F3 - Assets

Criteria for “Cash” or “Cash Equivalents”

• Readily available

• No restrictions

• Cash equivalents must mature within 90 days of purchase

Purpose of bank reconciliation

• Compare cash balance in our books (the General Ledger) vs the bank

• Identifies differences so we can spot discrepancies:

  • Outstanding checks

  • Deposits in transit

  • Bank Service charges

  • Interest earned

Restricted cash

• Cash that is legally or contractually set aside for a specific purpose → can’t be used for operations.

• Examples:

  • Balances required by lenders

  • Cash held in escrow for specific transactions like litigation settlement

  • Set aside for repayment of long-term debt

• Reported as:

  • Separate line on balance sheet

  • Can be “non-current asset” if restriction > 1 year

Net Realizable Value

(Selling price of asset - Costs necessary to make sale)

2 methods of estimating expected credit losses

• Direct Write-Off: Not GAAP; expense recorded only when uncollectible (no matching).

• CECL (Current Expected Credit Loss): GAAP; estimates future losses (e.g., aging method, historical loss rates).

Aging of Accounts Receivable Method

• A/R grouped by age, higher % uncollectible for older balances.

• Total gives desired ending Allowance for Doubtful Accounts

  • adjust JE to reach it.

Historical Loss Rate Method

• Uses past credit loss experience to forecast future losses.

• It can be applied as:

  • % of credit sales

  • % of outstanding accounts receivable

Direct Write-Off Method

• Only debit bad debt expense when AR is actually written off/ uncollectible.

• Not GAAP compliant.

• JE:

  • Dr. Bad Debt Expense

    • Cr. AR

Current Expected Credit Loss (CECL) model

• Expected credit losses are recognized in the same period as revenues or benefits generated from the AR asset.

• Provides more accurate representation of performance than direct write off.

Example JE for bad debt expense

• Dr. Bad Debt Expense

  • Allowance for Uncollectible

Example JE for a write-off using CECL

• Dr. Allowance for Uncollectible

  • Cr. AR

Example JE to book recovery of write-off

1. Bring back AR

   • Dr. AR

     • Cr. Allowance

2. Recognize collection of AR

   • Dr. Cash

     • Cr. AR

Factoring

• transaction between:

  • Factor → Buyer of AR

  • Company → Seller of AR

• benefit for company= immediate cash

• benefit for factor = purchases AR at a discount, if all collected, can make higher gain.

Factoring with Recourse

if customers don’t pay, company (seller) takes the loss.

Factoring without Recourse

if customers don’t pay, factor (buyer) takes the loss.

Subledger

detailed record to support a line item in the general ledger.

ex:

• if GL shows AR is 100K

• subledger shows details that make up 100K:

  • John owes $5k

  • Sara owes $2.5k

Control account

• name of a line item in a GL.

• backed up by a subledger.

General ledger

• master book of accounts

• where all JEs are posted

• subledgers feed into GL through control accounts

journals → GL → trial balance → financial statements

Reconciliation of Subledger to General Ledger

• make sure the details match the summary

• purpose: to catch mistakes and ensure F/S are backed by real, detailed data.

What is discounting a note receivable?

Selling a note to a bank for cash before maturity; bank takes interest (discount).

Discounting NR With vs. without recourse?

• With recourse → seller keeps risk; record liability.

• Without recourse → bank takes risk; treat as true sale, remove note.

4 types of inventory

1. Raw Materials – basic inputs used to produce goods (e.g., flour for bread, steel for cars).

2. Work-in-Process (WIP) – partially finished goods still in production.

3. Finished Goods – completed products ready for sale.

4. Merchandise/Retail Inventory – goods purchased in finished form for resale (what retailers hold).

👉 Manufacturers usually track the first three. Merchandisers (like Target) just track merchandise inventory.

What costs go into inventory?

All costs to get goods ready for sale: purchase price (net, + freight-in), direct materials/labor, and overhead.

Rule: Capitalize to prepare, expense to sell/admin.

What costs are excluded from inventory?

Freight-out, abnormal waste, unrelated storage, and admin/SG&A.

Rule: Capitalize to prepare, expense to sell/admin.

When is inventory valuation needed?

At purchase (record at cost), at period end (apply method (LIFO, FIFO, Weighted Avg) + LCM/LCNRV), and whenever value drops below cost.

Why does inventory valuation matter?

It affects COGS, net income, and balance sheet asset value.

Lower of cost or market (LCM)

Compare Cost vs. Market, where:

• Market = Replacement Cost, limited by:

  • Ceiling (NRV) = selling price – costs to complete/sell

  • Floor = NRV – normal profit margin

• If RC < floor → market = floor

• If RC > ceiling → market = ceiling

• Report inventory at the lower of cost or market.

Example:

• Cost = $50, RC = $30, NRV = $45, Floor = $35

• RC below floor → Market = $35

• Lower of cost ($50) vs. market ($35) → report $35.

Lower of Cost or Net Realizable Value (LCNRV)

• Compare Cost vs. NRV (selling price – costs to complete/sell).

• Report inventory at the lower amount.

• Used under IFRS (all methods) and GAAP (for FIFO/WA, not LIFO/retail).

👉 No ceiling/floor rules here — just cost vs. NRV, keep the lower.

When to write-down inventory?

Write down inventory when its value drops below cost —

• Damage, spoilage, obsolescence

• Decline in selling price

• Cost > NRV (IFRS/GAAP FIFO/WA)

• Cost > Market (GAAP LIFO/retail, using ceiling & floor test)

Perpetual inventory system

• Continuously updates inventory and COGS with each purchase and sale

• Always shows current balances.

Periodic inventory system

• Inventory and COGS updated only at period end by physical count

• Purchases tracked in a Purchases account during the period.

Which inventory system debits Purchases (not Inventory) when buying materials?

Periodic inventory system

JE for inventory purchase under the perpetual method

• Dr Inventory

  • Cr Cash/AP

JE for inventory purchase under the periodic method

• Dr Purchases

  • Cr Cash/AP

3 Inventory Methods

1. LIFO

2. FIFO

3. Weighted Average

LIFO

• Last-In, First-Out — newest costs go to COGS, oldest costs stay in inventory.

• 👉 Lowers taxable income when prices rise (higher COGS, lower NI). Not allowed under IFRS.

FIFO

• First-In, First-Out — oldest costs go to COGS, newest costs remain in ending inventory.

• Ending inventory is the same under perpetual and periodic

• 👉 When prices rise → lower COGS, higher NI, higher ending inventory.

Weighted Average

COGS and EI based on an average cost per unit.

• Periodic → Weighted Avg (total cost ÷ total units at period end).

• Perpetual → Moving Avg (recalculate avg after each purchase).

Gross Profit Method

• Estimates ending inventory by applying a known gross profit % to sales.

• Used for interim/unaudited reports, not GAAP for year-end.

Gross Profit Method Example

• Sales = $100,000

• Gross Profit % = 40% → COGS % = 60%

• Estimated COGS = $100,000 × 60% = $60,000

• Goods Available for Sale = $90,000

• Ending Inventory = $90,000 – $60,000 = $30,000

Retail Inventory method

• Estimates ending inventory by converting goods at retail prices to cost using the cost-to-retail ratio.

• Used for interim reporting and insurance purposes.

Retail Inventory Method Example

• Goods Available at Cost = $60,000

• Goods Available at Retail = $100,000

• Cost-to-Retail Ratio = $60,000 ÷ $100,000 = 60%

• Ending Inventory at Retail = $20,000

• Ending Inventory at Cost = $20,000 × 60% = $12,000

Difference between Gross Profit % and Cost Complement %

• Gross Profit % = GP ÷ Sales.

  • Gross Profit % tells margin

• Cost Complement % = 1 – GP% = COGS ÷ Sales.

  • Cost Complement % is what you apply to sales to estimate COGS.

Firm purchase commitment

• A binding contract to buy inventory at a set price in the future.

• If market price < contract price, record a loss and liability for the difference.

How do you account for a firm purchase commitment with a loss?

• Record loss + liability.

  • Dr Loss on Purchase Commitment 2,000

    Cr Estimated Liability 2,000

• Record purchase at contract price

  • Dr Inventory 10,000

    Cr Cash/AP 10,000

• Remove liability and reduce inventory → final inventory at market.

  • Dr Estimated Liability 2,000

    Cr Inventory 2,000

Does inventory lose value? How is it recorded? Can it depreciate?

• Inventory doesn’t depreciate (that’s for fixed assets).

• If value falls below cost (damage, obsolescence, price drop), record a write-down to LCM/LCNRV through a loss/expense.

PP&E

• Property, Plant & Equipment — long-term tangible assets used in operations (e.g., land, buildings, machinery).

• Recorded at cost and depreciated (except land).

Fixed assets are valued at [ ___ ].

Historical cost – accumulated depreciation (or impairment)

Donated fixed assets are recorded at [ _____ ] and a [ ____ ] is recognized.

Recorded at fair value, and a gain (contribution revenue) is recognized.

Property/Land should be recorded to reflect [ _____ ]

All costs to acquire and prepare it for use (purchase price, closing costs, site prep, clearing, stuff related to LAND -don’t confuse with related to buildings.

Does NOT depreciate.

Land improvements

• Costs with limited life that enhance land (e.g., paving, fencing, lighting).

• Depreciated, unlike land itself.

Plant (Type of PP&E)

• Buildings and structures used in operations (e.g., factories, warehouses, offices).

• Recorded at cost and depreciated.

Equipment repairs that are capitalized are…

Repairs that:

1. Extend useful life

2. Increase capacity

3. Improve efficiency (betterments).

Equipment repairs that are expensed

Ordinary maintenance and small repairs that just keep equipment in normal working condition (do not extend life or improve capacity).

How is interest on constructed fixed assets treated?

Capitalize interest incurred during construction (only on amounts spent, during construction period). Expense all other interest.

Physical depreciation

Loss of usefulness of an asset due to wear and tear, use, or damage over time.

Functional depreciation

Loss of usefulness due to obsolescence or inadequacy (e.g., new technology, asset no longer meets needs)

Component Depreciation + Example

• Depreciating asset parts separately if useful lives differ.

• Example:

  • Airplane cost $500k

    • Engines $300k (20 yrs)

    • Interior $200k (10 yrs)

  • Year 1 depreciation:

    Dr Depreciation Expense   25,000   (300k ÷ 20)  
    Dr Depreciation Expense   20,000   (200k ÷ 10)  
        Cr Accumulated Depreciation   45,000

    Depreciate each component by its own useful life.

Group Depreciation

Depreciates similar assets together using an average life.
Ex: 10 trucks cost $300k total, avg life 5 yrs → annual dep = $60k.

Dr Depreciation Expense   60,000  
    Cr Accumulated Depreciation   60,000

👉 Group = similar assets; Composite = mixed assets.

Composite Depreciation

• Depreciates dissimilar assets together as one pool with a composite rate/life.
  

• Ex: Machinery $400k (10 yrs), Furniture $100k (5 yrs). Total $500k. Composite life = 9 yrs. Annual dep ≈ $55.6k.

Dr Depreciation Expense   55,600  
    Cr Accumulated Depreciation   55,600

👉 Group = similar assets; Composite = mixed assets.

3 main types of depreciation methods

• Straight-line → equal expense each year.

• Declining Balance → accelerated, higher in early years.

• Sum-of-the-Years’-Digits (SYD) → accelerated, based on fraction of remaining life.

Straight - Line Depreciation

• Spreads cost evenly over useful life.

• Formula: (Cost–Salvage) ÷ Useful Life = annual depreciation.

Sum of the Years’ Digits

• Accelerated method: (Cost – Salvage) × (Remaining life ÷ SYD).

• 👉 SYD = n(n+1)/2, where n = useful life in years.

Declining Balance Method

1. Find straight-line rate = 1 ÷ useful life.

2. Multiply by factor (e.g., 2× for Double Declining).

3. Apply rate to beginning book value (BV) each year.

4. Ignore salvage upfront, but stop depreciating once BV = salvage.

Units of production method

• Depreciation based on actual usage/output.

Formula:

1. Rate per unit = (Cost - Salvage) / Total estimated units

2. Annual Dep = Rate x Units Produced in Period

Impairment (PP&E/finite assets)

A permanent drop in asset value.

• GAAP: Step 1: Test if BV > undiscounted future cash flows. If yes → Step 2: Write down to FV.

• IFRS: One-step: Impair if BV > (FV – costs to sell, or value in use).

Loss = BV – recoverable amount.

Allowance for depreciation and depletion

A contra-asset account (like accumulated depreciation/depletion) that reduces the related asset’s book value on the balance sheet.

Depletion

The allocation of cost of natural resources (oil, minerals, timber) to expense as they’re extracted/used. Formula similar to units-of-production.

2 steps to test impairment

1. Recoverability test: Is BV > undiscounted future cash flows?

2. If yes → Impairment loss = BV – Fair Value.

Impaired + Held for Use

• Write down to FV; loss recognized in income.

• Depreciate new cost basis.

• No reversal if FV recovers.

Impaired + Held for Disposal

• Write down to FV – disposal cost; loss in income.

• Stop depreciation.

• Can reverse impairment if FV increases (limited to original BV).

Intangible asset

• Long-term nonphysical asset (e.g., patents, trademarks, goodwill) that provides future benefits.

• Recorded at cost, amortized if finite life (not if indefinite).

Recording purchased intangibles at…

• At cost (purchase price + legal/registration fees).

• Amortize if finite life; test for impairment if indefinite.

Intangibles w. finite lives are amortized over which time period?

Over the shorter of useful life or legal life.

Examples of indefinite intangibles:

• Trademarks

• Goodwill

• Brand names

• Perpetual franchises

• Renewable licenses (if renewals are indefinite)

Economic life

The period an asset is expected to be useful in generating revenue, which may be shorter than its physical life.

Legal life

The time an asset is protected by law or contract (e.g., patent = 20 years, copyright = life of creator + 70 years).

When to test for impairment?

• GAAP: When events/changes indicate BV may not be recoverable.

• IFRS: Annually for indefinite intangibles & goodwill; otherwise when indicators exist.

Recognizing crypto assets

• As indefinite-lived intangible assets (not cash).

• Recorded at Fair Value

Recording Software Purchased

• As an intangible asset at cost (purchase price + related fees).

• Amortize over shorter of economic or legal life.

Recording Cloud Computing Arrangements (CCA)

• Fees to use software online.

• Implementation costs in the application development phase may be capitalized & amortized over the hosting term

• All other costs are expensed.

Franchise

• At present value as an intangible asset

• Amortized over the expected benefit period of the franchise.

Start-up costs (Financial accounting vs. Tax accounting)

• Financial accounting (GAAP): Expense as incurred.

• Tax accounting (IRS): May capitalize and amortize (with limited immediate deduction).