HBX- Accounting 4

Question 1

Explicit Transactions

Answer 1

Explicit Transactions

Transactions that involve some activity, event, or exchange of resources from one party to another. Explicit transactions are often accompanied by invoices or other paper documentation that initiates the recording of the transaction.

• *Here are some key indicators to look for in identifying explicit transactions:**
  (1) A transfer of resources, usually cash
  (2) Invoices, receipts or other paper documentation
  (3) A specific event or activity that clearly triggers a journal entry
  (4) Clarity regarding when to record and how much to record

Answer 2

Implicit Transactions

Transactions that do not involve a specific triggering activity, event, or exchange of resources from one party to another, and that are not accompanied by an invoice or other paper documentation. Often, implicit transactions represent changes in value related to the passage of time, such as depreciation, interest expense, and the amortization of a prepaid expense. Implicit transactions are often recorded using adjusting journal entries.

Under this method, revenue should be recognized in the period in which it is earned and realizable, not necessarily when the cash is received. Expenses should be recognized in the period in which the related revenue is recognized rather than when the related cash is paid. In order to do this we must make adjusting journal entries, which are implicit transactions.

• *Here are some key indicators to look for in identifying implicit transactions:**
  (1) No transfer of resources
  (2) No invoices or other paper documentation
  (3) No specific event or activity that clearly triggers a journal entry, just the passing of time
  (4) Judgement regarding when to record and how much to record

Question 3

What are the four basic types of adjusting journal entries:

Answer 3

(1) Recognizing expenses related to a prepaid asset
Suppose a company pays cash for one year’s worth of rent. They will now have an asset account, prepaid rent, on their books. As each month passes, that asset is worth less and less, and it will need to be reduced or expensed accordingly.

(2) Recognizing revenues related to deferred revenue (also called unearned revenue)
Suppose a company receives cash from a customer for a year-long, monthly magazine subscription. The company will now have an obligation to provide magazines to their customer. They will record a liability, deferred revenue, on their books. As each month passes, and the magazines are provided, the liability account needs to be reduced and revenue needs to be recognized as earned.

(3) Accruing of unrecorded expenses
Entries related to unrecorded expenses usually occur at the end of the accounting period, during the closing process. The purpose of this type of entry is to account for any expenses that weren’t recorded throughout the year because there was insufficient information. Some examples would be accruing for property tax or interest expense, or accounting for inventory shrinkage.

(4) Accruing of unrecorded revenues
Similar to the accrual for unrecorded expenses, unrecorded revenues are usually accounted for at the end of the accounting period. This type of entry reflects revenues that have been earned but not yet billed. For example, suppose a firm provides consulting services for a client in December. At year end, the firm has yet to send the client a bill for those services. Since the service has been provided, and the client will be billed eventually, revenue must be recorded.

Question 4

Identify which of the following are explicit and which are implicit transactions

• RECOGNIZING DEPRECIATION ON AN OFFICE BUILDING
• TAKING OUT A BANK LOAN
• RECOGNIZING EXPENSE RELATED TO 6 MONTHS OF PREPAID RENT USAGE
• SELLING GOODS TO CUSTOMERS ON CREDIT
• PAYING FOR ONE YEAR OF RENT IN ADVANCE

Answer 4

EXPLICIT

• TAKING OUT A BANK LOAN
• SELLING GOODS TO CUSTOMERS ON CREDIT
• PAYING FOR ONE YEAR OF RENT IN ADVANCE

IMPLICIT

• RECOGNIZING DEPRECIATION ON AN OFFICE BUILDING
• RECOGNIZING EXPENSE RELATED TO 6 MONTHS OF PREPAID RENT USAGE

Question 5

Accruals

Answer 5

Transactions where cash changes hands after revenue or expense is recognized

EXAMPLES RELATED TO REVENUE: (when a company delivers goods or performs a service before receiving payment !)

• Accounts receivable is the most common example of this type of accrual.
• When Cardullo’s sells gift baskets on credit to Harvard’s Society of Fellows, Cardullo’s immediately records a journal entry recognizing the revenue from the sale and recording the amount in accounts receivable, even though cash will not be received until later.

EXAMPLES RELATED TO EXPENSES: (when a company uses resources before paying for them.​)

• interest payable, salaries payable, taxes payable, and utilities payable.
• Interest is accrued in 2014, but not due till 2015… still has to be recorded in 2014!
• When Bikram Yoga Natick has maintenance performed on the studio’s heating system, Bikram Yoga Natick immediately records a journal entry recognizing the expense and recording the amount in accounts payable, even though cash will not be paid until later.

Accruals and deferrals always involve revenues or expenses and are the essence of two important concepts we have already covered—revenue recognition and the matching principle. Many adjusting entries typically relate to either accruals or deferrals.

Accruals may occur and be recorded throughout the year whenever these kinds of transactions arise, but they are only considered adjusting entries when they are implicit transactions recorded at the end of the period, during the closing process. Thus, neither the accounts receivable in the context of Cardullo’s nor the accounts payable in the context of Bikram Yoga Natick examples above are adjusting entries. At the end of the period, a company will want to ensure that all appropriate accrual entries have been made to accurately reflect the activities related to that period.

Question 6

Deferrals

Answer 6

Transactions where cash changes hands before revenue or expense is recorded.

Deferred revenue is recorded as a liability when cash is received, and an adjusting journal entry is made at the end of the period to convert the amount that has been earned into revenue.

EX: When Bikram Yoga Natick pays for a year’s worth of insurance in advance, the company records a journal entry recognizing the prepaid insurance as an asset. At the end of the period, an adjusting journal entry would be made to recognize the expense based on the amount of insurance benefit used up during the period.

Like accruals, deferrals may occur throughout the year whenever these kinds of transactions arise, but they are only considered adjusting entries when they are implicit transactions recorded at the end of the period, during the closing process. At the end of the period, a company will want to ensure that all appropriate deferral entries have been made to accurately reflect the activities related to that period.

Accruals and deferrals always involve revenues or expenses and are the essence of two important concepts we have already covered—revenue recognition and the matching principle. Many adjusting entries typically relate to either accruals or deferrals.

Question 7

Answer 7

Company A didn’t pay $8,000 to bank but recognized $8,000 of interest expense

Question 8

As part of the 2013 year end close, your company evaluates any potential liabilities related to 2013 activities that will be paid in 2014. The company ran an advertising campaign in December for which you agreed to pay $100,000, but you have not yet received the invoice.

What would the journal entry look like to record this obligation?

Answer 8

Question 9

Interest is accrued in 2014, but not due till 2015…

Answer 9

Question 10

On July 1, 2013, Bikram Yoga Natick sells 5 annual memberships for $1,200 each.
What would the entry look like to record the receipt of cash as deferred revenue?

Answer 10

Question 11

What is this an example of:
A magazine company collected annual subscription fees at the beginning of the year before delivering magazines.

Answer 11

Deferred Revenue

Question 12

What is this an example of?
A company recorded wages expense for May on May 31, and will pay the wages on June 15.

Answer 12

Accrued Liability

Question 13

Answer 13

Company D paid $30,000 for warehouse rental but didn’t recognize $30,000 of rent expense.

Question 14

On April 1, 2014, Apex Insurance Company receives payment of $6,000 for an annual property insurance policy from one of their corporate customers. How would Apex record the revenue related to this policy for the month of September, 2014?

Answer 14

Question 15

As part of the 2013 year end close, your company evaluates the total pension obligation and determines that it needs to be increased to properly reflect the obligation at the end of the year. The shortfall is estimated to be $100,000. What would the journal entry look like to record this obligation? (Lesson 4.2.3)

Answer 15

Question 16

Long-Lived Assets

Answer 16

Long-Lived Assets

Assets which are expected to provide value to the business for periods in excess of one year. Can be physical assets, such as buildings, vehicles, or machines, or can be intangible assets, such as patents or goodwill. Long-lived physical assets are sometimes referred to as fixed assets.

Question 17

What is the expense for Expense for long-lived physical assets called?

Answer 17

Depreciation

Question 18

Straight Line Depreciation

Answer 18

A common method of depreciating long-lived assets that spreads the anticipated decline in the value of the asset evenly over the expected useful life of the asset. The yearly depreciation amount is calculated as (Gross Book Value - Salvage Value) / Useful Life

• *The gross book value/original** cost, is the amount for which a business records the asset in its books. When a company purchases an asset, it records this asset at the price paid for the asset, plus any additional costs to prepare the asset for service in the business. These extra costs include delivery, installation, and testing. This accounting treatment is an example of the historical cost principle
• *The salvage value** is the amount the business expects to receive after the asset’s useful life is over. In practice, even after an asset is completely used up, it can still be sold as scrap.
• *The useful life** of an asset is the business’ estimate of how long the asset will provide a benefit. This is a judgment call made by management.

Question 19

The formula for Standard Depreciation

Answer 19

Question 20

Suppose your business purchased an asset that is expected to last for 10 years. At the end of its expected life, however, there will be no salvage value and you will have to pay a substantial amount to safely dispose of the asset. How should you treat these expected disposal costs?

Answer 20

Recognize the expense over the life of the asset

Because the matching principle requires matching revenues and corresponding expenses over the life of the asset

A business should spread out the disposal costs over the life of the asset, because the costs are necessary for the asset to help produce revenues over its useful life. Estimated disposal costs are added to the amount to be depreciated, just as estimated salvage value is subtracted from the amount to be depreciated.

Question 21

Accumulated Depreciation

Answer 21

Accumulated Depreciation

A contra asset account that includes the cumulative total of all depreciation expenses recorded to date for specific assets. The credit balance in this account offsets the debit balance in the asset account which shows the original value of the asset. When the original asset value is netted against the accumulated depreciation for the asset you arrive at the net book value of the asset.

****Accumulated Depreciation is a real account that appears right below the asset that is being depreciated on a trial balance. This account includes all the depreciation for the life of the asset.

Accumulated depreciation increases with a credit and decreases with a debit. The balance in a contra-asset account is always a credit balance. The original cost of the asset less accumulated depreciation is the net book value of the asset.

Question 23

Record $8,000 of depreciation on a journal entry and t account.

Answer 23

Question 24

What is the difference between a depreciation expense and accumulated depreciation?

Answer 24

Depreciation expense is a nominal, income statement expense account, which resets every period and simply shows the expense recognized in that period.

Accumulated depreciation is a real account that holds the cumulative balance of all depreciation expense recognized against the asset.

Question 25

What are the benefits of putting accumulated depreciation into a separate account?

Answer 25

1. It allows you to easily see the original cost of the asset so you can compare it to the current or replacement cost at any point in time.
2. It can also provide the reader of the financial statements with a quick feel for how old the assets of the business are, by looking at the relationship between the gross value or original cost of the assets, and the value of the accumulated depreciation account.

While we are talking about long-lived physical assets and depreciation, keep in mind that land is an exception to this rule. We do not depreciate land because it is not “used up” by the business, and its value is typically not reduced or consumed.

Question 26

Does land depreciate?

Answer 26

We do not depreciate land because it is not “used up” by the business, and its value is typically not reduced or consumed.

HOWEVER The Exception to the Exception
What about a mining company? Isn’t its land “used up” as it extracts resources from the land? Indeed this is an exception to the exception, and a mining company would need to recognize the decrease in value as it extracts resources. It would record this expense using an account called depletion, which acts very much like depreciation.

Question 27

What is a contra account? What are common contra accounts?

Answer 27

An account for which the typical balance is contrary to other accounts in its category. Used to adjust the net value of the account to which it relates. An example is Accumulated Depreciation, which is a contra-asset account used to arrive at the net book value of fixed assets.

• a contra asset account has a credit balance since a normal asset account has a debit balance.
• A contra revenue account has a debit balance since a normal revenue account has a credit balance.

COMMON CONTRA ACCOUNTS

• Accounts Receivable
  Less: Allowance for Doubtful Accounts
  Net Accounts Receivable
• Inventory
  Less: Reserve for Obsolete Inventory
  Net Inventory
• Fixed Assets
  Less: Accumulated Depreciation
  Net Fixed Assets
• Sales Revenue
  Less: Sales Discounts, Returns, and Allowances
  Net Sales
• Common Stock
  Less: Treasury Stock
  Net Shares Outstanding

Question 28

Suppose PepsiCo purchased a piece of plant equipment in December, 2013 and, after installing and testing the equipment, it was put into service on January 1, 2014. The total cost to put the equipment into service was $300,000; it is expected to have a useful life of 5 years and a salvage value of $60,000.

Assuming PepsiCo uses straight-line depreciation, what would the depreciation expense be for the month of July, 2014?

Answer 28

The amount to be depreciated is the total cost to put the asset in service ($300,000) minus the assumed salvage value after 5 years ($60,000). This leaves $240,000 to be depreciated over 5 years (60 months) or $4,000 per month.

Question 29

Suppose PepsiCo purchased a piece of plant equipment in December, 2013 and, after installing and testing the equipment, it was put into service on January 1, 2014. The total cost to put the equipment into service was $300,000; it is expected to have a useful life of 5 years and a salvage value of $60,000.

Assuming PepsiCo uses straight-line depreciation, what would the accumulated depreciation related to this asset be on July 1, 2014?

Answer 29

By July 1, 2014, the equipment would have been in use for 6 months. The amount to be depreciated is the total cost to put the asset in service ($300,000) minus the assumed salvage value after 5 years ($60,000). This leaves $240,000 to be depreciated over 5 years (60 months) or $4,000 per month. Therefore, the accumulated depreciation at that point would be $24,000 ($4,000 per month times 6 months).

Question 30

Suppose PepsiCo purchased a piece of plant equipment in December, 2013 and, after installing and testing the equipment, it was put into service on January 1, 2014. The total cost to put the equipment into service was $300,000; it is expected to have a useful life of 5 years and a salvage value of $60,000.
Suppose PepsiCo records an adjusting entry at the end of each quarter to record depreciation. What would the entry to record depreciation be for the quarter ending March 31, 2014?

Answer 30

Question 31

Double Declining Balance Depreciation

Answer 31

A common accelerated depreciation method of calculating and recording depreciation expense. It recognizes more depreciation expense in the early years and less in the later years compared to straight-line depreciation.

There’s a calculation tool for this- Depreciation calculator. (The module doesn’t get in to the exact calculations)

Question 32

What does double declining balance depreciation look like on a graph?

Answer 32

Question 33

units of measure depreciation

Answer 33

units of measure depreciation is used on assets that have a more fixed output potential. For example, a piece of equipment that is expected to produce 100,000 products over its lifetime, could be depreciated each period based on the proportionate number of products that it produced.

Question 34

When do you think it would make sense for a company to choose an accelerated depreciation method for financial reporting purposes?

Answer 34

PEER ANSWER: Accelerated depreciation may make sense when the actual fair market value of the object declines quickly at first and more slowly later. For instance, cars typically exhibit this property, losing a significant portion of their value the first time they are driven out of the lot, but retaining a reasonable amount of salvage value in the long term. Alternatively, a company could perform accounting shenanigans by using double declining balance depreciation to mask profits, which is one reason why the accounting principle of consistency is so important.

Question 35

Suppose PepsiCo sold one of the delivery trucks on January 1, 2013, for $60,000 that they’d originally purchased for $70,000. How do you report this gain on a journal entry? (4.3.3)

Answer 35

If Pepsi MAKES $$$ off of this!

1. Remove it from the books. CREDIT - P, P, & E
2. Remove the accumulated depreciation ($20,000) - DEBIT Accumulated Depreciation
   *Remember- accumulated depreciation is a (contra-asset) Contra-asset accounts increase with credits and decrease with debits.
3. Record Cash from sale: DEBIT - Cash
   AT THIS POINT THE EQUATION IS NOT EQUAL (Cause they made more $$ than they thought) Because of this….
4. To Include profits: CREDIT Gain on Sale of Equipment (similar to revenue- but not cause it’s not the main sales of the business. Pepsi sells drinks not trucks)

Question 36

Suppose PepsiCo sold one of the delivery trucks on January 1, 2013, for $60,000 that they’d originally purchased for $70,000. How do you report this loss on a journal entry? (4.3.3)

Answer 36

What if Pepsi LOST $$$ off of the sale!

1. Remove it from the books. CREDIT - P, P, & E
2. Remove the accumulated depreciation ($20,000) - DEBIT Accumulated Depreciation
   *Remember- accumulated depreciation is a (contra-asset) Contra-asset accounts increase with credits and decrease with debits.
3. Record Cash from sale: DEBIT - Cash
   AT THIS POINT THE EQUATION IS NOT EQUAL (Cause they lost $$) Because of this….
4. To include loss: DEBIT to Loss on sale of equipment (Similar to an expense)

Question 37

Different Types of Depreciation

Answer 37

1. Straight Line
2. Double Declining Balance Depreciation
3. Units of measure depreciation

Question 38

Impairment

Answer 38

Impairment

A permanent reduction in the value of an asset due to technological or market factors that cause the asset to have less value than it currently has in the accounts of the business. Impairment typically applies to intangible assets such as goodwill or patents.
But it can happen to fixed assets as well. For example, think of what would happen if PepsiCo became aware that the value of the truck had declined to $30,000 because the truck manufacturer has stopped supporting this line of trucks and stopped making spare parts (remember the truck was originally purchased for $70,000). Assume further, that PepsiCo plans to continue using the truck for three more years. In this case, PepsiCo would need to record an impairment charge to reduce the value of the asset.

Question 39

Think of what would happen if PepsiCo became aware that the value of the truck had declined to $30,000 because the truck manufacturer has stopped supporting this line of trucks and stopped making spare parts (remember the truck was originally purchased for $70,000). Assume further, that PepsiCo plans to continue using the truck for three more years. In this case PepsiCo would need to record an impairment charge to reduce the value of the asset. What would this look like? 4.3.3

Answer 39

The journal entry to record the impairment would recognize the actual impairment loss by debiting the Loss on Impairment account for $40,000. The other half of the journal entry would be a credit to Accumulated Depreciation for $40,000 to decrease the carrying value of the asset. Note that the journal entry does not directly reduce the value of the truck recorded on the books, but instead uses the Accumulated Depreciation account to reduce the net book value. The journal entry would look like this:

Question 40

Suppose a piece of plant equipment that PepsiCo put into service on January 1, 2014 at a total cost of $300,000 with an expected useful life of 5 years and a salvage value of $60,000 is sold on January 1, 2019 for $50,000. What would the journal entry look like to record this sale?

Answer 40

Question 41

On July 1, 2015, two years after the original purchase, Diamond Decals sold a building and the related land to another party. The building and land were originally purchased for $1,500,000, and $100,000 of depreciation had been recognized against the building. Diamond Decals received $1,100,000 from the purchaser of the land and building. How would the sale of the land and building be recorded? The value of the land had remained constant at $300,000 and depreciation on the building had been recorded through June 30. (4.3.3)

Answer 41

Question 42

Differentiation between US GAAP & IFRS on impairment

Answer 42

(((US GAAP vs. IFRS
Note that it is possible for an asset’s value to increase after a loss on impairment has been recognized if the factors leading to impairment no longer exist. US GAAP and IFRS differ in how these subsequent value increases are treated. Generally, US GAAP does not allow the value to be written back up once it has been impaired. There is no upward revaluation under US GAAP. In contrast, IFRS standards generally will allow the revaluation of certain assets, up to the asset’s original cost adjusted for depreciation.)))

Question 43

Intangible Asset

Answer 43

Non-physical long-lived assets such as patents, trademarks, copyrights, brands, and goodwill.

When an intangible asset is acquired, it is recorded on the balance sheet as an asset. It will then be converted into an expense over time using amortization (a contra-asset account that acts similarly to accumulated depreciation). The result is that the expense is recognized in the period in which it provided benefit to the business.

While the expense for long-lived physical assets is called depreciation, the expense for long-lived non-physical assets is called amortization.
Also similar to long-lived physical assets, intangible assets may significantly decrease in value. If a company becomes aware that this has happened, the company will need to record an impairment loss to reduce the value of the asset.

intangible assets that are determined to have indefinite useful lives do not follow the ordinary amortization rules. The most common of these that you will encounter is goodwill. Under the most recent standards for both US GAAP and IFRS, goodwill is not amortized, but rather is tested for impairment at least annually. If it is determined that goodwill has been impaired, a company will reflect this on the books by debiting impairment loss and crediting goodwill. Under both US GAAP and IFRS, once an impairment loss has been recognized on goodwill, the loss cannot be reversed.

***Note that some companies choose not to use the accumulated amortization account, and instead will directly credit the asset to reduce the value of the asset. This is in contrast to depreciation, where companies will always use an accumulated depreciation account.

Question 44

Goodwill

Answer 44

Goodwill is the excess of the amount paid to acquire a business over the fair market value of the business’ net assets. It is called Goodwill because this excess is often associated with the assumed value of the otherwise undefined intangible aspects of the business. Although a company may feel that it has value in its brands and name, goodwill is only recorded as the result of an acquisition. Self-generated brand value is not recorded as goodwill.

goodwill is not amortized, but rather is tested for impairment at least annually.

Question 45

Suppose that on January 1, 2014 Apple obtained a patent on a component of one of its products and it expected that this patent would have value for 4 years. The patent was recorded on the books for $2,400,000.

What will the entry look like to record amortization for the month of January, 2014?

Answer 45

Question 46

Suppose that Company A acquired Company Z in 2011 and recorded $500,000 of goodwill related to the acquisition. It is now the end of 2013, and there is evidence that Goodwill has been impaired. This impairment needs to be recognized on the books.

What will the entry look like to record $60,000 of impairment on December 31, 2013?

Answer 46

Question 47

Two ways to adjust journal inventories:

Answer 47

1. Perpetual Inventory System- The expense for Inventory is reported at the time of the sale.
   (Used by Pepsi & Becoming more common) When products are sold- Pespi increases costs of goods sold to debit
2. Periodic Inventory System (Used by other businesses)- the business only periodically records costs of good sold by physically counting the inventory on hand.

Question 48

Company A is a small candy store that sells a variety of candies, such as jelly beans, caramels, and taffies. In the store, most candies are stored in bulk containers, and customers can fill bags with candies and pay by the weight. Company A tracks its candy purchases and performs a monthly inventory count. Company A records an adjusting journal entry for Cost of Goods Sold at the end of the month after the inventory count reveals the ending inventory on hand.

Which type of inventory system does Company A utilize?

Answer 48

Periodic

Question 49

Company B is a small toy retail chain and has invested in a linked inventory and accounting information system. When a toy is purchased and scanned at the cash register, the accounting information system automatically records the journal entry transferring the specific inventory item from inventory to cost of goods sold. Company B also performs a monthly inventory count and then records an adjusting journal entry to account for any shrinkage.

Which type of inventory system does Company B utilize?

Answer 49

The correct answer is Perpetual.

Under a perpetual inventory system, a company continuously tracks the sales of inventory and records Cost of Goods Sold for each sale. Even companies with a perpetual inventory system may perform inventory counts periodically.

Question 50

Suppose Cardullo’s had 30 boxes of Cranberry Bog Frogs in inventory at the beginning of July 2013. Cardullo’s paid $5.00 for each box. During the month, Cardullo’s purchased 20 more boxes, also for $5.00 a piece. At the end of the month, a physical count revealed that 25 boxes remained in inventory. No boxes were lost or stolen during the period.

What would Cost of Goods Sold related to the Cranberry Bog Frogs be for the month of July?

Answer 50

Since there were 30 boxes in inventory at the beginning of the month and 20 more boxes were purchased, there were 50 boxes available for sale. Since there were 25 boxes remaining in inventory at the end of the month, it means that 25 boxes were sold during the month. At a cost of $5 per box, that means the Cost of Goods Sold was $125.

Question 51

Methods of Inventory Valutation

Answer 51

1. FIFO- FIRST IN, FIRST OUT. Used by Pepsi
   Whatever they sell first is recorded as the FIRST IN price (even if they physically sell the later items)
2. LIFO- LAST IN, FIRST OUT- Which recognizes the cost of the newest items first and weight average, which takes the average cost of all items in inventory.
3. Businesses that have expensive inventory, such as a car dealer, will use specific identification and track the cost of each item individually.

*US allows all methods and International system allows all except LIFO

Take note that LIFO and FIFO are accounting conventions for the purpose of inventory valuation, but do not necessarily represent the actual flow of goods.

Question 52

Company A is a new online hat retailer. During the first month they made the following purchases of hats and had the following sales of hats:

• January 1: Purchased 400 hats for $5 each.
• January 15: Purchased 200 hats for $6 each.
• January 31: Sold 250 hats.

What would be the Cost of Goods Sold if they use FIFO?

Answer 52

Under FIFO, the 250 hats sold would be expensed using the earliest inventory costs first. 250 *5 = $1,250.

Question 53

Company A is a new online hat retailer. During the first month they made the following purchases of hats and had the following sales of hats:

• January 1: Purchased 400 hats for $5 each.
• January 15: Purchased 200 hats for $6 each.
• January 31: Sold 250 hats.

What would be the value of the ending Inventory if they use FIFO?

Answer 53

Under FIFO, the 250 hats sold would be expensed using the earliest inventory costs first. So the ending Inventory balance is (150 * 5) + (200 * 6) = $1,950.

Question 54

Company A is a new online hat retailer. During the first month they made the following purchases of hats and had the following sales of hats:

• January 1: Purchased 400 hats for $5 each.
• January 15: Purchased 200 hats for $6 each.
• January 31: Sold 250 hats.

What would be the value of the ending Inventory if they use LIFO?

Answer 54

Under LIFO, the 250 sold would be expensed using the most recent inventory costs first. So the ending Inventory balance is 350 * 5 = $1,750.

Question 55

Product Costs

Answer 55

Product Costs- products that a business needs to buy, manufacture, or deliver a good/service.
They are recorded as assets on the balance sheet and expense at the time of sales. example for a retail industry being:

• Stage 1- Raw Materials
• Stage 2- Work in Progress
• Stage 3- Finished Goods

Other Examples….

• Raw Materials
• Direct Labor
• Overhead
• Packing

Question 56

Period Costs

Answer 56

Period Costs- all the other costs the business incurs, such as office salaries, or office rent. Period costs are expensed in the period that they are incurred.

These costs are only listed on the income statement- not the balance sheet

Question 57

Which costs are product costs and which are period?

• Manufacturing & Utilities
• Direct Materials
• R & D Cost
• Advertisting expense
• Admin Office Supplies
• Equipment Maintenance
• Manufactuing Equipment Depreciation
• Sales Commisions
• Head of Office Utilities

Answer 57

Product costs

• Manufacturing & Utilities
• Direct Materials
• Equipment Maintenance
• Manufacturing Equipment Depreciation

Period Costs

• Advertising expense
• Admin Office Supplies
• Sales Commisions
• Head of Office Utilities
• R & D Cost (Research and Development)

Question 58

Stages of Inventory

Answer 58

1. Raw materials are the components and supplies that a business purchases to be used in production. For PepsiCo, it would be sugar, concentrates, water, and plastic, among others. A home construction business could have wood or cement as raw materials. A business will usually have a supply of these items on hand.
2. Once an item has been taken from raw materials into the production process it is considered work in process inventory or WIP. These are items that are no longer raw materials but haven’t been fully made into completed products. Additional costs that are added to work in process inventory are labor and overhead costs. Labor cost is the wages paid to the factory workers.
   * *Overhead includes additional cost items in the manufacturing process where it isn’t practical to track those costs directly to a specific product. Think of manufacturing equipment depreciation or rent for the factory building. These costs are allocated on some reasonable basis to the items they help produce.*
3. Finished goods inventory. These are items that are completed and ready to be sold to customers. This is similar to inventory on the shelf found in a retail business. The cost of finished goods inventory includes raw materials, labor, and factory overhead costs.

When goods are sold, the total cost of producing the chips is Cost of Goods Sold on the income statement. If they aren’t sold… they remain as inventory on the balance sheet.

Question 59

Graph Example of a T Account for the Stages of Inventory of lays Potato Chips

Answer 59

Question 60

Answer 60

Inventory for a manufacturer includes Raw Materials, Work in Process, and Finished Goods.

The ending balance of Raw Materials + The ending balance of WIP + The ending balance of Finished Goods

= Total Inventory

$700,000 + $900,000 + $860,000 = $2,460,000.

Question 61

Answer 61

Inventory for a manufacturer includes Raw Materials, Work in Process, and Finished Goods.

The ending balance of Raw Materials + The ending balance of WIP + The ending balance of Finished Goods

= Total Inventory

$800,000 + $1,200,000 + $0 = $2,000,000.

Question 62

Company C, an automobile manufacturer, sold 2 trucks to a customer for $60,000 on January 5, 2014. Each of the trucks has a manufacturing cost of $20,000. What would be the entry to record the transfer of inventory to the customer?

Answer 62

Question 63

Deferred Taxes

Answer 63

Deferred Taxes arise from a temporary difference in the timing between recognizing the tax expense for a given period on the financial records compared to actually filing and paying the taxes per the tax records. There are many valid reasons that the two amounts may differ. Some examples include differences in depreciation methods, differences in bad debt estimates and actual write offs, tax-loss carry-forwards, and some pension payments and expenses.

Deferred taxes can be either an asset** or **a liability, and can be either current or non-current, depending on when the temporary timing difference is expected to reverse.

• In cases where the timing difference leads to a: ​
• *higher taxable income** (on income tax return) than the pretax income (income statement) the excess tax paid increases the deferred tax asset account.
• a deferred tax liability account reflects an obligation to pay taxes in the future related to the income already considered as income for financial reporting purposes.

At a given point in time, a balance sheet may show both a deferred tax asset and a deferred tax liability.

Deferred taxes exist because of the matching principle. In this case, the matching principle requires that we match the tax expense for a given period with the revenue and other expenses for that period, as they are shown on the financial statements. If we simply said that the taxes calculated on the tax return were the tax expense for the period, then the tax expense would be based on a different amount than the amount shown as Income Before Taxes on the financial statements and the tax expense would not relate to the reported results for the business. Deferred taxes are recorded so that the financial statements accurately reflect what amount of taxes relates to the current accounting period income, and what amount of taxes relates to income in other periods.

Question 64

What is a common circumstance that creates a difference between taxable income and income before taxes & results in recording a deferred tax amount

Answer 64

depreciation.

Maybe things are depreciated in different ways! One for financial statements- the other for Tax Books

Question 65

Using the double depreciation method for tax depreciation (when you’re using straight-line depreciation for financial reporting) results in…

Answer 65

a Deferred Income Tax Liability- you will owe later!
Anytime you see Deferred income- it means there will be taxes owed in the future

Question 66

Can income taxes affect the balance sheet? If so, where?

Answer 66

Yes- in the form of deferred income taxes. Such as:

1. Current assets OR Long-Term Assets
2. Current Liabilities OR Long-Term Liabilities

Ex: Bikram Yoga Natick, it shows up as a short-term asset and a long-term liability because the owner recognizes revenue and depreciation at different times for financial reporting than she does for tax filing.
Because most companies have 2 books
1- finance books
2- tax books

Question 67

What is the difference between taxable income and income before taxes.

Answer 67

• Income before taxes is the amount listed on the income statement after subtracting all losses and expenses except taxes from revenues and gains.
• Taxable income is the amount listed on a tax return after subtracting all of the deductions from the gross income.

Question 68

How are the Tax Expense & Taxes Payable Calculated?

Answer 68

1. Tax Expense for a given period is calculated by multiplying the Income Before Tax (on the balance sheet) from the financial accounts by the tax rate.
   * *Tax Expense = Income Before Taxes x Tax Rate**
2. Taxes Payable are calculated by multiplying the Taxable Income from the tax return by the tax rate.
   * *Taxes Payable = Taxable Income x Tax Rate**

**Whenever the Income Before Taxes on the Income Statement is different than the Taxable Income on the tax return, if that difference is caused by a temporary timing difference, then the difference between Tax Expense and Taxes Payable will be a Deferred Tax amount. The nature of the timing difference determines whether the Deferred Tax entry will be a liability, as in this example, or an asset, as we will see next.

Deferred Taxes = difference between Tax Expense and Taxes Payable due to a temporary timing difference

Question 69

Tax Expense

Answer 69

Tax Expense is the amount of tax that relates to activity that occurred during the current accounting period. As an expense account, it is closed out like all other expense accounts during the year-end close so the account balance at the start of the next year is zero. Be aware that the year-end closing process can take some weeks, or even months, to complete, but the closing entries are all made as of the last day in the fiscal year. The fiscal year can be different from the tax year and, in some ways this can be easier to handle but it is outside the scope of this course and we will not get into further detail.

Question 70

Taxes Payable

Answer 70

Taxes Payable is the amount of taxes you actually owe based on what the government says you owe. This liability is typically due and payable within a few months from the close of the tax year. Thus, a balance due at the end of one year related to the tax return for that year will normally be paid in the first half of the following year. For example, at December 31, 2013 an adjusting journal entry would be made to record the accrual for taxes payable based on activities in 2013, but the taxes would actually likely be paid by April 15, 2014.

Question 71

Which of the following is the amount of the tax liability that pertains to the current period and is payable in the next 12 months?

• Taxes Payable
• Deferred Tax Liability
• Deferred Tax Asset
• Tax Expense

Answer 71

• Taxes Payable

Taxes Payable is the tax liability due in the current period.

Question 72

Which of the following arises when Taxable Income is less than Income Before Taxes due to a temporary timing difference?

• Taxes Payable
• Deferred Tax Liability
• Deferred Tax Asset
• Tax Expense

Answer 72

Deferred Tax Liability

This is the amount that arises when Taxable Income is less than Income Before Taxes due to a temporary timing difference.

Question 73

It is mid-January and Company A is closing their year ending December 31, 2013 and they need to make their tax entry. The Income Before Taxes (on the income statement- created by the company) for the year is $110,000. Company A has also prepared a preliminary tax return for the year but the Taxable Income (on the income tax return) was only $100,000 due to the fact that the tax deduction for depreciation was greater than the depreciation expense. The tax rate is 30%. There have been no entries related to income taxes made for the year up to this point. Taxes are not required to be paid until April 15, 2014.

What is the entry required as of December 31, 2013 to record taxes?

Answer 73

The company needs to record the income taxes related to 2013. Because there is a temporary timing difference related to depreciation expense, the company will need to record deferred taxes related to the difference, in addition to recording income tax expense and taxes payable.

The correct answer is to:

• debit Income Tax Expense for $33,000 ($110,000 * 30%)
• credit Taxes Payable for $30,000 ($100,000 * 30%)
• credit Deferred Income Tax Liability for $3,000 (the difference between Income Tax Expense and Taxes Payable).

Question 74

In 2013, Company A’s Income Before Taxes for the year is $110,000 but the Taxable Income according to the tax return was only $100,000 due to the fact that the tax deduction for depreciation was greater than the depreciation expense. The tax rate is 30%. An adjusting entry to record taxes was recorded at December 31, 2013.

It is mid-April and Company A pays their taxes for the prior year. What is the entry required to record the payment?

Answer 74

Question 75

How would this be possible?

Answer 75

Bikram Yoga Natick.
You have seen that the yoga studio often receives payments in advance for yoga class memberships that customers can use over the next 12 months. Because Maria files her taxes on a cash basis, these advances from customers are taxable income right away. However, for financial accounting purposes, these advances are deferred and the revenue is recognized proportionately over the course of the next 12 months.

This timing difference could cause taxable income to be higher than income before taxes, and the difference would give rise to the recording of a deferred tax asset.

Question 76

Deferred Tax Asset

Answer 76

Deferred Tax Asset

In cases where a temporary timing difference leads to a higher taxable income in the current period than the financial income reported, then the excess tax paid is recorded and shown in the financial statements as a Deferred Tax Asset. A Deferred Tax Asset reflects a prepayment of taxes that will be due in the future related to activity already reported in the financial statements.

Question 77

It is mid-January and Company B is closing their year ending December 31, 2013 and they need to make their tax entry. The Income Before Taxes (Income Statement) for the year is $100,000. Company B has also prepared a preliminary tax return for the year but the Taxable Income (income tax return) was $110,000 due to a temporary timing difference that caused the revenue on the tax return to be greater than the revenue on the financial reports. The tax rate is 20%. There have been no entries related to income taxes made for the year up to this point. Taxes are not required to be paid until April 15, 2014.

What is the entry required as of December 31, 2013 to record taxes?

Answer 77

The company needs to record the income taxes related to 2013. Because there is a temporary timing difference, the company will need to record deferred taxes related to the difference, in addition to recording the tax expense and taxes payable.

The correct answer is to:

• debit Income Tax Expense for $20,000 ($100,000 * 20%),
• credit Taxes Payable for $22,000 ($110,000 * 20%), and
• debit Deferred Income Tax Asset for $2,000 (the difference between Income Tax Expense and Taxes Payable).

Question 78

In 2013, Company B’s Income Before Taxes for the year is $100,000 but the Taxable Income according to the tax return was $110,000 due to a temporary timing difference. The tax rate is 20%. An adjusting entry to record taxes was recorded at December 31, 2013.

It is mid-April and Company B pays their taxes for the prior year. What is the entry required to record the payment?

Answer 78

Question 79

Bikram Yoga Natick pays taxes on a cash basis so annual membership fees received during the year are included in determining their Taxable Income. However, for financial reporting purposes, they are only treated as revenue as time passes and the memberships are expiring. This creates a temporary timing difference which causes Taxable Income to be greater than Income Before Taxes in years when the Deferred Revenue increases; 2013 was such a year.

What will the entry be in 2013 to record this difference?

Answer 79

Debit the Deferred Tax Asset account
When a temporary timing difference causes Taxable Income to be higher than Income Before Taxes, the required entry is a debit. In this case, the debit is an increase to the Deferred Tax Asset account.

Question 80

Company A purchased a new piece of plant equipment in 2013 and, because it is being depreciated using straight-line for financial reporting but accelerated depreciation for tax purposes, the Taxable Income is less than the Income Before Taxes for 2013.

What will be the entry required due to this temporary timing difference?

Answer 80

Credit the Deferred Tax Liability account

The fact that the tax deduction for depreciation is higher than the Depreciation Expense causes Taxable Income to be less than Income Before Taxes. Since Tax Expense is based on Income Before Taxes, this means that the amount of Tax Payable for 2013 will be less than the Tax Expense for the year.

This is a temporary timing difference which will reverse in future years so it means that there will be taxes payable in some future year when the Depreciation Deduction is less than the Depreciation Expense. This difference in taxes paid versus tax expense for 2013 is recorded as a Deferred Tax Liability.

Question 81

Company B purchased a new piece of plant equipment in 2008. They used the straight-line depreciation method for financial reporting, but used the accelerated depreciation method for tax purposes. Thus, the Taxable Income is different from the Income Before Taxes for 2013. This difference has caused the Depreciation Deduction to be less than the Depreciation Expense.

What will be the entry required due to this difference?

Answer 81

The correct answer is to debit the Deferred Tax Liability account.

The fact that the tax deduction for depreciation is lower than the Depreciation Expense causes Taxable Income to be more than Income Before Taxes. Since Tax Expense is based on Income Before Taxes, this means that the amount of Tax Payable for 2013 will be more than the Tax Expense for the year.

This is a timing difference which was set up as a liability in the year that the asset was purchased, and it is now reversing so it means that the amount deferred as liability in previous years is now being paid down. Thus the liability is being reduced and debits reduce liabilities.

Question 82

Bikram Yoga Natick pays taxes on a cash basis so annual membership fees received during the year are included in determining their Taxable Income. However, for financial reporting purposes, they are only treated as revenue as time passes and the memberships are expiring. This creates a timing difference which causes Taxable Income to be greater than Income Before Taxes in years when the Deferred Revenue increases. In 2012 the Deferred Revenue account went down, meaning that Taxable Income was less than Income Before Taxes.

What was the entry in 2012 to record this difference?

Answer 82

Credit the Deferred Tax Asset account

When a temporary timing difference causes Taxable Income to be lower than Income Before Taxes, the required entry is a credit. In this case, the credit is a decrease to the Deferred Tax Asset account, because in previous years, when the Deferred Revenue was first recorded, a Deferred Tax Asset would have been created.

Question 83

Company C set up a Reserve for Bad Debts in 2013. Although there were no account balances written off, it was considered prudent to acknowledge that some of the Accounts Receivable would not be collectable. The IRS does not allow a deduction until the accounts are written off. As a result, the Taxable Income was greater than the Income Before Taxes.

This is a timing difference and will reverse in future years so it means that Taxable Income will be less than Income Before Taxes in some future years when the accounts written off will be greater than the increase in the Reserve for Bad Debts. What will be the entry required in 2013 to record this difference?

Answer 83

The correct answer is to debit the Deferred Tax Asset account.

The fact that the Provision for Bad Debts could not be deducted for tax purposes means that Taxable Income will be greater than Income Before Taxes.

Since this difference will reverse over time it means that the higher taxes paid this year will be recovered in future years so the amount of the increase in taxes paid is recorded as a Deferred Tax Asset.

Question 84

Suppose your company recorded a Deferred Tax Liability in 2010. It was not expected to be resolved for several years. It is now December 2014 and you note that the Deferred Tax Liability is expected to be resolved in the first six months of 2015.

Under which section of the balance sheet do you classify the Deferred Tax Liability?

Answer 84

Current Liabilities
The Deferred Tax Liability would have been classified as a Non-Current Liability initially, but as soon as it becomes evident that liability is expected to be resolved in a year or less, it should be reclassified as a Current Liability.

Question 85

Answer 85

The business recognizes $500,000 of Tax Expense but pays $550,000.

This is the correct answer! The Tax Expense for the year would be increased by $500,000 by this entry. However, due to timing differences the business had to pay $550,000 and the difference is set up as a Deferred Tax Asset.

Question 86

Answer 86

The business recognizes $500,000 of Tax Expense but will pay more as a temporary timing difference reverses.

This is the correct answer! The Tax Expense for the year would be increased by $500,000 by this entry. However, due to reversal of previously recorded temporary timing differences the business had to pay $525,000 and the difference is a reduction of a Deferred Tax Liability.

Question 87

Answer 87

The business incurs $500,000 for income tax expense for the year 2014.

This is the correct answer! The Tax Expense for the year would be increased by $500,000 by this entry. Since $50,000 would not be payable until a future year, it is set up as a Deferred Tax Liability.

Question 88

Answer 88

The business recognizes $500,000 of Tax Expense but will pay more as a temporary timing difference reverses.

This is the correct answer! Since the Deferred Tax Liability is being debited, it means that it is being reduced and an amount set up in a prior period when a temporary timing difference made Taxable Income less than Income Before Taxes is now reversing as the timing difference now makes Taxable Income higher than Income Before Taxes.

Question 89

What is the nature of the Deferred Taxes account?

Answer 89

Asset or Liability Account

Deferred Taxes can be either an asset or a liability account. In fact, some companies have both
Deferred Tax Asset and Deferred Tax Liability accounts in their Chart of Accounts and in their financial statements.

The nature of a Deferred Tax account depends on whether the difference between methods of recording activity for financial purposes and for tax purposes results in Taxable Income on the tax return being temporarily higher or lower than Income Before Taxes on the income statement.

Differences that cause Taxable Income to be higher than Income Before Taxes generate Deferred Tax Assets while differences that cause Taxable Income to be lower than Income Before Taxes generate Deferred Tax Liabilities. There are various ways that these temporary differences can occur and some of them generate Deferred Tax Assets and others generate Deferred Tax Liabilities so it is possible, and even common, for a company’s balance sheet to have both.

Question 90

Your company receives interest on a tax-free bond. This creates a permanent difference between the Pretax Profit (which includes the Interest Income) and the Taxable Income (which does not include the Interest Income from the tax-free bond).

How would you account for this difference in the year that the interest is received?

Answer 90

No Entry is required

Since this is a permanent difference the correct answer is that there is no Deferred Tax entry required.

The difference (reduction in this case) in Tax Expense is simply reported in the year that it occurs. Only temporary timing differences result in Deferred Taxes.

Question 91

What is the purpose of the closing process?

Answer 91

The closing process is really just an opportunity for a company to evaluate its trial balance and ensure that the proper accruals and other adjusting entries have been made so that the financial statements will accurately reflect the results of all transactions that occurred during the period.

The closing process brings together many of the accounting concepts and principles discussed in Module 1 (revenue recognition and matching concept as well as conservatism, consistency, materiality, historical cost, relevance, reliability, going concern, money measurement, and entity concept). Management looks at all of the accounts and transactions through the lens of the accounting principles and tries to make sure that they are applied.

Question 92

Suppose the end of 2013 is approaching and most of the activity for the year has been entered into the accounts of Hipzone Inc. However, there are a few transactions that still need to be posted.
List the journal entries required

Suppose on December 31, Hipzone Inc. bills one of their customers $450 for a project that they had completed which had accumulated $220 of costs. The invoice has the normal terms requesting payment in 30 days. Make ALL of the entries required by this transaction.
HINT: Think of Accumulated Project Costs as an account similar to Inventory - it is an asset account used to accumulate the costs that have been incurred related to the project being completed for the customer.
THEN Hipzone Inc. needs to record depreciation on a piece of office equipment. The equipment was purchased on 1/1/2010 for $2,000, was expected to last 10 years at the time of purchase, and had an expected salvage value of $200. No depreciation has been recorded on the equipment for 2013. Make ALL of the entries required by this transaction.

Answer 92

For the first transaction, Hipzone should

• debit Accounts Receivable for $450 and
• credit Sales for $450. At the same time, HIPZONE should
• debit Cost of Goods Sold for $220 and
• credit Accumulated Project Costs for $220.

For the second transaction, Hipzone should

• debit Depreciation Expense for $180 and
• credit Accumulated Depreciation for $180.

Question 93

On July 1, 2015, two years after the original purchase, Diamond Decals sold a building and the related land to another party. The building and land were originally purchased for $1,500,000, and $100,000 of depreciation had been recognized against the building. Diamond Decals received $1,100,000 from the purchaser of the land and building. How would the sale of the land and building be recorded? The value of the land had remained constant at $300,000 and depreciation on the building had been recorded through June 30.

Answer 93

This transaction results in

• a reduction of the Land and Building account of the initial, gross value of the land and building (credit of $1,500,000) offset by
• receipt of cash (debit of $1,100,000),
• reduction of accumulated depreciation (debit of $100,000), and
• recognition of the loss on the disposal of the asset (debit of $300,000).

Remember that accumulated depreciation is a contra-asset account associated with the related asset account. Whenever a company disposes of an asset, the value of that asset account, as well as the related contra-asset account, must both be removed from the books. The difference between the asset account and the contra-asset account is known as the net book value. Whenever the net book value is greater than the amount of cash received from the sale of the asset, a loss is recognized. When the net book value is less than the amount of cash received from the sale of the asset, a gain is recognized.