Flashcard Assets, Inventory and Investments | Quizlet

What is an asset?

It is a present economic resource held by the entity as a result of a past event, this economic resource can potentially produce future economic benefits.

Past event, present control of resource, future economic benefit

What are current assets?

They are assets that are expected to be realised, sold or consumed within the entity's operating cycle, are held primarly for trade, are expected to be realised within the balance sheet date, cash or cash equivalent not restricted in its use.

Fixed assets (for the EU) are the ones that are intended for continuing use in the business.

How many types of assets are there?

There are 3 major classes of assets: tangible, intagible and monetary

What are tangible assets?

They are assets referred as "Property, Pland, Equipments" PPE. They are held for use in the production of goods and services or for administration for more than one accounting period.

Investment properties (lands and buildings) rented out to another company or goods to be sold (inventory) are not part of tangible assets.

What are intangible assets?

They are harder to recognise: they hvae no physical substance but are "identifiable", such as securities.

Goodwill is not an intagible assets because it does not have a physical substance BUT it is not "identifiable"

What are monetary assets?

They are cash, securities & receivables

What are some recording issues of assets?

They relate to how to recognise specific assets, mainly tangible assets and leased assets; and how to record the value of each assets, which is usually affected by cost depreciation, impairment and measurement of fair value.

How do we recognise intangible assets?

They are assets held by the company which will provide future benefit without any physical substance BUT are "identifiable".

What does "identifiable" mean related to assets?

It means that they can be separated from the entity (sold or licensed) or that they arise from legal or contractual rights.

What are some intangible assets?

Brand names, patents and trademarks, copyright, software, customer lists and goodwill (but only if purchased)

Are purchased intagibles easier to recognise than internally generated intangibles?

Yes, they are easier to recognise and measure

What is goodwill?

It is a premium paid in a business acquisition which is above the identifiable net assets: it is bought because it recognises useful features such as loyal customers and trained staff.

I buy a company for 5M but its identifiable assets are worth 4M, the additional 1M is the goodwill.

It basically is something that will generate more profit in the future than simply acquiring the company itself.

How do we recognise leased assets?

Leased assets are made out of lease, a contract in which the lessee has the right to control and use an asset in exchange for a payment. The lessor is the one who own the asset (financial company), the lessee is the one who uses it (industrial firm)

Why are leased assets preferred?

They are preferred because they give liquidity advantage since there is no upfront payment, and because of the tax benefit since it usually reduces taxable income

What happens to leased assets under the IFRS?

They are capitalized, like all assets, on the lessee's balance sheet if the asset is controlled, which makes it similar to buying borrowed funds

How are assets recorded?

Assets are initially recorded at cost, but leater are measured using a mixed model based on the asset type. This happens because the assets are expected to: either wear out gradually (depreciation or amortization) or lose value suddenly (impairment)

What are depreciation and amortization?

They are the allocation of an asset's cost over thieir economic useful life: depreciation for tangible assets and amortization for intangible assets.

They do not mean a loss of value: it is planned and it does not necessarily mean a decline

What is impairment?

It is the sudden or permanend loss of value. When the loss goes below the recoverable amount it needs to be recorded.

It is due to: physical damage or economic obsolence.

It is not normal depreciation and it is recorded in the income statement.

Unde the IFRS, the carrying value is important and to it the recoverable amount is subtracted

Where are amortization, depreciation and impairment recorded?

Since they are expenses of the year, they are recorded in the income statment

What happens to land, buildings & machinery, intangible assets and all assets in general?

Land does not wear out so it remains at historical cost, buildings & machinery are depreciated over their useful life, intangible assets are amortizated over their useful life, and all assets are subject of impairment

Why does depreciation happen?

It happens because tangible assets wear out or become outdated due to: physical detoriation and economic obsolence

What is depreciation NOT for?

It is not a valuation tool: NBV and market value are different, NBV is unallocated costs. It is not a replacement tool: it cannot create cash, but only affects the reported profit. It doesn't affect taxes, it's only used for financial reporting BUT in countries like Italy or France it is used for tax purposes

How are assets depreciated correctly?

The way they are depreciated varies from assets to assets. The most common depreciated assets are leases, patents and buildings

How do you depreciate lands, building and patents?

The most common way is throught the straight-line/constant charge method in which there is a constant depreciation for the whole useful economic life of the asset (10.000 euros for 5 years = 2.000 of depreciation every year).

How do we depreciate tangible assets that are in need of increasing repair and maintenance?

We use the declining charge method, that is used when there is need for increasing maintenance. There are three types: constant percentage, sum of digits and double declining balance method

How do we depreciate tangible assets that wear out in proportion of their use?

They are depreciated using the usage methods, which calculates only the amount that asset has been used (cost 20.000 total hours that can be used 10.000, only used for 2.000 hours = depreciation for that year 4.000)

What is the revaluation method?

The revaluation method is another depreciation method: instead of allocating fixed costs, the asset class is regularly revaluated.

At the start of the year, value the entire group of similar assets, add new purchase happened during the year, subtract the end of the year valuation and from that you find the depreciation

What is the mostly used depreciation method?

It is the straight-line method because it is faster

What are some issues that come from depreciation?

The first issue is its useful economic life in which sometimes is underestimated or aligned with tax lives and leads to an asset still in use but fully depreciated.

Another one is the residual value & disposal, usually it is assumed there is no residual value but if there is it must subtracted from the cost.

Lastly are mid-year purchases, which need to be either proportional or 100% but MUST be consistent

What is fair value?

It is the current valu of an asset, it can be revalued both above and under costs.

It has 3 major problems: where is the revaluation recorded? In OCI

Should we calculate depreciation on revalueted assets? Yes

How do we measure gain on sales? By subtracting NBV from Proceed on Sales

It is mainly used in investment properties related to rental purpose

What happens to assets revalued before sales?

Part of the gain goes in the OCI, the rest in the Income Statement

What is the inventory?

It is goods for sale or used in production, which are classified as current assets.

Those goods can be sold in the year after by the company. Their valuation affect liquidity, performance metrics & financial ratios (current ration, invenotry turnover).

How many categories of inventory are there?

There are 3 categories: raw material, which are items yet to be manufactured, work in progress, which are items being manufactured, and finished goods which are items ready to be sold

How do we count the inventory?

It can be counted using 2 main methods: the periodic count, which includes regular intervals (usually at the end of the year) to count the inventory, it is best for small businesses, if it is done too often becomes too expensive; the other is the perpetual inventory, with real-time tracking of purchase and sales, and occasional physical check. It is best for large business with dygital systems

How is inventory valued?

The inventory is valued based on entry cost/historical cost for raw materials that are being transformed, and exit value for finished goods when they are sold.

The IFRS asks to evaluate the inventory at the lower of historical cost & Net Realisable Value (NRV) calculated item by item

What is the entry/historical cost?

It is one of the most common evaluation method for the inventory, it takes into consideration the amount the company paid when acquiring or producing the goods in the inventory

What are the possible issues to the inventory?

The possible issues are how to assign costs to Work in Progress items in the inventory, and how to allocate indirect overhead (indirect costs e.g. utuilities, depreciation).

In this case, approximation and assumptions is best, including production overhead but NOT including admin and selling overhead

What is the cost of goods sold (COGS)?

It is one of the evaluation method of the inventory, which includes the cost paid by the company to purchase and sell the goods for a certain period of time. It includes raw material, direct labour, production costs (electricity) and freight-in (cost of bringing the goods in the factory)

What are the inventory cost flow methods?

They are 4 methods that can be useed to calculate the cost of the inventory when taking into consideration the historical costs. They are ONLY accounting assumption, they do not affect the physical stock but only the cost value in the bookds.

They are: unit cost, FIFO, LIFO, and weighted average

What is the unit cost?

It is one of the inventory cash flow methods in which the cost of the inventory is calculated by tracking the actual cost of each unit individually. It is best for unique and high-value goods

What is FIFO?

FIFO means first in first out, it is one of the invenotry cost flow methods in which the first goods brought into the inventory are recorded as COGS first. It is best for items that are easily perishable or that rotate quickly

What is LIFO?

LIFO means last in first out, it is one of the inventory cost flow methods in which the last items brought inside of the inventory are the first ones to be recorded as COGS. It is best used for similar items

What is the weighted average cost?

It is one of the inventory cost flow methods in which an average cost of all units in stock is calculated. It is best when there are large volumes of similar items.

What are the methods allowed by IFRS in the evaluation of costs for the inventory?

Only FIFO and weighted average cost are allowed, with LIFO there is too much of a loss

What are other methods that can be used to evaluate the inventory based on the entry values?

There 5 additional methods: the standard cost method, the base inventory method, the retail inventory method, the gross profit method & the current replacement cost

What is the standard cost method?

It is one of the evaluations methods based on entry value for inventories, in which a predetermined cost is used for each level of production to simplify bookkeeping

What is the base invenotry method?

It is one of the evaluations methods based on entry value for inventories, in which there is the assumption that there always is a minimum inventory level (base stock) required for operations

What is the retail inventory method?

It is one of the evaluations methods based on entry value for inventories, in which cost of the inventory is calculated by using the cost-retail price ratio. It is best for thousand, small moving items, such as the ones in supermarkets

What is the gross profit method?

It is one of the evaluations methods based on entry value for inventories, in which inventory is calculated by using the historical gross-profit margin

What is the current replacement cost?

It is one of the evaluations methods based on entry value for inventories, in which the inventory is calculated based on how much it would cost today to replace it

What are other methods that can be used to evaluate the inventory based on the exit values?

There are 3 additional methods used to evaluate inventory based on exit values: discounted money receipts, current selling price/fair value and net realisable value (NRV)

What is the discounted money receipt?

It is one of the evaluations methods based on exit value for inventories, in which we evaluate the inventory based on the present value of future cash inflows from selling the inventory (it is a discounted future price). It is rarely used

What is the current selling price?

It is one of the evaluations methods based on exit value for inventories, in which the inventory is evaluated by using the price for which it could be sold for today

What is the net realisable value?

It is one of the evaluations methods based on exit value for inventories, in which we evaluate the inventory by taking into consideration the estimated amount a company expects to receive from selling it, minus all the costs related to finishing and selling it

What are financial assets?

Financial assets are contractual rights to receive cash or other financial assets from another entity, they are of financial nature.

They can be classified as: cash adn receivables, investments, equity and liabilities

What is cash

It is a financial asset which can be recognised either by having it at hands or in the bank. It is evaluated at face value (original stated value in the certificate). Its main potential issue is how to distinguish it from investments: based on the IFRS, cash equivalent are investments up to 3 months of maturity that are convertible to a known amount of cash

What are receivables?

They are financial assets: contractual rights to receive a certain amount of cahs ona a particular date.

They can be current or non-current: current receivables have the date which is less than 1 year, non-current receivables have the date which is more than 1 year.

Its value is calculated by subtracting from the amount expected to receive, the allowance for any possible nonpayments

How can allowance/impairment for doubtful debt can be?

They can be: specific, if we know there are debtors who are not going to pay (bankruptcy) or general, in which we calculate a percentage based on last year experience

How do we value allowance/impairment due to bad debts?

Based on the IFRS, they are valued using the incurred loss model, in which we take account of possible bad debts.

The potential issue is that in some countries allowance are tax deductible income, so some companies might overstate their bad debts to reduce taxable income.

Allowance/impairment are NOT at face value, but rather at fair value discounted to the present value

What is the difference between allowance/impairment and provision/reserves?

Allowances are adjustment of asset value, while provisions are recognition of a liability for future ourflows (e.g. future lawsuits)

What are investments?

Investments are financial assets: securities in form of debt or equity

What are investments debt securities?

They are loans or bonds issued by a company or governments, in which the investor becomes the creditor. He has fixed interests as returns with a specific maturity date. There are less risks, since the priority is repayment but there is no control whatsoever on what the company does (voting rights).

What are investment equity shares?

They are ownership share of the company, the investor becomes one of the shareholders who then receives part of the dividends and capital gain in return. There are more risks, since in case of liquidation there are lower claims, but has more control on what the company does (voting rights).

How are investments classified?

They are classified as current or fixed: the current one are held for short-term (such as for trading or sales), the fixed ones are held for long-term (such as for strategic or steady income).

The main issue is that this classification is arbitrary: it is depends on the management's intent, and it can affect the company's liquidity, profitability and overall stability interpreted

How are investments valued?

They are mainly valued at fair value, except for fixed investments which are at historical value (IFRS)

Where do we account for gains and losses of investments?

For traded financial instruments, they are accounted in the income statement and the profit and loss statement; for the non-traded financial instruments, they are accounted in the OCI

What are liabilities?

Liabilities are present current obligations to transfer an economic resource as a result of a past event. They basically are what the company owes, either in cash or service.

There are 3 categories of liabilities: payables, provisions and contingent liabilities

What are payables?

They are liabilities: amount legally owned by the company to another entity (supplier, banks).

They can be current or non-current: debenture loans are long-term loasn with a fixed interest rate, accruals are expenses incurred but not paid within the year-end, such as utilities used in december but paid in january, and incurred income is cash received in advance for goods not yet delivered.

They are valued at face value or based on interest

What are provisions?

Provisions are liabilities of uncertain amount or timing: we know we will need to pay for them but do not know how much.

They are pensions, estimated future amount to pay to employees, and taxes, in which he finalized amount to pay is not sure.

How are provisions valued? And what is their main issue?

They are valued at the "best estimate" and the costs settle at the balance sheet date.

Its main issue is whether restructuring is or not a provision: the IFRS requires a note disclosure in case it is announced or started by the time the financial statements are authorized

What is a contingent liability?

It is a less than probable payment due (in this case it is NOT a provision), such as guarantees for another company's debts.

Under the IFRS, they are reported in the notes

What is equity?

It is the company's value that belongs to the owners. Its equation shows how much the company owns, owes and how much the owners own.

How many components is equity made up of?

It is made up of 5 components: subscribed capital, share premium, revaluation reserve, legal reserve and profit or loss reserve

What is subscribed capital?

It is the money invested by shareholders, he part of equity which comes from issuing shares. It is divided in ordinary shares and preference shares

What is the difference between ordinary and preference shares?

Ordinary shares are standard equity shares: they are last in line if the company is liquidated and entitled only to leftovers after all the other obligations are met.

Preference share have special rights, they are divided in: cumulative shares, which are carried forward if dividends are not paid one year, and redeemable share, which can be bought back by the company

How do we evaluate shares?

We multiply the number of shares with the nominal value. The nominal value is the face value per share, NOT the market value

What are some special cases related to shares?

There are 3 special cases: issued but unpaid shares, to which the payment has been delayed but it still count as part of the subscribed capital; share-based payments, issued to employees as payment and/or incentive; and treasury shares, which are shares bought back and then held by the company, they show as negative equity until re-issued or cancelled

What is share premium?

It is the additional amount paid for shares when they are issued. There are some legal restrictions, such as the fact that it cannot be used for dividends

What is the revaluation reserve?

It is an increase in the assets value. They are shown in the OCI and are NOT distributable until they remain unsold

What is legal reserve?

It is the portion of reserve required by law. This portion of profit is not ditributed to shareholders but used as protection for creditors. It is required in many countries, mainly continental Europe

What are profit or loss reserves?

They are retained earnings, meaning profits that have not been distributed nor allocated to other reserves in the past

What is the difference between provisions, reserves and allowances?

Provisions are estimated liabilities, reserves are part of the equity, and allowances are expected loss on receivables