5-1 Accounting What the Numbers Mean CHAPTER 5: Accounting for and Presentation of Current Assets Marshall, McManus, and Viele 11th Edition 5-1 5-2 What are Current Assets? Current assets include cash and those assets that are expected to be converted to cash or used up within one year, or an operating cycle, whichever is longer. Cash Short-term Securities Accounts and Notes Receivable Current Assets include Deferred Tax Assets Inventories Prepaid s 5-3 Coins and paper money Petty cash funds Cash Cash Includes Undeposited receipts Checking accounts Money orders Learning Objective 5-1: Explain what is included in the cash and cash equivalents amount reported on the balance sheet. 5-4 Cash Equivalents Cash Management Goals U.S. Treasury securities Commercial paper Cash Equivalents include... Bank certificates of deposit Money market mutual funds l Invest excess cash with minimal risk. l Assure the availability of adequate amounts of cash. l Avoid unnecessarily large amounts of idle cash. l Prevent theft and fraud. Learning Objective 5-1: Explain what is included in the cash and cash equivalents amount reported on the balance sheet. 5-5 Learning Objective 5-1: Explain what is included in the cash and cash equivalents amount reported on the balance sheet. 5-6
5-2 The Internal Control System Internal control objectives are to ensure: Bank Statements 1. Effective and efficient operations. 2. Reliable financial reporting. 3. Compliance with applicable laws and regulations. Internal Control Over Cash l Require daily deposits. l Make all payments by check. l Promptly reconcile bank statements. Bank Statement Beginning Bank Balance + Deposits processed by the bank - Checks which have cleared the account +/- Other adjustments made by the bank Ending Balance Learning Objective 5-2: Describe the key features of a system of internal control and explain why internal controls are important. 5-7 Learning Objective 5-3: Explain the bank reconciliation procedure. 5-8 Bank Reconciliation Objective Identify Differences Between Ending cash balance reported on bank statement Compared to Ending cash balance in depositor s accounting records. Provides information for adjusting journal entries. Bank Reconciliation Process Balance per Bank + Deposits in Transit - Outstanding Checks ± Bank Errors Adjusted Balance End Result: Adjusted Bank Balance Adjusted Book Balance Balance per Depositor + Deposits by Bank - Bank Adjustments ± Book Errors Adjusted Balance Learning Objective 5-3: Explain the bank reconciliation procedure. 5-9 Learning Objective 5-3: Explain the bank reconciliation procedure. 5-10 Bank Reconciliation All reconciling items on the book side require an adjusting entry to the cash account. Balance per Depositor + Deposits by Bank - Bank Adjustments ± Book Errors Adjusted Balance Short-term Marketable Securities Bond Investments Readily Marketable Marketable Securities are... Almost As Liquid As Cash Capital Stock Investments Current Assets Learning Objective 5-3: Explain the bank reconciliation procedure. 5-11 Learning Objective 5-4: Explain how short-term marketable securities are reported on the balance sheet. 5-12
5-3 Uncollectible Accounts If a company makes credit sales to customers, some accounts inevitably will turn out to be uncollectible. Balance Sheet Presentation Accounts Receivable Less: Allowance for Bad Debts Net realizable value of accounts receivable Credit managers must estimate the probable bad debts expense (or uncollectible accounts expense) of the firm. PAST DUE The net realizable value is the amount of accounts receivable that the business expects to collect. Learning Objective 5-5: Discuss how accounts receivable are reported on the balance sheet, including the valuation allowances for Learning Objective 5-5: Discuss how accounts receivable are reported on the balance sheet, including the valuation allowances for estimated uncollectible accounts and estimated cash discounts. 5-13 estimated uncollectible accounts and estimated cash discounts. 5-14 Terms Time Due Cash Discounts Sellers offer cash discounts to customers which are a deduction from the invoice price granted to induce early payment of the amount due. Discount Period Invoice total less discount Purchase or Sale Credit Period Invoice total due Discount Percent Discount Period Otherwise, Net (or invoice total) is Due 2/10,n/30 Credit Period Notes Receivable A note is a written promise to pay a specific amount at a specific future date. Notes typically include an interest charge for use of the money during the time period of the note. Learning Objective 5-5: Discuss how accounts receivable are reported on the balance sheet, including the valuation allowances for estimated uncollectible accounts and estimated cash discounts. Learning Objective 5-6: Explain how notes receivable and related accrued interest are reported on the balance sheet. 5-15 5-16 Inventories Inventory Inventory Cost-Flow Assumptions We use one of these inventory valuation methods to determine cost of inventory sold. Goods owned and held for sale to customers Classified as a current asset Specific identification Weightedaverage FIFO LIFO Learning Objective 5-8: Discuss the alternative inventory cost flow assumptions and generalize about their respective Learning Objective 5-7: Explain how inventories are reported on the balance sheet. 5-17 effects on the income 5-18
5-4 Inventory Cost-Flow Assumptions The Bike Co. s purchases are recorded separately because the costs can change from one purchase to another. TBC has recorded two retail sales during the month. Cost of Goods Available for Sale Aug. 1 Beg. Inventory 10 units @ $ 91 $ 910 Aug. 3 Purchased 15 units @ $ 106 $ 1,590 Aug. 17 Purchased 20 units @ $ 115 $ 2,300 Aug. 28 Purchased 10 units @ $ 119 $ 1,190 55 Retail Sales of Goods Aug. 14 Sales 20 units @ $ 130 $ 2,600 Aug. 31 Sales 23 units @ $ 150 $ 3,450 43 Specific Identification When a unit is sold, the specific cost of the unit sold is added to cost of goods sold. 5-19 5-20 Cost of Goods Available for Sale During the Year Weighted-Average Calculate the average cost of the items in beginning inventory plus purchases made during the year. Units Available for Sale During the Year Cost of Goods Sold $108.9091 43 $4,683.09 Weighted-Average Date Purchases Aug. 1 10 @ $91 $910 Aug. 3 15 @ $106 1,590 Aug. 17 20 @ $115 2,300 Aug. 28 10 @ $119 1,190 Total 55 $5,990 $5,990 55 $108.9091 Ending Inventory $108.9091 12 $1,306.91 5-21 5-22 First-In, First-Out (FIFO) The first-in, first-out (FIFO) method assigns the oldest costs to cost of goods sold and the recent costs to ending inventory. Oldest Costs Costs of Goods Sold First-In, First-Out (FIFO) Date Purchases Aug. 1 10 @ $91 $910 Aug. 3 15 @ $106 1,590 Aug. 17 20 @ $115 2,300 Aug. 28 10 @ $119 1,190 Total 55 $5,990 Recent Costs Ending Inventory Cost of Goods Sold 10 91 $ 910 15 106 1,590 18 115 2,070 43 $ 4,570 Ending Inventory 10 $ 119 $ 1,190 2 $ 115 230 12 $ 1,420 5-23 5-24
5-5 Last-In, First-Out Method (LIFO) Last-in, last-out (LIFO) method assigns recent costs to cost of goods sold and the oldest costs to the ending inventory. Recent Costs Costs of Goods Sold Last-In, First-Out Method (LIFO) Date Purchases Aug. 1 10 @ $91 $910 Aug. 3 15 @ $106 1,590 Aug. 17 20 @ $115 2,300 Aug. 28 10 @ $119 1,190 Total 55 $5,990 Oldest Costs Ending Inventory Cost of Goods Sold 10 $ 119 $ 1,190 20 $ 115 2,300 13 $ 106 1,378 43 $ 4,868 Ending Inventory 10 $ 91 $ 910 2 $ 106 212 12 $ 1,122 255-25 5-26 The Impact of Changing Costs In periods of rising costs, LIFO results in lower ending inventory and higher cost of goods sold than FIFO. The Impact of Inventory Quantity Changes Changes in the quantities of inventory will have an impact on profits that is dependent on the cost-flow assumption used and the extent of cost changes during the year. 5-27 5-28 Inventory Accounting System Alternatives Periodic Inventory System Cost of goods sold is determined at the end of the fiscal period. Perpetual Inventory System Cost of goods sold is determined each time inventory is sold. Inventory Accounts RETAIL FIRMS Merchandise Inventory MANUFACTURING FIRMS Raw Materials Work in Process Finished Goods 5-29 5-30
5-6 Inventory Errors Errors in the amount of ending inventory have a direct dollar-fordollar effect on cost of goods sold and net income. For this reason, independent auditors, income tax auditors, and financial analysts look closely at reported inventory amounts. Lower of Cost or Market Inventory must be reported at market value when market is lower than cost. Defined as current replacement cost (not sales price). Consistent with the conservatism principle. Can be applied three ways: (1) Separately to each individual item. (2) to broad categories of inventory. (3) to the whole inventory. Learning Objective 5-9: Discuss the impact of inventory errors on the balance sheet and income statement. 5-31 Learning Objective 5-9: Discuss the impact of inventory errors on the balance sheet and income statement. 5-32 Prepaid s and Other Current Assets Prepaid s require adjusting entries. Assets are decreased. s are increased. Examples: Insurance Rent Prepaid expenses are expenses that have been paid in the current fiscal period but will not be subtracted from revenue until a subsequent fiscal period. Deferred Tax Assets A deferred tax asset arises when an income tax expense is recognized for financial accounting purposes in a fiscal year before the fiscal year in which it is deductible in the determination of taxable income. Learning Objective 5-10: Explain what prepaid expenses are and how they are reported on the balance sheet. 5-33 Learning Objective 5-10: Explain what prepaid expenses are and how they are reported on the balance sheet. 5-34 Accounting What the Numbers Mean CHAPTER 6: Accounting for and Presentation of Property, Plant, and Equipment, and Other Noncurrent Assets Marshall, McManus, and Viele 11th Edition 5-35 5-36
5-7 Noncurrent Assets Land Primary Issues for Noncurrent Assets Buildings Equipment Intangible Assets Natural Resources 1) Classified as assets because they are owned by the organization. 2) Have the ability to generate revenue beyond one year. 5-37 Acquisition Accounting for acquisition of the asset. Use Accounting for depreciation of the asset. Accounting for maintenance and repair costs. Disposal Accounting for the disposition of the asset. 5-38 Land is a nondepreciable asset. Purchase price Real estate commissions Land Title insurance premiums Title and legal fees All costs incurred to get land ready for use are capitalized. Delinquent taxes Razing costs of building on the land Purchase price Architectural fees Cost of permits Buildings and Equipment All costs incurred to get an asset ready for use are capitalized. Installation costs Transportation costs Excavation and construction costs Learning Objective 6-1: Illustrate the expansion of the basic accounting equation to include revenues and expenses. 5-39 Learning Objective 6-1: Illustrate the expansion of the basic accounting equation to include revenues and expenses. 5-40 is the allocation of the cost of an asset to the years in which the benefits of the asset are expected to be received. It is an application of the matching concept. for the current year Income Statement Balance Sheet Acquisition Cost (Unused) Cost Allocation Income Statement (Used) Does not reflect decline in value. Accumulated Total depreciation recorded as of balance sheet date Balance Sheet Learning Objective 6-2: Discuss how the terms capitalize and expense are used with respect to property, plant, and equipment. 5-41 Learning Objective 6-2: Discuss how the terms capitalize and expense are used with respect to property, plant, and equipment. 5-42
5-8 Methods In the early years of an asset s life, accelerated depreciation methods result in greater depreciation expense and lower net income than straight-line depreciation. Methods Straight-Line Methods Accelerated Methods Straight-line Sum-of-the-years -digits Units-of-production Declining-balance Straight-Line Accelerated Straight-Line Accelerated ($) Years of Life ($) Years of Life ($) Years of Life ($) Years of Life 5-43 5-44 Straight-Line Method EXAMPLE On December, 2016, equipment was purchased for $50,000 cash. The equipment has an estimated useful life of 5 years and an estimated salvage value of $5,000. Formula Cost - Estimated Salvage Value Estimated Useful Life SL Straight-line Method Cost - Estimated Salvage Value Estimated Useful Life $9,000 $50,000 - $5,000 5 years SL 5-45 5-46 Straight-line Method Accumulated Accumulated Undepreciated Balance Year (debit) (credit) Balance (NBV) 2017 $ 9,000 $ 9,000 $ 9,000 41,000 2018 $ 9,000 9,000 18,000 32,000 2019 $ 9,000 9,000 27,000 23,000 2020 $ 9,000 9,000 36,000 14,000 2021 $ 9,000 9,000 45,000 5,000 $ 45,000 $ 45,000 SL Salvage Value stops when NBV SALVAGE VALUE! $10,000 $9,000 $8,000 $7,000 $6,000 $5,000 $4,000 $3,000 $2,000 $1,000 $0 SL Straight-Line Method 2017 2018 2019 2020 2021 For the year ended December 31 Book Value is reported on the Balance Sheet. Book Value $45,000 $40,000 $35,000 $30,000 $25,000 $20,000 $15,000 $10,000 $5,000 $41,000 is reported on the Income Statement. $32,000 $23,000 $14,000 $0 2017 2018 2019 2020 2021 As of December 31 $5,000 5-47 5-48
5-9 Step 1: Per Unit Produced Step 2: Units-of-Production Method Number of Units Per Unit Produced Produced during the Year Cost - Estimated Salvage Value Estimated Total Units to be Made Units-of-Production Method On December 31, 2016, equipment was purchased for $50,000 cash. The equipment is expected to produce 100,000 units during its useful life and has an estimated salvage value of $5,000. If 22,000 units were produced in 2017, the first year that the asset was used, what is the amount of depreciation expense? 5-49 5-50 Units-of-Production Method Step 1: Per Unit Produced Step 2: $50,000 - $5,000 100,000 $0.45 per unit $0.45 per unit 22,000 $9,900 5-51 Units-of-Production Method Accumulated Undepreciated Balance Year Units Balance (book value) 2016 $ 50,000 2017 22,000 $ 9,900 $ 9,900 40,100 2018 28,000 12,600 22,500 27,500 2019 * - - 22,500 27,500 2020 32,000 14,400 36,900 13,100 2021 18,000 8,100 45,000 5,000 100,000 $ 45,000 Salvage Value *No depreciation expense is recorded if the equipment is idle. 5-52 Declining-Balance Method Declining-Balance Method Since we are using two times the straight-line rate, this is called the Declining-Balance Method or (Double-Declining Balance Method Double the Straight-line Rate Book Value at Beginning of Year 1 Life in Years 2 On December 31, 2016, equipment was purchased for $50,000 cash. The equipment has an estimated useful life of 5 years and an estimated residual value of $5,000. Calculate the depreciation expense for 2017 and 2018 (the first two years that the asset is used in the company. 5-53 5-54
5-10 Declining-Balance Method Double the Straight-line Rate 2 20% 40% for 2017 (yr1) 40% $50,000 $20,000 for 2018 (yr2) 40% ($50,000 - $20,000) $12,000 Net Book Value at Beginning of Year Declining-Balance Method Accumulated Undepreciated Balance Year (debit) Balance (NBV) 2016 $ 50,000 2017 $ 20,000 $ 20,000 30,000 2018 12,000 32,000 18,000 2019 7,200 39,200 10,800 2020 4,320 43,520 6,480 2021 2,592 46,112 3,888 $ 46,112 ($50,000 $43,520) 40% $2,592 Below salvage value! 5-55 5-56 Declining-Balance Method Accumulated Undepreciated Balance Year (debit) Balance (NBV) 2016 $ 50,000 2017 $ 20,000 $ 20,000 30,000 2018 12,000 32,000 18,000 2019 7,200 39,200 10,800 2020 4,320 43,520 6,480 2021 1,480 45,000 5,000 $ 45,000 $1,480 6,480 5,000 salvage value In the latter years, depreciation is limited to NBV X 40%, but the asset cannot be depreciated below salvage value. Comparing Methods $10,000 $8,000 $6,000 $4,000 $2,000 $0 $20,000 $15,000 $10,000 $5,000 $0 Straight-Line 1 2 3 4 5 Life in Years Double-Declining- Balance 1 2 3 4 5 Life in Years $16,000 $14,000 $12,000 $10,000 $8,000 $6,000 $4,000 $2,000 $0 Units-of-Production 1 2 3 4 5 Life in Years Total depreciation at end of useful life will be the same regardless of depreciation method 5-57 5-58 for Tax Reporting Maintenance and Repair Most corporations use the Modified Accelerated Cost Recovery System (MACRS) for tax purposes. MACRS depreciation provides for rapid write-off of an asset s cost in order to stimulate new investment. Salvage values are ignored Useful lives are set by the Internal Revenue Service Preventative maintenance expenditures and routine repair costs are clearly expenses of the period in which they are incurred. Learning Objective 6-4: Describe the accounting treatment of maintenance and repair expenditures. 5-59 Learning Objective 6-5: Explain why depreciation for income tax purposes is an important concern of taxpayers and how tax differs from financial accounting depreciation. 5-60
5-11 Disposal of Depreciable Assets Disposal of Depreciable Assets Update depreciation to the date of disposal. Determining Gain or Loss Recording cash received (debit). Removing accumulated depreciation (debit). Journalize disposal by: Recording a gain (credit) or loss (debit). Removing the asset cost (credit). Cash > BV, record a gain (credit). Cash < BV, record a loss (debit). Cash BV, no gain or loss. Recording a gain (credit) or loss (debit). Learning Objective 6-6: Describe the effect on the financial statements of the disposition of noncurrent assets, either by sale or abandonment. 5-61 Learning Objective 6-6: Describe the effect on the financial statements of the disposition of noncurrent assets, either by sale or abandonment. 5-62 Assets Acquired by Capital Lease Assets Acquired by Capital Lease An operating lease is an ordinary lease for the use of an asset that does not involve any attributes of ownership. A capital lease results in the lessee (renter) assuming virtually all of the benefits and risks of ownership for the leased asset. *Capital Lease Characteristics: 1. Transfers ownership to lessee. 2. Includes nominal purchase price. 3. Lease term is ³ 75% of life of asset. 4. Present value of lease payments is ³ 90% of fair value of asset. Only one criteria needs to be met! Learning Objective 6-7: Describe the difference between an operating lease and a capital lease. 5-63 Learning Objective 6-7: Describe the difference between an operating lease and a capital lease. 5-64 Buy or Lease an Asset? Computer Equipment Cost: $217,765 Issue a 10%, 6 year Note Payable payment: $50,000. Buy or Lease? Computer Equipment payment: $50,000. Present Value of Lease Payments: $50,000 @ 10%, 6 years $217,765 Learning Objective 6-8: Explain the similarities in the financial statement effects of buying an asset compared to using a capital lease to Owners' Liabilities + Equity 1. Date of Acquisition Computer Capital Lease Equipment Liability +217,765 +217,765 acquire the rights to an asset. 5-65 acquire the rights to an asset. 5-66 Buy Lease Assets Assets Owners' Liabilities + Equity 1. Date of Acquisition Computer Note Payable Equipment +217,765 +217,765 2. Accumulated Buy or Lease an Asset? Balance Sheet Balance Sheet Net income Net income Income Statement Revenues - s Income Statement Revenues - s 3. Lease Payment -Note Principal Interest 2. Accumulated 3. Lease Payment -Lease Liability Interest Leasing the computer is essentially the same as buying it. Both methods of acquiring the asset yield the same economic impact and the same effect on the financial statements. Learning Objective 6-8: Explain the similarities in the financial statement effects of buying an asset compared to using a capital lease to
5-12 Noncurrent assets without physical substance. Useful life is often difficult to determine. Intangible Assets Intangible Assets Often provide exclusive rights or privileges. Usually acquired for operational use. Record at current cash equivalent cost, including purchase price, legal fees, and filing fees. Intangible Assets Patents Copyrights Leaseholds Leasehold Improvements Franchises and Licenses Trademarks and Trade Names Goodwill 5-67 5-68 Intangible Assets Amortization is the term used to refer to the allocation of the cost of an intangible asset over Amortization its useful life. for The these process intangibles: is similar to Patent straight-line 20 years depreciation. Registered Trademark Unlimited life Patent 20 years Use straight-line method. Copyright Life of artist + 70 years Amortize over legal life or useful life, whichever is less Occurs when one company buys another company. Goodwill Goodwill Only purchased goodwill is an intangible asset. The amount by which the purchase price exceeds the fair market value of net assets acquired. 5-69 5-70 Goodwill Cruiser s Inc. paid $1,000,000 to purchase all of James Company s assets and assumed liabilities of $100,000. The acquired assets were appraised at a fair value of $800,000. If we subtract the $100,000 of debt, then the fair value of the net assets equal $700,000. What amount of goodwill should be recorded on Cruiser Inc. s books? a. $100,000. b. $200,000. c. $300,000. d. $400,000. Goodwill 5-71 5-72
5-13 What amount of goodwill should be recorded on Cruiser Inc. s books? a. $100,000. b. $200,000. c. $300,000. d. $400,000. Goodwill FMV of Assets $ 800,000 Debt Assumed 100,000 FMV of Net Assets $ 700,000 Purchase Price 1,000,000 Goodwill $ 300,000 Goodwill Goodwill is not amortized. Instead, it is tested annually for impairment. If the book value of goodwill exceeds its fair value, an impairment loss will be recorded. 5-73 5-74 Total cost, including exploration and development, is charged to depletion expense over periods benefited. Natural Resources Examples: oil, coal, gold Extracted from the natural environment and reported at cost less accumulated depletion. Natural Resources Depletion is the term used to refer to the allocation of the cost of a natural resource over its useful life. The process is similar to units-of-production depreciation. 5-75 5-76 Other Noncurrent Assets Long-term Investments Notes Receivables (with maturities more than a year after the balance sheet date) Long-term Deferred Income Tax Assets When these assets become current, they will be reclassified to current assets. Time Value of Money Future Value: the value at some future date of an investment made today. Today 1 year 2 years 3 years 4 years $ 1,000 Invested at 10% has a future value of $ 1,464 Present Value: the value now of an amount to be received or paid at some future date. Today 1 year 2 years 3 years 4 years $ 1,000 Is the present value at 10% of $ 1,464 Learning Objective 6-10: Explain the role of time value of money concepts in financial reporting and their usefulness in decision making. 5-77 5-78