MGA 306 Module 6

What are two depreciation methods?

1. Straight‐line method 2. Accelerated methods (e.g., Double‐declining‐balance method)

What do restructuring costs typically consist of?

-Employee severance or relocation costs - Asset write‐downs - Other (i.e., contract termination costs, legal expenses, etc.)

How are • R&D facilities and equipment depreciated?

-If they are general‐use in nature, the costs are capitalized on the balance sheet and depreciated over its useful life like other depreciable assets. -Only those R&D facilities and equipment that are purchased specifically for a single R&D project, and have no alternative use, are expensed immediately in the income statement.

What does a high PPE turnover indicate?

-implies a lower capital investment for a given level of sales as well as a higher turnover, therefore, increases profitability because the company avoids asset carrying costs and because the freed‐up assets can generate operating cash flow

How does the purchase of PPE effect the balance sheet?

-it is recorded at cost on the balance sheet. This is called capitalization, that is why expenditures for PPE are called CAPEX -Once capitalized, the cost of PPE is recognized as expense over the period of time that the assets produce revenues (directly or indirectly) in a process called depreciation.

How can one compare the income statements of companies that use LIFO?

-one must adjust cost of goods sold from LIFO to FIFO -To obtain FIFO CGS from LIFO CGS the formula is, FIFO CGS= LIFO CGS + Increase/decrease in LIFO reserve

For manufacturers, what are the components of manufacturer costs?

1. Cost of direct (raw) materials used in the product, 2. Cost of direct labor to manufacture the product, and 3. Manufacturing overhead.

What is the average days inventory outstanding formula?

=365 *(average inventory/CGS)

What is the formula for percent used up?

=Accumulated depreciation/ depreciable asset cost -Ratio shows the percentage of depreciable assets that are no longer productive. -The degree to which a companys assets are used up can help forecast future cash flows. For example: if depreciable assets are 80% used up, one might anticipate a higher level of capital expenditures to replace aging assets in the near future.

What is the inventory turnover ratio?

=Cost of goods sold/ Average inventory

What is the formula for average useful life?

=Depreciable asset cost/ depreciation expense

What is the formula for Gross profit ratio?

=Gross Profit/Sales

What is the formula to attain FIFO inventory?

=LIFO inventory + LIFO reserve

How do you compute the gain or loss on the sale (disposition) of a tangible asset?

=Proceeds from sale- Net book value of asset sold

What is the formula for PPE turnover?

=Sales/Average PPE, net

What happens on financial statements when inventory is sold?

Its cost is transferred from the balance sheet to the income statement as as an expense(Cost of Goods Sold)

What is the First‐In, First‐Out (FIFO) method?

An inventory costing method that assumes the first units purchased are the first units sold.

What is the • Last‐In, First‐Out (LIFO) method?

An inventory costing method that assumes the last units purchased are the first to be sold.

What is the • Average cost (AC) method?

An inventory costing method that assumes the units are sold without regard to the order in which they are purchased. Instead, it computes COGS and ending inventories as a simple weighted average.

What is the process of reporting inventories at the lower of cost or market?

At the end of each accounting period, companies compare the ending inventory balance (based on FIFO, LIFO or AC) with the market value of the inventory (its replacement cost). -inventory is carried on the balance sheet at whichever amount is lower: the cost of the inventory or its market value.

How is an asset sale recorded?

Example: Hilton sold the Waldorf Astoria hotel in NY for $1.95 billion. If we assume zero tax for simplicity, the hotel was carried on Hilton's balance sheet at a book value of $1.807 billion. Hilton recognized a gain on sale, net of $143 million ($1.95 billion -$1.807 billion). Debit: cash(1.95 Billion) Credit: PPE, net(1.81 Billion) Gain(.14 Billion)

What does a low(fewer days) number for average days inventory outstanding indicate??

Fewer days implies that products are salable, preferably without undue discounting.

What are a few inventory-costing methods?

First‐In, First‐Out (FIFO) • Last‐In, First‐Out (LIFO) • Average cost (AC)

How does one account for asset impairment?

For example: As oil prices declined in 2015, Chesapeake Energy was forced to write down its oil and gas properties because the properties' fair value also dropped drastically. • To determine the impairment charge, Chesapeake compared the fair value of certain properties using the 2015 market prices for oil and gas to the properties' carrying value (the net book value on the balance sheet). • This led to an impairment charge of $18,238 million. Dr. Assets impairment expense 18.2 mil. Cr. PPE, net 18.2 mil.

What is asset impairment?

If market values of PPE assets decrease—and the asset value is deemed to be permanently impaired

What are the Balance Sheet Adjustments for a LIFO Reserve?

In general, 1. Increase inventories by the LIFO reserve. 2. Increase tax liabilities by the tax rate applied to the LIFO reserve. 3. Increase retained earnings for the difference.

Why do companies typically use the straight line method for financial reporting purposes and accelerated depreciation method for tax returns?

In the early years following the purchase of PPE, the Straight line depreciation method yields higher income on financial statements, whereas accelerated deprecation yields lower taxable income. Although this relation reverses in the later years of a PPE's life, company's prefer to have the tax savings sooner than later.

What effect does reporting at lower of cost or market have on financial statements?

Inventory book value is written down to current market value; reducing inventory. - Inventory write‐down is reflected as an expense on the income statement. for example: Assume that a company has inventory on its balance sheet at a cost of $27,000. • Management learns that the inventory's replacement cost is $23,000 and writes inventories down to a balance of $23,000. -Expenses on the income statement increase by 4000 -Noncash assets decrease by 4000 on the balance sheet -Earned capital decreases by 4000 on the balance sheet

What does a decline in Gross profit Ratio indicate?

It depicts that the company has less ability to mark up the cost of its products into selling prices, it is a cause for concern.

How does one Report Employee Severance or Relocation Costs?

To accrue employee severance or relocation expenses, the company must: - Estimate total costs of terminating or relocating selected employees, and - Report total estimated costs as an expense and a liability in the period the restructuring program is announced.

What is the LIFO reserve?

an accounting term that measures the difference between the first in, first out (FIFO) and last in, first out (LIFO) cost of inventory for bookkeeping purposes

who is PPE turnover normally low for?

for a capital‐intensive manufacturing company. for example: automobile manufacturing, oil production and refining, steel production, telecommunications and transportation sectors, like railways and airlines

When is inventory "written down"?

if its replacement cost, referred to as 'market cost,' declines below its balance sheet cost

What is one main period in which it is recommended to use the LIFO method?

in periods of rising prices.

What is an asset's net book value?

its acquisition cost less accumulated depreciation.

What is Capitalization?

means that a cost is recorded on the balance sheet and is not immediately expensed in the income statement.

What is corporate restructuring?

restructuring designed to turn a company around, frequently initiated in response to poor performance, mounting debt, and shareholder pressure -can involve eliminating business segments, selling major assets, downsizing the workforce, and reconfiguring debt.

What is "Percent used up" relating to PPE assets?

the proportion of a company's depreciable assets that have already been transferred to the income statement.

What is Variance in Depreciation?

• A company can depreciate different assets using different depreciation rates and different useful lives.