Chapter 4: Assets

Amortization

* Amortization is the systematic allocation of intangible assets over an estimated useful life * Intangible assets are reduced on the balance sheet via amortization on the income statement

Types of intangible assets

* Customer Lists * Franchises, Memberships, Licenses * Patents and Technology * Trademarks and goodwill

Intangible assets are linked to _____ on the income statement

Amortization

Assets

Assets represent the company's resources To qualify as an asset the following requirements must be met: * A company must own the resource * The resource must be of value * The resource must have a quantifiable, measurable cost

Inventory costing: Average Costing Method

Average Cost: COGS and ending inventory are calculated as: COGS/total number of goods

New purchases of PP&E are called _______

Capital expenditures

Different asset classes

Cash + equivalents, AR, prepaid expenses, inventory, PPE, Intangible assets, goodwill

Cash and equivalents

Cash equivalents are extremely liquid assets; examples include US Treasury bills, which have a term of less than or equal to 90 days You'll also see marketable securities included in this line item or broke out separately

Intangible Assets

Comprised of non physical acquired assets, intangible assets are items are that have value based on the rights belonging to that company

Inventory costing methods

FIFO, LIFO, Average Cost

T/F: Write down = amortization

False. Write downs ≠ amortization Write down is reduction in asset's value while amortization is allocation of the asset over time

Inventory costing: FIFO

First in, first out The cost of the inventory first purchased (first in) is the cost assigned to the first inventory to sold (COGS - first out). Remaining inventory reflect the latest costs

Manufacturer: Inventory

For a manufacturer, inventory includes the costs fo producing the finished inventory * Raw materials used in the manufacture of finished inventory (i.e. oil, steel, lumber, etc.) * Work in process: Direct labor and factory overhead used in producing the finished inventory

Merchandiser: Inventory

For a merchandiser, inventory is simply the products procured for resale

Goodwill Impairment

Goodwill is not amortized, but it is tested annually for loss of value (impairment). If the value of the previously acquired company declines, goodwill is reduced, with a corresponding reduction to RE via the income statement, by the amount of the impairment * Conceptually, goodwill write downs imply that a company overpaid in the original acquisition

Goodwill

Goodwill is the amount by which the purchase price for a company exceeds its fair market value (FMV), representing the "intangible" value stemming from the acquired company's business name, customer relations, employee morale Goodwill is effectively an accounting plug, created only if the purchase price exceeds the FMV of all the assets acquired

Writing Down Inventory

Historical costs: As market value of inventories goes up, companies can't write up (increase in books) value of inventory Conservatism: Inventories can be marked down if they are destroyed, deteriorate, or become obsolete Under US GAAP, lower of cost-or-market (LCM) rule dictates that if the market value of inventory falls below historical cost, they must be written down to market value.

Where do inventory write-downs show up on the financial statements?

I/S: Write downs (loss) must be immediately recognized. Can be presented in COGS as non-operating expense or as a special write down if it's a big write down B/S: Inventories are credited (go down) and Retained Earnings is debited (goes down)

PP&E Sales

If a company chooses to sell some of their PP&E, the associated gross PP&E balance (and accumulated depreciation) is removed from the balance sheet, offset by: * The cash received, and (when applicable) * Any gain/loss on sale on the income statement

Inventory

Inventories represent goods waiting to be sold, and direct and (sometimes indirect) costs associated with the production or procurement of these goods

Inventory in the financial statements

Inventory cycles out of the B/S and into the I/S as COGS * Before inventory gets expensed as COGS and are matched to the revenues they help generate (matching principle), they are part of the company's inventories (on the balance sheet): Beginning Inventory + Purchases of new inventory - COGS = Ending Inventory

PP&E Write Downs on Financial Statements

Just like inventory, PP&E whose value declines, needs to be written down to market value The loss must be recognized immediately on the income statement. The loss can be presented in COGS, SG&A, non operating expenses, or as a separate line item * This is different from AD, write downs occur when something unusual happens (i.e. the machine breaks down unexpectedly)

2 Equations for LIFO Reserve

LIFO Reserve = LIFO inventory - FIFO inventory LIFO Reserve = LIFO COGS - FIFO COGS

Inventory costing: LIFO

Last In, First Out The items purchased last (last in) are the first to be sold (COGS - first out). Therefore, the cost of inventory most recently acquired (ending inventory - last in) is assigned to COGS. Ending inventory reflects cost of the purchased inventories

When prices are rising, what method of inventory costing should be used?

Net Income = Revenue - COGS - other expenses + other income Lower net income = lower taxes Higher COGS --> lower net income Use LIFO (last in prices are highest so COGS is greater)

Where does inventory costing show up on the financial statements?

On the income statement under COGS. COGS is affected by the different costing methods.

PP&E value changes on the financial statements

PP&E cycle out of the B/S and into the I/S as depreciation, either in COGS, SG&A, or elsewhere

PP&E

Property, plant, and equipment represent land, buildings, and machinery used in the manufacture of the company's services and products plus all costs (transportation, installation, other) necessary to prepare those fixed assets for their service

Accounts Receivable

Represent Sales that a company has made on credit; the product has been sold and delivered, but the company has not yet received the cash for the sale Most companies have a footnote of what constitutes these line items

A/R are linked to ______ on the income statement

Revenues

Marketable securities

Short-term, low-risk investments that can be easily sold and converted to cash Marketable securities are debt or equity investment held by the company In the B/S under cash line item Can also be its own line item

Depreciation

The systematic allocation of the cost of fixed assets over their estimated useful lives; PP&E represent those fixed assets

Accumulated Depreciation

The total amount of depreciation expense that has been recorded since the purchase of a plant asset (sum of depreciations over x years) PP&E is reported net of accumulated depreciation on the balance sheet, such that: Net PP&E = Gross PP&E - accumulated depreciation Accumulated depreciation is a contra account, which is an offsetting account to an asset * Increases in a contra account reduce the associated asset account * Accumulated depreciation offsets Gross PP&E account, and the 2 accounts are aggregated together on the balance sheet as Net PP&E

What intangible assets are not amortized?

Trademarks and goodwill are considered to have indefinite useful life so they are not amortized

Prepaid Expenses

When a company prepays for things like utilities, insurance, and rents, cash is reduced, but the expense is not yet recognized on the I/S Under the accrual concept, expenses are recognized when the associated benefit has been received With prepayments the benefit hasn't yet been received, so an asset is created to reflect that the company now has the right to future services (it's a noncash asset)

Gains on Sale

When a company sells assets , if it receives more than the net book value it recognizes on the B/S at the time of sale, a gain is recorded on the I/S - usually as "other" operating or non operating income, or within the expense category through which the asset was being depreciated (COGS or SG&A) Key takeaway: Regardless of the sale price, only the net book value is removed from the PP&E line, and any excess gain(loss) is recognized in the I/S * On the B/S the gain on sale is debited to retained earnings, or the loss on sale is debited to retained earnings

LIFO Reserve

When companies use the LIFO method, their footnotes must disclose what the value of their inventories would have been under FIFO. The difference is called the LIFO reserve LIFO Reserve = LIFO inventory - FIFO inventory