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AFM 182 > Chapter 2: Special Accounting Topics > Flashcards

Chapter 2: Special Accounting Topics Flashcards

Explain how certain events affect the accounting for inventory and PP&E, Prepare journal entries relating to specific inventory and PP&E events, Describe the basic differences between income tax and other types of taxes, Explain the function of deferred tax assets and liabilities

1
Q

what are the 3 methods for costing inventory

A
  • Specific identification
  • FIFO
  • Weighted-average cost
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2
Q

can costing inventory method be switched?

A

Costing inventory method can’t be switched from year to year to make their financial statements look better; one method must be used on a consistent basis

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3
Q

when can costing inventory method be switched

A
  • Can switch if it makes the cost information on the financial statements more relevant and reliable (more accurate/informative)
  • If a company is switching methods, the change must be done retroactively (comparative financial statements must look like the changed method has always been applied)
  • Disclosure to the notes of the financial statements is also required to show the effect of the change
  • Increased audit support
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4
Q

what are some issues with reporting inventory at a historical cost

A
  • Cost information could be inaccurate
  • Inventory can be worth less than the cost it was bought for
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5
Q

what are common issues with inventory

A
  • Obsolescence/spoilage
  • Damage & theft
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6
Q

what is Lower of Cost & Net Realizable Value (LCNRV) Rule

A

Requires that inventory owned by the company is measured and presented at either:
- Historical cost
- Net Realizable Value (NRV)
whichever is lower
- If historical cost is lower, nothing is done
- If the NRV is lower, an inventory write-down is required

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7
Q

what is Net Realizable Value (NRV)

A

The selling price of inventory - estimated costs required to make the sale

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8
Q

what is the journal entry to do an inventory write down

A

DR COGS
CR inventory
(treated like an inventory sale (without the revenue piece))

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9
Q

what is the LCNRV rule like for the different standards

A
  • common for both ASPE & IFRS
  • Standards require companies to monitor LCNRV regularly since inventory is required to be presented at LCNRV at every reporting period (month-end, quarter-end, year-end)
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10
Q

what does LCNRV normally show

A
  • the historical cost, so if net realizable value is lower, then inventory needs to be written down to match the NRV
  • If the NRV increases, inventory write-downs are reversed (write-up) to the new NRV as long as it doesn’t exceed the original cost
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11
Q

what is the journal entry for if NRV is lower than the historical cost

A

DR COGS
CR inventory
by the difference

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12
Q

what is the journal entry for if NRV increases (after it was written down)

A

DR Inventory
CR COGS
- should be the difference between the most recent LCNRV amount and the new NRV amount

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13
Q

what are causes of inventory valuations / write downs / errors

A
  • Inventory valuations and write-downs are beyond a company’s control
  • Mostly driven by market forces
  • Inventory errors are caused by the company; from poor control
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14
Q

How can there be inventory errors if transactions are electronic and done by the AIS?

A
  • From the process of validating ending inventory
  • Inventory is counted at least once per year to ensure accuracy (doesn’t matter what type of inventory system is used; periodic or perpetual)
  • If inventory is counted wrong (normally done when there are large amounts of inventory), the ending inventory balance reported would be wrong
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15
Q

what are the different possibilities of inventory errors

A

Ending inventory can only be overstated or understated

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16
Q

how can ending inventory be corrected

A

Ending inventory usually corrects by itself after 2 periods

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17
Q

how is ending inventory corrected if it is overstated in one period

A
  • If ending inventory is overstated in one period = COGS that period would be understated = overstating gross profit
  • In the next period, ending inventory is overstated = overstating COGS = understating gross profit
  • The total gross profit of the two periods would end up the same as if there were no errors in the two periods
  • The ending inventory at the end of period 2 would also be the same as if there were no errors
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18
Q

how is ending inventory corrected if it is understated in one period

A
  • If ending inventory is understated in one period = COGS that period would be overstated = understating gross profit
  • In the next period, ending inventory is understated = understating COGS = overstating gross profit
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19
Q

what happens to a fully depreciated asset when the company continues to use the asset

A

the asset and accumulated depreciation remains on the books but no more amortization expense entries are made

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20
Q

what is the journal entry for when an asset is discarded and has no residual value

A

DR Accumulated Amortization
CR PP&E

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21
Q

what is the journal entry for an asset that has a residual value but is removed for an amount above or below the residual value

A

DR Cash (if there is)
DR Accumulated Amortization
DR/CR Gain/loss on asset disposal
CR PP&E

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22
Q

what are the steps to correct accounting on asset disposal

A
  1. Update accumulated amortization
    2.Calculate carrying value prior to the sale/disposal
  2. Calculate gain/loss by calculating the value to the proceeds of sale/disposal
  3. Record the disposal
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23
Q

what is the first step to correct accounting on asset disposal

A

Update accumulated amortization
- Pay attention to when depreciation was last booked
- Make sure accumulated amortization is up to date at the time of sale/disposal
- Book any amortization entries if needed
- Note how the asset is depreciated (yearly, quarterly, monthly)

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24
Q

what is the second step to correct accounting on asset disposal

A

Calculate carrying value prior to the sale/disposal

Historical cost - accumulated depreciation

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25
Q

what is the third step to correct accounting on asset disposal

A

Calculate gain/loss by calculating the value to the proceeds of sale/disposal

Proceeds from sale - carrying value (NBV)

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26
Q

what is the fourth step to correct accounting on asset disposal

A

Record the disposal
- Book the journal entry

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27
Q

what is the PP&E value on the balance sheet

A
  • the amount that has not yet been expensed to the income statement (net book value)
  • Sometimes carrying value is different from the recoverable amount
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28
Q

what are the indicators of impairment of an asset

A
  • Decline in market value
  • Asset obsolescence (from major advances in technology) or idling
  • Physical damage
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29
Q

what is impairment

A

When carrying value (on the balance sheet) > fair value (asset value in the market)

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30
Q

what is the Recoverable Amount (RA)

A

Whichever of the following has a higher value
Fair value - costs of disposal OR Value In Use

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31
Q

what is value in use

A

Present value of estimated future cash flows the asset would generate - costs of disposal

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32
Q

when do you test for impairment

A
  • Only test for impairment if indicators of impairment exist
  • Impairment varies across industries, but is generally not something done regularly since the circumstances around impairment is the exception and not the rule
33
Q

what is the journal entry to impair/write down an asset

A

DR impairment loss
CR PP&E/Intangible Asset
Impairment amount = carrying value - recoverable amount

34
Q

can impairment be reversed?

A
  • yes
  • if the recoverable amount increases in the future
  • Limited to the amount of the original impairment loss
  • Partial reversals are also possible if the new recoverable amount is higher than the carrying amount but less than the original amortized cost before impairment
35
Q

what is tested for impairment under IFRS and when

A
  • PP&E must be tested for impairment when there are indicators of impairment
  • Goodwill and certain intangible assets are required to be tested for impairment annually
36
Q

what is tested for impairment under ASPE and when

A

Goodwill and certain intangible assets are only tested for impairment when indicators of impairment arise

37
Q

what is depreciation/amortization

A

Accounting method which allocates the depreciable cost of an asset of the asset’s estimated useful life

38
Q

what assets are depreciated

A

Most long-term assets (except for land) are depreciated over its useful life

39
Q

what is the Double-Declining Balance (DDB) Method/Double-Diminishing Balance Method

A

Another method of depreciation

40
Q

what are the steps of double declining balance method

A
  1. Calculate the total acquisition cost of the asset (becomes the beginning balance in year 1)
  2. Calculate straight-line (SL) depreciation rate: 1 / estimated useful life in years
  3. Calculate DDB rate: SL rate (from step 2) x 2
  4. Calculate depreciation: DDB rate x beginning period book value (aka carrying value)
    **Exception: need to calculate depreciation in the last year to make sure ending book value = residual value
41
Q

what are taxes

A
  • Every individual and corporation will be impacted by taxes
  • Taxes are a primary source of revenue for the government
  • They are a key lever in fiscal policy; how the government implements tax policies and allocates spending
42
Q

what is the most common type of tax

A

income tax

43
Q

what is income tax

A
  • An expense charged by governments on income generated by companies and individuals
44
Q

what are taxes like in Canada

A
  • In Canada, corporations and individuals pay federal and provincial taxes
  • The Canadian tax system is a progressive system (the tax rate paid varies based on the income earned; more tax the more income you earn)
  • Corporate rates in Canada are lower than personal rates
45
Q

how does taxes work with corporations & their shareholders that receive dividends

A
  • Corporations pay income tax
  • But corporations give out dividends (their income is given away)
  • Individuals’ dividends received are taxed, but at a lower rate
46
Q

how do you calculate income tax expense

A
  • Income tax expense is a percentage of pre-tax earnings
  • Income tax = total income earned x tax rate
  • To determine the income tax rate, can divide the income tax expense by the pre-tax earnings
47
Q

when do individuals file their taxes

A

Individuals have to file and pay their taxes for the year by the April 30th of the next year

48
Q

how do corporations pay their income taxes

A
  • Corporations usually pay tax instalments throughout the year
  • Companies with higher revenues are required to make tax instalments
  • A corporate tax year won’t match the calendar year if the company chose an off-calendar fiscal year-end
49
Q

what are tax instalments

A

Periodic payment of the estimated total annual income taxes to avoid a large tax bill when taxes are filled for the fiscal year

50
Q

what is the journal entry to record income tax

A

DR income tax expense
CR income tax payable
*like pre-paying the amount of taxes

51
Q

what are Goods & Services Tax (GST)

A
  • Tax imposed at every stage of the supply chain, from production, to distribution, to the sale to a customer
  • ex. producer pays tax to a shipping company, retailer pays tax to buy the goods from the producer, and end consumer pays the tax for buying the goods from the retailer
52
Q

what is GST also known as

A
  • Known as value-added tax (VAT) in many parts of the world
  • Known as harmonized sales tax (HST) in Ontario
53
Q

what is the HST rate

A

13%
HST applies to almost everything you buy

54
Q

in terms of tax, what does purchases generate & why

A
  • tax receivable/HST receivable
  • HST receivable because HST that a corporation pays is refundable by the provincial government unless they collect more HST (from sales) more than they pay (then they would need to pay the government)
55
Q

what is the tax journal entry for purchases

A

DR inventory
DR HST/tax receivable
CR Cash

56
Q

in terms of tax, what does sales generate & why

A
  • tax payable/HST payable
  • HST is collected on sales & will be compared to the HST paid on all of its purchases
  • If HST collected (payable) > HST paid (receivable), the company will have a net payable balance of HST and need to pay the tax to the provincial government
  • If HST collected < HST paid, the provincial government will reimburse the company for the difference
57
Q

what is the tax journal entry for sales

A

DR cash/A/R
CR revenue
CR HST/tax payable
*assuming rev rec was met

58
Q

what does it mean for HST to be remitted & how often should it happen

A
  • means to compare the HST receivable with the HST payable to see if the company needs to pay the government, or the government needs to pay the company
  • HST needs to be “remitted” with regular frequency (monthly, quarterly, or annually depending on business operations and size)
59
Q

what are Deferred Tax Assets (DTA) & Deferred Tax Liabilities (DTL)

A

Balance sheet items that can be either current or non-current & results from differences in the calculation of accounting income and taxable income

60
Q

what is income for accounting purposes like

A
  • Income that is calculated based on the accounting standards
  • Includes all revenues earned and expenses incurred, regardless of when the cash is received or paid (accrual accounting)
61
Q

what is income for tax purposes like

A
  • Income that is calculated based on the tax laws
  • The rules may allow for certain deductions or require certain inclusion that are different from accounting standards
62
Q

what is usually different from the taxable income

A

EBIT can be (and often is) different from the taxable income that is reported to the Canada Revenue Agency (CRA) for tax purposes

63
Q

what is a common cause for the differences in EBIT and taxable income

A
  • depreciation
  • Ex. A company depreciates equipment over 5 years based on assessment of useful life vs. CRA depreciates assets based on the asset class of the equipment
  • CRA uses many different asset classes, so they may consider an equipment to be in an asset class that has higher depreciation in the earlier part of its useful life and lower in the latter part
  • This would mean there is higher depreciation amount for tax purposes in the beginning of the asset’s useful life, meaning income for tax purposes would be lower than accounting income, and the company would pay less tax
  • Throughout the life of the asset, the amount of tax paid for accounting and tax purposes must be the same, so a deferred tax liability would be created for the amount of tax that would eventually need to be paid
64
Q

what happens if income tax < accounting income

A

there’s a deferred tax liability (taxes that will be paid in the future)

65
Q

what happens if income tax > accounting income

A

there would be a deferred tax asset (means less taxes to pay in the future)

66
Q

will the total income taxes and accounting income ever be the same

A

total income taxes and accounting income will be the same in the end

67
Q

what is depreciation called when completing tax returns in Canada

A

Capital Cost Allowance (CCA)

68
Q

what is property tax

A
  • An expense paid on non-movable property owned by an individual or corporation
  • Includes land, and any buildings on the land
69
Q

who collects property tax

A

Usually collected by the municipal government the land and/or building is on

70
Q

where does the property tax in a municipality go to

A
  • Libraries
  • Public schools
  • Fire stations
  • Police services
71
Q

how is property tax calculated in ontario

A

based on 3 variables
1. General municipal tax rate
2. Education tax rate
3. Property value

72
Q

who sets the general municipal tax rate

A

Set independently be each municipality & can vary based on the type of property owned

73
Q

who sets the education tax rate

A

Set by the provincial government

74
Q

who determines property value

A

Determined by the Municipal Property Assessment Corporation (MPAC) and reassessed every 4 years

75
Q

how are property taxes recorded and paid for corporations

A
  • Corporations are assessed property taxes on an annual basis & are recorded as an operating expense on the income statement
  • Typically paid in instalments
  • Amount known at beginning of year, and expensed by month
  • Record a corresponding property tax liability, and reduce the liability as it is paid
76
Q

what would be the journal entry for a property tax expense (not paid yet)

A

DR property tax expense
CR Property tax payable

77
Q

what would be the journal entry for when property tax is paid (after it was expensed)

A

DR property tax payable
CR cash

78
Q

what would the journal entry be if property tax incurs & is paid at the same time

A

DR property tax expense
CR cash

AFM 182 (11 decks)

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