Study Session 9
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Purchases = Ending Inventory - Begining +COGS
Costs included in inventory under IFRS GAAP same? What are 3? Are product costs capitalized/ If so, where?
They are same. 3 things are - Purchase costs less trade discoutns and rebates. Conversion costs including labor and overhead. Orther costs encesary to bring to current location.
Costs are capitalized in inventories account on balance sheet.
Are all inventory costs capitalized?
No. Some are expnesed. Called period costs include:
- -Abnormal waste of material, labor or overhaed
- -storage costs
- -admin overhead
- -selling costs
Unit Produced 5000
Raw amaterials $15,000
Conversion cost finished good $20,000
Freight in to plant $800
Storage cost for finsihed goods $500
Abnormal waste $100
Freight-out to customers $1,100
calculate capitalized cost of one unit?
Raw material +Conversion cost +Freight to plant=35,800/5,000 units produced equals 7.16 cap cost per unit
Assuming increasin prices and stable or increasing inventory levels, which one is higher LIFO or FIFO for the following , Cost of sales, ending inventory and gross profit.
- Cost of Sales - LIFO higher
- Ending Inventory - FIFO higher
- Gross Profit - FIFO higher
what is measurment of inventory at lower of cost and net realisable value under iFRS ?under gaaP inventory at lower of cost or market?
Under IFRS, it is lower of Cost or Net Realizable Value. Net realizable value is Selling price minus selling costs.
Under GAAP is lower of Cost or Market. Market is usually equal to replacement cost, but can't be greater then Net Realizable Value or less than NRV minus a normal profit margin. If replacement cost exceeds NRV, then NRV is market, if it is lower than NRV minus a profit, then it is market is NRV minus a normal profit.
What requires Inventory Disclosure in the footnotes under GAAP and IFRS?
- -Cost flow method (LIFO FIFO)
- -Carrying value of inventory with carrying value calssification (Raw materials, work in process, finsihed goods)
- -Carrying value of invetories reported at fair value less selling costs
- -Cost of inventory recognized as an expense during period
- -Amt of inventory writedowns
- -Reversal of inventory writedown (only IFRS, GAAP just increases profit in income Statement)
- -Carrying value of inventories pledged as collateral
If firm changes cost flow methods what happens and what is exception?Which cost flow method is not allowed under IFRS? What is the basis for a change in cost flows under IFRS or Gaap?
Must report retrospectivley, however exception is whench ghanging to LIFO, which is applied prospectivley. Carrying value of inventory under old method becomes first layer of inventory under LIFO.
Cost metho not allowed is LIFO
Basis for change under IFRS is that firm must demonstrate that it better provides reliable and relevant info
GAAP must explain why change in cost is more preferable.
As a general rule, how do you know whtehter to Capitlize cost or expense it? Difference between Capitalizing a cost, or expensing.
You typically capitalize costs that is expected to provide a future economic benefit over multiple accountier peridos. Typically expense if the future economic benefit is uncertain.
When you capitallize, you record an asset on the balance sheet as cost. The cost is then allocated to income statement over the life of the asset as a depreciation or amortization expense.
When you expense immediatley, you put all of the costs immediatley into expenses. THe impact is that with expenseing it, you're current period net income and margins take a hit, however long term they do not.
Once asset is capitalized, subsequent related expenditures that provide additional economic benefit are capitalized (rebuilding the asset), and one's that mesrely sustain the usefulness do not(maitenance).
The choice between the two affects, net income, shareholders equity, total assets, cash flow from operations, cash flow from investing, and numerous ratios.
How does Capitalzing vs expedintres affect net income?
Capitalizing causes a longterm decrease in Net Income after the 1st year. Expensing causes a decrease in net income in the intial year but after that is higher, realtive to capitlaizing.
Over the life of an asset TOTAL net income is the same.
How does Capitalzing vs expedintres affect Shareholders Equity?
Because capitalizing costs results in ghier net income in the period of the expenditure compared to expesning, retained earnings will also be higher. however, as cost is allocated in the future years, net income, owners equity, and retained earnings will all be reduced.
How does Capitalzing vs expedintres affect Cash Flow from Operation?
A capitalized expenditure is usually marked as an outflow from investing activities. If expensed immediatley will become operating outflow. Thus, capitalizing will result in a higher operating activiy.
How does Capitalzing vs expedintres affect Financial Ratios?
Capitalizing expenditure results in higher assets and higher equity. Thus, both the debt-to-asset ratio and debt-equity ratio are both lower.
Capitalizing will initally result in ghigher ROA and ROE, which is a result of higher net income in the first year.
How does Capitalzing vs expedintres affect Capitalized Interest?
When firm constructs asset for own use, interest that accrues, is capitalized. Similar under GAAP and IFRS.
Interest rate used to capitalize inters is based on debt specifically related to construction of asset.ONLY inters on construction cost is caitalized.
Under IFRS income earned by temporarily investing borrowed funds reduces the interst eligble for capitliztion. There is no such reduction of capitalized interest under US GAAP.
Capitalized interest not reported in incoe statement as interest expense. Once construction interst is capitelized, interest cost is allocated to income statement through depreciation or COGS.
Capilized interest is reporeted as outflow from investing activities. Interst expense reported as outflow from operating activites.
In year of expnediture, capitlizing interes results in a lower interest expense compared to expensing. Result is a higher interest coverage ratio. (EBIT/Interest Expense)
Intangible Assets? Finite-lived vs. indefinite0lived?What is identifaible intagible asset? What is unidentifiable intabgilble asset?
Intangible asset are long term assets that lack phycial substance.
Finite-lived are amortized over length of life. Indefintile lived are tested for impariment yearly, and if impaired, will show loss in income statmenet.
- Identifable intangbile Assets:
- -Capable of being seperated from firm or arise from contractual or legal right
- -controlled by the firm
- -expected to provide future economic benefits
- -economic benefit must be probable and asset's cost must be reliable measured.
Unidentifable is one tha tcan't be purchased and may have indefinite life. Show up on balance Sheet.
Intagible Assets created internally
Costs to create intagible assets are expensed as incurred. Exeption are R&D and software development
Under GAAP R&D is expensed, except for Software costs, once technological feasability has been established, can be capitalized under GAAP. All R&D costs are capitalized when a firm develops software FOR ITS OWN USE.
Under IFRS, Research costs, are expensed as incured. However, development costs are capitalized. Development costs is traslate research findings into a plan or design of new product.R&D Epensed, until techonlogical feasabilty is established. Goes the same for sfotware.
Intangible assets purchased
Go on balance sheet as cost,. If purchased as part of a group, purchase price is allocated to each asset on basis of fair value. Capitlaizing results in hgiher net income in first year and lower net income in subsequent. Same as other ways of capitalizing.
Intagbile assets obtained in a business combination
acquisition method is used to account for business combinations. Under tsi method, purchase price is allocated ot the identifiable assets and liabs of the firm. Any remainming amount is recorded as goodwill.
3 methods of Depreciation?.
Carrying (Book Value) = Value of asset or liability on balance sheet net of accumulated depreciation
Historical Cost 0 Purchase price of asset including installation and transportation costs
- Straight Line -=(Original cost - Salvage value) / Years
- DDB = 2x(Book Value at beg year)/Years then subtract anser for first year from book value, and keep going until reach salvage value
- Unit of production method = (Original Cost-Salvage)*(Amt used in period/Total Usage)
What happens with a change in Depreciation as far as reporting?
E.g. Alpine company purchased machinery for 20,000 with useful life of 5 years and salvage value of 4,000. Alpine uses straight line. At begining of 3rd year, alpine reduces salvage value estimate to 1,600. Break out dollar amt for depreciaton per year.
Change is made prospectivley.
- Year 1 = 3200
- Year 2 = 3,200
- Year 3-5 = 4,000
Estimates also used when allocationg depreciation between cogs and SG&A. While allocation doesn't affect firm's operating margin, it affects gross margin and operating expenses.
Intangibles with Infinte lives are not amortized.Tested annually for impariment.
Under GAAP most lng lvied assets reported on bs at depreciated cost. No fair value alternative under GAAP
Only under IFRS, you can revalue the asset at fair value, as long as active market exists for asset. Rarely used in IFRS. If lower than historic cost, loss is on income statement, decreasing net income. Value can be added back, but only back to historic cost in the income statement. Any gain more than historic cost is added in Reavlauation suprlus account in shareholders equity.
Revaluing assets upward results in greater total assets and shareholders euqity. also results in higher depreciation expense, lower profitablitly in periodafter revaulation.
Impairment under IFRS? Impairment under GAAP?
IFRS, firm must annually asses impairment. Asset is imparied when carrying (originial cost less accumulated depreciation) value exceeds recoverable amount. Recoverable amount is greater of fair value less any selling costs and its value in use. ( value in use is present value of future cash flow stream)
If impaired, written down on balance sheet, an impariment loss equal to excess of carrying value overrecoverable amount recognized in income statement.
Under IFRS loss can be reversed, which is limited to the original impariment loss.
Under GAAP, tested for impariment by applying recoverability test. Recoverabilitiy test is seeing if Carrying value exceeds Value of all future cash flows not discounted.
If so, the loss measurment takes excess of carrying value over Fair value or discouncte value of its future cash flows if fair value is not known.
Under GAAP loss recovereies not accepted. Item is written down on BS down to fair value, and loss is recognized on income statement of carrying value minus fair value.
Long lived assets held for sale
if changed from for use to for sale, asset is tested for impairment.. If impaired loss of carrying value over fair net realizable value (Fair value less selling costs) is recognized on income statemnt.
Longlived assets held for sales, loss can be reversed under IFRS and US GAAP if value of asset recovers in the future. Loss reversal limited to original impairment loss.
Derecognition of assets.
When long lived asset sold, asset is removed from balance sheet and difference between proeeds and carrying value reported in income statement. Carrying value is original cost minus accumulated depreciation and impairment charges.
For assets that are investment property, what is different in reporting than pp&E
GAAP, there is no difference.
IFRS, the revaluation method changes. Rather than having revaluations surplus account, gains just go on income statement.
Deferred Tax Liabilities? Deferred Tax Assets?
Defered Tax liability is the balance sheet amount that results from an excess of income tax expense over taxes payable expected in future cash outflows.
Deferred Tax Asset: Balance Sheet amount that result from an excess of taxes apyable over income tax expense that are expected to be recovered from future operations.
Tax Base and Carrying Value? Is it a Defered Tax Liability or Asset if the Tax Base is more, on an asset?
Tax Base is the Value of the Asset according to tax reporting purposes.
Carrying value is the value of asset according to financial statemetns
If Tax Base is more, Value of the Asset is more on Taxes reporting. This means that Depreciation expense is less, which means there is more taxable income, and more taxes paid. When there are more taxes paid for Tax Reporting purposes, it is a Defered Tax Asset..
What is the equation for Income Tax Expense?
Income Tax Expense = Taxes Payable +change in Deferred Tax Liability - change in Defered Tax Asset
What happens with an increase or decrease in tax rate to Defered Tax Liab or Assets?
Will increase both deferred tax liability and assets. Decrease in the rate will decrease both.
What is a permanent Difference?Temporary difference?
Difference between taxable income and pretax income that will not reverse in the future. Permanent difference to not create Derfed tax assets or liabilities.
Permanent differences cause firm's effective tax rate to differ from statutory tax rate (tax rate of jurisdiction where firm operates). Effective tax rate is Income Tax Expense/Pretax income
Temproary difference refers to difference between tax bae and carrying value of an asset or laibility that will result in taxable amounts or deductible amounts in the futuer.
Describe the valuation allowance for derred tax assets when is itrequired and what impact on fianncinal statement?
Deferred tax assets expted to reverse. however, derfed tax asset assessed at each balance sheet date to determine likelihood of sufficient future taxable income to recover tax assets.
According to GAAP, if it is more likely than not that some or all of a DTA will not be realized, DTA must be reduced by valuation allowance, which is conta account that reduces net balance sheet value of DTA. Increasing valuation allowance reduces DTA, increase income tax expense, and decrease net income.
For a premium bond is interest expense less than the coupon payment?
- The difference is the amortization of the premium.
To determin book value of a bond with a discount?
first you find par value. Coupon payment is PMT FV is Principal, N is number of Periods, and I/Y is Yield. Than figure out PV.
You take PV, add the yield payment, subract the coupon and you get the book value for end of year.
Under US Gaap are costs invloved with issuing a bond capitalized? Under IFRS?
Under GAAP, issuance cost capitalized as an asset, and expensed over period of bond.
Under IFRS the bond liability on the balance sheet is reduced by the amount of issuance costs, increasing bond's effective interest rate. Issuance costs are treated as amortized discount.
Consider a bond issued for 980K with issuance cost of 5k. Under GAAP, firm would increase asset by 980K( 975K cash, 5K deferred charge) and increase liabilities by 980 as well. Under IFRS bond issuance would reduce liability on the bs and will only increase asset and liabilty by 975K.
Effect of issuing bond on cash flow -
Issuance of debt, increase cash received in financing cash flow.
Periodic Interest Payments - Decrease by interest paid (coupon Rate x face value) affects Operating Cash Flow
Payment at maturity - Decrease by par value, cash flow from financing
Effect of issuing bond on Income Statement and balance sheet
Balance Sheet takes the premium or discount and adds or subtracts to come up with Bond Value. Then over course of Bond, deduct or add the Yield to maturity minust the coupon payment. For the intcome statmeent you multiply market rate at issue by balance sheet value at beging of period
Affirmative covenatnts vs neagtive convenats.
Affirmative they just agree to do certain things, like make timely payments. Negative they refrain from certain activities like issuing more debt.
Lessor is owner of asset, lessee is using the asset.
What is the difference of an oeprating lease and a finance lease?
Finance lease, is a purchase of an asset financed with debt. Lesee adds equal amounts of assets and liabilities to balance sheet. Over term of lease, recognizes depreciation expense on the asset and interest expense on the liability.
An operatin lease is a rental arrangemnt with no asset or liabilty reported by the lesee.
LESEE's persepctive classification of a lease?
Classification of a lease under IFRS is determined by economic substance of transaction. If all rights and risk of ownership transfered, the lease is a finance lease.
- Under GAAP, the criteria are conceptually similar, but are more specfic than IFRS. A lesee must treat a lease as a finance lease if any of the following criteria met:
- -Title is transfered at end of lease period
- -Bargain purchase option permits lesse to purcahse leased asset for price significantly lower than fair market value at future date
- -lease is 75% or more of economic life
- -Present value of lease payments is 90% or more of fair value of leased asset.
Lesee's prefer operating lease because no liability is reported.
Reporting by Lessee
Operating Lease - Balance sheet is unaffected. No asset or liab reported. During term, rent expense is recognized in lesee's income statement. Outflow from operating activities.
Finance Lease- Lower of present value of future mimum lease payments or fair value of leased asset is recognized as liability and asset. Over term of lease is deprciated in income statement and interest expense recognized. Interest expense is lease liabilty at beging of period multiplied by lease interest rate.
In C/F statement lease sepertaed into interest and principal compoinents. Under GAAP interest paid is outflow from Operating Activities and Principal outflow is from Financing Activities.
Financial Statement and ratio effect of Operating and Finance Leases
Balance Sheet - Bc finance leases have high asset and liabilities, any ratio with asset or flaibs in the denominator will be lower.Most importantly leverage ratios Debt/Assets or Debt/Equity will be higher. Additonally, principal payment due within next year is reported as current liability on lesee's balanc esheet which reduces current ratio and working capital.
-Operating income will be higher for companies that use finance leases relative to operating leases. BC with operating lease the entire payment is expensed straight off income statement, whereas capital lease has depreciation..
Under Cash Flow statement, finance leases pay out principal in financing and interest in operating cash flows whereas operating leases come straight out of operating. Therefore, operating cash flows higher for finance leases but financing cash flows lower.
Reportin by lessor.
A capital lease under US GAAP is treated as either sale type or direct financing lease. If Present value of lease payment exceeds carrying value of asset lease treated as sales-type lease.
Sales type lease treated as if lessor sold the asset for present value of the lease payments, while providing a loan to buyer for same amount. Typical when leasor is manufactor or dealer becase cost of leased asset is usually less than its fair value.
At inception of lease, lessor recognizes sale equal to present value of lease payments, and cost of goods sold equal to carrying value of the asset. Asset removed from balance sheet and lease receivab le created, equal to present value of lease payments. Principal portion received as lease receivable, and interest is interest income. Gross Profit is recognized as differecne between sales price and COGS
Direct Financing lease, no gross profit is recognized by the lessor at inception of le3ase. Because present value of lease payment equal to carrying value of leased asset, lessor is simply providing a financing function. At inception, lessor removes asset from balance sheet, creates lease receivable in same amount. As lease payments received, the principla portion of each payment reduces lease receivable. In income statement, lessor recognizes interest income over term of lease.
Both Lessee and Lessor required ti disclose useful information about finace leases and operating leases in finacinal statements including
- -General descriptioon of leasing arrangemnt
- 0nature timing and amout of payment to be paid or received in each of next 5 years.
- dEFINED bENEFIT OBLIGATION - Pressnet value of amount owed to employees for future pension benefits earned to date
- -Service cost present value of benefits earned by employees during current period. Service cost increases benefit obligation
- -Expected return on plan assets reduces pension expense.
- -Actuarial gains and losser - based on assumptions the actuary must make about the benefits to be paid in the future. Changes in assumptions about retirmement ages or rate of salary growth, for exapmple produce gains and losses that affect pension expense.
If value of plan assets exceeds present present value of benefit obligation, plan is said to be ovefunded. If benfit obligation exceeds plan assets, pplan is undefunded. Funded status represents economic reality of lplan.
Under GAAP, funded status is reported on balance Sheet. Overfunded is asset, underfunded liability.
Under IFRS, firms remove actuarial gains and loses, and unregonized prio service costs. Result is balsance sheet amount does not represe4nt economic reality.
Under IFRS AND GAAP, firms seperatly disclose componets of benefit obligation, plan assets, and pension expense.
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