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day 16 noncash expense 2009 spring v2 -...

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Noncash Expense: Bad News  Recognition Dr. James Gong
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Agenda Conservatism Why Asset write off expenses Bad Debt expense Inventory write off Asset impairment Contingent losses and gains
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Conservatism Principle Definition Conservatism Principle Definition FASB official definition : A prudent reaction to uncertainty is to try to ensure that uncertainty  and risks inherent in business situations are adequately considered  Not part of qualitative characteristics of useful information Requires a higher degree of verification for recognizing good  news than bad news in financial statements When in doubt about the value of an item: Understate assets Overstate liabilities Accelerate the recognition of losses Delay the recognition of gain
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Conservatism Principle  Implementation Interpretation of conservatism Expected future losses are recognized  immediately while expected future gains are  deferred until realized  Consequence of conservatism GAAP earnings are timely with respect to bad  news GAAP earnings are not as timely with respect  to good news
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Reason for Conservatism Reason for Conservatism Debt contracts: lenders needs protection Bonus contract: constrain managers’  tendency for opportunistically inflating  reported earnings Investor valuation: liability associated with  overstating the financial condition and  performance
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Expense Recognition  Principles Definition: Expenses are outflows or other using up of assets or  incurrence of liabilities from delivering or producing  goods, rendering services, or other activities that  constitute the entity’s ongoing major or central operations Matching principle Conservatism principle Assets/liabilities approach Write offs of impaired assets such as accounts receivable,  inventory, and fixed assets Recognition of contingent losses
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Conservatism and Noncash  Expenses Examples Bad Debt expense Inventory valuation and inventory write off Asset impairment Contingent losses All these expenses and losses are noncash  events
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Bad Debt Expense Bad debt expense is recognized under the  allowance method expected future uncollectible accounts are  estimated and recorded currently in a contra  asset account called the Allowance for Doubtful  Accounts (ADA) When A/R becomes uncollectible, we deduct  from ADA ADA is effectively a buffer
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Bad Debt Expense What are the two methods used to  recognize bad debt expense?
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Bad Debt Expense What are the two methods used to  recognize bad debt expense?
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