Define long-lived assets. Why are they considered to be a "bundle of future services"?

Define long-lived assets. Why are they considered to be a "bundle of future services"?

Long-lived assets are noncurrent assets, which a business retains beyond one year, not for sale, but for use in the course of normal operations. Long-lived assets include land in use, plant and equipment, natural resources, and certain intangibles such as a patent used in operating the business. Long-lived assets are acquired because of the future use that is expected of them. Thus, they may be thought of as a bundle of future services to be used over a period of time to earn revenue. As those services are used, as in the case of a machine, the cost of the asset is allocated as a periodic expense (i.e., matched with revenue)

How is the fixed asset turnover ratio computed? Explain its meaning.

How is the fixed asset turnover ratio computed? Explain its meaning.

The fixed asset turnover ratio = Net sales / [(Beginning net fixed asset balance + Ending net fixed asset balance) / 2] This ratio measures how efficiently a company utilizes its investment in property, plant, and equipment over time. The ratio can also be compared to the ratio for the company's competitors.

What are the classifications of long-lived assets? Explain each.

What are the classifications of long-lived assets? Explain each.

Long-lived assets are classified as follows: (1) Tangible long-lived assets—assets that are tangible (i.e., have physical substance) and long-lived (i.e., beyond one year); they are acquired for use in the operation of a business and are not intended for resale. They are comprised of three different kinds of assets: (a) Land—not subject to depreciation. (b) Plant and equipment—subject to depreciation. (c) Natural resources—mines, gravel pits, and timber tracts. Natural resources are subject to depletion. (2) Intangible long-lived assets—assets held by the business because of the special valuable rights that they confer; they have no physical substance. Examples are patents, copyrights, franchises, licenses, trademarks, technology, and goodwill. Intangible assets with definite lives are subject to amortization.

Distinguish between ordinary repairs and improvements. How is each accounted for?

Distinguish between ordinary repairs and improvements. How is each accounted for?

a. Capital expenditures—expenditures of resources (i.e., assets given up or debt incurred) for a service or asset that will help earn revenue for periods beyond the current accounting period. Capital expenditures should be debited to appropriate asset accounts and then allocated to those future periods in which revenues will be earned and against which the expenditures will be matched. Revenue expenditures—expenditures that help earn revenue only for the current period. Revenue expenditures are debited to appropriate expense accounts in the period in which incurred.

b. Ordinary repairs—expenditures for the normal maintenance and upkeep of machinery and other tangible long-lived assets that are necessary to keep the assets in their usual operating conditions. Generally, ordinary repairs are recurring in nature, involve relatively small amounts at each occurrence and do not extend the useful estimated life of the asset. Ordinary repairs are debited to expense in the period in which incurred. Improvements—unusual, nonrecurring, major renovations that are necessary because of unusual conditions.

Generally, they are large in amount, not recurring, and tend to either make the asset more efficient or to extend its useful life. Extraordinary repairs are debited to the appropriate asset accounts (or alternatively to the accumulated depreciation accounts) and in that way affect the amount of depreciation expense for the remaining estimated life of the asset.

Distinguish among depreciation, depletion, and amortization.

Distinguish among depreciation, depletion, and amortization.

Depreciation—allocation of the cost of a tangible long-lived asset over its useful life. Depreciation refers to allocation of the costs of such items as plant and equipment, buildings, and furniture.

Depletion—allocation of the cost of a natural resource over its useful life. It is identical in concept to depreciation except that it relates to a different kind of asset, depletable natural resources.

Amortization—allocation of the cost of an intangible asset over its estimated useful life. Conceptually, it is the same as depreciation and depletion except it relates to an intangible asset.

In computing depreciation, three values must be known or estimated; identify and explain the nature of each.

In computing depreciation, three values must be known or estimated; identify and explain the nature of each.

To compute depreciation, the three values that must be known or estimated are:

Cost—the actual total expenditures incurred in acquiring the asset in conformity with the cost principle.

Estimated useful life—the estimated length of time that the asset will be used by the present owner for the purposes for which it was acquired.

Residual value—the estimated amount of cash that is expected to be recovered at the end of the estimated useful life of the asset. The residual value is the estimated cash recovery amount minus the estimated cost of removing and disposing of the asset at the end of its estimated useful life.

Notice that, on the acquisition date, the first of these values is an actual known amount, while the latter two are estimates.

Over what period should an addition to an existing long-lived asset be depreciated? Explain.

Over what period should an addition to an existing long-lived asset be depreciated? Explain.

The cost of an addition to an existing long-lived asset should be depreciated over the shorter of the estimated life of the addition or the remaining life of the existing asset to which it relates. This rule is necessary because an addition to an existing long-lived asset has no use after the useful life of the existing asset has expired.

When equipment is sold for more than net book value, how is the transaction recorded? For less than net book value? What is net book value?

When equipment is sold for more than net book value, how is the transaction recorded? For less than net book value? What is net book value?

When equipment is sold, the Equipment account is credited for the asset's historical cost. Its related Accumulated Depreciation account is debited for the amount representing prior usage. The Cash account is debited for the sales price. If the cash received exceeds the cost less accumulated depreciation (net book value), a Gain on Sale of Equipment is recorded for the difference. If the cash received is lower than the net book value, a Loss on Sale of Equipment is recorded for the difference. Net book value is the asset's historical cost less accumulated depreciation on the asset.

Define goodwill. When is it appropriate to record goodwill as an intangible asset?

Define goodwill. When is it appropriate to record goodwill as an intangible asset?

Goodwill represents an intangible asset that exists because of the good reputation, customer appeal, and general acceptance of a business. Goodwill has value because other parties often are willing to pay a substantial amount for it when they buy a business. Goodwill should be recorded in the accounts and reported in the financial statements only when it has been purchased at a measurable cost. The cost of goodwill is measured in conformity with the cost principle. Because it is considered to have an indefinite life, goodwill is not amortized, but it is reviewed annually for impairment of value

Why is depreciation expense added to net income (indirect method) on the statement of cash flows?

Why is depreciation expense added to net income (indirect method) on the statement of cash flows?

Depreciation expense is a noncash expense. That is, each period when depreciation is recorded, no cash payment is made. (The cash outflow associated with depreciation occurs when the related asset is first acquired.) Since no cash payment is made for depreciation, the effect of the depreciation expense on net income needs to be reversed in the reconciliation to cash flows. Depreciation expense was originally subtracted to arrive at net income; thus, to reverse its effect, depreciation expense needs to be added back to net income on the statement of cash flows (indirect method).

What is an annuity?

What is an annuity?

An annuity is a term that refers to equal periodic cash payments or receipts of an equal amount each period for two or more periods. In contrast to a future value of $1 or a present value of $1 (which involve a single contribution or amount), an annuity involves a series of equal contributions for a series of equal periods. An annuity may refer to a future value or a present value.

Explain the basic difference between future value and present value.

Explain the basic difference between future value and present value.

Future value—The future value of a number of dollars is the amount that it will increase to in the future at i interest rate for n periods. The future value is the principal plus accumulated interest compounded each period.
Present value—The present value of a number of dollars, to be received at some specified date in the future, is that amount discounted to the present at i interest rate for n periods. It is the inverse of future value. In compound discounting, the interest is subtracted rather than added as in compounding.

Explain the concept of the time value of money.

Explain the concept of the time value of money.

The time value of money is another way to describe interest. Time value of money refers to the fact that a dollar received today is worth more than a dollar to be received at any later date because of interest.

What is a contingent liability? How is a contingent liability reported?

What is a contingent liability? How is a contingent liability reported?

A contingent liability is not an effective liability; rather it is a potential future liability. A contingent liability arises because of some transaction or event that has already occurred which may, depending upon one or more future events, cause the creation of a true liability. A typical example is a lawsuit for damages. Whether the defendant has a liability depends upon the ultimate decision of the court. Pending that decision there is a contingent liability (and a contingent loss). This contingency must be recorded and reported (debit, loss; credit, liability) if it is "probable" that the decision will require the payment of damages that can be reasonably estimated. If it is only "reasonably possible" that a loss will be incurred, only footnote disclosure is required.

Define Note Payable. Differentiate between a secured and unsecured note.

Define Note Payable. Differentiate between a secured and unsecured note.

A note payable is a written promise to pay a stated sum at one or more specified dates in the future. A secured note payable is one that has attached to it (or coupled with it) a mortgage document which commits specified assets as collateral to guarantee payment of the note when due. An unsecured note is one that does not have specific assets pledged, or committed, to its payment at maturity. A secured note carries less risk for the note holder (creditor).

Define Deferred Revenue. Why is it a liability.

Define Deferred Revenue. Why is it a liability.

A deferred revenue (usually called unearned revenue or revenue collected in advance) is a revenue that has been collected in advance of being earned and recorded in the accounts by the entity. Because the amount already has been collected and the goods or services have not been provided, there is a liability to provide goods or services to the party who made the payment in advance. A typical example is the collection of rent on December 15 for one full month to January 15 when the accounting period ends on December 31. At the date of the collection of the rent the following entry usually is made:
December 15:
Cash (+A) 4,000
Rent revenue (+R, +SE) 4,000
On the last day of the period, the following adjusting entry should be made to recognize the deferred revenue as a liability:
December 31:
Rent revenue (-R, -SE) 2,000
Deferred rent revenue (or Rent revenue collected in
advance) (+L)

2,000
The deferred rent revenue (credit) is reported as a liability on the balance sheet because two weeks' occupancy is owed in the next period for which the lessee already has made payment.

Define Accrued liability. What type of entry usually reflects and accrued liability?

Define Accrued liability. What type of entry usually reflects and accrued liability?

An accrued liability is an expense that was incurred before the end of the current period but has not been paid or recorded. Therefore, an accrued liability is recognized when such a transaction is recorded. A typical example is wages incurred during the last few days of the accounting period but not recorded because no payroll was prepared and paid that included these wages. Assuming wages of $2,000 were incurred, the adjusting entry to record the accrued liability and the wage expense would be as follows:
December 31:
Wage expense (+E, -SE).......................................... 2,000
Wages payable (+L) ......................................... 2,000

Liabilities are measured and reported at their current cash equivalent amount. Explain.

Liabilities are measured and reported at their current cash equivalent amount. Explain.

A liability is measured at acquisition at its current cash equivalent amount. Conceptually, this amount is the present value of all of the future payments of principal and interest. For a short-term liability the current cash equivalent usually is the same as the maturity amount. The current cash equivalent amount for an interest-bearing liability at the going rate of interest is the same as the maturity value. For a long-term liability, the current cash equivalent amount will be less than the maturity amount: (1) if there is no stated rate of interest, or (2) if the stated rate of interest is less than the going rate of interest.

Define Liability. Differentiate between a current liability and a long term liability.

Define Liability. Differentiate between a current liability and a long term liability.

Liabilities are obligations that result from past transactions that require future payment of assets or the future performance of services, that are definite in amount or are subject to reasonable estimation. A liability usually has a definite payment date known as the maturity or due date. A current liability is a short-term liability; that is, one that will be paid during the coming year or the current operating cycle of the business, whichever is longer. It is assumed that the current liability will be paid out of current assets. All other liabilities are defined as long-term liabilities.

Define intangible asset. What period should be used to amortize an intangible asset with a definite life?

Define intangible asset. What period should be used to amortize an intangible asset with a definite life?

An intangible asset is acquired and held by the business for use in operations and not for sale. Intangible assets are acquired because of the special rights they confer on ownership. They have no physical substance but represent valuable rights that will be used up in the future. Examples are patents, copyrights, trademarks, technology, franchises, goodwill, and licenses.

When equipment is sold for mare than net book value how is the transaction recorded? For less than? What is net book value?

When equipment is sold for mare than net book value how is the transaction recorded? For less than? What is net book value?

When equipment is sold, the Equipment account is credited for the asset's historical cost. Its related Accumulated Depreciation account is debited for the amount representing prior usage. The Cash account is debited for the sales price. If the cash received exceeds the cost less accumulated depreciation (net book value), a Gain on Sale of Equipment is recorded for the difference. If the cash received is lower than the net book value, a Loss on Sale of Equipment is recorded for the difference. Net book value is the asset's historical cost less accumulated depreciation on the asset.

What is asset impairment? How is it accounted for?

What is asset impairment? How is it accounted for?

Asset impairment—when events or changes in circumstances cause the book value of long-lived assets to be higher than their related estimated future cash flows. It is accounted for by writing down the asset to the asset's fair value and recording a loss.

What type of depreciation expense patter is used under each of the following methods and when is its use appropriate?

What type of depreciation expense patter is used under each of the following methods and when is its use appropriate? 

A Straight line B Units of Production C Double Declining Balance.



a. The straight-line method of depreciation causes an equal amount of depreciation expense to be apportioned to, or matched with, the revenues of each period. It is especially appropriate for tangible long-lived assets that are used at an approximately uniform level from period to period.
b. The units-of-production method of depreciation causes a depreciation expense pattern that varies in amount with the rate at which the asset is used productively each year. For example, if in the current year the asset is used twice as much as in the prior year, twice as much depreciation expense would be matched with the revenue of the current year as compared with the previous year. Usually use is measured in terms of productive output. The units-of-production method of depreciation is particularly appropriate for those assets that tend to earn revenue with use rather than with the passage of time. Thus, it normally would apply to assets that are not used at a uniform rate from period to period.
c. The double-declining-balance method of depreciation is a form of accelerated depreciation, causing a higher amount of depreciation expense to be matched with revenue in early periods of the estimated useful life of the asset. The double-declining-balance method is particularly appropriate when the long-lived assets perform more efficiently and therefore produce more revenue in the early years of their useful life than in the later years.

Distinguish among depreciation, depletion and amortization.

Distinguish among depreciation, depletion and amortization.

Depreciation—allocation of the cost of a tangible long-lived asset over its useful life. Depreciation refers to allocation of the costs of such items as plant and equipment, buildings, and furniture.
Depletion—allocation of the cost of a natural resource over its useful life. It is identical in concept to depreciation except that it relates to a different kind of asset, depletable natural resources.
Amortization—allocation of the cost of an intangible asset over its estimated useful life. Conceptually, it is the same as depreciation and depletion except it relates to an intangible asset.

Describe the relationship between the matching principle and accounting for long lived assets.

Describe the relationship between the matching principle and accounting for long lived assets.

In measuring and reporting long-lived assets, the matching principle is applied. As a long-lived asset is used, revenues are earned over a period of time. Over that same period of time, the long-lived asset tends to be used up or worn out. As a consequence, under the matching principle, the acquisition cost of the asset must be allocated to the periods in which it is used to earn revenue. In this way the cost of the asset is matched, as expense, with the revenues as they are earned from period to period through the use of the asset.

Under the cost principle, what amounts should be included in the acquisition cost of a long lived asset?

Under the cost principle, what amounts should be included in the acquisition cost of a long lived asset?

When a long-lived asset is acquired, it is recorded in the accounts in conformity with the cost principle. That is, the acquisition cost of a long-lived asset is the cash equivalent price paid for it plus all incidental costs expended to obtain it, to place it in the location in which it is to be used, and to prepare it for use.

What are the classifications for long lived assets. Explain each.

What are the classifications for long lived assets. Explain each.

Long-lived assets are classified as follows:
(1) Tangible long-lived assets—assets that are tangible (i.e., have physical substance) and long-lived (i.e., beyond one year); they are acquired for use in the operation of a business and are not intended for resale. They are comprised of three different kinds of assets:
(a) Land—not subject to depreciation.
(b) Plant and equipment—subject to depreciation.
(c) Natural resources—mines, gravel pits, and timber tracts. Natural resources are subject to depletion.

Define Long lived Assets. Why are they considered to be a "bundle of future services"?

Define Long lived Assets. Why are they considered to be a "bundle of future services"?

Long-lived assets are noncurrent assets, which a business retains beyond one year, not for sale, but for use in the course of normal operations. Long-lived assets include land in use, plant and equipment, natural resources, and certain intangibles such as a patent used in operating the business. Long-lived assets are acquired because of the future use that is expected of them. Thus, they may be thought of as a bundle of future services to be used over a period of time to earn revenue. As those services are used, as in the case of a machine, the cost of the asset is allocated as a periodic expense (i.e., matched with revenue).

Explain briefly the application of the LCM concept to the ending inventory and its effect on the income statement and the balance sheet when market is lower than cost.

Explain briefly the application of the LCM concept to the ending inventory and its effect on the income statement and the balance sheet when market is lower than cost.

LCM is applied when market (defined as current replacement cost) is lower than the cost of units on hand. The ending inventory is valued at market (lower), which (a) reduces net income and (b) reduces the inventory amount reported on the balance sheet. The effect of applying LCM is to include the holding loss on the income statement (as a part of CGS) in the period in which the replacement cost drops below cost rather than in the period of actual sale.

Contrast the effect of LIFO vs FIFO on cash outflow and inflow.

Contrast the effect of LIFO vs FIFO on cash outflow and inflow.

When prices are rising, LIFO causes a lower taxable income than does FIFO. Therefore, when prices are rising, income tax is less under LIFO than FIFO. A lower tax bill saves cash (reduces cash outflow for income tax). The total amount of cash saved is the difference between LIFO and FIFO inventory amounts multiplied by the income tax rate.

Contrast the income statement effect of LIFO vs FIF ie pretax income when A prices are rising and B when prices are falling.

Contrast the income statement effect of LIFO vs FIF ie pretax income when A prices are rising and B when prices are falling.

LIFO versus FIFO will affect the income statement in two ways: (1) the amount of cost of goods sold and (2) income. When the prices are rising, FIFO will give a lower cost of goods sold amount and hence a higher income amount than will LIFO. In contrast, when prices are falling, FIFO will give a higher cost of goods sold amount and, as a result, a lower income amount.

Contrast the effects of LIFO vs FIFO on reported assets ie. inventory when A prices are rising and B prices are falling.

Contrast the effects of LIFO vs FIFO on reported assets ie. inventory when A prices are rising and B prices are falling.

LIFO and FIFO have opposite effects on the inventory amount reported under assets on the balance sheet. The ending inventory is based upon either the oldest unit cost or the newest unit cost, depending upon which method is used. Under FIFO, the ending inventory is costed at the newest unit costs, and under LIFO, the ending inventory is costed at the oldest unit costs. Therefore, when prices are rising, the ending inventory reported on the balance sheet will be higher under FIFO than under LIFO. Conversely, when prices are falling the ending inventory on the balance sheet will be higher under LIFO than under FIFO.

Discuss four inventory costing methods. List the four methods and briefly explain each.

Discuss four inventory costing methods. List the four methods and briefly explain each.

1. Average cost
2. FIFO
3. LIFO
4. Specific identification

(a) Average cost-This inventory costing method in a periodic inventory system is based on a weighted-average cost for the entire period. At the end of the accounting period the average cost is computed by dividing the goods available for sale in units into the cost of goods available for sale in dollars. The computed unit cost then is used to determine the cost of goods sold for the period by multiplying the units sold by this average unit cost. Similarly, the ending inventory for the period is determined by multiplying this average unit cost by the number of units on hand.

(b) FIFO-This inventory costing method views the first units purchased as the first units sold. Under this method cost of goods sold is costed at the oldest unit costs, and the ending inventory is costed at the newest unit costs.

(c) LIFO-This inventory costing method assumes that the last units purchased are the first units sold. Under this method cost of goods sold is costed at the newest unit costs and the ending inventory is costed at the oldest unit costs.

(d) Specific identification-This inventory costing method requires that each item in the beginning inventory and each item purchased during the period be identified specifically so that its unit cost can be determined by identifying the specific item sold. This method usually requires that each item be marked, often with a code that indicates its cost. When it is sold, that unit cost is the cost of goods sold amount. It often is characterized as a pick-and-choose method. When the ending inventory is taken, the specific items on hand, valued at the cost indicated on each of them, is the ending inventory amount.

Define Goods available for sale. How does it differ from cost of goods sold?

Define Goods available for sale. How does it differ from cost of goods sold?

Goods available for sale is the sum of the beginning inventory and the amount of goods purchased during the period. Cost of goods sold is the amount of goods available for sale less the ending inventory.

Explain the application of the cost principle to an item in the ending inventory.

Explain the application of the cost principle to an item in the ending inventory.

The cost principle governs the measurement of the ending inventory amount. The ending inventory is determined in units and the cost of each unit is applied to that number. Under the cost principle, the unit cost is the sum of all costs incurred in obtaining one unit of the inventory item in its present state.

What are the guidelines for deciding which items should be included in inventory?

What are the guidelines for deciding which items should be included in inventory?

Fundamentally, inventory should include those items, and only those items, legally owned by the business. That is, inventory should include all goods that the company owns, regardless of their particular location at the time.

Does an increase in the receivables turn over ratio generally indicate faster or slower collection of receivables.?

Does an increase in the receivables turn over ratio generally indicate faster or slower collection of receivables.?

An increase in the receivables turnover ratio generally indicates faster collection of receivables. A higher receivables turnover ratio reflects an increase in the number of times average trade receivables were recorded and collected during the period.

What is the effect of the write off of bad debts (using the allowance method) on A net income and B accounts receivable, net.

What is the effect of the write off of bad debts (using the allowance method) on A net income and B accounts receivable, net.

The write-off of bad debts using the allowance method decreases the asset accounts receivable and the contra-asset allowance for doubtful accounts by the same amount. As a consequence, (a) net income is unaffected and (b) accounts receivable, net, is unaffected.

Using the allowance method is bad debt expense recognized in A the period in which sales related to the noncollectable account are made or B the period in which the seller learns that the customer is unable to pay?

Using the allowance method is bad debt expense recognized in A the period in which sales related to the noncollectable account are made or B the period in which the seller learns that the customer is unable to pay?

Using the allowance method, bad debt expense is recognized in the period in which the sale related to the uncollectible account was recorded.

Which basic accounting principles the allowance method of accounting for bad debts designed to satisfy?

Which basic accounting principles the allowance method of accounting for bad debts designed to satisfy?

In conformity with the matching principle, the allowance method records bad debt expense in the same period in which the credit was granted and the sale was made.

What is a sales discount? Use 1/10,n/30 for an explanation.

What is a sales discount? Use 1/10,n/30 for an explanation.

A sales discount is a discount given to customers for payment of accounts within a specified short period of time. Sales discounts arise only when goods are sold on credit and the seller extends credit terms that provide for a cash discount. For example, the credit terms may be 1/10, n/30. These terms mean that if the customer pays within 10 days, 1% can be deducted from the invoice price of the goods. Alternatively, if payment is not made within the 10-day period, no discount is permitted and the total invoice amount is due within 30 days from the purchase, after which the debt is past due. To illustrate, assume a $1,000 sale with these terms. If the customer paid within 10 days, $990 would have been paid. Thus, a sales discount of $10 was granted for early payment.

What is a credit card discount? How does it affect amounts reported on the income statement?

What is a credit card discount? How does it affect amounts reported on the income statement?

A credit card discount is the fee charged by the credit card company for services. When a company deposits its credit card receipts in the bank, it only receives credit for the sales amount less the discount. The credit card discount account either decreases net sales (it is a contra revenue) or increases selling expense.

What is gross profit or gross margin on sales? How is gross profit ratio computed?

What is gross profit or gross margin on sales? How is gross profit ratio computed?

Gross profit or gross margin on sales is the difference between net sales and cost of goods sold. It represents the average gross markup realized on the goods sold during the period. The gross profit ratio is computed by dividing the amount of gross profit by the amount of net sales.

Explain the difference between sales revenue and net sales.

Explain the difference between sales revenue and net sales.

The difference between sales revenue and net sales is the amount of goods returned by customers because the goods were either unsatisfactory or not desired and also includes sales allowances given to customers.