Accounting 211

Future Value Factor

(1 + i)^n

Price Index

(Ending inventory at current cost) / (ending inventory at base-year cost)

Free Cash Flow

(Net cash provided by operating activities) - (capital expenditure) - (cash dividends)

Acid-Test Ratio

(cash + short-term investments + accounts receivables) / current liabilities

Emerging Issues Task Force (EITF)

-"Problem filter" for the FASB -Provides implementation guidance within the framework of the Codification to reduce diversity in practice on a timely basis -Identifies controversial accounting problems as they arise

Sum-of-the-years'-digit

-(Cost - Salvage value) * a fraction -Fraction is (number of years remaining in the asset's life at the beginning of the period) / (sum of the years in the life) -Decreasing depreciation charge based on a decreasing fraction of depreciable cost -Year 1 is the first year the machine is in operation

Current Cash Debt Coverage

-(Net cash provided by operating activities)/ (average current liabilities) -Shows liquidity

Cash Debt Coverage

-(Net cash provided by operating activities)/ (average total liabilities) -Shows financial flexibility

Post-Closing Trial Balance

-A list of permanent accounts and their balances after closing entries -Shows that the company is moving into the next accounting period with debit balances equaling credit balances for the permanent accounts -Only contains balance sheet accounts

Contra-Asset Account

-Account that is offset against an asset account on the balance sheet -Normally shows a credit balance -Ex: accumulated depreciation

Accrued Expenses

-Accrual -Expenses incurred but not yet paid in cash or recorded -Interest, taxes, utilities, salaries -To adjust, debit an expense and credit a liability -Without adjustment, liabilities and expense is understated while net income and stockholders' equity are overstated

Accrued Revenues

-Accrual -Revenues for services performed but not yet received in cash or recorded -To adjust, debit an asset and credit a revenue -Without adjustment, assets, stockholders' equity, revenue, and net income are understated

Non GAAP EPS

-Adjusted EPS -Doesnt subtract things like infrequent loss -Allowed more now but must present GAAP first

Lump Sum Price

-Allocated to units on the basis of their relative sales values -Examples includes the petroleum industry

Intraperiod Tax Allocation

-Allocation within the income statement of a period -Resulting income tax effect should be directly associated with that event or item -Used for income before income tax and discontinued operations

Perpetual System

-Always know the amount of inventory -Still count for shrinkage -Purchases and sales are recorded in the Inventory account when they occur -Purchases, purchase discount, purchase returns and allowances, and freight-in are recorded in the Inventory account -At time of sale, debit COGS and credit Inventory

Limited Life Intangibles

-Amortized over its useful life on a straight line basis (due to conservatism) -Amortizable base is equal to cost minus residual value -Residual value is assumed to be zero unless the intangible has value to another entity at the end of its useful life or legal life, whichever is shorter -Should still be evaluated for impairment on a regular basis

Designated Market Value

-Amount the company compares to cost for LCM -Always the middle value of 3 amounts: replacement cost, NRV, and NRV less a normal profit margin

Allowance Method

-An estimate of the expected uncollectibles is made from sales on account or total outstanding receivables at the end of each period -Percentage of sales (income statement) approach: bad debt expense is a percent of credit sales -Percentage of receivables (balance sheet) approach: use a composite rate for all receivables or an aging schedule. The current balance of allowance for doubtful accounts cannot be ignored!. Receivables are cumulated (subtract beginning ADA so you're only looking at this year) -Recovery of bad debt: reverse the write off entry and journalize the collection. only affects balance sheet accounts

Lower of Cost or Market (LCM)

-An exception to the LCNRV approach for companies using the LIFO or retail inventory methods (lowest you can go for LCNRV is the ceiling for LCM. LCM gives lower inventory so lower taxes) -a. Value inventory at the lower of cost or market (replacement cost) -b. The market value (replacement cost) must lie between a ceiling amount and a floor amount -NRV = ceiling -NRV less a normal profit margin = floor -Rationale of establishing limits: not to over- or under-estimate inventory -To apply LCM, choose the lower of cost or designated market cost -LCM may be applied to each inventory item, to each inventory category, or to total inventory -Usually applied at the inventory item level (because it is required by taxes) -Whatever method is applied, should be used consistently

Account

-An individual accounting record of increases and decreases in a specific asset, liability, stockholders' equity, revenue, or expense -Consists of title of account, left debit side, right credit side -Referred to as a T-account

Committee on Accounting Procedure (CAP)

-Appointed by the AICPA -Composed of practicing CPAs -Issued 51 accounting research bulletins -Didn't provide needed structure

Retail Inventory Method

-Appropriate for retail concerns with high volume sales and different types of merchandise -Acceptable for financial reporting -This method assumes observable patterns between costs and prices -Goods available for sale at retail minus sales equals ending inventory at retail -Ending inventory at retail * ratio of cost to retail equals ending inventory at cost -Retailer must keep record of (1) total cost and retail value of goods purchased, (2) total cost and retail value of goods available for sale, and (3) the sales for the period -Has an averaging effect on varying rates of gross profit

Premiums and Coupons

-Are made to stimulate sales -Their costs should be charged to expense in the period of the sale

Copyright

-Artistic related intangible asset -Granted for the life of the creator plus 70 years -Copyrights can be sold or assigned, but cannot be renewed -Useful life is usually shorter than legal life so cost of copyright should be allocated to the years in which the benefits are expected to be received -Costs of acquiring copyrights are capitalized -Research and development costs involved are expensed as incurred

Environmental Liabilities

-Asset retirement obligation (ARO) should be recorded at fair value -Restoration, decommissioning, and closure -Companies should not record the capitalized asset retirement costs in a separate account because there is no future economic benefit that can be associated with these costs alone

Self Constructed Assets

-Assets constructed by the business for use in operations -Either assign no fixed overhead to the cost of the constructed asset OR assign a portion of all overhead to the construction process (full costing approach) Cost of Self-Constructed Asset includes: -Cost of direct materials -Cost of direct labor -Variable manufacturing overhead -A pro rata portion of the fixed overhead -Interest costs incurred during construction (with modification): capitalized and added to PPE

Qualifying Assets

-Assets must require a period of time to get them ready for their intended use -Two types of qualifying assets: 1. Assets under construction for use in operations 2. Discrete assets intended for sale and lease

Activity Method

-Assumes that depreciation is a function of use or productivity, instead of the passage of time -Company considers the life of the asset in terms of either the output it provides or an input number such as the number of hours it works -(Cost less salvage value / total units) * units produced

Inventory Valuation

-Beginning inventory + net purchases+ freight in =cost goods available for sale -Cost of goods available for sale - ending inventory =cost of goods sold -Must determine the physical goods to be included in inventory (ownership), the costs to be included in inventory (cost), and the cost flow assumption to be adopted (FIFO, LIFO, Average)

Markdown

-Below original sales price -Happens because of special sales, damaged goods, overstocking, and competition

Year

-Calendar year -52/53 week year (weekends matter)

Specific Identification

-Calls for identifying each item sold and each item in inventory -Cost flow matches the physical flow of the goods

Current Assets

-Cash and other assets a company expects to convert into cash or use to pay a current liability within a year or the current operating cycle, whichever is longer -Presented on the balance sheet in the order of liquidity: 1. Cash 2. Short Term investments 3. Receivables 4. Inventories 5. Prepaid Expenses

Changes in Accounting Principles

-Change from one GAAP to another -Ex: change in method of inventory pricing -Company makes a retrospective adjustment to the financial statements to maintain consistency (record the cumulative effect by adjusting the beginning retained earnings of the earliest year presented)

Comprehensive Income

-Changes in equity from non owner source -Net income + other comprehensive income

Generally Accepted Accounting Principles (GAAP)

-Common set of standards and procedures -Contributes to the comparability of accounting information -Dependent on the Securities and Exchange Commission (SEC), American Institute of Certified Public Accountants (AICPA), and Financial Accounting Standards Board (FASB) -Composed of over 2,000 documents

Stockholders' Equity

-Common stock is affected when the company issues new shares of stock in exchange for cash -Retained earnings is affected when the company recognizes revenue, incurs expenses, or pays dividends

Entity Perspective

-Companies are viewed as separate and distinct from their owners -The opposite (proprietary perspective) is not considered appropriate

Disposition of Receivables

-Companies may transfer receivables to other companies in order to get cash now -Sales financing for customers or because money is tight and access to normal credit is unavailable -Two ways to transfer receivables: sale of receivables and secured borrowing

LIFO Reserve

-Companies may use LIFO for reporting and tax purposes, but use a different method for internal purposes -The difference (of ending inventory and COGS) between internal reporting method and LIFO is called "Allowance to Reduce Inventory to LIFO" or the "LIFO Reserve" -Change in LIFO reserve between periods is called the "LIFO effect" -In inflation period, debit COGS and credit Allowance to Reduce Inventory to LIFO

Cash-Basis Accounting

-Companies record revenue at the time they receive cash. They record an expense at the time they pay out cash -Often produces misleading financial statements -Not in accordance with GAAP

Discontinued Operation

-Company discontinues a major line of business, geographical area, or equity method investment (not just a brand) -When recording, distinguish between the segment's results of operations (before you found a buyer) and the disposal of the segment's assets (sell for gain or loss) -Report net of tax -Report income from continuing operations above and net income below

Effective-Interest Method

-Company issuing the bond computes bond interest expense by multiplying the carrying value at the beginning of the period by the effective interest rate -Company determines bond discount or premium amortization by comparing bond interest expense with interest to be paid -Produces a periodic interest expense equal to a constant percentage of the carrying value of the bonds

Compound Interest

-Computes interest on principal and interest earned that has not been paid or withdrawn -Typical interest computation applied in business situations -Return on the principal for two or more time periods -Computes interest on principal and interest earned to date -Uses the accumulated balance at each year-end to commute interest in the succeeding year -Compound is always larger than simple

Straight Line Method

-Considers depreciation as a function of time rather than a function of usage -Simple and conceptually appropriate -Cost less salvage value / useful life -Distorts rate of return

Supplemental Balance Sheet Information

-Contingencies: material events (such as lawsuits) that have an uncertain outcome (record on balance sheet if it is probable and reasonably estimated, otherwise make a note) -Accounting Policies: explanations of valuation methods and basic assumptions -Contractual situations: explanations of restrictions or covenants attached to specific assets or liabilities -Fair Values: How did you come up with the estimate (3 levels)

Presentation of Intangibles

-Contra accounts are not normally shown -On the balance sheet, companies should report as a separate item all intangible assets other than goodwill -On income statement, amortization expense and impairment losses for all intangible assets other than goodwill should be presented as part of income from continuing operations -Unless goodwill impairment loss is associated with discounted operations, it should also be reported as part of continuing operations

Sales Discounts

-Contra revenue account -Cash discounts to encourage early payments -ex: 2/10, n/60 -Two methods to record sales discounts: 1. Gross method (assumes people won't take discount. preferred by managers): Record sales at gross amount, record discount at time of cash receipt if applicable, sales discount is a deduction from sales on income statement 2. Net method (assumes people will take discount. preferred theoretically because its more conservative): record sales at amount net of discount, if payment is received after discount date then debit AR and credit Sales Discounts Forfeited, Sales Discount Forfeited is other revenue on income statement

Franchise and Licenses

-Contract related intangible asset -Contractual agreement under which the franchisor grants the franchisee certain rights -The cost of franchise or license with limited life should be amortized over the life of the contract -A Franchise may be for a limited time, for an indefinite time period, or perpetual -The cost of a franchise (for a limited time) is amortized as on operating expense over the franchise term -A franchise (for an unlimited time) is carried at cost and not amortized -Annual payments for a franchise are expensed -One time fee then pay a percentage of revenues annually

Cost of Buildings

-Cost of materials, labor, and overhead -Professional fees and building permits

Product Costs

-Costs that attach to the inventory -Costs recorded in the inventory account: freight-in, cost of goods purchased, production costs incurred

Restricted Cash

-Current asset or long term asset depending on the date of availability or disbursement -Compensating balances: minimum cash balances in checking or saving accounts that banks and other lending institutions require customers to maintain (restricted amount of cash) -Compensating balances on short term borrowings: classified as current asset (cash and cash equivalents) -Compensating balances on long term borrowings: classified as non current asset (investments or other assets) -Other types of restricted cash: Payroll funds, dividend funds, and cash set aside for particular purposes

Working Capital

-Current assets - current liabilities -Mature companies have more capacity to borrow so sometimes maintain negative working capital

Current Ratio

-Current assets / current liabilities -Higher number is better -Liquidity

Operating Activities

-Current assets and current liabilities -Involve the cash effects of transactions that enter into the determination of net income -Add depreciation and amortization, subtract change in current assets, add change in current liabilities -Subtract gain in PPE because it should be in investing activities, not operating activities

Income Tax Payable

-Current liability -Only apply to corporations

Sales Taxes Payable

-Current liability for retailers -Debit cash or Accounts receivable, credit sales tax payable and sales revenue

Loss Method

-Debits "Loss due to market decline of inventory" for the write down of inventory to NRV, credits inventory or allowance to reduce inventory to market value -Benefits of loss method is that there is no distortion of COGS because the loss account is used

Cost of Goods Sold Method

-Debits COGS for the write down of inventory to NRV, credits inventory or allowance to reduce inventory to market -Dont report a loss on the income statement because COGS already includes the amount of the loss

Debt to Equity Ratio

-Debt / equity -Lower number is better -Solvency

Cash Dividends Payable

-Declared but not yet paid -Does not include dividends in arrears because they have not been declared (just disclosed in a note) -Debit retained earnings, credit dividends payable

Markup Cancelation

-Decreases in prices of merchandise that the retailer had marked up -Price of merchandise falls back to original retail price -Cant exceed original markup

Expenses

-Decreases stockholders' equity -Appear on income statement -Relates to major business activity -Transferred to retained earnings at the end of the period -Normally shows debit balance

Unearned Revenues

-Deferral -Cash received before services are performed -Rent, magazine subscriptions, customer deposits -To adjust, debit a liability account and credit a revenue account -Without adjustment, liabilities are overstated while revenues, net income, and stockholders' equity are understated

Prepaid Expenses

-Deferral -Expenses paid in cash before they are used or consumed -Insurance, supplies, advertising, rent -Costs that expire with the passage of time (rent/insurance), or through use (supplies) -To adjust, debit an expense and credit an asset -Without adjustment, expense is understated while net income, assets, and stockholders' equity are overstated

Diluted EPS

-Denominator includes stock options, convertible bonds, etc. -"worst scenario" if everyone converts

Revision of Depreciation Estimates

-Determination of depreciation requires initial estimates (useful life, salvage value, etc) -When these estimates are revised, depreciation must be recomputed -These revised depreciation expenses apply prospectively to the remaining life of the asset -These changes do not affect prior periods - (Current BV - New salvage value) / remaining useful life

Securities and Exchange Commission (SEC)

-Develops and standardizes financial information presented to stockholders -Administers the Securities Exchange Act of 1934 -Relies on the FASB to develop accounting standards -Enforcement -Government agency

Trade Discounts

-Discounts for quantity purchased -Deducted from list price and bill the customer the net amount -Discount goes directly to sales

Dividend

-Distribution by a corporation to its stockholders -Most common form is a cash dividend -Reduces stockholders' equity -Appears on retained earnings statement -Transferred to retained earnings at the end of the period -Normally shows debit balance -If you don't have retained earnings, you can still pay using additional payed in capital in some states

Impairment of Indefinite Life Intangibles

-Doesn't include goodwill -One step test (fair value test) at least annually -Loss = carrying amount - FV

Accounting Transactions

-Economic events that require recording in the financial statements -Exchange of assets, liabilities, and stockholders equity

Unusual or Infrequent Gains and Losses

-Either infrequent or unusual -Reported in the other revenues and gains (or other expenses and losses) section just above income from operation before income tax- cannot be shown net of tax -Ex: strike, natural disaster, sale of investment

Ending Inventory Understated

-Ending inventory: understated -COGS: overstated -Net Income: understated -Retained earnings: understated -Working capital: understated -Current ratio: understated -If ending inventory is overstated, the effects change to the opposite

Adjusting Entries

-Ensure that the revenue recognition and expense recognition principles are followed -Required every time a company prepares financial statements -Includes one income statement account and one balance sheet account -Classified as deferrals and accruals

LIFO Liquidation

-Erosion of LIFO inventory -LIFO layers increase in inventory balance from period to period -When price increases, inventory is liquidated. This means preceding period costs are matched with current revenues -Results in lower COGS, higher net income, and higher taxes -To alleviate the problem, use a specific goods pooled approach where items are grouped together when similar in nature. LIFO liquidation is less likely to happen because the reduction of one quantity in the pool may be offset by an increase in another

Conceptual Framework

-Establishes the concepts that underlie financial reporting -Coherent system of concepts that flow from an objective

Present Value

-Estimate of fair value -Applications: Notes, leases, pensions, long-term assets, stock-based compensation, business combinations, disclosures, and environmental liabilities -Amount needed to invest now, to produce a known future value -Always smaller than the known future value, due to earned and accumulated interest

Source Document

-Evidence of a transaction -Sales slip, check, bill, etc

Trademarks/Trade Names

-Ex: Nike swoosh -Marketing related intangible asset -Are renewable indefinitely by the original user in periods of 10 years each -Unlimited legal protection, therefore not amortized -Costs of acquired trademarks or trade names are capitalized -If trademarks or trade names are developed by a business, all direct costs (except R&D costs) are capitalized -If company doesn't plan to renew, they can start to amortize

Gain Contingencies

-Examples are pending litigation whose probable outcome is favorable, possible tax refunds in tax disputes, etc -Not recorded, only disclosed when probability is high

Sales of Receivables

-Factoring: A company sells receivable to a factor who will directly collect the money from customers (associated with textiles, apparel, furniture, etc) -Securitization: Takes a pool of receivables and sells shares in these pools of interest and principal payments; the seller still collects the receivables -In either type of sales, receivables are sold on either a with or without recourse basis -Sale without recourse: purchaser assumes the risk and absorbs any credit loses (transfer both title and control) -Sale with recourse: seller guarantees payment to purchaser if debtor fails to pay. Record Recourse Liability (liability) at fair value on date of sales (this increases loss on sale)

Bargain Purchase

-Fair value of assets acquired > purchase price -FASB requires the excess be recognized as a gain by the purchaser -Negative goodwill: company is in financial distress so can be bought for less than fair value

First in, First Out

-First goods purchased are the first used -In all cases where FIFO is used, the inventory and COGS would be the same at the end of the month whether a perpetual or periodic system is used

Objective of Financial Reporting

-First level -Provides information about the reporting entity that is useful to present and potential equity investors, lenders, and other creditors (external users) in decisions about providing resources to the entity

Petty Cash

-For daily operations -Money in cash register

Managerial Accounting

-For internal managers -Doesn't follow a standard (just rules of thumb) -No set financial reporting period

Valuation at Net Realizable Value

-GAAP permits companies to record inventory at NRV even if it is above the cost when 1. There is a controlled market with quoted prices available 2. No significant cost of disposal 3. Product ready for immediate delivery -Examples include mining, agriculture, and meat packing industries

Partial Year Depreciation

-Generally, depreciation is computed on the number of months an asset is used during the accounting period -To determine the depreciation for partial period 1. Determine the depreciation expenses for the full year 2. Then prorate the expense

Allocation of Depletion Base

-Generally, the activity method is used: (Cost - Estimated Salvage value) / total estimated units available = unit depletion -To record total depletion for the year: debit inventory and credit accumulated depletion -To record cost of material sold during the year: debit COGS and credit inventory

Purchase Commitments

-Generally, the seller retains title to the merchandise or materials covered in the purchase commitments -If contract price is greater than market price and buyer expects losses to occur, buyer should recognize losses in period during which such declines in market prices take place -Reporting the decline in market price is debatable because no assets are recorded -Don't record gain until it is realized due to conservatism

Financial Accounting Standards Board (FASB)

-Goal is to establish and improve standards of financial accounting and reporting for the guidance and education of the public -Responsive to the needs of the entire economic community -Operates with "due process" in the full view of the public -Their Accounting Standards Updates are considered GAAP -Main standard setting body -Private

FOB Shipping Point

-Goods in transit owned by buyer -Seller's responsibility stops at shipping point -Buyer records a debit to merchandise inventory and a credit to cash (or accounts payable)

FOB Destination

-Goods in transit owned by seller -Seller's responsibility stops at destination -Seller records a debit to delivery expense and a credit to cash (or accounts payable)

Aging

-Group receivables by their age -Further past due is more likely to be uncollectible

Decreasing Charge Method

-Higher depreciation cost in the earlier years and lower charges in later periods -Accelerated depreciation

Costs Subsequent to Acquisition

-If costs incurred increase future benefits, capitalize costs -Future benefits increase if one of the following three conditions exists: 1. Increase useful life 2. Increase production output 3. Increase production quality -If costs maintain a given level of services, expense costs -Costs incurred after acquisition can be classified as additions, improvements and replacements, rearrangements and reinstallation, or repairs

Service Type Warranty

-If warranty is sold separately, the warranty revenue is unearned until the end of the warranty period -Debit cash, credit sales and unearned revenue -When company performs warranty services, debit warranty liability and credit cash, inventory, or wages payable. Also, debit unearned revenue and credit warranty revenue

Impairments

-If you don't check for impairments, income is overstated -Occurs when the carrying amount of an asset is not recoverable. The asset needs to be written off -Fair value of asset is objective but how the company can use it is subjective -To determine if impairment has occurred, use Recoverability test 1. Estimate future net cash flows from the use of the asset and its eventual disposition 2. If it is less than the carrying amount, an impairment has occurred

Changes in Estimates

-In the accounting process, estimates are made for useful lives, salvage values, uncollectible receivables, etc -Not handled retroactively -Not considered errors (prior period adjustments) -Affects only the period of change

Property, Plant, and Equipment

-Includes land, building, structures, equipment, machinery, furniture, and tools -Used in operations and not for resale -Long term in nature so subject to depreciation -Land is not depreciable -Tangible -Initially valued at historical cost (price of obtaining the asset and the cost of readying the asset for its intended use) -Costs incurred after acquisition are added to the historical cost if they provide future service potential (otherwise expensed immediately)

Revenue

-Increases stockholders' equity -Appears on income statement -Relates to major business activity -Transferred to retained earnings at the end of the period -Normally shows credit balance

Period Costs

-Indirectly related to the acquisition or production of goods -Selling expenses and general and administrative expenses: not part of inventory costs -Interest costs that are routine are expensed as incurred -Interest costs for assets for internal use or discrete projects for sale/lease should be capitalized

Simple Interest

-Interest computed on the principal only -Return on principal for one time period -Interest = principal * interest rate for single period * number of periods

Short Term Investments

-Investment in other company's debt or equity securities -Based on management's intention 1. Held to maturity: debt securities that a company has the positive intent and ability to hold to maturity (amortized cost) 2. Trading: debt securities bought and held primarily for sale in the near term to generate income on short-term price differences 3. Available for Sale: debt securities not classified as held to maturity or trading securities (fair value) -Trading is current, the others depend on maturity date

International Financial Reporting Standards (IFRS)

-Issued by the International Accounting Standards Board (IASB) -Similar to GAAP but trying to fully converge

Common Stock

-Issued to investors in exchange for stockholders' investment -Appears on stockholders' equity section of balance sheet -Normally shows credit balance

Intangible Assets

-Lack physical substance -Not financial instruments -Long term in nature so need amortization (usually straight line) -Patents, copyright, franchise, goodwill, etc

Assets Held for Disposal

-Like inventory -Reported at LCNRV 1. Impairment loss = carrying amount - fair value + disposal cost 2. No depreciation taken 3. Restoration of impairment loss permitted

Trial Balance

-Lists accounts and their balances at a given time -Usually prepared at the end of an accounting period -Accounts are listed in the order in which they appear in the ledger -Proves the mathematical equality of debits and credits after posting -Doesn't guarantee accuracy (can double state or omit) -Order: assets, liabilities, stockholders' equity, revenues, expenses

Financing Activities

-Long-term debt and owners equity items -Includes obtaining resources from owners and providing them with a return on their investment, and borrowing money from creditors and repaying the amounts borrowed

LCNRV

-Lower of cost or NRV is an exception to the historical cost principle -A company abandons the historical cost principle when the future utility (revenue-producing ability) of the asset drops below its original cost -LCNRV may be applied to each inventory item, to each inventory category, or to total inventory -Usually applied at the inventory item level (because its required by taxes) -Whatever method is applied, should be used consistently -In Income Statement, report a "Loss due to Decline of Inventory to NRV"

Conventional Retail Inventory Methods

-Lower of cost or market approach only considers markups -Cost method considers markdowns as well

Net Markups

-Markup - markup cancellation -Dont include net markdown in ratio so that ratio is smaller

Last in, First Out

-Matches the cost of the last goods purchased against revenue -The periodic system assumes the cost of the total quantity sold or issued during the month comes from the most recent purchases -Under the perpetual system there is a different ending inventory and cost of goods sold amounts than the amounts calculated under the periodic method -Only used in the US (companies lobbied for it to save taxes)

Expense Recognition Principle

-Matching principle -Expenses follow revenues -Efforts (expenses) must be matched with accomplishment (revenues) -Recognize the expense in the same period as the revenue it helped generate

Correction of Errors

-Mathematical mistakes, oversight, misuse, etc -Prior years mistake uncovered this year -Treated as prior period adjustments (adjustment to beginning balance of retained earnings) -Net of tax

Accounting Principles Board (APB)

-Meant to advance the written expression of accounting principles, determine appropriate practices, and narrow the areas of difference and inconsistency in practice -Made announcements call APB Opinions -Replaced by FASB after Wheat Committee

Inventory Turnover

-Measures the number of times on average a company sells the inventory during the period -Measure of liquidity - COGS / Average inventory on hand during the period

Internally Created Intangibles

-Most costs are expensed as incurred -Only direct costs are capitalized (usually legal costs)

Cash

-Most liquid asset -Standard medium of exchange and the basis of measuring and accounting for all other items -Must be readily available for payment of obligations and free from contractual restrictions -Currency, money orders, personal checks, cashier's checks, certified checks, savings accounts, and petty cash and change funds -Does not include postdated checks, IOUs, travel advances, stamps on hand, money market funds, and CDs -Special issues in reporting cash: cash equivalents, restricted cash, and bank overdrafts

Earnings Per Share (EPS)

-Net income minus preferred dividends (income available to common stockholders) divided by the weighted average of common shares outstanding -How much earnings per common stock share -Must be disclosed on the face of the income statement -Show EPS for income from continuing operations, discontinued operations, and net income

Retained Earnings

-Net income that is retained in business -Accumulates from the profitable operation of a company -Dividends, revenues, and expenses -Appears on stockholders' equity section of balance sheet -Normally shows credit balance -May be restricted (by gov. or debt holders) due to contractual requirements, board policies, etc.These restricted retained earnings can be transferred to the Appropriated Retained Earnings account

Direct Write Off Method

-No entry is made until a specific account is established as uncollectible -Not GAAP -Doesnt use estimates -Because this method does not follow the matching principle and does not result in receivables being reported at NRV, it should not be used except for immaterial amounts

Indefinite Life Intangibles

-No foreseeable limit on useful life -Do not Amortize -Test for impairment at least annually

Temporary Accounts

-Nominal accounts -Relate only to a given accounting period -Revenues, expenses, and dividends

Other Comprehensive Income

-Non-owner changes in equity that bypass the income statement -Very volatile -Displayed as a separate statement of comprehensive income (two statement approach) OR as a combined income statement and comprehensive income statement (one statement approach) 1. Unrealized gain or loss in available for sale debt investment 2. Translation gain or loss on foreign currency 3. Unrealized gain or loss on certain hedging transactions 4. Adjustments related to pensions

Investing Activities

-Noncurrent assets (Long term investments, PPE, intangibles) -Includes making and collecting loans and acquiring and disposing of investments and PPE

Sales with High Rates of Return

-Normally recorded as a sale -Only partial control has transferred -Company should establish an Estimated Inventory Return account to recognize future returns -Only recognize the percentage actually sold. If you can't predict returns, don't consider it sold until refund period ends

Liabilities

-Normally show credit balances -Probable future sacrifices of economic benefits

Assets

-Normally show debit balances -Probable future economic benefits

Non Current Assets

-Not based on liquidity 1. Long term investments 2. Plant, property, and Equipment 3. Intangible Assets 4. Other Assets

Inventories

-Not depreciated because it is for resale rather than use. However, inventory value can still go down (becomes outdated so write off: conservatism) -Assets for sale in ordinary course of business -Goods that will be used or consumed in the production of goods to be sold -The basis of valuation and the method of pricing (LIFO, FIFO, Average) are disclosed -Manufacturing: raw material, work in progress, and finished goods -Merchandise inventory -Other inventory (packaging supplies, factory supplies, etc) -Accounted for at cost

Self Insurance

-Not insurance but risk assumption -Even though amount of losses can be estimated, the losses are not liabilities because they result from a future event, not a past event -No transaction took place

Current Liabilities

-Not reported in any particular order -Due within one year or the operating cycle, whichever is longer -Expected to use resources currently classified as current assets or the creation of other current liabilities -Working capital -Accounts payable, wages payable, taxes payable, unearned revenue, etc

Long Term Liabilities

-Obligations that a company does not reasonably expect to liquidate within the operating cycle -Bonds payable, notes payable, pension obligations, etc

Bank Overdrafts

-Occur when a company writes a check for more than the amount in its cash account -Should be reported as current liabilities (added to the amount reported as accounts payable) -Usually not offset against cash account unless cash is available in another account at the same bank

Markdown Cancellation

-Occurs when markdowns are later offset by increases in the prices of goods that the retailer had marked down -Cant exceed original markdown

Goodwill

-Only arises in merger and acquisition (otherwise too subjective) -Paying for brand name, synergy, and future earning potential of another company -Do not capitalize internally generated goodwill -Record goodwill only when an entire business is purchased -Goodwill is the excess of cost over fair value of acquired identifiable net assets (master valuation approach) -Record purchase of company using fair value of assets and liability acquired -Goodwill is considered an indefinite-life intangible, therefore should not be amortized (due to going concern assumption) -Only charged when it is impaired -Risk associated with goodwill: can't be sold or converted to cash -If goodwill is larger than market value, a financial crisis could lead to huge impairment

Accounts Receivable

-Oral promises of the purchaser to pay for goods and services sold -Normally collected within 30 to 60 days

Repairs

-Ordinary: expense cost of repairs when incurred -Extraordinary: as appropriate, treat as an addition, improvement, or replacement

Trade Receivables

-Owed by customers for goods and services -May be sub classified into accounts receivable and notes receivable

Disclosure Methods

-Parenthetical Explanations: in body of statement -Notes -Cross-Reference and Contra Items -Supporting Schedules (depreciation and aging) -Terminology

Sarbanes-Oxley Act

-Passed in response to a string of accounting scandals -Increased resources for SEC to combat fraud -Established the Public Company Accounting Oversight Board (PCAOB) -Public companies must attest to the effectiveness of their internal controls

Interest

-Payment for the use of money -Excess cash received or paid over the amount lent or borrowed (principal) -Interest rate is partially determined by level of credit risk -Pay more interest if (1) principal is large, (2) interest rate is high, or (3) time period is long

Employee Related Liabilities

-Payroll deductions (taxes, insurance premiums, union dues, etc) -Compensated absence (vacation, sick, holidays, etc) -Bonuses

Useful life

-Period of service -May differ from physical life -Retire assets due to inadequacy, supersession, or obsolescence

Receivables

-Presented at net realizable value (account receivable - allowance for doubtful accounts) -Claims held against others for goods, money, or services -Current or noncurrent -Trade or non trade

Land Improvements

-Private driveway, parking lot, etc -depreciated

Posting

-Procedure of transferring journal entry amounts to ledger accounts -Accumulates the effects of journalized transactions in the individual accounts

Depreciation

-Process of allocating the cost of an asset to expense over its useful life -Allocation concept, not valuation concept. Does not attempt to report the actual change in the value of an asset -Cost - accumulated depreciation = book value -Involves allocating the cost of tangible assets to expense in a systematic and rational manner to periods expected to benefit from use of its depreciable assets -No cash outflow

Warranty

-Product guarantee -Promise made by a seller to a buyer to make good on a deficiency of quantity, quality, or performance in a product -Assurance type warranty or service type warranty

Modified Perpetual Inventory System

-Provides detailed inventory records of increases and decreases in quantities only, not dollar amounts -Outside double entry system

Cost of Land

-Purchase price -Closing costs, attorney fees, and recording fees -Costs of getting land ready for use (clearing, etc) -Special assessments for local improvements -Assumption of liens, mortgages, or encumbrances -Additional improvements with an indefinite life -Sale of salvaged materials reduces cost -Improvements with limited lives are recorded as Land Improvements

Cost of Equipment

-Purchase price -Freight and handling charges -Insurance while in transit -Costs of special foundation, installation, and initial testing

Purchases not Recorded

-Purchases: understated -Ending inventory: understated -COGS: no effect -Net income: no effect -Retained Earnings: no effect -Accounts payable: understated -Working capital: no effect -Current ratio: depends (but usually overstated)

Statement of Cash Flows

-Purpose is to provide relevant information about the cash receipts and cash payments of a company during a period -Classifies cash flows into three different activities: operating, financing, and investing -Helps users evaluate liquidity, solvency, and financial flexibility -Non cash transactions

Assurance Type Warranty

-Quality guarantee -Expensed in the period the goods are provided or services are performed (matching principle) -Adjusting entry: debit warranty expense and credit warranty liability -Next year: debit warranty liability, credit cash, inventory, or wages payable -Can reverse later if you overestimated

Periodic System

-Quantity of inventory on hand is determined periodically -Purchases recorded in Purchases account -COGS determined by physical inventory count at the end of the period

R&D Costs

-R&D costs involve searching for new products and processes -R&D costs are expensed unless the costs have alternative future uses -Research: Lab costs aimed at new knowledge. Expensed -Development: Conceptual Formulation of possible product. Expensed -Raw materials for testing and equipment. Capitalized

Permanent Accounts

-Real accounts -Balance are carried forward into future accounting periods -Assets, liabilities, and stockholders' equity

Disposition of Plant Assets

-Record depreciation to date -Debit cash and accumulated depreciation, credit asset and gain -For involuntary conversion: Reported as other revenue and gains or other expenses and losses on income statement. Entry is the same as sales or disposals (use sales entry if cash settlement is received

Purchased Intangibles

-Recorded at cost -Cost is the purchase price plus all expenditures necessary to get the asset ready for its intended use -If received in exchange for stock or other assets use FMV of considerations given up or intangible received, whichever is more clearly evident

Impairment of Limited Life Intangibles

-Recoverability test: recognize impairment when carrying amount of the asset exceeds the sum of expected future cash flows (undiscounted) -Fair value test: impairment loss is measured as the amount by which carrying value > fair value of the asset -Cannot restore impairment losses for assets held for use -Same as PP&E

Time Value of Money

-Relationship between time and money -A dollar received today is worth more than a dollar promised at some time in the future -When deciding among investment or borrowing alternatives, it is essential to be able to compare today's dollar and tomorrow's dollar on the same footing (apples to apples) -Calculate present value of long term liability -Not about inflation

Annuity Due

-Rents occur at the beginning of each period -Interest will accumulate during the first period -Has one more interest period than ordinary annuity -Factor = multiply the future value of an ordinary annuity factor by 1 plus the interest rate -Annuity due gives a higher FV and PV

Ordinary Annuity

-Rents occur at the end of each period -No interest due during the first period -Number of compounding periods will always be one less than the number of rents -Equals periodic rent time future value factor of ordinary annuity

Income statement

-Report that measure the success of company operations for a given period of time -Helps determine profitability, investment value and credit worthiness. Also helpful in predicting the amounts, timing, and uncertainty of future cash flows -Helps users evaluate the past performance of the company (confirmatory value), predict future performance (predictive value), and assess the risk or uncertainty of achieving future cash flows

Balance Sheet

-Reports the assets, liabilities, and stockholders' equity of a business enterprise at a specific date. -Helps in predicting the amounts, timing, and uncertainty of future cash flows -Provides information about a company's liquidity, solvency, and financial flexibility -Account form (assets on left, liabilities and equity on right) or report form (sections above/below each other)

Statement of Stockholders' Equity

-Reports the changes in each stockholders' equity account and in total stockholders' equity during the year -Often uses columnar form -Contributed capital, retained earnings, and other comprehensive income

Net Realizable Value

-Requires an estimation of both uncollectibles and any returns or allowances -Net amount the company expects to receive in cash -Net amount that a company expects to realize from the sale of inventory -Estimated selling price minus cost of completion and disposal

Customer List

-Results from interaction with outside parties -List of contact information -Amortized over the asset's useful life -Residual value is usually zero -Limited life because people's information changes

Conventional

-Retail inventory method combined with LCM -Conservative so gives small ending inventory

Double Declining Balance Method

-Salvage value is NOT deducted when computing depreciable base -Utilizes a depreciation rate that is some multiple of the straight line rate (double is most common) -The depreciation rate is multiplied by the asset's book value at the beginning of the period to get the depreciation expense for the period -BV cannot go below salvage value

Elements

-Second level -Moment in time: assets, liabilities, and equity -Period of time: investment by owners, distribution to owners, comprehensive income, revenues, expenses, gains, and loses

Qualitative Characteristics

-Second level Relevance: capability of making a difference in a decision -Predictive value: helps investors to predict and form their own expectations about the future -Confirmatory value: helps users confirm or correct prior expectations/predictions -Materiality: omitting or misstating it could influence decisions. depends on relative size and importance (usually needs to be 5% of net income to be material) Faithful Representation: numbers and descriptions reflect what really existed -Completeness: all necessary information is provided -Neutrality: company can't select information to favor one set of interested parties over another. unbiased -Free from error: accurate representation Enhancing Qualities 1. Comparability (consistency): enables user to identify real similarities and differences across companies ( period to period within a company) 2. Verifiability: independent measurers obtain similar results 3. Timeliness: having information to decision makers before it loses its capacity to influence decisions. tradeoff with accuracy 4. Understandability: reasonably informed users can see the significance

Money Market Funds

-Short term investment -Money market fund with checking privilege is considered cash -Not riskless in financial crisis (not FDIC insured)

Adjusted Trial Balance

-Shows balance of all accounts, including those adjusted, at the end of the accounting period -Shows that debit balances equal credit balances after all adjustments -Primary basis for the preparation of financial statements

Dollar-Value LIFO

-Solution because it reduces the number of layers (decreases chance of tapping into earlier layer) -Increases and decreases in a pool are determined and measured in terms of total dollar value, not in physical quantity of the goods in the inventory pool -Having fewer pools means less costs and less chance of a reduction of a LIFO layer -A LIFO layer is formed when ending inventory at base-year prices exceed the beginning inventory at base-year prices -To get inventory at base year price: (ending year inventory at current end of year price) / (price index %) -If ending inventory at base-year price is less than beginning inventory at base-year price, the decrease is subtracted from the most recently added layer -Dollar-value LIFO is employed by most companies who use LIFO

Costs Similar to R&D

-Start Up costs (organizational cost): from inception to when business is formally up and running. expensed -Initial operating losses: loss -Advertising costs: future benefit is uncertain. expensed -Computer software costs: usually selling and administrative expenses

Owners Equity

-Stockholders equity 1. Capital stock 2. Additional paid in capital 3. Retained earnings 4. Accumulated Other Comprehensive income (filler for OCI) 5. Treasury stock (contra equity) 6. Noncontrolling interest (minority interest) - because assets and liabilities are consolidated

Special Assessments

-Streetlights, pavements, sewer, permanent landscaping, etc -Usually provided and maintained by government

Patent

-Technology related intangible asset -Product patents and process patents -Exclusive rights for 20 years -Should be amortized over legal life or useful life, whichever is shorter -Includes legal fees to defend patents -When purchased, debit patent and credit cash -When amortized, debit amortization expense and credit patent

Solvency

-The ability of a company to pay its debts as they mature -Long term

Avoidable interest

-The amount that could have been avoided if expenditures for that asset had not been made -Interest rate time the weighted average of accumulated expenditures

Liquidity

-The company's ability to convert something into cash -Short term

Treasury Stock

-The cost of shares repurchased -Raises EPS -Signals manager's confidence -How companies go private

Ledger

-The entire group of accounts maintained by a company -Provides the balance in each account and keeps track of changes in the balance

Financial Reporting

-The financial information a company provides to help users with capital allocation decisions about the company -Financial statements, CSR reports, CEO letter, press release, conference call transcript, and management forecast -Objective is to communicate with external parties -Challenges: (1) Comparability- cross listings follow different standards and LIFO is only in the US, (2) Political pressure in standard setting, (3) timeliness- accuracy vs reliability, (4) Expectation gap, (5) Some assets (like human capital) aren't reported

Group and Composite Depreciation Methods

-The group method is applied to a collection of assets similar in nature -The composite method is applied to a collection of assets dissimilar in nature -The composite depreciation rate is determined as follows: (total of annual depreciation for all assets) / (total cost of all assets)

Calculating Impairment Loss for Assets Held for Use

-The impairment loss is the amount by which the carrying amount exceeds its fair value -If an active market for the asset exists, Loss = Carrying amount of an asset - FMV; If an active market for the asset does not exist, Loss = Carrying amount of an asset - Present value of expected net cash flows -The entry to record the impairment loss is: debit loss on impairment, credit accumulated depreciation

Earnings Management

-The planned timing of revenues, expenses, gains, and loses to smooth out bumps in earnings -Negatively affects the quality of earnings (less useful for predicting future earnings and cash flows)

Current Maturities of Long Term Debt

-The portion of a long-term liability that will be paid within the next operating cycle -Excluded if they are to be: retired by assets accumulated for this purpose, refinanced, or converted into capital stock

Noncontrolling Interest

-The portion of equity interest in a subsidiary not attributable to the parent company -Reported after net income -Consolidated net income, less net income attributable to non controlling interest, gives net income attributable to common stockholders

Financial Accounting

-The process that culminates in the preparation of financial reports -For external users -Follows GAAP or IFRS (increases comparability) -Must file with SEC quarterly

Hedging

-The purchaser in the purchase commitment simultaneously enters into a contract in which it agrees to sell in the future the same quantity of the same (or similar) goods at a fixed price. The company holds a buy position in a purchase commitment and a sell position in a futures contract in the same commodity. -Offsets the price risk of the buy and sell positions

Risk Free Rate of Return

-The pure rate of return plus the expected inflation rate -FASB thinks companies should discount expected cash flows by this

Double-Entry System

-The two sided effect of each transaction is recorded in appropriate accounts -Helps to detect errors -Debits must equal credits

Cost Flow Assumptions

-There is no requirement that the cost flow assumption adopted be consistent with the physical movement of goods -Once you switch methods, you must stick with it for at least 3 years -Method for accounting must be the same method used for tax reporting -Choose the method that most clearly reflects periodic income 1. Specific Identification 2. Average Cost 3. FIFO: Inventory and COGS are the same under periodic and perpetual systems 4. LIFO

Recognition and Measurement

-Third level Basic assumptions: 1. Economic entity: economic activity can be identified with a particular unit of accountability (owner and company are separate and the company and subsidiaries are reported together) 2. Going concern: the company will have a long life 3. Monetary unit: economic activity can be measured by money (relevant, simple, universally available, understandable, and useful) 4. Periodicity: company can divide its economic activities into artificial time periods Principles: 1. Measurement: historical cost (more common, conservatism and verifiability, report based on acquisition price) and fair value ("mark-to-market" is okay because there's an open market). Use both so "mixed attribute" 2. Revenue recognition 3. Expense recognition 4. Full Disclosure: includes details that make a difference but condensed so the information is understandable (tradeoff because giving too much information can lead some things to be overlooked) Constraints: -Cost benefit: Companies must weigh the cost of providing the information against the benefits that can be derived from using it

Operating Cycle

-Time it takes for cash to buy materials, buy labor, get receivables, and get back to cash -Wouldn't make sense if inventory was listed as noncurrent

Cost to Retail Ratio

-Total goods available for sale at cost / total goods available at retail price -At cost: BI + Purchases - Purchase R&A, Discounts + Freight in - Abnormal spoilage -At retail: BI + Purchases - Purchase R&A, Discounts - Abnormal spoilage + Net markups

Closing Entries

-Transfer net income and dividends to retained earnings, so the balance in Retained Earnings agrees with the retained earnings statement -Produces a zero balance in each temporary account in order to prepare the accounts for the next period's transactions (revenues, expenses, and dividends) -First close revenues and expenses to the Income Summary account, then close income summary to retained earnings, then close dividends to retained earnings

Sales with Buyback Agreement

-Transfer with either an implicit or explicit repurchase agreement -Like a financing transaction (secure borrowing) with collateral -Title of inventory stays with seller -Seen at end of fiscal year to inflate sales

Special Retail Items

-Transfers-in: treated as purchase from outside company -Normal shortages: reduce retail but not cost -Abnormal Shortages: deducted from cost and retail -Employee discounts: reduce retail but not cost

Goodwill Impairment

-Two step process (test performed at least annually) -a. If fair value of reporting units is less than its carrying amount including good will, then impairment incurred (reporting unit level) -b. (goodwill level) Implied value of goodwill = fair value of reporting unit - carrying value of net assets (excluding good will) ; Impairment loss = carrying amount of good will - implied value of goodwill -Belief about company didn't pan out -Looks bad on financial statement

Secure Borrowing

-Use receivable as collateral for borrowing -Use interest rates and notes because not actually selling

Accounts Receivable Turnover

-Used to assess liquidity of receivables -Number of times, on average, a company collects receivables during the period -Net sales divided by average accounts receivables outstanding

Gross Profit Method

-Used to estimate cost of ending inventory (for interim reporting) -Also used when an estimate is needed due to a casualty loss (natural disaster, stolen, etc.) -Three assumptions: 1. Beginning inventory + Purchases = Total Goods Available 2. Goods not sold must be on hand 3. Total goods available - Sales at cost = Ending Inventory -To reduce sales to cost: Sale - Gross Profit = Sales at cost -Gross profit rate can be stated either as percent-of-sales or percent-of-cost -Usually not acceptable for financial reporting but acceptable for interim reporting (because its not accurate enough -Gross profit on selling price will always be less than the related percentage based on cost

Single Step Income Statement

-Uses just two groupings (revenues and expenses) -Income tax is reported separately as the last item before net income -Primary advantage lies in its simple presentation (concise) and the absence of any implication that one type of revenue or expense item has priority over another

Notes Payable

-Written promises to pay a certain amount at a future date -For interest bearing notes: Interest = principal * interest rate * time -For zero interest bearing notes, record discount on notes payable for difference between present value and fair value. amortize over life of the note

Notes Receivable

-Written promises to pay a certain sum of money on a specified future date -Can be short term or long term -Fairly liquid -Zero-interest bearing notes: interest is not explicitly stated. face value covers interest and principal -Interest bearing notes: interest is explicitly stated -Notes received for property, goods, or services: should state a reasonable interest rate and the face value should not be materially different than current price

Present Value Factor

1 / (1 + i)^n

Depletion Base

1. Acquisition cost of the deposit 2. Exploration costs -In most cases, expenses are incurred (future benefit is not certain -Capitalization if they are substantial and risks are uncertain (such as in oil and gas) 3. Development costs -Tangible equipment costs: Costs of equipment necessary to extract the natural resources and get it ready to shipment are not considered in depletion base -Intangible development costs: items such as drilling cost, tunnels, shafts, and wells are considered part of the depletion cost 4. Restoration costs: costs to restore the property to its natural state should be added to the depletion base

Nontrade Receivables

1. Advances to officers and employees. 2. Advances to subsidiaries. 3. Deposits paid to cover potential damages or losses. 4. Deposits paid as a guarantee of performance or payment. 5. Dividends and interest receivable. 6. Claims against...

Balance Sheet Classifications

1. Assets that differ in their type or expected function 2. Assets and liabilities with different implications for the company's financial flexibility 3. Assets and liabilities with different general liquidity characteristics

3 Approaches for Interest During Construction

1. Capitalize no interest charges during construction 2. Charge construction with all costs of funds employed, whether identifiable or not 3. Capitalize only the actual interest costs incurred during construction (required by GAAP)

Valuation of PP&E

1. Cash discounts: reduce the asset cost (make it net) 2. Deferred payment contract: present value of consideration to be exchanged 3. Lump sum purchases: allocate cost according to relative market value 4. Issuance of stock: use market value of stock (clearly more evident) 5. Non monetary assets exchange -The basic rule is that the exchange must be based on the fair value of the asset given up or the fair value of the asset received whichever is clearly more evident -The rules for gain/loss recognition depend upon whether the assets exchanged have commercial substance 6. Donated/contributed assets: use fair value -For received assets: recognize as revenue in the period received -For assets donated: record as an expense at fair value

Limitations of Income Statement

1. Companies omit items from the income statement that they cannot measure reliably 2. Income numbers are affected by the accounting methods employed 3. Income measurement involves judgement (ex: useful life)

Journal Entry

1. Date of transaction 2. Accounts and amounts debited/credited 3. Brief explanation of the transaction

Three Factors of Depreciation

1. Depreciation base 2. Useful life 3. Method of Depreciation -Straight line method -Activity method (unit of production method) -Sum-of-the-years'-digit -Double declining balance method

Journal

1. Discloses in one place the complete effect of a transaction 2. Provides a chronological record of transactions before they are transferred to accounts 3. Helps to prevent or locate errors because debit and credit amounts for each entry can be readily compared

Special Issues Related to Interest Capitalization

1. Expenditures for land: -If for particular use for land, the interest is capitalized as part of land -If for a site for construction, interest is capitalized as part of building -If for speculation, not capitalized 2. Interest revenue: companies should not net or offset interest revenue against interest cost

Ending Inventory at LIFO Cost

1. Find ending inventory at base year costs 2. Breakout into annual layers and multiply each layer by price index for that layer 3. Sum all layers to get a total inventory LIFO cost

What interest rate to use?

1. For portion of weighted average accumulated expenditures below or equal to amount borrowed, use rate on the specific borrowings 2. For portion greater than amount borrowed, use a weighted average interest rate incurred on all other outstanding debt during the period

Accounting Cycle

1. Identifying and recording transactions and other events 2. Journalizing 3. Posting 4. Trial Balance 5. Adjusting Entries 6. Adjusted Trial Balance 7. Financial Statements 8. Closing Entries 9. Post Closing Trial Balance

Assets Held for Use

1. Impairment loss = carrying amount - fair value 2. Depreciate on new cost basis 3. Restoration of impairment loss not permitted (not selling anytime soon)

Non Cash Transactions

1. Issuance of common stock to purchase assets 2. Conversion of bonds into common stock 3. Issuance of debt to purchase assets 4. Exchange of long-lived assets -Reported at bottom of the statement of cash flows or in a separate note

Advantages of LIFO

1. Matching of current costs to current revenues 2. Tax benefits 3. Improved cash flows 4. Future earnings hedge

Limitations of the Balance Sheet

1. Most assets and liabilities are reported at historical cost rather than fair value 2. Companies use judgements and estimates to determine many of the items reported in the Balance Sheet 3. The Balance Sheet omits many items that are of financial value but cannot be recorded objectively

Preparing Operating Activities Section

1. Net income 2. Subtract increase in current assets, add decrease in current assets 3. Add increase in current liabilities, subtract decrease in current liabilities 4. Add depreciation expense, add amortization of intangible assets 5. Subtract gains, add losses 6. Other/complexities 7. Cash used or provided by operating activities

FASB Conceptual Framework

1. Objectives of financial reporting (why) 2a. Qualitative charateristics of accounting information - Relevance - Reliability - Comparability 2b. Elements of financial statements (assets, liabilities) 4. Recognition, measurement, and disclosure concepts (how)

Multiple Step Income Statement

1. Operating Section: sales/revenues, COGS, gross profit, operating expenses (selling and administrative), income from operations 2. Non-operating section: other revenues/gains and other expenses/loses, income before income tax 3. Income tax, net income 4. Discontinued operations, net of tax 5. Non-controlling interest 6. Earnings per share

Components of Interest

1. Pure rate of interest (2%-4$): The amount a lender would charge if there were no possibilities of default and no expectation of inflation 2. Expected Inflation Rate of Interest (0%-?): Lenders recognize that in an inflationary economy, they are being paid back with less valuable dollars. Increase interest rate to compensate for this loss in purchasing power 3. Credit Risk Rate of Interest (0%-5%): The government has little credit risk, financially unstable businesses can have high credit risk

Fundamental Variables

1. Rate of interest (assume annual rate) 2. Number of time periods (number of compounding periods) 3. Future value 4. Present value

Disadvantages of LIFO

1. Reduced earnings 2. Inventory understated compared to current prices of inventory 3. LIFO does not approximate physical flow of inventory 4. Because of liquidation problem, LIFO may cause poor buying habits

Long-term Investments

1. Securities (corporate bonds, stock, etc) 2. Fixed assets not currently used in operations (land held for speculation - doesn't depreciate) 3. Special funds, such as sinking fund, pension fund, and cash surrender value of life insurance 4. Affiliated company/ non consolidated subsidiaries (company has 20%-50% ownership investment in other company)

3 Levels

1. Stated Value- most objective 2. Appraiser estimate 3. Company estimate - most subjective

Single Sum Problems

1. Unknown future value of a known single sum of money invested now 2. Unknown present value of a known single sum of money in the future -Future value = present value * future value factor

Average Days to Sell Inventory

365 / inventory turnover

Revenue Recognition Principle

A company must recognize revenue in the accounting period in which the performance obligation is satisfied

Weighted Average Accumulated Expenditures

A company weights the construction expenditures by the amount of time (fraction of a year or accounting period) that it can incur interest cost on the expenditure

Returnable Cash Deposits

A current liability that results from customers making deposits to guarantee performance of a contract or service, or as a guarantee to cover payment of expected future obligations.

Statements of Financial Accounting Concepts

A series of statements by the FASB that set forth fundamental objectives and concepts that the Board uses in developing future standards of financial accounting and reporting -Don't establish GAAP

Internal Controls

A system of checks and balances designed to prevent and detect fraud and errors

Periodicity Assumption

Accounting time periods are generally a month, a quarter, or a year

IOU

Accounts receivable

Postdated Check

Accounts receivable

Capitalized

Added to the asset

Markups

Additional markup of the original retail price

Deferred Annuity

An annuity in which the rents begin after a specified number of periods.

Relative Sales Value

Appropriate basis when basket purchases are made

Expanded Accounting Equation

Assets = Liabilities + Common Stock + Revenues - Expenses - Dividends

Accounting Equation

Assets = Liabilities + Stockholders' Equity

Accounts Payable

Balances owed for goods, services, or supplies

Capitalization Period

Begins when 1. Expenditures for the asset have been made 2. Activities to get the asset ready for its intended use is in progress 3. Interest costs are being incurred -Continues as long as these three conditions are present -Ends when the asset is substantially complete and ready for its intended use

Amount to be Capitalized

Capitalize the lesser of 1. Actual interest costs 2. Avoidable interest

Boot

Cash Received

Expenses on Accrual Basis

Cash paid for operating expenses - ∆ in prepaid expenses + ∆ in accrual liabilities

Revenue on Accrual Basis

Cash receipts from customer + ∆ in Accounts Receivables - ∆ in Unearned Revenue

Accounting Information System

Collects and processes transaction data and disseminates the financial information to interested parties

Financial Statements

Communicate financial information to people outside the company. Provide at the least cost the most useful information possible. Focuses on investors and creditors 1. Balance sheet 2. Income statement 3. Statement of cash flows 4. Statement of stockholders' equity

Additions

Companies capitalize any addition to plant assets because a new asset is created

Modified All-inclusive Concept

Companies record most items, including unusual or infrequent ones, as part of net income 1. Unusual and infrequent gains and losses 2. Discontinued operations 3. Non controlling interest 4. Earnings per share

Moving-Average Method

Company computes a new average unit cost each time it makes a purchase.

FASB Codification

Computer directory that allows people to quickly find information/standards on different topics

Litigation, Claims, and Assessments

Consider -Time period when underlying cause occurred (on or before the date of the financial statements) -Probability of unfavorable outcome -Reasonable estimate of loss -Debit litigation expense, credit litigation liability -In practice, many companies don't disclose this because it would be an admission of guild

Allowance to Reduce Inventory to Market

Contra inventory account

Journalizing Interest

Debit Asset (avoidable interest) Debit Interest expense (difference) Credit Cash (actual interest)

Credits

Decrease assets and increase liabilities

Losses

Decreases in equity (net assets) from peripheral business activity

Pension Fund

Defined benefit plan

Depletion

Depletion Refers to the cost basis write-off of natural resources (e.g. coal, oil, timber)

Financial Instrument

Derive their value from the right to receive cash or cash equivalents in the future

Distribution to Owners

Dividends

Liquidating Dividends

Dividends greater than the amount of accumulated net income

Indefinite life

Don't know how long it will last

Accounting Standards Updates

FASB pronouncement that amends accounting standards codification

Factor

Finance companies or banks that buy receivables from businesses for a fee and then collect the remittances directly from the customers

Cash Surrender Value of Life Insurance

For if key personnel leave the company

Depreciation Base

Function of 1. Original cost 2. Salvage value: how must you can sell asset for at the end of its life

Commercial Substance

Future cash flow pattern changes as a result of the transaction

Purchase Discounts

Gross Method: -Report purchases and accounts payable at gross amount -Purchase discount deducted from purchase on income statement Net Method: -Record at net amount -If purchases discount is not taken, record discount amount not taken as purchase discount loss (reported in "other expenses and loses" on income statement)

Percentage Markup on Cost

Gross profit on selling price / (100% - gross profit on selling price)

Fair Value Option

If companies choose the fair value option, the receivables are recorded at fair value, with unrealized holding gains or losses reported as part of net income

Prudent Cost

If for some reason a company ignorantly paid too much for an asset originally, it is theoretically preferable to charge a loss immediately

Debits

Increase assets and decrease liabilities

Gains

Increases in equity (net assets) from peripheral business activity

Consigned Goods

Inventory is property of consignor

Basket Purchases

Involve a group of varying units bought in a single lump sum price

Refinance

Issue stock or new debt

Unlimited life

Know it will last forever

Lien

Like a restriction or liability

Chart of Accounts

List of accounts used by a company

Profit Margin on Sales

Net Income / Net Sales

Return on Assets

Net income / Average total assets

Gross Profit on Selling Price

Percentage markup on cost / (100% + percentage markup on cost)

Travel Advance

Prepaid expense or accounts receivable

Average Cost

Prices items in the inventory on the basis of the average cost of all similar goods available during the period

Codification Research System (CRS)

Provides easy online access to the FASB's Codification

Due from Factor

Receivable

Loss Contingencies

Record if the loss is a. probable (greater than 70%) b. can be reasonably estimated Otherwise disclose in footnote

Successful Efforts Concept

Related to the accounting for exploration costs in the oil and gas industry, this view holds that companies should capitalize only the costs of successful projects. Companies should report any remaining costs as period charges.

Full Cost Concept

Related to the accounting for the oil and gas company, this view holds that the cost of drilling a dry hole is a cost needed to find the commercially profitable wells.

Annuity

Requires: 1. Period payments or receipts (called rents) of the same amount 2. Same length interval between rents 3. Compounding of interest once each interval

Equity

Residual interest in the assets of an entity that remains after deducting its liabilities. In a business enterprise, the equity is the ownership interest.

Net Income

Results from revenue, expense, gain, and loss transactions

Sinking Fund

Set aside money to redeem bond at maturity

CDs

Short term investment

Cash Equivalents

Short-term highly liquid investments that are: -Readily convertible to known amounts of cash -So near to maturity that there is no significant risk of changes of interest rate (general rule is investments with maturities of three months or less) -Almost risk-less (holds value) -Ex: treasury bills, commercial papers, money market funds

Normal Balance

Side where increases in the account are recorded

Discount on Bonds Payable

Stated rate < market rate

Par Value

Stated rate = market rate

Premium on Bonds Payable

Stated rate > market rate

Investment by Owners

Stock

Stamps on Hand

Supplies

Hybrid or Combination Methods

Tailor made depreciation method but must allocate cost in a systematic and rational manner

Financial Flexibility

The ability to alter the amount and timing of cash flows

Transaction Price

The amount of consideration that a company expects to receive from a customer in exchange for transferring goods or services

Book Value

The difference between the cost of any depreciable asset and its related accumulated depreciation

Additional Paid in Capital

The excess of amounts paid in over the par or stated value

Composite Life

The length of time it takes a company to depreciate its assets on a composite basis

Capital Stock

The par or stated value of the shares issued

Capital Allocation

The process of determining how and at what cost money is allocated among competing interests

Transaction Analysis

The process of identifying the specific effects of economic events on the accounting equation

Credit Balance

The total of the credit amounts exceeds the debits

Debit Balance

The total of the debit amounts exceeds the credits

Interest Costs During Construction

Three questions must be answered: 1. Which assets are qualifying assets? 2. What is the capitalization period? 3. What is the amount of interest to be capitalized

Short Term Obligations Expected to be Refinanced

To be excluded from short term debt must meet both of the following: 1. Intend to refinance on a long-term basis 2. Demonstrated ability to consummate refinancing. Two ways: a. Refinance after balance sheet date but before it is issued b. Enter into a financing agreement

Recognized Gain

Total gain * (boot / (boot + FV of asset received))

Weighted Average Interest Rate

Total interest / total principal

American Institute of Certified Public Accountants (AICPA)

Trade association that helps and gives advice to FASB

Accrual-Basis Accounting

Transactions that change a company's financial statements are recorded in the periods in which the events occur, even if cash was not exchanged

Nonreciprocal Transfers

Transfer assets in one direction

Valuation of Long-Term Bonds

Two Cash Flows: Periodic Interest Payments (annuity) Principal paid at maturity (single-sum)

Expected Cash Flow Approach

Uses a range of cash flows and incorporates the probabilities of those cash flows to provide a more relevant measurement of present value

Imputed Interest Rate

When a company must approximate an applicable interest rate that may differ from the stated interest rate

Future Value Factor of Ordinary Annuity

[(1 + i)^n - 1] / i

Types of Exchange

a. Exchange has commercial substance: recognize gain and losses immediately b. Exchange lacks commercial substance-no cash received: defer gains, recognize losses immediately c. Exchange lacks commercial substance-cash received: recognize partial gain, recognize losses immediately