Land = ?Price + real estate commissions + property tax + clearing the landwe expense an expenditure ifit benefits only the current period. Ex Oil changeProperty, Plant, and EquipmentThe original cost of the asset + All expenditures necessary to get the asset ready for useDepreciationAllocation of an asset's cost to expense over time
Students sometimes mistake accounting depreciation as recording the decrease in value of an asset. Depreciation in accounting is not a valuation process. Rather, depreciation in accounting is an allocation of an asset's cost to expense over time.Depreciation MethodsThree common methods: Straight-line Declining-balance Activity-basedTax DepreciationAccelerated methods reduce taxable income more in the earlier years of an asset's lifeAmortizationAllocating the cost of intangible assets to expense is calledThree Methods of Asset DisposalSale, retirement, exchangeAs a method of asset Disposal: SaleMost common method to dispose of a long-term assetAs a method of asset Disposal: retirementOccurs when a long-term asset is no longer useful but cannot be soldAs a method of asset Disposal: exchangeOccurs when two companies trade long-term assetsReturn on AssetsIndicates the amount of net income generated for each dollar invested in assets
Return on Assets = Net income / average total assetsProfit margin:indicates the earnings per dollar of salesAsset turnovermeasures the sales per dollar of assets investedTwo-Step Impairment ProcessSTEP 1:Test for Impairment (Are future cash flows less than book value?)
STEP 2:If Impaired, Record Loss (Loss equals book value of asset in excess of fair value of asset)ImpairmentEstimated future cash flows (future benefits) generated for a long-term asset fall below its book value.Current LiabilitiesDue within one year or an operating cycleLong-Term LiabilitiesDue in more than one year or operating cycleOperating cycleOperating cycle = Time it takes to perform the activities that produce revenues (for example, buy inventory, sell to customers, and collect cash)Notes PayableNote signed by a firm promising to repay the amount borrowed plus interestInterest on notes is calculated as:Interest = Face value * Annual interest rate * Fraction of the yearWe record interest expense in the period in which we ______, rather than in the period in which we_____.We record interest expense in the period in which we incur it, rather than in the period in which we pay it.Line of credit:Informal agreement Permits a company to borrow up to a prearranged limit Recorded similar to notes payableCommercial paper:Borrowing from another company rather than a bank Sold with maturities ranging from 30 to 270 days Interest rate is usually lower than on a bank loanEmployee CostsFederal and state income taxesEmployees may have additional amounts withheld from their paychecks for health, dental, disability, and life insurance• Employees may also have amounts deducted for retirement or employee savings plansFICA taxes7.65% (6.2% + 1.45%)
Collectively, Social Security and Medicare taxesEmployer CostsAdditional (matching) FICA tax on behalf of the employee• Employers also pay federal and state unemployment taxes on behalf of employees FUTA and SUTAFringe benefits:Additional employee benefits paid for by the employer Health, dental, disability, and life insurance Contributions to retirement or savings plansDeferred revenues:liability account used to record cash received in advance of the sale or serviceSales tax payablesales taxes collected from customers by the sellerCurrent portion of long-term debtdebt that will be paid within the next yearSales taxes collected from customers by the seller are not an expense. Instead, they representcurrent liabilities payable to the governmentContingent LiabilitiesAn existing uncertain situation that might result in a loss depending on the outcome of a future eventSome students think the balance in the Warranty Liability account is always equal to Warranty Expense. Remember,the Warranty Liability account is increased when the estimated warranty liability is recorded, but then is reduced over time by actual warranty expenditures.Contingent Gains• An existing uncertain situation that might result in a gain
• In a lawsuit, the defendant faces a contingent liability, while the other side—the plaintiff—has a contingent gain
• Contingent gains are not recorded until the gain is certain
Nice example of conservatismUnlike contingent liabilities, contingent gains arenot recorded until the gain is certain and no longer a contingency.Liquidity Analysisrefers to having sufficient cash or other current assets to pay currently maturing debts
Lack of liquidity can result in financial difficulties or even bankruptcyThree liquidity measures:Working capital Current ratio Acid-test ratioWorking CapitalWorking capital = Current assets − Current liabilities
Measure of current assets remaining after paying current liabilities• A large positive working capital is an indicator of liquidity• Not the best measure of liquidity for comparing across companies, because the ratio does not control for the relative size of each companyCurrent RatioCurrent Ratio = Current assets / Current liabilities
As a general rule, a higher current ratio is better. However, a high current ratio is not always a positive signal.
The amount of current assets available for every $1 of current liabilities• The higher the current ratio, the greater the company's liquidity• A current ratio of, say, 1.5 indicates that for every dollar of current liabilities, the company has $1.50 of current assetsAcid-Test Ratio= Cash + Current investments + Accounts receivable / Current liabilities
The amount of "quick assets" available for every $1 of current liabilities• Quick assets are current assets more readily convertible to cash Exclude current assets such as inventory and prepaid rent• By excluding less liquid current assets, the acid-test ratio may provide a better overall indication of a company's liquidityremember: Working capital is the difference between current assets and current liabilities. The current ratio is equal to current assets divided by current liabilities. The acid-test ratio is equal to quick assets (cash, current investments, and accounts receivable) divided by current liabilities. Each measures a company's liquidity, its ability to pay currently maturing debts.Key point
