Accounting 2051 UMN Exam #2

For calculating gain or loss

Find net book value (historical cost - accumulated depreciation)

Gain on selling an asset

When the cost you sell it at>NBV

Loss on selling an asset

When the cost you sell it at

Net book value

historical cost - accumulated depreciation

Depreciation charge

(cost-salvage value)/estimated life

Depreciation

The application of the matching principle to long-lived assets

Cost to be allocated for depreciation

Historical cost - salvage value

Impairment

Reflect markdown in fair market value

Fraud example

Did not book expenses immediately, instead pushed them into the future

Impairment

GAAP requires that you only mark down you can never mark upward revisions

Balance sheet approach

Gross A/R ending balance x % of A/R uncollectible; Uses aging analysis; Larger % are applied to older accounts i.e.

Income statement approach

Credit sales x % of sales uncollectible; Uses discretion; the value of A/R does not change as a result of writing off an account; No direct I/S effect

JE for impairment PP+E

Dr. asset impairment loss (IS/SE)

Cr. PP+E (A)

JE for impairment accumulated depreciation

Dr. asset impairment loss (IS/SE)

Cr. accumulated depreciation (XA)

Impairment loss

Net book value - fair market value; When impairment is recorded, the depreciation charge must be adjusted.

JE for credit sales

Dr. A/R (A)

Cr. Sales (IS/SE)

JE for uncollectible money

Dr. bad debt expense (IS/SE)

Cr. allowance for doubtful accounts (XA)

JE for write-off

Dr. allowance for doubtful accounts (XA)

Cr. A/R (A)

JE for receiving uncollectible cash

Dr. A/R (A)

Cr. Allowance for doubtful accounts (XA)

Goodwill cost

Acquisition price - fair value; the ultimate intangible asset; recorded ONLY when an entire business is bought

JE Goodwill

Dr. goodwill (A)

Dr. Assets (A)

Cr. liabilities (L)

Cr. Cash (A)

JE Goodwill impairment

Dr. Goodwill impairment loss (IS/SE)

Cr. Goodwill (A)

Return on equity

Net income/average stockholders' equity; indicates how much income was earned for every dollar invested by the owners; ROE can be high because of high net income and/or low shareholders' equity - if low shareholders' equity, companies may be relying on debt financing (bank loans) to increase their ROE. Debt financing is risky because failure to pay debt can have legal consequences.

Return on assets

net income/average total assets; Measures the return on investment for the company without regard to how it is financed (could be from debt or equity). ROA for performance measurement looks at the returns that managers achieve from the invested capital under their control.

Net profit margin

net income/net sales revenue; Tells us the % of each sales dollar, on average, that represents income. The median for publicly traded firms is about 7 to 7.5 cents per dollar of sales generated.

Net profit margin is impacted by

the level of gross profit, the level of expenses, the level of competition and the company's willingness and ability to control costs.

Earnings quality

cash flows from operating activities/net income; a ratio higher than 1 indicates high-quality earnings. Basically how easily is cash being generated.

Total asset turnover

net sales revenue/average total assets; This ratio captures how well a company uses its assets to generate revenue. Measures the productivity of a company's assets. Reveals the level of sales a company realizes from each dollar invested in assets. All things equal, a higher asset turnover is good. A company can increase its asset turnover by increasing sales volume with no increase in assets, and/or by reducing asset investment without reducing sales.

Debt-to-equity ratio

total liabilities/stockholders' equity; This ratio measures the amount of liabilities that exists for each dollar invested by owners - how reliant the company is on debt financing relative to equity financing. Ratio is used to measure solvency. Solvency is crucial since an insolvent company is a failed company. A higher ratio indicates less solvency and more risk. Median for publicly traded companies is 1.5.

Solvency

the ability of a company to meet its debt obligations

Another way to calculate ROA

net profit margin x total asset turnover