NNoteboook:: MGCR 211- Intro to Financial Accounting
CCreated:: 1/12/2012 15:53 Upddated:: 7/12/2012 14:35
The balance in the allowance for doubtful accounts might not be reasonable if the
collectability of receivables is not reflective of the industry. This could occur if
customers are less reliable, or if policies for checking and extending credit
are more lenient.
Establishing a reasonable allowance is particularly difficult in the first year of operations.
Better able to assess reasonableness after a few years history comparing its record of
uncollectible accounts to the industry average.
Failure of starting an allowance overstates value of account receivables and shareholders'
Percentage of Credit Sales Method (Income Statement Approach)
credit sales x bad debt rate
focus on amount of expense rather than amount of allowance
existing balance in the allowance account is not taken consideration
not directly related to the account receivable account
allowance/account receivable = bad debt ratio
Setting up an allowance for doubtful accounts based on a percentage of credit sales
is unlikely to result in a close estimate of the accounts that will actually be
Total Outstanding Gross Receivable Method (Balance Sheet Approach)
receivables as a whole x percentage of expected write-offs
Aging Method (Balance Sheet Approach)
dividing receivables into various age categories
total estimated write-offs = amount of receivables that are deemed to be
noncollectable = allowance
"work backward" in the equation as the difference between the final allowance and
the beginning balance of the allowance is the amount of bad debt
better picture of the net realizable value
basing the allowance for doubtful accounts upon specific customer balances that
are overdue (i.e. an aging schedule) might result in a better valuation of accounts
receivable. Short Term Investment
Debt securities (yielding interest)
–Held for Trading (FV; Gains & Losses thru NI)
–Held to Maturity (Amortized cost)
–Available for sale (FV; Gains & Losses thru OCI)
Equity securities (yielding dividends)
–Held for trading (FV; Gains & Losses thru NI) increase/decrease through net
income; increase/decrease retained earnings
–Available for sale (FV; Gains & Losses thru OCI)
Always value short term investment at fair market value
Affected account: short-term investment (Asset) & Unrealized/realized gain or loss on
short-term investment (SE) Chapter 7
Recognition of Inventory
Asset: controllable, future economic benefits, event that gave control has already
FOB point, consignment inventory
Gross profit > cost
Costs: comprise all costs of purchase, costs of conversion, and other costs incurred in
bringing the inventories to their present location and condition
Period cost: adminstration is not cost of sales. If i hire a purchasing department,
it is a cost of business but it is not a cost of the item. It is just adminstrative cost.
We don't include them in the cost of manufacturing.
Conversion cost: direct labor or manufacturing cost like overhead costs (factory
rent, depreciation on building)
Work-in-Process cost: collects all the costs that are incurred during the
production of the product
Finished goods cost: work-in-process cost when the production is completed
Freight-in cost: transportation for "purchased" goods
Lower of Cost and Net Realizable Value
LCM is the lower of cost or replacement cost, with the replacement cost
being no higher than NRV and no lower than NRV minus the normal profit.
NRV= market value (exit price) = current selling price - cost of sales
LCM = All Costs involved during production
Increase in COGS if there is a loss in inventory value due to LCM; increasing supply
of certain inventory will increase COGS for the certain industry
Use formula for periodic inventory system
Generally, a high inventory turnover ratio is desirable. The type of company and
products sold must be taken into consideration in evaluating the turnover ratios. An
exceptionally high ratio may mean that the company is not carrying an adequate stock of
inventory and may be losing sales as a result. It may also mean that production is
required to constantly change from one product to another to meet customer demands.
For example, a fruit and vegetable store should have a high inventory turnover, whereas
you would expect a car dealership to have a much lower one.
Cash Flow Assumptions (for determining cost of goods sold)
FIFO (first in, first out)
match oldest cost to the newest revenue
not respecting the matching principle (or the income statement)
total cost available for sales/ units available for sales LIFO (Last in, first out)
match the newest revenue to the newest cost
easy for income maximization
Gross Margin Estimation Method
cost to sales ratio
(1-GP%) because of common sizing
Value of Ending inventory decreases when net profit ratio decreases (COGS increases)
The gross margin method will provide reliable results so long as cost patterns remain
stable, and the selling price and mark-ups are predictable. In general, all factors
affecting the gross profit percentage must remain more or less unchanged for this
method to provide reliable results.
Conditions that might cause the gross profit method to provide unreliable results
Price changes that were not recorded or taken into account in determining the
gross profit margin.
Special merchandise purchases that are sold at a different gross profit margin.
Losses of inventory due to damage.
Losses of inventory due to theft and other causes.
Errors in recording inventory sales or purchases.
Reason for a lower GP%
Higher cost to manufacture (RM, Labour, Freight)
Lower margin products were sold
Decrease in production volume leads to increase in absorption of fixed costs
Sales in countries where margins are lower
Effects of foreign currency losses
Increase in obsolescence & inventory writedowns
Capital Asset: long-term assets required for production, often used until it is
IFRS permits both historical cost and net realizable value (fair market value)
Historical cost method amortize expense throughout usage period
change in market value is not reflected until the asset is disposed
Capitalizing cost: costs needed to get the asset ready for use
Under the matching principle, some costs like depreciation is recorded in future
purchase price (less any discounts)
shipping or transportation costs
preparation, installation, and set-up costs
Companies will have to wait until the assets are depreciated before the costs can be
deducted for tax purposes
Basket Purchase: a bundle
value is based on relative fair market values at time of acquisition
not intended to value fair market value
only a cost allocation tool
Unit of Activity Method
measure by utility, not time
activities that improve the asset (major repair, upgrade) is capitalized
activities that restore the asset to its original condition is expensed
Write-downs (Use higher of NET BOOK VALUE or net realizable value )
technology change, damage to the asset, change in asset's market
reduce the asset's carrying value
recognize impairment losses
Use higher of value in use or net realizable value
Proceeds - Net Book Value
If proceeds > NBV, increase in SE, increase in cash (Asset)
If purchased from another entity, record asset value in acquisition price
If internally developed, costs of developing it are expensed as incurred ex. R&D and advertisement as exact benefits cannot be measured
development cost may be capitalized if it matches certain criterias
Definite Life Intangibles: depreciated over EUL
Patents: legal life of 20 years
This periodwould be based on the remaining legal life of the patent or
estimateduseful life whicheveris shorter. Competitive technologies would
have to be considered to determine whetherthe patent`s benefits extend to
the end of its legal life.
Copyright: life of the creator + 50 years or economic life
If the economic life of 30 yearperiod is reasonable this would be acceptable
since it is less than the legal life of the copyright. Sales projections as
estimatedby management wouldhave to be obtainedto evaluate whether
this estimate is reasonable.
internally developed patents are expensed
legal cost and registration fee is depreciated over EUL
No residual value
Indefinite Life Intangibles: not depreciated
Trademark: 15 years or renewed
Goodwill is not recognized if its developed internally
only recorded when it acquires another company
Both equipment and patents are recorded initiallyas the amounts paid to acquire them.
Following the date of acquisition, the carrying values are adjusted for depreciation.
For equipment, both the original cost and the accumulated depreciation are reported.
In the case of patents, the allocation of original cost to a patent expen