Accounting Chapters 5, 6 and 7

Perpetual Inventory

Bar codes on products provide information to record Sale of item Update of inventory record Two entries needed for each sale Record revenue and asset received (cash or receivables) Record cost of sale and reduction of inventory

Expenses

Do not extend capacity or useful life Maintain or restore working order Cost is recorded as an expense

Depreciation

PPE assets wear out, grow obsolete, and lose value over time. To account for this process we allocate a PPE asset's cost to expense over its life—a process called depreciation. The depreciation process matches the asset's expense against revenue to measure income, as the matching principle directs. Recall that depreciation expense (not accumulated depreciation) is reported on the income statement. Land is the only PPE asset that has an unlimited life and is not depreciated for accounting purpose. For most PPE assets, depreciation is caused by: ■ Physical wear and tear. For example, physical deterioration takes its toll on the usefulness of furniture, equipment, delivery trucks, and buildings. ■ Obsolescence. Computers and other electronic equipment may become obsolete before they deteriorate. An asset is obsolete when another asset can do the job more efficiently. An asset's useful life may be shorter than its physical life. Companies may depreciate their computers over a short period of time—perhaps four years—even though the computers will remain in working condition much longer. 1. Depreciation is not a process of valuation. Businesses do not record depreciation based on changes in the market value of their plant assets. Instead, businesses allocate the asset's cost to the period of its useful life. 2. Depreciation does not mean setting aside cash to replace assets as they wear out. Any cash fund is entirely separate from depreciation. To measure depreciation for a PPE asset, we must know three things about the asset: Cost Estimated useful life Estimated residual value We have discussed cost, which is a known amount. The other two factors must be estimated. Estimated useful life is the length of service expected from using the asset. Useful life may be expressed in years, units of output, miles, or some other measure. For example, the useful life of a building is stated in years. The useful life of a delivery truck may be expressed as the number of miles the vehicle is expected to travel. Companies base estimates on their experience and trade publications. There are three main depreciation methods: Straight-line Units-of-production Double-declining-balance—an accelerated depreciation method These methods allocate different amounts of depreciation to each period. However, they all result in the same total amount of depreciation over the life of the asset, which is the asset's depreciable cost

Sales Price VS Cost of Inventory

-Sales revenue based on sales price of inventory sold -Cost of goods sold based on cost of inventory sold -Inventory based on cost of inventory on hand -Gross profit, also called gross margin -Sales revenue minus cost of goods sold

Accounts Receivable

A business's accounts receivable are the amounts collectible from customers from the sale of goods and services on account. Accounts receivable, which are current assets, are sometimes called trade receivables or merely receivables. The Accounts Receivable account in the general ledger serves as a control account that summarizes the total amount receivable from all customers. Companies also keep a subsidiary record of accounts receivable with a separate account for each customer.

Computing cash collections from customers

A company earns revenue and then collects the cash from customers. For most companies, there is a time lag between earning the revenue and collecting the cash. Collections from customers are the single most important source of cash for any business. You can compute a company's collections from customers by analyzing its Accounts Receivable account. Receivables typically hold only five items, as reflected in the five elements of the following Accounts Receivable account balance. Suppose you know all these amounts except collections from customers. You can compute collections by solving for ? in the T-account.

Uncollectible Receivables

A company gets an account receivable only when it sells its product or service on credit (on account). Ideally, the company would collect cash for all of its receivables. However, companies rarely collect all of their accounts receivables. So companies must account for their uncollectible accounts. Selling on credit creates both a benefit and a cost: ■ Benefit: Customers who cannot pay cash immediately can buy on credit, so sales and profits increase. ■ Cost: The company cannot collect from some customers. Accountants label this cost uncollectible-account expense, doubtful-account expense, or bad-debt expense. Uncollectible-account expense is an operating expense in the selling, general and administrative category along with salaries, depreciation, rent, and utilities.

Selling Factoring receivables

A company may make some large sales to other retailers on account, debiting Accounts Receivable and crediting Sales Revenue. This company might then sell these accounts receivable to another business, called a factor. The factor earns revenue by paying a discounted price for the receivable and then hopefully collecting the full amount from the customer. The benefit to the company selling the receivables is the immediate receipt of cash. The biggest disadvantage of factoring is that it is often quite expensive, when compared to the costs of retaining the receivable on the books and ultimately collecting the full amount. In addition, the company that factors its receivables loses control over the collection process. For these reasons, factoring is often not used by companies who have other less costly means to raise cash, such as short-term borrowing from banks. Factoring may be used by start-up companies with insufficient credit history to obtain loans at a reasonable cost, by companies with weak credit history, or by companies that are already saddled with a significant amount of debt.

Inventory turnover

A company strives to sell its inventory as quickly as possible because the goods generate no profit until they're sold. The faster the sales, the higher the income, and vice versa for slow-moving goods. Ideally, a business could operate with zero inventory, but most businesses, especially retailers, must keep some goods on hand. Inventory turnover, the ratio of cost of goods sold to average inventory, indicates how rapidly inventory is sold. Inventory turnover varies from industry to industry. The inventory turnover statistic shows how many times the company sold (or turned over) its average level of inventory during the year. Inventory turnover varies from industry to industry.

Credit Card or Bank card sales

A merchant sells merchandise and lets the customer pay with a credit card, such as VISA or MasterCard, or a company credit card such as HBC (Hudson's Bay Company). This strategy may dramatically increase sales, but the added revenue comes at a cost, which is typically about 2% to 3% of the total amount of the sale. Let's see how credit cards and bankcards work from the seller's perspective. Suppose a company sells products for $5,000, and the customer pays with a VISA card. The entry to record the sale is shown in this slide.

Realized Gains and Losses

A realized gain or loss occurs only when the investor sells an investment. This type of gain or loss is different from unrealized gains and losses. The result may be a: Realized gain = Sale price is greater than the Investment carrying amount Realized loss = Sale price is less than the Investment carrying amount Accountants rarely use the word "realized" in the account title. A gain (or a loss) is understood to be a realized gain (or loss) arising from a sale transaction. Unrealized gains and losses are clearly labeled as unrealized. A company would report Gain (or Loss) on Sale of investments among the "Other" items of the income statement.

Net Realisable Value

Accounts receivable are reported at net realizable value on the balance sheet. This is the balance of Accounts Receivable less the Allowance for Uncollectible Accounts. This is the amount the company expects to collect from its customers. The allowance can be shown as a separate line item on the balance sheet, as shown in the top figure. Or it can be combined into one line item shown at the net balance.

Days Sales in receivables

After a business makes a credit sale, the next step is collecting the receivable. Days' sales in receivables, also called the days sales outstanding (DSO) or the collection period, tells a company how long it takes to collect its average level of receivables. Shorter is better because cash is coming in quickly. The longer the collection period, the less cash is available to pay bills and expand. Days' sales in receivables can be computed in two logical steps. First, compute average daily sales (or average revenue for one day). Then divide average daily sales into average receivables for the period. Net sales come from the income statement, and the receivables amounts are taken from the balance sheet. Average receivables is the simple average of the beginning and ending balance. Companies watch their collection periods closely. Whenever collections slow down, the business must find other sources of financing, such as borrowing or selling receivables. During recessions, customers pay more slowly, and a longer collection period may be unavoidable.

Rapid Cash Flow

All companies want speedy cash receipts. Rapid cash flow means companies have the ability to pay off current liabilities faster, as well as to finance new products, research, and development. Thus, companies develop strategies to shorten the credit cycle and collect cash more quickly. For example, they might offer sales discounts for early payment, as discussed in the following slides. They might also charge interest on customer accounts that exceed a certain age. They adopt more effective credit and collection procedures. In recent years, as electronic banking has become more popular, a common strategy has been to emphasize credit card or bankcard sales. They may also sell the receivable to a factor.

Double Diminishing Balance

An accelerated depreciation method writes off a larger amount of the asset's cost near the start of its useful life than the straight-line method does. Double-diminishing-balance is the main accelerated depreciation method. Double-diminishing-balance (DDB) depreciation computes annual depreciation by multiplying the asset's declining carrying amount by a constant percentage, which is two times the straight-line depreciation rate. DDB amounts are computed as follows: ■ First, compute the straight-line depreciation rate per year. A 5-year truck has a straight-line depreciation rate of 1/5, or 20% each year. A 10-year asset has a straight-line rate of 1/10, or 10%, and so on. ■ Second, multiply the straight-line rate by 2 to compute the DDB rate. For a 5-year asset, the DDB rate is 40% (20% × 2). A 10-year asset has a DDB rate of 20% (10% × 2). The formula 2/Life in years shown on the slide is a short-cut way of combining these two steps. ■ Third, multiply the DDB rate by the period's beginning asset carrying amount (cost less accumulated depreciation). In the first year of the asset's life, the book value is equal to the cost. Under the DDB method, ignore the residual value of the asset in computing depreciation, except during the last year.

Fully Depreciated Assets

An asset can be used after it is fully depreciated. The asset and its depreciation account remain in the ledger with no additional depreciation entries.

Impairment

At each reporting date, a company should review its property, plant, and equipment to see if an asset is impaired. Impairment occurs when the carrying amount exceeds its recoverable amount. Recoverable amount is determined to be the higher of an asset's fair value (less costs to sell) and its value in use. Value in use is the present value of estimated future cash flows expected to be earned from the continuing use of an asset and from its disposal at the end of its useful life.

Disposal of PPE assets

Bring depreciation up to date to: Measure asset's final carrying amount Record expense up to date of sale Remove asset and related accumulated depreciation account from books

Risk of selling on credit

By selling on credit, companies run the risk of not collecting some receivables. Unfortunately, some customers don't pay their debts. The prospect of failing to collect from a customer provides the biggest challenge in accounting for receivables. Here are the management and accounting issues a business faces when the company extends credit to customers.

Partial year depreciation

Companies purchase plant assets whenever they need them, not just at the beginning of the year. Therefore, companies must compute depreciation for partial years. First, compute depreciation for a full year. Second, multiply full-year depreciation by the fraction of the year that the company held the asset.

Return on assets

Evaluating company performance is a key goal of financial statement analysis. Shareholders entrust managers with the responsibility of developing a business strategy that utilizes company assets in a manner that both effectively and efficiently generates a profit. The most basic framework for this purpose is return on assets (ROA), which measures how profitably management has used the assets that stockholders and creditors have provided the company. The basic formula for the ROA ratio is shown in this slide. ROA measures how much the entity earned for each dollar of assets invested by both stockholders and creditors. Companies with high ROA have both selected assets and managed them more successfully than companies with low ROA.

Disclosure Method

Financial statement should disclose enough information for users to make informed decisions Information should be relevant and representationally faithful Examples: Accounting methods used Substance of material transactions

Gross Profit percentage

Gross profit—sales minus cost of goods sold—is a key indicator of a company's ability to sell inventory at a profit. Merchandisers strive to increase gross profit percentage, also called the gross margin percentage. Gross profit percentage is markup stated as a percentage of sales. The gross profit percentage is watched carefully by managers and investors.

Measuring the cost of a PPE asset

Here is a basic working rule for determining the cost of an asset—the cost of any asset is the sum of all the costs incurred to bring the asset to its intended use. The cost of a property, plant and equipment (PPE) asset includes purchase price, plus any taxes, commissions, and other amounts paid to make the asset ready for use.

Comparing depreciation methods

IFRS directs a business to choose a depreciation method that reflects the pattern in which the asset will be used. For a plant asset that generates revenue evenly over time, the straight-line method best meets the matching principle. The units-of-production method best fits those assets that wear out because of physical use rather than obsolescence. The accelerated method (DDB) applies best to assets that generate more revenue earlier in their useful lives and less in later years.

Units of Production

In the units-of-production (UOP) method, a fixed amount of depreciation is assigned to each unit of output, or service, produced by the asset. Depreciable cost is divided by useful life—in units of activity or production—to determine this amount. This per-unit depreciation expense is then multiplied by the number of units of activity or units produced each period to compute depreciation. The amount of UOP depreciation varies with the number of units the asset produces.

Capital Expenditures

Increase capacity or extend useful life Cost is added to an asset account

Inventory Costing Methods

Inventory is the first asset for which a manager can decide which accounting method to use. The accounting method selected affects the profits to be reported, the amount of income tax to be paid, and the values of the ratios derived from the financial statements. Determining the cost of inventory is easy when the unit cost remains constant. But the unit cost usually changes. For example, prices often rise. To compute cost of goods sold and the cost of ending inventory still on hand, we must assign unit cost to the items. Accounting uses three generally accepted inventory methods: Specific unit cost Average cost First-in, first-out (FIFO) cost A company can use any of these methods since they are all permitted under Generally Accepted Accounting Principles. The methods can have very different effects on reported profits, income taxes, and cash flow. Therefore, companies select their inventory method with great care depending on their profit and cash flow objectives. Last-in, first-out (LIFO) cost is no longer acceptable for inventory costing, though you are apt to hear the term used.

Comparability Method

Investors want to compare a company's financial statements from one period to the next Therefore, must use the same accounting method for inventory from one period to the next If a change in accounting method can be justified, a change can be made, but prior statements need to be adjusted

Depreciation for Tax purposes

Many businesses use the straight-line method for reporting property, plant and depreciation expense on the income statement. The Income Tax Act permits taxpayers to use accelerated depreciation (up to specified CCA maximums) for tax purposes. In other words, a taxpayer can use one method for accounting purposes and another method for tax purposes.

Intangible assets

No physical form Carry special rights Include patents, copyrights, and franchises Two categories Finite lives Amortization recorded Straight-line method usually used, but... Other amortization methods are allowed Indefinite lives Tested for loss in value (impairment)

Notes Receivable

Notes receivable are more formal contracts than accounts receivable. For a note, the borrower signs a written promise to pay the lender a definite sum at the maturity date, plus interest. This is why notes are also called promissory notes. The note may require the borrower to pledge security for the loan. This means that the borrower gives the lender permission to claim certain assets, called collateral, if the borrower fails to pay the amount due.

Notes receivable

Notes receivable are more formal than accounts receivable. Notes receivable due within one year or less are current assets. Notes due beyond one year are long-term receivables and are reported as long-term assets. Some notes receivable are collected in installments. The portion due within one year is a current asset and the remainder is long term. Let's define some key terms: Creditor. The party to whom money is owed. The creditor is also called the lender. Debtor. The party that borrowed and owes money on the note. The debtor is also called the maker of the note or the borrower. Interest. Interest is the cost of borrowing money. The interest is stated in an annual percentage rate. Maturity date. The date on which the debtor must pay the note.

Receivable

Receivables are the third most liquid asset—after cash and short-term investments. Receivables are monetary claims against others. Receivables are acquired mainly by selling goods and services (accounts receivable) and by lending money (notes receivable).

Net revenue

Retailers, wholesalers, and manufacturers typically disclose sales revenue at the net amount, which means after sales discounts and sales returns and allowances have been subtracted.

Net Sales

Sales revenue - sales returns and allowances - sales discounts

Shot Term Investments

Short-term investments are also called marketable securities or temporary investments. These are investments in marketable securities easily convertible to cash that a company plans to hold for one year or less. They allow the company to invest cash for a short period of time and earn a return until the cash is needed. Short-term investments are the next-most-liquid asset after cash. This is why we report short-term investments in marketable securities immediately after cash and before receivables on the balance sheet

Short Term investment Categories

Short-term investments in marketable securities fall into one of three categories: trading, available-for-sale, and held-to-maturity. The investor expects to sell a trading security within a very short time—a few months at most. Therefore, all trading securities are included in current assets. The other two categories of securities can be either current or long-term, depending on how long management intends to hold them. However, available-for-sale and held-to-maturity securities are usually classified as long-term, unless they mature in the current period.

Sales discounts

Sometimes businesses offer customers sales discounts for early payment in order to speed up cash flow. A typical sales discount incentive might be stated as 2/10, n/30. This expression means that the seller is willing to discount the order by 2% if the buyer pays the invoice within 10 days. After that time, the seller withdraws the discount offer. Regardless, the buyer must pay within 30 days. Companies with plenty of cash often take advantage of early payment discounts on their purchases, thus adding to their reported profits and cash flows. The entry to record collection of a sale after providing sales discount is shown in this slide.

Differences with DDB

The DDB method differs from the other methods in two ways: 1. Residual value is ignored initially; first-year depreciation is computed on the asset's full cost. 2. Depreciation expense in the final year is the "plug" amount needed to reduce the asset's carrying amount to the residual amount

Weighted Average Cost

The average-cost method, sometimes called the weighted-average method, is based on the average cost of inventory during the period. The average cost per unit is determined by dividing the Cost of goods available by the number of units available. Goods and units available is found by summing the beginning inventory plus purchases. This average cost per unit is multiplied by the number of units sold to determine Cost of Goods Sold and by number of units on hand to determine ending inventory.

Quick or (acid test) ratio

The balance sheet lists assets in the order of relative liquidity: 1.Cash and cash equivalents 2.Short-term investments 3.Accounts (or notes) receivable Managers, stockholders, and creditors care about the liquidity of a company's assets. The current ratio measures ability to pay current liabilities with current assets. A more stringent measure of ability to pay current liabilities is the quick (or acid-test) ratio. The higher the quick ratio, the easier it is to pay current liabilities. The quick ratio excludes inventory and pre-paid expenses which may not be as liquid as needed to meet current liability requirements. Traditionally, companies have wanted an acid-test ratio of at least 1.0 to be safe. The ratio needs to be high enough for safety, but not too high. After all, cash and the other liquid assets don't earn very high rates of return, as inventory and plant assets do.

Two methods for estimating Uncollectibles

The best way to estimate uncollectibles uses the company's history of collections from customers. There are two basic ways to estimate uncollectibles: ■ Percent-of-sales method ■ Aging-of-receivables method The percent-of-sales method takes an income-statement approach. The aging method is a balance-sheet approach.

The allowance Method

The best way to measure bad debts is by the allowance method. This method records collection losses based on estimates developed from the company's collection experience. A company doesn't wait to see which customers will not pay. Instead, it records the estimated amount as Uncollectible-Account Expense and also sets up Allowance for Uncollectible Accounts. Other titles for this account are Allowance for Doubtful Accounts and Allowance for Bad Debts. This is a contra-account to Accounts Receivable. The allowance shows the amount of the receivables the business expects not to collect. The allowance shows how much of the receivable has been expensed.

Buildings

The cost of constructing a building includes architectural fees, building permits, contractors' charges, and payments for material, labor, and overhead. If the company constructs its own building, the cost will also include the cost of interest on money borrowed to finance the construction. When an existing building (new or old) is purchased, its cost includes the purchase price, brokerage commission, sales and other taxes paid, and all expenditures to repair and renovate the building for its intended purpose.

Equipment

The cost of equipment includes its purchase price (less any discounts), plus transportation from the seller, insurance while in transit, sales and other taxes, purchase commission, installation costs, and any expenditures to test the asset before it's placed in service. The equipment cost will also include the cost of any special platforms. Then after the asset is up and running, insurance, taxes, and maintenance costs are recorded as expenses, not as part of the asset's cost.

Land

The cost of land includes its purchase price (cash plus any note payable given), brokerage commission, survey fees, legal fees, and any back property taxes that the purchaser pays. Land cost also includes expenditures for grading and clearing the land and for removing unwanted buildings. The cost of land does not include the cost of fencing, paving, security systems, and lighting. These are separate plant assets—called land improvements—and they are subject to depreciation.

Lower-of-cost and net realizable value rule

The lower-of-cost-and-net-realizable-value rule (abbreviated as LCNRV) is based on the principles of relevance and representational faithfulness. LCNRV requires that inventory be reported in the financial statements at whichever is lower—the inventory's historical cost or its market value. Applied to inventories, market value generally means current replacement cost (that is, how much the business would have to pay now to replace its inventory). If the replacement cost of inventory falls below its historical cost, the business must write down the value of its goods to market value, which is the most relevant and representationally faithful measure of its true worth to the business. The business reports ending inventory at its LCNRV value on the balance sheet. If the market value of inventory is above cost, no adjustment is made for LCNRV.

Debit Card Sales

The merchant sells merchandise, and the customer pays by swiping a bank card such as a Scotiabank ScotiaCard or a TD Canada Trust Green Card using the Interac System. In this case, the bank card is being used as a debit card. To a merchant or service provider, a debit card is just like cash; when the card is swiped and the personal identification number (PIN) is entered, the merchant receives payment immediately as the Interac System takes money directly from the cardholder's bank account and transfers the money to the merchant's bank account less a processing fee. As with credit cards, the merchant is charged a fee. This slide shows how the sale of groceries for $65.48 would be recorded.

ageing of receivables method

The other popular method for estimating uncollectibles is called aging-of-receivables. The aging method is a balance-sheet approach because it focuses on what should be the most relevant and faithful representation of accounts receivable as of the balance sheet date. In the aging method, individual receivables from specific customers are analyzed based on how long they have been outstanding.

Percentage of Sales Method

The percent-of-sales method computes uncollectible-account expense as a percent of revenue. This method takes an income-statement approach because it focuses on the amount of expense to be reported on the income statement. The percentage-of-sales method employs the expense recognition concept, also called the matching concept, probably on a monthly or quarterly basis, the amount of cost that has been incurred in order to earn a certain amount of revenue, and to recognize both in the same time period. The entry to record the uncollectible accounts estimate debits the Uncollectible-Account Expense account and credits the Allowance for Uncollectible Accounts.

Held for Trading investments

The purpose of owning a trading security is to hold it for a short time and then sell it for more than its cost. Trading securities can be in the form of stock or debt securities of another company. Suppose a company purchases TransCanada Corporation stock, intending to sell the stock within a few months. If the market value of the TansCanada stock increases, the company will have a gain; if TansCanada's stock price drops, the company will have a loss. Along the way, the company will receive dividend revenue from TansCanada. If the company purchases a debt security, such as a bond, it would receive interest revenue.

Impact of writing off uncollectible accounts

The write-off of uncollectibles has no effect on a company's total assets, no effect on current assets, and no effect on net accounts receivable. There is no effect on net income either. Why is there no effect on net income? Net income is unaffected because the write-off of uncollectibles affects no expense account. If the company uses the allowance method as discussed in the previous section, expenses would have been properly recognized in the period they were incurred, which is the same period in which the related sales took place.

Inventory Accounting Systems

There are two main types of inventory accounting systems: the periodic system and the perpetual system. The periodic inventory system is used for inexpensive goods. A fabric store or a lumber yard won't keep a running record of every bolt of fabric or every two-by-four. Instead, these stores count their inventory periodically—at least once a year—to determine the quantities on hand. Businesses such as restaurants and hometown nurseries also use the periodic system because the accounting cost of a periodic system is low. A perpetual inventory system uses computer software to keep a running record of inventory on hand. This system achieves control over goods such as furniture, automobiles, jewelry, apparel, and most other types of inventory. Most businesses use the perpetual inventory system.

Direct Write-off method

There is another, less preferable, way to account for uncollectible receivables. Under the direct write-off method, the company waits until a specific customer's receivable proves uncollectible. Then the accountant writes off the customer's account and records Uncollectible-Account Expense. The direct write-off method is not considered generally accepted accounting for financial statement purposes. It is considered defective for two reasons: 1. It uses no allowance for uncollectibles. As a result, receivables are always reported at their full amount, which is more than the business expects to collect. Assets on the balance sheet may be overstated. 2. It causes a poor matching of uncollectible-account expense against revenue.

Income statements

This slide compares income statements from a service company and a merchandising company: A service company has service revenue, while a merchandising company has sales revenue or more simply "sales". The major difference between a merchandising company and a service company is that a merchandising company sells inventory, and a service company does not. This means that a merchandising company often has two extra lines on its income statement before the operating expenses, that a service company does not have: cost of goods sold and gross profit.

Cost of Goods sold method

This table presents the cost-of-goods-sold model. Some may view this model as related to the periodic inventory system. But the cost-of-goods-sold model is used by all companies, regardless of their accounting system. The model is extremely powerful because it captures all the inventory information for an entire accounting period.

Long lived asset transactions on the cash flow statements

Three main types of long-lived asset transactions appear on the statement of cash flows: ■ acquisitions ■ sales ■ depreciation (including amortization and depletion) Acquisitions and sales of long-term assets are investing activities. The payments for equipment and buildings are investing activities that appear on the statement of cash flows. The sale of long-lived assets results in a cash receipt. Also, "Depreciation and amortization" are listed as positive items under Adjustments to reconcile net income to cash provided by operating activities.

Dupont analysis

To better understand why ROA increased or decreased over time, companies often perform a DuPont Analysis, which breaks ROA down into two components ratios that drive it: net profit margin and total asset turnover. Net profit margin measures how much every sales dollar generates in profit. Net profit can be increased in one of three ways: (1) increasing sales volume, or the amount of goods or services sold or performed; (2) increasing sales prices; or (3) decreasing cost of goods sold and operating expenses. Total asset turnover measures how many sales dollars are generated for each dollar of assets invested. This is a measure of how effectively and efficiently the company manages its assets. Asset turnover can be increased by (1) increasing sales, (2) keeping less inventory on hand, or (3) closing unproductive facilities, selling idle assets, and consolidating operations to fewer places to reduce the amount of plant assets needed. ROA is the product of net profit margin and total asset turnover. By influencing the drivers of net profit margin and total asset turnover, management devises strategies to improve each one, thus increasing ROA.

Unrealised gains and losses

Trading securities are reported on the balance sheet at their current fair value, also called market value, because fair value is the amount the investor can receive by selling the securities. If the fair value at balance sheet date has increased from the original cost of the investment, the company reports an unrealized gain. It is "unrealized" because the company has not actually sold the investment. On the other hand, if the fair value has decreased from the original cost, an unrealized loss is reported.

First in First Out Method

Under the FIFO method, the first costs into inventory are the first costs assigned to cost of goods sold—hence, the name first-in, first-out. Under FIFO, the cost of ending inventory is always based on the latest costs incurred.

Specific Identification costs

Used for businesses with unique inventory items Automobiles, antique furniture, jewels, and real estate Businesses cost their inventories at the specific cost of the particular unit Too expensive for inventories with common characteristics

Straight line Method

Using the straight-line (SL) method, an equal amount of depreciation is assigned to each year (or period) of asset use. Depreciable cost is divided by useful life in years to determine the annual depreciation expense. As an asset is used in operations, ■ accumulated depreciation increases. ■ the carrying amount of the asset decreases. An asset's final carrying amount is its residual value. At the end of its useful life, the asset is said to be fully depreciated.

Computing Budgeted Purchases

What's the single most important question for a retailer to address? ■ What merchandise should the company offer to its customers? This is a marketing question that requires market research. If retailers continually stock up on the wrong merchandise, sales will suffer and profits will drop. What's the second most important question for a retailer? ■ How much inventory should it buy? This is an accounting question faced by all merchandisers. If a company buys too much merchandise, it will have to lower prices, the gross profit percentage will suffer, and the company may lose money. Buying the right quantity of inventory is critical for success. This question can be answered with the cost-of-goods-sold model.

selling of a PPE asset

When PPE assets are sold for cash, a gain or loss can be incurred. If the cash received is greater than the carrying amount of the asset at the time of the sale, a gain is recorded. If the cash received is less than the carrying amount, a loss is recorded.