Accounting 8-10

1. What is the process by which businesses spread the allocation of an intangible asset's cost over its useful life?

Amortization is the process by which businesses spread the allocation of an intangible asset's cost over its useful life.

1. What adjustment must be made at the end of the period for trading debt investments and available-for-sale debt investments?

An adjustment must be made at the end of the accounting period for trading debt investments and available-for-sale debt investments to bring the investment accounts to market (fair) value.

1. What is an equity security?

An equity security represents stock ownership in another company that sometimes pays cash or stock dividends.

1. Where on the financial statements is an unrealized holding gain or loss on trading debt investments reported?

An unrealized holding gain or loss on trading debt investments is classified as other income and (expenses) on the income statement.

How is discarding of a plant asset different from selling a plant asset?

Discarding of plant assets involves disposing of the asset for no cash. Selling an asset involves receiving cash in exchange for the asset.

1. What is a debt security?

A debt security is an investment in notes or bonds payable issued by another company. Debt securities represents a credit relationship with another company or governmental entity that typically pays interest for a fixed period and a final payment of face value at the end of the term.

1. When disposing of an available-for-sale debt investment, where is the gain or loss on disposal reported in the financial statements?

A gain or loss on disposal of an available-for-sale debt investment is classified as Other Income and (Expenses) on the income statement.

1. What is the expense account associated with the cost of uncollectible receivables called?

Bad Debts Expense is the account associated with the cost of the uncollectible receivables.

What does the word capitalize mean?

Capitalize means that an asset account was debited (increased) because the company acquired an asset. Capitalized assets, except for land, are depreciated over their useful lives.

1. List some common examples of other receivables, besides accounts receivable and notes receivable.

Common examples of other receivables include dividends receivable, interest receivable, and taxes receivable.

1. What is comprehensive income, and what does it include?

Comprehensive income is a company's change in total stockholders' equity from all sources other than investments made by owners into the company and dividends distributed to owners by the company. Comprehensive income includes net income plus other comprehensive income. Examples of items classified as other comprehensive income include the following: · Unrealized holding gains or losses on available-for-sale debt investments · Foreign-currency translation adjustments · Gains or losses from post-retirement benefit plans · Deferred gains or losses from derivatives

How do land improvements differ from land?

Land improvements are depreciable improvements to land, such as fencing, sprinklers, paving, signs, and lighting. Land is not depreciated.

Define property, plant, and equipment. Provide some examples.

Property, plant, and equipment are long-lived, tangible assets used in the operation of a business. Examples include land, buildings, equipment, furniture, and automobiles.

What does the accounts receivable turnover ratio measure, and how is it calculated?

The accounts receivable turnover ratio measures the number of times the company collects the average accounts receivable balance in a year. The higher the ratio, the faster the cash collections. It is calculated by taking net credit sales divided by average net accounts receivable.

1. Which depreciation method ignores residual value until the last year of depreciation? Why?

The double-declining-balance method ignores residual value until the last year of depreciation because the calculation is based on book value rather than depreciable cost. In the last year of depreciation, depreciation is calculated as the amount needed to bring the asset to its residual value.

1. What is the formula to compute interest on a note receivable?

The formula for computing Notes receivable interest is as follows: Amount of interest = Principal × Interest rate × Time.

1. Plant assets are recorded at historical cost. What does the historical cost of a plant asset include?

The historical cost of a plant asset includes the purchase price plus taxes, purchase commissions, and all other amounts paid to ready the asset for its intended use.

1. How is the purchase of a held-to-maturity debt security at face value recorded?

The purchase of a held-to-maturity debt security is recorded at cost, including any brokerage fees paid. The account Held-to-Maturity Debt Investments is debited and cash is credited for the amount paid.

1. When using the allowance method, how are accounts receivable shown on the balance sheet?

Under the allowance method, accounts receivable are shown at the net realizable value. Net realizable value is the net value that the company expects to collect from its receivables (Accounts Receivable less Allowance for Bad Debts).

1. When a receivable is written off under the allowance method, how does it affect the net realizable value shown on the balance sheet?

When an account is written off with the allowance method, there is no change in the net realizable value shown on the balance sheet.

1. What does the asset turnover ratio measure, and how is it calculated?

The asset turnover ratio measures how efficiently a business uses its average total assets to generate sales. Net sales / Average total assets.

1. In accounting for bad debts, how do the income statement approach and the balance sheet approach differ?

The income statement approach focuses on the amount of expense, Bad Debt Expense, that is reported on the income statement. The amount is determined by multiplying the estimated percentage by net credit sales. The balance sheet approach focuses on Accounts Receivable, a balance sheet account, and determines a target allowance balance based on a percentage of the receivable balance.

1. When is bad debts expense recorded when using the allowance method?

Under the allowance method, bad debts expense is estimated and recorded in the same period as the sales revenue as an adjusting entry at the end of the accounting period.

1. When dealing with receivables, give an example of a subsidiary account.

A business must maintain a separate accounts receivable account for each customer in order to account for payments received from the customer and amounts still owed. All sales and collections from that customer are tracked in that account, along with the balance.

1. How does a business decide which depreciation method is best to use?

A business should match an asset's expense against the revenue that the asset produces when deciding on a depreciation method. For an asset that :Straight-line (SL) method::Depreciation methodsstraight-line:generates revenue evenly over time, the straight-line method follows the matching principle. The units-of-production method works :Units-of-production (UOP) method::Double-declining-balance (DDB) method::Depreciation methodsunits-of-production::Depreciation methodsdouble-declining-balance:best for an asset that depreciates due to wear and tear rather than obsolescence. The accelerated method, double-declining-balance, works best for assets that produce more revenue in their early years.

1. What is the difference between a capital expenditure and a revenue expenditure? Give an example of each.

A capital expenditure is debited to an asset account because it increases the asset's capacity or efficiency, or extends the asset's useful life. Examples include extraordinary repairs, such as replacing the engine in a delivery truck. Revenue expenditures are debited to an expense account. Examples include routine repairs and maintenance, such as changing the oil or replacing the tires on a delivery truck.

1. What is a critical element of internal control in the handling of receivables by a business? Explain how this element is accomplished .

A critical element of internal control is the separation of cash-handling and cash-accounting duties. For good internal control over cash collections from receivables, separation of duties must be maintained and the credit department should have no access to cash. Additionally, those who handle cash should not be in a position to grant credit to customers.

How trading debt investments, AFS debt investments and HTM debt investments are accounted for during the holding period (meaning, while you own the investment)

A held-for-trading security is a debt and equity investment that investors purchase with the intent of selling within a short period of time, usually less than one year. Because of accounting standards, companies have to classify investments in debt or equity securities when they are purchased. Other than held-for trading, other options include: held to maturity, held for trading or available for sale.

1. What is a lump-sum purchase, and how is it accounted for?

A lump-sum purchase, also called a basket purchase, is the purchase of several assets as a group. The total cost paid (100%) is divided among the assets according to their relative market values.

What is the difference between accounts receivable and notes receivable?

Accounts receivable represent the right to receive cash in the future from customers for goods sold or for services performed. Accounts receivable are usually collected within a short period of time such as 30 or 60 days. Notes receivable are usually longer in term than accounts receivable. Notes receivable represent a written promise that a borrower will pay a fixed amount of principal plus interest by a certain date in the future.

What does it mean if an exchange of plant assets has commercial substance? Are gains and losses recorded on the books because of the exchange?

An exchange has commercial substance if the future cash flows change as a result of the transaction. In other words, if in the future cash flows (receipts of revenue or payment of expenses) of the business will change because of the exchange. Exchanges that have commercial substance require any gain or loss on the transaction to be recognized. The old asset will be removed from the books and the new asset will be recorded at its market value. Exchanges that lack commercial substance ignore any gain or loss on the transaction, except in a few limited situations. The new asset is recorded at the old asset's book value plus cash paid minus cash received instead of at market value.

How to determine the amount of bad debt expense using the percentage of sales, percentage of receivables and aging of receivables (especially focus on what to do, once the figure is calculated) a. For example, how the accounting works once you have calculated the amount of the allowance account.

Bad debt expenses are account receivables that are no longer collectible due to customers' inability to fulfill financial obligations. There are two distinct ways of calculating bad debt expenses - the direct write-off method and the allowance method. The bad debts are the losses that the business suffers because it did not receive immediate payment for the sold goods and provided services. It's recorded in the financial statements as a provision for credit losses.

1. What method is used for investments in equity securities with more than 50% ownership? Briefly describe this method.

Consolidation accounting is used by the investing company to account for equity securities that represent more than 50% ownership of the investee's outstanding voting stock. Consolidation accounting is the way to combine the financial statements of two or more companies that have the same owners. Consolidated financial statements combine the balance sheets, income statements, and cash flow statements of the parent company (the investor) with those of its controlling interest affiliates (the investees). The final outcome is a single set of financial statements, as if the parent and its subsidiaries were the same entity.

1. What does the days' sales in receivables indicate, and how is it calculated?

Days' sales in receivables, also called the collection period, indicates how many days it takes to collect the average level of accounts receivable. The number of days' sales in receivables should be close to the number of days customers are allowed to pay when credit is extended. The shorter the collection period, the more quickly the organization can use its cash. The longer the collection period, the less cash is available for operations. It is calculated by taking 365 days divided by the accounts receivable turnover ratio.

How are held-to-maturity debt investments reported on the financial statements?

Depending on the maturity date, held-to-maturity debt investments are categorized as current assets or long-term assets on the balance sheet and reported at amortized cost.

What is depreciation? Define useful life, residual value, and depreciable cost.

Depreciation is the allocation of a plant asset's cost to expense over its useful life. Depreciation matches the expense against the revenue generated from using the asset to measure net income. Useful life is the length of the service period expected from an asset. Residual value is the expected value of a depreciable asset at the end of its useful life. Depreciable cost is the cost of a plant asset minus its estimated residual value.

1. How is gain or loss determined when disposing of plant assets? What situation constitutes a gain? What situation constitutes a loss?

Gain or loss is determined by comparing the cash received and the market value of any other assets received with the book value of the plant asset disposed of. A gain occurs when the cash received and the market value of any other assets received is greater than the book value of the disposed plant asset. A loss occurs when the cash received and the market value of any other assets received is less than the book value of the disposed plant asset.

1. What is goodwill? Is goodwill amortized? What happens if the value of goodwill has decreased at the end of the year?

Goodwill is the excess of the cost of an acquired company over the sum of the market values of its net assets (assets minus liabilities). Goodwill is the value paid above the net worth of the company's assets and liabilities. Goodwill is not amortized. Instead, the acquiring company measures the fair value of its goodwill each year. If the goodwill has increased in value, there is nothing to record. But if goodwill's value has decreased, then the company records an impairment loss and writes the goodwill down.

1. What occurs when a business pledges its receivables?

In a pledging situation, a business uses its receivables as security for a loan. The business borrows money from a bank and offers its receivables as collateral. The business still is responsible for collecting on the receivables and uses the money collected to pay off the loan along with interest. In pledging, if the loan is not paid, the bank can collect on the receivables.

1. How do the percent-of-receivables and aging-of-receivables methods compute bad debts expense?

In both the percent-of-receivables method and aging-of-receivables method, the business determines the target balance of the Allowance for Bad Debts account based on a percentage of accounts receivable. This target balance is then used to determine the amount of bad debts expense after considering the previous balance in the Allowance for Bad Debts.

1. What is the difference between the percent-of-receivables and aging-of-receivables methods?

In the percent-of-receivables method, the business uses only one percentage to determine the balance of the Allowance for Bad Debts account. However, in the aging-of-receivables method, the business groups' individual accounts according to how long the receivable has been outstanding. They then apply a different percentage to each aging category.

1. What is an intangible asset? Provide some examples.

Intangible :Intangible assetsaccounting for:assets are assets that have no physical form. Instead, these assets convey special rights from patents, copyrights, trademarks, and other creative works.

1. What are some limitations of using the direct write-off method?

Limitations of the direct write-off method are that it violates the matching principle and is not allowed by GAAP. The matching principle requires that the expense of uncollectible accounts be matched with the related revenue. Under the direct write-off method the expense can occur in future months or years. In addition, the accounts receivable (asset) are overstated on the balance sheet.

1. What is the depreciation method that is used for tax accounting purposes? How is it different than the methods that are required by GAAP to be used for financial accounting purposes?

Modified Accelerated Cost Recovery System (MACRS) is a method used for tax purposes. Under MACRS, assets are divided into specific classes, such as 3-year, 5-year, 7-year, and 39-year property. Businesses do not get to choose the useful life of the asset. In addition, the MACRS method ignores residual value

1. What is a natural resource? What is the process by which businesses spread the allocation of a natural resource's cost over its usage?

Natural resources are assets :Natural resourcesaccounting for::Depletion expense:that come from the earth that are extracted or cut down. Examples include iron ore, oil, natural gas, diamonds, coal, and timber. Depletion is the process by which businesses spread the allocation of a natural resource's cost over its usage.

1. What financial statement are property, plant, and equipment reported on, and how?

Property, plant and equipment are reported at book value on the balance sheet. Companies may choose to report PP&E as a single amount, with a note to the financial statements that provides detailed information, or companies may provide detailed information on the face of the statement. The cost of the asset and the related accumulated depreciation should be disclosed.

1. What does the rate of return on total assets measure, and how is it calculated? The rate of return on total assets measures the success a company has in using its assets to earn income.

Rate of return on total assets = (Net income + Interest expense) / Average total assets(a) (a) Average total assets = (Beginning total assets + Ending total assets) / 2

How to calculate depreciation expense using straight-line, units of production and double-declining balance

Straight line: Depreciation Expense = ( Cost - Salvage ) / Useful Life Units of Production: Step 1: Calculate Depreciation per Unit: Depreciation per unit = ( Cost - Salvage) / expected # units over lifetime Step 2: Calculate Depreciation Expense: Depreciation Expense = Number of units produced this period x Depreciation per unit. The double declining balance method requires a 3-step process: Step 1: Calculate the Straight line (S/L) rate S/L rate = 1 / useful life in years Step 2: Calculate the double declining (DD) rate DD rate = 2 x S/L rate calculated in Step 1 Step 3: Calculate Depreciation Expense Depreciation Expense = Beginning Book Value x DD rate

1. How is the acid-test ratio calculated, and what does it signify?

The acid-test ratio is a ratio of the sum of cash (including cash equivalents) plus short-term investments plus net current receivables to total current liabilities. The acid-test ratio reveals whether the entity could pay all its current liabilities if they were to become due immediately.

1. What type of account must the sum of all subsidiary accounts be equal to?

The balance in all the subsidiary accounts receivable accounts must equal the total balance of the control account, Accounts Receivable.

1. What are some benefits to a business in accepting credit cards and debit cards?

The benefits to a business of accepting credit cards and debit cards include the ability to attract more customers, not having to check each customer's credit rating, and not having to keep accounts receivable records or receive collections from the customer.

How to determine the accounting impact under the cost and equity methods of accounting for equity investments when fair value changes, when dividends are received and when earnings in the subsidiary company occur.

The equity method is an accounting technique used by a company to record the profits earned through its investment in another company. With the equity method of accounting, the investor company reports the revenue earned by the other company on its income statement, in an amount proportional to the percentage of its equity investment in the other company.

1. What method is used for investments in equity securities when the investor has significant influence and typically 20% to 50% ownership? Briefly describe how dividends declared and received and share of net income are reported.

The equity method is used by the investing company to account for equity securities that represent 20% to 50% ownership of the investee's outstanding voting stock. The investor records its proportionate share of dividends declared and received by the investee as a decrease (credit) to the Equity Investments account. The investor records its proportionate share of the investee's net income as an increase (debit) to the Equity Investments account and an increase (credit) to the Revenue from Investments account.

Why must companies record accrued interest revenue at the end of the accounting period?

The interest revenue earned on the note up to year-end is part of that year's earnings. Interest revenue is earned over time, not just when cash is received. Because of the revenue recognition principle, a business must record the earnings from the note in the year in which they were earned.

How does the percent-of-sales method compute bad debts expense?

The percent-of-sales method computes bad debts expense as a percentage of net credit sales.

1. Briefly describe the specific types of debt and equity securities.

The specific types of debt securities are as follows: · Trading debt investments are debt securities that the investor plans to sell in the very near future—days, weeks, or only a few months—with the intent of generating a profit on a quick sale. Trading debt investments are categorized as current assets on the balance sheet. · Held-to-maturity debt investments are debt securities that the investor intends to hold and has the ability to hold until they mature. Depending on the maturity date, held-to-maturity debt investments are categorized as current assets or long-term assets on the balance sheet. · Available-for-sale debt investments are debt securities that aren't trading or held-to-maturity investments. The investor does not plan to hold the security until maturity. Available-for-sale debt investments are reported as current assets on the balance sheet if the business expects to sell them within one year. All other available-for-sale debt investments that are expected to be held longer than a year are reported as long-term assets on the balance sheet. 4., cont. The specific types of equity securities are as follows: · No significant influence equity investments are equity securities in which the investor lacks the ability to participate in the decisions of the investee company. No significant interest investments are reported either as current assets or long-term assets on the balance sheet. · Significant interest equity investments are equity securities in which the investor has the ability to exert influence over operating and financial decisions of the investee company. Typically, the investor owns 20% to 50% of the investee's outstanding voting stock. Significant interest investments are reported as long-term assets on the balance sheet. · Controlling interest equity investments are equity securities that represent more than 50% of the investee's outstanding voting stock. Controlling interest investments are consolidated into the investor's financial statements.

How to calculate the gain or loss upon the disposal or sale of a fixed asset

To calculate a gain or loss on the sale of an asset, compare the cash received to the carrying value of the asset. The following steps provide more detail about the process: If the asset is a fixed asset, verify that it has been depreciated through the end of the last reporting period. If the asset had previously been classified as held for sale, it should not have been depreciated since it was classified as such, which is acceptable. Verify that the amount of accumulated depreciation recorded for the asset matches the underlying depreciation calculation. If there is a difference (usually because the accumulated depreciation figure is too low), reconcile the two amounts and adjust the accounting records as necessary. The original purchase price of the asset, minus all accumulated depreciation and any accumulated impairment charges, is the carrying amount of the asset. Subtract this carrying amount from the sale price of the asset. If the remainder is positive, it is a gain. If the remainder is negative, it is a loss. If there is a gain, the entry is a debit to the accumulated depreciation account, a credit to a gain on sale of assets account, and a credit to the asset account. If there is a loss, the entry is a debit to the accumulated depreciation account, a debit to the loss on sale of assets account, and a credit to the asset account.

1. Why would a company invest in debt or equity securities?

Two common reasons why a company would invest in debt or equity securities are as follows: · The company may have short-term, excess cash that it doesn't need for normal operations. This excess cash could be the result of temporary or seasonal business fluctuations, or it could be cash available for a longer term. The company wants to make the best use of its excess cash, so it invests in debt or equity securities to generate investment income. This investment income may come from interest earned from debt investments, dividends earned from stock investments, and/or increases in the market value of the security. · The company may invest in debt or equity securities of other companies to pursue a certain business strategy. For example, a company may invest in a key vendor's debt or equity securities to further enhance a business relationship with that vendor. Doing so might strengthen the investing company's supply chain source.

When is bad debts expense recorded when using the direct write-off method?

Under the direct write-off method, accounts receivables are written off and bad debts expense is recorded when the business determines that it will never collect from a specific customer.

1. Where on the financial statements is an unrealized holding gain or loss on available-for-sale debt investments reported?

Unrealized holding gains or losses on available-for-sale debt investments are not included in net income. Instead, they are included in other comprehensive income, which is added to (gains), or subtracted from (losses) net income to determine comprehensive income. In addition, unrealized holding gains or losses on available-for-sale debt investments are reported as a component of Accumulated Other Comprehensive Income that is reported in the stockholders' equity section of the balance sheet.

1. What occurs when a business factors its receivables?

When a business factors its receivables, it sells its receivables to a finance company or bank (often called a factor). The business receives cash less an applicable fee from the factor for the receivables. The factor, instead of the business, now collects the cash on the receivables. The business no longer has to deal with the recordkeeping and collection of the receivables.

1. If a business changes the estimated useful life or estimated residual value of a plant asset, what must the business do in regard to depreciation expense?

When a company makes an accounting change in estimate, generally accepted accounting principles require the business to recalculate the depreciation for the asset in the year of change and in future periods. It does not require that businesses restate prior years' financial statements for this change in estimate. For a change in either estimated asset life or residual value, the asset's remaining depreciable book value is spread over the asset's remaining life.

1. When using the allowance method, what account is debited when writing off uncollectible accounts? How does this differ from the direct write-off method?

When using the allowance method, the Allowance for Bad Debts account is debited when writing off uncollectible accounts. This is different than the direct write-off method, which would debit Bad Debts Expense. The allowance method does not affect net income when an account is written off.