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This 11 page Class Notes was uploaded by Petey Martin on Friday October 30, 2015. The Class Notes belongs to ACC 201 at University of Rochester taught by WOJDAT K in Summer 2015. Since its upload, it has received 21 views. For similar materials see FINANCIAL ACCOUNTING in Accounting at University of Rochester.
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Date Created: 10/30/15
Petey Martin Notes 102715 0 Ratio analysis 0 Buying inventory uses up cash when the associated accounts payable are resolved 0 Inventorv Turnover COGS Average Inventory Inventory Turnover re ects how many times average inventory is purchased or produced and sold during a year A higher Inventory Turnover ratio indicates that inventory carried is a lower fraction of a year39s requirements Average Days to Sell Inventory equals 365 inventory turnover 0 The higher the inventory turnover or the lower the average days to sell inventory the better all else other than cash equal eg customer service equal etc Less inventory means that less cash is tied up in inventory so more is available to invest or to pay off debt 0 And that storage costs risk of theft and obsolescence risk should be reduced 0 IMPORTANT the Inventory Turnover ratio may be a poor indicator off actual turnover when the LIFO method is used to value inventory Under LIFO recent costs comprising the COGS numerator may be compared to very old costs comprising the inventory denominator Perpetual vs Periodic Inventory 0 A periodic inventory system leaves the inventory account unchanged until a count is done at period end Inventory balance is not adjusted for each sale COGS not known until year or period end count Inventory account is updated at time of year end or period end physical count 0 Inventory levels are not known until year or period end 0 No way to discover theft etc o No way to determine if rm is over or under stocked Purchases throughout the year are debited to a purchases account COGS beg inv per previous count purchases from purchases account end inv per count 0 A perpetual inventory system records a reduction to inventory for each individual sale Cost of goods sold account is always up to date although it may not be exactly right given the possibility of errors 0 Upon each sale COGS is recognized and inventory is reduced at the time that revenue is recognized Accounting records re ect expected inventory at any time 0 Can compare to inventory count to uncover problems such as errors or theft 0 Internal controls of inventory should include a number of steps 0 Storing inventory and limiting access to inventory so as to protect it from theft and damage 0 Separating responsibility for physical handling of inventory from that of inventory record keeping o Maintaining perpetual inventory records and comparing these to a physical count Chapter 8 Introductory Accounting 0 Operating assets are longlived assets that give a rm its productive capacity and ability to conduct business 0 Operating assets help generate future revenues but they are not held for resale themselves 0 Tangible operating assets are longlived assets that have physical substance Examples 0 Buildings xtures equipment and land used in operations also called Plant Property and Equipment 0 eg warehouses in use land with a factory on it not unused warehouse not land held for resale Developed natural resources 0 Intangible operating assets are longlived assets that have no physical substance can not be touched These are typically legal rights such as patents trademarks copyrights etc Accounting for operating assets entails recording the initial expenditure as an asset and then allocating the asset s cost as an expense to a number of accounting periods 0 Steps in accounting for operating assets Determine which costs are added to the asset balance Allocate assets costs to expenses over assets estimated life reducing the asset account balance Account for the disposition of asset Recording acquisition of plant property and equipment 0 Expenditures are payments to acquire goods or services and must be classi ed as a revenue expenditure or a capital expenditure Revenue expenditures are immediately expensed to the income statement reduce income immediately Capital expenditures are accounted for as additions to asset balances and then allocated to expense over some number of future periods Expenditures are said to be capitalized when they are recorded as an asset instead of a current period expense 0 Management can manage reported earning via choice of which expenditures to capitalize if decision is in a gray area or as an element of fraud 0 Capitalizing expenditures that should be expensed can have enormous effects on the nancial statements Increases current period reported income although decreases future period reported income if asset depreciates amortizes or depletes Increases operating cash ow by reclassifying cash out ows as investing activities Under the cost principle capitalized expenditures additions to asset accounts include all expenditures necessary to acquire a longlived asset to bring the asset to the location in which it will be used and to prepare the asset for its use 0 Include in Asset Value any of the following when paid by the acquiring company to acquire a longlived asset Cost incurred by buyer of acquiring ownership of long lived assets 0 Price paid lei special discounts Sales tax paid 0 Any real estate sales commissions paid 0 Any title fee associated with purchase 0 Any legal fees associated with purchase Delinquent property taxes to be paid upon acquisition 0 Other fees associated with acquisition such as title insurance and surveying fees Cost incurred by buyer to transport longlived assets to location of use 0 Freight charges 0 Insurance in transit Cost incurred by buyer of installation or modi cation necessary to bring long lived asset into service 0 Installation and testing Renovation or repairs done prior to use 0 Exclude from Asset Value ie expense immediately Unexpected and unnecessary costs eg damage in transit Financing charges associated with purchases Discounts lost Costs associated with operating the assets eg insurance for period of Operation Ordinary repairs done after asset is in service Petey Martin Notes 102915 Basket Purchase Capital expenditure for a group of assets 0 When longlived assets are purchased as a group the cost of acquisition must be allocated across all assets purchased because each asset may have unique accounting requirements 0 GAAP allows allocation of total cost to each asset based on the proportion that each asset s fair value bears to the group s total fair value Appraisals or tax assessments can be used as estimates of the market value 0 Recording expenditures related to assets already in service 0 Large infreguent expenditures that extend an asset39s productive life or improve its operating ef ciency or capacity are typically capitalized ie added to the associated asset39s book value 0 Some examples of improvements that expand or extend the asset and are capitalized are Additions expenditures to expand or enlarge the asset add a wing to a building Betterments expenditures to expand an asset s capabilities add towing packages to a eet of trucks Extraordinary Repairs expenditures that tend to involve large sums of money and occur infrequently and that are so extensive they actually increase the economic usefulness of a long lived asset thorough increased efficiency or a lengthened life 0 Expenditures that merely allow an asset to operate in its usual condition but that do not signi cantly change the asset are recorded as an expense in the accounting period in which they are incurred and are not capitalized Ordinary repairs recurring expenditures for the normal maintenance and upkeep of longlived assets which are individually relatively small in amount and do not directly lengthen the asset s useful life are not capitalized unless incurred to recondition asset prior to placing it in service Depreciation o Depreciation is a systematic rational allocation of previously capitalized costs to the Income Statement to recognize as an expense the portion of long lived assets deemed consumed in the generation of revenue expense matching principle Long lived assets are prepaid bundles of future services whose cost must be matched to the period in which revenue is earned as a result of using up the asset Most assets are only able to generate revenue for a speci c length of time Depreciation attempts to systematically match the cost of these long lived assets to the revenue generated over their productive life Depreciation does not attempt to reduce the recorded amount of an asset to its market value at any given nancial statement date The depreciation for each accounting period is recognized as an expense of the period Each accounting period s depreciation is also accumulated in a contra asset account called accumulated depreciation Net book value or carrying value is the term that refers to the balance sheet value asset account balance acquisition cost less the associated accumulated depreciation 0 Under IFRS components of an asset engine fuselage galley etc are depreciated separately 0 Depreciation requires An estimate of the useful life of the asset to the rm number of years the asset is expected to help generate revenue for the rm An estimated residual value or salvage value of the asset value expected to be recovered when asset taken out of service net of costs to dismantle or sell Depreciable cost of the asset total capitalized expenditures for the asset less estimated residual values 0 Differences in estimated useful life and estimated residual value can have a signi cant impact on the comparison of pro tability across companies 0 Choice among depreciation methods also needs to be accounted for in comparing pro tability of one company to another Straight line depreciation allocates an equal part of depreciable cost to expense each year over the asset39s estimated economic life 0 Steps a Calculate depreciable cost Capitalized cost Salvage value b Calculate SL depreciation rate 1estimated useful life c Calculate full year depreciation a x b Capitalized cost Salvage value x 1estimated economic life d For each year calculate of that year asset was in service generating revenues months in service 12 e Each year s depreciation equals c times d o Declining Balance Depreciation o Called an accelerated method because it recognizes more of the depreciable cost as expense in each asset39s early years than SL depreciation does 0 But this is completely offset later in an asset39s life when depreciation expense for a given asset becomes less under accelerated depreciation than it would be under SL depreciation 0 Steps a Calculate declining balance depreciation rate equal to straight line rate times quotquot100 quotquotl100 x 1useful life Doubledeclining balance refers to a rate twice 200 that of the straight line rate Calculate full year depreciation Asset net book value capitalized amount lei accumulated depreciation ignoring salvage value x declining balance depreciation rate Q 0 Amount needed to reduce net book value to estimated salvage value if less than above g if asset is in nal year of estimated economic life 0 Asset39s net book value can not be reduced below its residual value 0 No further depreciation recorded once asset s book value is reduced to its salvage value For the rst year s depreciation only multiply b by months in service during rst year 12 0 Units of Production Depreciation allocates the depreciable cost equally to each unit the asset is expected to help produce over its life 0 Steps Calculate depreciable cost Capitalized cost Salvage value Calculate units of production depreciation rate depreciable cost estimate of total number of units the asset is expected to help produce over its estimated economic life estimates are again subjective and not easy to determine Each year s depreciation equals b x units the asset actually helped produce in a given year until the net book value is reduced to the salvage value 0 Comparison of straightline to accelerated depreciation O 0 Does straightline depreciation or accelerated depreciation result in higher reported net income in a given year Either as rm has a combination of newer and older assets and relationship between accelerated and straightline depreciation reverses over the course of an asset s life Key is that different depreciation methods rather than real economic differences may be behind signi cant differences across rms in reported income and ratios Eg some analysts compare the net book value of assets to their original cost to approximate the remaining useful life if the net book value is 75 of original cost presumption is that 75 of assets useful life remains Clearly affected by choice of depreciation method 0 Issues regarding choice of method 0 If an asset is more productive when it is new a case can be made for using accelerated depreciation to match the higher revenue produced by the asset early in its life with higher depreciation expense Accelerated depreciation can also be justi ed when the asset experience rapid obsolescence early in its life Straightline is by far the most common depreciation method for nancial statement purposes Among the justi cations for straight line depreciation is that it results in a smooth allocation of expenses and is easy to explain Nevertheless any method is acceptable for any asset Also Different methods may be used for different assets in one company But once a method is chosen for a given asset consistency principle requires that method be continued for that asset through time unless it can be demonstrated that a new method better measures business39 income 0 Management can therefore manage earning via choice of depreciation method in addition to the estimate of residual value and life of asset o For each asset the method used for nancial statement purposes need not be the same as that used for tax purposes 0 O The tax code makes depreciation expense a tax deduction because capital expenditure is not Most rms use the Modi ed Accelerated Cost Recovery System MACRS for tax purposes for US operations and maintain a second set of books perfectly legal using straight line depreciation for nancial reporting purposes MACRS is an accelerated depreciation method based on double declining balance method MACRS often also leads to more rapid depreciation by assuming shorter asset lives than would be assumed under a strict interpretation of GAAP MACRS makes corporate investing more attractive than it would be if straight line depreciation were used for tax purposes Accounting for a change in estimate 0 0 At some point in time it may become necessary to change either the estimated useful life for an asset or the estimated residual value Also at some point during an asset s life the acquisition cost may be increased by additions betterments or extraordinary repairs In these cases for any method the undepreciated asset balance as of the time of the change in estimate plus any additions betterments or extraordinary repairs less the new estimated residual value becomes the new depreciable cost depreciated over remaining estimated economic life based on the new estimate of economic life Prior years are not changed 0 Asset Impairment 0 An asset impairment occurs when the total future net cash in ows undiscounted from an asset are estimated to be less than the asset s book value If this happens the asset is written down to its fair value which is usually less than its total future cash in ows yields some weird results under GAAP Asset accounting value is reduced m an impairment loss is recognized o m future depreciation will be less because asset net book value has been reduced Under GAAP reduced balance is the new cost basis and can not be recovered if value increases IFRS requires rms to check for recovery and increase asset value if indicated up to original cost basis recognizing a gain to the degree a loss was previously recognized o Assets are not written up to their fair value under US GAAP due to concern over lack of objectivity Under GAAP gains are not recognized if the future cash ows and fair value of an asset exceed the asset s book value 0 Under IFRS if fair value is higher than book value rms have the option to revalue PPampE to fair value under theory that current value is more relevant than cost Credit is not to a dam but is to a revaluation surplus account 0 Which is a stockholder s equity account not an income statement Anv subsequent write down until back to original cost is debited to this account not to loss Once begun must continue to llregularly revalue And must revalue all assets in a given class if one asset in that class is revalued Disposing of an asset o Businesses may voluntarily sell an asset or involuntarily O lose it through accident etc An entry is needed to remove the account balances related to the equipment disposed of after depreciation up to the date of disposal is recorded and to recognize any associated gain or loss Record depreciation up to date of disposal Record disposal Zero out accounts associated with disposed asset and accumulated depreciation on disposed asset Record assets received on disposal Record gain or loss not revenue or expense for difference between accounting value of resources received and net book value of asset as of time of disposition after nal depreciation 0 Note gain or loss comes about because net book value accounting value can diverge from market value over time Are not selling the asset for more or less than it is wo h o The gain or loss is typically reported on the income statement as a peripheral activity The gain or loss balances the entry and via retained earnings the balance sheet