfer and servicing of Financial Assets
- Basis for GAAP rules
- Focuses on control
- Financial assets and liabilities may be divided into many components
- These components may have different accounting methods applied to them depending on the circumstances
29
Working Capital: what is the definition of Surrender of Control as applied to the transfer and servicing of Financial Assets
All 3 conditions are required before control is deemed to be surrendered:
1. transferred assets have been isolated from the transferor
2. transferee has the right to pledge or exchange the assets
3. transferor does NOT maintain control over transferred assets under a repurchase agreement
30
Working Capital: how is the transfer of Financial Assets recorded when control is deemed to have been surrendered AND there is NO continuing involvement
- treat as a sale
- reduce receivables and
- recognize any gain or loss
31
Working Capital: how is the transfer of Financial Assets recorded when control is deemed to be surrendered and there IS continuing involvement
- use the Financial Components Approach
- divide transferred assets between those deemed "sold" and thos "not sold"
- record the transfer of the assets for which there is NO retained interest as a sale
- resulting gain or loss is recorded for the SOLD items
- any retained interests are still carried on books of transferor (including servicing assets) and are allocated a book value based on the relative fair value of all transferred assets at transfer date
32
Working Capital: how is the transfer of Financial Assets recorded when control is NOT deemed to be surrendered
- transferee and transferor account for the transfer as a secured borrowing with pledged collateral
- each party recognizes the appropriate asset/liability amounts and interest revenue/expense amounts
- accounting for collateral (non-cash) held depends on whether the debtor has defaulted and whether the secured party has the ability to sell or re-pledge the collateral
33
Working Capital: how are Servicing assets or liabilities recorded
- when entity is party to a servicing contract to service financial assets, it should record a servicing asset or liability for the contract
- the servicing A/L is initially measured at the price paid or fair value
- then amortize the contract A/L in proportion tot he estimated net servicing income (or loss)
- fair value is determined at regular intervals throughout the life of the contract and contract is assessed for impairment (or an increase in the liability) based on that fair value
34
Working Capital: how are Notes Receivable valued and presented
1. Short-term N/R = record @ maturity
2. Long-term = record @ PV of net value
State N/R at present value of FCF
- unearned interest and finance charges are deducted from face of note
- it it is non-interest bearing or interest rate is below market, value of note is determined by imputing the Market Rate of interest and using the Effective Interest Method
Note: interest-bearing notes issued at arms-length are presumed to be issued at the market rate of interest
35
Working Capital: what is Discounting of N/R and how is it calculated
- Discounting arises when the holder of a N/R endorses (with or without recourse) it to a 3rd party and receives a sum of cash
- amount of cash received by the holder is determined by applying a "discount rate" to the MATURITY VALUE of the note
- difference b/t the amount of cash received by holder and maturity value of note is the "discount"
Note: when discounting, after computing the maturity value, apply the bank discount to the payoff value (ex: if 60 days remains in a 90 day note, multiply the discount rate X (60/365))
36
Working Capital: what is a N/R Discounted With Recourse and how is it recorded
- holder remains contingently liable for ultimate payment of the note when it becomes due
- Option #1: report N/R on B/S with a corresponding contra-account ("Notes Receivable Discoutned") indicating they have been discoutned to a 3rd party
- Option #2: N/R may be removed from the B/S and teh contingent liability disclosed in notes to F/S
```
Dr. Cash
Cr. Notes Receivable Discounted (contra-asset)
-OR-
Dr. Cash
Cr. N/R
```
37
Working Capital: what is a N/R Discounted Without Recourse and how is it recorded
- represents a true sale (hold has not further liability)
- remove from B/S
Dr. Cash
Dr. Loss
Dr. Due From
Cr. N/R
38
Working Capital: how are dishonored Discounted N/R recognized
1. contingent liability removed by the following JE:
Dr. N/R Dishonored (??)
Cr. N/R
- N/R Dishonored recorded to the estimated recoverable amount of the note
- Loss is recognized if estimated recoverable amount is less than amount required to settle the note AND any applicable PENALTIES
39
Inventories: what are teh 4 types of inventories held for re-sale
1. Retail inventory
2. Raw Materials Inventory (manufacturing)
3. Work in Process Inventory (WIP) (manufacturing)
4. Finished Goods Inventory (manufacturing)
40
Inventories: what costs are included in inventory and what are the 7 exceptions to the general rule
GR: any goods and materials that the company has legal title to, generally with possession
Title passes in manner (1) agreed upon or (2) when seller delivers goods
Exception:
1. Goods in Transit:
- FOB Shipping Point = buyer's inventory (include freight in)
- FOB Destination = Sellers' Inventory (freight-out = selling expense)
2. Shipment of Non-Conforming Goods: title reverts to seller upon rejection by buyer (= seller's inventory)
3. Sales with a Right to Return:
- seller's inventory if amount of returns CANNOT be reasonably estimated
- buyer's inventory if amount of returns can be estimated, record transaction as a sale with an allowance for estimated returns
4. Consigned Goods: consignor's inventory (inventory costs includes shipping costs to the consignee)
5. Public Warehouse: include in inventory of company holding the warehouse receipt
6. Sales with a Mandatory Buyback: seller's inventory
7. Installment Sales
- seller's inventory if percentage of uncollectible debts cannot be estimated (and seller maintained legal title as security)
- buyer's inventory if percentage can be estimated; allowance for uncollectible debts must be recorded
41
Inventories: how is inventory initially recorded
GAAP: Lower of Cost or Market
- at cost when expect to sell at a profit (no loss recognized even though replacement or reproduction costs are lower)
- applied to single item, category, or total inventory
- recognize loss in current period
42
Inventories: what comprises the "cost" of inventory
Cost: price paid or consideration given to acquire an asset, = cost of expenditures and charges, direct and indirect, in bringing goods to their required condition or location
NOT included:
- selling expenses
- abnormal spoilage
- idle plant capacity
43
Inventories: how are inventories of precious metals and farm products valued
Valued at NRV (= selling price - costs of disposal)
INCLUDES
1. inventories of gold & silver when there is effective govt-controlled market at a fixed monetary value
2. Inventories of agricultural, mineral or other products meeting ALL:
- (a) immediate marketability at quoted prices
- (b) unit interchangeability, and
- (c) inability to determine appropriate costs
44
Inventories: how is the Lower of Cost or Market method applied to inventories
1. GAAP
- recognize loss (conservatism) in period incurred (matching)
- market = middle of:
- (a) net realizable value = ceiling
- (b) replacement cost
- (c) NRV - profit margin = floor
- write-down usually reflected in COGS unless material (then seperately)
- reversals are NOT allowed
- does not apply if company has a firm sales price contract
2. IFRS
- lower of cost or NRV
- recognize loss in current period
- reversal is allowed (but limited to previous write-down)
- record reversal as a reduction in total inventory costs on income statement (COGS) in the period of reversal
45
Inventories: describe periodic inventory system
- uses "Purchases"
- units of inventory and associated costs are counted and valued at the end of the accounting period
- actual COGS determined after count by "squeezing"
- disadvantage: shortages lumped with COGS
46
Inventories: describe the perpetual inventory system
- inventory record for each item of inventory is updated for each purchase and each sale as they occur
47
Inventories: list the hybrid systems of inventory recognition
1. Unit of Inventory on Hand - Quantities Only (changes in quantities recorded after each sale)
2. Perpetual with Periodic at Year-End (still perform a physical count at year end)
48
Inventories: what is the GAAP and IFRS guidance on inventory cost flow assumptions
1. GAAP: assumption is not required to have a rational relationship with physical inventory
2. IFRS: method should be based on order in which the products are sold relative to when they were put in inventory
- use specific identification whenever possible
- LIFO is prohibited
49
Inventories: list the primary inventory cost flow assumptions and when they are best applied
1. Specific identification:
- no estimating, used for physically large or high-value items
- allows for greater opportunity to manipulate income
2. FIFO
- ending balance approximates replacement cost
- EI and COGS are SAME whether a periodic or perpetual inventory system is used
- in periods of rising prices: highest EI, lowest COGS, highest NI
3. Weighted Average (Periodic)
- weighted average = (total costs of inventory available) / (total # units available)
- best for homogeneous products
4. Moving Average (Perpetual)
- computes the weighted average cost after each PURCHASE
- moving average = (total cost of inventory available) / (total units available) after each purchase
- more current than weighted average
5. LIFO (GAAP only)
- measured in units and priced at unit prices
- does NOT approximate replacement cost
- if used for tax, MUST be used for F/S
- eliminates holding gains and reduces net income during inflation
- BETTER matching unless layer liquidation occurs
- subject to income manipulation by intentionally liquidating layers
- additional LIFO layer created in any year where the ending inventory is greater than beginning inventory
- additional LIFO layer priced at earliest costs of the year in which it was created
- different under periodic and perpetual
6. Dollar-Value LIFO
- estimate of change in price levels required
- measured in dollars and adjusted for changing price levels
- price index used to convert from LIFO to Dollar-Value LIFO
- price index = (EI @ current yr cost)/(EI at base year costs)
50
Inventories: what is a firm purchase commitment and when are losses on such recognized
Firm Purchase Commitment = legally enforceable agreement to purchase a specified amount of goods at some time in the future
- must be disclosed in F/S or notes
If contract price > market price and if it is expected that losses will occur when purchase is actually made: recognize loss in period of decline in price (disclose description in I/S)
- report on I/S under "Other Expenses and Losses"
51
FA: what are the characteristics of fixed assets
1. acquired for use in operations and not for resale
2. long-term in nature and subject to depreciation
3. physical substance (tangible)
52
FA: what are the 4 main classification of fixed assets
Must be shown SEPARATELY on B/S (or footnotes) at original cost (historical cost):
1. Land (property)
2. Buildings (plant)
3. Equipment: may show machinery, tools, furniture and fixtures separately if significant
4. Accumulated Deprecation (contra-asset)
- may combine for 2+ categories
53
FA: how are fixed assets valued under GAAP and IFRS
1. GAAP:
- historical cost (cash or cash equivalent price of obtaining the asset and bringing it to the location and condition necessary for its intended use)
- donated FA: @ fair value + incidental costs incurred (recognize a gain on the I/S)
2a. IFRS Option #1: Cost Model
- initially valued at cot to acquire
- adjust cost for depreciation and impairment
2b. IFRS Option #2: Revaluation Model
- CLASSES of fixed assets revalued to FAIR VALUE (NOT individual assets)
- reported at FV less subsequent A/D and impairment
- revalue frequently enough to ensure carrying value does not materially differ from FV
- HISTORICAL COST EQUIVALENT MUST ALSO BE DISCLOSED
- Losses & Impairment --> (FV < CV) I/S unless reversing
- Gains: (FV > CV) OCI unless reversing
54
FA: what costs are included in the cost of equipment (office equipment, machinery, furniture, fixtures, and factory equipment)
- all expenditures related directly to their acquisition or construction
- invoice price
- LESS cash discounts and other discounts
- Plus freight-in (and insurance while in transit and while in construction)
- Plus installation charges (including testing and preparation for use)
- Plus sales and federal excise taxes
- Possible addition of construction period interest
55
FA: how are additions, improvements, replacements and repairs of equipment recorded
Determined based on purpose of the disbursement:
1. Additions = increase quantity of fixed assets = capitalize
2. Improvements = improve the quality of fixed assets = capitalize (see below for detail)
3. Replacement = new or similar asset is substituted for old asset:
- if carrying value of old asset is known: remove it and recognize any gain or loss then capitalize cost of improvement or replacement
- if carrying value is unknown and:
- (a) asset's life is extended: debit A/D for cost of improvement/replacement
- (b) usefulness (utility) of asset is increased: capitalize cost of improve/replacement to asset account
4. Repairs:
- ordinary = expense
- extraordinary = capitalize (treat as addition, improvement, or replacement as appropriate)
56
FA: what costs are included in the cost of land
- all costs incurred up to excavation for the new building (excavation/digging foundation = building cost)
- purchase price
- brokers' commissions
- title and recording fees
- legal fees
- draining of swamps
- clearing of brush and trees
- site development (grading (filling-in of mountain tops to make a "pad")
- PLUS: existing obligations assumed by buyer, including mortgages and back taxes
- Costs of razing (tearing down) an old building (demolition)
- LESS proceeds from sale of existing buildings, standing timber, etc.
57
FA: list examples of Land Improvements
(depreciate!)
- fences
- water systems
- sidewalks
- paving
- landscaping
- lighting
- PLUS: interest costs during construction period (based on weighted average of accumulated expenditures)
58
FA: how are land and buildings valued when purchased in a Basket Purchase
allocate purchase price based on the ratio of appraised values (FAIR VALUE) of individual items
59
FA: how is Investment Property defined under IFRS
Note: not recognized by GAAP
- land or buildings held by an entity or by a lessee under a finance (capital) lease to earn rentals or for capital appreciation
- includes property under construction or development for future use as investment property
60
FA: how is Investment Property (IFRS) valued
1. Initial cost =
- purchase price
- PLUS expenses directly related to purchase including:
- - legal services
- - professional fees
- - property transfer taxes
- - other taxes
Capitalize THESE subsequent costs:
- costs incurred to add to the property (additions)
- costs to replace part of the property
- costs to service the property
2a. Subsequent valuation: Option #1 - Cost Model
- report on B/S at historical cost less A/D
- when cost model is used FAIR VALUE MUST ALSO BE DISCLOSED
2b. Subsequent valuation: Option #2 - Fair Value Model
- NOT DEPRECIATED
- report on B/S at Fair Value
- best evidence: current prices in an active market for similar property in same location and condition
- must be applied consistently until disposed of or no longer classified as investment property (b/t owner-occupied or developed for sale in ordinary course of business)
- recognize gains and losses in earnings in period in which it arises
- revalue regularly
61
FA: what costs are included in fixed assets constructed by a company
1. direct materials and direct labor
2. repairs and maintenance expenses that add value to fixed assets
3. overhead, including direct items of overhead
4. construction period interest
NOT INCLUDED:
1. idle plant capacity (expense)
2. profit
62
FA: list the fixed assets for which construction period interest should be capitalize and those for which it should NOT be capitalized
(Note: interest cost is based on interest obligations having a stated or imputed interest rate)
INCLUDE:
1. buildings, machinery, land improvements constructed or produced for others or to be used internally
2. fixed assets intended for sale or lease and constructed as discrete projects (i.e. real estate)
3. land improvements: if structure is placed on land, charge interest to the structure (not land)
4. SPECIAL order goods on hand for sale to customers
5. interest cost during ORDINARY delays in construction
EXCLUDE:
1. inventory routinely manufactured
2. fixed assets held before or after construction period
3. during intentional delays in construction
63
FA: how is the amount of interest to be capitalized measured
- interest capitalized should be based on the weighted average of accumulated expenditure (not size of loan) .... money actually spent
- Part 1: weighted average amount of accumulated expenditures ("avoidable interest")
- Part 2: interest rate on borrowings
- --- interest rate paid on borrowings specifically for asset construction during a particular period should be used
- ---- interest related to a specific new borrowing, allocated interest cost is equal to the amount of interest incurred on the new borrowing
- Part 3: interest rate on excess expenditures (weighted average)
- ---- average accumulated expenditures > specific new borrowing, interest cost should be computed on the excess
- ---- interest rate used on the excess is the weighted average interest rate for OTHER borrowings of the company
- Part 4: not to exceed actual interest costs (applied on a consolidated basis in a consolidation)
- Part 5: do NOT reduce capitalize interest by income received on the unexpended portion of the loan
64
FA: when does the period for capitalizing interest begin and end
1. Begin when ALL:
- expenditures for the asset have been made
- activities that are necessary to get the asset ready for its intended use are in progress (permits filed) AND
- interest cost is being incurred
2. Ends when asset is (or independent parts of asset are) substantially complete and ready for the intended use (regardless of whether it is actually used)
65
FA: what disclosures are required for capitalized interest
1. total interest cost incurred during the period
| 2. capitalized interest cost for the period
66
Depreciation: list the 2 main types of depreciation
1. Physical Depreciation: assets deterioration and wear over a period
2. Functional Depreciation: arises from obsolescence or inadequacy of asset to perform efficiently
Note: applied to long-lived assets not held-for-sale and is systematic and rational allocation used to achieve matching
67
Depreciation: define salvage value
estimated residual value that will be realized at the end of the useful life of a depreciable asset
68
Depreciation: how are revisions in an assets estimated useful life accounted for
prospectively (change in estimate)
69
Depreciation: what is a common CPA exam trick
assets placed in service DURING the year (pay attention to months)
70
Depreciation: what amount is subject to depreciation
Base = cost - salvage value
71
Depreciation: what is the goal of depreciation
- provide for a reasonable, consistent matching of revenue and expense by systematic allocation of cost of the depreciable asset over its estimated useful live
- accomplished through use of a contra-account
72
Depreciation: what are the advantages of component depreciation
1. depreciation expense is more accurate
2. repair and maintenance expense more accurate b/c replacements of components would be excluded
Note: Not available for MACRS property for tax purposes (is available when straight-line is used)
73
Depreciation: specify unique IFRS requirements for depreciation
- component depreciation
- method should reflect expected pattern of fixed asset consumption
- estimated useful life, salvage value, and depreciation method used should be reviewed for appropriateness at each B/S date
74
Depreciation: define Composite (Dissimilar Assets) Depreciation and Group (Similar Assets) Depreciation (as opposed to Component Depr.)
- process of averaging the economic lives of a number of property units and depreciating the entire class over a single life
- NO G/L is recognized when one asset in the group is retired or sold (ABSORBED by A/D)
Advantage: simplifies recordkeeping
75
Depreciation: list the basic depreciation methods and their formulas
1. Straight-Line = (cost-salvage)/life
2. Sum-of-Years-Digits
- accelerated (higher depr. exp. early and lower later)
- = (cost-salvage) x (remaining yrs @ BEGINNING of year / ([n(n+1)]/2 ))
3. Declining Balance
- use for assets subject to rapid obsolescence
- multiply by straight-line rate
- in final year, depreciate TO SALVAGE VALUE
- = # x (1/N) x (cost - A/D)
- IGNORES SALVAGE VALUE in expense calc.
- cannot be depreciated below salvage value
4. Units-of-Production (productive output)
- service potential declines with use
- Step #1: (cost-salvage)/(est. units or hours) = rate
- Step #2: rate x # units or hours = depr. exp
76
Depreciation: how is depreciation calculated when an asset is placed into service during the year
depreciation expense is only taken for the portion of the year the asset is used
77
Depreciation: how is depreciation treated when assets are disposed of
```
1. sale of an asset during its useful life: depreciation taken individually to date of sale
Dr. cash
Dr. A/D of sold asset
Cr. Sold asset at cost
Dr./Cr Loss/Gain (plug)
```
2. write off fully depreciated asset: no change to total assets
Dr. A/D (100%)
Cr. Old asset at full cost
3. total and permanent impairment:
Dr. A/D per records
Dr. Loss
Cr. Asset at full cost
78
Depreciation: what disclosures are required for depreciation
1. A/D should be deducted from the asset
2. Depreciation expense for period
3. Balance of major classes by nature or function
4. A/D allowances by classes or in total
4. Methods used by major classes
79
Depreciation: hat are the advantages and disadvantages to the Straight-Line method
Advantages:
1. simple to compute
2. applies to virtually all assets
3. consistent from year to year
4. wide acceptability
5. similar to treatment of prepaid items
Disadvantages:
1. does not reflect difference in usage of asset from year to year
2. does not accurately match costs with revenue
80
Depreciation: what are the advantages and disadvantages of the Machine Hours and Units-of-Product methods
Advantages:
1. matches costs with revenue
2. reflects activity of the enterprise
Disadvantages:
1. if no activity, no depreciation expense when all assets depreciate in reality
2. cannot be used for all assets (buildings)
3. can be complex b/c it requires clerical work and records
81
Depreciation: what are the advantages and disadvantages of the Declining-Balance Method
Advantages:
1. matches costs to revenues
2. as amount of depr. expense decreases, repairs and maintenance charges increase thereby tending to balance out one another
Disadvantages:
1. does not reflect changes in the activity of the asset
2. computation can be complex
3. greater disparity in amount of depreciation b/t earlier years and later years
d. possibility that with decreasing depreciation and increasing repairs and maintenance, income is artificially smoothed
82
Depletion: define depletion
allocation of the cost of wasting natural resources such as oil, gas, timber, and minerals to the production process
83
Depletion: how are purchase costs calculated
purchase cost include any expenditures necessary to purchase and then prepare the land for the removal of resources (drilling, tunnels,) or to prepare for harvest (lumbar)
84
Depletion: what are the methods for depletion and which is permitted by GAAP
1. Cost Depletion (GAAP):
- rate = (cost- residual value)/recoverable units
- depletion expense = rate x units produced
2. Percentage (non-GAAP/tax)
- based on % of sales
- can and usually does exceed cost depletion
- limited to 50% of net income from the depletion property computed before the % depletion allowance
85
Depletion: how is the Depletion Base calculated
Cost to purchase property
Plus: development costs to prepare land for extraction
PLUS: any estimated restoration costs
Less: residual value of land after the resources are extracted
86
Depletion: how is depletion measured if all units extracted are not sol
allocate b/t COGS and EI
87
FA Impairment: which assets must be reviewed for impairment and how frequently
- fixed assets held for use and to be disposed of
| - annually
88
FA Impairment: how is impairment loss calculated under GAAP
Step 1: Undiscounted future NET cash flows - Carrying Value
- if negative = impairment
- if positive = no impairment
Step 2 - if step #1 is negative: FV (PV FVF) - CV = impairment loss
Note: if asset held for disposal:
- add cost of disposal
- do NOT depreciate
- restoration is permitted
89
FA Impairment: how is impairment loss calculated under IFRS
Compare carrying value (CV) to recoverable value
Recoverable value = GREATER OF
1. FV - costs to sell
2. value in use (PV FVF)
Note:
- reversal is permitted
90
FA Impairment: how is the impairment loss reported under GAAP
as a component of income from continuing operations before income taxes
recognize by reducing the CV of asset to its lower FV
91
Other Inv. Cost Flow Assumptions: list the alternative cost flow assumptions fo rinventory
1. Gross Profit Method
2. Retail Method
- - Conventional Retail
- - LIFO Application to Retail Method
- - Cost Retail Inventory Method
- - FIFO/Cost Retail Inventory Method:
- - LIFO/Cost Retail Inventory Method
- - Dollar Value LIFO/Cost Retail Inventory Method
92
Other Inv. Cost Flow Assumptions: summarize the Gross Profit Method
- used for INTERIM F/S as part of a periodic inventory system
- inventory valued at retail and the avg. GP% is used to determine inventory cost
- GP% is known
93
Other Inv. Cost Flow Assumptions: summarize the Retail Method and its additional rules
Summary:
- used by businesses that sell large volume of items with relatively low unit costs
- perpetual system
- records inventory at retail price and converts retail price to GAAP cost through application of a cost-to-retail ratio
- ratio depends on the cost flow assumption
- tends to highlight deviations from physical counts (shrinkage)
- requires keeping aggregate records at both cost and retail and periodic determination of their relationship (easier than physical count)
- must maintain records of purchases at both cost and selling price and records of sales at selling price
Basic calculation for EI @ Cost =
- Step 1: calc. amount of goods available for sale @ retail
- Step 2: subtract retail sales from amount of goods available for sale. to get EI @ retail
- Step 3: multiply EI at retail by ratio of aggregate cost to aggregate retail to get EI @ cost
Additional Rules
- freight costs are added to the COST (not retail) of purchases
- purchase returns and allowances are reductions of BOTH the cost and retail amounts
- sales returns and allowances are subtracted from SALES
- employee discounts are deducted from RETAIL in a manner similar to the sales discounts
- shrinkage is the difference b/t book EI and the amount per physical count
94
Other Inv. Cost Flow Assumptions: define the unique vocabulary associated with the Retail Method
1. Original retail: first selling price at which goods are offered for sale
2. Mark-ups: Increases in the selling price above original selling price
3. Markdowns: decreases in the selling price below original selling price
4. Markup cancellation: decreases in the markup selling price but not below the original selling price
5. Markdown cancellation: increase in the markdown selling price but not above original selling price
6. Net markup: markups minus markup cancellations
7. Net markdowns: markdowns minus markdown cancellations
8. Markon: difference b/t cost and original selling price
95
Other Inv. Cost Flow Assumptions: summarize the Conventional Retail Method
- approximates results that would have been obtained by taking a physical inventory and pricing goods at LCM
- Used in calculation ratio of cost-to-retail:
(a) beginning inventory
(b) markups
(c) markup cancellations
- Note: markdowns and markdown cancellations are excluded from the ratio and subtracted from the retail inventory AFTER ratio is determined
96
Other Inv. Cost Flow Assumptions: summarize the LIFO Application of the Retail method and how this method differs from the Conventional Retail Method
- approximates original cost of merchandise
- compute the LIFO layer added by"
(a) subtracting BI from EI at retail
(b) multiply layer at retail by cost-to-retail ratio
(c) add layer at cost to BI at cost to get EI
Note: subtract LIFO layer if BI @ retail was > EI @ retail (after multiplying by cost-to-retail ratio computed using BEGIN. INV.)
- two main differences:
1) net markups and net markdowns are included in the cost-to-retail ratio
2) beginning inventory is EXCLUDED from the cost-to-retail ratio
97
Other Inv. Cost Flow Assumptions: compare the Cost Retail Inventory Method to the Conventional Retail Inventory method
- in Cost Retail method, markdowns are included in the cost-to-retail ratio calculation
98
Other Inv. Cost Flow Assumptions: compare the FIFO/Cost Retail Inventory Method to Conventional Retail Method
in FIFO/Cost method, EI comes from the current period purchases INCLUDING markups and markdowns
99
Other Inv. Cost Flow Assumptions: compare the LIFO/Cost Retail Inventory Method to the Conventional Retail Inventory Method
in LIFO/Cost method, EI comes from beginning inventory plus an incremental increase for the period
100
Other Inv. Cost Flow Assumptions: compare the Dollar-Value LIFO/Cost Retail Inventory Method to the Conventional Retail Method
- Step #1: count the inventory at year-end at retail
- Step #2: convert the yr-end balance to base year amounts via price indices
- Step #3: compute the yearly increment (increase or decrease)
- Step #4: convert each yearly increment from base year amounts to year-end prices
- Step #5: convert retail prices to cost
101
Other Inv. Cost Flow Assumptions: list the 2 non-GAAP inventory cost flow assumptions
1. Base Stock Method - replenishes reductions in LIFO layers with the old cost (not replacement)
2. Next In, First Out (NIFO) Method - values COGS at replacement cost
102
Other Inv. Cost Flow Assumptions: what are GAAP disclosure requirements
1. inventory detail (raw materials, WIP, FG)
2. significant finance arrangements
3. pledged inventory
4. valuation method
5. cost flow method
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