ACC 301 Exam 1

Accrual Basis

• Recognizes revenue when performance obligation is satisfied

• Recognizes expenses in the period incurred

• No regard to the time of receipts or payment of cash

Cash Basis

• Revenue is recognized when cash is received 

• Expenses are recognized when cash is paid

Adjusting Entries never include:

cash accounts

Inventory

• Assets that a company holds for sale 

• what you sell

Merchandisers

• Sells finished goods

• Sells inventory

Inventory Account

• Raw materials

• Work in process

• Finished goods

Periodic Inventory System

• Debits purchases (on account —> accounts payable)

• Credits Cash (on account —> sales revenue)

• Company determines the quantity of inventory on hand only periodically 

• Only record revenue, NO COGS

  • Adds the COGS using inventory information at the end of the accounting period

Calculating COGS with ending inventory: COGS =

Ending inventory - cost of goods available for sale

Perpetual Inventory System

INVENTORY

Can calculate ending inventory whenever 

• 2 entries for every sale

  • Sales revenue, COGS, reduce inventory

Gross Profit =

Net sales - COGS

COGS

• Beginning inventory + cost of goods purchased - ending inventory

• Expense account

• Expense of selling inventory

Cost

amount spent to acquire asset

Expense

cost used to generate revenue

Demand

• Behavior of a consumer

• How much a consumer wants a product

Returns

• Use contra account to track purchase returns

• For each entry flip the debits and the credits

Allowance

Customer keeps the goods but there is a discount for damage or defect in the goods

Trade Discount (no journal entry needed)

• Avoid frequent changes in catalogs

• Alter prices for different quantities purchased

• Hide the true invoice price from competitors

Sale or Cash Discount (journal entry needed)

• Deduction from your sales 

• Recorded by both buyer and seller

• Credit Terms

Net Method

• Recording after the deduction of sales discount

• Making the assumption that the customer will pay within __ days 

Cost Flows Assumptions of Inventory

• COGS

• Ending Inventory

Cost Flow Assumptions

• No requirement that the cost flow assumption adopted be consistent with the physical movement of goods

• FIFO

• LIFO

• Weighted Average Method

Specific Identification Method

• Cost flow matches the physical flow of goods

• Know exactly which item we are selling

• Identifies specific cost of each item sold and each item left in inventory

• Relatively small number of costly, easily distinguishable items

LIFO

• Latest goods purchased are included in COGS

• Used when price level is going up

• produces a raw net income which means less tax

Income Tax Effects

• In periods of rising inventory costs, FIFO results in higher income taxes

• Higher tax payments reduce cash flows

• Lower income taxes owned translates to true cash savings

Earnings Impact

• In periods of rising inventory costs, FIO results in higher reported earnings which is pleasing to investors and the company’s stock price

• LIFO results in lower reported earnings which may not be pleasing to investors and may negatively impact the company’s stock price

Income Statement Effects: in periods of rising prices:

• FIFO reports the highest net income

• LIFO lowest net income 

• Average cost falls in the middle

Income Statement Effects: in periods of decreasing prices:

• FIFO will report  lowest net income

• LIFO reports highest

• Average cost in the middle

Balance Sheet Effects

• FIFO —> approximate current costs

• LIFO —> significantly understated

Tax Effects

• FIFO —> higher inventory & net income —> higher taxes

• LIFO —> Lower net income —> lower taxes

  • prefered

LIFO Reserve

Companies that use LIFO for tax and external reporting purposes often maintain a FIFO or average-cost system for internal reporting purposes

Liquidation

getting rid of inventory

LIFO Liquidation

• Liquidating older LIFO inventory

• Occurs when current sales exceed purchases resulting in the liquidation of any inventory not sold in a previous period 

• Used during periods of inflation when the cost to purchase inventory increases over time

Working Capital Equation

= Current assets - current liability

Dollar Value LIFO

• increases your COGS

• convert EI to base year prices

Net Realizable Value

• Net amount that a company expects to realize from the sale of inventory

• Estimated selling price in the ordinary course of business - reasonably predictable costs of completion, disposal, and transportation

Net Realizable Equation

= Sales price - estimated cost of completion and disposal

Conservative

if you sense loss immediately record it

Cost

Acquisition price of inventory computed using one of the historical cost-based methods

A company abandons the historical cost principle when…

the future utility (revenue-producing ability) of the asset drops below its original cost

Final Inventory Value (LCNRV) is the…

lower of A and B

Cost of Goods Sold Method

• Debits COGS for the write-down of the inventory to NRV

• Company doesn’t report a separate loss in the income statement because the COGS already includes the amount of the loss

• COGS   xxx

  • Inventory   xxx

Loss Method

• Debits a loss account for the write-down of the inventory to NRV

• Loss of Inventory   xxx

  • Inventory         xxx

    • This method is better

LCM: Net realizable value or ceiling

= sales price - estimated cost of completion and disposal

LCM: NRV

Normal profit margin or floor

LCM: Designated Market Value

select the middle value among a, b, and c

LCM: Final Inventory Value

Lower of D and E

Profit Margin =

Net income / sales

Estimating Ending Inventory: Gross Profit Method

1. Gross Profit = net sales - COGS

2. Gross Profit Rate → rate on sales

   1. Gross Profit / sales

3. Sales = GOGS + GP

Estimating Ending Inventory: Retail Inventory or Conventional Retail Method

1. Retail → at selling price

2. Cost to retail ratio 

2. LIFO Retail Method

Cost to Retail Ratio

= (cost of goods available for sale / sum of original retail price of goods) + net markups

• Includes markdown and markups

Retail Inventory Method Steps

1. Format

2. Compute EI at retail

3. Compute cost-to-retail ratio

4. Cost EI = EI (Retail) x cost-to-retail ratio

Net Purchases =

purchases - purchase returns

Conventional Retail Inventory Method

• Lower of cost or market approach

• Doesn’t include net markdowns

  • Stops CGAS calculation after net markups

LIFO Retail Method

• Tax advantages

• Results in a better matching of cost and revenues

Depreciation Expense

Allocate cost of assets over useful life

PPE

• What you need to make what you sell

• not for resale

• Depreciating asset

• Possess physical substance

Investments

Buying stock/bonds in another company/corp → dividends

Historical Cost

• How much did you pay for it?

• Basis for valuing PPE

• Acquisition price + sales tax

• Costs incurred bringing the asset to its location and getting it ready for use

  • Freight/shipping costs

Land

• Investment not PPE

• Resale —> classified as inventory

Capitalization

• recording as an asset

• Capitalize all costs until your asset is ready for use

Cost of Land

• Purchase price 

• Closing cost

• Costs incurred in getting the land in condition for its intended use such as grading, filling, draining, and clearing

• Assumption of any liens, mortgages, or other encumbrances on the property

• Any additional land improvements that have an indefinite life

Land Improvements

• Structural additions with limited lives that are made to land

• Depreciated (limited life)

Lump Sum Purchases

• Company purchases a group of assets at a single lump sum price

• Company allocates the total cost among the various assets  on the basis of their reactive fair value

Book Value

• Amount recorded in the balance sheet of the seller

• Lower-of-cost or market

Issuance of Stock

• The market price of the stock issued is a fair indication of the cost of property acquire

• The stock is a good measure of the current cash equivalent price

Interest Expense/Cost

• Cost of using someone else’s money

• Must have debt/borrowings to have interest cost

• Capitalize whichever is less (actual/avoidable)

• Can’t capitalize more than the actual interest cost

Actual Interest Cost

Loans x rate of interest

Avoidable Interest Cost

• How much interest cost you could have avoided if you didn’t have the project

• Weighted average accumulated expenditure x interest rate

Capitalize

Increase the cost of your asset

Capitalize Interest

• To capitalize interest companies must:

  • Qualifying assets

    • Asset must require period of time to prepare them for their intended use 

  • Capitalization period

    • Period of time during which a company must capitalize interest 

  • Amount to capitalize 

    • Limited to the lower of actual interest cost incurred during the period of avoidable interest

Borrowings

• Must have one or both to have interest cost

• Specific borrowing

  • Self construction, building, etc. 

  • Specific projects

• General borrowing

Accounts Payable

• from purchases

• no interest

Notes Payable =

Principle + interest

Interest Equation

Principle x rate x time

Weighted Average Accumulated Expenditures =

expenditures x time

Weighted Average Interest Rate =

total interest / total principle

Depreciatable Cost =

Original cost - salvage value

Moving Average Cost

recalculate average cost of inventory currently on hand each time a purchase occurs

Units Only Average Cost

calculate one average for all purchases —> apply it to ending units

Dollar Perpetual Average Cost

Recalculate the average after every purchase —> use that average for the next withdrawl

Lowest COGS =

highest gross profit

Gross Profit Rate

Rate on sales

What does an increasing ending inventory mean?

We did sell all of the goods we purchased

Monetary Exchange

• Received 100% in cash 

Nonmonetary Exchange

• Cash is not a significant amount in the exchange 

Commercial Substance

• When the future cash flows change as a result of the transaction

  • When the two parties economic positions change

Exchanges: If cash is 25% or more of the fair value of the exchange

recognize entire gain because the earnings process is complete

Exchanges: Exchange has commercial substance (dissimilar)

recognize gains and losses immediately

Exchanges: Exchange lacks commercial substance (no cash received) (similar)

defer gains, recognize losses immediately

Exchanges: Exchange lacks commercial substance (some cash received (insignificant amount)) (similar)

recognize partial gain, recognize losses immediately

Dissimilar & Similar

Dissimilar: different in producing cash

Similar: no significant difference

Recognized Gain =

= (cash received / (cash received + fair value of other assets received)) x total gain

Depreciation Expense & Equation

• Allocation of cost of tangible assets

= (Cost - Salvage Value) / Total Estimated Activity

Book Value Equation

= original cost - accumulated depreciation

Inventoriable Cost

Any expense incurred to produce or acquire a product that is capitalized as an asset on the balance sheet

• Only expensed as COGS when the item is sold

• = direct materials + direct labor + manufacturing costs + freight-in