Greatest Hits Problems

Course Note 4:  Course Notes GP 1, GP 2, GP 5 Scenario 1 and 2, Practice Problem 3

Course Note 5:  Definitions on page 2, GP 1, GP 2

Course Note 6:  GP 3, GP 5, GP 7, GP 8, Demo Prob 6 - 7, Practice Prob 1 

Homework 5:  1, 6, 7

Homework 6:  2, 5, 6

Homework 7:  1, 3, 5, 7

Homework 8:  2, 3

Questions & Answers:

What types of costs are capitalized (added to assets on the balance sheet) as Inventory?

• Any cost essential to either getting or making the inventory ready to sell

What government agency is responsible for regulating public companies to protect investors?

The US Securities and Exchange Commission “SEC”

What are the accounting rules which the above agency requires public companies to follow?

Generally Accepted Accounting Principles “GAAP”

What group develops these rules?

Financial Accounting Standards Board “FASB”

Will an asset with a high salvage value have more or less annual depreciation expense?

Less

Do you need to revise your depreciation calculation for future periods?

Yes

Do you need to update your depreciation expense reported in past periods?

No

Coure Note 4: Inventory Acquisition and Selling Costs

Definitions to know :

Inventory: Assets a company makes or acquires with the intention of selling.

Inventory Cost: Merchandise inventory is a current asset (i.e., it will appear in the top half of

the asset section of the balance sheet for companies that sell inventory).

First-In, First-Out. “FIFO”: Assume costs flow in the order incurred.

Cost of Goods Sold:

Taken from the earliest (first) inventory purchases

Ending Inventory:

Consist of the most recent (last) purchases

Last-In, First-Out. “LIFO”: Assume costs flow reverse to the order incurred.

Cost of Goods Sold:

Taken from the most recent (last) inventory purchases

Ending Inventory:

Consists of the earliest (first) purchasers

*Good to know : Does the accounting for inventory costs have to match the physical flow of inventory? Cost Flow and Physical Flow DO NOT HAVE TO BE THE SAME

Financial Statement Effect of Costing Methods

• FIFO – ending inventory on the Balance Sheet will approximate current costs

• LIFO – COGS on the Income Statement will approximate current costs

If prices increase over time, which method will show higher net income?

FIFO. Earliest, lowest prices are in COGS. Low COGS → higher income.

Tax Effect of Costing Methods

• LIFO - Tax deduction based on the latest prices (typically higher than earlier prices)

• FIFO- Tax deduction based on the earliest (typically lower) prices

Which inventory costing method will give SCE a tax advantage? Does your answer change if prices are falling rather than rising?

When Prices are rising, LIFO has tax advantage.

Recent, higher prices are in COGS → Income is lower → Tax is lower

The opposite is true when prices are falling.

• LIFO conformity rule – tax laws require companies to use LIFO for book purposes if

they want to use LIFO for tax purposes

Inventory Turnover

• Inventory Turnover = Cost of Goods Sold / Average Inventory!!!!

o Shows how many times a company turns over its inventory during a period

o Indicator of how well a company controls inventory levels

Day’s Sales in Inventory = Days in Period / Inventory Turnover!!!!

• Reveals how much inventory is available in terms of the number of days of sales

Perpetual versus Periodic Inventory Systems

• Perpetual system → inventory transactions are recorded in order and COGS is based on

what is physically available at the time of the sale

• Periodic system → order does not matter and COGS is recorded at the end of period

Cost of Goods Available for Sale (“COGAS”)

• COGAS = Beginning Inventory + Cost of Goods Purchased!!!!

o In the Periodic system, ALL inventory purchases during the period are included in

COGAS.

o Therefore, COGS under LIFO can include inventory acquisitions that happen

after a sale.

Weighted Average Costing Method

• Weighted Avg Cost per Unit = COGAS / Units Available for Sale!!!

*Good to know: Should the amount of Inventory reported on the balance sheet change as a result of this decision? YES

Lower of Cost or Market (“LCM”)

• Inventory should be reported at the lower of: historical cost or market value

• A loss is recorded if the inventory’s market value drops below its cost

Equations in CN4:

Price - cost = GP per unit

Revenue - COGS = GP

Sales - COGS = GP

Inventory Turnover = Cost of Goods Sold / Average Inventory

Day’s Sales in Inventory = Days in Period / Inventory Turnover

COGAS = Beginning Inventory + Cost of Goods Purchased

units available - units sold = units Ending Inventory

COGAS - End In. = COGS

Weighted Avg Cost per Unit = COGAS / Units Available for Sale

units ava. - units sold = units End. Inv. * Wtd Avg. Cost per unit = EI

Net Sales - COGS = GP

GP/ Rev or Net sales = GP%

Course Note 5: Financial Reporting Process, Fraud, and Cash

Definitions:

Accounting Staff - Record transactions and produces the financial statements.

Accounting Manager- Responsible for the production of accurate financial statements.

Internal Audit:

• Examine of the accounting staff’s work.

•The internal audit group often reports to the controller, who in turn reports directly to the CFO.

C-Suite:

•Chief financial officer (CFO) - Oversees all financial aspects of company, including accounting.

•Chief executive officer (CEO)- Oversees every aspect of the company.

•The Sarbanes-Oxley Act of 2002 requires the CFO & CEO to sign off on the financial reports, providing certification.

The Board of Directors

• Advocates for shareholders’ interests and serves as link to firm management

• Boards have audit committee with specific responsibility to oversee financial reporting

Fraud: When a company intentionally misreports its financial statements.

Rationalization/ Attitude: is a cognitive process that allows people to justify unethical behavior by creating a moral excuse or narrative that downplays the seriousness of their actions.

incentives and pressure: are factors that can contribute to fraud such as, bonuses, executive compensation, financial obligations, company targets, company targets, & Economic conditions

Opportunity: is the circumstances that allow fraud to occur such as, Weak internal controls, Poor accounting policies, Poor tone at the top, & Access to financial records or company assets

Cash and Cash Equivalents

• Cash: currency, coins, checks, and deposits in bank account

• Cash Equivalents: short-term, liquid investments convertible to a known amount of cash

and close to their due date (e.g., usually less than 3 months)

Equations in CN 5:

Principal x Interest Rate x Time = Intrest

Principle + intrest = Maturity

Course Note 6: Property, Plant, and Equipment

Definitions:

Review of Property, Plant, and Equipment (“PP&E” or “Plant Assets”)

• Long-term tangible assets that benefit the company for more than one period

• Recorded as an asset including all costs necessary to get asset in place and ready to use

o No expense is recorded until asset is used → depreciation expense

• Not held for sale to customers in the ordinary course of business

Examples: Equipment, land, buildings, vehicles, machinery, computers, sidewalks,

landscaping, display stands, etc

Additional PP&E Expenditures – costs incurred after the initial purchase of PP&E, and

classified as either Revenue or Capital Expenditures.

Revenue Expenditures:

• Do not materially increase asset’s life or capabilities

• Recorded as expense in current period

on the income statement

Capital Expenditures:

• Provide benefits for longer than thecurrent period

• Recorded as an addition to the asset account on the balance sheet

Review Depreciation

• Process of recording expense for the cost of plant assets over their useful lives.

• Depreciation expense will not necessarily match declines in market value.

Straight-Line Depreciation

Cost: All expenditures to acquire a plant asset and prepare it for use

Salvage value (or “residual value”): Estimate of the asset’s value at the end of its useful life

Useful life: Length of time the asset is used in operations (may be less than asset’s total life)

Review Accumulated Depreciation

• Shows total depreciation taken over the life of PP&E

• A contra asset account with a credit balance

o Reduces the book value of PP&E asset account which has a debit balance

Review Net Book Value

Cost less Accumulated Depreciation

Salvage Value and Depreciable Cost

• Salvage value represents the portion of an asset’s cost that is not depreciated

Change in Estimate & Depreciation After a Change in Estimate

• Changes are only applied prospectively and only affect future periods’ depreciation

Selling PP&E and Accounting For PP&E Disposals

1. Record cash received, if any

2. Remove the asset and any accumulated depreciation

3. Record any gain or loss (e.g., if cash received is less than Book Value of asset then you have a loss)

Journal Entry to record the disposal of PP&E. Note: You might have a gain OR a loss. You will never have both.

Dr. Cash (if any) xxx

Dr. Accumulated Depreciation xxx

Dr. Loss (if any). xxx

Cr. Gain (if any) xxx

Cr. PPE account xxx

Intangible Assets – nonphysical assets used in operations that give companies long-term rights, privileges, or competitive advantages

• Patents: Exclusive right to manufacture and sell a patented item or use a process for 20 years.

• Copyrights: Exclusive right to publish and sell a musical, literary, or artistic work during the life of the creator plus 70 years.

• Trademarks: Symbol, name, phrase, or jingle identified with a company, product, or service.

• Goodwill: Amount by which a company’s value exceeds the value of its individual assets and liabilities. Recorded only when a company is purchased.

Accounting for Intangibles – important distinction between internally developed and purchased

• Internally developed: expensed as incurred (e.g., R&D expense)

• Purchased: recorded as assets on the balance sheets

Amortization of Intangible Assets – distinction between finite and indefinite lived assets

• Finite lived assets – amortize over the life of the asset (e.g., patents)

o Straight-line over the useful life with no salvage value

Indefinite lived assets – do not amortize; instead check for impairment (e.g., goodwill)

o Goodwill = amount by which purchase price exceeds fair value of the net tangible

assets of the target

Example:

• Facebook bought WhatsApp for ~$20B and recorded around $15B of Goodwill meaning that WhatsApp only had ~$5B net tangible assets

• Facebook, now Meta, has been “testing” this goodwill annually and has not impaired it (i.e., the goodwill is still on the balance sheet at its original amount)

*Good to know: Book Value at end of asset’s life is equal to Salvage Value

*Good to Know: No Contra-asset is needed. But some companies do use Acc’d Amort.

Equations in CN 6:

Depreciation Expense = (Cost - Salvage Value) / Useful Life

Gross or Cost - A/D = Net

Revised Depreciation Expense = (Net Book Value at Point of Revision - Revised Salvage Value) / Remaining Useful Life

BV - Proceeds = Loss or Gain

Cost / Life = Amortization Expense