State some of the more serious problems encountered in seeking to achieve the ideal measurement of periodic net income. Explain what accountants do as a practical alternative.
From the revenue side, there are many types of revenue transactions which require estimation. For example, it is difficult to estimate the amount of revenue to recognize for a long-term contract in a given period. Other estimation situations also prevalent such as high rates of return on products sold, net versus gross sales issues, sales with buyback options, estimating revenues in licensing arrangements and so on. During a single fiscal period it often is difficult to determine the expiration of certain costs which may benefit several periods. Business is continuous and estimates have to be made of the future if we are to systematically apportion costs to fiscal periods. Examples of items which present serious obstacles include such items as institutional advertising costs.
Accountants have established certain rules for handling revenues and costs which are applied consistently and in a systematic manner. From period to period, application of these rules generally results in a satisfactory matching of costs and revenues unless there are large changes from one period to another. These rules, influenced by conservatism in the face of the uncertainties involved, tend to charge costs to expense earlier than might be ideally desirable if we had more knowledge of the future.
Costs or expenses of the types mentioned above, by their very nature, defy any attempt to relate them to revenues of a specific period or periods. Although it is known that institutional advertising will yield benefits beyond the present, both the amount of such benefits and when they will be enjoyed are shrouded in uncertainty. The degree of certainty with which their time distribution can be forecast is so small and the results, therefore, so unreliable that the accountant writes them off as applicable to the period or periods in which the expense was incurred.
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Accounting
- Distinguish between gross profit as a percentage of cost and gross profit as a percentage of sales price.
- What are the major uses of the gross profit method?
- Under what circumstances is relative sales value an appropriate basis for determining the price assigned to inventory?
- What approaches may be employed in applying the LCNRV procedure? Which approach is normally used and why?
- Why are inventories valued at the lower-of-cost-or-net realizable value (LCNRV)? What are the arguments against the use of the LCNRV method of valuing inventories?
- Why will the traditional LIFO inventory costing method and the dollar-value LIFO inventory costing method produce different inventory valuations if the composition of the inventory base changes?
- What advantage does the dollar-value method have over the specific goods approach of LIFO inventory valuation?
- What is the dollar-value method of LIFO inventory valuation?
- FIFO, average-cost, and LIFO methods are often used instead of specific identification for inventory valuation purposes. Compare these methods with the specific identification method, discussing the theoretical propriety of each method in the determination of income and asset valuation.
- Distinguish between product costs and period costs as they relate to inventory.
- Define "cost" as applied to the valuation of inventories.
- Where, if at all, should the following items be classified on a balance sheet?
- What is a repurchase agreement (product financing) arrangement? How should a product repurchase agreement be reported in the financial statements?
- What is the difference between a perpetual inventory and a physical inventory? If a company maintains a perpetual inventory, should its physical inventory at any date be equal to the amount indicated by the perpetual inventory records? Why?
- In what ways are the inventory accounts of a retailing company different from those of a manufacturing company?
- What is the fair value option? Where do companies that elect the fair value option report unrealized holding gains and losses?
- Indicate how the percentage-of-receivables method, based on an ageing schedule, accomplishes the objectives of the allowance method of accounting for bad debts. What other methods, besides an ageing analysis, can be used for estimating uncollectible accounts?
- What is the theoretical justification of the allowance method as contrasted with the direct write-off method of accounting for bad debts?
- What are the basic problems that occur in the valuation of accounts receivable?
- What are two methods of recording accounts receivable transactions when a cash discount situation is involved? Which is more theoretically correct? Which is used in practice more of the time? Why?
- What are the reasons that a company gives trade discounts? Why are trade discounts not recorded in accounts like cash discounts?
- What may be included under the heading of "cash"?
- State the generally accepted accounting principle applicable to balance sheet valuation of each of the following assets.
- Where should the following items be shown on the balance sheet, if shown at all?
- In what section of the balance sheet should the following items appear, and what balance sheet terminology would you use?
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