Feb 24 Intermed Ch 7 8 - Intermediate – Ch 7/8, Feb 24...

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Unformatted text preview: Intermediate – Ch 7/8, Feb 24 For next class: Thurs Feb 26 - remember extra lab 5:30-6:45 – E8-7; E8-14; E8-21 – P8-2; P8-9 ***Assignment #3 Due Thursday noon** Exam schedule posted – currently Monday April 13 9:00 AM 1 Estimating Uncollectible Receivables The Allowance Method • Records estimated bad debt expense in the same accounting period as the sale (matching concept) • Receivables are reported at their estimated realizable value – i.e., net of an Allowance for Doubtful Accounts 2 Estimating Uncollectible Accounts: The Allowance Method • The estimate of uncollectible accounts may be based on: • Percentage of Sales (or net sales) – referred to as the Income Statement approach • Outstanding Accounts Receivable – referred to as the Balance Sheet approach Many companies use the % of sales method during the year and adjust at year end based on the receivables approach 3 • The Income Statement Approach • Uses the relationship between sales and bad debts • Matches the estimated cost of bad debts to sales generated in the same accounting period • Any existing balance in the balance sheet account (Allowance for Doubtful Accounts) is ignored when calculating the current year’s bad debts expense 4 The Income Statement Approach Example: • Dockrill Corp. reports the following balances for its first year of operations (2007): – Net credit sales: $400,000 • The company estimates bad debts at 2% of net credit sales • Determine estimated bad debts expense for 2007 5 The Income Statement Approach 1 Estimated Bad Debts Expense: $400,000 x 2% = $8,000 $400,000 2 To record Bad Debts Expense: Bad Debts Expense $8,000 Allowance for Doubtful Accounts Allowance $8,000 3 Regardless of the existing balance in the Allowance for Doubtful Accounts, the Bad Debts Expense for for the year is $8,000 the 6 The Balance Sheet Approach • Uses past collection experience to estimate uncollectible accounts, without identifying specific accounts • Focus is to report accounts receivable at its net realizable value – Does not focus on matching bad debt expense to sales • Any existing balance in Allowance for Doubtful Accounts is used to calculate the current year’s bad debt expense • Can use: Percentage-of-receivables or aged receivable analysis 7 The Balance Sheet Approach: Aged Receivable Analysis Wilson & Co. – Aging Schedule Customer Balance < 60 Days $ 80,000 320,000 $55,000 60,000 $ 18,000 15% $14,000 $ 14,000 20% $ 55,000 25% 61 – 90 Days $ 18,000 91 – 120 Days > 120 Days Western Brockville Freeport Manitoba $ 98,000 320,000 55,000 74,000 $547,000 $460,000 Estimated Uncollectible 4% 8 The Balance Sheet Approach: Aged Receivable Analysis 1 Calculate bad debts expense: 460,000 x .04 $18,400 18,000 x .15 2,700 18,000 14,000 x .20 2,800 14,000 55,000 x .25 13,750 55,000 13,750 Required balance in Allowance $37,650 Cr. Required $37,650 less: current balance in Allowance 800 Cr. Bad Debts Expense Bad $36,850* $36,850* 2 To record bad debts expense: Bad Debts Expense *36,850 Bad *36,850 Allowance for Doubtful Accounts Allowance 36,850 9 Comparison of Methods for Estimating Uncollectibles Percentage-of-Sales Matching Percentage-of-Receivables Aging Method) Net Realizable Value (or Sales Bad Debt Expense A/R Allowance for Allowance Doubtful Accounts Doubtful Income Statement Income Approach Approach Balance Sheet Approach 10 Balance Sheet Presentation • Short-term accounts receivable are shown at their net realizable value as follows: Accounts Receivable $ xxx Less: Allow. for Doubtful Accounts xxx Net Realizable Value $ xxx 11 Allowance Method: Writing Off Accounts Receivable • When a specific customer’s account is determined to be uncollectible, the following entry is made: Dr. Allowance for Doubtful Accounts x Cr. Accounts Receivable –specific customer (for the amount to be written off) x • If payment is received after write-off of account, the account is reinstated and payment is recorded: Dr. Accounts Receivable Cr. Allowance for Doubtful Accounts Dr. Cash Cr. Accounts Receivable (for the amount collected) 12 Direct Write­off Method • If uncollectible amounts are not material, the allowance method is not required • Instead, direct write-off method can be used • Record bad debt expense only when specific account is determined to be uncollectible: Dr. Bad Debt Expense x Cr. Accounts Receivable x • No allowance account is used 13 Recognition of Short­Term Notes Receivable • Notes receivable differ from accounts receivable as they are supported by a promissory note (with specific terms) • All notes contain some interest • Notes are either: – Interest bearing • Have a stated rate of interest or – Zero-interest bearing (or non-interest bearing) • Interest rate not always stated • Interest amount is the difference between the amount borrowed and the face amount 14 Interest Bearing Short­Term Notes Receivable • Example: On March 14, 2008, Accounts Receivable of $1,000 is exchanged for a 6% six-month note March 14, 2008 (when note is issued): March Notes Receivable 1,000 Accounts Receivable 1,000 September 14, 2008 (on collection of note): Cash 1,030 Notes Receivable 1,000 Interest Income 30 Interest = $1,000 x 6% x 6/12 15 Non­Interest Bearing Short­Term Notes Receivable • On February 23, 2008, a $5,000 nine-month non-interest bearing note is issued; 8% is the implied interest rate On issuance of note: Notes Receivable 4,717 Cash 4,717* *5,000 / (1 + 6%); 8% x 9/12 = 6% On collection of note: Cash 5,000 Notes Receivable 4,717 Interest Income 283 Interest = $4,717 x 8% x 9/12 16 Long­term Loans Receivable • Long-term loans receivable are recognized at fair value – i.e. the present value of the future cash flows – When the stated interest rate is the same as the market interest rate, the note or loan is issued at its face value – When there is a difference between interest rates, the note or loan is issued at a premium or a discount (i.e. the present value is greater or less than the face value) 17 Long­term Loans Receivable – Interest Bearing Notes • Example: Morgan Corp. issues a $10,000, 10% three-year note; market interest rate is 12% and annual interest payments are $1,000 (10% x $10,000) • In calculating the note’s present value, use 12% market rate to discount all future cash flows as follows: ($10,000 x .71178) + ($1,000 x 2.40183) = $9,520 • The note is issued at a discount (as proceeds < face) Journal Entry at issuance of note: Dr. Notes Receivable 10,000 Cr. Discount on Notes Receivable 480 Cr. Cash 9,520 18 Long­term Loans Receivable – Interest Bearing Notes • Example continued: • At date of issue, the company has an unamortized discount of $480 (to be amortized over the 3 years) • The discount represents interest income to be recognized over the 3 year life of the note • $9,520 x 12% = $1,142 (first year interest income) Journal Entry to record first $1,000 interest received: Dr. Cash 1,000 Dr. Discount on Notes Receivable 142 Cr. Interest Income 1,142 19 Long­term Loans Receivable – Interest Bearing Notes • Example continued • Book value of Notes Receivable is now: $10,000 – ($480 - $142) = $9,662 • Interest Income for second year: $9,662 × 12% = $1,159 Journal Entry to record second $1,000 interest received: Dr. Cash 1,000 Dr. Disc. on Notes Receivable 159 Cr. Interest Income 1,159 20 Disposition of Accounts and Notes Receivable • • The holder of accounts or notes receivable may transfer them to another company for cash The transfer may be: – A secured borrowing – A sale of receivables Holder retains ownership of receivables in a secured borrowing transaction; the receivables are used as collateral Holder transfers ownership of receivables in a sale 21 • • Transfer of Receivables: Borrowing vs. Sale Treatment Conditions 1. Are transferred assets isolated from transferor? and and 2. Does transferee have right to pledge or sell the assets? and and 3. Transferor does not maintain control of the assets through repurchase agreement? repurchase Yes Sale Secured Borrowing No 22 Accounting for Transfers of Receivables Transfers Secured Borrowing Continuing Continuing involvement by seller involvement Use components approach: 1. Reduce receivables, 1. 2. Recognize component assets and liabilities, 3, Record gain/loss 3, Sale No continuing involvement by seller 1. Reduce receivables, 1. 2. Record gain/loss 2. 23 Secured Borrowing (Highlights) • Transferor records a finance charge • Transferor collects accounts receivable • Transferor records sales returns and sales discounts • Transferor absorbs bad debts expense • Transferor records interest expense on notes payable • Transferor pays the note periodically from collections 24 Sale of Receivables (e.g., Factoring) • Ownership of receivables transferred to the purchaser (the factor); receivables recorded as an asset in the purchaser’s books • If sold without recourse, purchaser is fully responsible for collections of the receivables • Seller records any retained proceeds as “due from factor” (a receivable) which covers possible sales discounts and sales returns and allowances • Seller records loss on sale of receivables (basically the finance charge) • Seller records any recourse liability (if receivables are sold with recourse i.e., seller’s guarantee) 25 Presentation of Trade Accounts and Notes Receivable • Segregate types of receivables (i.e. ordinary trade accounts, due from related parties and other receivables segregated) • If > 1 year, report amount and maturity date • If < 1 year, report in current assets • Disclose if receivables pledged as collateral for liabilities • Use allowance account to record impairments 26 For Loans and Receivables that are Financial Instruments Provide specific information about: • The significance of loans and receivables to a company’s financial position and performance, and • The nature and extent of risks arising from these assets 27 International Comparison – Loans and Receivables • Canadian and international GAAP are substantially converged • Some differences still exist related to transaction costs, related party transactions, and derecognition, for example 28 Analysis Accounts Receivable Turnover: Net Sales/Revenue Average Trade Receivables (Net) Days Sales Uncollected: 365 Days A/R Turnover 29 • Exercises 30 Chapter 8 Inventory Prepared by: Patricia Zima, CA Mohawk College of Applied Arts and Technology Inventory Introduction •GAAP GAAP update update •What is What inventory? inventory? •Types of Types inventory inventory •Inventory Inventory accounting systems systems •Inventory Inventory issues issues Determining Determining Inventory Cost Inventory •Physical goods Physical included in inventory inventory •Effect of Effect inventory errors inventory •What is “cost”? •Cost formulas •Exceptions to Exceptions “cost” “cost” Balance Sheet Balance Valuation Valuation •Rationale for Rationale lower of cost and net realizable value realizable •Application of Application lower of cost and net realizable value realizable •Evaluation of Evaluation lower of cost and net realizable value realizable •Purchase Purchase commitment issues issues Estimating Estimating Inventory Inventory •The need The for estimates for •Applying the Applying gross profit method method •Gross profit Gross percentage vs. markup on cost on •Using the Using results results Presentation, Presentation, Perspectives, and International Standards Standards •Disclosures Disclosures and presentation of inventories of •Perspectives Perspectives and analysis and •Comparison: Comparison: Canadian and international GAAP GAAP Appendices Appendices 8A and 8B 8A •A-Retail A-Retail method of estimating inventory cost cost •B-U.S. B-U.S. methods: LIFO and LCM LCM 32 Inventory • Definition of Inventory (Section 3031.06): Inventories are “assets: (a) held for sale in the ordinary course of business; (b) in the process of production for such sale; or (c) in the form of materials or supplies to be consumed in the production process or in the rendering of services.” 33 Inventory Classification • Inventory is classified as a current asset • A merchandising company: – has one inventory account on the balance sheet called Merchandise Inventory; – the cost of the inventory sold is transferred to Cost of Goods Sold (COGS) on the income statement • A manufacturing company: – will normally have three inventory accounts on the balance sheet: raw materials, work in process and finished goods; – Cost of Goods Manufactured (COGM) is used by a manufacturer which is similar to the COGS 34 Inventory Cost Flows Manufacturing Operations Raw Materials Direct Labour Work in Process Work Inventory Inventory $$$ Finished Finished Goods Goods $$$ COGS COGM Mfg. Overhead COGS $$$ 35 Inventory Control • An accurate inventory accounting system is important for: - ensuring availability of inventory items - preventing excessive accumulation of inventory items • Just-in-time (JIT) inventory order systems have helped reduce inventory levels • The perpetual system maintains a continuous record of inventory changes • The periodic system updates inventory records in the ledger only periodically 36 Perpetual System • Purchases of inventory and cost of inventory sold are recorded directly in the Inventory account • Cost of freight, purchase returns and allowances, and purchase discounts are all recorded in the Inventory account • Cost of Goods Sold (COGS) is debited and Inventory is credited when inventory is sold • A subsidiary ledger is maintained for individual inventory items on hand • Periodic inventory counts are still required to ensure reliability • Any differences between the inventory balance and the physical count are captured in a separate account called Inventory Over and Short (or may be recorded as an adjustment to Cost of Goods Sold) 37 Periodic System • Inventory purchases are recorded as a debit to a Purchases account • Cost of Goods Sold and Inventory accounts are not kept up to date • The quantity and cost of inventory on hand is determined by taking a physical inventory count • Cost of Goods Sold is determined at the end of the period • Under both periodic and perpetual inventory systems, physical counts of inventory are conducted at least once a year as there is the risk of loss and errors (e.g. waste, breakage, theft) • Freight, purchase returns and allowances, and purchase discounts are recorded in separate accounts 38 Perpetual and Periodic Systems: Example Fesmire Limited reports the following data: Beginning Inventory : 100 units at $6 Purchases: (all credit) 900 units at $6 Defective units (returned) 50 units at $6 Sales: (all credit) 600 units at $12 Ending Inventory: 350 units at $6 Provide all journal entries under each system 39 Perpetual System Transaction Purchase Record Inventory Changes Inventory Accounts Payable (900 units x $6) 5,400 5,400 Record Sales Revenue Purchase Return Accounts Payable Inventory (50 units x $6) 300 300 Sale Cost of goods sold Inventory (600 units x $6) 3,600 3,600 Accounts Receivable Sales (600 units x $12) 7,200 7,200 40 Periodic System Date Purchase Record Inventory Changes Purchases Accounts Payable (900 units x $6) 5,400 5,400 Record Sales Revenue Return Accounts Payable Purch. Returns and Allowances 300 300 Sale No entry Accounts Receiv. Sales (600 units x $12) 7,200 7,200 Year-End Adjusting Entry Cost of goods sold 3,600 Inventory (end - count) 2,100 Purchases Returns 300 Purchases Inventory (beg.) 5,400 41 600 Financial Statement Presentation Perpetual Net Sales $,$$$ Cost of Goods Sold $$$ Gross Profit $,$$$ Periodic Net Sales Cost of Goods Sold: Opening Inventory Add: Net Purchases Cost of Goods for Sale $,$$$ Less: Ending Inventory Cost of Goods Sold Gross Profit $,$$$ $$$ $$$ Available $$$ $$$ $,$$$ 42 Basic Valuation Issues Ending inventory valuation requires answers to each of the following: 1. Which physical goods should be included as part of inventory? 2. What costs should be included as part of inventory cost? 3. What cost formula should be adopted? 4. Is cost the appropriate balance sheet value? 43 Items to Be Included in Inventory • Legal title to goods determines items to be included in inventory • The following goods are included in the seller’s inventory: 1. Goods in transit (if seller has title during shipment, i.e., if shipped FOB Destination) 2. Goods out on consignment 3. Goods sold under buyback agreements 4. Goods sold with high rates of return that cannot be estimated 44 Effect of Inventory Errors Error in End Inv. End Understated Effect on Income Statement Items Effect on Balance Sheet Items -COGS (over) -Retained Earnings (under) -Net Income (under) -Working Capital (under) -Current ratio (under) -Current -COGS (under) -Retained Earnings (over) -Net Income (over) -Working Capital (over) -Current ratio (over) Overstated 45 Example Given for the year 2007: COGS = $1.4 million COGS Retained Earnings (R/E) = $5.2 million December 31st inventory errors both discovered after inventory 2007 books were closed: 2007 2006: inventory overstated by $110,000 2007: inventory overstated by $45,000 Calculate correct 2007 COGS and R/E at Dec. 31, 2007 46 Example COGS (as originally stated in 2007) Add: December 31, 2007 overstatement error statement Less: December 31, 2006 overstatement error statement Corrected 2007 COGS $1,400,000 45,000 1,445,000 1,445,000 110,000 $1,335,000 Retained Earnings (2007 original) $5,200,000 $5,200,000 Less: correction for 2007 inventory 45,000 Less: Retained Earnings (2007 restated) $5,155,000 Note: 2006 inventory error is self-corrected as it was Note: discovered after the books for 2007 were closed discovered 47 Costs Included in Inventory • Inventory cost includes “all costs of purchases, costs of conversion, and other costs incurred in bringing the inventories to their present location and condition” • These costs include: – Product costs including invoice, freight, and other direct acquisition costs – Conversion costs which include direct labour and fixed and variable overhead • Period costs (selling, general, and administrative) are not inventoriable costs 48 Costs Included in Inventory Other issues to consider: • Purchases discounts: gross method vs. net method • Vendor rebates: cash rebates related to inventory generally recorded as a reduction to the cost of inventory • Interest or borrowing costs: generally expensed if routinely manufactured • “Basket” purchases and joint product costs: total cost allocated to units based on relative sales value 49 Cost Formulas GAAP recognizes three acceptable cost formulas: 1. Specific identification 2. First-in, First-out (FIFO) 3. Weighted average cost 50 Cost Formulas • The ending inventory in units is the same in all three methods; the cost is different • The cost of goods sold and the cost of ending inventory are different • The cost of purchases is the same in all three methods • LIFO is no longer an acceptable cost formula (see next slide) 51 Cost Formulas • LIFO is not acceptable because: 1. LIFO does not represent actual inventory flows reliably 2. Costs assigned to ending inventory (oldest costs) do not represent recent cost of inventory on hand 3. Can distort reported income on the income statement • LIFO has never been allowed by CRA 52 Specific Identification • Each item sold and purchased is individually identified • Required for goods that are not ordinarily interchangeable; and that are produced and segregated for specific projects • Advantages: – Matches actual costs with revenue – Ending inventory reported at specific cost • Disadvantages: – May be costly to implement and maintain – May lead to income manipulation – May be difficult to allocate certain costs (e.g., storage, shipping) to specific inventory items 53 Cost Formulas : Example Call-Mart reports the following transactions for March: Date Purchases Sales Date 1 Beginning (500 @$3.80) Beginning Balance (units) 500 2,000 8,000 4,000 6,000 2 1,500 units (@$4.00) 15 6,000 units (@$4.40) 19 Sold 4,000 units 30 2,000 units (@$4.75) Determine the cost of goods sold and the cost of ending Determine inventory, under each cost formula inventory, 54 Weighted­Average Formula Date Date March 1 March 2 March 15 March 30 Purchases Purchases 500 units 1,500 units 6,000 units 2,000 units 10,000 units Unit Cost $3.80 $4.00 $4.40 $4.75 Purchase Cost $ 1,900 $ 6,000 $26,400 $ 9,500 $43,800 Unit Cost = $43,800 ÷ 10,000 = $4.38 Unit Cost of goods available $43,800 Cost of goods sold 4,000 X $4.38 = 17,520 Ending inventory 6,000 X $4.38 = $26,280 55 Moving­Average Formula Date Date • March 1 • March 2 • March 15 Purchases Purchases 500 units 1,500 units 6,000 units Unit Cost $3.80 $4.00 $4.40 Purchase Cost $ 1,900 $ 6,000 $26,400 On Hand $ 1,900 7,900 34,300 Mar. 19 New Unit Cost calculated – to use for Cost of Goods Sold $34,300/8,000 units = $4.2875 and 4,000 @ $4.2875 = $17,150 • • March 19 March 30 4,000 units remaining 2,000 units $4.75 $ 9,500 17,150 26,650 New Unit Cost calculated—to use as COGS for next sale and for inventory $26,650/6,000 units = $4.4417 NOTE: With each new purchase, a new average unit cost is determined 56 Average Cost Formula • Justification for using average cost formula: – Reasonable to cost inventory based on an average cost – Costs assigned closely follows the actual physical flow – Simple to apply, objective, less subject to income manipulation – Ending inventory cost on balance sheet is made up of average costs 57 First­In, First­Out Formula Date Date March 1 March 2 March 15 March 30 Purchases Purchases 500 units 1,500 units 6,000 units 2,000 units Unit Cost $3.80 $4.00 $4.40 $4.75 Purchase Cost $ 1,900 $ 6,000 $26,400 $ 9,500 Ending inventory 6,000 units 2,000 @ $4.75 = 4,000 @ $4.40 = $43,800 $ 9,500 17,600 17,600 $27,100 Cost of goods available Cost of goods sold $43,800 - $27,100 = $16,700 58 First­In, First­Out Formula Advantages: • Attempts to approximate physical flow of goods • Ending inventory made up of most recent costs, therefore close to its replacement cost • Does not permit manipulation of income Disadvantages: • Current costs not matched to current revenues, as oldest cost of goods are used with current revenue • When prices are changing rapidly, gross profit and net income are distorted 59 Choice of Cost Formula • The new inventory standards limit the choice • Specific identification is required in some cases • Should choose the best method that: 1. best reflects the physical flow 2. reflects the most recent costs in the inventory account, and 3. use this method for all inventory assets with same characteristics 60 • E8-8 61 LAB • Finish Problems – 20 minutes • Quiz – Ch 7 – 10 minutes • Hand-in exercise – Bank Recs – 30 minutes 62 ...
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