1 [ACCT1511] KEVIN NGUYEN 1
2 TABLE OF CONTENTS Table of Contents...... 2 1. Assets....... 3 2. Liabilities.. 10 3. Financial Statements........ 16 4. Cash Flow Statement and Analysis...... 29 5. Revisiting Financial Statement Analysis & Accounting Policy Choice.. 35 6. Management Accounting.... 41 2
3 1. ASSETS 1.1 ASSET DEFINITION Asset: An asset is a resource controlled by the entity as a result of a past event from which future economic benefits are expected to flow to the entity Three essential characteristics: 1. Future economic benefit 2. Controlled by the entity 3. Result of past events Two recognition criteria: 1. It is probable that any future economic benefit associated with the item will flow to the entity; and 2. The item has a cost or value that can be measured with reliability We can account for the costs in two different ways: 1.2 CAPITALIZE VS. EXPENSE 1. Capitalize the cost and record it as an asset 2. Not capitalize the cost and record it as an expense The first scenario is beneficial due to the matching principle which matches expenses used to generate revenue to the same period when that revenue is recognized Notes: - Cost of an asset includes all of the costs involved in implementing the asset for use - Repairs/maintenance are expensed - Improvements are capitalized 1.3 CURRENT VS. NON-CURRENT ASSETS An asset is considered current when they satisfy any of the following: - It is expected to be realized, or is intended for sale or consumption in the entity s normal operating cycle - It is held primarily for the purpose of being traded à Inventory - It is expected to be realized within twelve months after the reporting date; or - It is cash or cash equivalent All other assets are classified as non-current 3
4 THE VALUE OF NON-CIRRENT ASSETS 1. Historical cost: what did we pay for the asset or how much did it cost to develop the asset 2. Current or Market Value (value in exchange) what could we get for the asset if we sold it how much we would have to pay for the asset today) 3. Value in use (present value): what is the asset worth to the company 4. Liquidation value: what could we get for the asset if we have to sell it really fast 5. Pre-adjusted Historical Cost: the historical cost of the asset adjusted for inflation 1.4 PPE: COST MODEL VS. REVLUATION MODEL COST MODEL Cost Model: after recognition as an asset, an item of property, plant and equipment (PPE) shall be carried at its costs less accumulated depreciation and accumulated impairment Three methods of depreciation: 1. Straight-line 2. Reducing balance 3. Units of production REVALUATION MODEL Revaluation Model: after recognition as an asset, an item pf property plant and equipment whose fair value can be measured reliably shall be carried at a revalued amount, being its fair value at the date of revaluation less any subsequent accumulated depreciation and accumulated impairment A revaluation can either be: 1. An increment: increasing the value at which the asset is recorded 2. An Decrement: decreasing the value at which the asset is recorded Note: whole classes of assets must be revalued, not individual ones e.g. if Building A was to be revalued, building B, C D must also be revalued Initial Increment Dr Asset CR Revaluation Reserve Increment reversing previous decrement Dr Asset Dr Gain on Revaluation Cr Revaluation Reserve 4
5 Initial Increment DR Loss on Revaluation CR Asset Decrement reversing previous increment DR Revaluation Reserve DR Loss on Revaluation CR Asset 1.5 INTANGIBLE ASSETS Intangible Assets: is an identifiable non-monetary asset without physical substance Must meet the essential characteristics of an asset and in addition, must be identifiable. The identifiable criterion: 1. It is separable that is, capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, asset or liability 2. Arises from a contractual or other legal right, regardless of whether those rights are transferable or separable form the entity or from other rights or obligations Typical intangible assets include: - Patents - Licenses - Copyrights - Franchises - Trademarks Elements of costs - It s purchase price, including import duties and non-refundable purchases taxes after deducting trade discounts and rebates - Any directly attributable costs of preparing the asset for intended use - For internally generated intangibles the cost is the sum of expenditure incurred from the date when the asset first meets the recognition criterial ACQUISITON VS. INTERNALLY GENERATED Accounting for intangible assets when there is a separate acquisition is simple: Dr Intangible Asset CR Cash/Accounts Payable Accounting for internally generated intangibles/r&d is harder because it is difficult to assess whether an internally generated intangible asset qualifies for recognition because of two problems: 1. Determining whether there is an identifiable asset that will generate expected future benefits 2. Determining the cost of the asset reliably To assess whether an internally generated asset meets the criteria for recognition, an entity classifies the generation of the asset into: 5
6 a) A research phase à expenditure is expensed DR Research Expense CR Cash b) A development phase à expenditure is capitalized DR Asset CR Cash Note: in considering the cost or revaluation method, as the fair value of the intangible asset is difficult to determine, the cost method is often used instead. In order for the development phase to be recognized, the following must all be shown: - The technical feasibility of completing the intangible asset so that it will be available for use/sale - The intention to complete the asset and use or sell it - Its ability to use or sell the intangible asset - How the intangible asset will generate probable future economic benefits - The availability of adequate technical, financial or other resources to complete the development and to use or sell the intangible asset - Its ability to measure reliably the expenditure attributable to the intangible asset during its development 1.6 GOODWILL A SPECIAL CASE OF INTANGIBLE ASSET Goodwill: is a non-current intangible asset, but it is not identifiable Goodwill is an accounting concept meaning the value of an entity over and above the value of its separate identifiable assets less liabilities: - Because of synergies, reputation, loyalty of clients, staff knowledge etc. - So goodwill is the value of all things that is hard to measure, and not separately listed on the balance sheet such as buildings, inventory and so on Goodwill as of the acquisition date is measured as: 1. The consideration transferred (price paid) 2. Less the fair value of the net identifiable assets acquired and the liabilities assumed When acquiring a company (X): DR Identifiable Assets DR Goodwill CR Liabilities CR Cash 6
7 1.7 IMPAIRMENT If there is an indication of impairment, we must test for impairment. THE SOURCES OF IMPAIRMENT External sources of impairment: 1. An asset market value has declined significantly 2. Changes with adverse effect in the technological, market, economic or legal environment Internal sources of impairment 1. Obsolescence or physical damage of an asset 2. Changes making an asset idle, plans to discontinue or restructure operations to which asset belong, plans to dispose of assets before previously expected date 3. Internal reporting indicates the economic performance of an asset will be worse than expected THE TEST FOR IMPAIRMENT In order to test for impairment, the following steps must be followed 1. Obtain the carrying value of the asset 2. Find the recoverable amount, which is the higher of: Fair value less cost to sell Value in use 3. Compare the asset s carrying amount to the asset s recoverable amount Carrying amount < Recoverable amount asset is not impairment Carrying amount > Recoverable amount asset is impairmed ACCOUNTING FOR IMPAIRMENT Impairment Under the cost method: DR Loss on impairment CR Accumulated impairment Reversal of an Impairment under the cost method: DR Accumulated Impairment CR Gain on Reversal of Impairment Or Impairment Under the revaluation method (Impairment is treated as a decrement) DR Loss on revaluation CR Asset Reversal of impairment under the revaluation method: DR Asset CR Revaluation Reserve CR Revaluation Reserve 7
8 1.8 INVENTORY Inventory are assets: - Held for sale in the ordinary course of business - In the process of production for such sale, or - In the form of materials or supplies to be consumed in the production process or in rendering of services Inventory types: - Raw materials - Work in progress - Finished goods inventory - Merchandise inventory Costs of inventory: - Cost of purchase - Cost of conversion - Cost of manufacture - Other costs in bringing the inventory to their present location and condition COST OF GOODS SOLD (COGS) Opening Inventory Purchases/Cost of Goods manufactured (Ending Inventory) Cost of goods Sold Methods of calculating inventory/cogs: - FIFO - LIFO - Weighted average Note: inventory must be measured at the lower of cost or net realizable value method 1.9 ACCOUNTS RECIEVABLE & DOUBTFUL DEBTS Allowance for doubtful debts is usually estimated based on past experience, e.g. xx% of all credit sales Estimating bad debts DR Bad debt expense CR Allowance for doubtful debt Writing off: DR Allowance for doubtful Debt CR Accounts Receivable 8
9 1.10 FURTHER THEORY ON ASSETS RELEVANCE VS RELIABILITY Market/current value à relevant Historical cost à reliable PRUDENCE/CONSERVATISM Conservatism à we are careful not to overstate assets and income, and careful not to understate liabilities and expenses 9