chapter 1-1 financial accounting and accounting standards financial accounting and accounting...

Chapter 1-1

Financial Accounting and Financial Accounting and Accounting StandardsAccounting Standards

Financial Accounting and Financial Accounting and Accounting StandardsAccounting Standards

Chapter Chapter

11Intermediate Accounting,

12th EditionKieso, Weygandt, and Warfield

Chapter 1-2

Financial reporting should provide information: Financial reporting should provide information: Financial reporting should provide information: Financial reporting should provide information:

(a) that is useful to present and potential investors and (a) that is useful to present and potential investors and creditors and other users in making rational creditors and other users in making rational investment, credit, and similar decisions. investment, credit, and similar decisions.

(a) that is useful to present and potential investors and (a) that is useful to present and potential investors and creditors and other users in making rational creditors and other users in making rational investment, credit, and similar decisions. investment, credit, and similar decisions.

(b) to help present and potential investors and creditors (b) to help present and potential investors and creditors and other users in assessing the amounts, timing, and and other users in assessing the amounts, timing, and uncertainty of prospective cash receipts. uncertainty of prospective cash receipts.

(b) to help present and potential investors and creditors (b) to help present and potential investors and creditors and other users in assessing the amounts, timing, and and other users in assessing the amounts, timing, and uncertainty of prospective cash receipts. uncertainty of prospective cash receipts.

(c) about the economic resources of an enterprise, the (c) about the economic resources of an enterprise, the claims to those resources, and the effects of claims to those resources, and the effects of transactions, events, and circumstances that change transactions, events, and circumstances that change its resources and claims to those resources. its resources and claims to those resources.

(c) about the economic resources of an enterprise, the (c) about the economic resources of an enterprise, the claims to those resources, and the effects of claims to those resources, and the effects of transactions, events, and circumstances that change transactions, events, and circumstances that change its resources and claims to those resources. its resources and claims to those resources.

Objectives of Financial AccountingObjectives of Financial AccountingObjectives of Financial AccountingObjectives of Financial Accounting

LO 4 List the objectives of financial reporting.LO 4 List the objectives of financial reporting.

Chapter 1-3

Parties Involved in Standard SettingParties Involved in Standard SettingParties Involved in Standard SettingParties Involved in Standard Setting

Four organizations:Four organizations:

• Securities and Exchange Commission (SEC)• American Institute of Certified Public

Accountants (AICPA)• Financial Accounting Standards Board (FASB)• Government Accounting Standards Board

(GASB)

LO 6 Identify the major policy-setting bodies LO 6 Identify the major policy-setting bodies and their role in the standard-setting and their role in the standard-setting process.process.

Chapter 1-4

FASB relies on two basic premises:FASB relies on two basic premises:

(1)(1) Responsive to entire economic communityResponsive to entire economic community

(2) Operate in full view of the public

Due ProcessDue ProcessDue ProcessDue Process

Step 1 = Topic placed on agenda

Step 2 = Research conducted and Discussion Memorandum issued.

Step 3 = Public hearing

Step 4 = Board evaluates research, public response and issues Exposure Draft

Step 5 = Board evaluates responses and issues final Statement of Financial Accounting Standard


Chapter 1-5

Issued by the FASB:Issued by the FASB:

Types of PronouncementsTypes of PronouncementsTypes of PronouncementsTypes of Pronouncements

Standards, Interpretations, and Staff Positions.

Financial Accounting Concepts

Emerging Issues Task Force Statements


Chapter 1-6

FASB Statements, FASB Statements, Interpretations, and Interpretations, and

Staff PositionsStaff Positions

FASB Statements, FASB Statements, Interpretations, and Interpretations, and

Staff PositionsStaff PositionsAPB OpinionsAPB OpinionsAPB OpinionsAPB Opinions CAP Accounting CAP Accounting

Research BulletinsResearch BulletinsCAP Accounting CAP Accounting

Research BulletinsResearch Bulletins

Category ACategory A (Most Authoritative)(Most Authoritative)

FASB Technical Bulletins

FASB Technical Bulletins

AICPA Industry Audit and Accounting

Guides

AICPA Industry Audit and Accounting

Guides

AICPA Statements of Position

AICPA Statements of Position

Category B

FASB Emerging Issues Task ForceFASB Emerging Issues Task Force AICPA AcSEC Practice BulletinsAICPA AcSEC Practice Bulletins

Category C

AICPA Accounting Interpretations

AICPA Accounting Interpretations

Category D (Least Authoritative)

FASB Implementation Guides

FASB Implementation Guides

Recognized Industry Practices

Recognized Industry Practices

House of GAAPHouse of GAAPHouse of GAAPHouse of GAAP

LO 7LO 7

Chapter 1-7

Concepts UnderlyingConcepts UnderlyingFinancial AccountingFinancial Accounting

Concepts UnderlyingConcepts UnderlyingFinancial AccountingFinancial Accounting

Chapter Chapter

22Intermediate Accounting


Chapter 1-8

Conceptual Conceptual

FrameworkFramework

Conceptual Conceptual

FrameworkFramework

NeedNeed

DevelopmentDevelopment

First Level: First Level:

Basic Basic

ObjectivesObjectives

First Level: First Level:

Basic Basic

ObjectivesObjectives

Second Level: Second Level: Fundamental Fundamental

ConceptsConcepts

Second Level: Second Level: Fundamental Fundamental

ConceptsConcepts

Third Level: Third Level: Recognition and Recognition and

MeasurementMeasurement

Third Level: Third Level: Recognition and Recognition and

MeasurementMeasurement

Basic Basic assumptionsassumptions

Basic principlesBasic principles

ConstraintsConstraints

Qualitative Qualitative characteristicscharacteristics

Basic elementsBasic elements

Conceptual FrameworkConceptual FrameworkConceptual FrameworkConceptual Framework

Chapter 1-9 Objective 2Objective 2

The FASB has issued six Statements of Financial Accounting Concepts (SFAC) for business enterprises.

The FASB has issued six Statements of Financial Accounting Concepts (SFAC) for business enterprises.

Development of Conceptual Development of Conceptual FrameworkFramework

Development of Conceptual Development of Conceptual FrameworkFramework

SFAC No.1 -Objectives of Financial Reporting

SFAC No.2 - Qualitative Characteristics of Accounting Information

SFAC No.3 - Elements of Financial Statements (superceded by SFAC No. 6)

SFAC No.4 - Nonbusiness Organizations

SFAC No.5 -Recognition and Measurement in Financial Statements

SFAC No.6 - Elements of Financial Statements (replaces SFAC No. 3)

SFAC No.7 -Using Cash Flow Information and Present Value in Accounting Measurements

LO 2 Describe the FASB’s efforts to construct a conceptual LO 2 Describe the FASB’s efforts to construct a conceptual framework.framework.

Chapter 1-10

ASSUMPTIONSASSUMPTIONS

1.1. Economic entityEconomic entity

2.2. Going concernGoing concern

3.3. Monetary unitMonetary unit

4.4. PeriodicityPeriodicity

PRINCIPLESPRINCIPLES

1.1. Historical costHistorical cost

2.2. Revenue recognitionRevenue recognition

3.3. MatchingMatching

4.4. Full disclosureFull disclosure

CONSTRAINTSCONSTRAINTS

1.1. Cost-benefitCost-benefit

2.2. MaterialityMateriality

3.3. Industry practiceIndustry practice

4.4. ConservatismConservatism

OBJECTIVESOBJECTIVES1. 1. Useful in investment Useful in investment

and credit decisionsand credit decisions2. 2. Useful in assessing Useful in assessing

future cash flowsfuture cash flows3. About enterprise 3. About enterprise

resources, claims to resources, claims to resources, and resources, and changes in themchanges in them

ELEMENTSELEMENTS

Assets, Liabilities, and EquityAssets, Liabilities, and EquityInvestments by ownersInvestments by ownersDistribution to ownersDistribution to ownersComprehensive incomeComprehensive incomeRevenues and ExpensesRevenues and ExpensesGains and LossesGains and Losses

Illustration Illustration 2-62-6 Conceptual Framework for Financial Reporting

First level

Second level

Third level

LO 2 Describe the FASB’s LO 2 Describe the FASB’s efforts to construct a efforts to construct a

conceptual framework.conceptual framework.

QUALITATIVE QUALITATIVE CHARACTERISTICSCHARACTERISTICS

RelevanceRelevance

ReliabilityReliability

ComparabilityComparability

ConsistencyConsistency

Chapter 1-11

Financial reporting should provide information that: Financial reporting should provide information that: Financial reporting should provide information that: Financial reporting should provide information that:

(a) is useful to present and potential investors and (a) is useful to present and potential investors and creditors and other users in making rational creditors and other users in making rational investment, credit, and similar decisions. investment, credit, and similar decisions.

(a) is useful to present and potential investors and (a) is useful to present and potential investors and creditors and other users in making rational creditors and other users in making rational investment, credit, and similar decisions. investment, credit, and similar decisions.

(b) helps present and potential investors and creditors (b) helps present and potential investors and creditors and other users in assessing the amounts, timing, and and other users in assessing the amounts, timing, and uncertainty of prospective cash receipts. uncertainty of prospective cash receipts.

(b) helps present and potential investors and creditors (b) helps present and potential investors and creditors and other users in assessing the amounts, timing, and and other users in assessing the amounts, timing, and uncertainty of prospective cash receipts. uncertainty of prospective cash receipts.

(c) portrays the economic resources of an enterprise, the (c) portrays the economic resources of an enterprise, the claims to those resources, and the effects of claims to those resources, and the effects of transactions, events, and circumstances that change transactions, events, and circumstances that change its resources and claims to those resources. its resources and claims to those resources.

(c) portrays the economic resources of an enterprise, the (c) portrays the economic resources of an enterprise, the claims to those resources, and the effects of claims to those resources, and the effects of transactions, events, and circumstances that change transactions, events, and circumstances that change its resources and claims to those resources. its resources and claims to those resources.

First Level: Basic ObjectivesFirst Level: Basic ObjectivesFirst Level: Basic ObjectivesFirst Level: Basic Objectives

LO 3 Understand the objectives of financial LO 3 Understand the objectives of financial reporting.reporting.

Chapter 1-12

Second Level: Qualitative Second Level: Qualitative CharacteristicsCharacteristics

Second Level: Qualitative Second Level: Qualitative CharacteristicsCharacteristics

LO 4 Identify the qualitative characteristics of accounting LO 4 Identify the qualitative characteristics of accounting information.information.

Illustration 2-2Illustration 2-2 Hierarchy of Accounting Qualities

Chapter 1-13





















RelevanceRelevance




ELEMENTSELEMENTS



First level

Second level

Third levelRelevance and ReliabilityRelevance and ReliabilityRelevance and ReliabilityRelevance and Reliability

LO 4 Identify the LO 4 Identify the qualitative qualitative characteristics of characteristics of accounting accounting information.information.

Chapter 1-14





















RelevanceRelevance




ELEMENTSELEMENTS



First level

Second level

Third level

LO 4 Identify the LO 4 Identify the qualitative qualitative characteristics of characteristics of accounting accounting information.information.

Comparability and ConsistencyComparability and ConsistencyComparability and ConsistencyComparability and Consistency

Chapter 1-15





















RelevanceRelevance




ELEMENTSELEMENTS



First level

Second level

Third levelElementsElementsElementsElements

LO 5 Define the basic LO 5 Define the basic elements of elements of financial financial statements.statements.

Chapter 1-16

Third Level: Recognition and Third Level: Recognition and MeasurementMeasurement

Third Level: Recognition and Third Level: Recognition and MeasurementMeasurement

The FASB sets forth most of these concepts in its Statement of Financial Accounting Concepts No. 5, “Recognition and Measurement in Financial Statements of Business Enterprises.”
















LO 6 Describe the basic assumptions of accounting.LO 6 Describe the basic assumptions of accounting.

Chapter 1-17

The Accounting Information The Accounting Information SystemSystem The Accounting Information The Accounting Information SystemSystem

Chapter Chapter



Chapter 1-18

Accounting Information Accounting Information

SystemSystem

Accounting Information Accounting Information

SystemSystem

Basic terminologyBasic terminology

Debits and creditsDebits and credits

Basic equationBasic equation

Financial statements and Financial statements and ownership structureownership structure

The Accounting CycleThe Accounting CycleThe Accounting CycleThe Accounting Cycle

Identification and recordingIdentification and recording

JournalizingJournalizing

PostingPosting

Trial balanceTrial balance

Adjusting entriesAdjusting entries

Adjusted trial balanceAdjusted trial balance

Preparing financial Preparing financial statementsstatements

ClosingClosing

Post-closing trial balancePost-closing trial balance

Reversing entriesReversing entries

Financial statements for Financial statements for merchandisersmerchandisers

Accounting Information SystemAccounting Information SystemAccounting Information SystemAccounting Information System

Chapter 1-19

The Accounting CycleThe Accounting CycleThe Accounting CycleThe Accounting Cycle

LO 3 Identify steps in the accounting LO 3 Identify steps in the accounting cycle.cycle.

TransactionsTransactions

1. Journalization1. Journalization

6. Financial Statements6. Financial Statements

7. Closing entries7. Closing entries

8. Post-closing trail balance

8. Post-closing trail balance

9. Reversing entries9. Reversing entries

3. Trial balance3. Trial balance

2. Posting2. Posting

5. Adjusted trial balance5. Adjusted trial balance

4. Adjustments4. AdjustmentsWork SheetWork Sheet

Illustration 3-6

Chapter 1-20

Income Statement and Related Income Statement and Related InformationInformation Income Statement and Related Income Statement and Related InformationInformation

Chapter Chapter



Chapter 1-21

Income Income

StatementStatement

UsefulnessUsefulness

LimitationsLimitations

Quality of EarningsQuality of Earnings

Format of the Format of the

Income Income

StatementStatement

Reporting Reporting

Irregular ItemsIrregular Items

Special Special

Reporting Reporting

IssuesIssues

Intraperiod tax Intraperiod tax allocationallocation

Earnings per shareEarnings per share

Retained earnings Retained earnings statementstatement

Comprehensive Comprehensive incomeincome

Discontinued Discontinued operationsoperations

Extraordinary itemsExtraordinary items

Unusual gains and Unusual gains and losseslosses

Changes in Changes in accounting accounting principlesprinciples

Changes in Changes in estimatesestimates

Corrections of Corrections of errorserrors

Income Statement and Related InformationIncome Statement and Related InformationIncome Statement and Related InformationIncome Statement and Related Information

ElementsElements

Single-stepSingle-step

Multiple-stepMultiple-step

Condensed income Condensed income statementsstatements

Chapter 1-22

Elements of the Income StatementElements of the Income StatementElements of the Income StatementElements of the Income Statement

LO 1 Understand the uses and limitations of an income statement.LO 1 Understand the uses and limitations of an income statement.

Revenues – Inflows or other enhancements of – Inflows or other enhancements of assets or settlements of its liabilities that assets or settlements of its liabilities that constitute the entity’s ongoing major or central constitute the entity’s ongoing major or central operations.operations.

SalesSales

Fee revenueFee revenue

Interest revenueInterest revenue

Dividend Dividend revenuerevenue

Rent revenueRent revenue

Examples of Revenue Accounts

Chapter 1-23



Expenses – Outflows or other using-up of assets – Outflows or other using-up of assets or incurrences of liabilities that constitute the or incurrences of liabilities that constitute the entity’s ongoing major or central operations.entity’s ongoing major or central operations.

Cost of goods soldCost of goods sold

Depreciation Depreciation expenseexpense

Interest expenseInterest expense

Rent expenseRent expense

Salary expenseSalary expense

Examples of Expense Accounts

Chapter 1-24



Gains – Increases in equity (net assets) from – Increases in equity (net assets) from peripheral or incidental transactions.peripheral or incidental transactions.

Losses - Decreases in equity (net assets) - Decreases in equity (net assets) from peripheral or incidental transactions.from peripheral or incidental transactions.

Gains and losses can result fromGains and losses can result from

sale of investments or plant assets, sale of investments or plant assets,

settlement of liabilities, settlement of liabilities,

write-offs of assets.write-offs of assets.

Chapter 1-25

Single-Step Income StatementSingle-Step Income StatementSingle-Step Income StatementSingle-Step Income Statement

LO 2 Prepare a single-step income statement.LO 2 Prepare a single-step income statement.

The single-step The single-step statement consists of statement consists of just two groupings:just two groupings:

I ncome Statement (in thousands)

Revenues:

Sales 285,000$ I nterest revenue 17,000

Total revenue 302,000 Expenses:

Cost of goods sold 149,000 Advertising expense 10,000 Depreciation expense 43,000 I nterest expense 21,000 I ncome tax expense 24,000

Total expenses 247,000 Net income 55,000$

Earnings per share 0.75$

RevenuesRevenues

ExpensesExpenses

Net IncomeNet Income

Single- Single- StepStep

Single- Single- StepStep

No distinction between No distinction between OperatingOperating and and Non-Non-operatingoperating categories. categories.

Chapter 1-26

Multiple-Step Income StatementMultiple-Step Income StatementMultiple-Step Income StatementMultiple-Step Income Statement

LO 3 Prepare a multiple-step income statement.LO 3 Prepare a multiple-step income statement.

The The presentation presentation divides information divides information into major into major sections. sections.

The The presentation presentation divides information divides information into major into major sections. sections.


Sales 285,000$

Cost of goods sold 149,000 Gross profi t 136,000

Operating expenses:

Advertising expense 10,000 Depreciation expense 43,000

Total operating expense 53,000 I ncome from operations 83,000

Other revenue (expense):

I nterest revenue 17,000 I nterest expense (21,000)

Total other (4,000) I ncome bef ore taxes 79,000 I ncome tax expense 24,000 Net income 55,000$

Earnings per share 0.75$

1. Operating 1. Operating SectionSection

1. Operating 1. Operating SectionSection

2. Nonoperating 2. Nonoperating SectionSection

2. Nonoperating 2. Nonoperating SectionSection

3. Income tax3. Income tax 3. Income tax3. Income tax

Chapter 1-27

Irregular items fall into six categories

Discontinued operations.

Extraordinary items.

Unusual gains and losses.

Changes in accounting principle.

Changes in estimates.

Corrections of errors.

Reporting Irregular ItemsReporting Irregular ItemsReporting Irregular ItemsReporting Irregular Items

LO 4 Explain how to report irregular items.LO 4 Explain how to report irregular items.

Chapter 1-28

Discontinued Operations occurs when,

(a) company eliminates the

results of operations and

cash flows of a component.

(b) there is no significant continuing involvement in that component.

Amount reported “net of tax.”



Chapter 1-29

Reporting Discontinued OperationsReporting Discontinued OperationsReporting Discontinued OperationsReporting Discontinued Operations



Total other (4,000) I ncome bef ore taxes 79,000 I ncome tax expense 24,000 I ncome from continuing operations 55,000

Discontinued operations:

Loss from operations, net of tax 315

Loss on disposal, net of tax 189

Total loss on discontinued operations 504

Net income 54,496$


Sales 285,000$

Cost of goods sold 149,000 Discontinued Discontinued

Operations are Operations are reported after “Income reported after “Income

from continuing from continuing operations.”operations.”

Previously labeled as “Net Income”.

Moved to


Chapter 1-30

Extraordinary items are nonrecurring material items that differ significantly from a company’s typical business activities.

Extraordinary Item must be both of an

Unusual Nature and Occur Infrequently

Company must consider the environment in which it operates.

Amount reported “net of tax.”



Chapter 1-31

Not Extraordinary Not Extraordinary Not Extraordinary Not Extraordinary

Write-down or write-off of receivables, inventory, etc.

Gains or losses from exchange or translation of foreign currencies.

Gains or losses on disposal of business segment.

Gains or losses from sale or abandonment of productive assets.

Effects of a strike. Adjustment of accruals on long-term

contracts.

Chapter 1-32



Total other (4,000) I ncome bef ore taxes 79,000 I ncome tax expense 24,000 I ncome from continuing operations 55,000

Extraordinary loss, net of tax 539

Net income 54,461$


Sales 285,000$

Cost of goods sold 149,000 Extraordinary Items Extraordinary Items

are reported after are reported after “Income from “Income from

continuing continuing operations.”operations.”

Previously labeled as “Net Income”.

Reporting Extraordinary ItemsReporting Extraordinary ItemsReporting Extraordinary ItemsReporting Extraordinary Items

Moved to


Chapter 1-33

Unusual Gains and Losses

Material items that are unusual or infrequent, but not both, should be reported in a separate section just above “Income from continuing operations before income taxes.”

Examples can include:

Write-downs of inventoriesForeign exchange transaction gains and losses

The Board prohibits net-of-tax treatment for these items.



Chapter 1-34

Changes in Accounting Principles

Retrospective adjustment

Cumulative effect adjustment to beginning retained earnings

Approach preserves comparability

Examples include: change from FIFO to average cost

change for construction contract from the percentage-of-completion to the completed-contract method



Chapter 1-35

Changes in Estimate

Accounted for in the period of change and future periods

Not handled retrospectively

Not considered errors or extraordinary items

Examples include: Useful lives and salvage values of

depreciable assets Allowance for uncollectible receivables Inventory obsolescence



Chapter 1-36

Corrections of Errors

Result from: mathematical mistakes mistakes in application of accounting

principles oversight or misuse of facts

Corrections treated as prior period adjustments

Adjustment to the beginning balance of retained earnings



Chapter 1-37

An important business indicator.

Measures the dollars earned by each share of common stock.

Must be disclosed on the the income statement.

Earnings Per ShareEarnings Per ShareEarnings Per ShareEarnings Per Share

LO 6 LO 6 Identify where to report earnings per share information.Identify where to report earnings per share information.

Net income - Preferred dividends

Weighted average number of shares outstanding

Calculation

Chapter 1-38

All changes in equity during a period except those All changes in equity during a period except those resulting from investments by owners and resulting from investments by owners and distributions to owners.distributions to owners.

Comprehensive IncomeComprehensive IncomeComprehensive IncomeComprehensive Income


Sales 285,000$

Cost of goods sold 149,000 Gross profi t 136,000

Operating expenses:

Advertising expense 10,000 Depreciation expense 43,000

Total operating expense 53,000 I ncome from operations 83,000



Total other (4,000) I ncome bef ore taxes 79,000 I ncome tax expense 24,000 Net income 55,000$

Other Comprehensive Other Comprehensive IncomeIncome

Unrealized gains and losses on available-for-sale securities.

Translation gains and losses on foreign currency.

Plus others

+

Reported in Stockholders’ Equity

LO 8 LO 8 Explain how to report other comprehensive income.Explain how to report other comprehensive income.

Chapter 1-39

Three approaches to reporting Three approaches to reporting Comprehensive Income (SFAS No. 130, June Comprehensive Income (SFAS No. 130, June 1997):1997):

1.1. A second separate income statement;A second separate income statement;

2.2. A combined income statement of A combined income statement of comprehensive income; orcomprehensive income; or

3.3. As part of the statement of stockholders’ As part of the statement of stockholders’ equityequity



Chapter 1-40



Statement of Stockholders’ Equity (most common) Illustration 4-20Illustration 4-20

Chapter 1-41

Balance Sheet and Statement of Balance Sheet and Statement of Cash FlowsCash FlowsBalance Sheet and Statement of Balance Sheet and Statement of Cash FlowsCash Flows

Chapter Chapter



Chapter 1-42

Balance Balance

SheetSheetStatement of Statement of

Cash FlowsCash Flows

PurposePurpose

Content and Content and formatformat

PreparationPreparation


Balance Sheet and Statement of Cash FlowsBalance Sheet and Statement of Cash FlowsBalance Sheet and Statement of Cash FlowsBalance Sheet and Statement of Cash Flows


LimitationsLimitations

ClassificationClassification

Additional Additional information information reportedreported

Techniques of Techniques of disclosuredisclosure

Chapter 1-43 LO 2 Identify the major classifications of the balance sheet.LO 2 Identify the major classifications of the balance sheet.

Classification in the Balance SheetClassification in the Balance SheetClassification in the Balance SheetClassification in the Balance Sheet

Chapter 1-44

Generally any monies available “on demand.”

Cash equivalents are short-term highly liquid investments that will mature within three months or less.

Any restrictions or commitments must be disclosed.

Cash

LO 2 Identify the major classifications of the balance sheet.LO 2 Identify the major classifications of the balance sheet.

Balance Sheet – “Current Assets”Balance Sheet – “Current Assets”Balance Sheet – “Current Assets”Balance Sheet – “Current Assets”

Illustration 5-3Illustration 5-3

Chapter 1-45

Portfolios

Short-Term Investments


Type Valuation Classification

Held-to-Maturity

DebtAmortized

CostCurrent or Noncurrent

TradingDebt or Equity

Fair Value Current

Available- for-Sale

Debt or Equity

Fair ValueCurrent or Noncurrent


Chapter 1-46

Claims held against customers and others for money, goods, or services.

Accounts receivable – oral promises

Notes receivable – written promises

Major categories of receivables should be shown in the balance sheet or the related notes.

Receivables



Chapter 1-47

Company discloses:

basis of valuation (e.g., lower-of-cost-or-market) and

the method of pricing (e.g., FIFO or LIFO).

Inventories



Chapter 1-48

Payment of cash, that is recorded as an asset because Payment of cash, that is recorded as an asset because service or benefit will be received in the future.service or benefit will be received in the future.

insuranceinsurance

suppliessupplies

advertisingadvertising

Cash PaymentCash Payment Expense RecordedExpense RecordedBEFORE

rentrent

maintenance on maintenance on equipmentequipment

Prepayments often occur in regard to:Prepayments often occur in regard to:

Prepaid Expenses



Chapter 1-49

Generally consists of four types:

SecuritiesSecurities

Fixed assetsFixed assets

Special fundsSpecial funds

Nonconsolidated subsidiariesNonconsolidated subsidiaries or affiliated companies.

Long-Term Investments


Balance Sheet – “Noncurrent Assets”Balance Sheet – “Noncurrent Assets”Balance Sheet – “Noncurrent Assets”Balance Sheet – “Noncurrent Assets”

Chapter 1-50

Long-Term Investments

SecuritiesSecurities SecuritiesSecurities I nvestments:

I nvesment in ABC bonds 321,657 I nvestment in UC I nc. 253,980 Notes receivable 150,000 Land held f or speculation 550,000 Sinking f und 225,000 Pension f und 653,798 Cash surrender value 84,321 I nvestment in Uncon. Sub. 457,836

Total investments 2,696,592 Property, Plant, and Equip.

Building 1,375,778 Land 975,000



bonds, stock, and long-term notes

For marketable securities, management’s intent determines current or noncurrent classification.

Balance Sheet (in thousands)

Current assets

Cash 285,000$

Chapter 1-51

Property, Plant, and Equipment

Total investments 2,696,592 Property, Plant, and Equip.

Building 1,375,778 Land 975,000 Machinery and equipment 234,958 Capital leases 384,650 Leasehold improvements 175,000 Accumulated depreciation (975,000)

Total PP&E 2,170,386 I ntangibles

Goodwill 3,000,000 Patents 177,000 Trademarks 40,000



Assets of a durable nature used in the regular operations of the business.


Current assets

Cash 285,000$

Chapter 1-52

Intangibles

Accumulated depreciation (975,000) Total PP&E 2,170,386

I ntangibles

Goodwill 2,000,000 Patents 177,000 Trademark 40,000 Franchises 125,000 Copyright 55,000

Total intangibles 2,397,000 Other assets

Prepaid pension costs 133,000 Def erred income tax 40,000

Total other 173,000



Lack physical substance and are not financial instruments.

Limited life intangibles amortized.

Indefinite-life intangibles tested for impairment.


Current assets

Cash 285,000$

Chapter 1-53

“ Obligations that a company reasonably expects to liquidate either through the use of current assets or the creation of other current liabilities.”


Balance SheetBalance SheetBalance SheetBalance Sheet

Current Liabilities


Current liabilities

Notes payable 233,450$ Accounts payable 131,800 Accrued compensation 43,000 Unearned revenue 17,000 I ncome tax payable 23,400 Current maturities LT debt 121,000

Total current liabilities 569,650 Long- term liabilities

Long-term debt 979,500 Obligations capital lease 345,800 Def erred income taxes 77,909

Total long-term liabilities 2,093,859 Stockholders' equity

Chapter 1-54

“ Obligations that a company does not reasonably expect to liquidate within the normal operating cycle.”

All covenants and restrictions must be disclosed.




Current liabilities

Notes payable 233,450$ Accounts payable 131,800 Accrued compensation 43,000 Unearned revenue 17,000 I ncome tax payable 23,400 Current maturities LT debt 121,000

Total current liabilities 569,650 Long- term liabilities

Long-term debt 979,500 Obligations capital lease 345,800 Def erred income taxes 77,909

Total long-term liabilities 2,093,859 Stockholders' equity

Long-Term Liabilities

Chapter 1-55

Companies usually divide equity into three parts, (1) Capital Stock, (2) Additional Paid-In Capital, and (3) Retained Earnings.



Owners’ Equity


Chapter 1-56

Contributed CapitalContributed CapitalContributed CapitalContributed Capital

Two parts of contributed capital:Two parts of contributed capital:1.1. Capital Stock-Capital Stock- the number of shares x the the number of shares x the

par value.par value.a.a. Preferred stock-Preferred stock- usually paid a fixed annual usually paid a fixed annual

cash dividend and have rights to their cash dividend and have rights to their investment in bankruptcyinvestment in bankruptcy

b.b. Common stock-Common stock- real owners of the real owners of the corporation, have voting power, but are last corporation, have voting power, but are last in line for assets in bankruptcyin line for assets in bankruptcy

2.2. Additional paid-in capital-Additional paid-in capital- investment by investment by shareholders in excess of par value of shareholders in excess of par value of capital stock.capital stock.

Chapter 1-57

Three different activities:

Operating,

Content and Format

The Statement of Cash FlowsThe Statement of Cash FlowsThe Statement of Cash FlowsThe Statement of Cash Flows

LO 7 Identify the content of the statement of cash flows.LO 7 Identify the content of the statement of cash flows.

Investing, Financing


Chapter 1-58

Preparation


LO 8 Prepare a statement of cash flows.LO 8 Prepare a statement of cash flows.

BE 5-12 Midwest Beverage Company reported the following items in the most recent year.

Activity

OperatingFinancingOperatingOperatingInvesting

OperatingFinancing

Required: Prepare a Statement of Cash Flows

Chapter 1-59

PreparationStatement of Cash Flow (in thousands)

Operating activities

Net income 40,000$ I ncrease in accounts receivable (10,000) I ncrease in accounts payable 5,000 Depreciation expense 40,000

Cash flow f rom operations 75,000 I nvesting activities

Purchase of equipment (8,000) Financing activities

Proceeds f rom notes payable 20,000 Dividends paid (5,000)

Cash flow f rom financing 15,000 I ncrease in cash 82,000$



Noncash credit to revenues.

Noncash charge to expenses.

Chapter 1-60

Issuance of common stock to purchase assets.Conversion of bonds into common stock.Issuance of debt to purchase assets.Exchanges on long-lived assets.

Additional Information ReportedAdditional Information ReportedAdditional Information ReportedAdditional Information Reported

Significant financing and investing activities that do not affect cash are reported in either a separate schedule at the bottom of the statement of cash flows or in the notes.

Examples include:


Chapter 1-61

Understanding Cash and ReceivablesUnderstanding Cash and ReceivablesUnderstanding Cash and ReceivablesUnderstanding Cash and Receivables

ChapteChapter r

77Intermediate Accounting12th Edition

Kieso, Weygandt, and Warfield

Chapter 1-62

Cash and ReceivablesCash and ReceivablesCash and ReceivablesCash and Receivables

What is cash?What is cash?

Management and Management and control of cashcontrol of cash

Reporting cashReporting cash

Summary of cash-Summary of cash-related itemsrelated items

CashCash ReceivablesReceivables

Recognition of accounts Recognition of accounts receivablereceivable

Valuation of accounts Valuation of accounts receivablereceivable

Recognition of notes Recognition of notes receivablereceivable

Valuation of notes Valuation of notes receivablereceivable

Disposition of accounts Disposition of accounts and notes receivableand notes receivable

Presentation and Presentation and analysisanalysis

Chapter 1-63

Recognition of Accounts ReceivablesRecognition of Accounts ReceivablesRecognition of Accounts ReceivablesRecognition of Accounts Receivables

LO 4 Explain accounting issues related to recognition of accounts LO 4 Explain accounting issues related to recognition of accounts receivable.receivable.

Cash DiscountsCash Discounts

Inducements for Inducements for prompt paymentprompt payment

Gross Method vs. Gross Method vs. Net MethodNet Method

Cash DiscountsCash Discounts

Inducements for Inducements for prompt paymentprompt payment

Gross Method vs. Gross Method vs. Net MethodNet Method Payment

terms are 2/10, n/30

Chapter 1-64

Example:Example: On June 3, Benedict Corp. sold to Chester On June 3, Benedict Corp. sold to Chester Inc., merchandise having a sale price of $5,000 with Inc., merchandise having a sale price of $5,000 with terms of 2/10,n/60, f.o.b. shipping point. On June 12, terms of 2/10,n/60, f.o.b. shipping point. On June 12, Benedict received a check for the balance due from Benedict received a check for the balance due from Chester. Prepare required journal entries assuming Chester. Prepare required journal entries assuming Benedict records the sale at Benedict records the sale at netnet..

Sales

4,900

Accounts receivable 4,900June 3

Recognition of Accounts ReceivablesRecognition of Accounts ReceivablesRecognition of Accounts ReceivablesRecognition of Accounts Receivables

LO 4 Explain accounting issues related to recognition of accounts LO 4 Explain accounting issues related to recognition of accounts receivable.receivable.

Accounts receivable

4,900

Cash 4,900June 12

Net Method

Chapter 1-65

Uncollectible Accounts ReceivableUncollectible Accounts ReceivableUncollectible Accounts ReceivableUncollectible Accounts Receivable

LO 5 Explain accounting issues related to valuation of accounts LO 5 Explain accounting issues related to valuation of accounts receivable.receivable.

Allowance MethodAllowance MethodLosses are Estimated:

Percentage-of-salesPercentage-of-receivables

Methods of Accounting for Uncollectible Accounts

Direct Write-OffDirect Write-OffTheoretically

undesirable:no matchingreceivable not stated at net realizable value

Chapter 1-66

Income Stateme

nt Approach

Income Stateme

nt Approach

Balance Sheet

Approach

Balance Sheet

Approach

Percentage of SalesPercentage of Sales

Matching

Sales --- Bad Debt Expense

Percentage of ReceivablesPercentage of Receivables

Net Realizable Value

Receivables - Allowance for Bad Debt



Chapter 1-67

Example DataExample Data

Credit salesCredit sales $500,000 $500,000

Estimated % of credit sales not collectedEstimated % of credit sales not collected 1.25%1.25%

Accounts receivable balanceAccounts receivable balance $72,500 $72,500

Estimated % of A/R not collectedEstimated % of A/R not collected 8% 8%

Allowance for Doubtful Accounts:Allowance for Doubtful Accounts:

Case ICase I $150 (credit balance)$150 (credit balance)

Case 2Case 2 $150 (debit balance)$150 (debit balance)

Example DataExample Data

Credit salesCredit sales $500,000 $500,000

Estimated % of credit sales not collectedEstimated % of credit sales not collected 1.25%1.25%

Accounts receivable balanceAccounts receivable balance $72,500 $72,500

Estimated % of A/R not collectedEstimated % of A/R not collected 8% 8%

Allowance for Doubtful Accounts:Allowance for Doubtful Accounts:

Case ICase I $150 (credit balance)$150 (credit balance)

Case 2Case 2 $150 (debit balance)$150 (debit balance)



Chapter 1-68


Accounts receivableAccounts receivable $ 72,500$ 72,500

Estimated percentageEstimated percentage x 8%x 8%

Desired balanceDesired balance $ 5,800$ 5,800

======================================================================================================

What should the ending balance be for the allowance What should the ending balance be for the allowance account? -- account? -- Case 1Case 1 and and Case 2Case 2

Accounts receivableAccounts receivable $ 72,500$ 72,500

Estimated percentageEstimated percentage x 8%x 8%

Desired balanceDesired balance $ 5,800$ 5,800

======================================================================================================

What should the ending balance be for the allowance What should the ending balance be for the allowance account? -- account? -- Case 1Case 1 and and Case 2Case 2

Percentage of Receivables


Chapter 1-69


Actual balance (credit) (150) 150

Desired balance

(5,800) (5,800)

Adjustment (5,650) (5,950)

Journal entry – Case 1:

Allowance for doubtful accounts

5,650

Bad debt expense 5,650

Case 1 Case 2



Chapter 1-70


Actual balance (credit) (150) 150

Desired balance

(5,800) (5,800)

Adjustment (5,650) (5,950)

Journal entry – Case 2:

Allowance for doubtful accounts

5,950

Bad debt expense 5,950

Case 1 Case 2



Chapter 1-71 LO 6 Explain accounting issues related to recognition of notes LO 6 Explain accounting issues related to recognition of notes

receivable.receivable.

Recognition of Notes ReceivableRecognition of Notes ReceivableRecognition of Notes ReceivableRecognition of Notes Receivable

Short-Term Long-Term

Record at Face Value,

less allowance

Record at Present Value

of cash expected to be collected

Interest Rates

Stated rate = Market rate

Stated rate > Market rate

Stated rate < Market rate

Note Issued at

Face Value

Premium

Discount

Chapter 1-72

Amortization ScheduleNon-Interest-Bearing Note

LO 6 Explain accounting issues related to recognition of notes LO 6 Explain accounting issues related to recognition of notes receivable.receivable.

6% CarryingCash Interest Discount Amount

Received Revenue Amortized of NoteDate of issue 74,726$ End of yr. 1 - 4,484$ 4,484$ 79,210 End of yr. 2 - 4,753 4,753 83,962 End of yr. 3 - 5,038 5,038 89,000 End of yr. 4 - 5,340 5,340 94,340 End of yr. 5 - 5,660 5,660 100,000

- 25,274 25,274

Zero-Interest-Bearing NoteZero-Interest-Bearing NoteZero-Interest-Bearing NoteZero-Interest-Bearing Note

Chapter 1-73

Journal Entries for Non-Interest-Bearing note

Present value of Principal $74,726

Date Account Title Debit Credit

J an. yr. 1 Notes receivable 100,000

Discount on notes receivable 25,274

Cash 74,726

Dec. yr. 1 Disount on notes receivable 4,484

I nterest revenue 4,484

($74,726 x 6%)


Zero-Interest-Bearing NoteZero-Interest-Bearing NoteZero-Interest-Bearing NoteZero-Interest-Bearing Note

Chapter 1-74

Amortization ScheduleInterest-Bearing Note


10% CarryingCash Interest Discount Amount

Received Revenue Amortized of NoteDate of issue 92,418$ End of yr. 1 8,000 9,242$ 1,242$ 93,660 End of yr. 2 8,000 9,366 1,366 95,026 End of yr. 3 8,000 9,503 1,503 96,529 End of yr. 4 8,000 9,653 1,653 98,182 End of yr. 5 8,000 9,818 1,818 100,000

40,000 47,582 7,582

Interest-Bearing NoteInterest-Bearing NoteInterest-Bearing NoteInterest-Bearing Note

Chapter 1-75

Journal Entries for Interest-Bearing Note

Date Account Title Debit Credit

J an. yr. 1 Notes receivable 100,000

Discount on notes receivable 7,582

Cash 92,418

Dec. yr. 1 Cash 8,000

Disount on notes receivable 1,242

I nterest revenue 9,242

($92,418 x 10%)


Interest-Bearing NoteInterest-Bearing NoteInterest-Bearing NoteInterest-Bearing Note

Chapter 1-76

Factors are finance companies or banks that buy receivables from businesses for a fee.

LO 8 Explain accounting issues related to LO 8 Explain accounting issues related to disposition of accounts and notes disposition of accounts and notes receivable.receivable.

Sales of ReceivablesSales of ReceivablesSales of ReceivablesSales of Receivables


Chapter 1-77

Sale Without Recourse

Purchaser assumes risk of collection

Transfer is outright sale of receivable

Seller records loss on sale

Seller use Due from Factor (receivable) account to cover discounts, returns, and allowances


Sales of ReceivablesSales of ReceivablesSales of ReceivablesSales of Receivables

Sale With Recourse

Seller guarantees payment to purchaser

Financial components approach used to record transfer

Chapter 1-78

The FASB concluded that a sale occurs only if the seller surrenders control of the receivables to the buyer. Three conditions must be met:


Secured Borrowing versus SaleSecured Borrowing versus SaleSecured Borrowing versus SaleSecured Borrowing versus Sale


Chapter 1-79

Accounting and Reporting for Inventory: Accounting and Reporting for Inventory: The BasicsThe BasicsAccounting and Reporting for Inventory: Accounting and Reporting for Inventory: The BasicsThe Basics

Chapter Chapter



Chapter 1-80

InventoryClassificati

onand Control

Physical Goods

Included inInventory

Costs Included

in Inventory

Cost Flow Assumptio

ns

LIFO: Special Issues

ClassificationClassification

ControlControl

Basic Basic inventory inventory valuation valuation issuesissues

Basis for Selection

Goods in Goods in transittransit

Consigned Consigned goodsgoods

Special sales Special sales agreementsagreements

Inventory Inventory errorserrors

Product costsProduct costs

Period costsPeriod costs

Purchase Purchase discountsdiscounts

Specific Specific identificationidentification

Average costAverage cost

FIFOFIFO

LIFOLIFO

LIFO reserveLIFO reserve

LIFO LIFO liquidationliquidation

Dollar-value Dollar-value LIFOLIFO

Comparison of Comparison of LIFO LIFO approachesapproaches

Advantages of Advantages of LIFOLIFO

Disadvantages Disadvantages of LIFOof LIFO

Summary of Summary of inventory inventory valuation valuation methodsmethods

Valuation of Inventories:Valuation of Inventories:Cost-basis ApproachCost-basis ApproachValuation of Inventories:Valuation of Inventories:Cost-basis ApproachCost-basis Approach

Chapter 1-81

Features:

Inventory Classification and SystemsInventory Classification and SystemsInventory Classification and SystemsInventory Classification and Systems

LO 2 Distinguish between perpetual and periodic inventory LO 2 Distinguish between perpetual and periodic inventory systems.systems.

Perpetual System

1. Purchases of merchandise are debited to Inventory.

2. Freight-in, purchase returns and allowances, and purchase discounts are recorded in Inventory.

3. Cost of goods sold is debited and Inventory is credited for each sale.

4. Physical count done to verify Inventory balance.The perpetual inventory system provides a

continuous record of Inventory and Cost of Goods Sold.

Chapter 1-82

Features:



Periodic System

1. Purchases of merchandise are debited to Purchases.

2. Ending Inventory determined by physical count.

3. Calculation of Cost of Goods Sold:Beginning inventory

$ 100,000Purchases, net

800,000Goods available for sale

900,000Ending inventory

125,000Cost of goods sold

$ 775,000

Chapter 1-84

A company should record purchases when it obtains legal title to the goods.

Physical Goods Included in InventoryPhysical Goods Included in InventoryPhysical Goods Included in InventoryPhysical Goods Included in Inventory


Physical Goods

Special Consideration:

Goods in Transit (FOB shipping point, FOB destination)

Consigned goods

Sales with buyback agreement

Sales with high rates of return

Sales on installment

Inventory errors

Chapter 1-85

Costs Included in InventoryCosts Included in InventoryCosts Included in InventoryCosts Included in Inventory

LO 4 Understand the items to include as inventory cost.LO 4 Understand the items to include as inventory cost.

Product Costs - costs directly connected with bringing the goods to the buyer’s place of business and converting such goods to a salable condition.

Period Costs – generally selling, general, and administrative expenses.

Purchase Discounts – Gross vs. Net Method

Chapter 1-86

|

Purchase cost $20,000, terms 2/10, net 30:|

Purchases 20,000 | Purchases 19,600Accounts payable 20,000 | Accounts payable 19,600

|

Invoices of $15,000 are paid within discount period:|

Accounts payable 15,000 | Accounts payable 14,700Purchase discounts 300 | Cash 14,700Cash 14,700 |

|

Invoices of $5,000 are paid after discount period:|

Accounts payable 5,000 | Accounts payable 4,900Cash 5,000 | Purchase discount lost 100

| Cash 5,000

Treatment of Purchase DiscountsTreatment of Purchase DiscountsTreatment of Purchase DiscountsTreatment of Purchase Discounts

Gross Method Net Method vs.

LO 4 Understand the items to include as inventory cost.LO 4 Understand the items to include as inventory cost.

Chapter 1-87

Answer: Method adopted should be one that most clearly reflects periodic income.

Cost Flow Assumption Adopted

Physical Movement of Goods

does not need to equal

FIFO

What Cost Flow Assumption to Adopt?What Cost Flow Assumption to Adopt?What Cost Flow Assumption to Adopt?What Cost Flow Assumption to Adopt?

LIFO

Average Cost

Specific Identification

LO 5 Describe and compare the cost flow LO 5 Describe and compare the cost flow assumptions used to account for assumptions used to account for inventories.inventories.

Chapter 1-88

Cost Flow AssumptionsCost Flow AssumptionsCost Flow AssumptionsCost Flow Assumptions


FIFO:

Transactions: Inventory Balance:

Date Units Layer 1 Layer 2 Layer 3 Total

Jun 1 300 300

Jun 10 (200) (200)

Jun 11 800 800

Jun 15 (500) (100) (400)

Jun 20 500 500

Jun 27 (300) (300)

- 100 500 600

Cost 10$ 12$ 13$

600 -$ 1,200$ 6,500$ 7,700$

Calculation of Cost of Goods Sold: Units Dollars

Beg. inventory 300 3,000$

Purchases 1,300 16,100

Goods available 1,600 19,100

Ending inventory (600) (7,700)

COGS 1,000 11,400$

Perpetual Perpetual InventoryInventoryPerpetual Perpetual InventoryInventory

FIFO MethodFIFO MethodFIFO MethodFIFO Method

+

Chapter 1-89



FIFO:

Transactions: Inventory Balance:

Date Units Layer 1 Layer 2 Layer 3 Total

Jun 1 300

Jun 10 (200)

Jun 11 800 100

Jun 15 (500)

Jun 20 500 500

Jun 27 (300)

- 100 500 600

Cost 10$ 12$ 13$

600 -$ 1,200$ 6,500$ 7,700$

Calculation of Cost of Goods Sold: Units Dollars

Beg. inventory 300 3,000$

Purchases 1,300 16,100

Goods available 1,600 19,100

Ending inventory (600) (7,700)

COGS 1,000 11,400$

Periodic Periodic InventoryInventoryPeriodic Periodic

InventoryInventory

FIFO MethodFIFO MethodFIFO MethodFIFO Method

+

Chapter 1-90

Transactions: Calculation of Cost of Goods Sold:Date Units Cost Total Units DollarsJun 1 300 10.00$ 3,000$ Beg. inventory 300 3,000$ Jun 10 - Purchases 1,300 16,100 Jun 11 800 12.00 9,600 Goods available 1,600 19,100 Jun 15 - Ending inventory (600) (7,163) Jun 20 500 13.00 6,500 COGS 1,000 11,938$

Jun 27 - 1600 19,100

Divided by units available 1,600 Average cost per unit 11.94 Unit on hand 600 Ending inventory 7,163$



Periodic InventoryPeriodic InventoryPeriodic InventoryPeriodic Inventory Weighted AverageWeighted AverageWeighted AverageWeighted Average+

Chapter 1-91

Inventories: Valuation and Inventories: Valuation and Estimation ConceptsEstimation ConceptsInventories: Valuation and Inventories: Valuation and Estimation ConceptsEstimation Concepts

Chapter Chapter



Chapter 1-92

Inventories: Additional Valuation IssuesInventories: Additional Valuation IssuesInventories: Additional Valuation IssuesInventories: Additional Valuation Issues

Net realizable Net realizable valuevalue

Relative sales Relative sales valuevalue

Purchase Purchase commitmentscommitments

Lower-of-Lower-of-

Cost-or-Cost-or-

MarketMarket

Valuation Valuation

BasesBasesGross Profit Gross Profit

MethodMethod

Retail Retail

Inventory Inventory

MethodMethod

Presentation Presentation

and Analysisand Analysis

Ceiling and Ceiling and floorfloor

How LCM How LCM worksworks

Application of Application of LCMLCM

“ “Market”Market”

Evaluation of Evaluation of rulerule

Gross profit Gross profit percentagepercentage

Evaluation of Evaluation of methodmethod

ConceptsConcepts

Conventional Conventional methodmethod

Special itemsSpecial items

Evaluation of Evaluation of methodmethod

PresentationPresentation

AnalysisAnalysis

Chapter 1-93

NotNot<<

CostCost MarketMarket

Ceiling = NRVCeiling = NRV

ReplacementCost

ReplacementCost

Floor =NRV less Normal

Profit Margin

Floor =NRV less Normal

Profit MarginGAAPLCM

GAAPLCM

What is the rationale for theWhat is the rationale for the CeilingCeiling andand FloorFloor limitations?limitations?

Lower-of-Cost-or-MarketLower-of-Cost-or-MarketLower-of-Cost-or-MarketLower-of-Cost-or-Market

LO 1 Describe and apply the lower-of-cost-or-market rule.LO 1 Describe and apply the lower-of-cost-or-market rule.

NotNot>>


Chapter 1-94



How LCM Works (Individual Items)


Chapter 1-95

NotNot<<

Cost = 960Cost = 960 Market = 1,000Market = 1,000

Ceiling = 1,070(1,200 – 130)(1,200 – 130)

Ceiling = 1,070(1,200 – 130)(1,200 – 130)

ReplacementCost = 1,000ReplacementCost = 1,000

Floor = 830(1,070-(1,200 x 20%))(1,070-(1,200 x 20%))

Floor = 830(1,070-(1,200 x 20%))(1,070-(1,200 x 20%))

LCM = 960LCM = 960



NotNot>>

Finished Desks D

I nventory cost 960$ Est. cost to manufacture 1,000 Commissions and disposal costs 130 Catalog selling price 1,200

Chapter 1-96

Relies on Three Assumptions:

Gross Profit MethodGross Profit MethodGross Profit MethodGross Profit Method

LO 5 Determine ending inventory by applying the gross profit LO 5 Determine ending inventory by applying the gross profit method.method.

Substitute Measure to Approximate Inventory

(1) Beginning inventory plus purchases equal total goods to be accounted for.

(2) Goods not sold must be on hand.

(3) The sales, reduced to cost, deducted from the sum of the opening inventory plus purchases, equal ending inventory.

Chapter 1-97

E9-12 (Gross Profit Method - Solution)

(a) Inventory, May 1 (at cost) $ 160,000

Purchases (gross) (at cost) 640,000

Purchase discounts (12,000)

Freight- in 30,000

Goods available (at cost) 818,000

Sales (at selling price) $ 1,000,000

Sales returns (at selling price) (70,000)

Net sales (at selling price) 930,000

Less gross profit (30% of $930,000) 279,000

Sales (at cost) 651,000

Approximate inventory, May 31 (at cost) $ 167,000

(a) Compute the estimated inventory assuming gross profit is 30% of sales.



Chapter 1-98

(a) Inventory, May 1 (at cost) $ 160,000

Purchases (gross) (at cost) 640,000

Purchase discounts (12,000)

Freight- in 30,000

Goods available (at cost) 818,000

Sales (at selling price) $ 1,000,000

Sales returns (at selling price) (70,000)

Net sales (at selling price) 930,000

Less gross profit (23.08% of $930,000) 214,644

Sales (at cost) 715,356

Approximate inventory, May 31 (at cost) $ 102,644

E9-12 (Gross Profit Method - Solution)(b) Compute the estimated inventory assuming gross profit is 30% of cost.



30%100% + 30%

= 23.08% of sales

Chapter 1-99

Retail Inventory MethodRetail Inventory MethodRetail Inventory MethodRetail Inventory Method

LO 6 Determine ending inventory by applying the retail LO 6 Determine ending inventory by applying the retail inventory method.inventory method.

A method used by retailers, to value inventory without a physical count, by converting retail prices to cost.

(1) the total cost and retail value of goods purchased,

(2) the total cost and retail value of the goods available for sale, and

(3) the sales for the period.

Requires retailers to keep:

Chapter 1-100

P9-8 (Retail Inventory Method) Jared Jones Inc. uses the retail inventory method to estimate ending inventory for its monthly financial statements. The following data pertain to a single department for the month of October 2008.

Retail Inventory MethodRetail Inventory MethodRetail Inventory MethodRetail Inventory Method

COST RETAILBeg. inventory, Oct. 1 52,000$ 78,000$ Purchases 262,000 423,000 Freight in 16,600 Purchase returns 5,600 8,000 Additional markups 9,000 Markup cancellations 2,000 Markdowns (net) 3,600 Normal spoilage 10,000 Sales 380,000

Instructions:

Prepare a schedule computing estimate retail inventory using the following methods:

(1) Cost

(2) LCM

(3) LIFO (appendix)


Chapter 1-101

Retail Inventory - Cost MethodRetail Inventory - Cost MethodRetail Inventory - Cost MethodRetail Inventory - Cost Method


P9-8 Solution - Cost Method Cost toCOST RETAIL Retail %

Beg. inventory 52,000$ 78,000$ Purchases 262,000 423,000 Freight in 16,600 Purchase returns (5,600) (8,000) Markdowns, net (3,600) Markups, net 7,000

Current year additions 273,000 418,400 Goods available for sale 325,000 496,400 65.47% Normal spoilage (10,000) Sales (380,000) Ending inventory at retail 106,400$

Ending inventory at Cost:106,400$ x 65.47% = 69,660$

==//

Chapter 1-102

Retail Inventory - LCM MethodRetail Inventory - LCM MethodRetail Inventory - LCM MethodRetail Inventory - LCM Method


P9-8 Solution - LCM (CONVENTIONAL) Method:Cost to

COST RETAIL Retail %Beg. inventory 52,000$ 78,000$ Purchases 262,000 423,000 Freight in 16,600 Purchase returns (5,600) (8,000) Markups, net 7,000

Current year additions 273,000 422,000 Goods available for sale 325,000 500,000 65.00% Markdowns, net (3,600)

Normal spoilage (10,000) Sales (380,000) Ending inventory at retail 106,400$

Ending inventory at Cost:106,400$ x 65.00% = 69,160$

==//

Chapter 1-103

Property, Plant, and Equipment: Property, Plant, and Equipment: Acquisition and DispositionAcquisition and DispositionProperty, Plant, and Equipment: Property, Plant, and Equipment: Acquisition and DispositionAcquisition and Disposition

ChapteChapter r

1010Intermediate Accounting12th Edition

Kieso, Weygandt, and Warfield

Prepared by Coby Harmon, University of California, Santa Barbara

Chapter 1-104

Acquisition and Disposition of Property, Plant, Acquisition and Disposition of Property, Plant, and Equipmentand EquipmentAcquisition and Disposition of Property, Plant, Acquisition and Disposition of Property, Plant, and Equipmentand Equipment

AcquisitionAcquisition

Acquisition costs: Acquisition costs: Land, buildings, Land, buildings, equipmentequipment

Self-constructed Self-constructed assetsassets

Interest costsInterest costs

ObservationsObservations

ValuationValuationCost Cost

Subsequent to Subsequent to AcquisitionAcquisition

DispositionsDispositions

Cash discountsCash discounts

Deferred Deferred contractscontracts

Lump-sum Lump-sum purchasespurchases

Stock issuanceStock issuance

Nonmonetary Nonmonetary exchangesexchanges

ContributionsContributions

Other valuation Other valuation methodsmethods

SaleSale

Involuntary Involuntary conversionconversion

Miscellaneous Miscellaneous problemsproblems

AdditionsAdditions

Improvements Improvements and and replacementsreplacements

Rearrangement Rearrangement and reinstallationand reinstallation

RepairsRepairs

SummarySummary

Chapter 1-105

At acquisition, cost reflects fair value.

Historical cost is reliable.

Companies should not anticipate gains and losses but should recognize gains and losses only when the asset is sold.

Valued at Historical Cost, reasons include:

Acquisition and Valuation of PP&EAcquisition and Valuation of PP&EAcquisition and Valuation of PP&EAcquisition and Valuation of PP&E

LO 2 Identify the costs to include in initial LO 2 Identify the costs to include in initial valuation of property, plant, and valuation of property, plant, and equipment.equipment.

APB Opinion No. 6 states, “property, plant, and

equipment should not be written up to reflect appraisal, market, or

current values which are above cost.”

APB Opinion No. 6 states, “property, plant, and

equipment should not be written up to reflect appraisal, market, or

current values which are above cost.”

Chapter 1-106

Three approaches have been suggested to account for the interest incurred in financing the construction.

Interest Costs During Construction


LO 4 Describe the accounting problems associated with interest LO 4 Describe the accounting problems associated with interest capitalization.capitalization.

Capitalize no Capitalize no interest interest during during

constructionconstruction

Capitalize actual Capitalize actual costs incurred costs incurred

during construction during construction (with modification)(with modification)

Capitalize Capitalize all costs all costs of fundsof funds

GAAPGAAP

$ 0$ 0 $ ?$ ?Increase to Cost of AssetIncrease to Cost of Asset

Illustration 10-1

Chapter 1-107

Interest Capitalization Illustration: Delmar Corporation borrowed $200,000 at 12% interest from State Bank on Jan. 1, 2005, for specific purposes of constructing special-purpose equipment to be used in its operations. Construction on the equipment began on Jan. 1, 2005, and the following expenditures were made prior to the project’s completion on Dec. 31, 2005:



Actual Expenditures:

J anuary 1, 2005 $100,000

April 30, 2005 150,000

November 1, 2005 300,000

December 31, 2005 100,000

Total expenditures $650,000

Other general debt existing on Jan. 1, 2005:

$500,000, 14%, 10-year bonds payable

$300,000, 10%, 5-year note payable

Chapter 1-108

Step 1 - Determine which assets qualify for capitalization of interest.

Special purpose equipment qualifies because it requires a period of time to get ready and it will be used in the company’s operations.



Step 2 - Determine the capitalization period.

The capitalization period is from Jan. 1, 2005 through Dec. 31, 2005, because expenditures are being made and interest costs are being incurred during this period while construction is taking place.

Chapter 1-109



WeightedAverage

Actual Capitalization Accumulated Date Expenditures Period Expenditures

J an. 1 100,000$ 12/ 12 100,000$ Apr. 30 150,000 8/ 12 100,000 Nov. 1 300,000 2/ 12 50,000 Dec. 31 100,000 0/ 12 -

650,000$ 250,000$

Step 3 - Compute weighted-average accumulated expenditures.

A company weights the construction expenditures by the amount of time (fraction of a year or accounting period) that it can incur interest cost on the expenditure.

Chapter 1-110



Step 4 - Compute the Actual and Avoidable Interest. Selecting Appropriate Interest Rate:

1. For the portion of weighted-average accumulated expenditures that is less than or equal to any amounts borrowed specifically to finance construction of the assets, use the interest rate incurred on the specific borrowings.

2. For the portion of weighted-average accumulated expenditures that is greater than any debt incurred specifically to finance construction of the assets, use a weighted average of interest rates incurred on all other outstanding debt during the period.

Chapter 1-111



Accumulated I nterest Avoidable

Expenditures Rate I nterest

200,000$ 12% 24,000$

50,000 12.5% 6,250

250,000$ 30,250$

Step 4 - Compute the Actual and Avoidable Interest.

Avoidable Avoidable InterestInterest

I nterest Actual

Debt Rate I nterest

Specific Debt 200,000$ 12% 24,000$

General Debt 500,000 14% 70,000

300,000 10% 30,000

1,000,000$ 124,000$

Weighted-average interest rate on general

debt

Actual InterestActual Interest

$100,000 $800,000

= 12.5%

Chapter 1-112

Step 5 – Capitalize the lesser of Avoidable interest or Actual interest.



Avoidable interest 30,250$

Actual interest 124,000

Journal entry to Capitalize Interest:

Equipment (capitalized interest) 30,250

Interest expense 93,750

Cash 124,000

Chapter 1-113

Fair Value

Book Value

LossRecord Entire

Loss

Gain

W/ Commercial Substance

Record Entire Gain

W/O Commercial Substance

Receive no Cash

Defer Gain

Receive Cash

<25%

25% Record Entire Gain

Record Partial Gain

Exchanges of Nonmonetary AssetsExchanges of Nonmonetary Assets

Chapter 1-114

Lacks Commercial Substance

ValuationValuationValuationValuation

LO 5 Understand accounting issues related to acquiring and valuing LO 5 Understand accounting issues related to acquiring and valuing plant assets.plant assets.

Cash ReceivedCash Received

Cash Received + FMV of Assets Cash Received + FMV of Assets ReceivedReceived

xx Total Total GainGain

== Recognized Recognized GainGain

$3,000$3,000

$3,000 + $12,500$3,000 + $12,500xx $6,500$6,500 == $1,258$1,258

Deferred gain = $6,500 – 1,258 = Deferred gain = $6,500 – 1,258 = $5,242$5,242

When a company receives cash (sometimes referred to as “boot”) in an exchange that lacks commercial substance, it may immediately recognize a portion

of the gain.

Chapter 1-115

A:Equipment 7,258Cash

3,000Accumulated depreciation 19,000

Equipment28,000

Gain on exchange1,258

Value of new equipment: Market value – Deferred gain

(12,500 – 5,242) or

(12,500 – (6,500 – 1,258))

ValuationValuationValuationValuation

Lacks Commercial Substance

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