Module 6

Reporting and Analyzing

Operating Assets

Accounts Receivable

Offer sales on credit as a customer service that increases sales & build relationships

If interest is charged, then can earn income

BUT, increases risk and results in bad debt expense

Aging Analysis Example

GAAP requires companies to disclose the amount of the allowance for uncollectible accounts, either on the face of the balance sheet or in the notes.

Bad Debt Expense

Bad Debt Expense is equal to the needed increase in the allowance for uncollectible accounts.

In our previous example, if the current balance of $2,200 existed in the allowance for uncollectible accounts, the company would record a bad debt expense of $700 and increase the allowance to $2,900.

Write-off of Uncollectible Accounts

The write-off of an uncollectible account does not affect income. The amount written-off is reflected as a reduction of the account receivable balance and the allowance for uncollectible accounts:

NOTE: For income tax purposes, only the direct write-off of accounts may be deducted as bad debts expense.

Receivables Turnover Rate and

Days Sales in Receivables The accounts receivables turnover (ART)

rate is defined as

The accounts receivable turnover rate reveals how many times receivables have turned (been collected) during the period.

More turns indicate that receivables are being collected quickly.

A companion ratio is the Average Collection Period:

ExampleSuppose that sales are $1,000 average accounts receivable are $200.

Then: Accounts Receivable Turnover = $1,000/200

= 5 Average Collection Period = 200/

(1,000/365) = 200/2.73957 =

73 daysor 365 days / 5 turns =

73

Average collection Period for

Selected Industries

Inventories

Very Expensive. Costs of holding: space, insurance, counts Inventories deteriorate and/or become

obsolete No returns for investment Mistakes are hidden in inventories

In concept: Only need one of each item to show to customers or use plus a way to make or purchase another quickly

Inventory Costing Methods

First-In. First-Out (FIFO). Costs of the first units purchased are the first in cost of goods sold.

Last-In, First-Out (LIFO). Costs of the last units purchased are the first in cost of goods sold.

Average cost. Computes COGS and ending inventories as the weighted average of costs.

NOTES: During inflation, LIFO results in the

lowest taxable income If LIFO, then must disclose FIFO are LIFO

reserve LIFO not allowed in IFRS, many

companies are dropping LIFO

Lower of Cost or Market Companies must write down the carrying

amount of inventories on the balance sheet if the reported cost exceeds market value (replacement costs in US and NRV in IFRS).

This process is called reporting inventories at the lower of cost or market and creates the following financial statement effects: Inventory book value is written down to

current market value; reducing inventory and total assets.

Inventory write-down is reflected in cost of goods sold on the income statement.

Inventory Turnover Rates for Selected Companies

Property, Plant, & Equipment

Use of PPE generates revenues Consider with ownership:

Control quality and usage Fixed expenses: depreciation,

maintenance, insurance, property taxes

Business volume fluctuation Risk of technology change

Depreciation Methods

All depreciation methods have the following general formula:

Depreciation Methods:1. Straight-line method2. Accelerated Methods (Double-

declining-balance method)

Straight-line Depreciation Example

For the straight-line method, we use our illustrative asset to assign the following amounts to the depreciation formula:

Double-declining-balance method

Double-declining-balance method. For the double-declining-balance (DDB) method, we use our illustrative asset to assign the following amounts to the depreciation formula:

Double-declining-balance method

The asset is reported on the balance sheet as follows:

In the second year, $24,000 ($60,000 40%) of depreciation expense is recorded in the income statement and the NBV of the asset on the balance sheet follows:

Tax Issues MACRS Depreciation: DDB

Asset Life: 3, 5, 7, 10, 15, 30 Assumes the asset

purchased/disposed half way through period, then determines the DDB rates for each life asset

Sales and Trades:Taxable gains/losses occur on a sale

On like kind trades: flows to next asset

SO, trade your like-kind gains, sell your losses

Asset Impairments Impairment of plant assets other than goodwill

is determined by comparing the sum of the expected future (undiscounted) cash flows generated by the asset with its net book value.

Companies must recognize a loss if the asset is deemed to be impaired. (Impairment not recognized for tax purposes until sold. Loss may be reversed for IFRS.)

Analysis

PPE Turnover: analysis of the productivity of long-term assets

Lowe’s: 48,815/(22,089+22,499))/2 = 2.19Home Depot: 67,997/(25,060+25,550)/2= 2.69Home Depot earns $2.69 for each dollar of fixed assets.

Analysis of Useful life and Percent Used Up

Estimated useful life =

Percent used up =