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by: Odell Schimmel

IntermedFinancialAccounting ACC321

Marketplace > Miami University > Accounting > ACC321 > IntermedFinancialAccounting
Odell Schimmel
GPA 3.91


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This 0 page Study Guide was uploaded by Odell Schimmel on Sunday November 1, 2015. The Study Guide belongs to ACC321 at Miami University taught by BarryArlinghaus in Fall. Since its upload, it has received 17 views. For similar materials see /class/233336/acc321-miami-university in Accounting at Miami University.


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Date Created: 11/01/15
Exam TWO study guide Note Verbatim from the book Chapter 9 LOWER of COST or Market A company abandons the historical cost principle when the future utility revenueproducing ability of the asset drops below its original cost Companies therefore report inventories at the lowerofcostor market at each reporting period A departure from cost is justified because a company should charge a loss of utility against revenues in the period in which the loss occurs not in the period of sale Note also that the lower of cost or market method is a conservative approach to inventory valuation Net realizable value NRV is the estiInated selling price in the ordinary course of business less reasonably predictable costs of completion and disposal often referred to as net selling price A normal profit margin is subtracted from that amount to arrive at net realizable value less a normal profit margin The general lowerofcostormarket rule is A company values inventory at the lowerofcostormarket with market limited to an amount that is not more than net realizable value or less than net realizable value less a normal profit margin The miniInum lilnitation oor is not to be less than net realizable value reduced by an allowance for an approadmately normal profit margin Whichever method a company selects it should apply the method consistently from one period to another One method referred to as the direct method substitutes the lower market value figure for cost when valuing the inventory The second method referred to as the indirect method or allowance method does not change the cost amount Rather it establishes a separate contra asset account and a loss account to record the write off Quick l lmeTM and a ec ssor are needed to see thls plcture The direct method presentation buries the loss in the cost of goods sold The indirect method presentation is preferable because it clearly discloses the loss resulting from the market decline of inventory prices Valuation Bases However many believe that for purposes of applying the lower of cost or market rule companies should define market as net realizable value selling price less estilnated costs to complete and sell rather than as replacement cost Recording inventory at net realizable value 1 when there is a controlled market with a quoted price applicable to all quantities and 2 when no significant costs of disposal are involved A special problem arises when a company buys a group of varying units in a single lumpsum purchase also called a basket purchase lot example Purchase commitments need not be recorded in any manner until goods services are delivered to the buyer due to cancellation or executory contracts If the contract price is greater than the market price and the buyer expects that losses will occur when the purchase is effected the buyer should recognize losses in the period during which such declines in market prices take place In hedging the purchaser in the purchase commitment simultaneously enters into a contract in which it agrees to sell in the future the same quantity of the same or similar goods at a fixed price Gross Profit Method The gross profit method relies on three assumptions 1 The beginning inventory plus purchases equal total goods to be accounted for 2 Goods not sold must be on hand 3 The sales reduced to cost deducted from the sum of the opening inventory plus purchases equal ending inventory In most situations the gross profit percentage is stated as a percentage of selling price Cost Gross Profit Selling Price Quick39l39lmeTM and a decompressor are needed to see this picture Because selling price exceeds cost and with the gross profit amount the same for both gross profit on selling price will always be less than the related percentage based on cost Disadvantages 1 One disadvantage is that it provides an estimate 2 Uses past percentages in determining the markup 3 Companies must be careful in applying a blanket gross profit rate Retail Inventory Method Requires retailers keep records of 1 The total cost and retail value of goods purchased 2 The total cost and retail value of the goods available for sale 3 The sales for the period There are different versions of the retail inventory method These include the conventional method based on lower of average cost or market the cost method the LIFO retail method and the dollarvalue LIFO retail method For retailers the term markup means an additional markup of the original retail price Markup cancellations are decreases in prices of merchandise that the retailer had marked up above the original retail price Retailers often need to use markdowns which are decreases in the original sales prices Such cuts in sales prices may be necessary because of a decrease in the general level of prices special sales soiled or damaged goods overstocking and market competition Markdowns are common in retailing these days Markdown cancellations occur when the markdowns are later offset by increases in the prices of goods that the retailer had marked down such as after a one day sale for example A cost ratio using markups but not markdowns it approximates the lowerofaveragecostormarket This is known as the conventional retail inventory method or the lowerofcostormarket approach Costtoretail ratio dividing the cost of goods available for sale by the sum of the original retail price of these goods plus the net markups This calculation excludes markdowns and markdown cancellations Special Items 1 Freight costs are part of the purchase cost 2 Purchase returns are ordinarily considered as a reduction of the price at both cost and retail 3 Purchase discounts and allowances usually are considered as a reduction of the cost of purchases Note also that sales returns and allowances are considered as proper adjustments to gross sales However when sales are recorded gross companies do not recognize sales discounts To adjust for the sales discount account in such a situation would provide an ending inventory figure at retail that would be overvalued ltems Requiring Special Analysis 1 Transfersin from another department are reported in the same way as purchases from an outside enterprise 2 Normal shortages breakage damage theft shrinkage should reduce the retail column because these goods are no longer available for sale Such costs are re ected in the selling price because a certain amount of shortage is considered normal in a retail enterprise As a result companies do not consider this amount in computing the cost to retail percentage Rather to arrive at ending inventory at retail they show normal shortages as a deduction similar to sales 3 Abnormal shortages on the other hand are deducted from both the cost and retail columns and reported as a special inventory amount or as a loss To do otherwise distorts the cost to retail ratio and overstates ending inventory 4 Employee discounts given to employees to encourage loyalty better performance and so on are deducted from the retail column in the same way as sales These discounts should not be considered in the cost to retail percentage because they do not re ect an overall change in the selling price The retail inventory method has an averaging effect on varying rates of gross profit Presentation and Analysis Manufacturers should report the inventory composition either in the balance sheet or in a separate schedule in the notes A company should also report the basis on which it states inventory amounts lower of cost or market and the method used in determining cost LIFO FIFO average cost etc The inventory turnover ratio measures the number of times on average a company sells the inventory during the period It measures the liquidity of the inventory Quick39l39lmeTM and a decompressor are needed to see this picture Chapter 10 PPampE The major characteristics of property plant and equipment are as follows 1 They are acquired for use in operations and notfor resale 2 They are longterm in nature and usually depreciated 3 They possess physical substance Acquisition of PPampE Most companies use historical cost as the basis for valuing property plant and equipment Historical cost measures the cash or cash equivalent price of obtaining the asset and bringing it to the location and condition necessary for its intended use Consider the purchase price freight costs sales taxes and installation costs of a productive asset as part of the asset39s cost It then allocates these costs to future periods through depreciation After the asset39s acquisition such as additions iInprovements or replacements if they provide future service potential Otherwise expense these costs immediately The main reasons for this position are as follows 1 Historical cost involves actual not hypothetical transactions and so is the most reliable 2 Companies should not anticipate gains and losses but should recognize gains and losses only when the asset is sold A long lived asset is not depreciated if it is classified as held for sale This is because such assets are not being used to generate revenues Land costs typically include 1 the purchase price 2 closing costs such as title to the land attorney39s fees and recording fees 3 costs incurred in getting the land in condition for its intended use such as grading filling draining and clearing 4 assumption of any liens mortgages or encumbrances on the property and 5 any additional land iInprovements that have an indefinite life Special assessments for local iInprovements such as pavements street lights sewers and drainage systems It should charge these costs to the Land account because they are relatively permanent in nature Record separately any improvements with limited lives such as private driveways walks fences and parking lots as Land Improvements These costs are depreciated over their estilnated lives Generally land is part of property plant and equipment However if the major purpose of acquiring and holding land is speculative a company more appropriately classifies the land as an investment If a real estate concern holds the land for resale it should classify the land as inventory The cost of buildings should include all expenditures related directly to their acquisition or construction These costs include 1 materials labor and overhead costs incurred during construction and 2 professional fees and building permits The term equipment in accounting includes delivery equipment office equipment machinery furniture and fixtures furnishings factory equipment and similar fixed assets The cost of such assets includes the purchase price freight and handling charges incurred insurance on the equipment while in transit cost of special foundations if required assembling and installation costs and costs of conducting trial runs Costs thus include all expenditures incurred in acquiring the equipment and preparing it for use The company must allocate costs and expenses to arrive at the cost of the selfconstructed asset Materials and direct labor used in construction pose no problem A company can trace these costs directly to work and material orders related to the fixed assets constructed Dealing with overhead w self constructed assets 2 ways 1 Assign no fixed overhead to the cost of the constructed asset 2 Assign a portion of all overhead to the construction process lnterest Costs During Contruction 3 methods 1 Capitalize no interest charges during construction 2 Charge construction with all costs of funds employed whether identifiable or not 3 Capitalize only the actual interest costs incurred during construction GAAP a Consider i Qualifying assets ii Capitalization period iii Amount to capitalize Qualifying assets Assets must require a period of time to get them ready for their intended use Capitalization period 3 conditions must be met 1 Expenditures for the asset have been made 2 Activities that are necessary to get the asset ready for its intended use are in progress 3 Interest cost is being incurred Amount to Capitalize Avoidable interest is the amount of interest cost during the period that a company could theoretically avoid if it had not made expenditures for the asset Special Items w Interest Capitalization 1 Expenditures for land a interest costs capitalized during the period of construction are part of the cost of the plant not the land b it should not capitalize interest costs involved in purchasing land held for speculation because the asset is ready for its intended use c When a company purchases land with the intention of developing it for a particular use interest costs associated with those expenditures qualify for interest capitalization 2 Interest Revenue a companies should not net or offset interest revenue against interest cost b companies should capitalize the interest incurred on qualifying assets whether or not they temporarily invest excess funds in short term securities Valuation of PPampE Companies should record property plant and equipment at the fair value of what they give up or at the fair value of the asset received whichever is more clearly evident To properly reflect cost companies account for assets purchased on longterm credit contracts at the present value of the consideration exchanged between the contracting parties at the date of the transaction When no interest rate is stated or if the specified rate is unreasonable the company irnputes an appropriate interest rate he company uses the cash exchange price of the asset acquired if determinable as the basis for recording the asset and measuring the interest element LumpSum Purchases The company allocates the total cost among the various assets on the basis of their relative fair values Issuance of Stock If trading of the stock is active the market value of the stock issued is a fair indication of the cost of the property acquired The stock is a good measure of the current cash equivalent price N onmonetary Asset Exchange Ordinarily companies account for the exchange of nonmonetary assets on the basis of the fair value of the asset given up or the fair value of the asset received whichever is clearly more evident 5 Thus companies should recognize immediately any gains or losses on the exchange The rationale for iInmediate recognition is that most transactions have commercial substance and therefore gains and losses should be recognized QuickTimeTM and a deo essor are needed to see this picture Contributions Companies sometilnes receive or make contributions donations or gifts Such contributions nonreciprocal transfers transfer assets in one direction A contribution is often some type of asset such as cash securities land buildings or use of facilities but it also could be the forgiveness of a debt Therefore companies use the fair value of the asset to establish its value on the books The FASB s position is that in general companies should recognize contributions received as revenues in the period received If the promise is unconditional depends only on the passage of tilne or on demand by the recipient for performance the company should report the contribution expense and related payable immediately If the promise is conditional the company recognizes expense in the period benefited by the contribution generally when it transfers the asset Costs Subsequent to Acquisition In order to Capitalize Costs one of the follow conditions must be met 1 The useful life of the asset must be increased 2 The quantity of units produced from the asset must be increased 3 The quality of the units produced must be enhanced Major Types of Expenditures o ADDITIONS Increase or extension of existing assets i companies capitalize any addition to plant assets because a new asset is created 0 IMPROVEMENTS AND REPLACEMENTS Substitution of an i1nproved asset for an existing one i An improvement betterment is the substitution of a better asset for the one currently ii A replacement on the other hand is the substitution of a similar asset o REARRANGEMENT AND REINSTALLATION Movement of assets from one location to another i a major repair such as an overhaul occurs several periods will benefit 0 REPAIRS Expenditures that maintain assets in condition for operation Disposition of PPampE Sale of Plant Asset Companies record depreciation for the period of time between the date of the last depreciation entry and the date of sale Involuntary Conversion Companies report the difference between the amount recovered eg from a condemnation award or insurance recovery if any and the asset39s book value as a gain or loss Can be reported as extraordinary if conditions are met Miscellaneous Problems If a company scraps or abandons an asset without any cash recovery it recognizes a loss equal to the asset39s book value If scrap value exists the gain or loss that occurs is the difference between the asset39s scrap value and its book value If an asset still can be used even though it is fully depreciated it may be kept on the books at historical cost less depreciation Chapter 11 Depreciation o The accounting process of allocating the cost of tangible assets to expense in a systematic and rational manner to those periods expected to benefit from the use of the asset Depletion o Describes the reduction in the cost of natural resources such as timber gravel oil and coal over a period of time Amortization o The expiration of intangible assets such as patents or copyrights Companies retire assets for two reasons physical factors such as casualty or expiration of physical life and economic factors obsolescence Physical factors are the wear and tear decay and casualties that make it difficult for the asset to perform indefinitely These physical factors set the outside limit for the service life of an asset We can classify the economic or functional factors into three categories 1 Inadequacy results when an asset ceases to be useful to a company because the demands of the firm have changed An example would be the need for a larger building to handle increased production Although the old building may still be sound it may have become inadequate for the company39s purpose Supersession is the replacement of one asset with another more efficient and economical asset Examples would be the replacement of the mainframe computer with a PC network or the replacement of the Boeing 767 with the Boeing 787 3 Obsolescence is the catchall for situations not involving inadequacy and supersession Methods of Depreciation 1 Activity method units of use or production 2 Straight line method 3 Decreasing charge methods accelerated a Sum of the years digits b Declining balance method N 4 Special depreciation methods a Group and composite methods b Hybrid or combination methods Activity Method QuickTimeTM and a deco essor are needed to see this picture Straight Line Method QuickTimeTM and a de 0 ssor are needed to see this picture Sum of the Year s Digits Method Results in a decreasing depreciation charge based on a decreasing fraction of depreciable cost original cost less salvage value Declining Balance Method Utilizes a depreciation rate expressed as a percentage that is some multiple of the straight line method Does not deduct the salvage value Group or Composite Method Group method when the assets are similar in nature and have approximately the same useful lives 0 Composite approach when the assets are dissimilar and have different lives Hybrid or Combination Methods GAAP requires only that the method result in the allocation of an asset39s cost over the asset39s life in a systematic and rational manner Special Depreciation Issues 1 How should companies compute depreciation for partial periods a Companies must determine the depreciation expense for the full year and then prorate this depreciation expense between the two periods involved 2 Does depreciation provide for the replacement of assets a Depreciation is like other expenses in that it reduces net income It differs though in that it does not involve a current cash outflow 3 How should companies handle revisions in depreciation rates a They may need to revise them during the life of the asset Unexpected physical deterioration or unforeseen obsolescence may decrease the estimated useful life of the asset Improved maintenance procedures revision of operating procedures or similar developments may prolong the life of the asset beyond the expected period Impairments o The general accounting standard of lowerofcostormarket for inventories does not apply to property plant and equipment Recognizing Impairments o A significant decrease in the market value of an asset o A significant change in the extent or manner in which an asset is used 0 A significant adverse change in legal factors or in the business climate that affects the value of an asset 0 An accumulation of costs significantly in excess of the amount originally expected to acquire or construct an asset o A projection or forecast that demonstrates continuing losses associated with an asset Quick39l39lmeTM and a decompressor are needed to see this picture Impairment of Assets to Be Disposed Of Assets held for disposal are like inventory companies should report them at the lower of cost or net realizable value Depletion 1 The complete removal consumption of the asset 2 Replacement of the asset only by an act of nature Computation of the depletion base involves four factors 1 acquisition cost of the deposit 2 exploration costs 3 development costs and 4 restoration costs Acquisition cost is the price a company pays to obtain the property right to search and find an undiscovered natural resource It also can be the price paid for an already discovered resource A third type of acquisition cost can be lease payments for property containing a productive natural resource included in these acquisition costs are royalty payments to the owner of the property Exploration costs needed to find the resource When exploration costs are substantial some companies capitalize them into the depletion base In the oil and gas industry where the costs of finding the resource are significant and the risks of finding the resource are very uncertain most large companies expense these costs Smaller oil and gas companies often capitalize these exploration costs development costs into two parts 1 Tangible equipment costs a include all of the transportation and other heavy equipment needed to extract the resource and get it ready for market b companies do not normally include tangible equipment costs in the depletion base 2 Intangible development costs a such items as drilling costs tunnels shafts and wells b Intangible development costs are considered part of the depletion base Restoration Costs Companies sometimes incur substantial costs to restore property to its natural state after extraction has occurred WriteOff of Resource Cost QuickTimeTM and a are needed to see this picture Estimating Recoverable Reserves The procedure is to revise the depletion rate on a prospective basis A company divides the remaining cost by the new estimate of the recoverable reserves Liquidating Dividends Liquidating dividends which are dividends greater than the amount of accumulated net income Debit Paid in Capital in Excess of Par for that portion related to the original investment instead of debiting Retained Earnings Presentation amp Analysis Because of the significant impact on the financial statements of the depreciation methods used companies should disclose the following 1 Depreciation expense for the period Balances of major classes of depreciable assets by nature and function Accumulated depreciation either by major classes of depreciable assets or in total A general description of the method or methods used in computing depreciation with respect to major classes of depreciable assets Asset Turnover Ratio 59 QuickTimeTM and a dec sor are needed to see this picture Profit Margin on Sales Ratio Quick l imeTM and a dec sor are needed to see this picture Rate of Return on Assets QuickTimeTM and a deco sor are needed to see this picture Chapter 12 Issues with Intangible assets 1 They luck physical existence 2 They are notfinunciul instruments Valuation Purchased Intangibles Companies record at cost intangibles purchased from another party Cost includes all acquisition costs plus expenditures to make the intangible asset ready for its intended use Typical costs include purchase price legal fees and other incidental expenses Internally Created Intangibles Someti1nes a company may incur substantial research and development costs to create an intangible Costs incurred internally to create intangibles are generally expensed Companies capitalize only direct costs incurred in developing the intangible such as legal costs and expense the rest Amortization of Intangibles LimitedLife Intangibles Consider these factors in determining useful life 1 The expected use of the asset by the company 2 The expected useful life of another asset or a group of assets to which the useful life of the intangible asset may relate 3 Any provisions legal regulatory or contractual that enable renewal or extension of the asset39s legal or contractual life without substantial cost 4 The effects of obsolescence demand competition and other economic factors 5 Any legal regulatory or contractual provisions that may liInit the useful life 6 The level of maintenance expenditure required to obtain the expected future cash flows from the asset The amount of amortization expense for a lilnited life intangible asset should re ect the pattern in which the company consumes or uses up the asset if the company can reliably determine that pattern The amount of an intangible asset to be amortized should be its cost less residual value IndefiniteLife Intangibles A company does not amortize an intangible asset with an indefinite life Companies should test indefinite life intangibles for impairment at least annually Types of Intangible Assets Marketing related intangible assets Customer related intangible assets Artistic related intangible assets Contract related intangible assets Technology related intangible assets 6 Goodwill MarketingRelated Intangible Assets A trademark or trade name is a word phrase or symbol that distinguishes or identifies a particular company or product CustomerRelated Intangible Assets Customerrelated intangible assets result from interactions with outside parties Examples include customer lists order or production backlogs and both contractual and noncontractual customer relationships ArtisticRelated Intangible Assets Artisticrelated intangible assets involve ownership rights to plays literary works musical works pictures photographs and video and audiovisual material Copyrights protect these ownership rights Companies capitalize the costs of acquiring and defending a copyright They amortize any 959 capitalized costs over the useful life of the copyright if less than its legal life ContractRelated Intangible Assets A franchise is a contractual arrangement under which the franchisor grants the franchisee the right to sell certain products or services to use certain trademarks or trade names or to perform certain functions usually within a designated geographical area Such operating rights obtained through agreements with governmental units or agencies are frequently referred to as licenses or permits A company should amortize the cost of a franchise or license with a limited life as operating expense over the life of the franchise Annual payments made under a franchise agreement should be entered as operating expenses in the period in which they are incurred TechnologyRelated Intangible Assets Technologyrelated intangible assets relate to innovations or technological advances it must expense as incurred any research and development costs related to the development of the product process or idea that it subsequently patents Companies should amortize the cost of a patent over its legal life or its useful life whichever is shorter A company charges all legal fees and other costs incurred in successfully defending a patent suit to Patents an asset account Such costs should be amortized along with acquisition cost over the remaining useful life of the patent Goodwill Goodwill is measured as the excess of the cost of the purchase over the fair value of the identifiable net assets assets less liabilities purchased Recording Goodwill Intemully Created Goodwill Goodwill generated internally should not be capitalized in the accounts Purchused Goodwill As indicated earlier goodwill is recorded only when an entire business is purchased Goodwill is the residual the excess of cost over fair value of the identifiable net assets acquired Goodwill Writeoff Companies that recognize goodwill in a business combination consider it to have an indefinite life and therefore should not amortize it companies adjust its carrying value only when goodwill is impaired Bargain Purchase In a few cases the purchaser in a business combination pays less than the fair value of the identifiable net assets Such a situation is referred to as a bargain purchase This excess amount is recorded as a gain by the purchaser Impairment of LimitedLife Intangibles The rules that apply to impairments of property plant and equipment also apply to limitedlife intangibles 0 In performing this recoverability test the company estilnates the future cash flows expected from use of the assets and its eventual disposal o The company then uses the fair value test This test measures the ilnpairment loss by comparing the asset39s fair value with its carrying amount Impairment of IndefiniteLife Intangibles Other Than Goodwill o The ilnpairment test for an indefinite life asset other than goodwill is a fair value test 0 Companies use this one step test because many indefinite life assets easily meet the recoverability test because cash ows may extend many years into the future Thus companies do not use the recoverability test Impairment of Goodwill 1 First a company compares the fair value of the reporting unit to its carrying amount including goodwill 2 If the fair value of the reporting unit exceeds the carrying amount goodwill is not impaired The company does not have to do anything else Impairment Summary QuickTimeTM and a s or are needed to see this picture RampD COSTS 0 Research and development RampD costs are not in themselves intangible assets However we present the accounting for RampD costs here because RampD activities frequently result in the development of patents or copyrights such as a new product process idea formula composition or literary work that may provide future value 0 Companies must expense all research and development costs when incurred Identifying RampD Activities 0 research activities involve planned search or critical investigation aimed at discovery of new knowledge Companies are required to expense the costs of research activities as incurred 0 development activities tran slate resea rch findings or other knowledge into a plan or design for a new product or process or for a significant improvement to an existing product or process whether intended for sale or use Companies are required to expense the costs of development activities as incurred o RampD activities do not include routine or periodic alterations to existing products production lines manufacturing processes and other ongoing operations even though these alterations may represent improvements Accounting for RampD Activities 1 Materials Equipment and Facilities Expense the entire costs unless the items have alternative future uses other RampD projects or otherwise If there are alternative future uses carry the items as inventory and allocate as consumed or capitalize and depreciate as used 2 Personnel Expense as incurred salaries wages and other related costs of personnel engaged in RampD 3 Purchased Intangibles Recognize and measure at fair value After initial recognition account for in accordance with their nature as either lirnited life or indefinite life intangibles 4 Contract Services Expense the costs of services performed by others in connection with the RampD as incurred 5 Indirect Costs Include a reasonable allocation of indirect costs in RampD costs except for general and administrative cost which must be clearly related in order to be included in RampD Costs Similar to RampD Costs 1 Start up costs for a new operation a Expense startup costs as incurred 2 Initial operating losses a GAAP requires that operating losses during the early years should not be capitalized In short the accounting and reporting standards should be no different for an enterprise trying to establish a new business than they are for other enterprises 3 Advertising costs a Expense advertising costs as incurred or the first time the advertising takes place 4 Computer software costs a companies exclude from the definition of RampD activities the acquisition development or improvement of a product or process for use in their selling or administrative activities Presentation of Intangible Assets 0 The reporting of intangible assets is similar to the reporting of property plant and equipment However contra accounts are not normally shown for intangibles on the balance sheet 0 On the income statement companies should present amortization expense and impairment losses for intangible assets other than goodwill separately and as part of continuing operations 0 The notes to the financial statements should include information about acquired intangible assets including the aggregate amortization expense for each of the succeeding five years If separate accumulated amortization accounts are not used accumulated amortization should be disclosed in the notes The notes should include information about changes in the carrying amount of goodwill during the period Presentation of Research and Development Costs 0 Companies should disclose in the financial statements generally in the notes the total RampD costs charged to expense each period for which they present an income statement Chapter 13 liabilities as llprobable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events Characteristics 1 It is a present obligation that entails settlement by probable future transfer or use of cash goods or services 2 It is an unavoidable obligation 3 The transaction or other event creating the obligation has already occurred Current Liabilities 0 Current liabilities are obligations whose liquidation is reasonably expected to require use of edsting resources properly classified as current assets or the creation of other current liabilitiesquot 1 Accounts Payable a balances owed to others for goods supplies or services purchased on open account b Most companies record liabilities for purchases of goods upon receipt of the goods If title has passed to the purchaser before receipt of the goods the company should record the transaction at the time of title passage 2 Notes Payable a Discount on Notes Payable is a contra account to Notes Payable and therefore is subtracted from Notes Payable on the balance sheet b written promises to pay a certain sum of money on a specified future date i InterestBearing Note Issued ii ZeroInterestBearing Note Issued 3 Current maturities of long term debt a current liabilities the portion of bonds mortgage notes and other long term indebtedness that matures within the next fiscal year 39 retired by assets accumulated for this purpose that properly have not been shown as current assets refinanced or retired from the proceeds of a new debt issue iii converted into capital stock 4 Short term obligations expected to be refinanced a Obligations that after refinancing will be long term and therefore not require the use of working capital during the next year or operating cycle i i It must intend to refinance the obligation on a long term basis ii It must demonstrate an ability to consummate the refinancing 5 Dividends payable a amount owed by a corporation to its stockholders as a result of board of directors39 authorization b Companies always pay cash dividends within one year of declaration generally within three months they classify them as current liabilities c Dividends payable in the form of additional shares of stock are not recognized as a liability 6 Customer advances and deposits a results from customers making deposits to guarantee performance of a contract or service or as a guarantee to cover payment of expected future obligations 7 Unearned revenues a Upon receipt of the advance debit Cash and credit a current liability account identifying the source of the unearned revenue b Upon earning the revenue debit the unearned revenue account and credit an earned revenue account Sales taxes payable a taxes collected from customers but not yet remitted to the tax authority 9 Income taxes payable a taxes payable on net income as computed per the tax return b Most corporations must make periodic tax payments throughout the year in an authorized bank depository or a Federal Reserve Bank 10 Employee related liabilities a Payroll deductions i The most common types of payroll deductions are taxes insurance premiums employee savings and union due b Compensated absences 39 The employer39s obligation relating to employees39 rights to receive compensation for future absences is attributable to employees39 services already rendered ii The obligation relates to the rights that vest or accumulate iii Payment of the compensation is probable iv The amount can be reasonably estimated 0 Bonuses i bonus payments to employees as additional wages and should include them as a deduction in determining the net income for the year ii ProfitSharing Bonus Payable is usually payable within a short period of time Companies should include it as a current liability in the balance sheet 9 Contingencies 1 Gain Contingencies a Possible receipts of monies from gifts donations bonuses and so on b Possible refunds from the government in tax disputes 0 Pending court cases with a probable favorable outcome d Tax loss carryforwards Companies follow a conservative policy in this area Except for tax loss carryforwards they do not record gain contingencies A company discloses gain contingencies in the notes only when a high probability exists for realizing them As a result it is unusual to find information about contingent gains in the financial statements and the accompanying notes 0 Loss Contingencies 1 Probable 2 Reasonably Possible 3 Remote Companies should accrue an estimated loss from a loss contingency by a charge to expense and a liability recorded only if both of the following conditions are met 1 Information available prior to the issuance of the financial statements indicates that it is probable that a liability has been incurred at the date of the financial statements 2 The amount of the loss can be reasonably estimated What a company must know is whether it is probable that it incurred a liability QuickTimeTM and a deco essor are needed to see this picture Presentation of Current Liabilities o In practice current liabilities are usually recorded and reported in financial statements at their full maturity value 0 The current liabilities accounts are commonly presented as the first classification in the liabilities and stockholders39 equity section of the balance sheet 0 Detail and supplemental information concerning current liabilities should be sufficient to meet the requirement of full disclosure 0 A major exception eadsts when a company will pay a currently maturing obligation from assets classified as longterm o If a company excludes a short term obligation from current liabilities because of refinancing it should include the following in the note to the financial statements 1 A general description of the financing agreement 2 The terms of any new obligation incurred or to be incurred 3 The terms of any equity security issued or to be issued When a company expects to refinance on a long term basis by issuing equity securities it is not appropriate to include the short term obligation in stockholders39 equity 0 A company records a loss contingency and a liability if the loss is both probable and estimable But if the loss is either probable or estimable but not both and if there is at least a reasonable possibility that a company may have incurred a liability it must disclose the following in the notes a The nature of the contingency b An estimate of the possible loss or range of loss or a statement that an estimate cannot be made Companies should disclose certain other contingent liabilities even though the possibility of loss may be remote as follows 1 Guarantees of indebtedness of others 2 Obligations of commercial banks under stand by letters of creditquot 3 Guarantees to repurchase receivables or any related property that have been sold or assigned Current Ratioworking capital ratio Quick39l39lmeTM and a deco ssor are needed to see this picture AcidTest Ratio Quick39l39lmeTM and a decompressor are needed to see this picture


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