Lecture Accounting: What the numbers mean (5/e) - Chapter 5: Accounting for and presentation of current assets

After reading this chapter, you should be able to answer the following questions: What is included in the cash amount reported on the balance sheet? What are the features of an internal control system, and why are internal controls important? What is the bank reconciliation procedure?...

CHAPTER ACCOUNTING FOR AND PRESENTATION OF CURRENT ASSETS McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Learning Objectives What is included in the cash amount reported on the balance sheet? What are the features of an internal control system, and why are internal controls important? What is the bank reconciliation procedure? How are short-term marketable securities reported on the balance sheet? McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Learning Objectives How are accounts receivable reported on the balance sheet, including the valuation allowances for estimated uncollectible accounts and estimated cash discounts? How are notes receivable and related accrued interest reported on the balance sheet? How are inventories reported on the balance sheet? McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Learning Objectives What are the alternative inventory cost flow assumptions, and what are their respective effects on the income statement and balance sheet when price levels are changing? What are the effects of inventory errors on the balance sheet and income statement? 10 What are prepaid expenses, and how are they reported on the balance sheet? McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Learning Objective • What is included in the cash amount reported on the balance sheet? McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Cash and Cash Equivalents • Cash includes money on hand in change funds, petty cash, undeposited receipts, and checking and savings accounts • Cash equivalents are short-term investments easily convertible to cash • Cash management is concerned with maximizing earnings by having as much cash as feasible invested for the longest possible time McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Learning Objective ã What are the features of an internal control system, and why are internal controls important? McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Internal Control System ã A process designed to provide reasonable assurance that objects are achieved with respect to: – The effectiveness and efficiency of the operations – The reliability of the organization’s financial reporting – The organization’s compliance with applicable laws and regulations • Includes financial and administrative controls McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Financial Controls ã Are related to the concept of separation of duties • Includes a system of checks and balances such that one individual is not involved in an entire transaction • Example: individual preparing checks does not sign the checks McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Administrative Controls • Frequently included in policy and procedures manuals • Reflected in management reviews of operations and activities • Example: evaluating a customer’s credit history before approving a credit sale McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Weighted-Average ã Applied to individual items of inventory • Is not a simple average of the costs of the inventory items; the average is weighted by the number of units purchased at a specific price • The weighted average cost is then multiplied by the number of units sold to determine cost of goods sold, and by the number of units in ending inventory to determine the balance sheet valuation McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 First-In, First-Out (FIFO) ã The first costs in to inventory are the first costs out to cost of goods sold • The oldest costs are transferred to cost of goods sold • The balance sheet reports the most current costs of inventory McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Last-In, First-Out (LIFO) • The most recent costs of inventory are transferred to the income statement cost of goods sold – when items are sold • The oldest costs are reported on the balance sheet McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Impact of Changing Costs ã In times of rising costs, LIFO results in lower ending inventory amounts and higher cost of goods sold than FIFO • When inventory purchase costs are decreasing, FIFO results in lower ending inventory amounts and higher cost of goods sold than LIFO McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Selecting an Inventory CostFlow Assumption ã When rates of inflation are low, most financial managers choose FIFO • In periods of high inflation, managers choose LIFO to avoid high taxes • However, consistency requires the use of a single cost-flow assumption • If a change in methods is made, the effect of the change on both the balance sheet and the income statement must be disclosed McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Inventory Accounting System Alternatives ã Accounting for inventory is very complex • There are two principal inventory accounting systems: – Perpetual inventory systems – Periodic inventory systems McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Perpetual Inventory Accounting Systems • A record is made of every purchase and sale • A continuous record of the quantity and cost of each inventory item is maintained • Computers and bar codes scanning have aided in the development and use of this system McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Periodic Inventory Accounting Systems • A count of the inventory on hand is made periodically • The cost of the inventory on hand, based on the cost-flow assumption being used, is reported on the balance sheet • The remainder of the beginning inventory and the purchases are reported on the income statement as cost of goods sold McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Inventory Terms ã In a merchandising operation, inventory is referred to as “merchandise inventory” • In a manufacturing operation, there are three categories of inventory: – Raw materials inventory – raw material used in the manufacturing process – Work in process inventory – items currently being worked on – Finished goods inventory – ready to be sold McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Learning Objective ã What are the effects of inventory errors on the balance sheet and income statement? McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Inventory Errors ã Errors in the amount of ending inventory have a direct dollar-fordollar effect on cost of goods sold and net income • If ending inventory is understated, cost of goods sold will be overstated, and net income will be understated • The effect in the subsequent period will be reversed McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Balance Sheet Valuation at the Lower of Cost or Market • This reporting is an application of conservatism • Market is generally the replacement value • If market is lower than cost, then a loss is recognized • The determination may be done on an individual item basis or on the inventory as a whole McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Learning Objective 10 • What are prepaid expenses, and how are they reported on the balance sheet? McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Prepaid Expenses and Other Current Assets • Prepaid expenses are expenses that have been paid in the current fiscal period but will not be subtracted from revenue until a subsequent fiscal period • Often referred to as a deferral or deferred charge • Examples are prepaid insurance, prepaid rent, and office supplies McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Deferred Tax Assets • Arise from differences in the fiscal year in which revenues and expenses are recognized for financial accounting purposes and when they are recognized for income tax determination • Can have deferred tax assets (expenses recognized for financial purposes before they are recognized for tax purposes) and/or deferred tax liabilities (just the opposite) McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 ... McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Periodic Inventory Accounting Systems ã A count of the inventory on hand is made periodically • The cost of the inventory on hand, based on the cost-flow... made of every purchase and sale • A continuous record of the quantity and cost of each inventory item is maintained • Computers and bar codes scanning have aided in the development and use of this... respect to: – The effectiveness and efficiency of the operations – The reliability of the organization’s financial reporting – The organization’s compliance with applicable laws and regulations