Flashcards in Receivables & inventory Deck (70)
What is an accounts receivable?
an account receivable is usually related to the sale of goods to customers or the provision of services to customers
What is a notes receivable?
Often related to non-customer transactions although many larger consumer items and transactions between businesses require a promissory note
What are the 4 types of receivables?
Accounts Receivable, Notes Receivable, Trade Receivable, Non-trade Receivables
What is a trade receivable?
another name for customer accounts receivable
What is a non-trade receivable?
Those receivables created in non-customer transactions
What items adjust the accounts receivable balance?
1. trade (quantity) discounts;
2. cash (sales) discounts;
3. sales returns and allowances;
4. non-collectible accounts.
What are the two methods of accounting for receivables?
The gross method (before discount) and the net method (after discount)
what is sales discounts forfeited?
a miscellaneous revenue account used in the net method to separately record discounts not taken.
What is bad debt expense?
the account that records the effect of uncollectible accounts. Bad debt expense is on the income statement. The allowance for uncollectible accounts is a balance sheet account contra to accounts receivable
What are the two methods to account for bad debt expense?
The direct write off method and the allowance method
How does the Direct Write off Method work for bad debt expense?
This method records bad debt expense only when a specific account receivable is considered uncollectible and is written off
Negative Aspects - AR is overvalued, bad debt expense is recognized a year after it is earned, Not in accordance with GAAP
Positive Aspects - not materially different, simple and practical to use
How does the Allowance Method work for bad debt write off?
Required under GAAP of uncollectible accounts are probable and estimable.
positive aspects - recognize rev and expenses in the same year
How does the entry to write off uncollectible accounts affect income or net assets?
it has no effect since it has already been recognized.
How does the income statement approach work for estimating bad debt?
Under this approach a company may estimate bad debt expense as a percentage of credit sales
Remember that if you use the income statement approach, you are calculating an income statement number (bad debt expense).
In the income statement approach of estimating bad debt, does the existing balance effect the amount?
What are the two methods for estimating bad debt?
Income Statement approach and Balance Sheet approach
How does the Balance Sheet approach work for estimating bad debt?
the company estimates bad debt expense by analyzing the ending accounts receivable.
Remember that if you use the balance sheet approach, you are calculating a balance sheet number (allowance for doubtful accounts).
In the Balance Sheet approach of estimating bad debt, does the existing balance effect the amount?
The analysis of ending accounts receivable has one simple objective: the determination of the needed or desired balance in the allowance account
Once the needed balance in the allowance account has been determined, the needed balance is compared to the existing balance in the allowance account. The difference in these two balances is the amount of bad debt expense to be recorded for the accounting period.
Who is the maker of a note?
The buyer or borrower (This party is making an unconditional promise to pay principal and interest over the note term)
Who is the holder of a note?
The holder of the note (seller or lender) is the creditor and is the firm recording the note receivable on its books.
How are notes recorded?
at Present Value unless its less than a year term
How do you determine the present value of a cash transaction?
the present value of future cash flows will equal the amount of cash that exchanged hands on the date of note creation.
How do you determine the present value of a non-cash transaction?
the transaction will be recorded at the fair market value of the non-cash asset or the fair market value of the note receivable (present value of future cash flows), whichever one can be more clearly determined.
Who is the maker when refering to the sale of receivables?
the debtor that has borrowed funds or purchased an asset and provided a note to the original creditor
Who is the original creditor when refering to the sale of receivables?
the firm that has loaned funds or sold an asset to the maker.
Who is the transferee/3rd party when refering to the sale of receivables?
provides the funds to the original creditor
What criteria is required to determine if a transfer of receivables is considered a sale?
The transferred assets have been isolated from the transferor, even in bankruptcy.
The transferee is free to pledge or exchange the assets.
The transferor does not maintain effective control over the transferred assets either through an agreement that allows and requires the transferor to repurchase the assets or one that requires the transferor to return specific assets.
What does it mean when a transaction is completed with recourse?
the transferor is responsible for nonpayment on the part of the original maker of the receivable. This means that if the maker (original debtor) defaults, the original creditor must assume all the payments on the receivable
What does it mean when a transaction is completed without recourse?
the transferor is not responsible for nonpayment on the part of the maker of the receivable. Typically, nonrecourse transfers are accounted for as sales because control has passed to the transferee
What does it mean when a transaction is completed on notification basis?
the maker of the receivable is informed of the transaction and typically is instructed to make payments to the third party
What does it mean when a transaction is completed on non-notification basis?
the maker of the receivable is not informed of the transaction and continues to make payments to the original creditor
What does it mean to factor a receivable?
the transferor (original creditor) transfers the receivables to a factor (transferee, a financial institution) immediately as a normal part of business. The transferor prefers to pay the factor a fee in return for the factor's administration of the receivables
What happens when you assign an accounts receivable?
the borrower assigns rights to specific accounts receivable as collateral for a loan. The lender has the right to seek payment from these receivables should the borrower (original creditor for the accounts receivable) default on the loan. The borrower reclassifies the receivables as accounts receivable assigned
What does it mean to pledge accounts receivable?
Pledging of accounts receivable is less formal than assignment. Rights to specific receivables are not noted as collateral, and accounts receivable are not reclassified
When are receivables required to be written down?
the present value of the future cash flows expected to be collected using the original effective interest rate for the loan, or
market value if this value is more determinable.
How does impairement work under IFRS?
If the assets carrying value is greater than the amount that could be recovered through the assets use or by selling the asset, then it is impaired.
IS IFRS or GAAP more flexible to reverse impairment?
What is the recoverable amount?
the higher of the fair value less cost to sell or value in use:
a. Fair value less cost to sell is the amount obtainable from the sale in an arms-length transaction between knowledgeable, willing and able parties.
b. Value in use is the discounted present value of the futures cash flows expected from the asset.
What is a cash-generating unit?
the smallest group of assets that can be identified that generates cash flows independently of the cash flows from other assets
What is a periodic inventory system?
the beginning inventory balance is reflected in the merchandise inventory account throughout the year. That is, the merchandise inventory account will have an unchanging balance throughout the accounting year. The firm uses other means to obtain current inventory information for internal purposes.
The periodic system is much less expensive to administer than is the perpetual system.
Acquisitions are recorded in purchases and other related accounts
What is the equation for cost of goods sold?
Net purchases = Gross Purchases + Transportation In (Freight In)
- Purchases Returns and Allowances
- Purchases Discounts
Beginning Inventory + Net Purchases = Ending Inventory + Cost of Goods Sold
What are the 4 cost flow assumptions?
Specific identification, weighted average, LIFO, FIFO
Tell me about the Specific Identification cost flow assumption.
If the business entity has somewhat large, distinguishable products, it might be appropriate to use specific identification.
The specific identification assumption is not cost effective for most firms and allows firms to manipulate earnings.
Tell me about the Weighted Average cost flow assumption.
The term weighted average always implies the periodic inventory system. If the business entity selects this cost flow assumption, the weighted average cost per unit must be calculated. This calculation is shown below.
Weighted Average cost per unit = cost of goods available for sale / number of units available for sale
The ending inventory valuation is equal to the number of units in ending inventory multiplied by the weighted average cost per unit
The weighted average method treats each unit available for sale (beginning inventory and purchases) as if it were costed at the average cost during the period. It produces cost of goods sold and ending inventory results between those of FIFO and LIFO when prices change during the period.
Tell me about the FIFO cost flow assumption.
first-in, first-out philosophy. At the end of the accounting period, it is assumed the ending inventory is composed of units of inventory most recently acquired. Conversely, the cost of goods sold is made up of the oldest merchandise
FIFO cost-flow assumption reflects the way most firms actually move their inventory.
However, GAAP does not require that firms choose the inventory cost-flow assumption that reflects the actual movement of goods
During periods of rising specific inventory prices, FIFO produces the highest net income because cost of goods sold is costed with the lowest-cost (earliest) purchases in the period. Ending inventory reflects the highest (latest) costs
Tell me about the LIFO cost flow assumption.
This cost flow assumption is based on a last-in, first-out philosophy. At the end of the accounting period, it is assumed the ending inventory is composed of the oldest inventory layers, while the cost of goods sold is composed of the units of inventory most recently acquired.
During periods of rising specific inventory prices, LIFO produces the lowest net income because cost of goods sold is costed with the highest-cost (latest) purchases in the period. This feature of LIFO is considered an advantage because reported gross margin reflects the latest purchase costs and therefore is more indicative of future gross margin.
What are the main differences between the perpetual and periodic inventory system??
the use of the inventory account rather than purchases for the acquisition of inventory and adjustments such as returns and discounts; and
the recording of cost of goods sold at sale rather than at the end of the period.
What are the cost flow assumptions associated with the perpetual inventory system?
Specific identification, moving average, FIFO, LIFO
What is the moving average?
The term moving average always implies the perpetual inventory system.
That moving average is used for costing all subsequent sales until another purchase takes place, at which time the moving average is modified by the new purchase. When merchandise is sold, the current weighted average cost per unit is multiplied by the number of units sold to determine the amount of the cost-of-goods-sold entry.
In a period of steadily rising prices, the moving average method (perpetual) results in lower cost of goods sold than the weighted average method (periodic).
Which cost flow assumption is the same in both the period and perpetual inventory system?
Compare LIFO and FIFO
Ending Inventory Cost of goods sold
FIFO Reflects latest costs Reflects earliest costs
LIFO Reflects earliest costs Reflects latest costs
If FIFO is employed by a business entity, the flow of costs is the same as the physical flow of goods for most firms.
If FIFO is employed by a business entity, the balance sheet valuation of inventory is an approximation to current cost
If FIFO is employed by a business entity however, the matching of revenues and expenses on the income statement is not considered ideal
If LIFO is employed by a business entity, there are usually income tax advantages associated with that choice
LIFO tends to minimize "inventory" profits
Why do firms chose various cost flow assumptions?
firms often choose FIFO to maximize their reported income.
choosing LIFO is to minimize income tax
What is LIFO Liquidation?
When the number of units purchased or produced is less than the number of units sold
What causes LIFO liquidation?
poor planning or lack of supply
What are the advantages to using Dollar Value LIFO?
1- Reduces the effect of the liquidation problem
2- allows companies to use FIFO internally
3- Reduces clerical costs
What is the conversion index for Dollar Value Lifo?
Conversion Index = Ending Inventory in Current-Year Dollars / Ending Inventory in Base-Year Dollars
What are the steps to convert to Dollar Value LIFO?
1. Convert FIFO EI to EI at base year
EI = FIFO EI * 1/conversion index
2. Compute the change in inventory in base year cost
Change in inventory in Base-year cost = Ending inventory in base-year dollars - Beginning inventory in base-year dollars
3. Compute the current year layer at current year cost
Current-year layer at Current-year cost = Current-year layer at base-year cost x conversion index
4. Compute EI under DV LIFO
Ending DV LIFO inventory = Beginning DV LIFO inventory + Current-year layer at Current-year cost
What happens if there is a loss on inventory?
GAAP requires that firms recognize an end-of-period loss on inventory if its utility has declined. If market is below cost, then inventory must be written down to market.
If cost < market, there is no loss recognition and the inventory is reported at cost.
If cost > market, a loss is recognized and the inventory is written down to market.
What is cost? (in LCM)
The cost of ending inventory is determined by applying one of the four cost flow assumptions, and the general rule for including cost in inventory
What is market? (in LCM)
replacement cost, subject to the ceiling value and floor value
middle amount of replacement cost, net realizable value and net realizable value less profit margin
What is the ceiling in LCM?
Net Realizable Value (Sales price - cost to complete)
What is the floor in LCM?
Net Realizable Value minus the Profit Margin
What are the three approaches that a company can use to compare for LCM?
Individual item basis, Category Basis and Total basis
the individual basis yields the lowest inventory value because there is no change for items to offset
How does the direct method of journal entries work for LCM items?
Under the direct method, any holding loss (difference between a higher cost and a lower market value) related to inventory is simply included in cost of goods sold. It is directly included in cost of goods sold.
How does the allowance method of journal entries work for LCM items?
Under the allowance method, any holding loss related to inventory is separately identified in a contra inventory account with separate disclosure of the holding loss. Cost of goods sold does not include the holding loss under this method.
Can the gross margin method be used for financial reporting?
No, only for estimates
How does the Gross Margin method work for inventory valuation?
The gross margin method estimates cost of goods sold from sales using a percentage based on historical data. Then, ending inventory can be inferred from beginning inventory, purchases, and cost of goods sold.
To use the gross margin method, a company must have a consistent gross margin percentage (margin as a percentage of sales or margin based on cost). If inventory is heterogeneous, the method should be applied to pools of inventory with relatively homogeneous gross margin percentages.
What is the equation for Gross Margin Percentage (Margin on Sales)?
Gross margin percentage = margin on sales = (sales - cost of goods sold)/sales
What is the equation for Margin on Cost?
Margin on cost = (sales - cost of goods sold) / cost of goods sold