| What I Have Learned in This Class |
|
Chapter Seven:
Recall examples of common Cash and Cash Equivalents, especially:
- Treasury Bills (mature in 3 months or less from time of purchase)
- Commercial Paper (unsecured debt from very high credit companies, less than 270 days)
* "A major benefit of commercial paper is that it does not need to be registered with the Securities and Exchange Commission (SEC) as long as it matures before nine months (270 days), making it a very cost-effective means of financing"
Compensating Balance
* A requirement by a financial institution for a person or company to retain a certain percentage or dollar amount of a loan in the establishment (e.g. "I will loan you $100,000 if you leave $20,000 in your bank account until you payback the money")
* The net effect of a compensating balance is to increase the annual interest rate
* Calculate the real interest rate you are paying by taking the annual interest expense and dividing it by the actual dollar amount you have access to.
Trade Discounts
- Can be used to make a sale in the form of offering a deal ("give you a 5% discount if you buy now or pay cash").
- Can be used to make a bulk sale ("give you $0.10 off per can if you buy 10 or more")
- Can be used to promote a product (advertisement of discount or coupon to be used in purchase)
* Trade discounts directly reduce sales price. There is no journal entry for trade discounts as they occur before a price has even been established. Any sales price recorded will be at the final negotiated discount (i.e. net of any trade discounts)
* There are some examples of companies who do record trade discounts (we will not perform this transaction in class)
Cash Discounts
* Know 2/10, net 30 and understand that annualized this is offering 36% rate of return (also compute for other rates)
* Cash discounts tell the supplier about the buyer's financial position as long as the return rate of the discount is materially greater than interest rates for fund sources available to the buyer, such as a bank loan.
* Other advantages to cash discounts we discussed - industry norm, selling point to attract customers, get cash sooner
* Two methods for recording:
1) Gross method - Record the transaction at full sales price. When cash is received make a journal entry (Debit cash, Credit A/R) - if there is a difference between these two numbers since it is within the discount period (e.g. the 10 days for the 2% discount), then you must record a debit to Sales Discount, a contra-revenue account (some companies will record it as an expense, we will use it as a contra-revenue).
2) Net method - Record the transaction with the assumption that the cash discount will be taken on all of the sales (e.g. reduce sales by 2% upfront, instead of $100, record $98). When cash is received make journal entry (Debit cash, Credit A/R) - if there is a difference between these two numbers since a discount was NOT taken (e.g. they paid after the 10 days) you would record the difference as Interest Revenue. Why? Because it is viewed that if the customer does not take this great discount that they are basically 'borrowing' the money for those days between the discount period and the net date (e.g. the 20 days between 2/10, net 30). Therefore, any sacrificed discount is believed to be interest.
A/R and Allowance for Bad Debt
* Know the Income Statement and Balance Sheet Approach for calculating Bad Debt Expense.
* For any problem you should be able to provide for me:
1) Bad Debt Expense
2) Net A/R (A/R less any Allowance for Bad Debt)
3) Ending Allowance for Bad Debt
* Recall that when using the income statement approach, you blindly apply a percentage to any credit sales you make. This number will represent your bad debt expense and will be added to your allowance for bad debt (aka allowance for doubtful accounts)
* Recall that when using the balance sheet approach, you apply a percentage to ending accounts receivable to determine the amount of allowance for bad debt that you need to feel comfortable about your existing, outstanding accounts receivable
Bank Reconciliation:
Identify who knows about a certain transaction and know their definition
* NSF Checks (Bank)
* Notes Collected by Bank (Bank)
* Error by Bank (You)
* Service Charges (Bank)
* Outstanding Checks (You)
* Deposits in Transit (You)
* Interest (Bank)
Direct Write-Off
* Not allowable by GAAP as an acceptable methodology to handle bad debt expense
* Records expenses at the time of default, rather than at time of sale
* Fails to follow the matching principle
Secured Borrowing Against A/R
> Assigning/Assignment
* Uses following journal entry setup
Cash $$$$
Finance Charge $$$$
Liability - Financing Arrangement $$$$
* Receive cash for desired borrowed amount
* Finance Charge will typically be a percentage of A/R Assigned (not total amount borrowed)
* Liability - Finance Arrangement will equal the amount of cash received plus the financing charge
* The amount of Assigned A/R will be greater the amount of the liability to ensure adequate collateral for the bank
* The Liability - Financing Arrangement is netted against the assigned A/R
> Pledging
* The company makes a disclosure note to advise external financial statement users that some or all of the A/R are collateral for a loan
* The liability is recorded as a liability and the A/R is recorded at its full value (i.e. the values are not netted)
Sale of A/R
* Accounts Receivable may be sold with or without recourse
* Without recourse is riskier and will demand a higher finance fee
* Companies who purchase A/R are typically called Factors
* The general journal entry structure for the sale of A/R is:
Cash $$$$
Loss on Sale of A/R $$$$
Receivable from Factor $$$$
Recourse Liability $$$$
A/R $$$$
> Cash is the amount you receive from the Factor on day one when you sell the A/R
> Loss on Sale of A/R is the Factor Fee (the finance fee) which is normally based on a percentage of A/R sold plus any amount recorded for the Recourse Liability (for without recourse, Recourse Liability will be zero, $0)
> Receivable from Factor - the Factor typically retains a certain amount of money, which allows them to increase their investment yield, similar to a compensating balance
> Recourse Liability is management's estimate of A/R which will be uncollectible (for A/R sold without recourse, this amount should be zero, $0)
> A/R is the amount sold to the factor
|
|
Chapter Eight and Nine:
Types of Inventory for a manufacturer - Raw Materials, Work-in-Progress, and Finished Goods
Periodic Inventory:
* Pro: It is cheaper and easier than a perpetual system
* Con: Not a lot of information, can't tell what has been stolen or broken compared to just sold
* You know what your inventory is at the beginning of the period, you know what you purchaser during the period, and you can count your inventory at the end of the period, therefore you can calculate the amount of cost of goods sold.
* Beginning Inventory + Purchases - Ending Inventory = Cost of Goods Sold
Perpetual Inventory:
* Pro: Management reports about sales, tracks shrinkage (stolen goods), assists in inventory purchasing (automated ordering and Just-in-Time inventory systems
* Con: Expensive and time consuming
* Record a sale, record the cost of goods sold .... record a sale, record the cost of goods sold
Expenditures Included in Inventory:
* All necessary expenditures to acquire and bring the inventory to its desired location and desired condition for sale
> Product Costs
> Shipping Expenses Paid
> less Purchase Returns
> less Purchase Discounts
* Purchase Discounts may reduce CGS (Periodic) or Inventory (Perpetual). For our class it will always reduce inventory.
Know Inventory Cost Flow Methods of both periodic and perpetual for:
Last-In-First-Out (LIFO)
First-In-First-Out (FIFO) - perpetual and periodic will give you the same answer
Weighted Average
LIFO Liquidation:
* One or more "layers" (quantities of inventory at a given price) will accumulate of time as the company always maintains a certain quantity of inventory.
* To increase net income, the company may select to not purchase as much inventory and use up some or all of a LIFO "layer" which, if the inventory is old and at a much cheaper price, will artificially increase gross margin and net income
* If a LIFO liquidation occurs, the company should disclose this information in a disclosure note
FIFO / LIFO Considerations:
* If inventory prices are generally increasing, then FIFO will provide a higher net income and higher total assets.
* If inventory prices are generally decreasing, then LIFO will provide a higher net income and higher total assets.
* If you are a manager/accountant for a public company, you will most likely focus on higher net income and higher total assets
* If you are a manager/accountant for a private company, you will most likely focus on lower net income and lower total assets (lower taxes)
Purchasing Manager Manipulations:
*With LIFO Periodic and Weighted Average Periodic, a final large purchasing amount may drastically affect the declared amount of cost of goods sold and ending inventory
Which is better, LIFO or FIFO?
* LIFO provides more accurate and timely information on the income statement as the cost of goods sold is comprised of more currently priced inventory items
* FIFO provides more accurate and timely information on the balance sheet as the inventory account is comprised of more currently priced inventory items
* To assist in equalizing the information, when analyzing a company look to see what inventory method they use (LIFO or FIFO), then rely on the information that is more accurate to calculate a better average value per inventory item.
Gross Profit Method:
* Not a Generally Accepted Accounting Principle (GAAP) for calculating inventory
* Provides a good estimate for inventory for a quick management analysis or perhaps an insurance claim
* Tests your knowledge of:
> The inventory formula (Beginning Inventory + Purchases - Cost of Goods Sold = Ending Inventory)
> Gross Profit Formula (Sales - Cost of Goods Sold = Gross Profit)
Inventory Ratio/Calculation Analysis:
* These problems test your understanding and ability to apply the following formulas
> Inventory Turnover = Cost of Goods Sold / Average Inventory
> Sales - CGS = Gross Profit
> Inventory Formula (Sales - Cost of Goods Sold = Gross Profit)
* Be able to calculate sales and purchases by using provided information to complete these formulas
Discounting a Note Receivable:
* We are addressing shorter term notes where all of the interest will be paid upon maturity of the note.
1) To discount a note, first find the total value of the note (principal + total interest to be paid upon maturity)
2) Discount the note by multiplying the total value of the note by the bank's discount rate multiplied by the remaining time left until the note matures. This number is the amount by which the bank ultimately benefits from undertaking this note.
3) Subtract the ultimate from #2 above from #1 above to find the amount of cash that the bank will pay you for the note.
4) Calculate the interest revenue that you have benefited from holding the note (remember that you still receive revenue, despite not being paid in cash by borrower).
5) Subtract the total value of the note (#1 above) from the principal amount plus the interest revenue calculated in #4 above, this amount is your loss. There will always be a loss (even though some manager will try to convince you that you still have a gain).
** This seems complicated in writing, but give the problem on the study guide a try, that is the best way to be comfortable with this methodology.**
Lower of Cost or Market
* Required by GAAP
* Conservative approach
* We should write-down inventory periodically if the value of the inventory is lower than the original cost. How do we calculate?
* Three amounts to calculate:
> Net Realizable Value (NRV) = Selling price minus applicable selling costs
> Replacement Cost = The amount at which you could repurchase the inventory
> Net Realizable Value (NRV) minus a Normal Profit = NRV less a regular profit from the sale
* After calculating the three amounts above, put them in numerical order and select the one in the middle - this amount represents the new ending inventory amount. You will take an Inventory Write-Down (an expense) and reduce inventory by an amount which will bring your historic cost down to this new ending inventory amount.
* Remember that the Normal Profit margin is normally calculated using a percentage of the Sales Price, not the NRV
Categories for Testing for Inventory Write-Downs
> Individually - you may look at every each inventory item separately. This will be the timely and labor-intensive approach, but will result in the highest write-down, which could be advantageous for a private company.
> Group - a middle of the road approach where inventory is grouped into very similar 'buckets' and each 'bucket' is reviewed for possible write-downs
> Composite - the collection of many types of inventory. This will be the least timely and labor-intensive approach and result in the smallest possibility for inventory write-downs, if at all.
Retail Terminology:
Initial Markup - The amount by which inventory is initially marked up when placed out for sale
Additional Markup - An increase in the price above the initial markup
Markup Cancellation - A reduction of the price, but still at or above the initial markup
Markdown - A reduction of the price below the initial markup
Markdown cancellation - An increase in the price, but still at or below the initial markup
Good Luck on the Exam!!!
See you Thursday!
|
|