Rules Flashcards
Revenue recognition – multiple deliverables
For sales of bundled products, companies should assign individual values to each of the bundled components
Revenue recognition – long-term projects
For long-term projects, companies can either use the percentage of completion method or the completed contract method. The percentage of completion method recognises revenue on the basis of the percentage of total work completed during the accounting period. The completed contract method is rarely used in the US but allows revenue recognition only once the entire project has been completed
Straight-line depreciation method
Under the straight-line depreciation method, the depreciation cost of an asset is spread evenly over the asset’s estimated useful life. The annual depreciation expense is:
(Original cost – salvage value) /
Useful life
Accelerated depreciation method
While most companies choose straight-line depreciation, under both US GAAP and IFRS, companies are allowed to use accelerated depreciation methods, which calculate a greater amount of depreciation in earlier years than later years. The most common accelerated depreciation methods are:
• Declining balance
• Sum of years digits
• Units of production
Double entry accounting
The framework is called double entry accounting and it records the two sides of every economic event – 1) the funding source and 2) how the funds are used.Every transaction is recorded through the use of a “credit” (source of funds) and an offsetting “debit” (use of funds) such that total debits always equal total credits in value.It facilitates understanding of the relationship between assets (resources) and liabilities/shareholders’ equity (funding) of a company. The income statement, the balance sheet, and the statement of cash flows are connected; the relationship among these three statements and their impact on one another can often be initially “illustrated” through debits and credits. Double-entry accounting is depicted through the use of a “T account” to track each source and use of funds in a transaction:
Assets are presented in descending order of liquidity
Cash is the most liquid asset so it’s always first
• Cash equivalents are extremely liquid assets, i.e. U.S. Treasury bills which will have a term of less than or equal to 90 days
• Cash is usually followed by assets like accounts receivable and inventory, as these can be converted into cash (i.e. sold) quickly
• Less liquid assets like PP&E and intangible assets are listed towards the bottom of the asset side of the balance sheet.
Current assets
• In fact, as long as assets can be converted into cash within 12 months, they are considered “current” and classified as such on the balance sheet.
Liabilities are presented in order of when they are to be paid
- Liabilities like short term debt and accounts payable are to be paid within 12 months and are labelled “current.”
- Long term liabilities (such as long-term debt) are not due within the year.
Inventory costing – First In, First Out (FIFO)
The cost of the inventory first purchased (first in) is the cost assigned to the first inventory to be sold (COGS – first out). Remaining inventory reflect the latest costs.
Inventory costing – Last In, First Out (LIFO)
The items purchased last (last in) are the first to be sold (COGS – first out). Therefore, the cost of inventory most recently acquired (ending inventory – last in) is assigned to COGS (first out). Ending inventory reflects cost of the first purchased inventories.
Inventory costing – Average Cost
COGS and ending inventory are calculated as: COGS / total number of goods.
LIFO Reserve
When companies use the LIFO method, their footnotes must disclose what the value of their inventories would have been under the FIFO method. The difference is called the LIFO reserve.
• The LIFO Reserve allows comparison of inventories and COGS across both methods:
• LIFO inventory + LIFO Reserve = FIFO inventory
• FIFO COGS + LIFO Reserve = LIFO COGS
When comparing a LIFO company against a FIFO company, the LIFO reserve must be subtracted from the LIFO company’s COGS to arrive at apples-to-apples profits comparisons.
Writing down inventories - lower of cost-or-market (LCM) rule
If the market value of inventory falls below historical cost, they must be written down to market value. Under IFRS the idea is similar; the rule is called lower of cost or net realizable value:
• The loss must be recognized immediately on the income statement. The loss can be presented in COGS, in ‘Other operating (or non operating) expenses’ or – if it is a big write down, as a separate line item
Goodwill impairment
Unlike finite life intangible assets, Goodwill is not amortized, but is tested annually for loss of value (impairment). If the value of the previously acquired company declines, goodwill is reduced, with a corresponding reduction to RE via the income statement, by the amount of the impairment.
Common stock
The accounting for common stock involves splitting the value of a share of common stock into two components:
• Common stock par value: Represents some nominal value to an issued share ($0.10/share)
• Additional paid in capital: Represents the excess value of the share issued over par value
