Receivables, Inventory, Plant Assets, and Investments: Study Guide for Financial Accounting

Chapter 5: Receivables and Revenue

Revenue Recognition

Revenue is recognized when a company satisfies its performance obligation to a customer, typically when goods or services are delivered.

• Performance Obligation: A promise to transfer a good or service to a customer.

• Revenue Recognition Criteria: Revenue is recognized when control of the good or service passes to the customer.

• Example: If a company ships goods FOB shipping point, revenue is recognized when the goods leave the seller's premises.

Shipping Terms

• FOB Shipping Point: Buyer takes ownership when goods leave the seller's location.

• FOB Destination: Buyer takes ownership when goods arrive at the buyer's location.

• Impact: Determines when revenue is recognized and who bears shipping risk.

Sales Discounts, Returns, and Allowances

• Sales Discounts: Reductions in price for early payment (e.g., 2/10, n/30 means 2% discount if paid within 10 days).

• Sales Returns & Allowances: Reductions in revenue for returned goods or price adjustments. Accounted for in the month of sale.

• Net Revenue Calculation: Net revenue = Gross sales - Sales discounts - Sales returns & allowances.

• Example: If gross sales are $10,000, discounts are $200, and returns are $300, net revenue is $9,500.

Types of Receivables

• Trade Receivables: Amounts owed by customers from sales of goods/services.

• Non-Trade Receivables: Amounts owed from sources other than customers (e.g., interest receivable, loans to employees).

Accounting for Accounts Receivable

• Increase: Sales on account increase accounts receivable.

• Decrease: Collections from customers and write-offs decrease accounts receivable.

Allowance Method for Uncollectible Accounts

• Allowance for Doubtful Accounts: A contra-asset account used to estimate uncollectible receivables.

• Journal Entry:

  • To record estimated uncollectibles: $\text{Bad Debt Expense} \quad \text{Dr.} \\ \text{Allowance for Doubtful Accounts} \quad \text{Cr.}$

• Net Realizable Value (NRV): The amount expected to be collected: $\text{NRV} = \text{Accounts Receivable} - \text{Allowance for Doubtful Accounts}$

Methods for Estimating Uncollectibles

• Percent-of-Sales Method: Estimate bad debts as a percentage of credit sales.

• Aging-of-Receivables Method: Estimate based on the age of each receivable.

Writing Off Uncollectible Accounts

• Write-Off Entry: $\text{Allowance for Doubtful Accounts} \quad \text{Dr.} \\ \text{Accounts Receivable} \quad \text{Cr.}$

• Effect on NRV: No effect; both accounts decrease by the same amount.

Notes Receivable

• Interest Calculation: $\text{Interest} = \text{Principal} \times \text{Rate} \times \text{Time}$

• Maturity Value: $\text{Maturity Value} = \text{Principal} + \text{Interest}$

• Accruing Interest: At period-end, accrue interest earned but not yet received.

• Failure to Accrue: Understates assets and income.

Receivables Ratios

• Quick (Acid-Test) Ratio: Measures liquidity. $\text{Quick Ratio} = \frac{\text{Cash} + \text{Short-term Investments} + \text{Receivables}}{\text{Current Liabilities}}$

  • Higher is better; indicates greater ability to pay short-term obligations.

• Days' Sales Outstanding (DSO): Average days to collect receivables. $\text{DSO} = \frac{365}{\text{Receivables Turnover Ratio}}$

  • Lower is better; indicates faster collection.

Excel and AR Analysis

• Pivot Tables: Useful for summarizing and analyzing accounts receivable data, such as aging and collection patterns.

Chapter 6: Inventory and Cost of Goods Sold

Inventory Cost

• Included Costs: Purchase price, freight-in, insurance, taxes, and any costs to prepare inventory for sale.

Special Inventory Arrangements

• Consignment: Goods held for sale by one party (consignee) but owned by another (consignor). Consignor reports inventory until sold.

Cost of Goods Sold (CoGS)

• Definition: The cost of inventory sold during the period.

• Account Type: Expense account, reported on the income statement.

Perpetual Inventory System

• Characteristics: Continuously updates inventory and CoGS with each purchase and sale.

Periodic Inventory System

• CoGS Calculation: $\text{CoGS} = \text{Beginning Inventory} + \text{Purchases} - \text{Ending Inventory}$

Inventory Costing Methods

• FIFO (First-In, First-Out): Oldest inventory costs assigned to CoGS; ending inventory reflects recent costs.

• LIFO (Last-In, First-Out): Most recent inventory costs assigned to CoGS; ending inventory reflects older costs.

• Average Cost: CoGS and ending inventory based on weighted average cost per unit.

Effect on Financial Statements

• During Rising Prices: FIFO yields higher net income and ending inventory; LIFO yields lower net income and ending inventory.

Lower-of-Cost-or-Market (LCM) Rule

• Application: Inventory is reported at the lower of its historical cost or market value to reflect potential losses from obsolescence.

Gross Profit and Gross Profit Percent

• Gross Profit: $\text{Gross Profit} = \text{Net Sales} - \text{CoGS}$

• Gross Profit Percent: $\text{Gross Profit Percent} = \frac{\text{Gross Profit}}{\text{Net Sales}} \times 100\%$

  • Higher is generally better; indicates profitability of core operations.

Inventory Turnover

• Formula: $\text{Inventory Turnover} = \frac{\text{CoGS}}{\text{Average Inventory}}$

  • Higher is better; indicates efficient inventory management.

Chapter 7: Plant Assets, Natural Resources, and Intangibles

Capitalization of Costs

• To Capitalize: Record a cost as an asset rather than an expense, if it provides future economic benefit.

Characteristics of Plant Assets

• Definition: Long-term tangible assets used in operations (e.g., land, buildings, equipment).

• Depreciable (except land): Plant assets (except land) are depreciated over their useful lives.

Capitalizable Costs by Asset Type

Asset Type	Capitalizable Costs
Land	Purchase price, legal fees, grading, demolition (less salvage)
Land Improvements	Driveways, fences, landscaping
Building	Purchase/construction cost, permits, architect fees
Equipment	Purchase price, installation, testing, delivery

Lump-Sum (Basket) Purchases

• Definition: Purchase of multiple assets for one price; allocate cost based on relative fair values.

Capital Expenditure vs. Immediate Expense

• Capital Expenditure: Increases asset's value or extends useful life; capitalized.

• Immediate Expense: Maintains asset's current condition; expensed immediately.

Depreciation

• Definition: Systematic allocation of asset's cost over its useful life.

• Required Information: Cost, estimated useful life, estimated residual value.

Accumulated Depreciation

• Definition: Total depreciation recorded to date; contra-asset account.

Depreciation Methods

• Straight-Line: $\text{Annual Depreciation} = \frac{\text{Cost} - \text{Residual Value}}{\text{Useful Life}}$

• Units-of-Production: $\text{Depreciation per Unit} = \frac{\text{Cost} - \text{Residual Value}}{\text{Total Estimated Units}}$ Annual Depreciation = Depreciation per Unit × Units Produced

• Double-Declining Balance (DDB): $\text{DDB Depreciation (Year 1)} = \text{Cost} \times \frac{2}{\text{Useful Life}}$

  • DDB accelerates depreciation; higher expense in early years.

Book Value

• Definition: Asset's cost minus accumulated depreciation.

Sale of Plant Assets

• Journal Entry: Remove asset and accumulated depreciation; record cash received and gain/loss.

Intangible Assets

• Characteristics: Non-physical assets (e.g., patents, copyrights, trademarks).

• Amortization: Systematic allocation of cost over useful life (if finite).

• Examples: Patents (amortized), trademarks (not amortized if indefinite).

Goodwill

• Definition: Excess of purchase price over fair value of net assets acquired in a business combination.

• Amortization: Not amortized; tested for impairment.

Impairment

• Definition: Permanent decline in value of an asset; asset is written down to fair value.

Return on Assets (ROA)

• Formula: $\text{ROA} = \frac{\text{Net Income}}{\text{Average Total Assets}}$

  • Higher is better; indicates efficient use of assets.

Excel Functions for Depreciation

• SLN: Straight-line depreciation.

• DDB: Double-declining balance depreciation.

• SYD: Sum-of-years-digits depreciation.

ESG and Plant Assets

• ESG Issues: Environmental, social, and governance factors can affect asset valuation, useful life, and impairment (e.g., environmental regulations may require earlier asset retirement).

Appendix E: Investments

Reporting Basis for Investments

• Original Reporting Basis: Investments are initially recorded at cost on the purchase date.

• Subsequent Reporting: Depends on investment type (e.g., fair value for trading securities, equity method for significant influence).