ACCOUNTG 321 Lecture 7: Chapter 4 pt.1
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I am unsure of what is unclear. The instructions are:
1. Set up a worksheet for the solvency ratios--currentratio and the quick ratio.
2. Compute these ratios for Doctors Smith and Brown. Todo so, you will need one additional piece of information that isnot present on the doctorsâstatements: their maximum annual debt service is$22,200.
Practice Exercise 11âII: Solvency Ratios
Refer to Doctors Smith and Brownâs financial statementspresented in the preceding Chapter 10.
Required
1. Set up a worksheet for the solvency ratios. current ratio and the quick ratio.
2. Compute these ratios for Doctors Smith and Brown. Todo so, you will need one additional piece of information that isnot present on the doctorsâstatements: their maximum annual debt service is$22,200.
The requested information is below:
Exhibit 10-1 Westside Clinic Balance Sheet
Assets | December 31, 20x2 | December 31, 20x1 | ||
Current Assets | ||||
Cash and cash equivalents | $190,000 | $145,000 | ||
Accounts receivable (net) | 250,000 | 300,000 | ||
Inventories | 25,000 | 20,000 | ||
Prepaid Insurance | 5,000 | 3,000 | ||
Total Current Assets | $470,000 | $468,000 | ||
Property, Plant, and Equipment | ||||
Land | $100,000 | $100,000 | ||
Buildings (net) | 0 | 0 | ||
Equipment (net) | 260,000 | 300,000 | ||
Net Property, Plant, and Equipment | 360,000 | 400,000 | ||
Other Assets | ||||
Investments | $133,000 | $32,000 | ||
Total Other Assets | 133,000 | 32,000 | ||
Total Assets | $963,000 | $900,000 | ||
Liabilities and Fund Balance | ||||
Current Liabilities | ||||
Current maturities of long-term debt | $52,000 | $48,000 | ||
Accounts payable and accruedexpenses | 293,000 | 302,000 | ||
Total Current Liabilities | $345,000 | $350,000 | ||
Long-Term Debt | $252,000 | $300,000 | ||
Less Current Maturities of Long-Term Debt | ?52,000 | ?48,000 | ||
Net Long-Term Debt | 200,000 | 252,000 | ||
Total Liabilities | $545,000 | $602,000 | ||
Fund Balances | ||||
Unrestricted fund balance | $418,000 | $298,000 | ||
Restricted fund balance | 0 | 0 | ||
Total Fund Balances | 418,000 | 298,000 | ||
Total Liabilities | $963,000 | $900,000 | ||
Exhibit 10-2 sets out the result of operations for two years,with the most current period in the left column. If the balancesheet is a snapshot, then the statement of revenue and expenses isa diary because it is a record of transactions over the period of ayear. Operating revenues and operating expenses are set out first,with the result being income from operations of $115,000($2,000,000 less $1,885,000). Then other transactions are reported;in this case, interest income of $5,000 under the headingâNonoperating Gains (Losses).â The total of $120,000 ($115,000 plus$5,000) is reported as an increase in fund balance. This figurecarries forward to the next major report, known as the statement ofchanges in fund balance.
STATEMENT OF CHANGES IN FUND BALANCE/NET WORTH
Remember that our formula for a basic statement of revenue andexpense looked like this:
Operating Revenue â Operating Expenses = Operating Income
Exhibit 10-2 Westside Clinic Statement of Revenue andExpenses
For the Year Ending | |||||
Revenue | December 31, 20x2 | December 31, 20x1 | |||
Net patient service revenue | $2,000,000 | $1,850,000 | |||
Total operating revenue | $2,000,000 | $1,850,000 | |||
Operating Expenses | |||||
Medical/surgical services | $600,000 | $575,000 | |||
Therapy services | 860,000 | 806,000 | |||
Other professional services | 80,000 | 75,000 | |||
Support services | 220,000 | 220,000 | |||
General services | 65,000 | 60,000 | |||
Depreciation | 40,000 | 40,000 | |||
Interest | 20,000 | 24,000 | |||
Total operating expenses | 1,885,000 | 1,800,000 | |||
Income from Operations | $115,000 | $50,000 | |||
Nonoperating Gains (Losses) | |||||
Interest Income | $5,000 | $2,000 | |||
Net nonoperating gains | 5,000 | 2,000 | |||
Revenue and Gains in Excess of | |||||
Expenses and Losses | $120,000 | $52,000 | |||
Increase in Unrestricted Fund Balance | $120,000 | $52,000 | |||
The excess of revenue over expenses flows back into equity orfund balance through the mechanism of the statement of fundbalance/net worth. Exhibit 10-3 shows a balance at the first of theyear; then it adds the excess of revenue over expenses (in theamount of $115,000) plus some interest income (in the amount of$5,000) to arrive at the balance at the end of the year.
If you refer back to the balance sheet, you will see the$418,000 balance at the end of the year appearing on it. So we canthink of the balance sheet, the statement of revenue and expenses,and the statement of changes in fund balance/net worth as lockedtogether, with the statement of changes in fund balance being themechanism that links the other two statements.
But there is one more major reportâthe statement of cashflowsâand we will examine it next.
STATEMENT OF CASH FLOWS
To perceive why a statement of cash flows is necessary, we mustfirst revisit the concept of accrual basis accounting. If cash isnot paid or received when revenues and expenses are entered on thebooksâthe usual situation in accrual accountingâwhat happens? Theother side of the entry for revenues is accounts receivable, andthe other side of the entry for expenses is accounts payable. Theseaccounts rest on the balance sheet and have not yet been turnedinto cash. Another characteristic of accrual accounting is therecognition of depreciation. A capital assetâa piece of equipment,for exampleâis purchased for $20,000. It has a usable life of fiveyears. So depreciation expense is recognized in each of the fiveyears until the $20,000 is used up, or depreciated. (Land is anexception to this rule: it is never depreciated.) Depreciation isrecognized within each year as an expense, but it does notrepresent a cash expense. This is a concept that now enters intothe statement of cash flows.
Exhibit 10-4 presents the current period cash flow. In effect,this statement takes the accrual basis statements and converts themto a cash flow for the period through a series of reconcilingadjustments that account for the noncash amounts.
Understanding the cash/noncash concept makes sense of thisstatement. The starting point is the income from operations, thesubtotal from the statement of revenue and expense. Depreciationand interest are added back, and changes in asset and liabilityac-counts, both positive and negative, are recognized. Theseadjustments account for operating activities. Next, capital andrelated financing activities are addressed; then investingactivities are adjusted. The result is a net increase in cash andcash equivalents of $45,000 in our example. This figure is added tothe cash balance at the beginning of the year ($145,000) to arriveat the cash balance at the end of the year ($190,000). Now referback to the balance sheet, and you will find the cash balance isindeed $190,000. So the fourth major reportâthe statement of cashflowsâinterlocks with the other three major reports.
Exhibit 10-3 Westside Clinic Statement of Changes in FundBalance
For the Year Ending | |||
Statement of Changes in Fund Balance | December 31, 20x2 | December 31, 20x1 | |
Balance First of Year | $298,000 | $246,000 | |
Revenue in Excess of Expenses | 115,000 | 50,000 | |
Interest Income | 5,000 | 2,000 | |
Balance End of Year | $418,000 | $298,000 | |
Exhibit 10-4 Westside Clinic Statement of Cash Flows
Statement of Cash Flows | For the Year Ending | |||
December 31, 20x2 | December 31, 20x1 | |||
Operating Activities | ||||
Income from operations | $115,000 | $50,000 | ||
Adjustments to reconcile income from | ||||
operations to net cash flows from | ||||
operating activities | ||||
Depreciation and amortization | 40,000 | 40,000 | ||
Interest expense | 20,000 | 24,000 | ||
Changes in asset and liabilityaccounts | ||||
Patient accountsreceivable | 50,000 | â250,000 | ||
Inventories | â5,000 | â5,000 | ||
Prepaid expenses andother assets | â2,000 | â1,000 | ||
Accounts payable andaccrued expenses | â9,000 | 185,000 | ||
Net cash flow from operating activities | $209,000 | $43,000 | ||
Cash Flows from Noncapital Financing Activities | 0 | 0 | ||
Cash Flows from Capital and Related Financing ActivitiesAcquisition of equipment | $ 0 | $(300,000) | ||
Proceeds from loan for equipment | 0 | 300,000 | ||
Interest paid on long-term obligations | â20,000 | 0 | ||
Repayment of long-term obligations | â48,000 | 0 | ||
Net cash flows from capital and related financing activities | â68,000 | 0 | ||
Cash Flows from Investing Activities | ||||
Interest income received | $5,000 | $2,000 | ||
Investments purchased (net) | â 101,000 | 0 | ||
Net cash flows from investing activities | â96,000 | 2,000 | ||
Net Increase (Decrease) in Cash and Cash Equivalents | $45,000 | $45,000 | ||
Cash and Cash Equivalents, Beginning of Year | 145,000 | 100,000 | ||
Cash and Cash Equivalents, End of Year | $190,000 | $145,000 | ||
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. |
