Interpeting Reliability and Comparability of Financial Statements Module 4

Question 1

Where Are Changes in Accounting Methods Found?

Answer 1

In the Footnotes of Audited Financial Statements and Opinion Letter

Question 2

How Is an Accounting Change Reported

Answer 2

1. A Change In Accounting Principal Requires that the Cummulative effect of all prior periods be reported on the current balance sheet.
2. Accounting estimates changes do not require cumulative adjustments
3. Reporting Perod changes require restating of prior periods
4. Error correction requires restating prior periods that were affected.

Question 3

Methods of Revenue Recognition

Answer 3

1. Accrual
2. Before a sale - companies in the gold and silver mining industry recognize a sale before delivery or at the end of production
3. During the Perfomance of Service

Question 4

Straight LIne Depreciation

Answer 4

Purchase Price + Installation Price - Slavage Value= Depreciable Value

Question 5

Double Declining Balance

Answer 5

Begin with the straight- line meth percetage of annual depreciation (20% fir a five-year useful life)
Double this annual percentage by to 40% and apply to underapreciated balance each subsequent year.

Question 6

Sum-of-the-Year’s Digits Method

Answer 6

The sum-of-the-years-digits method uses the number of years in the asset’s useful life to develop a set of decreasing fractions. The denominator is the sum of the years of useful life. The numerator is the specific year of useful life taken in inverse order. This method must deduct salvage value from asset cost, as unlike the double-declining balance method, the math leaves no portion of the asset undepreciated.

Question 7

um Of the Year’s Digits Example

Answer 7

Denominator
1 + 2 + 3 + 4 + 5 = 15
First-year depreciation expense
5/15 of $15,000 asset cost or $5,000
Second-year depreciation expense
4/15 of $15,000 or $4,000
Third-year depreciation expense
3/15 of $15,000 or $3,000
Fourth-year depreciation expense
2/15 of $15,000 or $2,000
Fifth-year depreciation expense
1/15 of $15,000 or $1,000

Question 8

Impact of Depreciation Methods

Answer 8

In early years for companies using accelarated methods will show higher depreciation expense and lower net fixed assets. In later years that relationship reverses This also lowers taxable income.

Question 9

Do Changes In Depreciation Methods Require Restatement of Financial Statements?

Answer 9

No, however companies must disclose current-perilod effects of the change and estimate effect on future periods.

Question 10

What is the effect if Depreciation Expense is higher on the tax return than on Financial Statements

Answer 10

The company will have a deferred tax liability

Question 11

Inventory Valuation

Answer 11

GAAP requires Inventory to be Shown on the balance at it historical cost or the current market value, whichever is lower.

Question 12

What must a company do if Inventory Value has dropped.

Answer 12

Reduce the Inventory Value and recognize the value loss on the income statememnt

Question 13

What Is Inventory Valuation

Answer 13

It is the process of assigning value to each cost layer of product sold.

Question 14

Name Methods of Inventory Valuation

Answer 14

Specific Identification
Average Cost
First-In First Out (FIFO)
Last In, First Out (Lifo)

Question 15

Specific Identification

Answer 15

Assigns a specific cost to each inventory item and can asign a specific cost to each sale.
Automobiles are a good example

Question 16

Average Costs

Answer 16

Company determines the average cost of units avaiable for sale which includes units carried over from last period inventory and units acquired during the current period.

Question 17

FIFO

Answer 17

First Items Purchased first Items Sold

Question 18

LIFO

Answer 18

Periods Sales were from the company’s most recently purchase inventory.

Question 19

What Happens if a Company Used FIFO during a period of Rising inventory costs

Answer 19

The company will report higher earning and higher taxes. than if using LIFO. Balance sheet will likely reflect current market valueations.

Question 20

If a company uses LIFO

Answer 20

Inventory account may understate the current value of inventory on hand/

Question 21

Does the Choice of Inventory Method contributed to defferred taxes

Answer 21

Inventory menthods used in the financial statments must be the same those in tax preparation

Question 22

What is the most conservatvie method of inventory valutation during a period of rising inventory costs?

Answer 22

LIFO is the most conservative approach when reporting earnings. It also tends to understate the value of inventory on the balance sheet.

Question 23

What must a company due it it wants to change inventory valuation method

Answer 23

It must demonstrate that the new method is preferrable
The company must disclose the change and its impact on the financial statements
The company must apply the new mehtod to all previously issued financial statments.

Question 24

What must a company do if it uses LIFO

Answer 24

It must maintain reocords showing what inventory and COGS would have been under the FIFO menthod. The result is called the LIFO reserve

Question 25

THe LIFO Reserve Does what

Answer 25

Accomulated over time when prices are rising
Has a lowerve inventory balance than if FIFO had been used
Measures the cummulative amount by which the LIFO method understates invormtory compared to FIFO
Grows each year prices rise.

Question 26

What does a company that has a LIFO reservie have

Answer 26

Lower inventory Prices
Higher cumlative COGS
Lower cummulative pretax profit

Question 27

LIFO memory method

Answer 27

LIFO begins with the letter L which stands for less profit and less inventory than if FIFO were used

Question 28

LIFO reserve INCREASE a year means:

Answer 28

A company’s COGS for that is more thtn it would have been if FIFO had been used

Question 29

LIFO Reserve Decrease

Answer 29

Lower COGS

Higher profits and income taxes

Question 30

LIFO Reserve and Taxes

Answer 30

When prices are rising LIFO minimizes taxes
When prices fall or a company cuts bank its inventoryy a LIFO liquidation can occur, resulting in higher profits and higher taxes.

Question 31

When are Costs Capitalized?

Answer 31

When they provide benenfits beyond the accounting period in which they are incurred
R & D is an exception.

Question 32

Lease vs. Own

Answer 32

A company can by and assets, acquire and asset under a capital lease, or Acquire the asset under and Operating Lease.

Question 33

Buy the Assets

Answer 33

A company can buy and asset and account for its costs over time by depreciating the asset. The asset is shown on the balance sheet

Question 34

Capital Lease Agreement

Answer 34

Must be accounted for as a contract of sale

Question 35

What Considerations cause and accountant to classify a lease as a capital lease

Answer 35

Which party retains the rights of ownership and the risks associated the assets

Question 36

If the Lease Agreement fails any one of theses tests the lease is a capital lease and treat like sale

Answer 36

1. At the end of the lease the lesse automatically received the title
   At the end of the lease the lesee must pay only a nominal amount to purchase the assets
2. The lease term is equal to 75% or more of the estimated useful life of the asset
3. The present value of the contract lease payments equal or exceeds 90% of FMV of the asset.

Question 37

To Account for an Asset Acquired under a captial lease on the balance sheet.

Answer 37

The company leasing the asset includes the asset on the balance sheet.
Shows a liability that equals the financed value of the asset

Question 38

To reflect a Capital Lease on the Income Statement.

Answer 38

The company depreciates the asset based on the economic life and recognized interest and expense that is implicit int he lease contract.

Question 39

Operating Lease

Answer 39

If the lease transacton does not fail any of the ownership test, then it is an operating lease. The company recognizes the lease payment as rental expense. No effect on balance sheet.

Question 40

Why Would A company Choose and Operating Lease

Answer 40

1. Rental payments may be less than depreciation and interest expense maixmizing profits
2. Operating lease’s payments represent only portion of the value of the assets. The company will not need the assets at the time the lease period ends.
3. Operaing lease lower total leverage.
4. Lower taxable income