ACCT10002 Lecture Notes - Lecture 6: Cash Flow, Book Value, Matching Principle

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amaranthbadger280

19 Jun 2018

School

University of Melbourne

Department

Accounting

Course

ACCT10002

Professor

Warren McKeown

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Introductory Financial Accounting

Lecture 6: Non-current Assets

What is PPE?

AASB 116 Property, Plant and Equipment- PPE are tangible items that a) are held for use in production or

supply of goods and services, for rental to others, or for administrative purposes; and b) are expected to be

used during more than one period.

i.e. Non-Current Assets.

Recognition of PPE:

The cost of an item of property, plant and equipment shall be recognised as an asset if, and only if:

a) It is probable that future economic benefits associated with the item will flow to the entity; and

b) the cost of the item can be measured reliably.

i.e. (PPE) are physical assets used in the business to provide future economic benefits for a number of

years

The two classes of PPE assets are:

1. Property- including land and buildings

2. Plant and equipment- including cash registers, computers, office furniture, factory machinery,

motor vehicles etc.

Determining the cost of PPE

Initially recorded at historical cost (The amount of cash or cash equivalents paid OR the fair value of the

other consideration given to acquire the asset).

Fair value: the amount for which an asset could be exchanged between knowledgeable willing partners in

an arm’s-length transaction

The cost of an asset includes all expenditure necessary to acquire the asset and make it ready for use.

Including freight-in, purchase price, installation costs etc.

Excludes non-capital expenditure e.g. training an operator, oil for machine etc.

Note: some costs are capitalised (added to the asset- balance sheet) some are expensed (income

statement).

Cost of property includes:

- Purchase price, settlement costs, stamp duty, accrued property taxes assumed by purchaser

Costs of plant and equipment include:

- Purchase price, freight in, insurance during transit, installation costs

PPE valuation

The PPE account involves a great risk/estimation in valuation of the asset as it is a great percentage of total

assets. Judgements to consider when evaluating them include the cost of the asset, depreciation and fair

value.

Depreciation

Depreciation is the process of allocating to expense the cost of a PPE asset over its useful (service) life in a

rational and systematic manner. Carrying amount (value) equals cost less accumulated depreciation.

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Depreciation is not a cash flow, it is an estimate of the consumption of the future economic benefits (i.e.

service potential) embodied in the asset (the matching principle). It does NOT measure the decline in

MARKET value!

Choice of depreciation methods

“The depreciation method used shall reflect the pattern in which the asset’s future economic benefits are

expected to be consumed by the entity”

Four factors relating to the decline in value of a depreciable asset are:

1. Usage of asset

2. Wear and tear through physical use of asset

3. Technical and commercial obsolescence

4. Legal life

Factors in calculating depreciation include:

- Cost- the expenditures to acquire asset and make it ready for use

- Useful life- estimate expected life based on intended use, need for repair, vulnerability to

obsolescence and legal life.

- Residual value- estimate of assets value at the end of its useful life

Depreciation methods include:

- Straight line- Depreciation expense same each year as benefits are consumed at same rate each

year

- Reducing balance- Depreciation expense decreases each year on percentage basis as greater

benefits are consumed earlier in assets life

- Units of production- Useful life is expressed in terms of total units of production or use expected

from the asset

Subsequent expenditure

Firms may include additional costs including ordinary repair (expensed in operating statement) and

additions and improvements (expenditure capitalised and depreciated over the rest of the assets useful

life)

Disposal of PPE assets

PPE assets may be disposed of by:

- Sales- equipment sold to another party

- Scrapping- equipment scrapped or discarded

- Exchange- existing equipment traded for new equipment

Sale of PPE

Sale of Assets- at the end of useful life a business may want to recoup some initial cost.

At the date of sale an entry is made for the portion of depreciation since the last adjustment

The final carrying amount (cost less Accumulated Depreciation) is compared to the proceeds of the

sale:

- If proceeds > CA => recognise a profit on sale of asset

- If proceeds < CA => recognise a loss on sale of asset

What does a profit (or Loss) on sale represent?

Cost less proceeds = actual cost of benefit

Profits on sales represent an over-provision for depreciation. A loss on sale is then in this sense, an under-

provision.

Valuation of Assets

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Document Summary

The cost of an item of property, plant and equipment shall be recognised as an asset if, and only if: a) b) The two classes of ppe assets are: property- including land and buildings, plant and equipment- including cash registers, computers, office furniture, factory machinery, motor vehicles etc. Initially recorded at historical cost (the amount of cash or cash equivalents paid or the fair value of the other consideration given to acquire the asset). Fair value: the amount for which an asset could be exchanged between knowledgeable willing partners in an arm"s-length transaction. The cost of an asset includes all expenditure necessary to acquire the asset and make it ready for use. Excludes non-capital expenditure e. g. training an operator, oil for machine etc. Note: some costs are capitalised (added to the asset- balance sheet) some are expensed (income statement). Purchase price, settlement costs, stamp duty, accrued property taxes assumed by purchaser. Purchase price, freight in, insurance during transit, installation costs.

Related Questions

Identify two categories of revenue for Panera Bread from the table in the article Revenue Recognition: Key differences between U.S. GAAP and IFRSs. Compare and contrast the companyâs current U.S. GAAP revenue recognition with the potential adoption of IFRS. Provide the IASB Framework or the IAS statement, the changes in revenue recognition as well as potential challenges the company may face in adoption.

Table:

Subject	U.S. GAAP	IFRSs
Concept/objective	realized or realizable and earned.	According to paragraph 83 of the IASB's Framework for the Preparation and Presentation of Financial Statements, revenue is recognized when (1) "it is probable that any future economic benefit" will flow to the entity and (2) such a benefit can be measured reliably. Further, paragraph 93 of the IASB Framework indicates that revenue normally must be earned before it can be recognized.
Definition of revenue	Paragraph 78 of FASB Concepts Statement No. 6, Elements of Financial Statements, defines revenue as "inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or other activities that constitute the entity's ongoing major or central operations."	Paragraph 74 of the IASB Framework states, "The definition of income encompasses both revenue and gains. Revenue arises in the course of the ordinary activities of an entity and is referred to by a variety of different names including sales, fees, interest, dividends, royalties and rent." Paragraph 7 of IAS 18 defines revenue as "the gross inflow of economic benefits during the period arising in the course of the ordinary activities of an entity when those inflows result in increases in equity, other than increases relating to contributions from equity participants."
Sale of goods or products	SAB Topic 13 indicates that revenue from the sale of goods or products should not be recognized until it is earned and realized, or realizable. Revenue is generally earned and realized, or realizable, when all of the following conditions have been satisfied: There is persuasive evidence of an arrangement. Delivery has occurred (e.g., an exchange has taken place). The sales price is fixed or determinable. Collectibility is reasonably assured. In addition, ASC 605-15 provides guidance on product transactions that include a right of return. Further, various industry- and transaction-specific guidance is provided in other U.S. GAAP.	Under paragraph 14 of IAS 18, revenue from the sale of goods is recognized if all of the following conditions are met: The "entity has transferred to the buyer the significant risks and rewards of ownership of the goods." The "entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold." The "amount of revenue can be measured reliably." "[I]t is probable that the economic benefits associated with the transaction will flow to the entity." The "costs incurred or to be incurred in respect of the transaction can be measured reliably."
Rendering services	>Like revenue from product sales, revenue from service transactions should not be recognized until it is earned and realized, or realizable. Revenue is generally earned and realized, or realizable, when all of the following conditions have been satisfied: There is persuasive evidence of an arrangement. Service has been rendered. The sales price is fixed or determinable. Collectibility is reasonably assured. Other than the limited guidance in >ASC 605-20, no specific guidance on the rendering of services exists under U.S. GAAP. The appropriate method for recognizing revenue in such transactions depends on the individual transaction but is usually based on the proportional performance as of the balance sheet date.	Paragraph 20 of IAS 18 states, "When the outcome of a transaction involving the rendering of services can be estimated reliably, revenue associated with the transaction shall be recognised by reference to the stage [i.e., percentage] of completion of the transaction at the balance sheet date." Paragraph 20 goes on to list specific conditions for determining whether an outcome of a transaction can be estimated reliably. And subsequent paragraphs provide guidance on determining the stage of completion. Paragraph 26 of IAS 18 states, "When the outcome of the transaction involving the rendering of services cannot be estimated reliably, revenue shall be recognised only to the extent of the expenses recognised that are recoverable."
Software arrangements	ASC 985-605 provides guidance on recognizing revenue in a software arrangement.	There is no specific guidance on software revenue recognition in IFRSs. An entity should apply the provisions of IAS 18 as appropriate.
Construction-type contracts	ASC 605-35 provides guidance on construction-type contracts. ASC 605-35-25-90 indicates that when the percentage-of-completion method is deemed inappropriate (e.g., when dependable estimates cause the outcome to be doubtful), the completed-contract method is preferable. ASC 605-35-25-25 through 25-27, the customer must approve the scope and price of change orders before the related revenue can be recognized.	IAS 11, Construction Contracts, provides guidance on construction-type contracts. Paragraph 32 of IAS 11 indicates that when the percentage-of-completion method is deemed inappropriate (e.g., when the outcome of the contract cannot be estimated reliably), revenue is recognized to the extent that costs have been incurred, provided that the costs are recoverable. Use of the completed-contract method is prohibited under IFRSs. Paragraph 13 of IAS 11 specifies that when it is probable that the customer will approve the scope and price of a change order, the related revenue can be recognized.
Milestone method	ASC 605-28 provides guidance on the application of the milestone method for recognizing revenue in research or development arrangements.	There is no specific guidance in IFRSs on the application of the milestone method for recognizing revenue in research or development arrangements.
Multiple-element arrangements	ASC 605-25 provides guidance on multiple-element revenue arrangements and establishes detailed criteria for determining whether each element may be separately considered for recognition. This guidance does not apply to arrangements or deliverables that are within the scope of other authoritative literature (e.g., ASC 985-605).	Paragraph 13 of IAS 18 indicates that the recognition criteria under IAS 18 are usually applied separately to each transaction unless either of the following conditions applies: "[I]t is necessary to apply the recognition criteria to the separately identifiable components of a single transaction in order to reflect the substance of the transaction." Two or more transactions "are linked in such a way that the commercial effect cannot be understood without reference to the series of transactions as a whole."
Bill-and-hold arrangements	The SEC staff lists specific criteria that must be met for revenue to be recognized in bill-and-hold arrangements before delivery of the product. (Non-SEC entities also use these revenue recognition criteria because no other authoritative guidance in U.S. GAAP addresses the accounting for these transactions.) The criteria restrict revenue recognition to limited circumstances.	Illustrative Examples to IAS 18 list criteria for recognizing revenue under bill-and-hold arrangements before delivery of the product. While the objective for recognizing revenue in bill-and-hold arrangements may be similar to that in U.S. GAAP, the criteria are not the same.
Gross versus net	ASC 605-45 provides guidance on whether to report revenue on the basis of the gross amount billed to the customer (as a principal) or the net amount retained by the company (as an agent).	Paragraph 8 of IAS 18 requires that revenue be reported on a net basis in agency relationships but does not provide specific guidance to consider. Improvements to IFRSs issued in April 2009) provides examples that indicate whether an entity is acting as a principal or as an agent.
Customer loyalty programs	Revenue recognition for customer loyalty programs is not specifically addressed in U.S. GAAP. (The EITF attempted to address this issue but did not reach a consensus.) Although entities account for customer loyalty programs in different ways, such programs are typically accounted for under ASC 605-25 as multiple-element arrangements or under an incremental-cost model.	IFRIC 13 indicates that customer loyalty programs are deemed multiple-element revenue transactions and that the fair value of the consideration received should be allocated between the components of the arrangement.
Rebates, discounts, incentives, and other consideration	ASC 605-50 indicates that consideration given by an entity to its customers is presumed to be a reduction of revenue unless an identifiable benefit whose fair value can be reasonably estimated is received.	Paragraph 10 of IAS 18 states that revenue "is measured at the fair value of the consideration received or receivable taking into account the amount of any trade discounts and volume rebates allowed by the entity." There is no specific guidance on other types of consideration given by an entity to its customers.
Specific industry and other guidance	Certain standards in U.S. GAAP provide specialized guidance on revenue recognition, including guidance that applies to specific industries and transactions.	IFRSs provide no (or limited) revenue recognition guidance that applies to specific industries or transactions.

greyhornet170

Comparative financial statement data for Carmono Company follow:

	This Year		Last Year
Assets
Cash	$	7.50	$	14.00
Accounts receivable		50.00		43.00
Inventory		92.50		79.20

Total current assets		150.00		136.20

Property, plant, and equipment		231.00		194.00
Less accumulated depreciation		45.60		34.20

Net property, plant, and equipment		185.40		159.80

Total assets	$	335.40	$	296.00

Liabilities and Stockholdersâ Equity
Accounts payable	$	55.50	$	46.00
Common stock		118.00		91.00
Retained earnings		161.90		159.00

Total liabilities and stockholdersâ equity	$	335.40	$	296.00

For this year, the company reported net income as follows:


Sales	$	850.00
Cost of goods sold		510.00

Gross margin		340.00
Selling and administrative expenses		320.00

Net income	$	20.00

This year Carmono declared and paid a cash dividend. There were no sales of property, plant, and equipment during this year. The company did not repurchase any of its own stock this year.

Carmono CompanyStatement of Cash Flows - Indirect MethodFor This Year Ended December 31Operating activities:Net income$20.00Adjustments to convert net income to a cash basis:Depreciation$11.40Increase in accounts receivable(7.00)Increase in inventory(13.30)Increase in accounts payable9.500.60Net cash provided by operating activities20.60Investing activities:Increase in plant and equipment(37.00)Net cash used in investing activities(37.00)Financing activities:Increase in common stock27.00Cash dividends(17.10)Net cash provided by financing activities9.90Net decrease in cash(6.50)Beginning cash and cash equivalents14.00Ending cash and cash equivalents$7.50

2.	Compute Carmonoâs free cash flow for this year. (Negative amount should be indicated by a minus sign. Round your intermediate calculations and final answer to 2 decimal places.)

Free cash flow$

Changes in various accounts and gains and losses on the sale of assets during the year for Argon Company are given below:

Item		Amount
Accounts receivable	$	79,000	decrease
Inventory	$	120,000	increase
Prepaid expenses	$	3,500	decrease
Accounts payable	$	41,000	decrease
Accrued liabilities	$	9,600	increase
Income taxes payable	$	15,700	increase
Sale of equipment	$	8,100	gain
Sale of long-term investments	$	12,200	loss

Required:

For each item, indicate whether the dollar amount should be added to or deducted from net income under the indirect method when computing the net cash provided by operating activities for the year.

Item	Amount	Effect
Accounts receivable
Inventory
Prepaid expenses
Accounts payable
Accrued liabilities
Income taxes payable
Sale of equipment
Sale of long-term investments

Apex Company prepared the statement of cash flows for the current year that is shown below:

Apex Company Statement of Cash FlowsâIndirect Method
Operating activities:
Net income			$	41,500
Adjustments to convert net income to cash basis:
Depreciation	$	20,100
Increase in accounts receivable		(61,500)
Increase in inventory		(25,100)
Decrease in prepaid expenses		9,400
Increase in accounts payable		54,300
Decrease in accrued liabilities		(10,100)
Increase in income taxes payable		3,300		(9,600)

Net cash provided by operating activities				31,900
Investing activities:
Proceeds from the sale of equipment		15,200
Loan to Thomas Company		(41,900)
Additions to plant and equipment		(121,800)

Net cash used for investing activities				(148,500)
Financing activities:
Increase in bonds payable		88,800
Increase in common stock		38,700
Cash dividends		(28,400)

Net cash provided by financing activities				99,100

Net decrease in cash				(17,500)
Beginning cash balance				27,200

Ending cash balance			$	9,700

Required:

Compute Apex Companyâs free cash flow for the current year. (Negative amount should be indicated by a minus sign.)

Free Cash Flow

For the just completed year, Hanna Company had net income of $95,000. Balances in the companyâs current asset and current liability accounts at the beginning and end of the year were as follows:

	December 31
	End of Year		Beginning of Year
Current assets:
Cash	$	59,000	$	80,000
Accounts receivable	$	164,000	$	184,000
Inventory	$	448,000	$	346,000
Prepaid expenses	$	11,500	$	15,000
Current liabilities:
Accounts payable	$	366,000	$	392,000
Accrued liabilities	$	8,000	$	13,000
Income taxes payable	$	32,000	$	25,000

The Accumulated Depreciation account had total credits of $42,000 during the year. Hanna Company did not record any gains or losses during the year.

Required:

Use the indirect method to determine the net cash provided by (or used in) operating activities for the year. (List any deduction in cash and cash outflows as negative amounts.)

redgrasshopper904

You have obtained the following information:

STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR TO 31 DECEMBER

		20X8	20X7
	Note	Draft ($m)	Actual ($m)
Revenue	(1)	645.5	606.5

Other income	(2)	15.6	14.4

Changes in inventories		3.8	(16.4)

Cost of materials		(334.1)	(286.8)

Employee benefits expense		(91.0)	(83.9)

Depreciation	(3)	(29.8)	(23.6)

Other expenses	(4)	(116.3)	(100.6)

Interest income, net	(5)	12.3	(20.9)

Profit before tax		106.0	130.5

Income tax expense		(44.4)	(47.7)

Profit for the year		61.6	82.8

STATEMENT OF FINANCIAL POSITION AT 31 DECEMBER

		20X8	20X7
	Note	Draft ($m)	Actual ($m)
Assets
Non-current assets
Intangible assets	(6)	47.8	40.5
Property, plant and equipment	(7)	124.5	102.5
		172.3	143.0
Current assets
Inventories	(8)	30.3	27.9
Trade receivables		73.1	50.3
Cash and cash equivalents		111.4	86.0
Total assets		387.1	307.2
Equity and liabilities
Equity		5.8	5.8
Share capital		15.3	15.3
Share premium		112.1	80.1
Retained earnings		133.2	101.2
Non-current liabilities
Provisions	(9)	160.1	121.4
Current liabilities
Trade payables		33.5	31.8
Tax		50.4	44.3
Other liabilities		9.9	8.5
Total equity and liabilities		387.1	307.2

Notes

(1) Revenue from business activities:

Revenue from business activities
	20X8 ($M)	20X7 ($M)
Vehicles	588.0	526.0
Parts and accessories	39.6	36.8
Other	17.9	43.7
	645.5	606.5

Other income includes gains on the disposals of tangible assets and income from the reversal of provisions.

Average number of employees:


	20X8 (Draft)	20X7 (Actual)
Wage earners	484	499
Salaried employees	483	477
Apprentices and trainees	36	37
	1,003	1,013

Other expenses include costs for warranties, administration and distribution, maintenance and insurance.

Interest income, net:

	20X8 (Draft ($m)	20X7 (Actual $m)
Interest and similar income	16.8	25.1
Interest and similar expenses	(4.5)	(4.2)
	12.3	20.9

Intangible assets include development costs, also franchises and industrial rights and licenses. During the year, $12.7 million (20X7 - $6.3 million) was spent on developing a new sports model, the Fox.

Property, plant and equipment:

	Land and Buildings	Equipment	Assets under construction	Total
	$m	$m	$m	$m
Cost
1 January 20X8	61.8	212.1	19.0	292.9
Additions	5.0	28.9	9.4	43.3
Disposals	0.0	(4.5)	0.0	(4.5)
Reclassification	3.0	8.9	(11.9)	0.0
31 December 20X8	69.8	245.4	16.5	331.7

Depreciation
Current year	1.9	18.4	0.0	20.3
Accumulated	28.7	178.5	0.0	207.2

Net book value
31 December 20X8	41.1	66.9	16.5	124.5
31 December 20X7	34.9	48.6	19.0	102.5

(8) Inventories comprise:


	20X8 (Draft $m)	20X7 (Draft $m)
Raw materials, consumables and supplies	8.3	7.3
Work-in-progress	6.8	4.8
Finished goods	15.2	15.8
	30.3	27.9

(9) Provisions mainly cover manufacturing warranty, product liability and litigation risks. Also, provisions have been established for deferred maintenance and IT reorganization.

The following additional information is available:

(i) Pavia has achieved record sales in 20X8 with the delivery of 10,153 vehicles (20X7 â 7,642 vehicles).

(ii) Although some sales are direct to individual customers the majority are ordered through dealers who take new vehicles on consignment.

(iii) Since 1 January 20X8 Pavia has offered 0% finance for three years on new vehicle sales in its most competitive markets.

(iv) The launch of the Fox has been postponed from late 20X8 to early 20X9 as internal trials have revealed that the doors are not sufficiently secure at high speeds.

(v) A car part required for the Cipeta model is bought-in exclusively from an overseas manufacturer. Deliveries of supplies have been unpredictable in 20X7 causing disruption to the Cipeta model assembly schedules.

Given all of the information above you are required to do the following:

In respect of the financial statements audit of Pavia Co for the year ending 31 December 20X8:

Identify and explain the risks of material misstatement to be taken into account in planning the final audit.

ACCT10002 Lecture Notes - Lecture 6: Cash Flow, Book Value, Matching Principle

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