F4: Working Capital and Fixed Assets Flashcards
Working Capital
current assets - current liabilities
- measure of solvency of a company
- ability to pay debt as due
- ST financial risk
- the bigger the ratio, the less risk
Current Assets
reasonably expected to be realized in cash, sold, or consumed during the normal operating cycle of a business or one year, whichever is longer
- cash
- trading securities
- other ST investments
- cash surrender value of life insurance* (if surrendered w/i operating cycle or year)
- receivables
- inventories
- prepaid expenses
Current Liabilities
require use of current asset or creation of other current liabilities
- used for matching principle
- w/i normal operating cycle or one year, whichever longer
- ST payables
- current portion of LT debt
- cash dividends payable, declared
- accrued liabilities
- payroll liabilities
- taxes payable
- advances from customers
- deferred/unearned revenue in general
Short Term Obligations Expected to be Refinanced*
Current Liabilities
under GAAP, ST obligation may be excluded from current liabilities and included in long-term liabilities if company intends to refinance it on LT basis + shows ability by:
- actual refinancing prior to issuance of FSs or
- existence of noncanclable financing agreement from a lender having the financial resources to accomplish refinancing
dr: ST liab, cr: LT liab
GAAP vs IFRS
- under IFRS, ST obligations expected to be refinanced can not be classified as LT
- must wait til actual refinancing agreement
Cash and Cash Equivalents
305
cash + ST highly liquid investments w ORIGINAL maturity 90 days or less
- coin and currency on hand including petty
- checking and savings accts
- money market funds
- *deposits held as compensating balances that are NOT legally restricted
- negotiable paper: bank checks, commercial paper, treasury bills, certificates of deposits <90 days, etc
Not Cash or Cash Equiv
- certificates of deposit w original maturity >90 days
- legally restricted compensating balances* w lending institution
Restricted or Unrestricted
Cash and Cash Equivalents
Restricted: set aside for specific use or purpose
- nature, amt, and timing of restrictions should be disclosed in footnotes
- if restriction associated w current asset or liability, classify as current asset but separate from unrestricted cash
- if associated w noncurrent asset or liab, classify as noncurrent but separate from Investments or Other Assets
Unrestricted: used for all current operations
examples F4-5
Bank Reconciliations
Cash and Cash Equivalents
- Simple Reconciliation- goal: calculate “true balance”
- deposits in transit: add to bank
- outstanding checks: subtract from bank
- service charges: subtract from book
- bank collections: add to book
- errors: either side, fix it
- non-sufficient funds (NSF): subtract from book
- interest income: add to book
reconciled “true” balance should appear on BS as “Cash and Cash Equivalents”
- book balance is adjusted to reflect corrections by bank - Reconciliation of Cash Receipts and Disbursements
- aka four-column reconciliation or proof of cash
- serves as proof of proper recording of cash transactions
- need bank reconciliation info for present and prior month
- goal: reconcile differences b/w mat depositor has recorded as cash receipts and amt bank has recorded as deposits
Accounts Receivable
310
oral promises to pay debts and GR classified as current assets
- classified as either trade or nontrade receivables
add:
- beginning AR
- credit sales
subtract:
- write offs
- conversions to notes
- cash collected
Net Realizable Value of AR*
Accounts Receivable
the balance of the AR acct adjusted for allowances for receivables that may be uncollectible, sales discounts, and sales returns and allowances
- gross amount of AR would be misleading
Valuation of AR w Discounts and Returns
Accounts Receivable
Sales or Cash Discounts (speed): generally based on % of the sales price (e.g. 2/10 n/30) 2 methods of calculation
- Gross Method
- records sale w/o regard to discount
- if payment received in discount period, a ‘sales discount taken’ (contra revenue) account is debited to reflect the discount - Net Method
- records sales and AR net of discount
- adjustment not needed if payment received w/i discount period
- if payment received after, a ‘sales discount not taken’ account (revenue) must be credited
Trade Discounts (quantity): quoted in percentages
- sales revenue and AR are recorded net of trade discounts
- applied sequentially
Sales Returns and Allowances
- expected exchanges do not affect sales, inv., or COGS GR: wait until actual
- goods returned are deductions from AR and sales
- Exception: if past experience show that a material % of receivables are returned, a ‘Sales Returns and Allowances’ (contra sales) should be established
Estimating Uncollectible AR*
Accounts Receivable
2 methods of recognizing uncollectible AR
- Direct Write-Off Method
- not GAAP, used for tax
- wait until actually uncollectible
- dr: bad debt expense, cr: AR
- AR overstated bc uncollectible not accted for - Allowance Method (GAAP)
- based on past experience
- 3 methods - % of Sales Method
- IS approach, emphasizes matching
- dr: bad debt expense, cr: allowance for doubtful accts
- write offs would decrease - % of AR at Year End
- BS approach
- amt of estimated allowance calculated is the ending balance that should be in the allowance for doubtful accts on the BS
- the difference b/w unadjusted balance and desired ending balance is debited to bad debt expense - Aging of Receivables Method
- BS approach, emphasizes asset valuation NRV
- schedule prepared categorizing accts by time outstanding w each category’s dollar amt multiplied by a % representing uncollectibility based on past experience
- sum of product for each aging category is desired ending balance in allowance acct
- bad debt expense is plug like % of AR
Bad Debt Expense
Accounts Receivable
usually includes 2 items:
- provision made during the period and
- adjustment made at year-end to increase/decrease the balance in the allowance for uncollectible accounts, if needed
Write-Off of a Specific Account Receivable
Accounts Receivable
- under allowance method (GAAP) since direct write off is now allowed
- dr: allowance for doubtful accts, cr: AR
- AR down, allowance down, equals no change in NRV
- doesn’t touch IS through bad debt expense
Subsequent Collection of AR Written Off
Accounts Receivable
depends upon method of acct used
Direct Write-Off Method
- tax, not GAAP
- dr: cash, cr: uncollectible accts recovered (revenue acct)
Allowance Method
- reverse write-off (dr: AR, cr: allowance for uncollectible accts)
- then, dr: cash, cr: AR
Allowance for Doubtful Acct Analysis Format
- plug n chug
- F4-15
Pledging (Assignment)
Accounts Receivable
company uses existing AR as collateral for a loan
- company retains title but pledges that it’ll use the proceeds to pay the loan
- requires only note disclosure
- AR not adjusted
- dr: cash, cr: note payable
Factoring of AR*
Accounts Receivable
process which a company can convert it’s receivables into cash by assigning them to a factor either with or without recourse
- customer may or may not be notified
Without Recourse
- true sale
- sale is final and assignee (the factor) assumes risk of any loss on collections
- dr: cash, Due from Factor, Loss on Sale of Receivables, cr: AR
- due from factor is factor’s security, proceeds retained by factor to protect against sales returns, discounts, allowances, and customer disputes
With Recourse
- could be sale or loan
- factor has option to resell any uncollectible receivables back to seller
- sale if: then treat like w/o recourse
a. seller’s obligation for uncollectible accts can be reasonably be estimated (due from)*
b. seller surrenders control
c. seller not required to repurchase the receivables, but may be required to replace the receivables w other similar receivables - if any ^ are not met, transfer treated as a loan (dr: cash, cr: note payable) and footnote
Notes Receivable
written promises to pay a debt, writing is called a promissory note
- classified same as AR
- either current or LT depending on when collection is
- PV future cash flows
Valuation and Presentation
Notes Receivable
for FS purposes, unearned interest and finance charges are deducted from face amount of note (PV future cash flows)
- if note is non-interest bearing or interest rate is below market, value determined by imputing the market rate of interest and using the effective interest method
- interest bearing promissory notes issued in an arms-length transaction are presumed to be issued at market rate of interest
Discounting NR
Notes Receivable
when holder endorses the note (with or w/o recourse) to a third party and receives cash
- amt received by holder determined by applying “discount rate” to maturity value of the note
- diff b/w amt of cash received and maturity value of the note is the “discount”
NR with and w/o Recourse
Notes Receivable
With Recourse
- holder remains contingently liable
- dr: cash, cr: ‘Notes Receivable Discounted’ (contra asset) or ‘Note Receivable’ + contingent liability disclosed in the notes to the FS
Without Recourse
- true sale
- holder assumes no further liability
- dr: cash, dr: loss, dr: possibly factor, cr: note receivable
good example F4-19
Dishonored Discounted NR~
- when disc. NR is dishonored, contingent liability removed by dr: NR Discounted, cr: NR
- NR Dishonored should be recorded to the estimated recoverable amount of the note
- loss is recognized if estimated recoverable amt is less than amt required to settle the note + any penalties
Transfers and Servicing of Financial Assets~
objective: recognize only assets entity has control over (+ related liabilities incurred) and derecognize (remove previously recognized items) assets when control has been surrendered and liabilities extinguished
Financial Components Approach
- basis for GAAP rules for trans. and serv. of FA
- financial assets and liabs may be divided into many components that have diff. acct methods applied to them
Definition of Surrender of Control: 3 conditions must all be met
- transferred assets isolated from transferor
- transferee has right to pledge or exchange assets and
- transferor does not maintain control over assets under a repurchase agreement
Control is Surrendered- No Cont. Involvement
- if 3 conditions are met and no continuing involvement, entire transfer is recorded as a sale
Control is Surrendered- Cont. Involvement
- if 3 conditions met and cont. involvement, the transfer is a sale using the financial components approach
- assets divided into sold and not and gain/loss recorded for sold items
- any retained interests in assets are carried on books of transferor (including servicing assets) and allocated at BV based on relative fair value of all transferred assets at date of transfer
No Control Surrendered
- accounted for as secured borrowing w pledge collateral
- accounting for the collateral (non cash) depends whether debtor has defaulted and whether secured party has ability to sell or re-pledge the collateral
Servicing Assets and Liabilities
- if entity a party of servicing contract, record servicing asset or liab for the contract
- contract (asset or liab) will then be amortized in proportion to est.net servicing income (or loss)
- FV will be determined at regular intervals throughout life of contract and contract assessed for impairment based on that FV
Types of Inventory Held for Resale
Inventories
inventories must be periodically counted, valued, and recorded in the books. GR: 4 types
- Retail Inventory
- finished goods only - Raw Materials Inventory
- held for use in production process - Work in Process Inventory (WIP)
- in production but incomplete - Finished Goods Inventory
- production inventory that’s complete and ready for sale
Goods and Materials Included in Inventory
Inventories
GR: any goods and materials in which company has legal title should be included in inventory
- legal title typically follows possession of goods
Goods in Transit
- read carefully if “we” are buyer or seller
- title passes under conditions agreed upon, but if none then based on delivery
- FOB Shipping Point: buyer pays, buyer’s inventory, freight in added to cost of inventory
- FOB Destination: seller pays, seller’s inventory, freight out is selling expense
Shipment of Non-conforming Goods
- title reverts to seller upon rejection by buyer
- even if buyer possess goods before retuning, goods are seller’s inventory
Sale w Right to Return
- GR: goods in seller’s inventory if amt of goods likely to be returned can not be estimated
- if you can reasonably estimate the returns, record sale w allowance for estimated returns recorded if:
a. sales price subs. fixed at date of sale
b. buyer assumes all risk of loss bc goods in possession
c. buyer paid consideration
d. product subs. complete and
e. amt of future returns can be reasonably estimated*
Consigned Goods
- seller/consignor delivers goods to agent/consignee to hold and sell on consignor’s behalf
- consignor’s inventory bc title and risk of loss retained
- inventory cost includes shipping cost to consignee
- subtract commission expense and advertising for NI
Public Warehouses
- inventory of comp holding warehouse receipt
Sales w Mandatory Buyback
- seller includes goods in inventory even tho title passed to buyer
Installment Sales
- if seller sells on installment but retains legal title as security, goods included in seller’s inventory if % of uncollectible debts can not be estimated
- if can estimate, record as sale and record allowance for uncollectible debts
Valuation of Inventory GR
GR: GAAP requires inventory be stated at cost, if sold at a profit in ordinary course of business
- no loss recognized even tho replacement or reproduction costs are lower
Exceptions: Selling Price < Cost = loss (in another card)
methods to determine cost of inventory: FIFO, LIFO, average cost, and retail inventory method
- IFRS doesn’t permit LIFO
Departure from Cost Basis- Exceptions
Valuation of Inventory
Lower of Cost or Market and Lower of Cost and NRV
- when utility of goods is no longer as great as their cost
- state goods at market value or NRV
- purpose: reducing inventory to lower of cost or market or lower of cost and NRV is to show probably loss sustained (conservatism) in the period in which the loss occurred (matching principle)
Pass Key**
- Acct Standards Update: all inventory not costed using LIFO or retail inventory method should be measured at lower of cost and net realizable value
- if using LIFO or retail, measured at lower of cost or market
- IFRS, all inventory at lower of cost and NRV
Precious Metals and Farm Products
- valued at NRV: net selling price less costs of disposal
- when inventory stated at value above cost, fully disclose in FS
Recognize Loss in Current Period
- under GAAP, write-down of inventory is reflected in COGS unless amt is material, then loss identified separately in IS in unusual/infrequent
Reversal of Inventory Write-Down
- GAAP, reversals of write-downs prohibited
- IFRS, allowed but limited to amt of original write down
Exceptions~
- lower of cost or market and lower of cost and NRV do not apply when:
- subsequent sales price of end product is not affected by market value or
- company has a firm sales price contract
Lower of Cost or Market
Valuation of Inventory
LIFO or Retail Inventory Method
- GAAP only
- may be applied to single item, category, or total inventory, if method most clearly reflect periodic income
- separately applying LCM to each item results in most conservative ending inventory
Market Value
- middle value of item’s replacement cost, market ceiling, and market floor
- replacement cost: cost to purchase as of valuation date
- market ceiling: NRV = net selling price less costs to complete and dispose
- market floor: market ceiling - normal profit margin
JE for write-downs
dr: inventory loss due to decline in market value, cr: Inventory
Lower of Cost and Net Realizable Value
Valuation of Inventory
not LIFO or Retail Inventory
- GAAP and IFRS
- may be applied to single item, category, or total inventory
NRV
- net selling price less costs to complete and dispose of the inventory
- same as market ceiling