ACTG 350 Key Terms (Midterm 2 - Final)
Determine the amount that can be excluded from classification as a current liability (that is, reported as a noncurrent liability) b. Management intended to refinance $6 million of its 10% notes that mature in May 2019. In early March, prior to the actual issuance of the 2018 financial statements, Nevada Harvester negotiated a line of credit with a commercial bank for up to $5 million any time during 2019. Any borrowings will mature two years from the date of borrowing
$5 million can be reported as long term, but $1 million must be reported as a current liability. Short-term obligations that are expected to be refinanced with long-term obligations can be reported as noncurrent liabilities only if the firm (1) intends to refinance on a long-term basis and (2) actually has demonstrated the ability to do so. Ability to refinance on a long-term basis can be demonstrated by either an existing refinancing agreement or by actual financing prior to the issuance of the financial statements. The refinancing agreement in this case limits the ability to refinance to $5 million of the notes. In the absence of other evidence of ability to refinance, the remaining $1 million cannot be reported as long term
A provision for a loss contingency is recorded when it is both (1) _____________ that a liability has been incurred and (2) _____________________________________________________ .
(1) probable (2) the amount of the liability can be reasonably estimated.
what are markdowns? (give an example)
-decreases in the original sales price selling price goes from $50 to $40
what are markup cancellations? (give an example)
-eliminate markups (back to original price) selling price goes from initial markup of $100 to $70 this is a markup cancellation of $30
what are additional markups? (give an example)
-increase in selling price subsequent to initial markup selling price goes from initial markup of $100 to $150
what are markups? (give an example)
-the increase in price -Expressed as a dollar or percentage amount selling price goes from $50 to $100
what is the 2-step process for how unasserted claims should be reported?
1. First, ask whether it is probable that a claim will be asserted. If the answer is "no" then no accrual or disclosure is needed. If the answer is yes then go to step 2. 2. Treat the claim as if the claim has been asserted (i.e. as any other loss contingency) a. Assess the likelihood of an unfavorable outcome (probably, reasonably possible, remote) b. Evaluate whether the amount of loss can be reasonably estimated.
how do you find per unit inventory value using the LCNRV method?
1. For each product, calculate NRV (estimated selling price - cost to sell). 2. Compare NRV with cost and take the lower number. That is your per unit inventory value using the LCNRV method
start of MOD 10: Current liabilities and contingencies CHARACTERISTICS OF LIABILITIES
1. Probable, future sacrifices of economic benefits 2. Arise from present obligations to other entities 3. Result from past transactions of events Note a liability is a present responsibility to sacrifice assets in the future because of a transaction or other event that happened in the past.
Accrual of a loss contingency depends on:
1. The likelihood that the confirming event will occur 2. Whether the amount of loss can be reasonably estimated
what are the 2 inventory measurement approaches?
1. lower of cost or net realizable value (LCNRV) 2. lower of cost or market (LCM)
What is LIFO Layer Liquidation?
A LIFO layer is a quantity of inventory purchased at a particular point in time (period of time) that remains in the Inventory account. -Under LIFO, the costs of later purchases are transferred to COGS before the costs of earlier purchases.
what is a line of credit?
A financial arrangement between a firm and a bank in which the bank pre-approves credit up to a specified limit, provided that the firm maintains an acceptable credit rating -the maximum amount of money a creditor will allow a credit user to borrow EX: a line of credit of $5M allows you to borrow up to 5M and will be paid back
gain contingencies
A gain contingency is an uncertain situation that might result in a gain • Gain contingencies are NOT accrued o This is another example of conservatism - we record uncertain losses, but not uncertain gains (similar to discontinued operations we studied earlier this year)
What do we do if: Did the cause of the contingency occur before the year-end? Answer = NO (see chart on slide 12)
A loss contingency cannot be accrued but is disclosed in a disclosure note
Unasserted claims and assessments
A loss contingency may warrant accrual or disclosure even if a claim has yet to be made when the financial statements are issued. A two-step process is used in determining how an unasserted claim should be reported.
The Peridot Company purchased machinery on January 2, 2016, for $800,000. A five-year life was estimated and no residual value was anticipated. Peridot decided to use the straight-line depreciation method and recorded $160,000 in depreciation in 2016 and 2017. Early in 2018, the company revised the total estimated life of the machinery to eight years. A. What type of accounting change is this? B. Briefly describe the accounting treatment for this change. C) Determine depreciation for 2018
A) This is a change in accounting estimate. B) ▪ We do not recast prior years' financial statements to reflect the new estimate. ▪ Instead, we merely incorporate the new estimate in any related accounting determinations from there on. (prospective) ▪ If the after-tax income effect of the change in estimate is material, the effect on net income and earnings per share must be disclosed in a note, along with the justification for the change. C) remaining BV (800,000 - 320,000) / 6 = $80,000 depreciation
purchase commitments
Agreements to buy inventory weeks, months, or years in advance. The seller generally retains title to the merchandise or materials covered in the purchase commitments. -can specify determinable prices and quantities -The need for such arrangements with suppliers and vendors arises from the extended production planning horizon for many of our products
what is a contingency?
An existing situation where uncertainty exists as to possible gain or loss that will be resolved when one or more future events occur or fail to occur.
inventory formula
Beginning Inventory + Net Purchases - Ending Inventory = Cost of Goods Sold
what formula do we use when calculating LIFO reserve year-year?
COGS(L) - COGS(F) = [E(L) - E(F)] - [B(F) - B(L)] [E(L) - E(F)] = LIFO reserve end [B(F) - B(L)] = LIFO reserve beginning if you repeat the process year to year the end lifo reserve continuously cancels. You end up with final [E(L) - E(F)] - beginning year 1 [B(F) - B(L)]
if LIFO reserve increases year-year, it means the firm shifted $ that would have been ________________ instead of ___________ under FIFO
COGS, end inventory
How do we estimate inventory using the conventional retail method?
Calculate everything at cost and at retail. 1. start with inventory, add net purchases and add net markups = goods available for sale 2. subtract net markdowns to get real goods available for sale 3. subtract sale for July to get ending inventory at retail 4. multiply by cost-to-retail ratio to get ending retail at cost 5. get COGS my doing goods available for sale (before net markdowns) at cost - ending inventory at cost
How do we find the effect on current period net income if LCNRV were applied on a total inventory basis?
Compare total inventory at cost and total inventory at NRV. If cost<NRV, no write-down is required. If NRV>cost, an adjustment is necessary.
CLASSIFYING LIABILITIES: Liabilities are classified as either __________ or _______________
Current, Non-Current (Long-term)
Accrual of loss contingencies journal entry. Between one of these 2.
Dr) Loss (or expense) XXX Cr) Liability XXX OR Asset impairment: Dr) Loss (or expense) XXX Cr) Asset (or valuation account) XXX
Prepare the year-end entries for any amounts that should be recorded as a result of each of these contingencies and indicate whether a disclosure note is indicated 4) In November 2018, Classical became aware of a design flaw in an industrial saw that poses a potential electrical hazard. A product recall appears unavoidable. Such an action would likely cost the company $500,000.
Dr) Loss—product recall.............................................................. 500,000 Cr) Liability—product recall........................................................ 500,000 A disclosure note also is appropriate. Dr) Promotional expense ([60% x $25 x 10,000] - $105,000) = ......... 45,000 Cr) Estimated premium liability .................................................. 45,000
Prepare the year-end entries for any amounts that should be recorded as a result of each of these contingencies and indicate whether a disclosure note is indicated 1) Classical's products carry a one-year warranty against manufacturer's defects. Based on previous experience, warranty costs are expected to approximate 4% of sales. Sales were $2 million (all credit) for 2018. Actual warranty expenditures were $30,800 and were recorded as warranty expense when incurred.
Dr) Warranty expense ([4% x $2,000,000] - $30,800) = 49,200 Cr) Estimated warranty liability ............................................... 49,200
In November 2013, The Brunswick Company signed the following purchase commitment. Brunswick's fiscal year-end is December 31, 2013. The company uses a perpetual inventory system. The contract was exercised and paid in cash on its expiration date. ▪ A commitment to purchase 20,000 units of inventory at $11 per unit at March 15, 2014. a. Prepare the necessary adjusting entry at December 31, 2013 (year-end), assuming a unit market price on that date is $10.
Dr) estimated loss $20,000 [($11-$10) x 20,000] Cr) estimated liability $20,000
In November 2013, The Brunswick Company signed the following purchase commitment. Brunswick's fiscal year-end is December 31, 2013. The company uses a perpetual inventory system. The contract was exercised and paid in cash on its expiration date. ▪ A commitment to purchase 20,000 units of inventory at $11 per unit at March 15, 2014. b. Prepare the journal entry to record the purchase for cash on March 15, 2014, assuming a unit market price on that date is $12.
Dr) inventory $200,000 Dr) estimated liability $20,000 Cr) cash $220,000 ($11 x 20,000)
journal for warranties if expense is calculated upfront as % of sales.
Dr) warranty expense (% of sales) Cr) warranty liability Dr) warranty liability xxx Cr) parts xxx
journal for warranties if expense is calculated upfront as % of sales but you incur the liability first (main way)
Dr) warranty expense (actual warranty exp. for year) Cr) parts xxx Adjusting entry: Dr) estimated warranty liability [% of sales - actual warranty] Cr) warranty liability xxx
What is the journal entry for write downs of inventory?
Dr. COGS xxxx Cr. inventory xxxx Dr. loss on write-down xxxx Cr. inventory xxxx
What would be the effect on current period net income if LCM were applied on a total inventory basis? EX: Total cost = $160K , Total "Market" $157,000. Is a write down journal entry necessary?
EX: Total Cost: (20+90+50)*1000 = $160K Total "Market" = (29+80+48) * 1000 = $157,000 Since market < cost by $3000, inventory must be written down by $3000 DR) Loss or COGS $3000 CR) Inventory $3000
What are markdown cancellations?(give an example)
Eliminate markdowns (back to original prices) selling price goes from initial markdown of $40 to $45 this is a markdown cancellation of $5
What's the action required to correct error: Error discovered in the same year
Erroneous journal entry is reversed and the appropriate entry is recorded
(start of next unit) The expected benefit of unsold inventory may change over time. Circumstances may arise that indicate a company will have to sell its inventory for less than cost. What are some examples of this?
Examples include damage, deterioration, change in price levels, obsolescence, or any situation that leads to change in demand.
how do you find per unit inventory value using the LCM method?
For each product, compare cost with designated market value. Whichever is lower is your LCM value and this your per unit inventory value.
Dollar value LIFO steps for computing problems: EX3
Given: year-end inventory values Step 1: State ending values in terms of base-year dollars (divide by cost index to adjust for inflation) Step 2: Make your LIFO layers (subtract each year besides first year by year 1 LIFO inventory value (these are LIFO layers) Step 3: Put price increases back into each layer (multiply each LIFO layers in years after year 1 by the cost index. Then add them up. Adding these up gets you end inventory in final year.
What's the action required to correct error: Errors discovered in subsequent years
Immaterial: correct in year discovered Material: Prior period adjustment recorded
What do we do if: Did the cause of the contingency occur before the year-end? Answer = YES. No claim was made before issuance of financial statements. and it IS probable a claim will be asserted This is also the same thing as if there was a claim made before issuance of financial statements.
Is the likelihood that a liability has been incurred probable? AND Is the amount of loss either known or reasonably estimable? IF NO, Is the likelihood that a liability has been incurred remote? IF NO: Disclosure note only IF YES: Do Nothing Is the likelihood that a liability has been incurred probable? AND Is the amount of loss either known or reasonably estimable? IF YES, A loss contingency is required to be accrued.
what is the standard for if an error is a material error?
It is a material error if financial statement users would make different decisions based on the error
What is LIFO liquidation?
It occurs when a company that uses the last-in, first-out (LIFO) inventory costing method liquidates its older LIFO inventory. A LIFO liquidation occurs when current sales exceed purchases, resulting in the liquidation of any inventory not sold in a previous period
LIFO liquidation problems have to do with ending $ amount vs beginning $ amount. These problems are all about finding these numbers because if quantity of end inventory decreases, we have to record _________________________________.
LIFO liquidation
If LIFO reserve increased by 4M from 2015 to 2016, what does this mean? Assume a 40% tax rate. How does this affect net income?
LIFO reserve increased by $4M; This means that the firm shifted $4M that would have been in COGS instead of inventory under FIFO, back into inventory (and out of COGS) by using LIFO. This increases net income before taxes by $4M, or $4M*(1-.4)=$2.4M after taxes.
difference between liability and contingency
Liability is accounted for immediately as you owe the obligation. Amount is recorded in books as accounts or notes payable. Contingent account is accounted for only when the obligation is probable and amount is estimated
If Cost > "Market" at year end, what do we do?
Make an adjusting entry to reduce the inventory value to "Market"
how are gain contingencies accounted for?
Material gain contingencies are disclosed in the notes to the financial statements
upper limit (ceiling)
NRV (expected incremental cash inflows from selling the inventory) ▪ If inventory were valued above this level, it would have a negative gross margin when it is sold
lower limit
NRV-normal profit margin (inventory value that would give you the profit you normally get on this item) ▪ Reducing the inventory value below this level would increase the gross margin above its normal level
do you make an adjusting journal entry if market price is greater than contract price?
No, similar to the unit on discontinued operations, there is no adjusting journal entry if there is benefit.
for purchase commitments that you have, is it good if market price < contract price?
No. It is bad because you have to pay a higher price (due to contract) when market price is lower. It is good if market price > contract price because the company is obligated to sell to you at a price lower than the market
EX3 (related to last problem): Assuming that the unit market price for the second purchase commitment was $10.30 on December 31, prepare the journal entry to record the purchase for cash on March 15, 2014, assuming the following alternative unit market prices on that date: remember original price of $11. a. $11.50 b. $10.00
Part a) No decline in value since the December adjusting entry - record at Dec. 31 price (do not reverse loss): Dr) Inventory 206,000 (11*20K-14K or 10.30*20K) Dr) Estimated liability on purchase commitment 14,000 Cr) Cash 220,000 ($11 x 20,000) Part b) Decline in value since December adjusting entry - record at March 15 price and recognize additional loss: Dr) Inventory 200,000 (20K*10) Dr) Estimated liability on purchase commitment 14,000 Dr) Loss on purchase commitment 6,000 Cr) Cash 220,000
EX2: A commitment to purchase 20,000 units of inventory at $11 per unit by March 15, 2014. Prepare the necessary adjusting entry at December 31, 2013, assuming the following alternative unit market prices on that date:Prepare the necessary adjusting entry at December 31, 2013, assuming the following alternative unit market prices on that date: a) $12.50 b) $10.30
Part a) No entry (market price is above contract price) Part b) Market price is below contract price → record estimated loss Dr) Estimated loss on purchase commitment 14,000 ((11-10.30)*20K) Cr) Estimated liability on purchase commitment 14,000
Since the company started using LIFO, the cumulative increase in COGS is $20M, i.e., the full amount of the current LIFO reserve. What is the cumulative effect on income taxes?
Put another way, if the company had been using FIFO all this time, inventory would have been $20M higher at the end of 2014, and cumulative net income would have been $20M lower over the years. Total tax savings: $20M*.4 = $8M
what is the retrospective approach?
Revise prior years' statements (that are presented for comparative purposes on the current period's statements) to reflect the impact of the change (PAST)
methods of minimizing LIFO liquidation
Specific goods pooled LIFO and Dollar-value LIFO (generally used in practice)
Dollar Value LIFO when LIFO liquidation occurred steps for computing problems: EX 4
Step 1: Convert Dec. 31, 2016 and 2017 ending inventories to base year cost (i.e., get rid of price inflation) Step 2: Create LIFO layers for each year, using inventory values restated in base year dollars. This gives you Ending inventory in 2015 dollars Step 3: Restate each layer using the cost index for the year it was acquired and calculate total ending inventory (i.e., readjust each layer to put cost increases back in). Then add them together to get the estimate of cost of inventory
what is the prospective approach?
The change is implemented in the current period, and its effects are reflected in the financial statements of the current and future years only. (FUTURE)
What is the modified retrospective approach?
The change is implemented in the current period, and its effects are reflected in the financial statements of the current and future years.
Determine the amount that can be excluded from classification as a current liability (that is, reported as a noncurrent liability) d. A $12 million 9% bank loan is payable on October 31, 2024. The bank has the right to demand payment after any fiscal year-end in which Nevada Harvester's ratio of current assets to current liabilities falls below a contractual minimum of 1.7 and remains so for six months. That ratio was 1.45 on December 31, 2018, due primarily to an intentional temporary decline in inventory levels. Normal inventory levels will be reestablished during the first quarter of 2019.
The entire $12 million loan should be reported as a long-term liability because that amount is payable in 2024 and it will not be refinanced with long-term obligations. The current liability classification includes (a) situations in which the creditor has the right to demand payment because an existing violation of a provision of the debt agreement makes it callable and (b) situations in which debt is not yet callable, but will be callable within the year if an existing violation is not corrected within a specified grace period—unless it's probable the violation will be corrected within the grace period. Here, the existing violation is expected to be corrected within six months (actually three months in this case).
Determine the amount that can be excluded from classification as a current liability (that is, reported as a noncurrent liability) c. Noncallable 12% bonds with a face amount of $20 million were issued for $20 million on September 30, 1996. The bonds mature on September 30, 2019. Sufficient cash is expected to be available to retire the bonds at maturity.
The entire $20 million maturity amount should be reported as a current liability because that amount is payable in the upcoming year and it will not be refinanced with long-term obligations.
Determine the amount that can be excluded from classification as a current liability (that is, reported as a noncurrent liability) a. 11% bonds with a face amount of $40 million were issued for $40 million on October 31, 2009. The bonds mature on October 31, 2029. Bondholders have the option of calling (demanding payment on) the bonds on October 31, 2019, at a redemption price of $40 million. Market conditions are such that the call is not expected to be exercised.
The requirement to classify currently maturing debt as a current liability includes debt that is callable by the creditor in the upcoming year—even if the debt is not expected to be called. So, the entire $40 million debt is a current liability.
Prepare the year-end entries for any amounts that should be recorded as a result of each of these contingencies and indicate whether a disclosure note is indicated 3) Classical is the plaintiff in a $4 million lawsuit filed against a supplier. The suit is in final appeal and attorneys advise that it is virtually certain that Classical will win the case and be awarded $2.5 million.
This is a gain contingency. Gain contingencies are not accrued even if the gain is probable and reasonably estimable. The gain should be recognized only when realized. A disclosure note is appropriate.
Prepare the year-end entries for any amounts that should be recorded as a result of each of these contingencies and indicate whether a disclosure note is indicated 2) In December 2018, the state of Tennessee filed suit against Classical, seeking penalties for violations of clean air laws. On January 23, 2019, Classical reached a settlement with state authorities to pay $1.5 million in penalties
This is a loss contingency. Classical can use the information occurring after the end of the year and before the financial statements are issued to determine appropriate disclosure. Dr) Loss—litigation ....................................................................... 1,500,000 Cr) Liability—litigation ............................................................ 1,500,000 A A disclosure note also is appropriate
What do we do if: Did the cause of the contingency occur before the year-end? Answer = YES. No claim was made before issuance of financial statements. and it is not probable a claim will be asserted
Was a claim made before the issuance of financial statements? NO Is it probable that a claim will be asserted? NO Then neither accrual nor disclosure is required
EX: A commitment to purchase 10,000 units of inventory at $10 per unit by December 15, 2013. Prepare the journal entry to record the December 15 purchase for cash assuming the following alternative unit market prices. a. $10.50 b. $9.50
a) Market price > Contract price → record at cost Dr) Inventory 100,000 Cr) Cash 100,000 b) Market price < Contract price → record at market price Dr) Inventory 95,000 Dr) Loss on purchase commitment 5000 Cr) Cash 100,000
Describe what we do for dollar amount of potential loss if the likelihood of loss is probable, reasonably possible, and remote for the following: If dollar amount of potential loss is: a) known b) reasonably estimable c) not reasonably estimable
a) likelihood of loss is KNOWN probable: Liability accrued and disclosure note, reasonably possible: disclosure note only, remote: no disclosure required b) likelihood of loss is REASONABLY ESTIMABLE probable: Liability accrued and disclosure note, reasonably possible: disclosure note only, remote: no disclosure required c) likelihood of loss is NOT REASONABLY ESTIMABLE probable: disclosure note only, reasonably estimable: disclosure note only, remote: no disclosure required
Additional retail method elements: Before calculating the cost-to-retail percentage we treat the following: a. Freight-in b. Purchase returns c. Purchase discounts taken d. Abnormal shortages How do we treat these?
a. Added in the cost column b. Deducted in both the cost and retail columns c. Deducted in the cost column d. Deducted in both the cost and retail columns
Additional retail method elements: After calculating the cost-to-retail percentage we treat the following: a. Normal shortages How do we treat these?
a. Deducted in the retail column
Physical goods to be included - any inventory owned by the company on the balance sheet date. Name some examples.
a. Goods in transit (FOB Destination) b. Goods on consignment with consignee c. Goods expected to be returned to customers (Inventory - Estimated Returns)
Costs to be included in inventory - any expenditures necessary to acquire inventory and bring it to its desired condition and location for sale or use in manufacturing process. Name some examples.
a. Purchase price of goods b. Freight charges and any associated insurance costs c. Costs associated with unloading, unpacking and preparing inventory for sale d. Purchase returns and discounts (reduce cost)
Cost flow assumption used - assumption about how units flow through inventory (i.e. which units assumed to be sold during the period and which units remain in ending inventory). What are the four types?
a. Specific identification b. Average cost c. First-in; First-out (FIFO) d. Last-in; First-out (LIFO)
examples of purchase commitments
agreements for inventory procurement, tooling costs, electricity and natural gas contracts, property, plant and equipment, and other miscellaneous production related obligations
Cost of Goods Available for Sale =
beginning inventory + net purchases
When LIFO layers are liquidated, earlier costs are matched against term-22_____________________________________
current sales, resulting in distorted income and higher taxes (assuming prices rise over time).
subsequent events
events occurring between the date of the financial statements and the date of the auditor's report
why do we need inventory estimation techniques?
for some retailers taking a physical count can be very costly and labor intensive
how do you calculate cost to retail ratio?
goods available for sale (cost) / goods available for sale (retial) all calculated before net markdowns
This is a departure from the cost basis of reporting ending inventory. The adjusting entry, referred to as an _________________________ , reduces ending inventory and net for the period
inventory write-down
formula for LIFO reserve
inventory(FIFO) - LIFO reserve = inventory(LIFO)
classification issues: Generally, managers would prefer to report obligations as ____________ liabilities rather than ___________ liabilities. This is because ______________________________________________________________________________________________________________.
long-term, current debt that is payable currently is perceived to be riskier than debt that is not payable for some time by external stakeholders such as creditors and shareholders. (think of current ratio = CA / CL)
what are 4 terms we use to describe the change in selling price?
markups, additional markups, markdowns, markup cancellations
markdowns - markdown cancellations =
net markdowns
additional markups - markup cancellations =
net markdowns (self explanatory)
Obligations callable by the creditor should be reported as current in the following 3 situations:
o Debt that is callable by the creditor in the upcoming year o Violation of a provision of the debt agreement makes it callable o Violation is not corrected within a grace period makes it callable
When short-term obligations are expected to be refinanced they can be classified as long-term if the following conditions are met:
o Must intend to refinance on a long-term basis o Must demonstrate the ability to do so by: ▪ Existing refinancing agreement, or ▪ Actual financing prior to issuance of financial statements
Specific goods pooled LIFO
o Similar items are pooled together as a "single" inventory item as long as they are similar items (less record keeping) o A quantity reduction for one item can be offset by increases in other items (LIFO layer liquidations less likely) o Disadvantage: Can be complicated if pools need to be redefined frequently as products are introduced or discontinued -The ending quantity vs. beginning quantity
Dollar-value LIFO (generally used in practice)
o To determine whether inventory layers should be added or removed, we determine whether the dollar value of inventory (adjusted for inflation) has increased or decreased. (In contrast, we focused on changes in physical units of inventory to determine the LIFO layers in unit-LIFO and Specific-goods pooled LIFO.) -The ending dollar amount vs. the beginning dollar amount
MEASUREMENT: Liabilities should be recorded at their _____________ → record the present value of all anticipated future cash payments resulting from the debt (i.e. principal and interest).
present value
goal of all of this unit?
reduce likelihood of LIFO liquidation! Increase tax savings. All about ending quantity vs beginning inventory Ultimate goal achieved by first determining end inventory and COGS
GAAP requires that companies evaluate unsold inventory at the end of each reporting period and adjust the carrying value of inventory when _____________________________________________________________________________ .
the expected benefit of unsold inventory has fallen below its cost.
what is designated market value?
the median of replacement cost, upper limit, and lower limit Median{lower, replacement cost, upper)
if changing from LIFO to FIFO makes costs increase, COGS increases, so what happens to taxes?
there is less taxible income so there is tax savings
Current maturities of long-term debt - long-term obligations are reclassified and reported as current liabilities when ...
they become payable within the upcoming year.
why do we want to minimize likelihood of LIFO liquidation?
to avoid a decrease in COGS thus an increase in income and an obligation to pay more tax.
Market value is replacement cost, and is subject to ________________________ .
upper and lower limits:
how do we calculate LCM upper and lower limits?
upper limit = selling price - cost to sell lower limit = ceiling - normal profit margin
What would be the effect (if any) of applying LCM on an individual item basis on the current period income statement?
write down each product if LCM value is less than cost. EX: (assume that there are 1,000 units of each product in ending inventory): -Write down product 2 by $10 per unit (10*1000 = $10,000 total write down) -Write down product 3 by $2 per unit (2*1000 = $2,000 total write down) DR) Loss or COGS 12,000 CR) Inventory 12,000
When do you write a product down using the LCNRV method?
you write down a product if the NRV<cost. Remember, you original value inventory at cost so you only write down if the adjustment needs to be made
what is a loss contingency? Name some examples.
• An existing, uncertain situation involving a potential loss depending on whether some future event occurs • The circumstance giving rise to the contingency occurred before the financial statement date • Examples: Warranties and guarantees, cash rebates, litigation claims
describe the application of LCNRV and LCM
• Apply to individual items, categories or total inventory • No reversals - once inventory is written down it is never reversed • Write-downs generally included as part of COGS, but should be recorded as a separate loss is substantial and unusual.
Disadvantages of LIFO
• Costlier to implement (more record keeping) • LIFO generally yields lowest net income for financial reporting (LIFO Conformity Rule) • Under LIFO, ending inventory is understated relative to current costs (companies required to disclose difference between LIFO ending inventory and current cost) • LIFO involuntary liquidations
INVENTORY, What is it?
• Finished goods held for sale in the ordinary course of business • Goods held or consumed in the production of finished goods (i.e. raw materials, work in process)
Important notes about subsequent events. What do we do if the claim existed before and after the accounting period ends. Before or after we issue financial statements?
• If information becomes available that sheds light on a claim that existed when the fiscal year ended, that information should be used in determining the probability of a loss contingency materializing and in estimating the amount of the loss. (in financial statements) • For a loss contingency to be accrued, the cause of the contingency must have occurred before the accounting period ended. • Sometimes a loss contingency occurs after the end of the year but before issuance of financial statements. In this situation a liability cannot be accrued because it did not exist at the end of the year. However, the situation should be described in a disclosure note, including the effect of the possible loss on accounting numbers.
What is the LIFO reserve?
• In practice, most companies use a non-LIFO basis (generally FIFO) for internal reporting of inventory costs. • An Allowance to Reduce Inventory to LIFO (LIFO Reserve) is used to reduce the cost to a LIFO basis. the difference between the value of the inventory under LIFO and the value under FIFO
explain the lower of cost or market (LCM) method. how is inventory valued?
• Inventory is valued at whichever is lower: its original cost or its "Market" value
explain the lower of cost or net realizable value (LCNRV) method. What does net realizable value (NRV) equal?
• Inventory is valued at whichever is lower: its original cost or its net realizable value • Net Realizable Value (NRV) = Estimated selling price - cost of completion/disposal/transportation • If Cost > NRV at year end → Make an adjusting entry to reduce the inventory value to its NRV
Advantages of LIFO
• LIFO matches more recent costs with current revenues (better measure of income) • LIFO generally yields lowest taxable income • Cash flow is improved because of reduced taxes • Write-down of inventory to market less likely (because carried at lower cost)
Current Liabilities
• Liabilities expected to be satisfied with the current assets or the creation of other current liabilities. Generally, obligations payable within one year or within the firm's operating cycle. • Classification is important because it helps users of financial statements assess the risk that liabilities will require use of cash or other assets in the near term, which in turn may reduce the amount of liquid funds available for other uses. EX: A/P, Accrued Expenses, Taxes Payable, etc.
Merchandising versus Manufacturing
• Merchandising - purchase finished goods for resale • Manufacturing - Raw Materials, Work-in-Process, Finished Goods -We will focus on Merchandising for class examples
Perpetual versus Periodic
• Perpetual system maintains continuous record of inventory changes • Periodic system updates inventory records on a periodic basis -We will focus on Periodic for class examples
What do you change when using prospective approach?
• Prior years' statements are not revised. • Account balances are not revised.
What do you change when using the modified retrospective approach?
• Prior years' statements are not revised. • Adjust the beginning balance of retained earnings in the adoption period to reflect the effects on prior periods.
AAP requires that the likelihood that a future event will confirm the incurrence of the liability be categorized as probable, reasonably possible, or remote. Describe what each of those terms means?
• Probable - confirming event is likely to occur • Reasonably possible - the chance the confirming event will occur is more than remote, but less than likely • Remote - the chance the confirming event will occur is slight
What do you change when using retrospective approach?
• The balance in each account affected is revised to appear as if the newly adopted accounting method had been applied all along or that the error had never occurred. • Adjust the beginning balance of earliest presented retained earnings to reflect the effects on prior periods.
Conventional Retail Inventory Method
• Used by high-volume retailers selling many different items at relatively low prices. • Principal benefit is that a physical count of inventory is not required to estimate ending inventory and COGS. Under RIM, inventory cost and the resulting gross margins are calculated by applying a cost-to-retail ratio to the inventory retail value. RIM is an averaging method that has been widely used in the retail industry due to its practicality.
Change in Accounting Principle: Replaces one GAAP rule with another GAAP rule What are the 2 reasons for a change in ACTG principal?
▪ Changes mandated by FASB (i.e., adoption of new standard) o Usually implemented using retrospective approach, but modified retrospective or prospective approach are sometimes allowed ▪ Voluntary changes (i.e., change in inventory costing method) • Usually implemented retrospectively
describe the Correction of Accounting Errors
▪ Errors occur when a transaction is recorded incorrectly or not at all ▪ Examples: math mistake, recording asset as expense or vice versa, inaccurate inventory count
Change in Accounting Estimate examples
▪ Examples: Future warranty estimates, change estimate of useful life or salvage value of depreciable asset, change estimate of bad debt % ▪ Accounted for prospectively
Prior period adjustments for material errors:
▪ Required when a material error is discovered in the statements that have been published and distributed to shareholders ▪ Accounted for retrospectively ▪ In addition to retrospectively correcting the current year financial statements, prior year financial statements affected by the error must be retrospectively restated and reissued ▪ A disclosure note communicates the impact of the error on prior periods' net income
