ACCT 5001 exam 2 review

Land

Non-Depreciable Tangible asset, does not depreciate over time, no limited useful life

How is land depreciated?

Land is NEVER depreciated

Plant and Equipment

Depreciable Tangible asset, depreciates over time, has a limited useful life, allocates the cost of the asset over its useful life

Acquisition Cost of Land

purchase price + commissions + taxes + land preparation costs + title fees + legal fees - proceeds from salvage

Land improvements

costs of improving the land for use (ex. Fences, parking lots)

Acquisition Cost of Buildings

construction costs + construction financing costs (interest) + permits + closing costs + commissions + remodeling

Acquisition Cost of Equipment

purchase price + freight-in + insurance in-transit + title fees + installation costs (training) + testing + sales tax

Costs after acquisition

Capitalize if the costs incurred achieve greater future benefits, but Expense costs that maintain a given level of service

Inputs to depreciation computation

cost, salvage/residual value, useful life, pattern

Types of depreciation

Straight-line, double declining(accelerated method, more cost is allocated to earlier years), units-of-production (activity-based)

Straight-line depreciation formula

(Cost of Asset - Salvage Value) / # of years of useful life

Double-declining balance method

Calculate the straight line rate, multiply the straight line rate by 2, multiply the book value by the DDB rate, stop depreciating when you hit the salvage value

Units of Production

((Cost of Asset - Salvage Value) / Total # of Units in Assets Life) *# of units produced this year

Tangible Asset Impairment

1. Compute BOOK VALUE of the tangible/intangible asset, 2. Estimate UNDISCOUNTED SUM of FUTURE CASH FLOWS the asset is expected to generate, 3. If the sum of cash flows is greater than the book value, do nothing. The asset is not impaired, 4. If the sum of cash flows is less than the book value, the asset is IMPAIRED and we must write the tangible asset down to its FAIR VALUE

Purpose of Short-Term Investments

provide financial flexibility and liquidity, use trading securities to generate short-term gains

Purpose of Debt Investments

fixed income payments, safe investment

Purpose of Investments in other Companies

Influence their decisions (investing in a suppliers), Control their decisions, Quick growth, Foothold in a new market, industry, geographic location, Acquire particular expertise, skill, product, Eliminate competition

Debt securities

Investments in the debts of others (corporate or gov bonds), Types include trading, AFS, and held to maturity, Classification of securities is driven by the intent of the owner

Equity securities

Investments in the equity of others (buy stock in another company), Types include <20%, 20-50%, >50% (degree of influence), Classification of securities is driven by the influence of the owner

Trading securities (debt)

1) Fair Value - Net Income, 2) Unrealized holding gains/losses recognized in net income, 3) Other income effects include interest when earned; gains/losses from sale

Available for sale securities (debt)

1) Fair Value - Other Comprehensive Income, 2) Unrealized holding gains/losses recognized in OCI, 3) Other income effects include interest when earned; gains/losses from sale

Held to maturity securities (debt)

1) Amortized Cost(Historical Cost), 2) Unrealized gains or losses not recognized, 3) Other income effects include interest when earned; gains/losses if sold or redeemed early

Comprehensive income formula

Net Income + Other comprehensive income

Equity - Fair Value Method

1) Insignificant Influence, 2) Holdings <20% (No differentiation between Trading/AFS), 3) Unrealized gains/losses recognized in Net Income, 4) Other Income Effects: Dividend revenue, gains/losses from sale, 5) Invest cash because they think the value of the security will increase, or to hedge risk

Equity - Equity Method

1) Significant Influence (Holdings between 20% - 50%), 2) Unrealized gains/losses not recognized, 3) Other Income Effects: proportionate share of investee's net income, reduced by dividends declared, 4) Influence the operations of another company

Equity - Consolidation

1) Controlling Influence (>50% Holdings), 2) Unrealized gains/losses not recognized, 3) Income entirely consolidated

valuation of debt securities trading

fair value- (NI), AFS- fair value(OCI), HTM- amortized cost(not recognized in NI or OCI)

No significant influence

less than 20%; invest excess cash because they think value of the security will increase, or to hedge risk

Significant influence

20-50% ownership, Influence the operations of another company, EX: invest in a key supplier, influencing operations

Control

greater than 50%; majority shareholder

equity securities valuation

< 20%- fair value(NI), 20-50%- equity method (not recognized in NI), >50%- consolidation (not recognized in NI)

amortized cost

original purchase price of the investment (considers premiums/discounts if necessary)

unrealized gains

amount the security has appreciated above the historic cost

unrealized loss

amount the security has fallen below the historic cost.

Equity Method

investment cost + proportionate share of investee's profits - proportionate share of investee's losses - dividends received from the investor = ending balance

Consolidation

The financial statements of the investor company and investee company are combined as if they were a single company

Consolidation on the B/S

Report ALL assets and liabilities of subsidiaries owned more than 50%, A non-controlling interest EQUITY item represents the percentage of net assets not owned by the parent company

Consolidation on the I/S

Report ALL revenues and expenses of subsidiaries owned more than 50%, A non-controlling interest income item represents the percentage of subsidiary net income not owned by the parent company

Commercial Banks

May have better knowledge of a firm but are constrained in the amount of risk they can assume

Non-bank financial institutions and private debt

Credit unions, insurance companies, etc. supplement banks to provide specific needs. Also, investment bankers may broker private debt placement

Public debt markets

Requires that a firm have the size, financial strength, and credibility to bypass the banking sector. Firms issue either commercial paper or bonds

Sellers who provide financing

Suppliers typically extend very short-term financing to buyers but may occasionally grant a loan

Negative covenants

The company receiving the $$ CANNOT do certain things, ex. Prohibition on mergers, additional borrowing, sale of key assets

Positive covenants

The company receiving the $$ MUST do these things, ex. Maintain certain financial ratios, provide audited financial statements, use assets as collateral, maintain insurance coverage, etc

Debt service coverage ratio

operating income / annual debt service

Types of debt available

Accounts payable, notes payable, bonds payable

Accounts payable

lender is the seller of product / service

Notes payable

lender is bank / financial institution

Bonds payable

lender is investors (individual / corporation)

demand for credit reasons

Operating (to cushion cyclical operating needs), Investing (to purchase new equipment and property), Financing (stock repurchases, debt maturity payments)

Debt (the good)

Interest tax shields (tax deductible), Take advantage of opportunities (leverage)

Debt (the bad)

No payment flexibility, Restrictive covenants, Foregone investment opportunities

Debt (the ugly)

potential default, potential bankruptcy

Current debt on the balance sheet

A/P, Accrued expenses (wages, utilities, etc.), Notes/Bonds Payable (when principal balance due within a year), Interest Payable

Long-term debt on the balance sheet

Notes/Bonds payable (when principle balance is due beyond a year from B/S date)

Debt on the income statement

Interest expense is recognized each period the debt is outstanding

Debt on the cash flow statement

Cash paid for interest impacts operating activities, Cash received from borrowing and paid on principal impacts financing activities

Total interest formula

Cash received (PV of Bond) - Cash Paid (Sum of Int. payments + Principal)

Discount Bond

Coupon Interest Rate < Market Interest Rate, Carrying Value of the bond increases over time (int. Exp > cash payment)

Premium Bond

Coupon Interest Rate > Market Interest Rate, Carrying value of the bond decreases over time (int. Exp < cash payment)

Public Debt Repurchases

Companies can go into the market and buy back their own public debt securities at the market price, A realized gain or loss is recognized for the difference between the carrying value of the debt and the cash paid to repurchase the debt (Fair market value)

Debt/Equity Hybrid Securities

debt securities that include an equity option

Debt/Equity Hybrid Securities effects for companies

reduces interest costs; convertible securities offer a lower interest rate due to their option

Debt/Equity Hybrid Securities effects for investors

Upside potential with lower risk; fixed income now, growth potential later

Short-term liquidity risk

the near-term ability to generate cash to service working capital needs and debt service requirements, i.e., will the firm be able to fund operations and pay off suppliers and providers of short-term debt?

Long-term solvency risk

the longer-term ability to generate cash internally or from external sources to satisfy plant capacity (capital expenditures) and debt repayment needs

Tax Cuts and Jobs Act (TCJA)

2017 change in corporate tax law that reduced US corporate tax rate from 35% to 21%, purpose was to bring cash back to the US

Goals of tax cuts and jobs act

To prevent shifting of income to lower tax jurisdictions, To incentivize spending that will boost productivity and lead to wage growth

Impacts of tax cuts and jobs act

Significant savings noted for many companies in 2017 financials compared to prior years, Lessened repatriation tax on previously deferred foreign Income, Minimum tax on certain foreign earnings

Effective Tax Rate

Total Tax Expense / Pre-Tax Income

2018 U.S. Statutory tax rate

25%, legally imposed tax rate

2018 Median U.S. Effective tax rate

12-17%, this is the average rate at which a corporation's income is taxed

Tax Reporting

Record must be kept of many different jurisdictions - cities, states, countries. Different types of taxes - income, sales, special taxes, Goals- revenue, social welfare, taxpayer behavior, Uses- modified cash basis

Permanent differences

Increases or decreases the effective tax rate by increasing or decreasing pre-tax financial income subject to tax

Temporary differences create...

deferred tax assets (future tax deductions) & deferred tax liabilities (future tax outlays)

temporary differences are

timing differences between the two systems (GAAP and IRC), as they arise when tax rules and accounting rules recognize income/expenses in different periods

Types of book tax differences

Permanent and Temporary

Examples of income that is never taxed

Income from municipal bonds, Life insurance proceeds on the death of a key executive, A portion of dividends received from other companies

Examples of expenses that are never deducted for tax purposes

Expenses related to obtaining tax-exempt income, Premiums paid for life insurance policies of key executives, Payments and fines due to violations of the law, Political contributions

Deferred tax assets

future tax-related benefits

Deferred tax liabilities

future tax-related costs

financial income < taxable income

future deductible amounts, DTA

financial income > taxable income

future taxable amounts, DTL

DTA examples

cash advances from customers (unearned revenue), BDE, stock comp. expense, warranty expense, loss carry forwards

DTL examples

depreciation, prepaid expenses, goodwill

Estimated warranty expenses are deducted in the current year for book purposes, but cannot be deducted for tax purposes until paid. DTA OR DTL?

DTA

A piece of equipment is acquired. Straight-line is used for book depreciation; MACRS (accelerated method) is used for tax depreciation. DTA OR DTL?

DTL

Estimated bad debt expense is deducted in the current year for book purposes, but cannot be deducted for tax purposes until deemed uncollectible. DTA OR DTL?

DTA

Unearned revenue is recorded as a liability until it is "earned" for book purposes, but is recognized immediately as revenue for tax purposes. DTA OR DTL?

DTA

Goodwill is tested for impairment annually, but for tax purposes is normally amortized over a 15 year period. What would this be considered in the first year of reported GW if there was no impairment? DTA OR DTL?

DTL

Financial Income Subject to Tax

Pretax Financial Income (Rev - Exp.) adjusted for permanent differences

Taxable Income

Financial Income subject to tax adjusted for temporary differences

Total Tax Expense formula

Financial Income Subject to Tax * Statutory Rate

Current Tax Expense formula

Taxable Income * Statutory Rate (often reflected as Income Tax Payable)

Deferred Tax Expense formula

Temporary Differences * Statutory Rate OR Total Tax Expense - Current Tax Expense

DTA journal entry

Debit income tax expense (IS) and DTA (BS), Credit income tax payable (BS)

DTL journal entry

Debit income tax expense (IS) Credit DTL (BS) & income tax payable (BS)

DTL from accelerated depreciation...

is 80% of all DTL, Expected tax on income EARNED but TEMPORARILY SHIELDED from taxation because of an accelerated depreciation income tax deduction.