ACC 207 class Fall 2005 I am posting a brief study guide here. This is a review of Chapters 7 to 11. However the summaries below cover the entire chapter. Please leave out those parts of the chapters and those topics we did not cover. I gave you the page numbers in class. BRIEF CHAPTER OUTLINE Chapter 7 I BUSINESS BACKGROUND II NATURE OF INVENTORY AND COST OF GOODS SOLD (LO 1) A. Items Included in Inventory B. Flow of Inventory Costs C. Nature of Cost of Goods Sold III INVENTORY COSTING METHODS (LO 2, 3, 4, 5) A. Specific Identification Method B. Cost Flow Assumptions 1. First-In, First-Out Method 2. Last-In, First-Out Method 3. Average Cost Method C. Financial Statement Effects of Inventory Methods D. Managers' Choice of Inventory Methods E. Inventory Methods and Financial Statement Analysis F. Valuation at Lower of Cost or Market IV EVALUATING INVENTORY MANAGEMENT (LO 6) A. Measuring Efficiency in Inventory Management V CONTROL OF INVENTORY (LO 7) A. Errors in Measuring Ending Inventory B. Perpetual and Periodic Inventory Systems VI CHAPTER SUPPLEMENTS A. LIFO Liquidations 1. Financial Statement Effects of LIFO Liquidations 2. LIFO Liquidations and Financial Statement Analysis B. Additional Issues in Measuring Purchases 1. Purchase Returns and Allowances 2. Purchase Discounts C. Comparison of Perpetual and Periodic Inventory Systems WHAT’S NEW IN THIS EDITION Updated all information on Harley-Davidson New LIFO, FIFO, and weighted average inventory graphics Simplified approach to the effects of LIFO and FIFO on financial statement analysis Inventory errors and accounting systems combined in new section on control of inventory Journal entries for periodic inventory system moved to chapter supplement CHAPTER SUMMARY Costs flow into inventory when goods are purchased or manufactured and flow out when the goods are sold. In conformity with the matching principle, the total cost of the goods sold during the period must be matched with the sales revenue earned during the period. Cost of Goods Sold measures the cost of inventory that was sold while Sales Revenue measures the selling price of the same inventory. When cost of goods sold is deducted from sales revenue for the period, the difference is called gross profit or gross margin on sales. From this amount, the remaining operating expenses must be deducted to derive net income. This chapter focuses on the problem of measuring cost of goods sold and ending inventory when unit costs change during the period. Inventory should include all the items held for resale that the entity owns. When there are different unit cost amounts, a rational and systematic method must be used to allocate costs to the units remaining in inventory and to the units sold. This chapter discusses four different inventory costing methods and their applications in different economic circumstances. The methods discussed are specific identification, FIFO, LIFO, and average cost. Each of the inventory costing methods is in conformity with GAAP. The selection of a method of inventory costing is important because it will affect reported income, income tax expense (and hence cash flow), and the inventory valuation reported on the balance sheet. In a period of rising prices, FIFO normally results in a higher net income than does LIFO; in a period of falling prices, the opposite result occurs. Public companies using LIFO provide footnote disclosures that allow conversion of inventory and cost of goods sold to FIFO amounts. Ending inventory should be measured on the basis of the lower of actual cost or replacement cost (LCM basis), which can have a major effect on the statements of companies facing declining costs. Also, damaged, obsolete, and deteriorated items in inventory should be assigned a cost that represents their current estimated net realizable value if that is below cost. Two inventory systems are discussed for keeping track of the ending inventory and cost of goods sold for the period: (1) the perpetual inventory system, which is based on the maintenance of detailed and continuous inventory records for each kind of inventory stocked; and (2) the periodic inventory system, which is based on a physical inventory count of ending inventory and the costing of those goods to determine the proper amounts for cost of goods sold and ending inventory. CHAPTER LEARNING OBJECTIVES 1. Apply the cost principle to identify the amounts that should be included in inventory and the matching principle to determine costs of goods sold for typical retailers, wholesalers, and manufacturers. 2 Report inventory and cost of goods sold using the four inventory costing methods. 3. Decide when the use of different inventory costing methods is beneficial to a company. 4. Compare companies that use different inventory costing methods. 5. Report inventory at the lower of cost or market (LCM). 6. Evaluate inventory management using the inventory turnover ratio and the effects of inventory on cash flows. 7. Analyze the effects of inventory errors on financial statements and methods for keeping track of inventory. BRIEF CHAPTER OUTLINE Chapter 8 I BUSINESS BACKGROUND II ACQUISITION AND MAINTENANCE OF PLANT AND EQUIPMENT (LO 1, 2) A. Classifying Long-Lived Assets B. Measuring and Recording Acquisition Cost C. Repairs, Maintenance, and Additions III USE, IMPAIRMENT, AND DISPOSAL OF PLANT AND EQUIPMENT (LO 3, 4, 5) A. Depreciation Concepts B. Alternative Depreciation Methods C. How Managers Choose D. Measuring Asset Impairment E. Disposal of Property, Plant, and Equipment IV NATURAL RESOURCES AND INTANGIBLE ASSETS (LO 6) A. Acquisition and Depletion of Natural Resources B. Acquisition and Amortization of Intangible Assets V CHAPTER SUPPLEMENT A A. Changes in Depreciation Estimates WHAT’S NEW IN THIS EDITION Reorganized the chapter to improve the flow of topics Updated all information for Delta Airlines Added more visual illustrations of key concepts Shifted ratio analysis earlier to reinforce the use of accounting information in analytic decisions Deleted discussion and illustration of acquisition by a basket purchase to simplify the content Moved discussion of changes in depreciation estimates to a chapter supplement to simplify the content Shifted cash flow effects to later in the chapter New Financial Analysis segment on WorldCom CHAPTER SUMMARY This chapter discusses accounting for long-lived productive assets. These are the noncurrent assets that a business retains for long periods of time for use in the course of normal operations rather than being held for sale. They include tangible assets and intangible assets. At acquisition, an asset is recorded at cost. Cost includes the cash equivalent purchase price plus all reasonable and necessary expenditures made to acquire and prepare the asset for its intended use. Expenditures related to long-lived assets are classified in two groups. Capital expenditures are those expenditures that provide benefits for one or more accounting periods beyond the current period; therefore, they are debited to appropriate asset accounts and depreciated, depleted, or amortized over their useful lives. Revenue expenditures are those expenditures that provide benefits during the current accounting period only; therefore, they are debited to appropriate expense accounts when incurred. A long-lived productive asset represents a bundle of future services and benefits that have been paid for in advance. As this asset is used, this bundle of services is gradually used to earn revenue. In conformity with the matching principle, cost (less any estimated residual value) is allocated to expense over the periods benefited. In this way, the expense associated with the use of operational assets is matched with the revenues earned. This allocation process is called depreciation in the case of property, plant, and equipment; depletion in the case of natural resources; and amortization in the case of intangibles. Three of the most widely used methods of depreciation are straight-line, units-of-production, and declining-balance. The disposal of long-lived assets is recorded by removing the cost of the asset and the related accumulated depreciation account. A gain or loss on the disposal will result when the disposal price is different from the book value of the asset. When an asset’s ability to provide benefits in the future is impaired, the asset is written down. CHAPTER LEARNING OBJECTIVES 1. Define, classify, and explain the nature of long-lived productive assets and interpret the fixed asset turnover ratio. 2. Apply the cost principle to measure the acquisition and maintenance of property, plant, and equipment. 3. Apply various cost allocation methods as assets are held and used over time. 4. Explain the effect of asset impairment on the financial statements. 5. Analyze the disposal of property, plant, and equipment. 6. Apply measurement and reporting concepts for natural resources and intangible assets. 7. Explain the impact on cash flows of acquiring, using, and disposing of long-lived assets. BRIEF CHAPTER OUTLINE Chapter 9 I BUSINESS BACKGROUND II LIABILITIES DEFINED AND CLASSIFIED (LO 1, 2) III CURRENT LIABILITIES (LO 3, 4, 5, 6) A. Accounts Payable B. Accrued Liabilities C. Notes Payable D. Current Portion of Long-Term Debt E. Deferred Revenues F. Estimated Liabilities Reported on the Balance Sheet G. Estimated Liabilities Reported in the Notes H. Working Capital Management IV LONG-TERM LIABILITIES (LO 7) A. Long-Term Notes Payable and Bonds B. Lease Liabilities V PRESENT AND FUTURE VALUE CONCEPTS (LO 8) A. Future and Present Values of a Single Amount B. Future and Present Values of an Annuity VI ACCOUNTING APPLICATIONS OF FUTURE AND PRESENT VALUES (LO 9) VII CHAPTER SUPPLEMENTS A. Income Taxes and Retirement Benefits 1. Deferred Taxes 2. Accrued Retirement Benefits B. Federal Income Tax Concepts 1. Calculation of Taxes Payable 2. Revenue and Expense Recognition for Income Tax Purposes 3. Tax Minimization Versus Tax Evasion WHAT’S NEW IN THIS EDITION Reorganized discussion of current liabilities Revised discussion of accrued liabilities Revised discussion of estimated liabilities Improved discussion of working capital management Expanded discussion of lease liabilities Moved discussion of deferred taxes and retirement benefits to chapter supplement Simplified presentation of present values and future values Eliminated discussion of contra accounts and debt issued at a discount Eliminated presentation of debt amortization schedule Changed location of cash flow discussion to provide users with greater flexibility CHAPTER SUMMARY Liabilities are obligations of either a known or estimated amount. Detailed information about the liabilities of an entity is important to many decision makers, whether internal or external to the enterprise, because liabilities represent claims against the resources of an entity. The existence and amount of liabilities sometimes are easy to conceal from outsiders. The accounting model and the verification by an independent CPA are the best assurances that all liabilities are disclosed. Current liabilities are short-term obligations that will be paid within the coming year or within the normal operating cycle of the business, whichever is longer. All other liabilities (except contingent liabilities) are reported as long-term liabilities. A contingent liability is a potential claim due to some event or transaction that has happened, but whether it will materialize as an effective liability is not certain because that depends on some future event or transaction. At the end of the accounting period, a contingent liability must be recorded (as a debit to a loss account and a credit to a liability account) if (a) it is probable that a loss will occur and (b) if the amount of the loss can be reasonably estimated. Contingent liabilities that are reasonably possible must be disclosed in the notes to the financial statements. Future and present value concepts often must be applied in accounting for liabilities. These concepts focus on the time value of money (i.e., interest). Future value is the amount that a principal amount will increase to in the future due to compound interest. Present value is the amount that a future principal amount is worth today. It is computed with a process of compound discounting of future cash flows. Future and present values are related to (a) a single amount or (b) a series of equal periodic amounts (called annuities). Typical applications of future and present values are to create a fund, determine the cost of an asset, account for notes payable, and account for installment debts and receivables. CHAPTER LEARNING OBJECTIVES 1. Define, measure, and report current liabilities. 2. Use the current ratio. 3. Analyze the accounts payable turnover ratio. 4. Report notes payable and explain the time value of money. 5. Report contingent liabilities. 6. Explain the importance of working capital and its impact on cash flows. 7. Report long-term liabilities. 8. Apply the concepts of the future and present values. 9. Apply present value concepts to liabilities. BRIEF CHAPTER OUTLINE Chapter 10 I BUSINESS BACKGROUND (LO 1) II CHARACTERISTICS OF BONDS PAYABLE (LO 1) III REPORTING BOND TRANSACTIONS (LO 2, 3) A. Bonds Issued at Par B. Bonds Issued at a Discount C. Bonds Issued at a Premium IV ADDITIONAL TOPICS (LO 4, 5, 6) A. Effective-Interest Amortization B. Early Retirement of Debt WHAT’S NEW IN THIS EDITION Simplified discussion of financial leverage Improved graphics to enhance understanding Simplified discussion of the process of issuing a bond Improved focus of discussion of types of bonds Simplified present value presentation Eliminated discussion of bonds issued at a variable interest rate Eliminated discussion of bond sinking fund Simplified discussion of early retirement of debt Discussion of bond investments moved to chapter 12 Changed location of cash flow discussion to provide users with greater flexibility CHAPTER SUMMARY This chapter discusses bonds payable, which represent a primary way for corporations to obtain funds to acquire long-term assets and to expand a business. An important advantage of bonds payable is that the cost of borrowing the funds - interest expense - is deductible on the income statement (and for income tax purposes) which reduces the interest cost to the business. Bonds may be sold at their par amount, at a premium, or at a discount, depending on the stated interest rate on the bonds compared with the market rate of interest. In each case, bonds are recorded at the present value of their future cash flows. The issue price of a bond varies based on the relationship between the market rate and stated rate of interest. If the stated rate is higher than the market rate on the bond, the bonds will sell at a premium. Conversely, if the stated rate is lower than the market rate on the bond, the bonds will sell at a discount. If the stated rate and the market rate on the bonds are the same, the bonds will sell at par. Discounts and premiums on bonds payable are adjustments to interest expense for the issuing company during the term of the bonds. Therefore, the discount or premium on bonds payable is amortized over the period outstanding from issue date to maturity date. BRIEF CHAPTER OUTLINE Chapter 11 I BUSINESS BACKGROUND II OWNERSHIP OF A CORPORATION (LO 1, 2) A. Authorized, Issued, and Outstanding Shares III COMMON STOCK TRANSACTIONS (LO 3) A. Initial Sale of Stock B. Sale of Stock in Secondary Markets C. Stock Issued for Noncash Assets or Services D. Stock Issued for Employee Compensation E. Repurchase of Stock IV DIVIDENDS ON COMMON STOCK (LO 4, 5) V STOCK DIVIDENDS AND STOCK SPLITS (LO 6) A. Stock Dividends B. Stock Splits VI PREFERRED STOCK (LO 7) A. Dividends on Preferred Stock VII RESTRICTIONS ON RETAINED EARNINGS VIII CHAPTER SUPPLEMENT A. Accounting for Owners' Equity for Sole Proprietorships and Partnerships 1. Owner's Equity for a Sole Proprietorship 2. Owners' Equity for a Partnership WHAT’S NEW IN THIS EDITION New focus company (Outback Steakhouse) Improved presentation of issued and outstanding stock Simplified discussion of par value and legal capital Re-organized discussion of the sale of common stock Simplified discussion of initial public offerings Separated the discussion of common and preferred stock to achieve greater clarity Changed location of cash flow discussion to provide users with greater flexibility Improved and simplified discussion of dividends on preferred stock Simplified discussion of retained earnings Eliminated discussion of dividend payout ratio Added discussion of earnings per share ratio CHAPTER SUMMARY This chapter discusses accounting for owners' equity for corporations. Sole proprietorships and partnerships are discussed in Chapter Supplement A. Except for owners' equity items and details, accounting is basically unaffected by the type of business organization. Each specific source of owners' equity should be accounted for separately. The two basic sources of owners' equity for a corporation are contributed capital and retained earnings. Separate accounts are kept for each element of capital stock. A corporation may purchase its own stock in the marketplace. Stock previously issued by the corporation and subsequently reacquired is known as treasury stock as long as it is held by the issuing corporation. The purchase of treasury stock is viewed as a contraction of corporate capital, and the subsequent resale of the treasury stock is viewed as an expansion of corporate capital. The earnings of a corporation that are not retained for business growth and expansion are distributed to the stockholders by means of dividends. Dividends are paid only after dividends are declared by the board of directors of the corporation. A cash dividend results in a decrease in assets (cash) and a commensurate decrease in stockholders' equity (retained earnings). In contrast, a stock dividend does not change assets, liabilities, or total stockholders' equity. A stock dividend results in a transfer of retained earnings to the permanent or contributed capital of the corporation. Therefore, a stock dividend affects only certain account balances within stockholders' equity. A stock split affects only the par value of the stock and the number of shares outstanding; the individual equity account balances are not changed. CHAPTER LEARNING OBJECTIVES 1. Explain the role of stock in the capital structure of a corporation. 2. Analyze the earnings per share ratio. 3. Describe the characteristics of common stock and analyze transactions affecting common stock. 4. Discuss dividends and analyze transactions. 5. Analyze the dividend yield ratio. 6. Discuss the purpose of stock dividends, stock splits, and report transactions. 7. Describe the characteristics of preferred stock and analyze transactions affecting preferred stock 8. Discuss the impact of capital stock transactions on cash flows. CHAPTER LEARNING OBJECTIVES 1. Describe the characteristics of bonds and use the debt-to-equity ratio. 2. Report bonds payable and interest expense, with bonds sold at par, at a discount and at a premium. 3. Analyze the times interest earned ratio. 4. Use the effective-interest method of amortization. 5. Report the early retirement of bonds. 6. Explain how financing activities are reported in the statement of cash flows.
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