Oper. Decisions - 1
OPERATING DECISIONS
UNCOLLECTIBLE ACCOUNTSRECEIVABLE
When credit is extended, some amount of uncollectible receivables is generally inevitable.
If uncollectible receivables are probable and can be estimated, an estimate should be made of the amount uncollectible and recorded in the period in which the revenue was produced (allowance method).(allowance method).
The Allowance for Doubtful Accounts is a contracontra accountaccount to Accounts Receivable..
P E R I O D I C M E T H O D
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P E R P E T U A L M E T H O D
I N V E N T O R Y R E C O R D I N G M E T H O D S
INVENTORY RECORDING METHODS
Periodic inventory system
-- Inventory value is determined only at particular times, such as end of the accounting period.
-- Purchases recorded in “Purchases” account
-- Cost of goods sold determined at the end of the period following a physical count
INVENTORY RECORDING METHODS
Perpetual inventory system
-- The ongoing physical flow of inventory is monitored, and the cost of the inventory items is maintained on a continual basis.
-- Purchases recorded directly in “Inventory” account
-- Cost of goods sold is determined at the point sales revenue is recognized
COST FLOW METHODS
An allocation of total cost of goods available for sale:
Ending inventory
Cost of goods sold
Cost of goodsAvailable
(Beg. Inven. + Purch)
The cost flowcost flow assumption used for accounting purposescan be different from the physical flowphysical flow of goods throughthe company.
INVENTORY VALUESCOST FLOW ASSUMPTIONS
Specific costidentification
Average cost
First-in, first-out (FIFO)
Last-in, first-out (LIFO)
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FIRST-IN, FIRST-OUT
Cost of the oldest inventory items are included in Cost of Goods Sold
Cost of the newest items are included in the Ending Inventory
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LAST-IN, FIRST-OUT
Cost of the newest inventory items are included in Cost of Goods Sold
Cost of the oldest items are included in the Ending Inventory
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PENSIONS
A pension is cash compensation received by an employee after the employee has retired
There are two types of pension plans:– Defined contribution plan– Defined benefit plan
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DEFINED CONTRIBUTION PLAN
This type of plan requires the company to contribute a fixed amount of money to a pension fund each year on behalf of the employee
The amount of cash contributed to the pension fund during the year is reported as pension expense
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DEFINED BENEFIT PLAN
This type of plan requires the company to pay employees a fixed monthly cash amount after they retire based on a pension formula that considers years of service and highest salary
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POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
Other employee benefits provided after retirement include– Health care plans– Life insurance plans
Accounting rules require that these benefits be recognized as an expense and a liability as they are incurred
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INCOME TAXES
Income tax expense and the amount paid for income tax during a period are different for two reasons:– Income taxes are not paid in the
same year in which they are incurred– A firm may choose one accounting
method for tax purposes and another for financial reporting purposes
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INCOME TAXES
Differences in financial income and taxable income are due to timing differences
Timing differences can be– Permanent or– Temporary
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TIMING DIFFERENCES
Permanent differences– Enter into accounting income, but
never into taxable income– These are statutory differences
between GAAP and the Internal Revenue Code
– For example, interest on state and local bonds is included in financial income, but not in taxable income
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TIMING DIFFERENCES
Temporary differences– Some transactions affect taxable
income in a different period from financial accounting income• Depreciation methods• Rent received in advance
– The affects of these differences are recorded as deferred tax assets or liabilities and shown on the balance sheet
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DEFERRED TAXES
Deferred Tax Liability– Requires a payment in the future– Is the expected income tax on income
earned but not yet taxed– Is not an existing legal liability
Income Taxes Payable, based on taxable income on the tax return, is an existing legal liability
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DEFERRED TAXES
Deferred Tax Asset– Represents the expected benefit of a
future tax deduction for an expense item that has already been incurred but is not yet deductible for tax purposes
– It can only be recognized if it is “more likely than not” that future income will be realized against which the deduction can be offset
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CAPITALIZE VERSUS EXPENSE
An expenditure that is expected to benefit future periods is capitalized as an asset
All other expenditures are treated as expenses
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CAPITALIZE VERSUS EXPENSE
Research and development costs
– Research is defined as• Those activities undertaken to discover new
knowledge that will be useful in developing new products, services, or processes or that will result in significant improvement of existing products or processes
– Development • Applies the research findings to develop a
plan or design for new or improved products and processes
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CAPITALIZE VERSUS EXPENSE
Research and development costs are expensed in the period incurred due to the uncertainty surrounding the future economic benefits of R&D activities
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CAPITALIZE VERSUS EXPENSE
Software development requires special treatment– All costs incurred up to the point
where technological feasibility is established are to be expensed as research and development
– After technological feasibility is established, costs incurred are capitalized•Determining technological feasibility
is a matter of judgement
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CAPITALIZE VERSUS EXPENSE
Oil and gas exploration costs– Two methods of accounting for
the cost of “dry holes”:•Full cost method
All exploratory costs are capitalized and allocated to the cost of successful wells
•Successful efforts methodExploratory costs for dry holes are
expensed, and only exploratory costs for successful wells are capitalized
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CAPITALIZE VERSUS EXPENSE
Advertising costs– Generally, advertising costs are
expensed due to the uncertainty of their future economic benefits
– In selected cases where the future benefits are more certain, advertising costs should be capitalized
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CONTINGENCIES
A contingency is an uncertain circumstance involving a potential gain or loss that will not be resolved until some future event occurs
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CONTINGENCIES
Three important definitions:– Probable
• Likely to occur
– Remote• Not likely to occur
– Reasonably possible• More than remote but less than likely
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CONTINGENT LOSSES
LikelihoodProbable
Reasonably possible
Remote
Accounting Action Recognize a probable
liability if the amount can be reasonably estimated.
Disclose a possible liability in a note.
No recognition or disclosure unless contingency represents a guarantee. Then, note disclosure is required.
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CONTINGENT GAINS
LikelihoodProbable
Reasonably possible
Remote
Accounting Action An asset may be recorded if
it seems assured and the amount can be reasonably estimated. Normally you would simply disclose facts in a note.
Disclose a possible asset in a note, but be careful to avoid misleading implications. In practice, possible contingent gains are often not disclosed.
No recognition or disclosure.
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ACCOUNTING FOR LAWSUITS
If the facts of the case indicate that a loss is probable and the amount of the loss can be estimated, a loss should be reported on the income statement and a liability should be reported on the balance sheet
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ACCOUNTING FOR ENVIRONMENTAL LIABILITIES
Most companies do not reflect these loss contingencies as liabilities on the balance sheet because the future cost of the cleanup is very difficult to estimate
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