Accounting – Miscellaneous Notes

Investment Activities

For example, lending monies to a third party would be an increase in notes receivable and a cash outflow from investing activities. Investing activities arise from the acquisition and sale of assets such as buildings, equipment, and land.
 

Financing Activities

Financing activities relate to transactions with creditors and owners. Cash receipts from financing activities arise from bonds, mortgages, notes, and other long-term borrowing as well as the sale of common stock. Thus, repayment of a note payable would be a cash outflow for financing in that period.
 

Operating Activities

Operating activities are those transactions and events directly related to the regular production and delivery of goods and services to customers. Cash flows from operations are the cash effects of the transactions that impact net income. Included are the cash receipts from the sale of goods or services and cash payments for expenses such as merchandise inventory, wages, supplies, interest, taxes, and the like.

Step 1(a) – Calculate the Change in Cash;
 
Step 1(b) – Calculate the Change in Each Noncash Account;
 
Step 2(a) – Calculate Cash Flows from Operating Activities
The indirect method begins with net income and makes adjustments to remove the noncash revenues and expenses. Indirect method commonly used to calculate cash flows from operations. Direct method makes the noncash adjustments directly to the revenue and expense accounts.

Step 2(b) – Calculate Cash Flows From Investing Activities

Step 2(c) – Calculate Cash Flows From Financing Activities.

BEGINNING RETAINED EARNINGS +(-) NET INCOME (LOSS) – DIVIDENDS = ENDING RETAINED EARNINGS

Noncash Transactions

Examples include purchasing property by signing a mortgage, paying a liability by conveying equipment, transferring land to a company in return for common stock, refinancing long-term debt, retiring bonds by issuing common stock, etc. Not included on SCF, on separate section.

Accounts Receivable

Record receivables at the amount expected to be collected in cash, charge against income expected, uncollectible amounts, sales discounts, and sales returns and allowances in the period when the sales occur.

• Uncollectible accounts

Direct write-off method – recognize losses from uncollectible accounts in the period when a firm decides specific customer accounts are uncollectible -does not recognize the loss from uncollectible accounts in the period in which revenue is recognized.

Allowance method – estimate the uncollectible accounts that will occur over time in connection with the sales of each period. Reduce income of the period to provide for the estimated uncollectible accounts (debit bad debit expense). Adjust the amount of accounts receivable so the balance sheet figure reports the amount expected to be collected (credit allowance for doubtful accounts). When a specific account is deemed uncollectible, the account is written off and the allowance is reduced; no effect on income (debit allowance for doubtful accounts and credit accounts receivable)

• Estimating uncollectibles

Percentage-of-sales method – record bad debt expense and credit allowance for a percentage of credit sales made during the period-the periodic provision for uncollectible accounts increases the allowance.

Aging-of-accounts-receivable method – classifies each customer’s account as to the length of time for which the account has be uncollected; the balance in the allowance is adjusted to reflect the balance which is indicated by the aging.

Intangibles

Assets which provide future benefits but have no physical form.

• Research and development – GAAP requires immediate expensing -future benefits for most R&D efforts are too uncertain to warrant capitalization.
• Patents – if purchased, the firm capitalizes the cost-if developed internally, the firm expenses the total cost of product development as required for all R&D.
• Advertising – "although GAAP allows capitalizing and then amortizing advertising costs, common practice immediately expenses all advertising costs, regardless of the timing of their impact." 
• Goodwill – arises from the purchase of one company or operating unit by another company-is the difference between the amount paid for the acquired company as a whole and the sum of the current values of its individual assets less its liabilities.

Liabilities

• Current liabilities – due within one year (operating cycle)
• Contingent liabilities – potential obligations for which it is (1) probable that a liability has been incurred and (2) the amount of the loss can be reasonably estimated. {examples: lawsuits, regulations (e.g., environmental laws)} transfer receivables with recourse -extensive footnote disclosures, "commitments and contingencies" found with liabilities on the balance sheet with no amount given
• Long-term liabilities with no explicit interest cost – shown on balance sheet at present value of future cash payments; impute the interest rate using the market value of the asset acquired in the transaction.

Inventories

• Beginning inventory + purchases – ending inventory = cost of goods sold.
• FIFO gives higher income, better for book purposes.
• LIFO gives lower income, better for tax purposes.
• Manufacturing inventories: Purchases go to Raw Materials (used in production); then to Work in Process. Once finished they go to Finished Goods; then once sold, to Cost of Goods Sold.

Plant, Equipment

• Acquisition Cost – includes invoice price, transportation costs, installation charges, all costs incurred before equipment is ready for use.
• Self-constructed assets – include labor, material, overhead, and interest paid during construction.
• Depreciation – allocate the cost of the asset to the period of its use.
  • Straight line method – [(cost – salvage value) / service life (years)]
  • Production/use method – [(cost – salvage value) / total units].
  • Declining-balance method – multiply net book value (cost – accumulated depreciation) by fixed percentage; cease depreciation when salvage value is reached.
  • Double-declining balance – rate equals twice the straight-line rate.
  • Sum-of-the-years’-digits method – [(cost – salvage value) x fraction]; fraction = [(number of years remaining in service life) / sum of all such numbers, i.e. (1+2+3+…n) or [n(n+1)/2])]. 
  • Accelerated cost recovery system – used only for tax purposes.
  • Changes in periodic depreciation – make no adjustment to past depreciation; spread the remaining un-depreciated balance less the new estimate of salvage value over the new estimate of remaining service life of the asset.
  • Repairs and maintenance – expenses of the period.
  • Improvements – improve the asset’s service potential, capitalized.
  • Retirement of Assets – remove the cost of the asset and related accumulated depreciation from the books; record the amount received from the sale; record gain or loss for difference between the proceeds and the book value.
  • Wasting Assets – record depletion using the units-of-production depletion method.