Acct Exam 2
Where would depreciation be found in the income statement?
- Depends on nature of asset that is being depreciated- Could be COGS (each goods purchased) or SGA (cost of cash register)- will see depreciation on cash flow statement- income statement profits affected by depreciation CF isn't. Depending on how the asset is used, Depreciation and Amortization may be included in cost of goods sold, SG&A expenses, another operating expense or listed separately.
What can you determine from a company's inventory footnote?
- Footnotes to the financial statements refer to additional information that helps explain how a company arrived at its financial statement figures. They also help to explain any irregularities or perceived inconsistencies in year to year account methodologies. - It lets you know about the details regarding FIFO and LIFO with certain numbers and figures.
How is the fixed asset presented on the financial statements?
A company's fixed assets are reported in the non-current (or long-term) asset section of the balance sheet in the section described as property, plant and equipment. The fixed assets except for land will be depreciated and their accumulated depreciation will also be reported under property, plant and equipment.
How can you make adjustments to a company's LIFO numbers to make the company comparable to a FIFO firm?
GAAP require LIFO companies report a reconciliation of LIFO values to FIFO values. • LIFO Reserve • Excess of FIFO costs over LIFO LIFO reserve is the difference between the value of ending inventory under LIFO and the value of ending inventory IF the firm used FIFO. • Balance Sheet adjustment. • This is a CUMULATIVE difference in COGS. • Retained Earnings Impact = (1‐tax rate) * LIFO Reserve Calculate ending inventory as if the LIFO company uses FIFO: Inventory(FIFO) + LIFO (Reserve) = Inventory(FIFO) • Calculate cost of goods sold as if the LIFO company uses FIFO: COGS(LIFO) - Increase in LIFO(Reserve) or + Decrease in LIFO (Reserve) All divided by COGS (FIFO)
What is the LIFO reserve? What is the tax consequence for a company using LIFO?
GAAP require LIFO companies report a reconciliation of LIFO values to FIFO values. • LIFO Reserve • Excess of FIFO costs over LIFO LIFO reserve is the difference between the value of ending inventory under LIFO and the value of ending inventory IF the firm used FIFO. • Balance Sheet adjustment. • This is a CUMULATIVE difference in COGS. • Retained Earnings Impact = (1‐tax rate) * LIFO Reserve The change in the LIFO reserve can be used to convert COGS under LIFO to COGS under FIFO. Less Taxes
What is the financial statement impact of a company's sale of a fixed asset?
Generally, if the future expenditure extends the useful life or increases the value of the asset, it is capitalized. General repairs and maintenance costs are expensed as incurred. • Change the oil in a vehicle -> Expense (Dec Income) • Replace the engine in a vehicle -> Capitalize (Inc Asset)im
What is the financial impact of - recording bad debt expense? Writing off a bankrupt customer's account? Estimating that a certain portion of unused gift cards will likely ever be redeemed and a breakage of the liability is necessary?
Bad debt expenses are generally classified as a sales and general administrative expense and are found on the income statement. Recognizing bad debts leads to an offsetting reduction to accounts receivable on the balance sheet—though businesses retain the right to collect funds should the circumstances change. The income statement method estimates bad debt based on a percentage of credit sales. Bad Debt Expense increases (debit) and Allowance for Doubtful Accounts increases (credit) for the amount estimated as uncollectible. The balance sheet method estimates bad debt based on a percentage of outstanding accounts receivable.
Estimation for sales returns is recorded? How do you analyze if the allowance for doubtful accounts is adequate?
Because the allowance for doubtful accounts account is a contra asset account, the allowance for doubtful accounts normal balance is a credit balance. So for an allowance for doubtful accounts journal entry, credit entries increase the amount in this account and debits decrease the amount in this account.
Which company shows more relevant COGS (inventory) in times of rising or falling prices?
LIFO for rising. FIFO for falling.
How does the use of LIFO distort a company's financial statements?
LIFO liquidation can distort a company's net operating income. Interest expense, interest income, and other non-operational revenue sources are not considered in computing operating income, which generally leads to more taxable income. In most cases, a company uses the most recent costs when selling inventory items.
Understand the managerial discretion between where some costs are placed - COGS or SG&A - and the implications on the financial statements for analysts.
Cost of Sales: This is the cost Pfizer incurred to make or buy the products it sold during the year. As goods are manufactured or purchased, the cost is recognized as inventory on the balance sheet. The inventory remains there until the product is sold, ay which time the cost is transferred from the balance sheet into the income statement as cost of goods sold. SG&A: - Salaries and benefits for admin personnel and executives. - Rent and utilities for office facilities. - Marketing and selling expenses. - IT, legal, and accounting expenses. - Depreciation for depreciable assets that are used for admin purposes. (Pg. 5-24)
What accounting differences result between companies using FIFO and LIFO? (Note that economically, the companies are the same. The accounting allocation of cost can result in different financial statement impacts.)
FIFO: - Transfer costs from inventory in the order that they were initially recorded. FIFO assumes that the first costs recorded in inventory are the costs transferred from inventory. LIFO: - Transfers the most recent inventory costs from the balance sheet to COGS. LIFO assumes that the most recent inventory purchases are the first costs transferred from inventory. LIFO vs. FIFO impact on the Income Statement RISING PRICES: FIFO produces higher gross profits. Lower cost (older) inventories are matched against sales revenues. (Gross profit ratio) LIFO vs. FIFO impact on the Balance Sheet RISING PRICES: LIFO reports lower ending inventories as it uses prices which are lower than replacement costs. (Inventory Turnover Ratio impacted) NEXT TIME: LIFO vs. FIFO impact on the Cash Flows The increase in profits under FIFO also results in higher pretax income and, consequently, a higher tax liability (more cash outflow).
What costs are "capitalized" into the cost of a fixed asset? Determine the allocation of the asset's cost (i.e. depreciation) using the straight line method.
PP&E (Depreciation) Finance Leased Asset (Amortization) Accumulated Depreciation Also, in Module 6 part 3 Pg. 6-18
How do the inventory costs flow between the asset account (inventory) and the expense account (cost of goods sold).
The cost of inventory available at the beginning of a period is a carryover from the ending inventory balance of the prior period. Current period inventory purchases are added to the beginning inventory balance, yielding the total cost of goods available for sale. Then, the goods available are either sold, and end up in cost of goods gold for the period, or the goods available remain unsold and are still in inventory at the end of the period. (Shown on page 6-4)
How to analyze and compare companies on their efficient use of fixed assets (Sales / Average PP&E, net)
Turnover Ratios • Gross Profit Margin (%): Gross profit / Sales • Days Inventories: 365 / Inventory turnover (COGS / Avg Inventory) Common Reasons for Decline: • Stale or obsolete product line (slowing sales; lower sales prices) • New competitors (cause sales price pressure) • Decline in economic conditions • Inventory pressures (too much -> lower selling prices) • Increasing manufacturing costs (higher COGS) • Changes in product mix (lower margin versus higher margin products)
How can you evaluate a company's investment into capital? Does the company appear to replace fixed assets in a timely fashion? (See E 6-36 and P 6-42).
Asset Turnover Ratio Capital Expenditures
How does the choice between LIFO or FIFO impact the common financial statement ratios? What happens when prices fall? What happens if there is a LIFO liquidation?
In contrast, a company using LIFO reports lower ending inventory, producing a lower current ratio. In addition, shareholder's equity is lower under the LIFO method versus FIFO because LIFO produces a lower asset base. Thus, assets minus liabilities produces a higher result under FIFO. If COGS improves because a LIFO layer is liquidated, a firm must disclose this information to shareholders. • This number is reported either before tax or after tax. (After‐tax effect) = (Pretax effect) * (1‐ tax rate) Could management intentionally force a LIFO liquidation? The LIFO liquidation occurs when there are less ending units than beginning units for that product (i.e. units sold > units purchased): LIQUIDATIONS caused by purchasing fewer units than you are selling. Why would you want to force a LIFO liquidation? Why would you choose to avoid a LIFO liquidation?
What costs are capitalized into inventories?
Inventory costs are capitalized because inventories are assets that provide future economic benefits. When inventories are sold, these benefits are realized. According to the matching principle, the capitalized cost should at this time be matched against the revenue recognized from the sale. Product Costs: Capitalized or included in inventory and stay on the balance sheet as a current asset until sold. The costs are then transferred to cost of goods sold.
What is the financial statement impact of a company's impairment of a fixed asset?
When is an asset impaired? effi• When it is no longer expected to produce previously anticipated levels of revenue or cash flow • Accounting Speak: Expected net CF < Book Value What is the reporting impact of an asset impairment? • Non-cash reduction in income Which line item will include the impairment loss? • If significant -> Separate line item in the operating section of the Income Statement • Otherwise -> Same line item where depreciation expense would be recorded.
How do management's decisions about fixed assets impact a company's ROA (income / average asset) or PP&E turnover ratios?
You want to think about turnover. If you're assets are turning over too fast, then they are not good investments. Same with PP&E. You want something that will last longer and have high productivity.
