ACC 3010 Exam 4 Study Guide

Difference between IRFS and GAAP

#1 GAAP allows component depreciation, but it is not often used. IRFS requires that each component of an item of property, plant, and equipment must be depreciated separately if its cost is significant in relation to the item. #2 GAAP - Depreciable base is determined by subtracting estimated residual value from cost. IFRS - Same, except for a review of residual values is required annually. #3 GAAP - Various deprecation methods are allowed and used in practice IFRS - Three specific methods: Straight-line, units-of-production, and diminishing (declining) balance. #4 GAAP - PPE reported at cost less depreciation (book value). Re-valuation is prohibited. IFRS - Can revalue PPE to fair value at the end of the year. #5 GAAP - Prohibits revaluation of any intangible asset IFRS- Allows companies to revalue all intangibles excep goodwill.

Purchase commitments

A purchase commitment is a contract that obligates a company to purchase a specified amount of merchandise/raw materials at specified prices on/before specified dates. This is to protect the buyer against increase in purchase price and provides a supply of product. We don't recognize a gain when the market price is higher than the price we have agreed to pay, but we do recognize a loss if the opposite is true. A journal entry where the market price is at least equal to the contract price would look like: Debit: Inventory Credit: Cash (both at contract price) A journal entry where the market price is lower than the contract price would look like: Debit: Inventory (at market price) Debit: Loss on commitment (difference between contract and market price) Credit: Cash (contract price) If we have a contract for a purchase in a future year, and the market price is at least as high as the contract price, we don't make any journal entries in the current year. However, if the contract price is greater than the market price at year end, we will preemptively record the following entry: Debit: Estimated loss on commitment Credit: Estimated liability on purchase commitment If nothing changes or market value increase from year end to the time of purchase, we would record: Debit: Inventory and Estimated Liability Credit: Cash If market price drops even lower in the next year, we would record: Debit: Inventory (market price) Debit: Loss on Purchase Commitment Debit: Estimated Liability Credit: Cash

Natural resources - what to record as original cost (including, when appropriate, Asset Retirement Obligation - also sometimes called restoration costs) and how to calculate and record depreciation

A retirement obligation, also referred to as a restoration cost, is an obligation to a restore a piece of land to its original condition after extraction of natural resources has occurred. There are two methods to account for gas and oil, they are successful efforts and full cost. Full cost allows for exploration expenses to be capitalized and expensed as oil is withdrawn. Depletion refers to allocating the cost of natural resources, and works the same as amortization and depreciation.

Lump-sum (basket) purchases

Acquisition of a group of assets for a single sum. How do we account for this? Scenario 1: Each asset is indistinguishable (such as 10 identical trucks) In this case, we would spread the cost of purchase out evenly among the assets Scenario 2: Assets have different characteristics and useful lives (such as the acquisition of a factory with different assets like land and machinery) In this case, we would take the fair value of each asset, and sum them together, then divide each fair value by this sum to find their proportion of the cost. The journal entry would appear as follows: Debit: Each asset acquired Credit: Total cash price of summed assets

Costs that go into the amount recorded for various assets

All costs in order to get that asset up and running.

Retail method of accounting for inventory, including basic use of LIFO, FIFO, and weighted-average

Calculate good available for sale by adding purchases to beginning, and adding/subtracting markups and markdowns. After this, subtract sales from retail goods available to get ending retail balance. From here, it depends on what method we use to determine the cost-to-retail ratio: FIFO: Purchases (net of markups and markdowns) LIFO: Beginning Inventory AVG Cost: Goods Available for Sale LCM: Same as AVG, but without markdowns (keep markups)

Asset Disposal

Debit: Cash (amounts received for sale), Accumulated Depreciation Loss (if there is one) Credit: Equipment Gain (if there is one)

Deferred Payments

Deferred payment is a type of non-cash acquisition, we recognize the present value in our journal entry.

Donated Assets

Donated assets are typically used as some type of enticement for companies. To record them, we record their fair values (based on market price or an appraisal). Journal entry when payment comes due looks like: Debit: Land/Equipment/Whatever Credit: Revenue - donation (amount of donated asset) Credit: Cash (any amount we paid beyond the donation)

When expenditures related to an asset are expensed and when capitalized (key is whether or not it adds to the useful life or increase the productive capacity)

Expenditures are capitalized when they add productive capability or extend useful life. Otherwise, they are expensed. (Think about how prepaid insurance works. We capitalize what we pay for it into the Prepaid Insurance account because it represents future economic value. As that value is used up, we expense into Insurance Expense)

Interest capitalization

First, we determine the specific debt rate. This is the rate of interest on the loan taken out specifically for our project. Second, we determine the general debt rate. This is the weighted average of all other non-specific loans we have. To calculate, we take each loan, multiply it by its rate, sum the products, and divide by the total amount of general loans outstanding. Third, we begin to calculate our avoidable interest for the first year. We do this by taking each expenditure for the year, multiplying it by rate corresponding with its loan, and multiply the product of those by the amount of months/12 in which interest would've been avoided. Sum these products for total avoidable interest for the year. Fourth, we calculate the actual interest paid. To do so, multiply each loan outstanding by its rate and sum the products. (NOTE: IF AVOIDABLE INTEREST IS HIGHER THAN INTEREST PAID, WE CANNOT CAPITALIZE MORE THAN WHAT WE PAID). Fifth, we complete the journal entry for the first year, it appears as such: Debit: CIP (by the amount of avoidable interest) and Interest Expense (actual - avoidable) Credit: Cash (Actual Interest) Sixth, we begin on the avoidable interest for the next year, moving through the expenditures from the beginning once again, and also adding in last years avoidable interest. Perform the same steps as in step 3, then create the journal entry for the new year with the updated figures.

How to calculate goodwill

Goodwill is calculated using the following equation: Considerations Exchanged (What we paid) - Fair Value of Net Assets (Fair Value of Assets - Liabilities) = Goodwill Journal entry looks like this: Debit: Acquired Asset, Goodwill Credit: Cash

Difference between group and composite depreciation methods.

Group is a collection of similar depreciable assets, where composite refers to a collection of physically dissimilar assets that are aggregated anyway for convenience.

Impairment of assets with a finite life

Impairment occurs when a significant reduction in the benefits of an asset occurs, like a building being burnt down. The way we recognize impairment depends on whether the asset is being held for use or being held for sale. If there is a significant decline in value of an asset we intend to continue using, we can write down its book value because of this impairment. To determine if impairment has occurred, there are two steps. The first step is a recoverability test. This test look to see if the undiscounted sum of estimated future cash flows from an asset is less than the asset's book value. The next step is to find the difference between the asset's book value and its fair value. If one exists, we must write the asset down to fair value. How is fair value determined? It can be estimated, it could be the amount at which the asset could be sold, or it could be the present value of future cash flows. Solving Problems: In step 1, we're comparing book value to CASH FLOW, if cash flow is lower, we then move on to step 2. In step 2, we compare book value to fair value, and if fair value is lower, we have to write down the difference. The journal entry for the loss is: Debit: Loss on Impairment (difference between fair and book) Debit: Depreciation (depreciation to date) Credit: Asset (depreciation + loss)

Amount at which to record non-monetary exchanges, including donated assets

Journal Entry for Non-Monetary Exchange: Debit: Equipment - new (Fair value of exchanged equipment + other considerations), Accumulated Depreciation (total accumulated for old equipment), Loss (if there is one, FV - BV) Credit: Cash (if paid) Gain (if there is one) Equipment - old (remaining difference to even out)

Allocation of purchase price

Just determine what percentage parts are of the whole.

LCM and LCNRV

LCM - Lower of Cost or Market LCNRV - Lower of Cost and Net Realizable Value Net realizable value is the estimated selling price of the produced reduced by reasonably predictable costs of completion, disposal, and transportation. If we sell it, how much can we get out of it. If LCNRV is lower than cost, inventory needs to be written down. If this is a commonplace write-down, losses are included in costs of goods sold, while a substantial/unusual write-down is required to have an expressly disclosed loss. Journal entries appear as such: For commonplace write-downs Debit: Cost of Goods Sold Credit: Inventory For substantial write-downs Debit: Loss on write-down of inventory Credit: Inventory FOR LCM: This is when companies are using either the LIFO or retail inventory methods.

Difference between private and public companies when it comes to goodwill

Private companies can amortize goodwill over the course of 10 years. Public companies assess for impairment.

Accounting for research and development and when costs for software development can be capitalized

RESEARCH AND DEVELOPMENT The costs that go into R&D are as follows: - Salaries, wages, and other labor costs of R&D personnel -Costs of materials, equipment, facilities, and intangibles used in R&D projects -Costs of services performed by others -A reasonable allocation of indirect costs related to the R&D activities The costs that do not go into R&D include: - Equipment purchased for multiple projects - Patents and legal costs If an asset is purchased for a single R&D project, the cost is considered R&D and expensed immediately in the current year. If an asset is purchased for more than one project, depreciation/amortization of the asset is included as R&D expense in the current and future periods. Costs incurred after the start of commercial production are all non-R&D. SOFTWARE DEVELOPMENT Capitalized upon reaching technological feasibility. Feasibility is defined as having "completed all planning, designing, coding, and testing activities necessary to establish that the product can be produced to meet its design specifications.

Impairment of Goodwill

Since indefinite assets can't be amortized, they must be tested regularly to determine if the asset may have become impaired. Typically, a qualitative assessment is used first. There isn't a recoverability test like with finite assets, we simply check if book value exceeds the fair value of the reporting unit. We then know an impairment has occurred, and have to determine what the "implied" fair value of goodwill is. To journalize: Debit: Loss on impairment of goodwill (difference between implied fair value and book value) Credit: Goodwill (Difference between GAAP and IRFS) GAAP allows a company to avoid annual testing by making qualitative evaluations. IRFS Requires annual goodwill testing GAAP and IRFS both prohibit the reversal of goodwill impairment losses. (If FV is higher than BV when it comes to Goodwill, there is no impairment loss to that goodwill, even if other assets have become impaired)

Various types of depreciation

There are two overarching types of depreciation methods, those that are time-based, and those that are activity based. Within the time-based methods, we have as follows: Straight Line Method: Allocates an equal amount of depreciable base to each year. Accelerated methods: Methods in which higher depreciation in the early years and less in the later years, there are two "submethods" within this, they are: Sum-of-the-years'-digits (SYD): Multiples depreciable base by a declining fraction and Declining Balance Method: Multiplies beginning-of-year book value by an annual rate that is a multiple of the straight line rate. In terms of activity based methods, we have: Units-of-production method: Computes a depreciation rate per measure of activity and then multiplies this rate by actual activity to determine periodic depreciation. How do we solve these? Straight Line - Easy, already know how SYD - Sum the years (if there is five years, add 5+4+3+2+1), this is the denominator of the depreciation rate. The numerator is how many years we have left to go (year 1: 5/15, year 2: 4/15, etc.) Multiply the annual depreciation rate by the depreciable base (cost - residual value) to find that years depreciation. Double Declining Balance - Multiply beginning book value by twice the straight line rate (if we have 5 years, straight line rate is 20% because of 1/5, so in this case, we'd use 40%). Moving on to the next year, we use the update book value (original book value - year 1 depreciation). This goes on, for each year, but we cannot depreciate below our residual value (in last year, if depreciation would be too high, just depreciate the difference between salvage and current book value) Units of Production - Calculate a depreciation rate, which is equal to Book Value - Residual Value/Units Produced. Multiply this rate each year by the amount of units produced to find depreciation. Like in double declining, if we didn't produce enough units, we can't depreciate past our residual, just depreciate the difference.

Gross profit method to estimate inventory

This is used at a time in which we need to estimate inventory because we can't physically count it. We utilize a cost of goods sold estimate and cost of goods available for sale (begin + purchases) to obtain an estimate of ending inventory. It is not acceptable for the preparation of annual financial statements. Actual formula: Begin Inventory + Net purchases = Cost of Good available for sale - Cost of Goods sold = Ending Inventory Cost of goods sold is calculated by multiplying our Net Sales by our Gross Profit Ratio, then subtracting that number from our net sales.

Various types of intangible assets and how to account for them, including amortization (when it's used and when it's not, how to calculate)

Types of intangible assets: Patents - Exclusive 20-year right to manufacture a product or use a process Copyrights - Exclusive right to benefit from a creative work such as a song, film, photo, or book. Trademarks - Exclusive right to display a word, a slogan, a symbol, or an emblem that distinctively identifies a company or product Franchise - Contractual agreement under which a franchisor grants the franchisee the exclusive right to the franchisor's trademark and product rights Goodwill - Unique value of the company as a whole over and above all identifiable assets Intangible assets can be purchased from others or developed internally. They are amortized if they have a finite useful life, but are not amortized if they have indefinite useful life. Cost of intangible assets is equal to the purchase price and all other costs necessary to bring the asset to its desired condition and location for use Amortization is calculated the same way as depreciation. When journalizing amortization, we directly credit the asset (patent, franchise, etc.), and debit amortization expense.