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Generally accepted accounting principles outline accounting rules for financial transactions. Companies that sell products often use product samples to show options to customers. These samples can be either manufactured or purchased by the company. In both of these cases, there is a cost to the samples. There are multiple allowable methods of expensing these samples under GAAP.
According to GAAP principles, expenses must be recorded in the period that contains the related revenues. If the expenses cannot be tied directly to revenues, they are to be expensed in the period they are incurred. To incur an expense, the business must be legally responsible for it. The expense does not necessarily have to have been paid for, just contracted. For example, if a business rents office space, each month's rent should be expensed in that month, even if the rent has not yet been paid. For product samples, GAAP principles allow immediate expensing of the samples when the company purchases them or capitalization and deferral of part of the cost to future periods.
Even though product samples may be used over several accounting periods or even several years, GAAP allows them to be expensed when initially purchased. This is due to the fact that samples cannot often be matched directly with related revenues. Many customers and potential customers may view the samples. Some may make a purchase and some may not. Expensing the samples allows the company to recognize the cost when incurred rather than trying to determining which future periods the expense belongs to. To account for the expense, debit Samples or Supplies on the income statement and credit either Bank or Accounts Payable, depending on whether the samples have been paid for.
If product samples can be traced to a specific sale, they can be capitalized and then expensed in the period of the related revenues. For example, if custom wood trim samples were created for a specific customer in May, a company could capitalize the costs on the books and expense them when the customer makes the purchase in September. The initial accounting entries are a credit to Cash or Accounts Payable and a debit to Prepaid Expenses. When the cost is expensed, the Prepaid Expenses account is credited and the Samples or Supplies account is debited.
Obsolete Samples
If a company chooses to capitalize product samples and expense them in a future period or over multiple periods, it must review them regularly to ensure that they are still usable. If a capitalized product sample becomes obsolete or otherwise not used by the company any longer, it must be written off in that period. This also holds true if the sample is damaged and can no longer be used.
1. Determine the cost of the sample. Do not consider the retail value of the sample; just figure out how much it cost you. If you have given a customer one widget from a box of 10 widgets and your cost for the box is $10.00, the cost of the sample is $1.00. If the product is something you have manufactured, you need to know the cost of the raw materials used to make the sample. Do not include the value of your time spent manufacturing it. 2. Create a cost of goods sold account named "Samples." Click on "Company" and choose "Chart of Accounts." At the bottom of the screen choose "New" from the "Account" drop-down menu. Choose "Other Account Types" and choose "Cost of Goods Sold" from the drop-down menu. Click "Continue" and name the account "Samples" on the next screen. Give the account a description, if desired. Click "Save & Close" when you are finished. 3. Create a journal entry. Go to "Company," "Make General Journal Entries" and enter the date you gave out the sample for the entry date. Debit "Samples" for the cost of the sample and credit "Inventory" for the same amount. Use the Memo column to describe the transaction. A proper description would be "To record cost of sample given to customer." You may want to use the customer name, if available, in the description. Click "Save & Close" when you are done.
Accounting standards require that a company prepares four financial reports: a balance sheet, a statement of income, a statement of cash flows and a statement of shareholders' equity. The balance sheet must indicate corporate equity capital, assets and debts. The income statement must tell the rest of the world how much the company earned -- and expenses that it incurred -- over a specific period of time, such as a quarter or fiscal year. The cash flow statement indicates a company's liquidity movements in operating, investing and financing activities. A statement of shareholders' equity provides insight into stockholders' investments in a publicly listed firm.
Discontinued Operations
Discontinued operations are business units that a company is in the process of selling, even though it has not yet completed the sale. GAAP and international financial reporting standards require that firms report below the "operating income" section corporate losses and gains that relate to discontinued operations.
Comprehensive Income
Under GAAP, companies must report a comprehensive income if their operations involve specific items, such as available-for-sale securities and held-to-maturity assets as well as pension and post-retirement benefits. Available-for-sale securities, such as stocks, are items that a company buys and holds with a profit motive. Held-to-maturity securities are investments that a company intends to sell at maturity (corporate bonds, for example).
Financial-reporting standards allow a company to rectify prior errors in its financial reports. Correcting prior errors is a mark of operational integrity, even though investors may question top leadership's financial dexterity and ability to put sound accounting policies into place. Error-correction procedures are retrospective, focusing on previously reported data. Accounting changes are prospective, ensuring that future reports are accurate and in line with GAAP.
Earnings-per-share calculation requires a knack for identifying a company's classes of equity shares (common and preferred stocks, for example) and understanding how the shares affect stockholders' equity amounts. Earnings-per-share ratio equals net income available for common shareholders divided by number of common shares outstanding, which are shares currently traded on securities exchanges. This ratio indicates how much revenue a publicly listed company generates on each share of equity that it sold to the investment community.