BA211Z Quiz 2 Skills List and Study Aid PDF

BA211Z Quiz 2 Skills List and Study Aid Chapters 6, 7 & 8 SKILLS LIST Chapter 6: - Understand inventory flows for merchandising companies - Understand how cost of goods sold is reported in a multiple-step income statement. - Determine the cost of goods sold and ending inventory using diff...

BA211Z Quiz 2 Skills List and Study Aid Chapters 6, 7 & 8 SKILLS LIST Chapter 6: - Understand inventory flows for merchandising companies - Understand how cost of goods sold is reported in a multiple-step income statement. - Determine the cost of goods sold and ending inventory using different inventory cost methods. - Understand freight charges, purchase discounts and purchase returns in relation to inventory purchases. - Understand the lower of cost and net realizable value rule for inventories. Chapter 7: - Identify the major types of property, plant and equipment. - Identify the major types of intangible assets. - Describe the accounting treatment of expenditures after acquisition. - Calculate depreciation of property, plant and equipment. - Understand that amortization is the cost allocation method used for intangible assets with finite lives. - Understand what impairment of goodwill relates to. - Understand the economic results of asset disposals and sales. Chapter 8: - Define cash and cash equivalents. - Explain why companies invest in other companies. - Describe the three methods of accounting for investments in equity securities. - Account for investments in equity securities when the investor has insignificant influence. STUDY AID Chapter 6: Inventory and Cost of Goods Sold Two types of companies have inventory: Merchandisers and Manufacturers. The cost flow for these two types of companies is shown below. In this class we focus on Merchandisers. Cost of Good Sold is the term used for the value of the inventory that has been sold to customers. COGS is subtracted from Revenues to derive Gross Profit, the first key subtotal on a properly constructed multi-step income statement: The ‘cost’ described can be thought of as the “Beginning” plus “Purchases during the Year” in the following: Inventory, as an asset, has a beginning balance, then Purchases are added to it – this results in a subtotal of “Total Inventory Available for Sale” we then use an inventory costing method to split (allocate) that value between COGS (what was sold) and Ending Inventory (what we still have – which becomes the beginning balance in the next accounting period). Inventory costing (the allocation between COGS and Ending Inventory) is done using one of four methods (the company selects the method and then does not change):  Specific identification: Matches each unit of inventory with its actual cost  Weighted-average cost: Assumes each unit of inventory has a cost equal to the weighted-average unit cost of all inventory items   First-in, first-out (FIFO): Assumes first units purchased (oldest) are first ones sold  Last-in, first-out (LIFO): Assumes last units purchased (newest) are first ones sold The three primary methods can be compared as follows: These methods produce different financial statement effects: In periods of changing prices the methods will produce different results: The determination of whether shipping costs need to be included in inventory depends on the shipping terms: If the company is purchasing inventory to stock in its stores/warehouse and they are buying items ‘on credit’ then they will likely be offered purchase discounts and, if taken, reduces inventory: At each year end the company must asset if their ‘cost’ (the amount on the balance sheet) is greater than the Net Realizable Value (selling price less cost to sell), if Cost is Greater than an adjusting entry is needed to REDUCE inventory down to Net Realizable Value. Chapter 7: Long-Term Assets Long-term assets are categorized into two main groups: Key accounting areas within each category are: - What is the ‘cost’ assigned to the asset when it is purchased? - How is the cost allocated over time when the asset is being used? - What occurs when the company is done using the asset (disposal)? TANGIBLE: Plant, Property & Equipment Acquisition cost: The asset is recorded at: For each primary type of asset, the following are details about the asset category and typical costs that need to be included in the ‘acquisition cost’ of the asset because they are ‘necessary to get the asset ready for its intended use’:  Land: o Real estate commissions and fees o Back property taxes or other obligations o Clearing, filling, and leveling the land o Cash received from selling salvaged building materials reduces the cost of land  Land improvements are amounts spent to improve the land. o Examples: Parking lots, sidewalks, driveways, landscaping, lighting systems, fences, and sprinklers o Land improvements have limited useful lives and are recorded separately from the Land account.  Buildings: administrative offices, retail stores, manufacturing facilities, and storage warehouses o Costs of getting a building ready for use include items such as:  Realtor commissions and legal fees  Remodeling costs   Equipment: machinery used in manufacturing, computers and other office equipment, vehicles, furniture, and fixtures o Additional costs of equipment might include:  Sales tax  Shipping  Assembly and testing  Any other costs to prepare the asset for use. o Recurring costs such as annual property insurance and annual property taxes on vehicles are expensed as incurred (not capitalized) o Repairs at purchase or other avoidable costs would also be expensed (not capitalized) Once the cost of the asset has been determined, then an entry needs recorded to put the asset on the company’s books. The entry is the same structure no matter what type of asset: Expenditures on the Asset while it is Owned: When a company spends money on an asset during ownership there are two possible accounting treatments for the money spent:  Capitalize: Add to the cost of the asset o Appropriate when the expenditure significantly improves the asset causing it to produce more, be significantly more efficient, or last longer (think of these as betterments)  Expense: Record as maintenance on the income statement o Appropriate when the expenditure keeps the asset functioning in its current state (think maintenance, like changing the oil in a car – just the basic activities necessary to keep the asset working) Depreciation of Assets: Depreciation is allocation of an asset’s cost to an expense over time (expense it over the periods of use)  Do report depreciation for land, unlike other long-term assets, land is not “used up” over time.  Depreciation does not refer to the change in value or selling price Journal entry for depreciation is always the same:  Remember that Accumulated Depreciation is a ‘Contra-Asset’ that tracks total Depreciation over time and is a reduction of the asset to determine Net Book Value (or also just called Book Value) Depreciation is calculated using one of three methods:  Straight-line (this is the one you need to be able to do)  Activity Based o Similar to straight-line except that instead of using ‘time’ as the basis for allocation, the output of the asset is used (i.e. miles driven, # of units produced)  Double-Declining o Accelerated method o Produces MORE depreciation expense early in the life of the asset (relative to straight-line) and LESS later o Used to better match the usefulness of an asset to the company Depreciation calculation inputs:  Service life (or useful life)—How long the company expects to use it in their business.  Residual value (or salvage value)—The amount the company expects to receive when they sell the asset. o This amount can be zero.  Depreciation method—How the cost is allocated over time. Straight-line calculation formula: Disposal of Assets: When companies are done using assets one of two things occur:  Retirement: o Involves getting rid of the asset (donation or other) o No cash is received  Step 1: Determine the Book Value of the Asset  Step 2: Record a loss for that amount o Losses appear in the ‘non-operating’ section of the income statement  Sale (cash is received): o Involves a transaction where cash is received for the asset given up  Step 1: Determine the Book Value of the Asset  Step 2: Determine the amount of Cash received  Step 3: Record a gain or loss for the difference  Gain if cash is greater than book value  Loss if cash is less than book value o Gains and losses appear in the ‘non-operating’ section of the income statement INTANGIBLE: Various Intangible assets have no physical substance and generally represent exclusive rights that provide benefits to owners. Examples include patents, trademarks, copyrights, franchises, and goodwill. Accounting treatment at acquisition:  Purchased intangibles: Record at their original cost plus all other costs necessary to get the asset ready for use  Intangible assets developed internally: Expense in the income statement most of the costs for internally developed intangible assets in the period we incur those costs (typically called R&D (research and development) expense. o R&D: Costs incurred to conduct research and to develop a new product or process  Not reported as an intangible asset in the balance sheet  Reported as an expense in the income statement because of the difficulty in determining the portion of R&D that benefits future periods Specifics on typical types of intangible assets:  Patents: o Exclusive right to manufacture a product or to use a process o Granted for 20 years o When purchased: capitalize the purchase price plus legal and filing fees o When developed internally: expense  Copyrights: o Exclusive right of protection given to the creator of a published work o Granted for the life of the creator plus 70 years o Allows holder to pursue legal action against anyone who attempts to infringe the copyright o Accounting is virtually identical to that of patents  Trademarks: o Word, slogan, or symbol that distinctively identifies a company, product, or service o Renewable for an indefinite number of 10-year periods o Capitalize legal and registration fees o Advertising costs expensed as incurred  Franchises: o Local outlets that pay for the exclusive right to use the franchisor’s name and to sell its products within a specified geographical area. o The franchisee records the initial fee as an intangible asset. o Additional periodic payments to the franchisor are usually expensed as incurred.  Goodwill: o Goodwill amount of purchase price that exceeds the fair value of identifiable net assets  Net assets = assets acquired less liabilities assumed o Reported only when one company acquires another company Amortization of Intangibles: Allocating the cost of intangible assets to expense is called amortization.   Most intangible assets have a FINITE useful life that can be estimated.  The service life of an intangible asset usually is limited by legal, regulatory, or contractual provisions.  Most companies use straight-line amortization for intangibles. The following are types of intangibles that typically have FINITE and, conversely, INDEFINITE lives: Goodwill is a special type of Intangible Asset, that has an INDEFINITE life:  Goodwill is not amortized  Instead, companies, at least annually, assess the business unit the goodwill relates to (i.e. Jimmy Choo) and evaluates performance and market conditions o If the evaluation indicates the future value (called fair value) is less than the Goodwill then an Impairment Loss is recorded o Impairment Losses are typically large, non-routine, and appear in the ‘non-operating’ section of income statement 8: Cash and Investments Cash and Cash Equivalents:  Cash includes coins and currency, balances in savings and checking accounts and credit card and debit card sales.  Cash equivalents are defined as investments that mature within three months from the date of purchase (such as money market funds, Treasury bills, and certificates of deposit). Investments: Why do companies invest in other companies?  Companies invest in other companies primarily to receive dividends, earn interest, and gain from the increase in the value of their investment.  Many companies also make investments for strategic purposes to develop closer business ties, increase market share, or expand into new industries. Investments: How do companies invest in other companies?   Equity: Buying the STOCK of another company o Dividend income o Appreciation in the value of stock o Strategic reasons  Debt: Buying the DEBT of another company (i.e. purchasing Bonds) o Interest income o Changes in value of security Equity Investments: Accounting Treatment: Depends on HOW MUCH of the company is purchased. The following are the three types of purchases (note the percentages (%) and the accounting treatments):  < 20% - Fair value method (the one you need to be able to do the accounting for)  20 – 50% - Equity method (you need to know that this is the method used for that level of ownership)  > 50% - Consolidation (you need to know that this is the method used for that level of ownership) Fair Value Method:  Used when a company (investor) purchases less than 20% of another company’s stock (investee).  Investor is presumed to have insignificant influence over the investee  Equity securities are reported in the balance sheet at their fair value  Changes in fair value from one period to the next are reported as gains and losses in the income statement  Critical events over the life of an equity investment in another company, include the following: o Purchasing the equity security. o Receiving dividends (for some equity securities). o Holding the investment during periods in which the investment’s fair value changes (unrealized holding gains and losses). o Selling the investment (realized gains and losses). Example transactions for these events: Purchase: Nathan’s Sportswear purchases 1,000 shares of Canadian Falcon’s common stock for $30 per share on December 6, 2026. Receipt of Dividend: Nathan’s Sportswear receives cash dividends paid by Canadian Falcon of $0.50 per share on December 15, 2026. Change in Fair Value while the stock is OWNED: At the end of the year, Canadian Falcon’s stock has a current price of $28 (a decrease of $2 per share). Sale of Investment:  Companies might sell some or all the shares they own in another company at any time  This will likely result in a Gain or a Loss o Gain when the per share price is greater than the last fair value adjustment o Loss when the per share price is less than the last fair value adjustment  Realized Gains and Losses result from the SALE of the investment Debt Investments: Accounting Treatment: Depends on HOW LONG the company intends to own the debt Typical accounting method is Fair Value: The critical events over the life of a debt investment in another company, such as a bond, include the following:  Purchasing the debt security.  Receiving interest (for some debt securities).  Holding the investment during periods in which the investment’s fair value changes (unrealized holding gains and losses).  Either selling the investment before maturity (realized gains and losses) or receiving principal payment at maturity.