Int. Acc. Unit 3 Flashcards
(92 cards)
1
Q
What must be true for an item to be reported as “cash”?
A
For an item to be reported as “cash”, it must be readily available for the payment of current obligations AND free from contractual restrictions that limit its use in satisfying debts.
2
Q
What is a Cash Equivalent?
A
Liquidity within 3 months (ex. treasury bills, certificates of deposit)
3
Q
Define Restricted Cash. When should it be included with Cash?
A
Cash held for a specific purpose and is therefore not available for general use; If restricted for a short-term purpose, include with Cash and disclose in footnotes; If restricted for a long-term purpose, classify as LT assets (usually investments)
4
Q
Accounts Receivable
A
Promises of the purchaser to pay for goods and services sold. They represent “open accounts” resulting from “short-term” extensions of credit
5
Q
What do the terms 2/10, net 30 stand for?
A
2% cash discount in 10 days, net or remaining amount due in 30 days
6
Q
What is Net Realizable Value as it is reported on the balance sheet?
A
NRV = A/R - AFDA
7
Q
Allowance for Doubtful Accounts (AFDA)
A
Contra asset
Credit balance
Based on history, I know I won’t collect it all
8
Q
Uncollectible accounts (Bad Debts) are ____________ for entities that extend credit to customers
A
NORMAL operating expenses
9
Q
Where does the expense for bad debt go?
A
Income Statement
10
Q
Allowance Method for Bad Debt
A
Record estimates of Bad Debt as an AJE (adheres to “matching”)
11
Q
Direct Write-Off Method for Bad Debt
A
Do not record an estimate. Only write off A/R and bed debt expense when a specific account is deemed uncollectible (not typically permitted by GAAP)
12
Q
Advantages of Allowance Method for Bad Debt
A
AFDA acts as a margin of safety for companies. It helps them acknowledge the risks inherent in collecting on account and present more realistic AR figures.
Modeling complex business scenarios becomes challenging when underlying data is inaccurate, which in turn can hamper business growth. Incorrect AR data also cripples accrual accounting processes, leading to false revenue and cash flow figures
13
Q
Should the credit balance in AFDA appropriately align with the debit balance in A/R?
A
Yes, but this does not mean “equal”
14
Q
What is the difference between AFDA and Bad Debt Expense
A
AFDA is an ESTIMATE of accounts receivable that will likely go uncollected
BDE is a record of receivables that went unpaid during a financial reporting period (ACTUAL impact)
15
Q
Process for Allowance Method of Recording (estimating) bad debts
A
- Entry to ESTIMATE bad debt expense (recorded as an AJE on the last day of the accounting period.
Bad Debt expense xxx
AFDA xxx - Entry to write-off a specific account deemed uncollectible (recorded throughout the accounting period)
AFDA xxx
A/R - [name] xxx - Entry to record collection of an account previously written off:
A/R xxx
AFDA xxx
Cash xxx
A/R xxx
16
Q
How can AFDA have a debit balance before AJE’s?
A
Underestimated bad debt - more write offs than previously estimated
17
Q
What tupe of cash flows do receivables create?
A
INFLOWS
18
Q
2 ways to estimate bad debt expense (allowance method)
A
- Percentage of Sales (income statement approach)
- Percentage/Aging-of-A/R (balance sheet approach)
19
Q
- Percentage of Sales Method
A
Bad Debt Expense = % x Net Credit Sales
20
Q
- Aging of A/R Method
A
E.B. in A/R = E.B. in AFDA (balance sheet)
21
Q
What is the difference between accounts receivable and notes receivable?
A
Notes receivable has longer timeline and has interest
Customer cannot pay within terms (i.e. - 30 days), so they are willing to pay some interest in order to pay later
22
Q
Short-term notes (called interest bearing notes)
A
Carries stated rate of interest (agreed on amount)
Interest is paid separately and in addition to the face value of the note
23
Q
What is true of stated rate = market rate?
A
If stated rate = market rate, then the Note’s PV = Face Value (interest is above and beyond)
24
Q
What are the cash flows associated with short-term notes?
A
Cash Flows = Principle repayment + interest payments (2 separate cash flows- Interest is operating; principle is investing)
25
What is the formula for interest revenue and cash interest received? (short-term)
(Face Value) x (stated int. rate) x (#months/12)
26
Journal Entry for receipt of Note
Year-end AJE for accrued interest
Entry on Maturity Date
N/R xxx
Cash/Asset/Rev. xxx
Interest Rec. xxx
Interest Rev. xxx
Cash 6,280
Note Rec. (full face value) 6,000
Interest Rec. 175
Interest Rev. 105
27
Long-Term Notes (called non-Interest Bearing/Zero Interest Notes)
Interest is included in the Face Amount, but there are no regular cash interest payments made on the note
Instead, the cash received by the borrower when the note is first executed is less than Face Value, but the borrower must pay back the full face value on the maturity date of the note.
28
Imputed/Implied Interest Rate
Rate at which debtor can obtain financing of a similar nature under prevailing economic conditions
29
Discount on Notes Receivable
The difference between the Face Value and the Present Value ($10,000-$7,200 = $2,800) is called the discount and it represents the amount of imputed interest rate on the note
Notes Receivable 10,000
Discount on N/R 2,800
Cash/Asset/Rev 7,200
Discount on N/R is a contra-asset account (normal credit balance)
Discount represents interest revenue included in Face Value of Note
Discount is amortized to interest revenue over the life of the note
30
Carrying Value
PV of the note on whatever date you're looking at
31
Term Note
Present Value of a Lump Sum
32
Installment Note
Present Value of an Ordinary Annuity
33
Carrying Value
Carrying Value = Previous C/V + Discount Amort. - PMTS made during the period
Carrying Value = Balance of N/R - Balance of Discount on N/R
34
Cash Flows with Long-Term Notes Receivable
Cash Flows = Face Value at maturity (lump sum)
or
If an installment note, you will have the cash payments made
35
Interest Revenue on the Income Statement
Interest Revenue = Carrying Value x Market Rate (or imputed rate)
36
Discount Amortized on on a non-interest bearing note
Discount Amortized = Interest Revenue - Cash interest received
Interest Revenue = Discount Amort. on a non-interest-bearing note (no cash)
37
Journal Entries for Notes Receivable (long-term)
Entry for receipt of Note:
N/R (face value) xxx
Discount on N/R xxx (placeholder)
Cash/Asset/Rev xxx
Year-end AJE for accrued interest:
Discount on N/R xxx (amount of int. rev. earned)
Interest Rev. xxx (CV x %)
Installment Payment:
Cash xxx
Note Rec. xxx (just for that payment)
Entry on maturity date:
Cash xxx
Discount on N/R xxx
Note Rec. xxx
Interest Revenue xxx
38
Where does inventory appear on the financial statements?
Income Statement: COGS
Balance Sheet: Inventory (finished goods)
Statement of Cash Flows: Operating
39
Inventory Journal Entries
Purchase:
Inventory xxx
Cash or A/P xxx
Sale:
COGS xxx
Inventory xxx
Cash or A/R xxx
Revenue xxx
40
Goods in Transit - f.o.b. shipping point
Title passes at the SHIPPING POINT
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Goods in Transit - f.o.b. destination
Title passes at the DESTINATION
41
Goods included in Inventory
1. Goods in Transit
2. Cosigned Goods
3. Purchase Commitments
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Consigned Goods
Goods out on consignment remain the property of the consigner
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Total Inventory
Total Inventory = Physical Count + Consignment + what's in transit
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Purchase Commitments
Agreement to buy inventory at a specified price sometime in the future
Generally, seller retains title to goods
Under GAAP, no asset or liability is reported at the inception of the agreement
If the commitment is non-cancelable and material, it should be disclosed in footnotes
45
Consistency Principle
Companies should be consistent in using an inventory valuation method; Changing methods is permitted, but only infrequently, and the reason for the change, as well as the effect on the financial statements, mist be disclosed in the period of the change
46
Specific Identification
This method values units in inventory and units sold at actual cost
When to use?
Best for distinct, customized goods, such as high-end cars, fine jewelry, custom homes (when every unit is the same, its not worth tracking every single unit)
Advantage:
Inventory and COGS reflect actual cost of units
47
Average Cost (periodic)
This method takes the average cost of the units
Avg. Unit Cost = COGAFS/(# of units avail. for sale)
When to use?
When a company has a lot of inventory and it is more efficient to take the average cost
Advantage:
Ease and efficiency
48
FIFO (first in, first out)
Assumes that the goods that are purchased first are the goods that are sold first
COGS consists of the oldest purchases
Ending inventory consists of the most recent purchases
49
Phantom Profit
FIFO can create a concept called "Phantom Profit"
Cost of the oldest inventory (lowest cost) is charged to expense when product is sold
50
LIFO (last in, first out)
Assumes that the goods that are purchased most recently, are the goods that are sold first
COGS consists of the most recent purchases
Ending inventory consists of the oldest purchases
Best follows "matching" principle because revenues and costs are recorded in same period
51
Advantages of FIFO and LIFO
FIFO:
- It is the most widely used method of valuing inventory
- It does not require as much record keeping as LIFO, because it assumes that older items are gone
LIFO:
- More current financial data: the LIFO method requires you to apply your most recent inventory costs to COGS first
- Best follows "matching principle" because revenues and costs are recorded in same period
52
Disadvantages of FIFO and LIFO
FIFO:
- Requires better systems for compliance, which can be difficult to track at scale
- System rigidity can result in inflexibility in some situations
- More complex than LIFO when attemption to extract COGS
- Does not adhere to matching principle
- Creates phantom profit
LIFO:
- LIFO is not realistic for many companies because they would not leave their older inventory sitting idle in stock while using the most recently acquired inventory
- The closing inventory value may differ from the current market value
- Inventory is generally understated on your balance sheet when using the LIFO method because its valuation is based on the oldest costs
53
Inventory Errors
Inventory errors effect 2 years because one year's ending inventory is the next year's beginning inventory
(year 1) End. Inv. Overstated -> COGS understated -> Net Income overstated
(year 2) Beg. Inv. Overstated -> when we correct the error, COGS if overstated -> Net Income is understated
"Counter balancing error" that corrects itself within a 2-year cycle. Even though it is self correcting, it is not idea. Causes drastic impacts on Net Income.
54
Phantom Profit
Phantom Profit = E.I. in FIFO - E.I. in LIFO
55
Lower of Cost or Net Realizable Value
GAAP requires the inventory be reported at the lower of cost or NRV on the B.S.
56
Three Characteristics of PP&E
1. Acquired for use in operations and not for resale
2. It is long-term and usually subject to depreciation (except land)
3. Must be tangible
57
Valuation requirements for PPE
GAAP requires PPE to be valued at historical cost
IFRS - may be valued at historical cost or market value
58
Journal Entries
Purchase of PPE:
PPE (specific acct) xxx
Cash, Rev, A/P, N/P xxx
Depreciation/Depletion:
Depr. Expense xxx
Accum. Depr. xxx
59
What does the term "capitalization" mean?
Capitalization is an accounting method in which a cost is included in the value of an asset and expensed over the useful life of that asset, rather than being expensed in the period the cost was originally incurred
Assets are capitalized to record the expense over time to match the period when benefit is received to when costs are recognized
60
Capital Expenditures
Expenditures that have future economic benefits and therefore should be reported as an ASSET (capitalized)
Examples- Additions, improvements/replacements
61
Revenue Expenditures
Expenditures that only benefit the current period and therefore should be recorded as an EXPENSE in the current period
62
Journal Entries for PPE
Subsequent Capitalization (goes on the B.S.)
PPE xxx
Cash, Rev, A/P, N/P xxx
Sale of PPE:
Cash, Rev, A/P, N/P xxx
Accum. Depr. xxx
[losses] xxx
[gains] xxx
PPE (specific acct.) xxx
63
What costs does PPE include?
PPE should include any cost necessary to get the asset in position and condition for use
64
What do you think is meant by the term capitalization of interest? Which assets qualify for interest capitalization?
Any PPE we get a loan for that has interest
Interest is a cost of building a building, but only items under construction
Don't debit interest expense, debit the PPE
65
Lump-Sum Purchase
Allocate purchase price using relative market (appraisal) value
66
Straight-Line Depreciation
Depreciates an equal amount each year of the asset's estimated useful life
Annual Depr. Exp. = (cost - salv. value)/estimated useful life
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Activity Method of Depreciation
Depreciation expense is based on output or activity rather than passage of time
Depreciation Rate = (cost - salv. value)/estimated output
Annual Depr. Exp. = Depr. Rate x Actual output
68
Double-Declining Balance (accelerated method) Depreciation
Depreciates a greater amount in the early years of the asset's life
DDB rate = 2 x straight-line rate
Ann. Depr. Exp. DDB Rate x Book Value
Note: Ignore salvage value when calculating all but last year's depreciation
69
Partial Year Depreciation
If not acquired on January 1, need to only depreciate for portion of year owned (round to the nearest month)
Half-year convention - Record 6 month's depreciation in year of purchase regardless of date of purchase
70
If a depreciable asset is sold in mid year, why do you think it is necessary to bring depreciation up to date before recording the sale transaction?
When a depreciable asset is sold, a gain or loss on the sale is likely. However, before computing the gain or loss, it is necessary to record the asset's depreciation right up to the moment of the sale. This is how you determine the exact gain or loss on the sale.
71
Journal Entry for selling PPE
Cash xxx
Acc. Depr. xxx
Loss xxx
Asset (at cost) xxx
Gain xxx
72
Revising Depreciation
Company may determine original depreciation calculation needs revision
Determine book value at the beginning of the year of change
Compute new depr. = (current book value - salvage value)/
remaining useful life
73
Depletion
Expensing the cost of a natural resource over the periods benefitted
Calculate using units-of-production (activity method)
Depletion Rate = Depletion base/estimated output
Annual Depletion = Depletion rate x actual output
Depletion base = Acquisition costs
+ Intangible development costs
+ Asset retirement obligation
+ exploration costs
- Residual Value
74
Asset Retirement Obligation
Describes a legal obligation associated with the retirement of a tangible, long-lived asset, where a company will be responsible for removing equipment or cleaning up hazardous materials at some future date
The costs associated with AROs are called Asset Retirement Costs (ARCs)
RECORDED AS A LIABILITY FOR THE PV OF THE FUTURE OBLIGATION
When the liability is recorded, it also increases the cost of the landfill by an amount equal to the fair value of the ARO
75
Intangible Assets
Derive future benefit (value) from rights and privileges granted to owners
76
What are some characteristics that an asset must possess in order to be properly classified as an intangible asset on the balance sheet?
1. Not physical in nature, cannot be held or manipulated
2. Non-monetary, not cash or cash equivalent
3. They are expected to generate future economic benefit (LT assets)
4. They are identifiably separate from other assets (i.e. competitive advg.)
5. They are difficult to value; subjective and depend on various factors
77
When are intangibles capitalized?
Intangibles purchased from another entity are capitalized (recorded) at cost, which is their fair value at the date of acquisition
Capitalize any direct costs as incurred (legal fees, registration fees, etc.)
78
How should internally-created intangibles be recorded?
Most, such as patents, trademarks will be expenses to research and development
Goodwill can be built internally but not recognized as an asset because it is not an identifiable resource
79
Give two examples of a limited life intangible asset
1. Copyrights
2. Patents
80
Give two examples of an indefinite life intangible asset
1. Trademarks (company can renew indefinitely)
2. Goodwill (ongoing)
81
Amortization Expense of Intangible Assets
Amortization Expense = (cost - residual value)/useful life
82
Patents
Grants exclusive right to use, manufacture, and sell a product or process
Legal life = 20 years
Capitalize purchase price, registration fees, legal fees incurred to successfully defend in court; Expense the costs of developing a patent
83
Copyrights
Literary works, motion pictures, computer software, songs, photographs, web pages, musicals, educational materials, etc.
Legal Life = 70 years + lilfe of creator
84
Non-renewable Franchises
Contractual arrangement under which the franchisor grants the franchisee the right to sell products/services, use certain processes, use trademarks or trade names, etc.
85
Indefinite-Life Intangibles
Over what specific period should the cost of an intangible asset be amortized if its useful life appears to be indefinite (such as in the case of a valuable trade name that is purchased from another entity)
Indefinite-life intangibles are never amortized (doesn't have a specific useful life)
Assessed for impairment (annually)
86
Goodwill
Refers to an intangible asset that arises when one company acquires another company
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Research and Development Costs - _________ when incurred
R&D costs are EXPENSED when incurred
Materials, equipment, and facilities - expense entire costs unless alternative future uses
Personnel - Expense when incurred
Contract services - Expense
Indirect costs - Expense
Purchased in-process R&D - Capitalize at FMV as intangible asset
88
Organization Fees
Expensed when incurred (start up costs)
89
Cryptocurrency
Currently treated like an intangible asset, record at cost and impair
90
Advertising costs
Expensed when incurred unless advertizing will occur in a future period, then record as prepaid advertising
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Research and Development Costs
Expensed when incurred
