Book cover for Intermediate Accounting

Intermediate Accounting

Donald E. Kieso, Jerry J. Weygandt, Terry D. Warfield

ISBN #9780470374948

13th Edition

695 Questions

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7,109 Students Helped

Homework Questions

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Summary
Learning Objectives
Key Concepts
Example Problems
Explanations
Common Mistakes

Summary

This chapter covers asset management in financial reporting, with a focus on cash, receivables, and inventory. It emphasizes the classification, recognition, and valuation of these assets, and details methods such as the allowance method for receivables and key inventory valuation techniques like LIFO and FIFO. Mastery of these methods is essential for accurate financial analysis and informed decision-making.

Learning Objectives

1

Describe the classification, recognition, and valuation of cash, receivables, and inventories.

2

Explain the methods of accounting for discounts, bad debts, and factoring in financial reporting.

3

Compare inventory valuation methods such as LIFO and FIFO and discuss their impacts on the income statement and balance sheet.

4

Analyze the application of the allowance method for receivables in estimating bad debts.

5

Apply asset management techniques to support accurate financial analysis and decision-making.

Key Concepts

CONCEPT

DEFINITION

Cash and Receivables

Liquid assets including cash on hand, bank balances, and amounts owed by customers, subject to recognition and valuation rules in financial reporting.

Allowance Method

An accounting technique used to estimate and record potential bad debts from receivables by establishing an allowance based on historical data or expected loss percentages.

Discounts

Reductions in the recorded value of receivables offered as incentives for early payment or to reflect potential losses, influencing the net realizable value of assets.

Bad Debts

Portions of receivables that are expected to be uncollectible, requiring estimation and adjustment in financial statements through methods such as the allowance method.

Factoring

A financial transaction where receivables are sold to a third party at a discount, transferring the risk and management of collection.

Inventory Valuation

The process of assigning costs to a company’s inventory, which affects the cost of goods sold and the valuation of inventory on the balance sheet.

LIFO (Last-In, First-Out)

An inventory valuation method assuming that the most recently acquired items are sold first, often impacting the cost of goods sold during periods of rising prices.

FIFO (First-In, First-Out)

An inventory valuation method that assumes the oldest inventory items are sold first, typically leading to a different impact on profits compared to LIFO.

Example Problems

Example 1

What may be included under the heading of "cash"?

Example 2

In what accounts should the following items be classified? (a) Coins and currency. (b) U.S. Treasury (government) bonds. (c) Certificate of deposit. (d) Cash in a bank that is in receivership. (e) $\mathrm{NSF}$ check (returned with bank statement). (f) Deposit in foreign bank (exchangeability limited). (g) Postdated checks. (h) Cash to be used for retirement of long-term bonds. (i) Deposits in transit. (j) 100 shares of Dell stock (intention is to sell in one year or less). (k) Savings and checking accounts. (l) Petty cash. $(\mathrm{m})$ Stamps. (n) Travel advances.

Example 3

Define a "compensating balance." How should a compensating balance be reported?

Example 4

Springsteen Inc. reported in a recent annual report "Restricted cash for debt redemption." What section of the balance sheet would report this item?

Example 5

What are the reasons that a company gives trade discounts? Why are trade discounts not recorded in the accounts like cash discounts?
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Step-by-Step Explanations

QUESTION

How do you apply the allowance method to estimate and adjust for bad debts in receivables?

STEP-BY-STEP ANSWER:

Step 1: Assess historical data or use industry benchmarks to estimate a percentage of receivables likely to become uncollectible.
Step 2: Multiply the total receivables by this estimated percentage to determine the bad debt expense.
Step 3: Record the bad debt expense and adjust the allowance for doubtful accounts accordingly.
Step 4: Reflect the adjusted net receivables on the balance sheet and corresponding expense on the income statement.
Final Answer: The allowance method involves estimating uncollectible receivables based on historical trends, recording an expense to match potential losses, and adjusting the net realizable value of receivables on the balance sheet.

Allowance Method for Receivables

QUESTION

How do you calculate the inventory value and cost of goods sold using the LIFO method?

STEP-BY-STEP ANSWER:

Step 1: Identify the most recent inventory purchases, as these are assumed to be the first sold under LIFO.
Step 2: Calculate the cost of goods sold based on current inventory costs for the items sold.
Step 3: Remove the cost of the most recent items from the inventory records.
Step 4: Determine the remaining inventory value using the older cost layers.
Final Answer: LIFO assumes that the latest inventory additions are sold first, which typically results in a higher cost of goods sold during inflationary periods, leaving older costs in inventory.

LIFO Inventory Valuation

QUESTION

How do you determine the cost of goods sold and ending inventory using FIFO?

STEP-BY-STEP ANSWER:

Step 1: Identify the earliest acquired inventory items, as these are assumed to be sold first under FIFO.
Step 2: Calculate the cost of goods sold based on the cost of these older inventory items.
Step 3: Retain the cost of the more recently purchased items in the ending inventory.
Step 4: Reflect the different cost flows on the income statement and balance sheet accordingly.
Final Answer: FIFO assumes that the oldest inventory is sold first, often resulting in a lower cost of goods sold during periods of rising prices and a higher ending inventory value.

FIFO Inventory Valuation

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Common Mistakes

  • Confusing the treatment of discounts, bad debts, and factoring methods within receivables management.
  • Overlooking the proper application of the allowance method, leading to misstatement of net receivables.
  • Failing to understand the impact of cost flow assumptions in LIFO and FIFO on financial statements.
  • Assuming that inventory valuation techniques have minimal impact on both the income statement and balance sheet.