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    Seminar Week 5 (Lecture Slides Chapter 8)

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    palekingye
    This document provides an overview of accounting for selected assets including accounts receivable, inventory, property, plant and equipment, and intangible assets. It discusses the direct write-off and allowance methods for handling bad debts in accounts receivable. For inventory, it covers valuation at the lower of cost or net realizable value and methods for determining cost including FIFO, weighted average, and LIFO. It also discusses depreciation methods including straight-line, reducing balance, and units-of-production for allocating the cost of non-current assets over multiple periods.

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    Seminar Week 5 (Lecture Slides Chapter 8)

    Uploaded by

    palekingye
    15 views38 pages
    This document provides an overview of accounting for selected assets including accounts receivable, inventory, property, plant and equipment, and intangible assets. It discusses the direct write-off and allowance methods for handling bad debts in accounts receivable. For inventory, it covers valuation at the lower of cost or net realizable value and methods for determining cost including FIFO, weighted average, and LIFO. It also discusses depreciation methods including straight-line, reducing balance, and units-of-production for allocating the cost of non-current assets over multiple periods.

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    This document provides an overview of accounting for selected assets including accounts receivable, inventory, property, plant and equipment, and intangible assets. It discusses the direct write-off and allowance methods for handling bad debts in accounts receivable. For inventory, it covers valuation at the lower of cost or net realizable value and methods for determining cost including FIFO, weighted average, and LIFO. It also discusses depreciation methods including straight-line, reducing balance, and units-of-production for allocating the cost of non-current assets over multiple periods.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    15 views38 pages

    Seminar Week 5 (Lecture Slides Chapter 8)

    Uploaded by

    palekingye
    This document provides an overview of accounting for selected assets including accounts receivable, inventory, property, plant and equipment, and intangible assets. It discusses the direct write-off and allowance methods for handling bad debts in accounts receivable. For inventory, it covers valuation at the lower of cost or net realizable value and methods for determining cost including FIFO, weighted average, and LIFO. It also discusses depreciation methods including straight-line, reducing balance, and units-of-production for allocating the cost of non-current assets over multiple periods.

    Copyright:

    © All Rights Reserved
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    Download as pptx, pdf, or txt
    of 38

    CHAPTER 8

    Accounting for selected assets


    LEARNING OBJECTIVES
    By the end of this section of the course, you should be able to:
    1. explain what is meant by the terms ‘accounts receivable’ and explain and apply
    the direct write-off and allowance methods for handling bad debts
    2. identify the accounting policy implications of accounting for bad and doubtful
    debts
    3. explain what is meant by the term ‘inventory’ and identify and apply the
    valuation rule for inventory
    4. explain and apply the principles used to determine the cost of inventory
    5. identify the implications of the accounting policy choice used for determining
    inventory costing methods
    6. explain the concept of depreciation explain why non-current assets are
    depreciated
    7. summarise and apply the straight-line, reducing-balance and units-of-
    production methods of depreciation
    8. identify the implications of depreciation accounting policy choices for financial
    reporting
    9. explain what is meant by the term ‘intangible assets’ and identify the difference
    between identifiable and unidentifiable intangible assets
    10. explain the accounting treatment for identifiable and unidentifiable intangible
    assets.
    INTRODUCTION
    • The flexibility of accounting standards
    means that accounting for certain assets
    involves accounting policy choices:
    – accounts receivable
    – inventories
    – property, plant and equipment
    – intangible assets.
    ACCOUNTS RECEIVABLE (LO 1)
    Accounts receivable arise from a business selling goods or
    services on credit, with payment to be received at a later date.
    BAD AND DOUBTFUL DEBTS
    • Not all credit customers will pay amounts when
    they fall due. How to account for this?
    – Direct write-off
    – Allowance for doubtful debts.

    Direct write-off
    • Eliminate the amount owing from the
    (doubtful) debtor and create an expense.
    • This decreases assets, as well as equity,
    directly.
    BAD AND DOUBTFUL DEBTS (CONT.)
    Allowance for doubtful debts
    • An estimate of the debts where payment is
    ‘doubtful’ is made each time the financial
    statements are prepared.
    • Allowance is created for doubtful debts, the
    estimated total of the receivables that are
    anticipated to be irrecoverable.
    • Allowance is deducted from the debtors’ balance:
    – It is not a liability.
    – It is a contra-asset account, reducing the related
    asset.
    BAD AND DOUBTFUL DEBTS (CONT.)
    Allowance for doubtful debts (CONT.)
    Accounts receivable (gross)
    – Allowance for doubtful debts

    = Amount expected to be collected


    ESTIMATING THE DOUBTFUL DEBTS
    AMOUNT
    • There are two main ways of estimating the doubtful
    debts expense:
    1. percentage of sales for the period
    2. age of accounts receivable.

    Percentage of sales method


    • This method is easy to apply, but it may not take into
    account business variables such as the age of the sale,
    the status of the customer or the current credit policies
    for the period.
    • It takes a percentage of credit sales based on past
    experience.
    ESTIMATING THE DOUBTFUL DEBTS
    AMOUNT (CONT.)
    Ageing of accounts receivable

    • While this method still does not take into account the
    status of the customer or current credit policies, it does
    allow for an assessment of the likelihood of payment
    based on age.
    • The assumption is that the longer a debt has been
    outstanding, the greater the likelihood that the amount
    owing will prove to be irrecoverable.
    ACCOUNTING POLICIES FOR BAD
    AND DOUBTFUL DEBTS AND
    IMPLICATIONS FOR USERS (LO 2)
    • Allowance for doubtful debts can be used
    as a mechanism for managing earnings:
    – contracts using earnings numbers
    – income smoothing.
    INVENTORY (LO 3)
    Inventories are assets either:
    • held for sale in the ordinary course of business
    • in the process of production for such sale
    • in the form of materials or supplies to be
    consumed in the production process or in the
    rendering of services.
    VALUING INVENTORY
    Valuation rule
    • Inventory should be valued at the lower of
    cost and net realisable value (AASB 102,
    para. 9).
    Net realisable value
    • The estimated selling price in the ordinary
    course of business less the estimated costs
    of completion and the estimated costs
    necessary to make the sale (AASB 102,
    para. 6).
    ESTABLISHING THE COST OF
    INVENTORIES (LO 4)
    AASB 102 Inventories
    Following AASB 102, cost consists of:
    • the cost of purchase, plus
    • the cost of transporting goods to a location for sale
    or conversion, plus
    • the cost of import duty or other taxes incurred prior
    to sale.
    ESTABLISHING THE COST OF
    INVENTORIES (CONT.)
    Effects of price changes
    AASB 102 inventory cost methods
    • First in, first out (FIFO)
    • Weighted average cost
    • Last in, first out (LIFO; not allowed for
    external reporting in Australia)
    • Specific identification
    • The first three methods are independent of
    the physical movement of stock.
    ESTABLISHING THE COST OF
    INVENTORIES (CONT.)
    Worked example 8.3: Jackie

    • What are the amounts of COGS and ending inventory?


    ESTABLISHING THE COST OF INVENTORIES (CONT.)
    FIFO

    • An ending inventory of 200 units is assumed from the fourth quarter’s


    purchases.
    • COGS of 1800 units is assumed from the opening inventory purchased in
    the first three quarters, with 100 units in fourth-quarter purchases.
    ESTABLISHING THE COST OF INVENTORIES (CONT.)
    Weighted average cost

    • The weighted average method makes no assumptions about the way in


    which goods flow through the business.
    • Ending inventory and COGS are calculated using the weighted average
    cost per unit of inventory.
    ESTABLISHING THE COST OF INVENTORIES (CONT.)
    LIFO
    • The LIFO method would value the closing inventory using the price of
    the opening inventory, which would be 200 units at $1.10, or $220.
    • The cost of sales would be total cost of goods available for sale of
    $2500 less $220, or $2280.
    • Gross profit would therefore be $2700 less $2280, or $420.
    • This method may lead to an inappropriate statement of financial
    position.
    • It permits management to influence the current period’s financial
    performance through the timing of purchases.
    • LIFO is often used in the US for income tax purposes – the Internal
    Revenue Service requires that if this method is used for tax purposes, it
    must also be used for financial statement reporting.
    ACCOUNTING POLICIES FOR
    INVENTORIES
    AND IMPLICATIONS FOR USERS (LO 5)
    • AASB 102 permits the use of the FIFO or
    average cost methods; LIFO is not permitted.
    • Choice of accounting method may contribute to
    differences in reported profits among
    companies.
    • Differences in accounting policy should be
    distinguished from differences in profits.
    PROPERTY, PLANT AND EQUIPMENT,
    AND DEPRECIATION (LO 6)
    • The cost of property, plant and equipment must
    be spread over periods beyond one year. How
    much? How to determine this?
    • Depreciation is the process used to spread the
    cost over future periods, conducted on a
    consistent and economically plausible basis
    each year.
    • Depreciation is the process of allocating the
    net acquisition cost of an asset to the particular
    periods that relate to the use of that asset.
    METHODS OF DEPRECIATION (LO 7)
    • Straight-line method
    • Reducing-balance method
    • Units-of-production (or units-of-output) method.

    Why depreciate?

    • Shows consumption of economic benefits from


    the use of the non-current asset
    • Matches the income incurred by the asset to its
    use.
    WHY DEPRECIATE? DEPRECIATION
    AND BUSINESS CAPACITY
    • Does depreciation help to maintain the
    productive capacity of a business?
    – Only spreading original cost and maintaining
    original capital
    – Ignores changes in price, technology, size of
    business and customer demand.
    WHY DEPRECIATE? DEPRECIATION
    AND ASSET REPLACEMENT

    • The process of depreciation does not involve


    the setting aside of cash funds for asset
    replacement.
    • Depreciation is only the systematic allocation
    of an asset’s cost to expense – a ‘book entry’
    with no cash flow implications.
    WHY DEPRECIATE? WRITTEN-DOWN
    VALUE (CARRYING OR BOOK VALUE)

    • This is normally the cost of the non-


    current asset less the total depreciation
    to date.
    • If the asset (e.g. property, plant and
    equipment) has been revalued, the
    written-down value is the valuation less
    total depreciation to date.
    THE STRAIGHT-LINE METHOD
    Straight-line method
    (Cost – Residual value)
    Useful life
    A machine costs $100 000 and has an estimated
    useful life of four years and a residual value of
    $20 000.
    The depreciation expense :
    100 000 – 20 000
    4
    = $20 000 per annum
    THE REDUCING-BALANCE METHOD

    • Reducing balance in theory:

    n Residual value
    = 1− √ Cost of asset

    where
    where nn == useful
    useful life
    life
    REDUCING-BALANCE METHOD IN
    PRACTICE
    • The rate is often based on a multiple of 1.5
    or 2 times the straight-line rate
    • Straight line rate = 1/useful life in years;
    e.g. with a useful life of 10 years, the
    straight-line rate is 10 per cent:
    – The double straight-line rate is 20 per cent.
    – The one-and-a-half times straight-line rate is
    15 per cent.
    REDUCING-BALANCE METHOD IN
    PRACTICE (CONT.)
    • A machine costs $100 000 and has an
    estimated useful life of four years.
    • Under the straight-line method, we determined
    that the depreciation rate would be ¼, or 25 per
    cent per annum
    • We can use a reducing-balance rate of 1.5 times
    the straight-line rate (i.e. 25% ×1.5 = 37.5%) to
    calculate the depreciation charge.
    COMPARISON OF THE TWO
    METHODS
    • Total depreciation over four years:
    – straight-line = $80 000
    – reducing-balance = $84 741.
     These totals are very similar, and if we were to
    use the theoretical rate in the reducing
    balance, they would be the same.
    • In any given year, depreciation expense (and,
    hence, profit) is different between the two
    methods.
    STRAIGHT-LINE VS. REDUCING-
    BALANCE
    • Straight-line:
    – simple and convenient
    – higher profits in earlier years.
    • Reducing-balance:
    – more complex to calculate
    – lower profits in earlier years.
    UNITS-OF-PRODUCTION METHOD
    • This is a third method that is often used in the
    resources sector and is based on the depletion of a
    resource.
    • A gold mine is capitalised at $10 million and is
    expected to produce 100 000 ounces of gold with zero
    residual value. In the first year, 10 000 ounces of gold
    are extracted.
    • Depreciation expense using the units-of-production
    method.
    UNITS-OF-PRODUCTION METHOD
    (CONT.)

    (Cost – Residual value) x (Number of units produced)


    Total
    expected number of units

    $10 000 000 – 0 x 10 000


    100 000
    $10 000 000 x 10%

    = $1 000 000
    ACCOUNTING POLICIES FOR DEPRECIATION
    AND IMPLICATIONS FOR USERS (LO 8)
    • Given the extent to which estimation and choice
    can influence the amount of depreciation expense
    recorded, as well as asset book values, it is
    important to consider the depreciation policies of
    entities when comparing performance:
    – Be aware of differences in depreciation policies.
    – Be aware of tax implications.
    INTANGIBLE ASSETS (LO 9)
    • Intangible assets are non-current assets that
    lack a physical substance and are not held for
    investment purposes.
    • They are classified as either identifiable or
    unidentifiable.
    • Identifiable intangible assets are assets that
    are capable of being individually identified and
    recorded; e.g.:
    – patents
    – trademarks or brand names
    – copyright.
    INTANGIBLE ASSETS (CONT.)
    • Unidentifiable intangible assets are the
    economic benefits that flow to the business
    from such things as location, reputation (e.g.
    brand) or customer relations.
    • Goodwill is the future benefit from
    unidentifiable assets:
     It reflects the entity’s excess value as a whole over
    the aggregate of the individual values of its net
    assets.
    INTANGIBLE ASSETS: THE COST OF
    INTANGIBLE ASSETS
    • Recorded and recognised at cost
    • If they are of finite life, they are amortised
    (depreciated) over the life of the asset
    • If they are of infinite life, they are not amortised
    but are subject to annual impairment test:
    – valued at least once per year
    – if value has declined, the difference must be
    recognised as impairment expense and the asset be
    reduced accordingly.
    SUMMARY
    • Bad debts are a contra-asset (i.e. negative) and may be accounted for
    via two methods.
    • The choice of method will influence both the financial position and
    performance of an entity.
    • Inventories are assets of an entity and may be in the form of raw
    materials, partly processed or finished goods.
    • Entities have choices and alternatives in the valuation of inventories –
    these also affect the financial position and performance of an entity.
    • Depreciation is a method of allocating the cost of a non-current asset
    over the period during which that asset is providing a benefit to the
    entity.
    • Depreciation methods include the straight-line, reducing-balance and
    units-of-production methods.
    • Identifiable intangible assets with finite lives are amortised over their
    expected life.

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