ACC 305 Unit 2

Trading securities

-debt of equity securities: expected to be sold in the very short term (generally less than 3 months) -reported at fair value on the balance sheet, usually short term assets -unrealized gains/losses (ie changes in fair value) are recorded in the income statement

Available for sale securities

-debt securities: not classified as trading or held to maturity -reported at fair value -unrealized gains/losses are recorded in AOCI (equity)

Implied goodwill

= fair value of reporting unit - fair value of net assets

Carrying value

=book value: the number right on the balance sheet

Capitalize vs. Expensing costs

Capitalize: create asset, expense over time Expense: expense immediately.

Bonds issued at a Premium

For the initial purchase: debit cash (the full amount at premium and credit bonds payable (Face value) and premiums on bonds payable (difference) Interest Expense: debit to interest expense, debit to premium on bonds payable (difference) and credit to cash

LIFO conformity rule

IRS rule requiring a company that uses LIFO for tax reporting to also use LIFO for financial reporting

Comprehensive income

a broader definition of income that includes all revenues, expenses, gains, and losses; it's all changes in stockholders' equity other than investments by stockholders and distributions to stockholder

accumulated depreciation

a contra asset account representing the total depreciation taken to date

Recording a lease

a long term lease creates an asset and a liability for the user. record a long term lease for the present value of payments. Debit to lease asset and credit to lease payable

Amortization

allocation of the cost of an intangible asset over its serviceable life

Purchase discount

allow buyers to trim a portion of the cost of the purchase in exchange for payment within a certain period of time

LIFO adjustment

an adjustment used to convert a company's own inventory record maintained throughout the year on a FIFO basis to LIFO basis for preparing financial statements at the end of the year

book value

an assets original cost less accumulated depreciation

Patents

an exclusive right to manufacture a product or use a process. lasts for 20 year. when a firm purchases a patent, it records the patent as an intangible asset at its purchased price plus other costs such as legal and filing fees to secure patents. the cost of successfully defending a patent, including attorney's fees are added to the patent account

Sinking funds

an investment fund used to set aside money to be used to pay debts as they come due

Other comprehensive income

another bottom line, but not a better bottom line. a separate, broader, and more encompassing way to measure performance -all realized gains and losses goes into the income statement, but unrealized gains and losses goes into the other comprehensive income

Average days in inventory

approximate number of days the average inventory is held =365/inventory turnover ratio

Tangible assets

assets in this category include land, land improvements, buildings, equipment, and natural resources

intangible assets

assets in this category include patents, trademarks, copyrights, franchises, and goodwill. we distinguish these assets from PPE by their lack of physical substance. the evidence of their existence is often based on a legal contract

natural resources:

assets like oil, natural gas, and timber that we can physically use up or deplete

Serial Bond

bond issue matures in installments. bonds that require payment of the principal amount of the bond over a series of maturity dates

term bonds

bond issue matures on a single date. Payment in full at maturity. no coupon payments

Secured bonds

bonds are backed by collateral. supported by specific assets pledged as collateral. if the bond goes into default, the bond holder can lay claim to the collateral

Public debt

bonds sold to the public are different from bank loans in a few ways. they are securities sold to investors, and so will generally have a market value. the risk and maturity of the bond we determine its issue price, that is, how much investors will pay for the bond. they tend to have longer maturity dates (more than 10 years

unsecured bonds

bonds that are not backed by collateral. most bonds are unsecured. also referred to as debentures. only secured by the full faith and credit of the issuing company

bank loan/note

borrow principal; make periodic interest payments; repay full principal at end of loan period

Debt financing

borrowing money from creditors (liabilities)

mortgage

borrowing principal; make periodic interest payment over the loan period

Equipment

broad term that includes machinery used in manufacturing, computers, and other office equipment, vehicles, furniture, and fixtures. the cost of exuipment is the actual purchase price plus all other costs necessary to prepare the asset for use. these can be any of a variety of other costs including sales tax, shipping, delivery insurance, assembly, installation, testing, and even legal fees incurred to establish title

Annuity

cash payments of equal amount over equal time periods

Consolidated financial statements

combination of the separate financial statements of the parent (purchasing company) and the subsidiary (acquired company) into a single set of financial statements

General impairment rules

companies must check impairment at least annually for the following accounts: inventory, investments (some), PP&E, and intangibles

Corporate bonds

company sells debt to the market. make periodic cash payments; pay lump sump off at maturity. investors pay the PV of cash payments and principal. investors can freely buy and sell bonds until payoff

finished goods

consists of items for which the manufacturing process is complete

Debt

contract based liability, usually with a stated rate and horizon. mortgages, loans (notes), bonds. there is a difference between debt and liabilities. there is a subset between debt and liabilities. debt is a subset of liabilities. interest bearing and liability based

Freight Out

cost of freight on shipments to customer, which is included in the income statement as either a part of COGS or as a selling expense

Freight in

cost to transport inventory to the company, which is included as part of the inventory cost. we add the cost fo freight in to the balance sheet inventory. later when the inventory is sold, those freight charges come part of the CoGS

Weighted average cost

costing method that assumes both CoGS and ending inventory consists of a random mixture of all goods available for sale. weighted average cost = cost of goods available for sale / # of units available for sale

bonds issued at face amount

debit to cash and credit to bonds payable for the full face value of the bond

Adjust to fair value: available for sale securities

debit to investments and credit to unrealized holding gain--other and comprehensive income. Comprehensive income = net income + other comprehensive income

Goodwill

equals the purchase price less the fair value the net asset acquired. it is required only when one company acquires another. the difference between acquisitions price and the fair market value of acquired firm's net identifiable assets

Short term liabilities

generally non-interest bearing. short term IOU's to suppliers and other stakeholders (landlords, employees, insurance companies, tax authorities, etc). examples include accounts payable, wages payable, taxes payable, accrued liabilities. Key word, "payable". recorded on the BS at nominal value (not at present value. less than 12 months

Leases

has become the number one method of external financing by us companies. a lease is a contractual agreement by which the lease (owner) provides the lessor (user) with the right to use an asset for a specific period of time

Do not report fair value changes

held to maturity securities: debt securities that are expected to be held until they mature which means until the issuer is required to repay the full amount of the bonds to the investors

When inventory costs are rising, FIFO results in...

higher reported amount of inventory in the balance sheet higher reported gross profit in the income statement

Profiting from the sale of equipment

if we dispose of an asset more than its book value, we record a gain. if we dispose of an asset for less than its book value, we record a loss

Land Improvements

improvements to land such as paving, lighting, and landscaping that, unlike land itself, is subject to depreciation

Buildings

include administrative offices, retail stores, manufacturing facilities, and storage warehouses. the cost of acquiring building usually includes realtor commissions and legal fees in addition to the purchase price

Installment Payments

includes both an amount that represents interest and an amount that represents a reduction of the outstanding balance

Raw Materials

includes the cost of components that will become part of the finished product but have not yet been used in production

internal vs External financing

internal refers to profits generated by the company. while external are funds coming from those outside of the company

Last in, First out (LIFO)

inventory costing method that assumes the last units purchased are the first ones sold. also called the income statement approach. companies use LIFO for reporting purchases calculate COGS and ending inventory only once per period--at the end

Specific identification method

inventory costing method that matches or identifies each unit of inventory with its actual cost. records actual inits sold. it may be too costly to know the specific unit cost for each individual sale. for this reason, this method is used primarily in companies with unique, expensive products with low sales volume

perpetual inventory system

inventory system that periodically adjusts for purchases and sales of inventory at the end of the reporting period based on physical count of inventory on hand. when companies purchase inventory using a perpetual inventory system, they increase the inventory account and either decrease cash or increase accounts payable. when companies sell inventory, they make 2 entries: they increase an asset account and increase sales revenue, and they increase CoGS and decrease inventory

What are investments

investments in stocks or bonds or another company; marketable securities

Debt investments

investments made in debt issued by another party

convertible bonds

investor can convert bonds to common stock

Market interest rate

is also know as the effective interest rate or yield rate. an implied rate based on the price investors are willing to pay to purchase a bond in return for the right to receive the face amount at maturity and periodic interest payments over the remaining life of the bond

Cost of Goods Sold (CoGS)

is driven by accounting assumptions, not by the actual outflow of goods sold. the major accounting assumptions include what exact costs to include and what method they use (LIFO, FIFO, AVG). Different companies include different things in their CoGS

Callable bonds

issuing company can pay off bonds early at a specific call price. allow the investor to convert each bond into a specific number of shares of common stock. set a higher price and require a lower interest rate than bonds without a conversion feature. a call feature is more common than a conversion feature

Non-depreciable asset

land does not depreciate over time, no limited useful life

Franchise

local outlets that pay for the exclusive right to use the franchisor company's name and to sell its products within a specified geographic are. restaurants, auto dealerships, and hotels are common Francises. many franchisors provide other benefits to the franchisee, such as participating in the construction of the retail outlet, training employees, and purchasing national advertising. to record the cost of a franchise, the franchisee records the initial fees as an intangible asset. additional periodic payments to the franchisor usually are for services the franchisor provides on a continuous base, and the franchisee will expense them as incurred

free on board destination

means ownership passes when the inventory reaches the buyer's destination

Free on board Shipping point

means ownership passes when the seller ships the item

Gross profit ratio

measure of the amount by which the sales of inventory exceeds its cost per dollar of sale =gross profit/net sales

Fair value method

method of recording equity investments when an investor has an insignificant influence. under this method, equity securities are reported in the balance sheet at their fair value, with changes from fair value

equity method

method of recording equity investments when an investor has significant influence over, yet does not control, the operations of the invested, often indicated by ownership from 20-50% of the voting shares

Long term liabilities

most are recorded on the BS at PV of future cash payments. after initial recognition, some are market to fair value on the balance sheet but most are held at amortized cost. greater than 12 months

intangible assets subject to amortization

most intangible assets have a finite useful life that we can estimate. the service life of an intangible asset usually us limited by legal, regulatory or contractual provisions. most companies use straight line amortization for intangibles

short term lease

not on the balance sheet. treat as a short term contract (like renting a car fo the weekend). simply debit expense and credit cash

Equity financing

obtaining investment from stockholders (stockholder's equity)

purchase returns

occasionally, a company will find inventory items to be unacceptable for some reason--prehaps they are damaged or are different from what they ordered. in this case, the company returns the items to the supplier and records the purchase return as a reduction in both inventory and accounts payable

Asset impairment

occurs when the future cash flows (future benefits) generated for a long term asset fall below its book value (cost - accumulated depreciation)

Consistency in reporting (Inventory Costing methods)

once a company chooses a method, it is not allowed to frequently change to another, however, a company need not use the same method for all its inventory

LIFO Layers

over time, the creation of LIFO layers can result in a substantial difference between the current market value (or replacement cost) of inventory and reported LIFO cost of inventory on the balance sheet. this difference is called the LIFO Reserve. For companies that have been using LIFO for years, there is always something that doesn't get accounted for

Significant influence

ownership between 20% and 50%. we use equity method as the reporting method

controlling influence

ownership between 50% and 100%. we use consolidated financial statements as the reporting method

depreciable asset

plant and equipment: depreciates over time and has a limited life. allocate the cost of the asset over its useful life

Manufacturing companies

produce the inventory they sell, rather than buying them from finished from suppliers. they buy the inputs and produce the goods

Amortization Schedule

provides a table format detailing the cash payment each period, the portion of each payment that represents interest and the change in carrying value, and the balance of the carrying value

retailers

purchase inventory from manufacturers or wholesalers and then sell this inventory to end users

Basket purchase

purchase of more than one asset at the same time for one purchase price. when you separate the items, separately summed together they are worth more than the basket. in this case you need to find the weights and multiply each weight by the basket price.

Capitalize

record an expenditure as an asset. most capitalized expenditures are expensed over time as the asset is used in company operations

Big bath

recording all losses in one year to make a bad deal even worse.

work in progress

refers to the products that have been started in the production process but are not yet complete at the end of the period. costs include raw materials, direct labor, indirect manufacturing costs called overhead

Wholesaler

resell inventory to retail companies or to professional users

Operating lease

resembles a rental agreement between the lessee and lessor. all leases that are not financing leases are, by default, operating leases

Financing lease

resembles the purchase of an asset with debt financing. must meet several criteria that make it feel more like buying than renting the asset

residual value

salvage value. the amount the company expects to receive from selling the asset at the end of its service life

recording depreciation requires accountants to establish 3 factors at the time the asset is put into use

service life residual value depreciation method

2 step impairment process

step 1: test for impairment. the long term asset is impaired if future cash flows are less than book value step 2: if impaired, we record the loss. the loss is calculated as the amount by which book value exceeds fair value. we record impairment loss as follows. debit to loss and credit to trademark

Fair Value

the amount for which the investment could be bought or sold in a current transaction between willing parties

Current portion of long term debt

the amount of the loan that will be settled within one year of the balance sheet date. if it is not settled within a year, it is classified as long term debt

interest paid vs interest expense

the bond agreement specifies that cash paid for interest will be the same every 6 months--the face value amount times the stated rate

equity investments with insignificant influence

the critical events over the life of an equity investment in another company, such as shares of common stock, include the following: -purchase the equity security: debit to investment and credit to cash -recieving dividends from some equity securities: debit to cash and credit to dividend revenue -holding the investment during periods in which the investment's fair value changes (unrealized holding gains and losses: debit unrealized holding loss--net income and credit to investments. the opposite for gains. the unrealized holding loss is reported in the current year's income statement when calculating net income -selling the investment (realized gains and losses): debit cash and loss (if any) and credit investments and gains (if any)

rising interest rates cause unrealized holding losses

the fair value of the bond has decreased, but that loss hasn't been realized, because the investment hasn't been sold

falling interest rates cause unrealized holding gains

the fair value of the bond has increased but that gain hasn't yet been realized, because the investment hasn't been sold

Equity Method

the investing company records the initial investment at cost. subsequent changes to the investment value are then recorded due to earnings of the invested company (which increases the investment) and dividends are paid by the invest company (which decreases the investment)

Pricing a bond

the issue price of a bond equals the present value of the bonds face amount plus the present value of its periodic interest payments to calculate, we need to know: the face amount of the bond, the interest payment each period based on the stated interest rate of the bond, the number of periods until the bond matures, and the market interest rate per period. if the market interest rate is not stated in the bond contract, it is implied to be the market rate

Early extinguishment of debt

the issuer retires debt before its scheduled maturity date

Bond retirement before maturity:

the issuing company can retire bonds early by purchasing them on the open market. this is called an early extinguishment of debt. debit bonds payable (account balance, premium on bonds payable, and loss (difference). credit cash (amount paid)

Land

the land account represents land a company is using in its operation. (in contrast, land purchases for investment purposes is recorded in a separate investment account). Capitalization costs include the purchase price of the land plus closing costs such as fees for attorney, real estate agent commission, title, title search and recording fees

Capital Structure

the mixture of liabilities and stockholders equity in a business

Inventory turnover ratio

the number of times a firm sells its average inventory balance during a reported period =CoGS/Average inventory

depreciation method

the pattern in which the asset's depreciable cost (original cost - residual value) is allocated over time

Current portion of long term debt

the portion of long term debt that is due within the next year

depreciation

the process of allocating the cost of a long term asset to expense over its useful life. refers to the allocation of the assets original cost to an expense during the periods benefited. depreciation does not refer to the change in value or selling price

stated interest rate

the rate specified in the bond contract used to calculate the cash payments for interest. interest expense is debited while cash is credited

Default risk

the risk that a company will be unable to pay the bonds face amount or interest payments as they become due. as the default risk of the bond increases, investors can increase their rate of return over the life of the bond by paying a lower price at the issue date

Who choose FIFO

-it has a balance sheet focus -better approximates actual CoGS for most companies, since most companies actual physical flows follows FIFO -during periods of rising costs, which is the case for most companies, FIFO results in higher ending inventory, lower cost of goods sold, and higher reported profits than does LIFO. -generally results in higher assets and higher net income when inventory costs are rising

Category 1 of impairment

-recoverability: the asset estimated undercounted future cash flows. the sum of all future cash flows without discounting 1) compute book value of the tangible/intangible asset 2) estimate undercounted sum of future cash flows the asset is expected to generate 3) if the sum of cash flows is greater than the book value, fo nothing. the asset is not impaired. 4) if the sum of cash flows is less than the book value, the asset is impaired and write the intangible asset down to its fair value

why do companies invest in other companies?

-to receive dividends, interest gains on investment -to temporarily invest cash -strategic purposes (alliances, M&A)

Double declining balance (4 step)

1) calculate the straight line rate 2) multiply the straight line rate by 2 3) multiply beginning book value by the DDB rate 4) stop depreciating when you hit the salvage value

Impairment test

1) estimate fair value of the reporting unit: fair value will always be given 2) estimate the fair value of the net assets on the books: net assets = total assets - Total liabilities 3) the difference between the fair value of the entity and the fair value of the net assets is the implied fair value of goodwill

Why do companies lease rather than buy

1) leasing reduces the upfront cash needed to use an asset 2) lease payments are often lower than installment payments 3) leasing offers flexibility and lower costs when dissing of an asset 4) leasing may offer protection agains the risk of dealing asset values

Categories of Impairment

1) long lived assets and finite life intangibles 2) indefinite life intangibles 3) Goodwill

Companies acquire assets in 2 ways

1) they purchase intangible assets like patents, copyrights, trademarks, or franchise rights from other companies 2) they develop intangible assets internally, for instance, by developing a new product or process and obtaining a protective patent

3 reasons for companies to invest in other companies

1) to receive dividends, earn interest, and gain from the increase in the value of their investment 2) to temporarily invest excess cash created by operating in seasonal industries 3) to build strategic alliances, increase market share, or enter new industries

Premium bond

A bond with an issue price that is above the face amount. coupon rate is greater than market rate. cash payment is greater than interest expense

Discounted bond

A bond's with an issue price that is below the face amount. coupon rate is less than the market rate. cash payment is less than interest rate

Bond

A formal debt instrument issued by a company to borrow money. the issuing company (borrower) is obligated to pay back to the investor (lender) 1: a stated amount, referred to as the principal or face amount, at a specified maturity date and 2: periodic interest payments over the life of the bond -traditionally paid 2x a year -for large corporations, bonds are sold, or underwritten by investment houses

Freight charges

A significant cost associated with inventory and most merchandising companies include freight charges. this includes the cost of shipments of inventory from suppliers, as well as the cost of shipment to customers. two categories: Free on board shipping point and free on board Destination

Trademarks

A word, slogan, or symbol that distinctively identifies a company, product, or service. lasts for a period of 10 years, which can be renewed for an infinite number of 10 year periods. since these items are so difficult to estimate, when a firm develops a trademark internally through advertising, it doesn't record the advertising cost as part of the intangible asset. instead, it expenses the advertising cost in the income statement

Copyrights

An exclusive right of protection to the creditor of a published work such as a song, full, painting, photograph, book, or computer software. they are protected by law and give creators (and heirs) the exclusive right to reproduce and sell the artistic or published work for the life of the creator plus 70 years. accounting for the cost of copyrights is virtually identical to that of patents

Report fair value in other comprehensive incomes

Available for sale securities: debt securities held for reasons other than attempting to profit from trading them in the near future

Bonds issued at a discount

Debit to cash amount received and the difference between the face value and the prices as discount on bonds payable. we then credit bonds payable to the face value amount

Goodwill impairment

Impairment test: 1) estimate the fair value of the reporting unit 2) estimate the fair value of the net assets on the books 3) the difference between the fair value of the entity and the fair value of the net assets is the implied fair value of goodwill... -now compare implied goodwill to actual goodwill. if implied is less than actual, the goodwill is impaired. write it down to its impaired value

Why should a company choose to borrow money rather than issue additional stock in the company?

Interest expense incurred when borrowing is a tax deductible, whereas dividends paid to stockholders are not tax deductible

First In, First Out (FIFO)

Inventory costing method that assumes the first units purchased are the first ones sold. also called balance sheet approach. assumes beginning inventory sales first, and going in order of earliest purchase

Equity investments

Investments made in the equity (or stock) issued by another party. the way we account for equity investments is determined by the degreee of influence an investor has over the company in which it invests. a guideline for determining the degree of influence is the percentage of stock held for investor

Inventory

Items a company intends for sale to customers in the ordinary course of business. Includes items that are not yet finished products. Inventory is a current asset and cost of goods sold is an expense

Company's 3 primary sources of long term debt financing

Notes leases bonds

Insignificant influence

Ownership between 0% and 20%. we use fair value method as the reporting method

3 categories of inventory for manufacturing companies

Raw Materials Work in progress finished goods

Private Placement

Sale of debt securities directly to a single investor.

4 methods for investors costing

Specific identification first in, first out last in, first out weighted average cost

Why Choose LIFO

The primary benefit of choosing LIFO is tax savings. results in lower amount of reported profits (when inventory costs are rising) which results in tax savings

Report fair value changes in net income

Trading securities: debt securities that an investor expects to sell in the near future. we report trading securities as current assets at their fair value, and any unrealized gains or losses are recognized in the income statement as part of the net income

sale of long term asset

the sale of long term assets typically involves a transaction in which cash is received for the asset given up. the difference between the cash received and the book value of the asset given up is reported as a gain or a loss in the income statement -debit to cash, accumulated depreciation, and loss if applicable. a credit to equipment and gains (if applicable) -the same occurs for retirement except there is no cash

Time value of money

the value of money today is greater than the value of the same amount in the future

bond retirement at maturity

their carrying value at maturity will equal their face value. debit to bonds payable and credit to cash for full par value

merchandising company

these companies do not manufacture their products. instead, they purchase complete units and sell those completed units. they serve as intermediaries in the process of moving inventory from the manufacturer to the end user

research and development costs

they are expensed as incurred. we expense in the income statement most of the costs for internally developed intangible assets in the period we incur those costs. Adverting costs are recorded as expenses and are reported in the income statement in the period incurred

Straight line depreciation

this method allocated an equal amount of depreciation to each year. the implication is that the asset is used evenly over its useful life. this method is by far the simplest and most common way

Activity based

this method calculates depreciation based on the activity associated with the asset. for example, a vehicle can be depreciated based on the miles driven, or a machine can be depreciated based on the hours used. the method is commonly used to allocate the cost of natural resources

Declining balance depreciation

this method is an accelerated method, meaning that the more depreciation expense is taken in earlier years than in the later years of an asset's life. declining balance methods are also used in calculating depreciation for tax purposes.

When companies invest in other companies

to finance growing operations, a company raises additional funds, either by issuing equity securities, such as common and preferred stock, or by increasing debt securities, such as bonds

Average Cost (AVCO)

total cost of units (beginning + purchases)/ total number of units (Beginning + purchases)

Service life

useful life. the estimated use the company expects to receive from the asset before disposing of it

intangible assets not subject to amortization

we do not amortize intangible assets with indefinite (unknown or not determinable) useful lives. an assets useful life is indefinite if there is no foreseeable limit on the period of time over which we expect it to contribute to the cash flows of the entity. goodwill is the most common intangible asset with an indefinite useful life. management must review long term assets for potential write down when events or changes in circumstances indicate the assets recoverable amount is less than its recorded amount in the accounting records

How to record PPE

we record long term assets as its cost plus all expenditures necessary to get the asset ready to use

Hoe to record the purchase of intangible assets

we record purchased intangible assets at their original cost plus all other costs, such as legal fees necessary to get the asset ready to use

Why buy back debt early

when interest rates decrease, companies with a call feature are more likely to repurchase higher cost debt and then reissue debt at a new lower interest rate. this type of buyback and resistance lowers future interest expense. another reason is to improve the company's debt ratio. can also be timed to manage reported earnings

Retirement of bonds

when the issuing company buys back its bonds from the investors, we say that the company has retired those bonds. this occurs at maturity and sometimes before