Midterm 2 Flashcards
Credit sales
Transfer products and services to a customer today while bearing the risk of collection payment from that customer in the future
- even though we don’t revive cash at the time do credit sale we still record revenue as long as future collection is reasonably certain
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Net revenues
A company’s total revenues less any amounts for discounts, returns, and allowances
Trade discounts
A reduction in the listed price of a product or service
- to provide incentives
Sales return
When a customer returns a product
sales allowance
Providing a reduction or a partial refund
- recorded as a contra revenue
Contra revenue
an account with a balance that is opposite to that of a related revenue account
- it is not an expense
Sales discount
A reduction, not in the selling price of a product or service, but in the amount to be paid by a credit customer if payment is made within a specified period of time
- record as a contra revenue account
Net realizable value
The amount of cash the firm expects to collect
Un collectible accounts (bad debts)
Customers accounts that we no longer consider collectible.
- Reduces assets
- Increases expenses
Allowance method
Allowing for the possibility that some accounts will be un collectible at some point in the future. Companies are required to estimate future un collectible accounts and record those estimates in the current year
Percentage of receivables method
Estimating uncollectible accounts based on the percentage of accounts receivable expected not to be collected (sometimes known as balance sheet method)
Bad debt expense
Represents the cost of the estimated future bad debts
allowance for uncollectible accounts
Represents the amount of accounts receivable we do not expect to collect
Net accounts receiveable
The difference between total accounts receivable and the allowance for uncollectible accounts
aging method
Consider the age of various accounts receivable and use a higher % for old accounts than for new accounts. The older the account, the less likely it is to be collected
What does a credit balance before adjustment mean
that the estimate of uncollectible accounts at the beginning of the year may have been too high
What does a debit balance before adjustment mean
That the estimate at the beginning of the year was too low
direct write off method
Recording bad debt expense at time we know the account to be uncollectible
- used for tax purposes but is not generally permitted for financial accounting
Notes receivable
more formal credit arrangements evidenced by a written debt instrument
Receivables turnover ratio
Net credit sales / average accounts receivable
average collection period
365 days / receivables turnover ratio
service companies
earn revenue by providing services to their customers
Companies that earn revenue by selling inventory are either
Manufacturing or merchandising
Inventory
Items a company intends for sale or customers
- also includes not yet finished products
- reported as a current asset in the balance sheet
Cost of goods sold
The company reports the cost of the inventory it’s sold in the income statement
- often the largest expense in the income statement
Merchandising companies
Purchase inventories that are primarily in finished form for resale to customers
- wholesalers
- retailers
Manufacturing companies
Manufacture the inventory they sell, rather than buying it in finished form
Overhead
Indirect manufacturing costs
Multi step income statement
An income statement that reports multiple levels of income/profitability
- Gross profit
- Operating income
- Income before income taxes
- Net income
Gross profit
Net sales minus cost of goods sold
Operating expenses
Selling, general, and administrative expenses
Operating income
Gross profit reduced by these operating expenses
Income before income taxes
Combining operating income with nonoperating revenues and expenses
Net income
Subtract income tax expense to find.
All revenues- all expenses
Inventory cost methods
Specific identification method
FIFO method
LIFO method
Weighted average cost method
Specific identification method
Matches identities- each unit of inventory with its actual cost
- practical only for companies selling expensive, unique products
FIFO method
Assume the first units purchased are the first ones sold
- balance sheet approach
LIFO method
Assume the last units purchased are the first ones sold
- income state approach
weighted average cost method
Assume that both cost of goods sold and ending inventory consist of a random mixture of all the goods available for sale.
= cost of goods available for sale/number of units available for sale
Most companies actual physical flow follows
FIFO
During periods of rising costs (the case for most companies) FIFO results in
Higher ending inventory
Lower cost of goods sold
Hide reported profit than does LIFO
What is the primary benefit of choosing LIFO?
Tax savings
LIFO conformity rule
A company that uses LIFO for tax reporting also has to use LIFO of financial reporting
Perpetual inventory system
Involves recording inventory purchases and sales on a perpetual (continual) basis
- most often used in practice
Periodic inventory system
Does not continually record inventory amounts. Instead it calculates the balance of inventory once per period, at the end, based on a physical count of inventory on hand
LIFO adjustment
Adjusting inventory records maintained on a FIFO basis to a LIFO basis for preparing financial statements
Freight charges
Shipping/delivery charges
Freight in
Freight charge on incoming shipments from suppliers
- add to the balance of inventory
- later when inventory is sold, the freight charges become part of cost of goods sold
Freight out
The cost of freight on shipments to customers
Purchase discounts
Same as sales discount, just from the buyers perspective
Replacement cost
The cost to replace the inventory item in its identical form
Lower of cost or market method (LCM)
once determined both the cost and market value of inventory the company reports ending inventory in the balance sheet at the lower of the 2 amounts
Inventory turnover ratio
Number of times the firm sells its average inventory balance during a reported period
= cost of goods sold/average inventory
average days in inventory
365/inventory turnover ratio
gross profit ratio
Gross profit/net sales
Tangible assets
Land, land improvements, buildings, equipment, natural resources
Intangible assets
Patents, trademarks(most valuable) , copyrights, franchises, goodwill
- lack of physical substance
Capitalize
Recording an expenditure as an asset
Depreciation
The allocation of the cost of an asset over its service life
Basket purchase
When companies purchase more than one asset at the same time for one purchase price
Patent
An exclusive right to manufacture a product or to use a process
Copyright
An exclusive right of protection given by the US copyright office to the creator of a published work
Trademark
A word, slogan, or symbol that distinctively identifies a company, product, or service
Franchise
Local outlets that pay for the exclusive right to use the franchisers company’s name and to sell its products within a specified geographical area
Goodwill
Represents the value of a company as a whole, over and above the value of its identifiable net assets
Expenditure after acquisition
Repairs and maintenance Addition Improvement Legal defense of intangible assets Materiality
Addition
Occurs when we add a new major component to an existing asset
Improvement
The cost of replacing a major component of an asset
Material
If it is large enough to influence a decision
Accumulated depreciation
The depreciation that accumulates each year recorded as a contra asset account
Book value
Equals the original cost of the asset minus the current value in accumulated depreciation
Service life
(Useful life) how long the company expects to receive benefits from the asset before disposing of it
Residual value
(Salvage value) the value the company expects to receive from selling the asset at the end of its service life
Is land depreciated
NO
Straight line depreciation method
Takes an equal amount of depreciation each year
- most common
Declining balance depreciation method
An accelerated method, more depreciation expense is taken in the early years than in the later years of an assets life.
- used in calculating depreciation for tax purposes
Activity based depreciation method
Calculates depreciation based on the use of the asset
- commonly used by companies that depend heavily on natural resources
Depreciable cost
The assets cost minus it’s estimated residual value
Accelerated depreciation method
Higher depreciation in the earlier years, lower in the later years
Both declining balance and straight line will result in
The same total depreciation over the assets service life
A simple way to get the depreciation rate for a double declining balance is to divide 2 by the estimated service life
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Amortization
Allocating the cost of intangible assets to expense
- we do not amortize intangible assets with indefinite useful lives (ex: goodwill)
Exchange
Two companies trade assets
Gain
Credit balance (revenue)
Loss
debit balance
Expense
Return on assets
Net income divided by average total assets
Profit margin
Net income divided by net sales
Asset turnover
Net sales/ average total assets
Impairment
Occurs when the future cash flows (future benefits) generated for a long term asset fall below its book value
Big bath
Recording all losses in one year to make a bad year even worse
Characteristics of liabilities
Probable future sacrifices of economic benefits
Arising from present obligations to other entities
Resulting from past transactions or events
Operating cycle
The time it takes to produce revenue
It’s more preferable to report a liability as a
Long term
Interest
Face value x annual interest rate x fraction of the year
Notes payable corresponds to
Interest expense
Notes receivable corresponds to
Interest revenue
Line of credit
An informal agreement that permits a company to borrow up to a prearranged limit without having to follow formal loan procedures and prepare paperwork
Commercial paper
Borrowing from another company rather than from a bank
FICA taxes
Based on the federal insurance contributions act; tax withheld from employees pay checks and matched by employers for social security and Medicare
Unemployment taxes
A tax to cover federal and state unemployment costs paid by the employer on behalf of its employees
Fringe benefits
Additional employee benefits paid for by the employer
Deferred revenue
Is a liability not a revenue account
Sales tax payable
Sales tax collected from customers by the seller, representing current liabilities payable to the government
Current portion of long term debt
Debt that will be paid within the next year
Long term obligations (notes, mortgages, bonds) are reported as
Current liabilities when they become payable
Contingencies
Uncertain situations that can result in a gain or a loss for a company
Contingent liability
An existing uncertain situation that might result in a loss
- lawsuits, product warranties, environmental problems, premium offers
When is a contingent liability recorded
Only if a loss is probable and the amount is reasonably estimable
Contingent gain
An existing uncertain situation that might result in a gain
When do we record contingent gains
Not until the gain is certain
Liquidity
Having sufficient cash (or other assets convertible to cash in a short time) to pay currently maturing debts
Working capital
The difference between current assets and current liabilities
Current ratio
Current assets/current liabilities
Acid test ratio
(Quick ratio) measures the availability of liquid current assets
= cash+current investments+accounts receivable/ current liabilities
Quick assets
Includes only cash, current investments, and accounts receivable
Debt covenant
An agreement between a borrower and a lender requiring certain minimum financial measures be met or the lender can recall the debt
Accounts receive able
The amount of cash owed to a company by its customers
