Chapter 7 Cash & Receivables

Cash Cash Unrestricted Cash Restricted Current/noncurrent Asset Petty Cash & Change Fund Cash Reported as Cash Short-term Paper Cash Equivalent < 3 months, often reported as cash Short-term Paper Temp. Investment Maturity of 3 to 12 months Post-dated check & IOUs Receivables Assumed to be collectible Travel Advance Receivables Assumed collectible from employee/deduct salary Postage Prepaid Expenses Office Supplies Inventory Bank Overdraft Current Liability If right of offset exists, reduce cash Compensating Balance Cash separately classified as deposit Current/Noncurrent in balance sheet. Disclose in notes. Net Realizable Value Net amount company expects to receive in cash. (NRV) Allowance Method: Ensure company state receivable @ NRV(Balance S.) Companies dont close Allowance for Doubtful Accounts at end of fiscal year. Direct Write-off: Immaterial Direct Write-Off Method-Charge loss to bad Debt Expense, Allowance-Estimate uncollectible accounts at the end of each not appropriate period. Bad Debt Expense 8,000 Bad Debt Expense 8,000 Accounts Receivable 8,000 Allowance for D. Acct 8,000 Allowance for D. Acct 1,000 Accounts Receivable 1,000 Accounts Receivable 1,000 Allowance for D. Acct 1,000 Recording Write off of Uncollectible Cash 1,000 Recovery of Uncollectible ---------------- Accounts Receivable 1,000 Percentage of Sales-Income Statement Percentage of Receivables-Balance Sheet Composite rate -estimate of uncollectible Bad Debt Expense 8,000 Aging schedule-different % based on past experience to various Allowance for D. Acct 8,000 age categories 1% * $800,000 = $8,000 Credit Balance $800 before adjustment Debit Balance of $200 before adjustment ($37,650 - $800 = $36,850) ($37,650 + $200 = $37,850) Bad Debt Expense 36,850 Bad Debt Expense 37,850 Allowance for D. 36,850 Allowance for D. 37,850 Impairments-Note receivable considered impaired when probable that creditor will be unable to collect all amounts due (both principal & interest) according to contract. Fair Value Option-Receivable recorded @ FV,w/unrealized Disposition of Receivable-To accelerate receipt of cash from holding gain/loss ( change in the FV of receivable from 1 receivables; owner may transfer accounts/notes receivables to period to another, exclusive of interest revenue) reported as another company for cash. (Secured borrowing/Sale of part of net income. Receivables) Common sale to factor. (finance companies/ bank Notes Receivable 19,000 that buy receivables from business for fee. UHG/L-Income 19,000 W/out Recourse-purchaser assumes risk of collectibility & W/Recourse- seller guarantees to pay purchaser if debtor fails to absorbs credit losses. Out right sale of rcvbl. both in form pay. To record seller uses financial components approach, (transfer of title) & substance (transfer of control). Cash received 460,000 Cash 460,000 Due from Factor 25,000 485,000 Due from Factor 25,000 Less:Recourse liability 6,000 Loss on Sale of R. 15,000 Account (Note) R. 479,000 Account (Note) R. 500,000 Net proceedscash/other assets received in sale less any liabilities incurred. Carrying (Book) Value Net Proceeds = Loss on Sale of Receivables Transfer of Receivables: Does it meet 3 conditions? 1.Transferred assets isolated from transferor 2.Transferee right to pledge or sell asset 3. Transferor doesnt maintain control through repurchase agreement. If NO record as secured borrowing: a. Record liability b. Record interest expense. If YES: Is there continuing involvement? If YES: Record as Sale: A. Reduce receivables B. Recognize assets obtained & liabilities incurred. C. Record gain or loss. If NO: A. Reduce receivables B. Record gain or loss. Accts. Receivable Turnover = Net Sales / Avg. Trade Receivables (net) Days to collect Accts. Receivable or Days Outstanding = Accts. Receivable Turnover / 365 Days
Items considered cash. To be reported as cash, an asset must be readily available for payment of current obligations & free from contractual restrictions that limit its use in satisfying debts. Cash consists of coin, currency, & available funds on deposit at bank. Negotiable instruments ie: money orders, certified checks, cashiers checks, personal checks, & bank drafts are also viewed as cash. Savings accounts usually classified as cash. (1) ABC's checkbook balance on 12/31/10 was $21,200 & ABC held the following items in its safe on 12/31. (A) Check for $450 from XYZ received 12/30/10, which was not included in the checkbook balance. (B) NSF check from JKL in amount of $900 that had been deposited at the bank, but was returned for lack of sufficient funds on 12/29. The check was to be redeposited on 1/3/11. Original deposit has been included in 12/31-checkbook balance. (C) Coin & currency on hand amounted to $1,450. The proper amount to be reported on Finley's balance sheet for cash at 12/31/10 is Answer: $21,200 + $450 $900 + $1,450 = $22,200. (2 ) In preparing its 5/31/10 bank reconciliation, ABC has the following info available: Balance per bank statement, 5/31/10 $30,000; Deposit in transit, 5/31/10 $5,400; Outstanding checks, 5/31/10 $4,900, Note collected by bank in May $1,250 The correct balance of cash at 5/31/10 is Answer: $30,000 + $5,400 $4,900 = $30,500. (3) ABC factors $2,000,000 of its accounts receivables w/out recourse for a finance charge of 5%. Finance company retains an amount equal to 10% of the accounts receivable for possible adjustments. ABC estimates fair value of the recourse liability at $75,000. What would be recorded as a gain (loss) on transfer of receivables? Answer Loss of $100,000. ($2,000,000 .05 = $100,000) (4) ABC factored, w/recourse, $300,000 of accounts receivable w/XYZ. The finance charge is 3%, & 5% was retained to cover sales discounts, returns, & allowances. ABC estimates the recourse obligation at $7,200. What amount should ABC report as a loss on sale of receivables? Answer: ($300,000 .03) + $7,200 = $16,200. (5) Assuming that the ideal measure of short-term receivables in the balance sheet is the discounted value of the cash to be received in the future, failure to follow this practice usually does not make the balance sheet misleading because Answer: the amount of the discount is not material.

Chapter 8 Valuation of Inventories A Cost-Basis Approach Inventory Costs- Companies generally account for the acquisition of inventories, like other assets, on a cost basis.
Product costs-costs that attach to the inventory & recorded in Period costs (costs that are indirectly related to acquisition or inventory account. IE: Freight charges on goods, other direct costs production of goods). IE: Selling expense, general & admin of acquisition, & labor & other production costs incurred in expense arent included as part of inventory cost. Interest Cost processing the goods up to time of sale. Companies usually expense interest costs. Perpetual inventory system continuously track changes in Periodic inventory system, Determine quantity of inventory on Inventory account. (Records all purchases & sales (issues) of hand periodically. COGAFS = Purchases Start + Purchase End goods directly in Inventory account as they occur) COGS = COGAFS Ending Inventory. In audit of ABC, you find physical inventory on 12/31/12 showed merchandise w/cost of $441,000. You discover following excluded from $441,000:1. Merchandise ($61,000), held by ABC on consignment. 2. Merchandise ($33,000), shipped by ABC f.o.b. destination to client on 12/31/12. Client expected to receive on 1/6/13. 3. Merchandise ($46,000), shipped by ABC f.o.b. shipping point to client on 12/29/2012. Client scheduled to receive on 1/2/13 4. Merchandise ($73,000) shipped by vendor f.o.b. destination on 12/30/12, & ABC received on 1/4/13. 5. Merchandise ($51,000) shipped by vendor f.o.b. shipping point on 12/31/12, & received by ABC on 1/5/13. Based on info, calculate amount that should be on ABCs balance sheet at 12/31/12, for inventory. $441,000 + $33,000 + $51,000 = $525,000 LoBianco Companys record of transactions for the month of April was as follows. (A) Assuming periodic inventory records kept, Purchases Sales compute inventory at 4/30 using (1) LIFO & (2) April 1 600 @ $6.00 3,600 April 3 500 @ $10.00 avg. cost. (1) LIFO (5,300 4,500) 600 @ $6.00 = 4 1,500 @ 6.08 9,120 9 1,300 @ 10.00 $3,600; 200 @ $6.08 = $1,216 ($3,600 + $1,216 = 8 800 @ 6.40 5,120 11 600 @ 11.00 $4,816) 13 1,200 @ 6.50 7,800 23 1,200 @ 11.00 Go to oldest inventory (800 (600 @ $6.00) = (200 21 700 @ 6.60 4,620 27 900 @ 12.00 @ $6.08)) 29 500 @ 6.79 3,395 4,500 (2) Average Cost: Weighted-average cost per unit 5,300 $33,655 $33,655 / 5,300 units available = $6.35 avg. cost per unit (600 units @ $6.35 = $5,080) (B) Assume perpetual inventory records are kept, determine inventory at 4/30 using (1) FIFO & (2) LIFO. 4/1: 600 500 = 100 @ $6.00 (1) FIFO - Perpetual (Same as Periodic) (2) LIFO 4/4:1,500 1,300 = 200 @ $6.08 100 @ $6.00 = $600 4/8: 800 600 = 200 @ $6.40 500 @ $6.79 = $3,395 200 @ $6.08 = $1,216 4/13:1,200 1,200 = 0 300 @ $6.60 = $1,980 500 @ $6.79 = $3,395 $3,395 + $1,980 = $5,375 $600 + $1,216 + $3,395 =$5,211 4/21: 700 900 = -200 (200; 4/8) April 29: 500 @ $6.79 = $3,395 (c) Compute cost of goods sold assuming periodic inventory procedures and inventory priced at FIFO. (COG Available for sale) $33,655 (Ending Inventory) $5,375 = (Cost of Goods Sold) $28,280 Inventory at Price End of year inventory Split into Ending Inventory Date Current Prices Index at base-year price Layers at Lifo Cost / 100 $220,000 $220,000 X 1.00 $220,000 2009 $220,000 (1.00) / $240,000 $220,000 X 1.00 $220,000 December 31, 107 $256,800 $ 20,000 1.07 $ 21,400 2010 (1.07) $241,400 / $232,000 $220,000 X 1.00 $220,000 December 31, 125 290,000 $ 12,000 1.07 $ 12,840 2011 (1.25) $232,840 / $250,000 $220,000 X 1.00 $220,000 December 31, 130 $ 20,000 1.07 $ 21,400 325,000 2012 (1.30) $ 10,000 1.30 $ 25,840 $267,200
LIFO Advantages: (1)Matches recent costs against current revenues to provide better measure of current earnings. (2) As long as price level increases & inventory quantities dont decrease, deferral of income tax occurs in LIFO.(3)Because of deferral of income tax, cash flow improves. Disadvantages: (1) reduced earnings, (2) understated inventory, (3) does not approximate physical flow of items except in peculiar situations, & (4) involuntary liquidation issues. LIFO Reserve - Difference btwn. inventory method used for internal reporting purposes & LIFO is referred to as Allowance to Reduce Inventory to LIFO, or LIFO reserve. Change in LIFO reserve is referred to as LIFO effect. Companies should disclose either LIFO reserve or replacement cost of inventory in financial statements. Effect of LIFO liquidations-LIFO liquidations match costs from preceding periods against sales revenues reported in current dollars. This distorts net income & results in increased taxable income in the current period. LIFO liquidations can occur frequently when using a specific-goods LIFO approach. (1) ABC uses periodic inventory system. For current month, beginning inventory consisted of 200 units @ cost $65 each. During month, company made 2 purchases: 300 units at $68 each & 150 units at $70 each. ABC also sold 500 units during month. Using FIFO method, what is the amount of cost of goods sold for the month? Answer: $33,400. Beginning Inventory: 200 @ $65 = $13,000 Purchases: 300 @ $68 = $20,400, 150 @ $70 = $10,500; Sales: 500; (500 200 300 = 0) 150 units @ $70 left over ($13,000 + 20,400 + 10,500 = 43,900) - 150 @ $70 = $10,500 = $33,400 (2) ABC reported total assets of $1,600,000 & net income of $85,000 for current year. ABC determined that inventory was understated by $23,000 at beginning of year & $10,000 at end of year. What is corrected amount for total assets and net income for the year? Answer: $1,610,000 and $72,000. (3) LIFO liquidations can occur frequently when using a specific-goods approach. Answer: True (4) The dollar-value LIFO method measures any increases & decreases in a pool in terms of total dollar value and physical quantity of the goods. Answer: False (5) Purchase Discounts Lost is a financial expense & is reported in other expenses & losses section of income statement. Answer: 1. True (6) Use of LIFO provides a tax benefit in an industry where unit costs tend to decrease as production increases. Answer: False (7) Assuming no beginning inventory, what can be said about trend of inventory prices if cost of goods sold computed when inventory is valued using FIFO method exceeds cost of goods sold when inventory is valued using LIFO method? Answer: Prices decreased (8) During 2010 ABC transferred inventory to XYZ & agreed to repurchase the merchandise early in 2011. XYZ then used inventory as collateral to borrow from Norwalk Bank, remitting the proceeds to ABC. In 2011 when ABC repurchased inventory, XYZ used the proceeds to repay its bank loan. This transaction is known as a(n) Answer: product financing arrangement. (9) What happens when inventory in base year dollars decreases? Answer: LIFO layer is liquidated. Under dollar-value LIFO method, 1 pool may contain the entire inventory. However, companies generally use several pools. In general, the more goods included in a pool, the more likely that increases in quantities of some goods will offset decreases in other goods in the same pool. Thus, companies avoid liquidation of the LIFO layers. It follows that having fewer pools means less cost and less chance of a reduction of a LIFO layer.

Chapter 9 Inventories: Additional Valuation Issues

Item No. 1320 1333 1426 1437 1510 1522 1573 1626 Cost per Unit $3.20 2.70 4.50 3.60 2.25 3.00 1.80 4.70 Cost to Replace $3.00 2.30 3.70 3.10 2.00 2.70 1.60 5.20 Cost per Unit $3.20 2.70 4.50 3.60 2.25 3.00 1.80 4.70 Estimated Selling Price $4.50 3.40 5.00 3.20 3.25 3.90 2.50 6.00 Cost to Replace $3.00 2.30 3.70 3.10 2.00 2.70 1.60 5.20 Cost of Completion & Disposal $0.35 = 0.50 = 0.40 = 0.45 = 0.80 = 0.40 = 0.75 = 0.50 = Designated LCM by Market Individual Value Items $3.00 $3.00 2.40 2.40 3.70 3.70 2.75 2.75 2.00 2.00 3.00 3.00 1.60 1.60 5.20 4.70 Normal Profit $1.25 0.50 1.00 0.90 0.60 0.50 0.50 1.00 NRV Ceiling $4.15 2.90 4.60 2.75 2.45 3.50 1.75 5.50 NRV Less NP Floor $2.90 2.40 3.60 1.85 1.85 3.00 1.25 4.50 DMV $3.00 2.40 3.70 2.75 2.00 3.00 1.60 5.20

Chapter 10 Acquisition & Disposition of Property, Plant & Equipment

Identify costs to include in initial valuation of property, plant, & equipment. Costs included in initial valuation of PP&E are as follows. Cost of land: Includes all expenditures made to acquire land & to ready it for use. Land costs include (1) purchase price; (2) closing costs, ie: title to land, attorneys fees, & recording fees; (3) costs incurred in getting the land in condition for intended use, ie: grading, filling, draining, & clearing; (4) assumption of any liens, mortgages, or encumbrances on property; & (5) any additional land improvements that have an indefinite life. Cost of buildings: Includes all expenditures related directly to their acquisition or construction. Costs include (1) materials, labor, & overhead costs incurred during construction, & (2) professional fees & building permits. Cost of equipment: Includes purchase price, freight & handling charges incurred, insurance on equipment while in transit, cost of special foundations if required, assembling & installation costs, & costs of conducting trial runs.
(a) Money borrowed to pay building contractor (signed a note) $(275,000) Notes Payable Describe accounting (b) Payment for construction from note proceeds 275,000 Buildings treatment for the disposal of (c) Cost of land fill and clearing 10,000 Land PP&E. Regardless of time of (d) Delinquent real estate taxes on property assumed by purchaser 7,000 Land disposal, companies take (e) Premium on 6-month insurance policy during construction 6,000 Buildings depreciation up to the date of (f) Refund of 1-month insurance premium because construction completed early (1,000) Buildings disposition, & then remove all accounts related to retired asset. (g) Architects fee on building 25,000 Buildings Gains or losses on the (h) Cost of real estate purchased as a plant site (land $200,000 & building $50,000) 250,000 Land retirement of plant assets are (i) Commission fee paid to real estate agency 9,000 Land shown in income statement (j) Installation of fences around property 4,000 Land Improvement along w/other items that arise (k) Cost of razing and removing building 11,000 Land from customary business (l) Proceeds from salvage of demolished building (5,000) Land activities. Gains or losses on (m) Interest paid during construction on money borrowed for construction 13,000 Buildings involuntary conversions, if (n) Cost of parking lots and driveways 19,000 Land Improvement unusual & infrequent, may be (o) Cost of trees and shrubbery planted (permanent in nature) 14,000 Land reported as extraordinary items. (p) Excavation costs for new building 3,000 Buildings Describe accounting problems associated w/interest capitalization. Only actual interest (w/modifications) should be capitalized. Rationale for this is that during construction, the asset is not generating revenue & therefore companies should defer (capitalize) interest cost. Once construction is completed, asset is ready for its intended use & revenues can be earned. Any interest cost incurred in purchasing an asset that is ready for its intended use should be expensed.

Lower-of-cost-ormarket rule is: A company values Ceiling Floor Quantity inventory at LCM, $4.15 $2.90 1,200 w/market limited to an amount that is not 2.90 2.40 900 more than NRV or less 4.60 3.60 800 than net realizable 2.75 1.85 1,000 value less a normal 2.45 1.85 700 profit margin.(Ceiling) 3.50 3.00 500 NRV, prevents overstatement of value 1.75 1.25 3,000 of obsolete, damaged, 5.50 4.50 1,000 inventories. (Floor) NRVLNP. Companies shouldnt price inventory below floor, regardless of replacement cost. Deters understatement of inventory & overstatement of loss in current period. DMV is amount company compares to cost, always middle value of 3 amounts: replacement cost, NRV, & NRVLNP.

Total Inventory $3,600 2,160 2,960 2,750 1,400 1,500 4,800 4,700 23,870

ABC uses gross profit method to estimate inventory for monthly reporting purposes. Info for the month of May: Inventory, May 1 $ 160,000 Sales 1,000,000 Purchases (gross) 640,000 Sales returns 70,000 Freight-in 30,000 Purchase discounts 12,000
(a)Compute estimated inventory at 5/31, assuming gross profit is 25% of (b) Compute estimated inventory at 5/31, assuming gross profit is 25% of sales. cost. Gross profit on selling price: 25% / (100% + 25%) = 20% Beginning Inventory (at cost) $160,000 Beginning Inventory (at cost) $160,000 Purchases (at cost) 640,000 Purchases (at cost) 640,000 Freight-in 30,000 Freight-in 30,000 Purchase discounts (12,000) Purchase discounts (12,000) Goods available (at cost) 818,000 Goods available (at cost) 818,000 Sales (at selling price) $1,000,000 Sales (at selling price) $1,000,000 Sales returns (70,000) Sales returns (70,000) Net Sales (at selling price) 930,000 Net Sales (at selling price) 930,000 Less: Gross profit (25% of 930,000) 232,500 Less: Gross profit (20% of 930,000) 186,000 Sales (at cost) 697,500 Sales (at cost) 744,000 Approximate inventory (at cost) $120,500 Approximate inventory (at cost) $ 74,000 Inventory taken morning after large theft discloses $60,000 of goods on hand as of 3/12. The following data is available from the books: Inventory on hand, March 1, $84,000; Purchases received, March 1 11, $75,000; Sales (goods delivered to customers) $120,000. Past records indicate sales are made at 50% above cost. Estimate inventory at close of business on 3/11 by gross profit method & determine amount of theft loss. Beginning inventory $ 84,000 Beginning inventory $ 84,000 Gross Profit Purchases 75,000 Purchases 75,000 on Selling Goods Available 159,000 Goods Available 159,000 Price Less: (120,000 / 1.5) Sales 120,000 0.50 / (1.00 + Cost + Gross profit = Selling Price Less: Gross profit (33.33% of 120,000) 40,000 0.50) = 0. C + 0.50C = 120,00 Sales 80,000 33 1/3% 80,000 1.50C = 120,000; C = 80,000 Inventory 79,000 Inventory 79,000 Actual Inventory 60,000 Theft of goods (19,000) Theft of goods (19,000) Actual Inventory 60,000 Gross Profit on Selling Price Percentage Markup on Cost Gross Profit on Selling Price Percentage Markup on Cost Given: 20% 0.20 / (1.00 - 0.20) = 25% 0.25 / (1.00 + 0.25) = 20% Given: 25% Given: 25% 0.25 / (1.00 - 0.25) = 33.3% 0.50 / (1.00 + 0.50) = 33.3% Given: 50%

Sale of Plant Asset - Companies record depreciation for period of time btwn. date of last depreciation entry & date of sale. IE: Assume ABC recorded depreciation on a machine costing $18,000 for 9 years at rate of $1,200 per year. If it sells the machine in the middle of the 10th year for $7,000, ABC records depreciation to date of sale as: Depreciation Expense ($1,200 * ) 600 Accumulated Depreciation-Machinery 600 The entry for the sale of the asset then is: Cash 7,000 Accumulated Depreciation-Machinery 11,400 [($12,00 * 9) + 600] = 11,400 Machinery 18,000 Gain on Disposal of Machinery *(7,000 400* Book Value ($6,600) = ($18,000 - $11,400) 6,600)

Involuntary Conversion - Assets service terminated through ie: (fire, flood, theft, condemnation) Companies report difference btwn amount recovered (ie: from a condemnation award or insurance recovery), if any, & assets book value as gain/loss. Some cases gains/losses may be reported as extraordinary items in income statement, if unusual & infrequent in nature. IE: ABC had to sell plant in path of highway. For years state sought to purchase land on which the plant stood, but company resisted. State exercised right of eminent domain, which courts upheld. In settlement, ABC received $500,000, which exceeded $200,000 book value of plant & land (cost of $400,000 less accumulated depreciation of $200,000). Cash 500,000 Accumulated Depreciation-PlantAssets 200,000 Plant Assets 400,000 Gain on Disposal of Plant Assets 300,000 (Disposition of Assets) On 4/1/12, ABC received condemnation award of $410,000 as compensation for forced sale of companys land & building, which stood in path of new highway. The land & building cost $60,000 & $280,000, respectively, when acquired. At 4/1/12, accumulated depreciation relating to the building amounted to $160,000. On 8/1/12, ABC purchased a piece of replacement property for cash. The new land cost $90,000, & the new building cost $380,000. Prepare journal entries to record transactions on 4/1/12 & 8/1/12. Book Value: (land) 60,000 + (bldg.) [$280,000 - $160,000] = $180,000 Cash 410,000 Gain on Disposal = $410,000 - $180,000 = $230,000 Accumulated Depreciation - Buildings 160,000 90,000 Land 60,000 Land 380,000 Buildings 280,000 Buildings Cash 470,000 Gain on Disposal of Plant Assets 230,000
(Nonmonetary Exchange) ABC purchased an electric wax melter on 4/30/13, by trading in its old gas model & paying balance in cash. List price of new melter $15,800; Cash paid $10,000; Cost of old melter (5-year life, $700 residual value) $12,700; Accumulated depreciation old melter (straight-line) $7,200; Secondhand fair value of old melter $5,200 Prepare journal entry(ies) necessary to record exchange, assuming exchange (a) has commercial substance, & (b) lacks commercial substance. Montgomerys year ends on 12/31, & depreciation has been recorded through 12/31/12. Commercial substance: Depreciation Expense 800 Boot (cash received) > Fair value of used melter $ 5,200 Accumulated Depreciation Equipment 800 25% fair value of the Cash Paid 10,000 Lacks commercial substance same as has commercial exchange Cost of Equipment Equipment Melter ($10,000 + $5,200) 15,200 (Boot / Boot + Fair $15,200 Accumulated Depreciation - Used Melter 8,000 value of Other Assets Fair value of used melter 5,200 Melter (used) 12,700 Received) * Total Gain Cost of used melter $12,700 Gain on disposal of Used Melter 500 Less:Accumulated depreciation 8,000* Cash 10,000 = Recognized Gain Book Value of used melter (4,700) $12,700 - $700 (residual value) = $12,000 / 5 = $2,400 (Straight-line) Accumulated Depreciation - Used Melter $ 500 $2400 * (4/12 1/1 to 4/30) = $800; $7,200 + $800 = $8,000* 1. Compute total gain/loss on transaction. This amount is equal to difference between fair value of asset given up & book value of asset given up. 2. If a loss is computed in step 1, always recognize the entire loss. 3. If a gain is computed in step 1, (a) & exchange has commercial substance, recognize the entire gain. (b) & exchange lacks commercial substance, (1) & no cash is involved, no gain is recognized. (2) & some cash is given, no gain is recognized. (3) & some cash is received, the following portion of the gain is recognized: (Boot / Boot + Fair value of Other Assets Received) x Total Gain* *If the amount of cash exchanged is 25% or more, both parties recognize entire gain or loss.

Inventory Turnover = Cost of Goods Sold / Average Inventory Measures # of times on average a company sells inventory during period & measures the liquidity of the inventory. Average days to sell inventory = Inventory Turnover / 365 days Measure represents average # of days sales for which a company has inventory on hand. Companies that keep inventory at lower levels w/higher turnovers than competitors, & still satisfy customers, are most successful. (1) ABC had a gross profit of $360,000, total purchases of $420,000 & an ending inventory of $240,000 in its 1 st year of operations. ABCs sales must be Answer: $540,000; [$540,000 + ($420,000 - $240,000) = $540,000] Gross Profit + COGS = Sales Revenue; COGS = Cost of goods available for sale during period Ending Inventory. (2) ABC sells product X for $40/unit, cost of 1 unit is $36, replacement cost is $34, the estimated cost to dispose a unit is $8 & normal profit is 40%. At what amount per unit should product X be reported applying lower-of cost or market? Answer: $32 [NRV = $40 - $8 = $32; NRV-PM = $32 ($40 x 0.40) = $16, RC = $34, Cost = $36. (3) ABC estimates the cost of inventory at 3/31. Rate of markup on cost is 25%. Inventory 3/1 = $220,000, Purchases = $172,000, Purchase returns = $8,000, Sales during March = $300,000. The estimate of the cost of inventory 3/31 is Answer: $144,000 [$300,000 / 1.25 = $240,000; ($220,000 + $172,000 - $8,000) - $240,000 = $144,000.

Chapter 12 Intangible Assets

Chapter 11 Depreciation, Impairments & Depletion

(Depreciation Computations) ABC purchased a new machine on 8/1/12. The cost of this machine was $150,000. The company estimated that the machine would have a salvage value of $24,000 at the end of its service life. Its life is estimated at 5 years & working hours estimated at 21,000 hours. Year-end is December 31. Compute the depreciation expense under the following methods. Each of the following should be considered unrelated. (a) Straight-line depreciation for 2012. $10,500 Depreciation Base Original Cost $150,000 $25,000 x (5/12) = $10,500 Less: Salvage value 24,000 Depreciation base $126,000 (c) Sum-of-the-years-digits for 2013. $38,500 SOTYD method results in a decreasing depreciation charge based on a decreasing fraction of depreciable cost (original cost less salvage value). Each fraction uses sum of years as a denominator (5 + 4 + 3 + 2 + 1 = 15). Numerator is # of years of estimated life remaining as of beginning of the year. N(N+1) / 2 Depreciation Remaining Depreciation Depreciation 2012 2013 Book Value, Year Base Life in Years Fraction Expense End of Year 1 $126,000 5 5 / 15 $42,000 $42,000 x (5/12) = $17,500 $42,000 x (7/12) = $24,500 $108,000 2 $126,000 4 4 / 15 33,600 $33,600 x (5/12) = $14,000 74,400 $38,500 (b) Activity method for 2012, assuming that machine Depreciation Remaining Depreciation Depreciation Base Life in Years Fraction Expense Book Value, End of Year usage was 800 hours. : ( ) $126,000 5 5 / 15 $42,000 $108,000 $126,000 4 4 / 15 33,600 74,400 $126,000 3 3 / 15 25,200 49,200 $126,000 2 2 / 15 16,800 32,400 $126,000 1 1 / 15 8,400 24,000* (d) Double-declining-balance for 2013. $50,000 15** 15 / 15 $126,000 Salvage value* Book Value of Rate on Balance Book Value Rate on Balance Asset 1st of Declining Depreciation Accumulated of Asset 1st Declining Depreciation Accumulated Book Value, Year Year Balance* Expense Depreciation 2012 2013 Year of Year Balance* Expense Depreciation End of Year $60,000 x $60,000 x 1 150,000 40% 60,000 60,000 (5/12) = (7/12) = 1 150,000 40% 60,000 60,000 $90,000 $25,000 $35,000 $36,000 x 2 90,000 40% 36,000 96,000 (5/12) = 2 90,000 40% 36,000 96,000 54,000 $15,000 $50,000 3 54,000 40% 21,600 117,600 32,400 4 32,400 40% 12,960 130,560 19,440 5 19,440 40% 7,776 138,336 11,664 *Based on twice the straight-line rate of 20% ($25,200 / $126,000 = 20% x 2 = 40% (Straight-line Depreciation / Cost less Salvage) x 2 = Rate on Decl Year 1 2 3 4 5

Accounting for Impairment: Recoverability Test (If sum of expected future net cash flows, undiscounted, is less than carrying amount of asset No Impairment) If IMPAIRMENT ASSETS HELD FOR USE: 1. Impairment loss: excess of carrying amount over fair value. 2. Depreciate on new cost basis. 3. Restoration of impairment loss not permitted. ASSETS HELD FOR DISPOSAL: 1. Impairment loss: excess of carrying amount over fair value less cost of disposal. 2. No depreciation taken. 3. Restoration of impairment loss permitted.
IE: Expected future net cash flows from ABC equipment are $580,000 & carrying amount is $600,000 ($800,000 cost - $200,000 accumulated depreciation). Recoverability Test: $580,000 (Expected future net cash flows) $600,000 Carrying amount of the equipment $600,000 (Carrying amount) Yes Impairment Fair value of equipment (525,000) Difference between carrying amount of ABC asset & its fair value is impairment Loss on impairment $ 75,000 loss. Assuming it has a fair value of $525,000. ABC records impairment loss as: Loss on impairment 75,000 ABC reports impairment loss as part of income from continuing operations, in Accumulated Depreciation - Equipment 75,000 Other expenses & losses section. IE: Cost $9,000,000; Accumulated depreciation to date $1,000,000; Expected future net cash flows $7,000,000; Fair Value $4,400,000; Cost of disposal $20,000. Assume ABC will continue to use this. As of 12/31/12, equipment has a remaining useful life of 4 years. (a) Prepare the journal entry (if any) to record the impairment of the asset at December 31, 2012. $9,000,000 $1,000,000 = (Carrying Amount) $8,000,000 (Fair Value) $4,400,000 + (Cost of Disposal) $20,000 = (Loss on impairment) $3,620,000 (b) Prepare the journal entry to record depreciation expense for 2013. Loss on impairment (a) 3,620,000 Accumulated Depreciation-Equipment 3,620,000 No depreciation taken (c) Fair value of equipment at 12/31/13, is $5,100,000. Prepare the journal entry (if any) necessary to record this increase in fair value (Fair Value) $5,100,000 (Cost of Disposal) $20,000 = $5,080,000 Accumulated Depreciation-Equipment (c) 3,620,000 Recovery of Loss on Impairment 3,620,000 $5,080,000 (Carrying Amount*) $4,380,000 = (Recovery of impairment loss) $700,000 [*$9,000,000 - $1,000,000 - $3,620,000 = $4,380,000] To account for depletion of natural resources, companies (1) establish depletion base & (2) write off resource cost. 4 factors part of establishing depletion base: (a) acquisition costs, (b) exploration costs, (c) development costs, & (d) restoration costs. To write off resource cost, companies normally compute depletion on the units- of-production method. Thus, depletion is a function of # of units w/drawn during period. To obtain a cost per unit of product, the total cost of natural resource less salvage value is divided by # of units estimated to be in the resource deposit, to obtain a cost per unit of product. To compute depletion, this cost per unit is multiplied by the # of units w/drawn. ABC owns 9,000 acres of timberland purchased in 2001, cost of $1,400/acre. At time of purchase, land w/out timber was valued at $400/acre. 2002, ABC built roads, w/a life of 30 years, cost of $87,000. Every year, ABC sprays to prevent disease, cost of $3,000/year & spends $7,000 to maintain roads. During 2003, Hernandez selectively logged & sold 700,000 board feet of timber, of the estimated 3,000,000 board ft. In 2004, ABC planted new seedlings to replace the trees cut at a cost of $100,000. (a) Determine the depreciation expense & cost of timber sold related to depletion for 2003. Depreciation Expense: $87,000 / 30 yrs. = $2,900/year Cost of Timber Sold: $1,400 - $400 = $1,000; $1,000 * 9,000 = $9,000,000 value ($9,000,000 / 3,000,000 ft.) * 700,000 ft. = $2,100,000 (b) ABC has not logged since 2003. If ABC logged & sold 900,000 board ft of timber in 2014, when timber (appraiser) estimated 5,000,000 board ft, determine cost of timber sold related to depletion for 2014. Cost of Timber Sold: $9,000,000 - $2,100,000 = $6,900,000; $6,900,000 + $100,000 = $7,000,000; ($7,000,000 / 5,000,000 ft.) * 900,000 ft. = $1,260,000 In March, 2010, Maley Mines Co. purchased a coal mine for $6,000,000. Removable coal is estimated at 1,500,000 tons. Maley is required to restore the land at an estimated cost of $720,000, and the land should have a value of $630,000. The company incurred $1,500,000 of development costs preparing the mine for production. During 2010, 450,000 tons were removed and 300,000 tons were sold. The total amount of depletion that Maley should record for 2010 is
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Intangible assets have 2 main characteristics. 1. They lack physical existence. Tangible assets ie: PP&E have physical form. Intangible assets derive their value from the rights & privileges granted to company using them. 2. They arent financial instruments. Assets ie: bank deposits, accounts receivable, & longterm investments in bonds & stocks also lack physical substance. Financial instruments derive their value from right (claim) to receive cash/cash equivalents in the future & arent classified as intangibles. Intangible assets provide benefits over a period of years. Companies normally classify them as long-term assets. 1. Marketing-related 2. Customer-related 3. Artistic-related 4. Contract-related 5. Technology-related 6. Goodwill. Marketing-related-trademark or trade name is a word, phrase, or symbol that distinguishes or identifies a particular company or product. (Legal protection for an indefinite # of renewals for periods of 10 years each.) Company that uses one may consider it to have an indefinite life & doesnt amortize its cost. If company buys one, it capitalizes cost at purchase price. If company develops one, it capitalizes costs related to securing it, ie: attorney fees, registration fees, design costs, consulting fees, & successful legal defense costs. It excludes R&D costs. When total cost of one is insignificant, a company expenses it. Customer-related-result from interactions w/outside parties. IE: customer lists, order or production backlogs, & both contractual & noncontractual customer relationships. IE: ABC acquires customer list for $6,000,000 on 1/1/12. ABC expects to benefit from info evenly over a 3-year period. In this case, customer list is a limited-life intangible that ABC should amortize on a straight-line basis. Jan 1,2012 Dec. 31, 2012, 2013, 2014 Customer List 6,000,000 Amortization Expense 2,000,000 Cash 6,000,000 Customer List (or Accumulated C. List Amortization) 2,000,000 (To record purchase of Customer List) (To record amortization Expense) What if ABC determines it can sell list for $60,000 to another company at end of 3 years? In that case, ABC should subtract this residual value from cost to determine amortization expense for each year. Amortization expense would be $1,980,000, [(Cost) $6,000,000 (Residual Value) $60,000 = (Amortization Base) $5,940,000] Amortization expense per period: $1,980,000 ($5,940,000 / 3) Companies should assume a 0 residual value unless the assets useful life is less than the economic life & reliable evidence is available concerning the residual value. Artistic-related- copyright is a federally granted right that all authors, painters, musicians, sculptors, & other artists have in their creations & expressions. It is granted for life of creator plus 70 years. It gives owner or heirs exclusive right to reproduce & sell an artistic or published work. Copyrights are not renewable. Companies capitalize the costs of acquiring & defending a copyright. They amortize any capitalized costs over useful life of the copyright if less than its legal life (life of the creator plus 70 years). Companies must expense the R&D that lead to a copyright as those costs are incurred. Contract-related-represent value of rights that arise from contractual arrangements. IE: franchise & licensing agreements, construction permits, broadcast rights, & service or supply contracts. Franchise is a contractual arrangement under which franchisor grants franchisee right to sell certain product/services, to use certain trademarks or trade names, or to perform certain functions, usually w/in a designated geographical area. Another type of franchise arrangement, a municipality (or other governmental body) allows a privately owned company to use public property in performing its services. IE: Use of public waterways for a ferry service, use of public land for telephone or electric lines, use of phone lines for cable TV, use of city streets for a bus line, or use of airwaves for radio or TV broadcasting. Such operating rights, obtained through agreements w/governmental units or agencies, are frequently referred to as licenses or permits. Franchises & licenses may be for a definite period of time, for an indefinite period of time, or perpetual. Company securing franchise/license carries an intangible asset account (entitled Franchise or License) on its books, only when it can identify costs w/the acquisition of the operating right. (IE: legal fees, advance lump-sum payment) Company should amortize cost of a franchise (or license) w/a limited life as operating expense over life of franchise. It shouldnt amortize a franchise w/an indefinite life nor a perpetual franchise; Company should instead carry such franchises at cost. Annual payments made under a franchise agreement should be entered as operating expenses in the period in which they are incurred. These payments do not represent an asset since they do not relate to future rights to use the property. Technology-related-patent gives holder exclusive right to use, manufacture, & sell a product or process for a period of 20 years w/out interference or infringement by others. If a company purchases a patent from inventor, purchase price represents its cost. Company can capitalize other costs incurred in connection w/securing a patent, ie: attorneys fees & other unrecovered costs of successful legal suit to protect it, as part of patent cost. It must expense as incurred any R&D costs related to development of product, process, or idea that it subsequently patents. Companies should amortize cost of a patent over its legal life or useful life (period in which benefits are received), whichever is shorter. If they own a patent from the date it is granted, & expects patent to be useful during its entire legal life, company should amortize it over 20 years. If it appears that patent will be useful for shorter period of time, ie: 5 years, it should amortize its cost over 5 years. Companies capitalize costs of defending copyrights. Accounting treatment for a patent defense is similar. A company charges all unrecovered legal fees & other costs incurred in successfully defending a patent suit to Patents, an asset account. Such costs should be amortized along with acquisition cost over the remaining useful life of the patent. Companies often make small modifications or additions that lead to a new patent. The effect may be to extend life of patent. If new patent provides essentially same benefits, Company can apply unamortized costs of old patent to new patent. If patent becomes impaired because demand drops for product, asset should be written down or written off immediately to expense. Jan 1,2012 Dec. 31, 2012, 2013, 2014 Patents 180,000 Amortization Expense 9,000 Cash 180,000 Patents (or Accumulated Patent Amortization) 9,000 (To record Legal Fees Related to Patent) (To record amortization of Patent) Goodwill-measured as excess of cost of purchase over fair value of identifiable net assets (assets less liabilities) purchased. IE: If ABC paid $2,000,000 to purchase XYZs identifiable net assets (w/a fair value of $1,500,000), Portofino records goodwill of $500,000. Goodwill is measured as a residual. That is why goodwill is sometimes referred to as a plug, gap filler, or a master valuation account. Conceptually, goodwill represents future economic benefits arising from other assets acquired in a business combination that arent individually identified & separately recognized. Often called most intangible of intangible assets, because only identified w/business as a whole. Only way to sell goodwill is to sell business. Internally Created Goodwill. Goodwill generated internally should not be capitalized in the accounts. Measuring components of goodwill is too complex, & associating any costs w/ future benefits is too difficult. Purchased Goodwill. Goodwill is recorded only when an entire business is purchased. To record it, a company compares fair value of net tangible & identifiable intangible assets w/purchase price of acquired business. Difference is goodwill. Goodwill is residualexcess of cost over fair value of the identifiable net assets acquired. IE: ABC Fair Value: (Cash) $25,000 + (AR) $35,000 + (Inventory) $122,000+ (PP&E) $205,000+ (Patents) $18,000 (Liabilities) $55,000 = $350,000 (Fair Value of Net Assets) If purchase price is $400,000 Goodwill = $50,000 (Balance Sheet). Procedure for valuation is called master valuation approach. Goodwill write-off. Companies that recognize goodwill in a business combination consider it to have an indefinite life & should not amortize it. Although goodwill may decrease in value over time, predicting actual life of goodwill & an appropriate pattern of amortization is difficult. Companies adjust its carrying value only when goodwill is impaired. Bargain Purchase-Purchaser in a business combination pays less than fair value of identifiable net assets. Purchaser records this excess amount as a gain. (Company must disclose nature of gain.) Rules that apply to impairments of PP&E also apply to limited-life intangibles. Type of Intangible Asset Impairment Test Limited life Recoverability Test, Then Fair Value Test (R. Test-If sum of expected future net cash flows (undiscounted) is less than carrying LOI $40,000 amount of asset, company measures & recognizes an impairment loss.)(Carrying Amount Fair Value = I L) IE: Carrying Patents $40,000 Amount $60,000 Fair Value $20,000,= $40,000 Loss on Impairment. Indefinite life other than Fair Value Test - If fair value is less than carrying amount, company recognizes impairment. IE: Carrying Amount $2,000,000 goodwill Fair Value $1,500,000 = $500,000 Loss on Impairment. Company now reports it at $1,500,000 (Fair Value Amount) Even if value increases in remaining years, they cant restore previously recognized impairment loss. Goodwill Fair Value Test on reporting unit, then Fair Value Test on implied Goodwill (1st company compares fair value of reporting unit to its carrying amount, including goodwill. If fair value of reporting unit exceeds carrying amount, Goodwill Not Impaired.)IE: Identifiable assets ($150,000) Goodwill ($90,000) Total Net Assets = $240,000. Fair Value = $190,000 < $240,000 Carrying Amount. There is impairment Fair Value $190,000 Net identifiable Assets excluding Goodwill $150,000 = $40,000 Implied value of Goodwill. $90,000 - $40,000 = $50,000 LOI

Asset Turnover = Net Sales / Average Total Assets; Profit Margin on Sales = Net Income / Net Sales Rate of Return on Assets = Profit Margin on Sales x Asset Turnover OR Rate of Return on Assets = Net Income / Average Total Assets

Chapter 13 Current Liabilities & Contingencies

Employee-Related Liabilities-1. Payroll deductions. 2. Compensated absences. 3. Bonuses. Long-term debt-Probable future sacrifices of economic benefits arising from present obligations that are not payable w/in a year or operating cycle of company, Payroll Deductions-Common types: taxes, insurance premiums, employee savings, & union dues. To extent that a company has not remitted amounts whichever is longer. IE: Bonds, long-term notes & mortgages payable, pension & lease liabilities. Bond arises from a contract known as bond indenture. Bond deducted to proper authority at end of accounting period, it should recognize them as current liabilities. Social Security Taxes. Federal Old Age, Survivor, & represents promise to pay: (1) sum of money at a designated maturity date, plus (2) periodic interest at specified rate on maturity amount (face value). Main Disability Insurance (OASDI). Come from taxes levied on employer & employee. Employers collect employees share by deducting it from employees gross purpose of bonds is to borrow for long term when amount of capital needed is too large for one lender to supply. Investment community (buyers) values a bond pay, & remit it to govt. along w/their share. Govt. taxes employer & employee at same rate, currently 6.2 % based on employees gross pay up to $106,800 at present value of its expected future cash flows, which consist of (1) interest & (2) principal. Rate used to compute PV of these cash flows is the interest rate annual limit. OASDI tax usually referred to as FICA (Federal Insurance Contribution Act). Combination of OASDI tax (FICA) & Federal Hospital Insurance that provides an acceptable return on an investment commensurate w/ issuers risk characteristics. Interest rate written in terms of the bond indenture) known Tax = Social Security tax. Combined rate for these taxes, 7.65% on employees wages to $106,800 & 1.45% in excess of $106,800, changes by Congress. as stated, coupon, or nominal rate. Issuer of bonds sets this rate. Stated rate is expressed as a percentage of face value of bonds (aka par value, principal Companies should report amount of unremitted employee & employer Social Security tax on gross wages paid as a current liability. Unemployment Taxes amount, or maturity value). If rate employed by investment community (buyers) differs from stated rate, PV of bonds computed by buyers (& current purchase All employers who meet following criteria are subject to Federal Unemployment Tax Act (FUTA): (1) those who paid wages of $1,500 or more during any price) will differ from face value of bonds. Difference between face value & PV of bonds determines actual price that buyers pay for bonds. Difference is either calendar quarter in year or preceding year, or (2) those who employed at least 1 individual on at least 1 day in each of 20 weeks during current or preceding a discount or premium. Discount-If bonds sell for less than face value. Premium-If bonds sell for more than face value. Rate of interest actually earned by calendar year. Only employers pay unemployment tax. Rate is 6.2% on 1st $7,000 of compensation paid to each employee during calendar year. Employer bondholders is called effective yield or market rate. If bonds sell at discount, effective yield exceeds stated rate. Conversely, if bonds sell at a premium, receives a tax credit not to exceed 5.4% for contributions paid to a state plan for unemployment compensation. Thus, if employer is subject to a state effective yield is lower than stated rate. There is an inverse relationship between market interest rate & price of bond. IE: ABC issues $100,000 in bonds, due unemployment tax of 5.4% or more, it pays only 0.8% tax to federal govt. IE: ABC taxable payroll of $100,000, subject to Federal rate of 6.2% & state rate of in 5 years w/9% interest payable annually at year-end. At time of issue, the market rate for such bonds is 11%. PV of Principal: $100,000 x 0.59345 (Tbl. 2) 5.7%, however its stable employment experience reduces company state rate to 1%. State unemployment tax payment (1% * $100,000)=$1,000; Federal = $59,345; PV of Interest Payments: $9,000 x 3.69590 (Tbl. 4) = $33,263.10; PV (Selling Price) of Bonds: $59,345 + $33,263.10 = $92,608.10. By paying Unemployment tax [(6.2%-5.4%) * $100,000]=$800; $1,000-$800=$1,800 (Total federal & state unemployment tax). Companies pay federal & state $92,608.10 at date of issue, investors realize an effective rate or yield of 11% over the 5-year term of bonds. These bonds sell at a discount of $7,391.90 unemployment tax quarterly, and file a tax form annually. Because both taxes accrue on earned compensation, companies should record amount of ($100,000 - $92,608.10). Price at which bonds sell is typically stated as a percentage of face or par value of bonds. IE: ServiceMaster bonds sold for 92.6 accrued but unpaid employer contributions as an operating expense & as current liability when preparing financial statements at year-end. Income Tax (92.6% of par). If they had received $102,000, then bonds sold for 102 (102% of par). When bonds sell at less than face value, it means that investors demand Withholding. Federal & some state income tax laws require employers to w/hold from employees pay applicable income tax due on those wages. Employees a rate of interest higher than stated rate. Investors receive interest at stated rate computed on face value, but they actually earn at an effective rate that Pay: Income tax w/holding, FICA taxes-employee share, & union dues. Employers Pay: FICA taxes-employer share, Federal & state unemployment. exceeds stated rate because they paid less than face value for bonds. Bonds Issued at Par on Interest Date-When a company issues bonds on an interest Payroll IE: Assume weekly payroll of $10,000 entirely subject to FICA & Medicare (7.65%), federal (0.8%) & state (4%) unemployment taxes, w/income tax payment date at par (face value), it accrues no interest. No premium or discount exists. The company simply records the cash proceeds & face value of bonds. w/holding of $1,320 & union dues of $88 deducted. The company records the salaries & wages paid & employee payroll deductions as follows. IE: If ABC issues at par 10-year term bonds w/a par value of $800,000, dated 1/1/2012, & bearing interest at an annual rate of 10% payable semiannually on 1/1 Employer must remit to govt. its share of FICA tax along w/amount of & 7/1, it records the following entry. Cash (Debit) 800,000 Bonds Payable (Credit) 800,000. ABC records the 1 st semiannual interest payment of $40,000 Salaries and Wages Expense 10,000 Record Employer Payroll Taxes: FICA tax deducted from each employees gross compensation. It ($800,000 x 0.10 x (1/2)) on 7/1/12: Interest Expense (Debit) 40,000 Cash (Credit) 40,000. It records accrued interest expense at 12/31/12 (year-end): Interest Withholding Taxes Payable 1,320 Payroll Tax Expense 1,245 expense (Debit) 40,000 Interest Payable (Credit) 40,000. Bonds Issued at Discount or Premium on Interest Date-Discount: If ABC issues the $800,000 of FICA Taxes Payable 765 FICA Taxes Payable 765 should record all unremitted employer FICA taxes as payroll tax bonds on 1/1/12 at 97 (meaning 97% of par), it records the issuance: Cash ($800,000 x 0.97) (Debit) 776,000 Discount on Bonds Payable (Debit) 24,000 Bonds Union Dues Payable 88 FUTA Taxes Payable 80 expense & payroll tax payable. Payable (Credit) 800,000. Because of its relation to interest, companies amortize discount & charge it to interest expense over period of time that bonds are Cash 7,827 SUTA Taxes Payable 400 outstanding. Straight-line method amortizes a constant amount each interest period (in this case 20 interest periods ). IE: Using bond discount of Gain contingencies-Claims/rights to receive assets (or have a liability reduced) whose existence is uncertain but which may become valid eventually. IE: 1. $24,000, ABC amortizes $1,200 to interest expense each period for 20 periods ($24,000 / 20). ABC records 1st semiannual interest payment of $40,000 Possible receipts of monies (gifts, donations, asset sales, etc.) 2. Possible refunds from govt. in tax disputes. 3. Pending court cases w/a probable favorable ($800,000 x 10% x 12) & bond discount on 7/1/12 as follows: Interest expense (Debit) 41,200 Discount on Bonds Payable (Credit) 1,200 Cash (Credit) 40,000. outcome. 4. Tax loss carryforwards. Except for tax loss carryforwards, dont record gain contingencies. Company discloses gain contingencies in notes only At 12/31/12 ABC makes adjusting entry: Interest expense (Debit) 41,200 Discount on Bonds Payable (Credit) 1,200 Interest Payable (Credit) 40,000. At end of when a high probability exists for realizing them. 1st year, 2012, balance in Discount on Bonds Payable account is $21,600 ($24,000 - $1,200 - $1,200). Over the term of the bonds, balance in Discount on Bonds Loss contingencies involve possible losses. Contingent liability-A liability incurred as a result of a loss contingency. They depend on occurrence of 1 or more Payable will decrease by same amount until it has 0 balance at maturity date of bonds. If bonds issued on 10/1/12 & fiscal year ends 12/31/12, then discount future events to confirm either the amount payable, payee, date payable, or its existence; these factors depend on a contingency. Likelihood of Loss-When a loss amortized during 2012 is $600 ($24,000 x (3/12) x (1/10)) Premium: If ABC dates & sells 10-year bonds w/par value of $800,000 on 1/1/12, at 103, it records: contingency exists, likelihood that the future event(s) will confirm the incurrence of a liability can range from probable to remote. Probable. Future event(s) are Cash (Debit) ($800,000 x 1.03) 824,000 Premium on Bonds Payable (Credit) 24,000 Bonds Payable (Credit) 800,000. W/ bond premium of $24,000, ABC likely to occur. Reasonably possible. Chance of the future event(s) occurring is more than remote but less than likely. Remote. Chance of the future event(s) amortizes $1,200 to interest expense each period for 20 periods ($24,000 / 20). ABC records 1st semiannual interest payment of $40,000 ($800,000 x 10% x 12) occurring is slight. Companies should accrue an estimated loss from a loss contingency by a charge to expense & a liability recorded only if both of & bond premium on 7/1/12, as: Interest Expense (Debit) 38,800 Premium on Bonds Payable (Debit) 1,200 Cash (Credit) 40,000. At 12/31/12 ABC makes following conditions are met. 1. Info available prior to issuance of financial statements indicates that it is probable that a liability has been incurred at the date adjusting entry: Interest Expense (Debit) 38,800 Premium on Bonds Payable (Debit) 1,200 Interest Payable (Credit) 40,000. Amortization of a discount of financial statements. 2. The amount of the loss can be reasonably estimated. To record a liability, a company doesnt need to know exact payee nor exact increases interest expense. Amortization of a premium decreases interest expense. Issuer may call some bonds at a stated price after a certain date, giving the nd date payable. They must know whether it is probable that it incurred a liability. To meet 2 criterion, a company needs to be able to reasonably determine issuing corporation opportunity to reduce its bonded indebtedness or take advantage of lower interest rates . Whether callable or not, a company must amortize an amount for liability. To determine a reasonable estimate of liability, a company may use its own experience, experience of other companies in the industry, any premium or discount over bonds life to maturity because early redemption (cal l of bond) is not a certainty. engineering or research studies, legal advice, or educated guesses by qualified personnel. USUSALLY ACCRUED-Loss Related to: 1. Collectibility of Debt to total assets = Total Debt / Total Assets; Measures percentage of total assets provided by creditors. Times interest earned = Income before receivables 2. Obligations related to product warranties & defects 3. Premiums offered to customers. NOT ACCRUED-Loss Related to: 4. Risk of loss or damage of enterprise property by fire, explosion, or other hazards 5. General or unspecified business risks 6. Risk of loss from catastrophes assumed by property income taxes & interest expense / Interest Expense; Companys ability to meet interest payments as they come due. If bonds are issued between interest dates, the entry on the books of the issuing corporation could include a credit to Interest Expense. Replacement of existing & casualty insurance companies, including reinsurance companies MAY BE ACCRUED* Loss Related to: 7. Threat of expropriation of assets 8. Pending or bond issue w/new one is called refunding. (True) On 1/1/10, ABC sold property to XYZ. There was no established exchange price for property, & ABC gave threatened litigation 9. Actual or possible claims and assessments** 10. Guarantees of indebtedness of others 11. Obligations of commercial banks under XYZ a $2,000,000 0-interest-bearing note payable in 5 equal annual installments of $400,000, w/1st payment due 12/31/10. The prevailing rate of interest for a standby letters of credit 12. Agreements to repurchase receivables (or the related property) that have been sold. *Should be accrued when both criteria probable & reasonably estimableare met. **Estimated amounts of losses incurred prior to balance sheet date but settled subsequently should be accrued note of this type is 9%. Present value of note at 9% was $1,442,000 at 1/1/10. What should be balance of Discount on Notes Payable account on books of ABC as of balance sheet date. More common loss contingencies: 1. Litigation, claims, & assessments. 2. Guarantee & warranty costs. 3. Premiums & coupons. 4. at 1/31/10 after adjusting entries are made, assuming effective-interest method is used? Answer: $2,000,000 $1,442,000 ($1,442,000 .09) = $428,220. ABC issues $20,000,000, 7.8%, 20-year bonds to yield 8% on 1/1/210. Interest is paid on 6/30 & 12/31. Proceeds from the bonds are $19,604,145. What is Environmental liabilities. Companies dont record or report in notes to financial statements general risk contingencies inherent in business operations (ie: possibility of war, strike, uninsurable catastrophes, or business recession). Litigation, Claims, & Assesments-Companies must consider following factors, in interest expense for 2011, using straight-line amortization? Answer Feedback:($20,000,000 .078) + ($395,855 20) = $1,579,793. On 1/1/10, ABC issued 8year bonds w/face value of $1,000,000 & stated interest rate of 6%, payable semiannually on 6/30 & 12/31. The bonds were sold to yield 8%. Answer: PV of 1 determining whether to record a liability w/respect to pending or threatened litigation & actual or possible claims & assessments. 1. Time period in which underlying cause of action occurred. 2. Probability of an unfavorable outcome. 3. Ability to make a reasonable estimate of amount of loss. To report a loss & a for 16 periods at 4% 0.534, ($1,000,000 x 0.534 = $534,000) ABC borrowed money from a bank to build a building. The long-term note signed by ABC is liability in financial statements, cause for litigation must have occurred on or before date of financial statements. It doesnt matter that the company became secured by a mortgage that pledges title to the building as security for loan. ABC is to pay the bank $80,000 each year for 10 years to repay loan. Which of the aware of existence or possibility of lawsuit or claims after the date of financial statements but before issuing them. To evaluate probability of an unfavorable following relationships can you expect to apply to the situation? Amount of interest expense will decrease each period the loan is outstanding, while the outcome, a company considers following: nature of litigation; progress of the case; the opinion of legal counsel; its own & others experience in similar cases; portion of the annual payment applied to the loan principal will increase each period. In the recent year ABC had net income of $140,000, interest expense of $40,000, and tax expense of $20,000. What was ABCs times interest earned ratio for the year? Answer: ($140,000 + $40,000 + $20,000) $40,000 = 5.0. On & any management response to the lawsuit. W/respect to unfiled suits & unasserted claims & assessments, a company must determine (1) degree of 1/2/10, a calendar-year corporation sold 8% bonds w/face value of $600,000. These bonds mature in 5 years, & interest is paid semiannually on 6/30 & 12/31. probability that a suit may be filed or a claim or assessment may be asserted, & (2) probability of an unfavorable outcome. IE: Federal Trade Commission investigates ABC for restraint of trade, & institutes enforcement proceedings. Private claims of triple damages for redress often follow such proceedings. ABC The bonds were sold for $553,600 to yield 10%. Using the effective-interest method of computing interest, how much should be charged to interest expense in must determine probability of claims being asserted & probability of triple damages being awarded. If both are probable, if loss is reasonably estimable, & if the 2010? Answer: $55,544; 1. $600,000 x .04 = $24,000, 2. $553,600 .05 = $27,680, 3. [$553,600 + ($27,680 $24,000)] .05 = 27,864, 4. $27,680 + $27,864 = $55,544 cause for action is dated on or before date of financial statements, then ABC should accrue the liability. Guarantee & Warranty Costs-Warranty (product guarantee) is a promise made by seller to buyer to make good on a deficiency of quantity, quality, or performance in a product. Warranties & guarantees entail E14-5 (Entries for Bond TransactionsEffective-Interest) Assume same info as in E14-4, except that ABC uses effective-interest method of amortization future costs (after costs, post-sale costs). Companies should recognize this liability in accounts if they can reasonably estimate it & estimated amount of liability for bond premium or discount. Assume an effective yield of 9.7705%. E14-4 ABC issued $800,000 of 10%, 20-year bonds on 1/1/13, at 102. Interest is payable semiannually on July 1 & January 1. ABC uses the straight-line method of amortization for bond premium or discount. Prepare the journal entries includes all costs that company will incur after sale & delivery & that are incident to correction of defects or deficiencies required under warranty provisions. to record the following. (Round to the nearest dollar.) Cash Basis-Companies expense warranty costs as incurred. (Seller or manufacturer charges warranty costs to period in which it complies w/warranty. The (a) The issuance of the bonds. (b) The payment of interest and related amortization on July 1, 2013. company doesnt record a liability for future costs arising from warranties, nor does it charge the period of sa le. Company uses cash-basis method when it Cash ($800,000 * 102%) $816,000 Interest Expense ($816,000 * 9.7705% * (1/2)) = $39,863.64 39,864 doesnt accrue a warranty liability in year of sale either because: 1. It isnt probable that liability has been incurred, or 2. It cant reasonably estimate the Bonds Payable 800,000 Premium on Bonds Payable 136 amount of liability. Accrual Basis- If its probable that customers will make warranty claims & a company can reasonably estimate costs involved, company Premium on Bonds Payable 16,000 Cash ($800,000 x 10% x (6/12)) = $40,000 40,000 must use accrual method. Companies charge warranty costs to operating expense in year of sale & should use it whenever warranty is an integral & inseparable part of sale & is viewed as a loss contingency. This approach is expense warranty approach. IE: ABC begins production on new machine in 7/12 & sells 100 (c) The accrual of interest and the related amortization on December 31, 2013. units at $5,000 by, 12/31/12. Machine under warranty for 1 year. ABC estimates, based on past experience, that warranty cost will average $200/unit. Further, Interest Expense ($816,000 ($40,000 - $39,864)) = $815,000 ($815,864 * 9.7705% * (1/2)) = $39,856.99 39,857 as a result of parts replacements & services rendered in compliance w/warranties, it incurs $4,000 in warranty costs in 2012 & $16,000 in 2013. Premium on Bonds Payable 143 Recognition of warranty cost July 2012 December 2012 Recognition of warranty Expense July 2012 December 2012 Interest Payable 40,000 incurred in 2013 (2012 sales): Cash or Accounts Receivable 500,000 Warranty Expense 4,000 Warranty liability 16,000 Explain the accounting for long-term notes payable . Accounting procedures for notes and bonds are similar. Like a bond, a note is valued at the Sales Revenue (100 * $5,000) 500,000 Cash, Inventory, Accrued Payroll (Warranty Costs) 4,000 Cash, Inventory, Accrued Pay present value of its expected future interest and principal cash flows, with any discount or premium being similarly amortized over the life of the note. Warranty Expense 16,000* 16,000 Whenever the face amount of the note does not reasonably represent the present value of the consideration in the exchange, a company must evaluate the entire *(100 * $200 = $20,000 $4,000 = $16,000) Warranty Liability (To accrue estimated warranty costs) 16,000 roll arrangement in order to properly record the exchange and the subsequent interest. If ABC applies cash-basis method, it reports $4,000 as warranty expense in 2012 & $16,000 as warranty expense in 2013. It records all of sale price as revenue in 2012. In many instances, application of the cash-basis method fails to record warranty costs relating to products sold during a given period w/revenues derived from such products. It violates expense recognition principle. PREMIUMS-ABC offers its customers a bowl if they send in 4 boxtops from ABC boxes & $1.00. Company estimates that 60% of boxtops will be redeemed. In 2010, company sold 500,000 boxes & customers redeemed 220,000 boxtops receiving 55,000 bowls. If the bowls cost ABC $2.50 each, how much liability for outstanding premiums should be recorded at the end of 2010? {[(500,000 0.60) 220,000] 4} $1.50 = $30,000. Purchase of Bowl: Inventory of Premiums (Debit) 137,500 Cash (Credit) 137,500 Sales: Cash (Debit) Sales Revenue (Credit) Redemption of boxtops: Cash (Debit) 500,000 / 4 = 125,000 * $1.00 = $125,000

Chapter 14 Long-term Liabilities