Accounting exam 2

3 accountable events

account for acquiring

account for depreciation

account for sale/disposal

acquiring asset cost

cost+sales tax+shipiing+installation+repair costs+assembly costs+fees

(all costs to get the asset up and running)

capitalization

a cost is capitalized when it is recorded as part of an asset on the balance sheet rather than as an expense on the income sheet

(recurring costs like repairs are an expense)

lump sum

when a company purchases more than one asset for one lump sum amount

• need to determine the cost assigned to each individual asset purchased

Depreciation

the systematic allocation of the cost of a plant asset (buildings and equipment) to expense over its lifetime

The “using up” of a building + equipment and becomes an expense

DUE TO THE MATCHING CONCEPT

what to debit/credit when doing depreciation

debit depreciation expense

credit accumulated depreciation

depreciation expense account

found on income statement

reduces net income

represents the amount of building or equipment ‘used up’ in the current year

accumulated depreciation account

causes a decrease in assets

classified as a contra asset account

found on balance sheet directly under the asset being depreciated as a decrease

how to calculate the book value

cost of asset - accumulated depreciation = book value

straight line method

depreciation expense = (cost - salvage value) / life in years

same amount every year

assumes an equal using up of the asset over time

sum of the years digits method

accelerated depreciation method

more depreciation in early years and less depreciation in later years

depreciation expense = (cost - salvage value) (life / SYD)

Double declining balance depreciation

accelerated depreciation method

more in early life and less in later life

based on book value

double declining balance = book value at beginning of year (2 / life)

salvage value is ignored

what happens when a change in estimates are made

no corrections or changes made to previously recorded a depreciation expense

new estimate incorporated in current and future years

gain

if cash received from the sale is greater than the book value

recorded as a revenue

loss

if cash received is less than the book value

recorded as an expense

statement of cash flows

shows the changes in cash for the same period of time as covered by the income statement

• shows cash receipts (inflows)

• shows cash payments (outflows)

NOT BASED ON ACCRUAL ACCOUNTING

operating activities

(income statement)

cash in/out flows of normal business operations

ex

• sales of goods/services

• interest / dividends received

• to supplies for inventory

• to employers for salaries

• to gov for taxes

• to lenders for interest

• to others for expenses

investing activities

(long term assets)

cash in/out flows related to the purchase and sale of long term assets and investments

ex

• sale of PPE

• sale of intangibles

• sale of investments

• purchase PPE

• to acquire intangible

• to purchase investments

financing activities

(bank / stockholders equity)

cash paid or received from owners / creditors

ex

• selling common stock

• from borrowing money (bank loan)

• to stockholders as dividends

• to creditors as payment of PRINCIPLE of funds borrowed (not interest)

examples of noncash revenues/expenses

depreciation expense

gains

losses

cash flow analysis (to be a good company):

• needs to have a positive net cash flow from operating activities

• company should have a negative net cash flow from investing activities

• the cash flows from financing activities can be positive or negative

how to calculate net cash flow from operating activities

cash receipts - cash payments = net cash flow from operating activities

current assets

assets expected to be converted to cash within one year from the balance sheet date

internal control system

a set of policies and procedures established by the company to provide reasonable assurance that the firm’s objective will be met

segregation of duties

ensures that more than one person is involved in a transaction from beginning to end

requires that no single employee be given too much responsibility over business transactions

3 segregation of duties roles

Authorization: approving transactions and decisions

Recording: maintaining journals and ledgers

Custody: handling cash, maintaining an inventory store room, receiving incoming customer checks, writing checks on the organization’s bank account

collusion

when two or more people work together to commit fraud

sales discount

offer of a cash discount to a credit customer for the prompt payment of a balance due

ex 3/10, n/30 “three ten net thirty”

this means a 3% discount is allowed on all payments made within 10 days of purchase. After 10 days, there is no discount available, and the remaining balance is due within 30 days of purchase

contra revenue account

bad debt expense

• not all customers pay their bill

• recorded in the same year the credit sale is made → MATCHING CONCEPT

• must be estimated

• expense account

• found on income statement

• reduces net income

allowance for bad debts

• decrease in assets

• classified as a contra asset account

• normal balance in credit

• on balance sheet, found directly under accounts receivable as a decrease

• represents the amount of accounts receivable the company estimates it will not collect

write off

represent the actual bad debts of the company

• does not effect bad debt expense

• no effect on the net realizable value

Aging method

used to estimate bad debt each year

analysis of accounts receivable balances by the length of time they have been unpaid - longer = less likely to be paid (aging schedule)

FIFO

• first in first out

• the oldest inventory items are sold first

• the oldest inventory costs make up the cost of goods sold on the income statement

• ending inventory are the newest inventory

assuming costs increase over time:

• shows the highest net income (oldest costs are cheapest)

• shows the highest assets (newest, most expensive, ending inventory)

• Shows ending inventory at its most current acquisition cost (ALWAYS FIFO)

LIFO

• last in first out

• the newest inventory items are sold first

• the newest inventory costs make up the cost of goods sold on the income statement

• ending inventory consists of the cost of the oldest inventory items purchased

Assuming costs increase over time:

• gives an income tax advantage (higher expense, lower net income)

• shows the lowest assets (oldest, least expensive, ending inventory)

weighted average

• assumes all inventory items have the same cost

• doesn’t matter if we assume old or new units are sold since all units have the same cost

• This ‘same cost’ if called weighted average per unit

(cost of beginning + cost of purchases) / (units in beginning + units purchased) = weighted average per unit

consistency principle

follows GAAP

requires that companies use the same accounting methods period after period so the financial statement of succeeding periods will be comparable