BUAD 280: Closing Entries, Chapters 5-6 and 8-9

land improvements?

any structural additions to the land things like driveways, parking lots, landscaping, etc. recorded separately from land because they are assumed to have a limited life (e.g. subject to wear and tear) → depreciated land, on the other hand, is not depreciated because it's assumed to last indefinitely

three factors used in computing depreciation?

1. cost 2. useful life (estimate of the expected productive value of an asset) 3. salvage value (estimate of the asset's worth at the end of the useful life; salvage value might be an asset's worth as scrap metal; residual value, scrap value; at end of useful, can make money off of remainders)

two methods to determine uncollectible accounts?

1. direct write-off method 2. allowance method

steps for the allowance method?

1. estimate/record the amount of uncollectible a/r → record as ending balance for allowance of doubtful accounts 2. adjusting entry: debit bad debts expense, credit allowance (always!) 3. write off when figure out that a customer won't pay

two methods used to estimate the amount of uncollectible a/r?

1. percentage-of-receivables method -take a percentage of the ending value of a/r → ending balance for allowance 2. aging method (more accurate)

gross profit?

= sales revenue - COGS

COGS equation

COGS = Beg Inv + Purchases - End Inv End Inv = Beg Inv + Purchases - COGS End Inv: cost of goods available @ end; on this year's BS Beg Inv: cost of goods @ beg; End Inv on last year's BS Purchases: cost of goods purchased; in journal entries Beg Inv + Purchases = total cost of all goods available for sale = COGS + End Inv

EBIT vs. EBITDA?

Earnings Before Interest and Taxes Earnings Before Interest, Taxes, Depreciation, Amortization

determining the cost of plant assets?

PPE recorded at cost cost consists of all expenditures necessary to acquire the asset and make it ready for its intended use present cost as one number

consignment?

a consignment store has no inventory, it's a service store takes consigned goods, which are goods that they take to display and try to sell if sold, take a portion of the sale as commission if not sold after a certain amount of time, goods returned to seller consignment store does not count consigned goods as part of their inventory because it has not taken ownership of the goods

aging method?

a firm can use an aging schedule to more accurately estimate the amount of uncollectible a/r as a/r become older and more overdue, the more likely they are going to become uncollectible steps: 1. arrange accounts by age ("age the a/r") → separate each account into buckets (not yet due, 1-30 days past due, 31-60 days past due, 61-90 days past due, over 90 days past due) → find bucket totals 2. estimate probable bad debt loss rates for each bucket (older buckets should have higher loss rates than younger buckets) 3. calculate total estimated bad debts (estimate % x bucket totals → sum all together = amount of existing a/r expected to become uncollectible in future/ending balance in allowance for the period)

temporary accounts?

accounts that only relate to a given accounting period (income statement accounts, dividend accounts) and are closed out at the end of the period accounts: revenues (IS), expenses (IS), dividends (RE S) need to erase temporary accounts after the period

permanent accounts?

accounts that relate to one or more future accounting periods (balance sheet accounts) and are not closed at the end of the period accounts: assets, liabilities, SE

income summary?

additional temporary account that helps us close the revenue/expense accounts and transfer the resulting net income to RE

inventory cost methods?

after a company counts how much inventory it has left, it needs to determine: 1. cost of End Inv 2. COGS four methods: 1. specific identification 2. FIFO 3. LIFO 4. Average Cost

plant assets?

aka PPE, Plant and Equipment, or Fixed Assets long lives three characteristics: 1. have a physical substance 2. used in operation of a business 3. not intended for sale to customers types: 1. land 2. land improvements 3. buildings 4. equipment

cash realizable value?

aka accounts receivable, net = a/r - allowance for doubtful accounts

weighted-average?

allocates the cost of goods based on the weighted average unit cost weighted average unit cost = cost of goods available for sale/ total units available for sale different from taking simple average of unit costs

depreciation of plant assets?

applies to assets like buildings, land improvements, and equipment because their revenue-producing abilities decline over time due to wear and tear does not apply to land since land's usefulness and revenue-producing abilities don't decline over time balances in accumulated depreciation = total amount that the company has charged to depreciation expense

retirement of asset?

asset is scrapped or discarded and no cash is received for it no salvage value case 1: retire asset when it has been fully depreciated and there is no salvage value; no cash is received -records journal entry to take asset off the BS -to do this, must take everything that is associated w/ that asset off the BS → includes the A/D associated with the asset -decrease (debit) A/D for the full amount of depreciation taken over the life of the asset; decrease (credit) the asset account for the original cost of the asset -note: if salvage value = 0 at the end of useful life, A/D = cost case 2: retire asset before its fully depreciated, no salvage value and thus no cash received (e.g. equipment is a piece of junk that is not preforming well) -debit loss on disposal, debit A/D, credit machine case 3: keep using a fully depreciated asset (it's still useful even after fully depreciating its cost), no salvage value -no additional depreciation is taken even if asset is still being used -machine cost = A/D; BV = 0 (stays like this)

closing entries?

at the end of the annual accounting period (e.g. fiscal year), the company transfers temporary account balances to RE (permanent account) completed after a company prepares its financial statements @ the END of the year 1. journalize and post closing entries 2. prepare a post closing trial balance revenue and expenses: 1. move revenues into income summary (debit revenues, credit income summary) 2. move expenses into income summary (credit expenses, debit income summary) 3. find the net balance (e.g. net income/loss) on the income summary 4. debit/credit income summary and debit/credit retained earnings account 5. move dividends into RE (credit dividends, debit RE) 6. post retained earnings balance to post-closing trial balance ***note: often have beginning balance (RE beg) in retained earnings ledger completed in the general journal after the last adjusting entry after prepared, all temporary accounts will have a zero balance and the new balance in RE = RE end

computing interest?

calculation: face value of note x annual interest rate x time in terms of one year = interest if the maturity date is expressed in terms of months, divide number of months by 12 if the maturity date is expressed in terms of days, divide number of days by 360 notes: -360 is a bank convention -rates could be annual or monthly

depreciation methods?

companies can choose which depreciation method to use to depreciate its assets can choose different methods for different assets should choose a method that makes sense for the asset (e.g. one that best measures how the asset is used over time)... method needs to be consistent with reality 1. straight-line method 2. units of activity method 3. double declining method

perpetual?

companies keep a continuous record of inventories and COGS determine COGS each time a sale occurs → inventory up to date a company does the following: 1. purchase inventory, record purchase of inventory 2. sell inventory, record revenue and compute/record COGS 3. at the end of the accounting period, no entry

lower-of-cost-or-market (LOCOM)?

companies value inventory at the lower-of-cost-or-market (e.g. cost or market price, whichever is lower) in the period in which the price decline occurs note: not written down when sell inventory but when price decline occurs market price: replacement cost— current replacement cost of the inventory; current price needs to pay suppliers applicable to companies that sell trendy or short life-cycle products (e.g. fashion or tech) inventory write downs: End Inv (cost) - End Inv (LOCOM) = write down amount under the direct method, companies add the additional cost directly to COGS: -debit COGS, credit inventory

sale of plant asset?

compare the book value of the asset with the proceeds received from the sale if proceeds > BV, a gain on disposal occurs if proceeds < BV, a loss on disposal occurs case 1: sell asset for exactly the book value → no gain or loss on disposal of asset (BV = proceeds from sale) -debit cash, debit A/D, credit machine -doesn't happen too often because the actual sale price is likely to differ from the book value case 2: sell asset for more than the book value (proceeds from sale > BV) -debit cash, debit A/D, credit machine, credit gain on disposal of machine case 3: sell asset for less than the book value (proceeds from sale < book value) -debit loss on disposal of machine, debit cash, debit A/D, credit machine case 4: sell asset before end of useful life -find current A/D -compare current BV to proceeds received to figure out if gain or loss, do the following: -sale price - BV gain/loss on disposal shows up on income statement in "other" section note: sell when have salvage value or sell before its end; anything over book value, gain; anything below book value, loss

periodic?

compute COGS and ending inventory at the end of the accounting period, when they take a physical count of inventory a company does the following 1. purchase inventory, record purchase 2. sell inventory, record revenue only 3. at the end of the accounting period, compute/record COGS under a periodic system, a business would not keep a detailed inventory record of what they have at any point in time

sales returns and allowances and sales discounts?

contra-revenue accounts -debit normal balances (balance opposite of revenue accounts) net sales = sales revenue - sales returns/allowances - sales discounts

general layout of inventory table?

date, name, units, cost/unit, total cost

double declining method?

declining balance under this method, depreciation is high in the early years and then less high in the later years because of this, this is considered an accelerated depreciation method this method makes sense with some assets that lose usefulness quickly because of obsolescence (e.g. technology) obsolescence: process of becoming out of date before the assets physically wears out (e.g. computers, televisions, cell phones, etc.) under this method, instead of using the depreciable cost, the depreciation is based on a declining book value (BV = cost - A/D) calculation: annual depreciation expense = (Beg BV x declining balance depreciation rate) method does not take into consideration the salvage value of the asset (depreciation stops when BV = expected salvage value) if an asset if acquired during the middle of a fiscal year, you prorate it process: 1. calculate straight-line rate = 100%/useful life 2. double the straight-line rate to get the double-declining rate 3. year 1 = Beg BV x DD rate = depreciation expense 4. year 2 = BEG BV x DD rate (Beg BV from year 1 End BV) 5. Final year, do the following: -carry End BV from last year over to final year's Beg BV -depreciation expense: amount needed to equate End BV w/ salvage value (plug; Beg BV - x = End BV = salvage value) -if did normal way, End BV < salvage value, which is not possible -at end of useful life, assumption that BV = salvage value unlike other methods, very important to do things year by year → use table year, Beg BV, depreciation rate, annual depreciation expense, accumulated depreciation, End BV

allowance method?

estimate the amount of uncollectible a/r at the end of each accounting period different from the direct write off method, in which the bad debts expense was the actual amount of uncollectible a/r this method allows firms to match estimated expenses with revenues in the same period in which they record the revenues firms record estimated uncollectibles through an adjusting entry at the end of each period adjusting journal entry: debit bad debts expense, credit allowance for doubtful accounts

Allowance for Doubtful Accounts?

estimation of amount of a/r that will be uncollectible contra-asset account: if it increases, a/r net decreases (e.g. total assets) permanent account on the BS → not closed out at the end of the fiscal year; balance carries over to the next year normal credit balance is possible to have a debit balance at the start of the period... happens when write offs during the year have exceeded the provisions you set for bad debts

recovery of write off?

firm already assumed they would not be collecting this amount and already wrote off the account 1. reinstate account to reverse write off: -debit a/r, credit allowance 2. journalize collection of a/r in a normal manner: -debit cash, credit a/r

receivables?

general term that refers to cash that is due from individuals or other companies w/ receivables, can recognize revenue; can increase profits while cash is still tied up in a/r (why a/r = a fraudster's best friend) types: 1. accounts receivables (relatively short-term; explain why a company can be low in cash, yet high in profit) 2. notes receivables 3. other receivables

post-closing trial balance?

has the fewest accounts lists only the permanent accounts, since temporary have been closed (no revenue/expense accounts) RE = ending retained earnings (vs. adjusted trial balance which shows beginning retained earnings)

impairments?

if there's a permanent decline in the market value of an asset, the asset is said to be impaired company writes down asset to its new fair value during the year in which the decline occurs (reduces value of the asset in year impairment discovered)

spoilage or theft of inventory?

if your inventory is perishable and can spoil or if you have a theft problem, you need to write-down your inventory to account for this loss in inventory but, if you have an abnormally large amount of spoilage or theft, companies may disclose as "loss from merchandise inventory shrinkage"

bad debts expense?

in order to account for the risk of not getting paid back 100% of a/r, companies account for these credit losses companies record these credit losses as debits to bad debts expense (an expense item) credit losses = debits since debits increase expenses since these losses are expected in the course of the business, companies report them as part of their operating expenses account closed at the end of the year

income and retained earnings statement vs balance sheet?

income and retained earnings statement covers a period whereas the balance sheet is a snapshot in time report card vs. bank account

other expenses/losses?

interest expense casualty losses from recurring causes (vandalism, accidents) loss from sale or abandonment of PPE loss from strikes by employees and suppliers

other revenues/gains?

interest revenue from notes receivable and marketable securities dividend revenue from investments in capital stock rent revenue from subleasing a portion of store gain from sale of PPE

accounting for notes receivable?

journal entry for when company lends money using a note: -debit n/r, credit cash -only includes face value of the loan; interest is earned/accrued as time passes and is recognized as interest receivable and interest revenue journal entry for receiving a note in exchange for settling an open account (e.g. customer owes money but indicates that won't be able to pay back for long time → company requires customer to issue a promissory note to ensure payment) -debit n/r, credit a/r -only includes face value of the loan; interest is earned/accrued as time passes and is recognized as interest receivable and interest revenue like a/r, n/r also has an allowance for doubtful accounts and "n/r, net" represents n/r-allowance

determining the maturity date of the notes receivable?

maturity date: when money is due life of a promissory note is expressed in terms of months: -to find maturity date, you count the number of months from the date of issue life of a promissory note is expressed in terms of days: -to find maturity date, you count the number of days being careful to: 1. exclude the date the note was issued on 2. include the date the note is due on trick for finding the number of days in months: -knuckles = 31 -non-knuckles = 30 or 28 (Feb)

days in inventory?

measures the average number of days inventory is held the approximate time it takes a company to sell its inventory = (365/inventory turnover ratio)

inventory turnover?

measures the number of times on average the inventory is sold during the period the purpose of this is to analyze the liquidity of the inventory the higher, the better = (COGS/average inventory) average inventory = (Beg Inv + End Inv)/2)

cost flow methods?

most companies choose a cost flow method 1. FIFO (first in, first out) 2. LIFO (last in, first out; most recently purchased sold first) 3. Average Cost choose one and stick to it → method does not have to be in line with how you actually sell goods; merely a cost assumption companies can choose to use more than one method to value different types of inventory COGS and End Inv vary among the three methods, yet Beg Inv and Purchases are the same for all inventory cost methods allocate total inventory cost across periods

inventory management?

need to make sure that you have enough inventory to meet demand, but too much inventory could be costly, especially if the inventory spoils or becomes obsolete two tools used to analyze inventory: 1. inventory turnover 2. days in inventory

specific identification?

no public company uses this straight forward, yet likely not feasible under this method, company keeps track of the cost of every item sold to determine COGS good for a company that has a unique set of items and knows the cost of each (jewelry, art, luxury cars) if prices fluctuate (items bought at differing costs), not practical

COGS is _________ an operating expense

not

dishonored note?

one that is not paid in full at its maturity if the payee expects the maker to pay her back eventually, the payee transfers this amount to a/r: -debit a/r, credit n/r, credit interest receivable/interest revenue (depends on whether or not adjusting entries happened; whether or not interest accrued) if the payee does not expect the maker to pay her back, the payee writes off the n/r by doing the following: -debit allowance for doubtful accounts, credit n/r, credit interest receivable/revenue (depends) no interest accrued, just have interest revenue (e.g. interest not adjusted for before maturity date)

merchandise vs. service companies?

operating cycle of a merchandising company ordinarily is longer than that of a service company service: 1. perform services 2. a/r 3. receive cash 4. repeat merchandising: 1. buy inventory 2. merchandise inventory 3. sell inventory 4. a/r 5. receive cash 6. repeat

comparison of methods?

regardless of which method you choose, total depreciation is the same over the useful life of the asset across the three methods order of popularity: 1. straight-line 2. accelerated 3. units of activity

note receivable?

represent money that is owed to the company— the difference from a/r is that it comes with more of a formal agreement that gives the company a stronger claim than a/r do for shady customers company issuing the loan or credit receives a promissory note (e.g. a written promise to pay) borrower: the party making the promise to pay is called the maker lender: the party to whom the payment is to be made is called the payee

Valuing Accounts Receivable?

risk of not getting cash for 100% of a/r... how to account for this risk?

credit sales?

sales made on account

Free on Board Destination?

seller places the goods on board the truck/carrier and pays the freight costs ownership of goods remains with seller until the goods reach the buyer free for buyer (e.g. the destination) freight costs incurred = operating expense

Free on Board Shipping Point?

seller places the goods onboard the truck/carrier for free → the buyer pays the freight cost and receives ownership ownership of goods transfers to the buyer when its is placed on the truck/carrier free for seller (e.g. the shipping point) note: whoever pays for shipping owns it

LIFO vs. FIFO profits

short-term profits differ but long term level out if costs of inventory are rising, FIFO will show the lowest COGS and the highest profit; LIFO will show the highest COGS and lowest gross profit; weighted average will be in the middle of the two if prices are decreasing, FIFO has higher costs and lower profits; LIFO has lower costs and higher profits

revising periodic depreciation?

since depreciation is an estimate (estimate of useful life, of total units of activity), it's not perfect management from time to time may need to revise their estimates to do this, companies change depreciation in current and future years, not for prior periods how does this work? 1. determine depreciable cost at the time of revision 2. allocate the revised depreciable cost to the remaining useful life straight-line method: 1. find current BV and use BV instead of initial cost in depreciable cost calculation → BV - salvage value 2. find remaining useful life don't change historical numbers but change everything going forward instead of using new cost, substitute with book value → BV becomes new cost → recalculate depreciation expense can revise useful life and salvage value

sales of recievables?

sometimes companies choose to sell off their receivables (a/r) to a third party, called a factor (similar to a big bank; call people until they get annoyed and give money) a factor is a finance company or a bank that buys receivables from businesses and then collects the payments directly from the customers factors make their money by charging the business a commission... fee usually ranges between 1-3% of the amount of receivables sell receivables to improve financial ratios, to get rid of the hassle of collecting accounts, or to accelerate cash receipts journal entry for sale: debit cash, debit service charge expense, credit a/r

for a/r write offs, list _____________

specific accounts

depreciation and taxes?

tax regulations don't require companies to use the same depreciation method on their tax return that they use in their financial statements as a result, many companies use straight-line for financials (to maximize net income) and accelerate depreciation on their tax returns (to minimize income taxes; less profit with higher expense) for tax, companies must use either the straight-line or an accelerated method called the Modified Accelerated Cost Recovery System (MACRS)

equipment?

the cost of equipment includes purchase price, sales taxes, freight charges, insurance during transit time to the buyer (one time), costs for assembling, installing, and testing the equipment what is NOT included: costs that are annual recurring expenses like DMV licenses for cars or insurance fees → these would be treated as expenses when incurred (operating expense) → license expense, prepaid insurance

land?

the cost of land includes items such as: 1. the cash purchase price 2. closing costs such as title and attorney's fees 3. real estate brokers commissions 4. accrued property taxes (exist when purchase) the costs of making the land ready for its intended use → included in the cost of the land → clearing, draining, demolition, removal costs never depreciated!

write off of uncollectible accounts?

throughout the year, when the company REALIZES that a customer is not going to pay, they write-off that customer's account amount reduces the allowance (e.g. drink from the allowance well) done via a journal entry subjective journal entry: debit allowance, credit a/r-specific account bad debts expense was already accounted for in the adjusting entry, so the income statement does not change cash-realizable value and thus total assets do not change (see notes)

straight-line method?

under this method, companies expense the same amount of depreciation for each year of the asset's useful life asset used equally throughout the year 1. determine depreciable cost = (cost of asset - salvage value) -represents the total amount subject to depreciation 2. find annual depreciation expense = (depreciable cost/useful life) alternative method of finding annual depreciation expense: 1. determine annual rate of depreciation = (100%/useful life) = straight-line rate 2. annual depreciation = (depreciable cost x depreciation rate) at end of useful life, BV = salvage value and A/D = depreciable cost when an asset is boughten during the middle of a year as opposed to the beginning of a fiscal year, annual depreciation needs to be prorated year, depreciable cost, useful life, annual depreciation expense, accumulated depreciation, book value at the end of the year

units of activity method?

under this method, useful life is expressed in terms of the total units of production rather than as a time period (# miles on a car, # machine hours, etc.) asset varies in activity throughout the year not appropriate for things like buildings or furniture because these assets are more of a function of time than of use (would be hard to measure use!) to use this method, companies estimate the total units of activity for the entire useful life, then divide these units into depreciable cost calculation: -depreciable cost per unit = (depreciable cost/total units of activity) -annual depreciation expense = (depreciable cost per unit x units of activity during the year) units of activity sum to total units of activity at end of useful life → once total reached, BV = salvage value year, units of activity, depreciable cost/unit, annual depreciation expense, accumulated depreciation, BV at the end of the year

multiple-step income statement?

used in merchandising operations sales revenue less: contra-revenue accounts -------- net sales less: COGS -------- gross profit less: operating expenses -------- income from operations (EBIT) other revenues/gains other expenses/losses --------- income before income taxes income tax expense --------- net income/loss notes: -COGS not used in service companies -operating expenses = recurring -investors care about income from operations -street earnings, non-GAAP, proforma show up on MD&A -other revenues/gains/expenses/losses are not related to operations

sales revenues?

what is sold

buildings?

when a building is purchased, the cost includes things like purchase price, closing costs, and brokers commission also includes costs to make the building ready for its intended use, such as costs to remodel or repair when a building is constructed, the cost includes contractor's feeds, architect's fees, building permits, etc. sometimes, if a company incurs interest costs to finance to building project (such as if it takes a long time for the building to be prepared for use), the company will charge these interest costs to the building account (e.g. include these costs as part of the building cost on the BS) → inclusion of interest costs is limited to the construction period

direct write off method?

when a company finds out the customer won't pay, it charges this amount to bad debts expense bad debts expense will show the actual losses that the company has incurred from uncollected a/r advantages: 1. simple 2. bad debt expense based on actual credit losses (record loss when realize that not going to get paid back) disadvantages: 1. violates expense matching 2. firms don't determine whether a customer will default until several periods later 3. recognition of bad debts expense will not happen until several periods after the revenue recognized 4. a/r in the BS is not really the amount the company expects to receive... unless the amount of bad debt expense is insignificant, GAAP does not allow companies to use this method... instead need to use allowance method! regular journal entry (happens on a specific date): debit bad debts expense, credit a/r

plant disposals?

when companies are done with using their assets, they can dispose of it in three different ways 1. retire the asset 2. sell the asset 3. exchange it for another asset

effects on income statement?

when prices are rising: - FIFO: lowest COGS, highest net income/tax expense/inventory balance -LIFO: highest COGS, lowest net income/tax expense/inventory balance FIFO -may choose FIFO if care about reporting higher earnings to investors -managers/CEOs who are compensated based on net income (compensation = a +(b*NI)) may choose FIFO to maximize their own compensation -cost of ending inventory is based on higher prices (more accurate estimate of the cost it would require to replace goods) LIFO -when prices are rising, companies may choose LIFO to pay lower taxes (old companies → care less about higher income) -US tax rule (LIFO conformity) requires that companies who use LIFO for tax purposes must use for financial purposes -when prices are rising, LIFO results in an End Inv that's based on old costs that are no longer relevant

honored note?

when the maker pays note in full at its maturity date for notes that are interest bearing, maker will pay back the face value plus the amount of interest that accrued on the loan if interest not accrued, do the following: -debit cash, credit n/r, credit interest revenue adjusting entries for interest if interest is accrued: -debit interest receivable, credit interest revenue if interest is accrued, do the following: -debit cash, credit n/r, credit interest receivable, credit interest revenue

capitalizing vs expensing costs?

when you have an asset, it is often common to make repairs or improvements on an asset ordinary repairs (oil changes on cars, painting of buildings, replacing machine parts) additions/improvements: costs incurred that increase the operating efficiency, productive capacity, or useful life of an asset -costs usually material in amount and occur infrequently -in this case, companies debit these amounts to the assets, increasing the value of the assets on the BS -referred to as capital expenditures sometimes, difficult to tell capital expenditures from ordinary repairs (aka revenue expenditures) -one consideration = materiality principle— if an items would not make a material difference in decision making, the company does not have to follow the GAAP in reporting that item -company will decide on threshold for materiality

physical count of inventory?

whether a company uses a perpetual or a periodic system, they all need to do a physical count of inventory at the end of the accounting period for companies with a perpetual inventory system, this count allows them to: 1. check the accuracy of their continuous records 2. see how much their inventory is damaged or stolen for companies with periodic systems, this count allows them to: 1. determine how much of their inventory is on hand and COGS for the period need to count inventory that you OWN