Financial Accounting CH 5-8

How does the write-off affect total assets and net income?

net income - not affected total assets - not affected

Receivables Turnover Ratio

Number of times during a year the average accounts receivable balance is collected Formula: RTR = (Net Credit Sales) / (Average A/R)

debit, credit

Over both years, _____ Bad Debt Expense and ____ Accounts Receivable

Franchises

- local outlets that pay for the exclusive right to use the franchisor's name and to sell its products within a specified geographical area - the franchisee records the initial fee as an intangible asset

Perpetual Inventory System

- maintains a continual record of inventory - helps a company better manage inventory levels

anticipate

Common Mistake: Some students erroneously think firms should reduce total assets and record bad debt expense at the time the bad debt actually occurs. However, companies ______ future bad debts and establish an allowance for those estimates and record bad debt expense.

not acceptable

The direct write-off method reduces accounts receivable and records bad debt expense at the time the account receivable proves uncollectible. If the credit sale occurs in a prior reporting period, bad debt expense is not properly matched with revenues (credit sales). Also, accounts receivable will be overstated in the prior period. The direct write-off method typically is ________ for financial reporting.

no effect

The write-off has _______ on total assets (balance sheet) or total expenses (income statement)

Working capital, current ratio, acid-test ratio

Three liquidity measures

more accurate

Using the aging method to estimate uncollectible accounts is _____ than applying a single percentage to all accounts receivable. The aging method recognizes that the longer accounts are past due, the less likely they are to be collected

Accounts Receivable

cash owed to the company by its customers from sales or services on account

Current portion of long-term debt

debt that will be paid within the next year

Current Liabilities

due within one year or an operating cycle

administrative offices, retail stores, manufacturing facilities, and storage warehouses

examples of Buildings

Intangible Assets Not Subject to Amortization

goodwill and trademarks with indefinite life

Average Days in Inventory

indicates the approximate number of days the average inventory is held (365) / (ITR)

Natural Resources

oil, natural gas, timber, and salt - distinguished from other assets by the fact that they are physically used up, or depleted - recorded at cost plus all other costs necessary to get the natural resource ready for its intended use

Intangible Assets Subject to Amortization

patents, copyrights, trademarks (with finite life), and franchises

intangible assets

patents, copyrights, trademarks, franchises, and goodwill - lack physical substance, but can be very valuable - existence often based on legal contract - acquired in two ways: (a) purchased (b) developed internally

Sales Tax Payable

sales tax collected from customers by the seller

at the time of the sale or service

when is accounts receivable recorded?

Direct Write-Off Method

write off bad debts only at the time they actually become uncollectible

Trade Receivables

Accounts Receivable is aka

management's ability to collect cash from customers in a timely manner

Key Point: The receivables turnover ratio and average collection period can provide an indication of ____________.

writes off the estimated uncollectible accounts

When it becomes clear the customer will not pay, the company _____________.

Sales Return (full refund)

customer returns a product (a) seller issues a cash refund if original sale was for cash (b) seller reduces balance of accounts receivable if original sale was on account

sales return or sales allowances

customers are sometimes dissatisfied with a product or service

Inventory Turnover Ratio

shows the number of times the firm sells its average inventory balance during a reporting period (COGS) / (Average inventory)

1. The loss is probable and, 2. the amount is reasonably estimable

A contingent liability is recorded only if:

the original cost of the asset and all expenditures necessary to get the asset ready for use

All Property, Plant, and Equipment are recorded at:

credited, debited

Allowance account is _____ for the estimate and ______ for the actual write-off (balance methods)

Return on Assets

indicates the amount of net income generated for each dollar invested in assets - always lower than one - as low as possible is best = (Net income) / (Average total assets)

Profit margin

indicates the earnings per dollar of sales

LIFO Method

- cost of goods sold reflects current cost

Weighted-Average Cost

(COG available for sale) / (# of units available for sale)

Acid-Test Ratio

(Cash + Current Investments + A/R) / (Current Liabilities) - the amount of "quick assets" available for every $1 of current liabilities - quick assets are current assets more readily convertible to cash (a) exclude current assets such as inventory and prepaid rent - by excluding less liquid current assets, the acid-test ratio may provide a better overall indication of a company's liquidity

Working Capital

(Current Assets) - (Current Liabilities) - measure of current assets remaining after paying current liabilities - a large positive ______ is an indicator of liquidity - not the best measure of liquidity for comparing across companies, because the ratio does not control for the relative size of each company - the larger the better

Current Ratio

(Current Assets) / (Current Liabilities) - amount of current assets available for every $1 of current liabilities - the higher the current ratio, the greater the company's liquidity

Contingent Gains

- An existing uncertain situation that might result in a gain - In a lawsuit, the defendant faces a contingent liability, while the other side--the plaintiff--has a ________. - not recorded until the gain is certain

Indefinite-Life Intangibles

- No foreseeable limit on time the asset is expected to provide cash flows - No amortization

Note Receivable

- Similar to Accounts Receivable but include a written debt agreement, or note - classified as either current or noncurrent asset depending on the time until the due date

Limited-Life Intangibles

- amortize to expense - credit asset account

Commercial paper (cheaper to borrow)

- borrowing from another company rather than a bank - sold with maturities ranging from 30 to 270 days - interest rate is usually lower than on a bank loan

Allowance for Uncollectible Accounts

- contra asset reported in the balance sheet - reduces the balance of total assets

Copyrights

- exclusive right of protection given to the creator of a published work to reproduce and sell the work - granted for the life of the creator plus 70 years - allows holder to pursue legal action against anyone who attempts to infringe the copyright - accounting is virtually identical to that of patents

Patents

- exclusive right to manufacture a product or to use a process - granted for a period of 20 years - When purchased: (a) capitalize the purchase price plus legal and filing fees - when developed internally: (a) capitalize legal and filing fees only (Research and Development costs are expensed as incurred)

Gross Profit Ratio

- indicator of the company's successful management of the inventory - measures the amount by which the sale price of inventory exceeds its cost per dollar of sales GPR = (gross profit) / (net sales)

Line of credit

- informal agreement with a bank - permits a company to borrow up to a prearranged limit without having to follow formal loan procedures and preparing paperwork - recorded similar to notes payable each time the company borrows money

FIFO Method

- matches physical flow for most companies - ending inventory reflects current cost

Sales Discount

- offers a customer a reduction if payment is made within a specified period of time - the supplier offers the customer terms of 2/10, n/30 on $350 owed; the customer pays within 10 days of original purchase date.

The write-off

- reduces the balance of Accounts Receivable - reduces the balance of the Allowance for Uncollectible Accounts

Trademarks

- word, slogan, or symbol that distinctively identifies a company, product or service - renewed for an indefinite number of 10-year periods - capitalize legal, registration, and design fees (a) advertising costs expensed as incurred

represents a reduction in a related asset account

Common Mistake: Because Allowance for Uncollectible Accounts has a normal credit balance, students sometimes misclassify this account as a liability, which also has a normal credit balance. Instead this contra asset _________________________.

Warranty Liability account, Warranty Expense, Warranty Liability account

Common Mistake: Some students think the balance in the _______________ is always equal to _________. Remember, the ____________ is increased when the estimated warranty liability is recorded, but then is reduced over time by actual warranty expenditures.

not, allocation

Common Mistake: Students sometimes mistake accounting depreciation as recording the decrease in value of an asset. Depreciation in accounting _______ a valuation process. Rather, depreciation in accounting is an ______ of an asset's cost to expense over time. Some students want to depreciate land. Land is NOT depreciated, because its service life never ends.

incorrectly as cost minus the residual value times the depreciation rate simply multiply cost times the depreciation rate depreciation expense in the final year is the amount necessary to reduce book value down to residual value.

Common Mistake: When using the declining-balance method, mistakes are commonly made in the first and last year of the calculation. In the first year, students sometimes calculate depreciation ____________________. The correct way in the first year is to ____________. In the final year, some students incorrectly calculate depreciation expense in the same manner as in earlier years, multiplying book value by the depreciation rate. However, under the declining-balance method, _______________________.

Allowance Method

Companies are required to: (a) estimate future uncollectible accounts (b) record estimates in the current year

- real estate commissions and fees - back property taxes or other obligations -clearing, filling and leveling the land

Costs to get the land ready for use include items such as:

Sales on Account or Services on Account

Credit Sales is aka

- Straight-line - Declining-balance - Activity-based

Depreciation Methods

timing

Difference between the Allowance Method and the Direct Write-Off Method is ____.

Long-Term Liabilities

Due in more than one year or operating cycle

Bad Debt Expense

Expense reported in the income statement

Inventory Cost Methods

FIFO, LIFO, Weighted-average cost

Percentage of Receivables Method

Formula: End A/R x % believed to be uncollectible = ending balance in ABD account - remember, this method estimates ending balance in allowance for bad debts

gross profit, operating income, income before income taxes, net income

Key Point: A multiple-step income statement reports multiple levels of profitability. _______ equals net revenues (or net sales) minus cost of goods sold. ________ equals gross profit minus operating expenses. _______ equals operating income plus nonoperating revenues and minus nonoperating expenses. ______ equals all revenues minus all expenses.

rising, higher, higher, lower, reducing, tax obligation

Key Point: Generally, FIFO more closely resembles the actual physical flow of inventory. When inventory costs are ___, FIFO results in _____ reported inventory in the balance sheet and _____ reported income in the income statement. Conversely, LIFO results in a ____ reported inventory and net income, _____ the company's income ______.

current asset, not yet sold, expense, sold

Key Point: Inventory is a _______ reported in the balance sheet and represents the cost of inventory ______ at the end of period. Cost of goods sold is an _______ reported in the income statement and represents the cost of inventory _____.

expense

Key Point: Sales taxes collected from customers by the seller are not an _________. Instead, they represent current liabilities payable to the government.

inventory turnover ratio, gross profit ratio

Key Point: The __________ indicates the number of times the firm sells, or turns over, its average inventory balance during a reporting period. The _________ measures the amount by which the sale of inventory exceeds its cost per dollar of sales.

future, current matches net realizable value

Key Point: Under the allowance method, companies are required to estimate ______ uncollectible accounts and record those estimates in the _____ year. Estimated uncollectible accounts reduce assets and increase expenses. Adjusting for estimates of future uncollectible accounts _____ expenses (bad debts) in the same period as the revenues (credit sales) they help to generate. Recording an allowance for uncollectible accounts correctly reports accounts receivable at their ________.

no change

Key Point: Writing off a customer's account as uncollectible reduces the balance of accounts receivable but also reduces the contra asset - allowance for uncollectible accounts. The net effect is that there is ______ in the net receivable (accounts receivable less the allowance) or in total assets. We recorded the decrease to assets as a result of the bad debt when we established the allowance for uncollectible accounts in a prior year.

incur, pay

Key Point: We record interest expense in the period in which we incur it, rather than in the period in which we pay it.

are not

Key Point: Amortization is a process, similar to depreciation, in which we allocate the cost of intangible assets over their estimated service lives. Intangible assets with an indefinite useful life (goodwill and most trademarks) _____ amortized.

parking lots, sidewalks, driveways, landscaping, lighting systems, fences, and sprinklers

Land improvements are amounts spent to improve the land. Examples include...

cost, ready for its intended use

Land includes the _____ of the land and all expenditures necessary to get the land __________.

Notes Payable

Note signed by a firm promising to repay the amount borrowed plus interest on the maturity day - Interest on notes is calculated: Interest = (Face Value) x (Annual Interest Rate) x (Fraction of the Year)

Average Collection Period

Number of days the average A/R balance is outstanding Formula: ACP = (365 days) / (RTR)

Amortization

allocating the cost of intangible assets to expense

Depreciation

allocation of an asset's cost to expense over time

Net Realizable Value

amount of cash the firm expects to collect

Contingent Liabilities

an existing uncertain situation that might result in a loss depending on the outcome of a future event

Net Assets

assets acquired less liabilities assumed

LIFO conformity rule

companies that use LIFO for tax reporting must also use LIFO for financial reporting

sales tax, shipping, assembly, and any other costs to prepare the asset for use

costs of equipment might include:

- real estate commissions and fees - inspection costs - remodeling costs

costs of getting a building ready for use include items such as:

Sales Allowances (part refund)

customer does NOT return a product (a) Seller issues a cash refund if original sale was for cash (b) seller reduces balance of accounts receivable if original sale was on account

Long-term tangible assets

land, land improvements, buildings, equipment, natural resources

Deferred Revenues

liability account used to record cash received in advance of the sale or service

Equipment

machinery used in manufacturing, computers and other office equipment, vehicles, furniture, and fixtures

Asset turnover

measures the sales per dollar of assets invented

long-term intangible assets (existence often based on legal contract)

patents, trademarks, copyrights, franchises, and goodwill

Goodwill

recorded only when one company acquires another company - portion of purchase price that exceeds the fair value of identifiable net assets = (Purchase Price) - (Fair value of the identifiable net assets acquired)

Liquidity

refers to having sufficient cash or other current assets to pay currently maturing debts - lack of ______ can result in financial difficulties or even bankruptcy

operating cycle

time it takes to perform the activities that produce revenues (for example, buy inventory, sell to customers, and collect cash)

Credit Sales

transfer products and services to a customer today and expect to collect cash in the future