Download Oper. Decisions

Oper. Decisions - 1
OPERATING DECISIONS
UNCOLLECTIBLE ACCOUNTS
RECEIVABLE
 When credit is extended, some amount of
uncollectible receivables is generally inevitable.
 If uncollectible receivables are probable
and
can be estimated, an estimate should be made
of the amount uncollectible and recorded in the
period in which the revenue was produced
(allowance method).
The Allowance for Doubtful Accounts is a contra
account to Accounts Receivable.
INVENTORY RECORDING
METHODS
PERIODIC METHOD
vs.
PERPETUAL METHOD
INVENTORY RECORDING METHODS
 Periodic inventory system
-- Inventory value is determined only at particular
times, such as end of the accounting period.
-- Purchases recorded in “Purchases” account
-- Cost of goods sold determined at the end of the
period following a physical count
INVENTORY RECORDING METHODS
 Perpetual inventory system
-- The ongoing physical flow of inventory is
monitored, and the cost of the inventory items
is maintained on a continual basis.
-- Purchases recorded directly in “Inventory”
account
-- Cost of goods sold is determined at the point
sales revenue is recognized
COST FLOW METHODS
An allocation of total cost of goods available for sale:
Ending inventory
Cost of goods
Available
(Beg. Inven. + Purch)
Cost of goods sold
The cost flow assumption used for accounting purposes
can be different from the physical flow of goods through
the company.
INVENTORY VALUES
COST FLOW ASSUMPTIONS
Specific cost
identification
Average cost
First-in, first-out (FIFO)
Last-in, first-out (LIFO)
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FIRST-IN, FIRST-OUT
 Cost of the oldest inventory items are
included in Cost of Goods Sold
 Cost of the newest items are
included in the Ending Inventory
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LAST-IN, FIRST-OUT
 Cost of the newest inventory items
are included in Cost of Goods Sold
 Cost of the oldest items are included
in the Ending Inventory
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PENSIONS
 A pension is cash compensation
received by an employee after the
employee has retired
 There are two types of pension plans:
– Defined contribution plan
– Defined benefit plan
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POSTRETIREMENT BENEFITS OTHER
THAN PENSIONS
 Other employee benefits provided after
retirement include
– Health care plans
– Life insurance plans
 Accounting rules require that these
benefits be recognized as an expense
and a liability as they are incurred
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INCOME TAXES
 Income tax expense and the amount
paid for income tax during a period are
different for two reasons:
– Income taxes are not paid in the same
year in which they are incurred
– A firm may choose one accounting method
for tax purposes and another for financial
reporting purposes
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INCOME TAXES
 Differences in financial income and
taxable income are due to timing
differences
 Timing differences can be
– Permanent or
– Temporary
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TIMING DIFFERENCES
 Permanent differences
– Enter into accounting income, but never
into taxable income
– These are statutory differences between
GAAP and the Internal Revenue Code
– For example, interest on state and local
bonds is included in financial income, but
not in taxable income
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TIMING DIFFERENCES
 Temporary differences
– Some transactions affect taxable income in
a different period from financial accounting
income
• Depreciation methods
• Rent received in advance
– The affects of these differences are
recorded as deferred tax assets or liabilities
and shown on the balance sheet
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DEFERRED TAXES
 Deferred Tax Liability
– Requires a payment in the future
– Is the expected income tax on income
earned but not yet taxed
– Is not an existing legal liability
 Income Taxes Payable, based on
taxable income on the tax return, is an
existing legal liability
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DEFERRED TAXES
 Deferred Tax Asset
– Represents the expected benefit of a
future tax deduction for an expense item
that has already been incurred but is not
yet deductible for tax purposes
– It can only be recognized if it is “more
likely than not” that future income will be
realized against which the deduction can
be offset
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CAPITALIZE VERSUS EXPENSE
 An expenditure that is expected to
benefit future periods is capitalized as an
asset
 All other expenditures are treated as
expenses
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CAPITALIZE VERSUS EXPENSE
 Research and development costs
– Research is defined as
• Those activities undertaken to discover new
knowledge that will be useful in developing new
products, services, or processes or that will result
in significant improvement of existing products or
processes
– Development
• Applies the research findings to develop a plan or
design for new or improved products and
processes
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CAPITALIZE VERSUS EXPENSE
 Research and development costs are
expensed in the period incurred due to
the uncertainty surrounding the future
economic benefits of R&D activities
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CAPITALIZE VERSUS EXPENSE
 Software development requires special
treatment
– All costs incurred up to the point where
technological feasibility is established are
to be expensed as research and
development
– After technological feasibility is established,
costs incurred are capitalized
• Determining technological feasibility is a
matter of judgement
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CAPITALIZE VERSUS EXPENSE
 Oil and gas exploration costs
– Two methods of accounting for the
cost of “dry holes”:
• Full cost method
 All exploratory costs are capitalized and
allocated to the cost of successful wells
• Successful efforts method
 Exploratory costs for dry holes are expensed,
and only exploratory costs for successful wells
are capitalized
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CAPITALIZE VERSUS EXPENSE
 Advertising costs
– Generally, advertising costs are expensed
due to the uncertainty of their future
economic benefits
– In selected cases where the future benefits
are more certain, advertising costs should
be capitalized
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CONTINGENCIES
 A contingency is an uncertain
circumstance involving a potential gain
or loss that will not be resolved until
some future event occurs
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CONTINGENCIES
 Three important definitions:
– Probable
• Likely to occur
– Remote
• Not likely to occur
– Reasonably possible
• More than remote but less than likely
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CONTINGENT LOSSES
Likelihood
Probable
Reasonably possible
Remote
Accounting Action
Recognize a probable
liability if the amount can be
reasonably estimated.
Disclose a possible liability
in a note.
No recognition or disclosure
unless contingency
represents a guarantee.
Then, note disclosure is
required.
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CONTINGENT GAINS
Likelihood
Probable
Reasonably possible
Remote
Accounting Action
An asset may be recorded
if it seems assured and the
amount can be reasonably
estimated. Normally you
would simply disclose facts
in a note.
Disclose a possible asset in
a note, but be careful to
avoid misleading
implications. In practice,
possible contingent gains
are often not disclosed.
No recognition or
disclosure.
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ACCOUNTING FOR LAWSUITS
 If the facts of the case indicate that a
loss is probable and the amount of the
loss can be estimated, a loss should be
reported on the income statement and
a liability should be reported on the
balance sheet
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ACCOUNTING FOR ENVIRONMENTAL
LIABILITIES
 Most companies do not reflect these
loss contingencies as liabilities on the
balance sheet because the future cost
of the cleanup is very difficult to
estimate