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Summary Accounting notes from the book iba
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FINANCIAL ACCOUNTING (PART.2)Book notes from Wong et Al.
Chapter 7 : Reporting and Analyzing Inventory 2
A. Reporting operating expenses 2
B. Inventory costing methods 3
C. Financial statement disclosure 5
D. Analyzing financial statements 6
Chapter 8 : Reporting and Analyzing Long-Term Operating Assets 8
A. Introduction 8
B. Property, plant and equipment (PPE) 8
C. Analyzing financial statements 13
D. Intangible assets 14
Chapter 9 : Reporting and Analyzing Liabilities 17
A. Introduction 17
B. Current liabilities 17
C. Long-term liabilities 20
D. Analyzing financial statements 24
Chapter 11 : Reporting and Analyzing Shareholder’s Equity 26
A. Introduction 26
B. Contributed capital 27
C. Earned capital 29
D. Analyzing financial statements 31
E. Earnings per share 31
,CHAPTER 7 : REPORTING AND ANALYZING INVENTORY
A. Reporting operating expenses
❖ Operating expenses = include the costs of acquiring products (and services) plus the costs of selling efforts,
administrative functions and other activities that support the operations of the company.
❖ Cost of goods sold (COGS) = often largest expense in income statement ➔ information about it = critical
to understand financial statements.
Expense recognition principles
❖ Matching principle requires that expenses be recognized in the same period that associates revenue is.
❖ Three approaches to expenses recognition :
- Direct association = if a cost can be directly associated with a specific revenue ➔ should be
recognized as an expense at same time that related revenue is recognized. For manufacturing
companies there is a difference between :
• Product costs = incurred to benefit the company’s activity (raw material, production
workers, depreciation on equipment, facilities…)
• Period costs = all other costs.
- Immediate recognition = many period costs are necessary for generating revenue but cannot be
directly associated with specific revenues. These costs are recognized as expenses in the period
where the costs are incurred.
- System allocation = for cost that benefit more than one accounting period + cannot be associated
with specific revenues ➔ must be allocated across all of the periods benefited. Most common
example is depreciation expenses.
Reporting inventory costs in the financial statements
When inventory is purchased it is capitalized and carried on the balance sheet as an asset until sold.
We have :
Gross profit = Sales Revenues — Costs of goods sold
Inventory and the Cost of Acquisition
❖ In general : companies should recognize inventory for which they hold legal title + it should be recognized at
the cost of acquiring the inventory.
❖ This means that sometimes, companies will recognize items in inventory that are not on its premises.
❖ Inventory is reported on the balance sheet at its cost (including costs to acquire, transport + prepare for
sales).
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, Inventory Reporting by manufacturing firms
❖ A manufacturing firm produces goods which it sells ➔ incurs two types of costs :
- Product costs = costs directly associated with production ➔ recorded on balance sheet in three
categories of inventory :
• Raw materials inventory = cost of parts and materials purchased from suppliers for use in
production process. When used, cost is transferred to the work-in-process account.
• Work-in-process inventory (WIP) = cost of inventory of partially completed goods. When
production is completed, cost is transferred into finished goods inventory account.
• Finished good inventory = cost of the stock of completed product ready for delivery to
customers.
- Period expenses = costs not directly associated with production ➔ expensed to the income
statement in period incurred.
❖ Some formulas :
- Cost of raw materials (RM) used during the production process :
RM Used = Beginning RM Inventories + RM Purchased — Ending RM Inventories
- Cost of goods produced (FLSR = Factor Labor Services Rendered)
Ending WIP Inventories = Beginning WIP Inventories + (RM Used + FLSR + Factory overhead incurred) — Goods produced
- Cost of goods sold :
Ending FG Inventories = Beginning FG Inventories + goods produced — Costs of Goods sold
B. Inventory costing methods
❖ Cost of inventor y available at
beginning of the period is taken from
the ending inventory balance of the
previous period.
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, ❖ Understanding flow inventory cost = important.
❖ If beginning inventory plus all inventory purchased or manufactured during the period is sold ➔ COGS =
cost of goods available for sale.
❖ Most companies will organize the physical flow of their inventories to keep cost of inventory management
low, while minimizing likelihood of spoilage or obsolescence.
First-In, First-Out (FIFO)
❖ First-In, First-Out (FIFO) inventory method = transfers costs form inventory in the order that they were
initially recorded.
❖ FIFO assumes that the financial reports costs recorded in inventory (first-in) are the first costs transferred
from inventory (first-out) to cost of goods sold.
Average Cost (AC)
❖ Average cost : Inventory costing method that views cost of goods sold as an average of the cost to
purchase all inventories available for sale during a particular period.
❖ When average cost is appleid in future years, beginning inventory balance’s average cost is again averaged
with the inventory acquisitions made during the year. New average ➔ used to assign costs to that year’s
ending inventory and cost of goods sold.
Lower of Cost or Market
❖ Companies are required to write down the carrying amount of inventories on the balance sheet if the
reported cost exceeds the market value (determined by net realizable value).
❖ Lower of cost or market = the process of reporting inventories at the lower of its cost or its current
market value.
❖ If net realizable value is less than reported cost, inventories must be written down from cost to market
value, this leads to :
- Inventory book value is written down to current value (net realizable value), reducing total assets.
- Inventory write-down is reflected as an expense (part of COGS) on the income statement,
reducing current period gross profit, income and equity.
- Write downs are included in COGS.
❖ Companies can also reverse the write-down of the inventory up to the acquisition cost if market value
warrant. Revaluation ➔ debit to inventory + credit to cost of goods sold.
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