MGT220H5 Midterm: Exam Notes Mini

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Randolph Christopher Small

Accounts Receivable: Recording Cash Discounts • Two methods: gross method and net method • Gross method records discounts when customers pay within discount period o “Sales Discounts” are deducted from sales on the income statement o Most common method • Net method records accounts receivable net of the discount; discounts forfeited by customers are recorded when not taken o Preferred method but rarely used o “Sales Discounts Theoretically Forfeited” is recorded as “Other revenue” if customer does not take the discount Example of Gross Method • $10,000 sales on credit (terms 2/10, n/30) Dr. Accounts Receivable 10,000 Cr. Sales Revenue 10,000 • Customer pays account within discount period Dr. Cash 9,800 Dr. Sales Discounts 200 Cr. Accounts Receivable 10,000 Example of Net Method • $10,000 sales on credit (terms 2/10, n/30) Dr. Accounts Receivable 9,800 Cr. Sales Revenue 9,800 • Customer pays account after discount period Dr. Cash 10,000 Cr. Sales Discounts Forfeited 200 Cr. Accounts Receivable 9,800 Allowance Procedure Only • Uses past collection experience to estimate uncollectible accounts • Focus is to report accounts receivable at net realizable value o Does not focus on matching bad debt expense to sales • Any existing balance in Allowance for Doubtful Accounts is used to calculate the current year’s bad debt expense • Can use: Percentage-of-receivables or aged receivable analysis Mix of Procedures • Initial use of “percentage-of-sales” approach is based on the relationship between sales and bad debts • Matches the estimated cost of bad debts to sales generated in the same accounting period • Any existing balance in the balance sheet account (Allowance for Doubtful Accounts) is initially ignored when calculating the current period’s bad debts expense • Receivables are also reviewed at year-end to ensure that balance is appropriate, and adjustment to Allowance for Doubtful Accounts is made Mix of Procedures: Example • Dockrill Corp. reports the following balances for its first year of operations (2014): Net credit sales: $400,000 • The company estimates bad debts at 2% of net credit sales • Determine estimated bad debts expense for 2014 Balance Sheet Presentation • Short-term accounts receivable are shown at their net realizable value as follows: Accounts Receivable $ xxx Less: Allowance for Doubtful Accounts xxx Net Realizable Value $ xxx Allowance Method: Writing Off Accounts Receivable • When a specific customer’s account is determined to be uncollectible, the following entry is made: Dr. Allowance for Doubtful Accounts x Cr. Accounts Receivable–specific customer x (for the amount to be written off) • If payment is received after write-off of account, the account is reinstated and payment is recorded: Direct Write-off Method • If uncollectible amounts are highly immaterial, the allowance method is not required • Instead, direct write-off method can be used • Record bad debt expense only when specific account is determined to be uncollectible: Dr. Bad Debt Expense x Cr. Accounts Receivable x • No allowance account is used Interest Bearing Short-Term Notes Receivable • Example: On March 14, 2014, Accounts Receivable of $1,000 is exchanged for a 6% six- month note Non-Interest Bearing Short-Term Notes Receivable • On February 23, 2014, a $5,000 nine-month non-interest bearing note is issued; 8% is the implied interest rate Long-term Loans Receivable – Interest Bearing Notes • Example: Morgan Corp. issues a $10,000, 10% three-year note; market interest rate is 12% and annual interest payments are $1,000 (10% x $10,000) • In calculating the note’s present value, use 12% market rate to discount all future cash flows as follows: ($10,000 x .71178) + ($1,000 x 2.40183) = $9,520 • The note is issued at a discount (as proceeds < face) • At date of issue, the company has an unamortized discount of $480 (to be amortized over the 3 years) • The discount represents interest income to be recognized over the 3-year life of the note • $9,520 x 12% = $1,142 (first year interest income) • Book value of Notes Receivable is now: $10,000 – ($480 - $142) = $9,662 • Interest Income for second year: $9,662 × 12% = $1,159 • Under straight-line method (as opposed to the effective interest rate method), initial discount of $480 is recognized as interest income evenly over 3 years at $480/3 yrs = $160 per year • IFRS requires the use of effective interest method of amortization • ASPE does not specify the amortization method Analysis Comparison • Both ASPE and IFRS are in state of flux • IFRS generally requires more extensive disclosures • The two sets of standards are very similar • ASPE does not require use of the effective interest method, whereas IFRS generally does • Impairment Provisions and derecognition of financial assets are two issues that remain under study by IASB – may generate additional differences in the near future Items to Be Included in Inventory • Legal title to goods generally determines items to be included in inventory • The following goods are included in the seller’s inventory: 1. Goods in transit (if seller has title during shipment, i.e., if shipped f.o.b. destination) 2. Goods out on consignment 3. Goods sold under buyback agreements 4. Goods sold with high rates of return that cannot be estimated Effect of Inventory Errors Example Given for the year 2014: COGS = $1.4 million Retained Earnings (R/E) = $5.2 million December 31 inventory errors both discovered after 2014 books were closed: 2013: inventory overstated by $110,000 2014: inventory overstated by $45,000 Calculate correct 2014 COGS and R/E at Dec. 31, 2014 Interest or borrowing costs • Under IFRS, interest costs are included as product costs if manufacturing of inventory takes a long time (otherwise, company has a choice whether to capitalize interest costs or not) • Under ASPE, interest costs may be either capitalized or expensed, but policy must be disclosed Perpetual and Periodic Systems: Example Fesmire Limited reports the following data: Beginning Inventory: 100 units at $6 Purchases: (all credit) 900 units at $6 Defective units (returned) 50 units at $6 Sales: (all credit) 600 units at $12 Ending Inventory: 350 units at $6 Perpetual System Periodic System Cost Formulas IFRS and ASPE recognize three acceptable cost formulas: 1. Specific identification 2. First-in, First-out (FIFO) 3. Weighted average cost • The ending inventory in units is the same in all three methods; the cost is different • The cost of goods sold and the cost of ending inventory are different • The cost of purchases is the same in all three methods Cost Formulas: Example Call-Mart reports the following transactions for March: Date Purchases Sales Balance (units) 1 Beginning (500 @$3.80) 500 2 1,500 units (@$4.00) 2,000 15 6,000 units (@$4.40) 8,000 19 Sold 4,000 units 4,000 30 2,000 units (@$4.75) 6,000 Determine the cost of goods sold and the cost of ending inventory, under each cost formula. Weighted-Average Formula Date Purchases Unit Cost Purchase Cost March 1 500 units $3.80 $ 1,900 March 2 1,500 units $4.00 $ 6,000 March 15 6,000 units $4.40 $26,400 March 30 2,000 units $4.75 $ 9,500 10,000 units $43,800 Moving-Average Formula Date Purchases Unit Cost Purchase Cost On Hand March 1 500 units $3.80 $ 1,900 $ 1,900 March 2 1,500 units $4.00 $ 6,000 $ 7,900 March 15 6,000 units $4.40 $26,400 $34,300 Mar. 19 New Unit Cost calculated – to use for Cost of Goods Sold $34,300/8,000 units = $4.2875 and 4,000 @ $4.2875 = $17,150 March 19 4,000 units remaining 17,150 March 30 2,000 units $4.75 $ 9,500 26,650 New Unit Cost calculated—to use as COGS for next sale and for inventory $26,650/6,000 units = $4.4417 NOTE: With each new purchase, a new average unit cost is determined First-In, First-Out Formula Date Purchases Unit Cost Purchase Cost March 1 500 units $3.80 $ 1,900 March 2 1,500 units $4.00 $ 6,000 March 15 6,000 units $4.40 $26,400 March 30 2,000 units $4.75 $ 9,500 Gross Profit Method: Example Given: • Beginning inventory (at cost): $ 60,000 • Purchases (at cost): $ 200,000 • Sales (at selling price): $ 280,000 • Gross profit percentage on sales: 30% • Estimate the ending inventory using the gross profit method Understanding Markups Common ratios Comparison of IFRS and ASPE • Major different between IFRS and ASPE relates to a specific IFRS standard covering biological assets and agricultural produce at the point of harvest • ASPE has no specific guidance in this area Borrowing Costs • Under IFRS, borrowing costs that are incurred during acquisition, construction or production of qualifying assets must be capitalized as part of the asset’s cost • ASPE allows a choice of capitalizing or expensing such interest costs Deferred Payment Contracts Example: Sutter Corporation, given: • Five-year, $100,000 non-interest bearing note issued in exchange for new equipment • Market interest rate = 10% • Payable over 5 years—$20,000 per year • Record acquisition of equipment Asset Exchange • Monetary exchange of assets occurs when: o Non-monetary assets (e.g., PP&E) are acquired for cash or other monetary assets (e.g., accounts and notes receivable), or o Non-monetary assets are disposed of in exchange for monetary assets • Non-monetary transaction or exchange of assets occurs when: o Non-monetary asset is exchanged for another non-monetary asset Exchange of Assets with Commercial Substance Example: Information Processing Inc. (IPI) exchanges a used machine for a new model • Fair value of used machine: $ 6,000 • Book value of used machine: $ 8,000 (Cost=$12,000; Accum. Depreciation=$ 4,000) • Cash paid to seller: $ 7,000 Record the purchase in IPI’s books: Equipment (new) 13,000 Accumulated Depreciation (old) 4,000 Loss on Disposal 2,000 Equipment (old) 12,000 Cash 7,000 Non-monetary Exchange with Commercial Substance Cathay Corp. exchanges a number of trucks for land: • Fair value of trucks: $ 49,000 • Book value of trucks: $ 42,000 (Cost=$64,000; Accum. Depreciation= $ 22,000) • Cash paid to seller: $ 4,000 Record
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