Accounting & Financial Reporting BUSG 503 Michael Dimond

Financial Statements for Sysco (SYY)

Financial Statements How much profit did the company make? How much did they invest in assets? Was the purchase of equipment an expense? How are the assets allocated? How did they finance their assets? How did cash change during the period? How did owners’ wealth (equity) change during the period? What return did the owners get on their investment?

Initial questions about the balance sheet Some companies carry high levels of cash. Why is that? Is there a cost to holding too much cash? Is it costly to carry too little cash? The relative proportion of short-term and long-term assets is largely dictated by companies’ business models. Why is this the case? Why is the composition of assets on balance sheets for companies in the same industry similar? By what degree can a company’s asset composition safely deviate from industry norms? What are the trade-offs in financing a company by owner versus non-owner financing? If non-owner financing is less costly, why don’t we see companies financed entirely with borrowed money? How do shareholders influence the strategic direction of a company? How can long-term creditors influence strategic direction? Most assets and liabilities are reported on the balance sheet at their acquisition price, called historical cost. Would reporting assets and liabilities at fair market values be more informative? What problems might fair-value reporting cause?

Initial questions about the income statement Assume a company sells a product to a customer who will pay in 30 days. Should the seller recognize the sale when it is made or when cash is collected? When a company purchases a long-term asset such as a building, its cost is reported on the balance sheet as an asset. Should a company, instead, record the cost of that building as an expense when it is acquired? If not, how should a company report the cost of that asset over the course of its useful life? Manufacturers and merchandisers report the cost of a product as an expense when the product sale is recorded. How might we measure the costs of a product that is sold by a merchandiser? By a manufacturer? If an asset, such as a building, increases in value, that increase in value is not reported as income until the building is sold, if ever. What concerns arise if we record increases in asset values as part of income, when measurement of that increase is based on appraised values? Employees commonly earn wages that are yet to be paid at the end of a particular period. Should their wages be recognized as an expense in the period that the work is performed, or when the wages are paid? Companies are not allowed to report profit on transactions relating to their own stock. That is, they don’t report income when stock is sold, nor do they report an expense when dividends are paid to shareholders. Why is this the case?

Initial questions about the statement of cash flows What is the usefulness of the statement of cash flows? Do the balance sheet and income statement provide sufficient cash flow information? What types of information are disclosed in the statement of cash flows and why are they important? What kinds of activities are reported in each of the operating, investing and financing sections of the statement of cash flows? How is this information useful? Is it important for a company to report net cash inflows (positive amounts) relating to operating activities over the longer term? What are the implications if operating cash flows are negative for an extended period of time? Why is it important to know the composition of a company’s investment activities? What kind of information might we look for? Are positive investing cash flows favorable? Is it important to know the sources of a company’s financing activities? What questions might that information help us answer? How might the composition of operating, investing and financing cash flows change over a company’s life cycle? Is the bottom line increase in cash flow the key number? Why or why not?

Inventories and Cost of Goods Sold

Inventory Types Merchandise inventory: held by retailers and wholesalers Merchandise inventory Production inventory: held by manufacturers Raw materials Work-in-progress Finished goods LO 1

Inventory Costs by Type of Business

Account for Sales of Merchandise Sales revenue: representation of the inflow of assets, either cash or accounts receivable, from the sale of a product during the period Net Sales = Sales − Sales Return and Allowances − Sales Discount Gross Profit = Net Sales − Cost of Goods Sold LO 2

Net Sales Section of the Income Statement

Sales Returns and Allowances Sales returns and allowances: contra-revenue account used to record refunds to customers and reductions of their accounts Sales discounts: contra-revenue account used to record discounts given to customers for early payment of their accounts Credit terms: firm’s policy for granting credit Example: n/30; Net, 10 EOM; 1/10, n/30

Credit Terms and Sales Discounts Credit terms: firm’s policy for granting credit n/30: the net amount of the selling price is due within 30 days of the date of the invoice Net, 10 EOM: the net amount is due anytime within ten days after the end of the month 1/10, n/30: the customer can deduct 1% from the selling price if the bill is paid within ten days Sales discounts: contra-revenue account used to record discounts given to customers for early payment of their accounts

Cost of Goods Sold Beginning inventory + Cost of goods purchased Recognition of cost of goods sold as an expense is an excellent example of matching principle Sales revenue: inflow of assets, cash or accounts receivable Cost of goods sold: outflow of asset, inventory Cost of goods available for sale Cost of goods sold Beginning inventory + Cost of goods purchased Cost of goods available for sale − Ending inventory LO 3

Cost of Goods Sold on the Income Statement

Inventory Systems: Perpetual and Periodic The inventory account is increased at the time of each purchase and decreased at the time of each sale Periodic The inventory account is updated only at the end of the period

Recording COGS in a Perpetual System Daisy’s sells a pair of running shoes that costs $70. In addition to the entry to record the sale, Daisy’s would also record an adjustment as follows:

Cost of Goods Purchased

Recording Purchase in a Periodic System Daisy’s buys shoes from Nike at a cost of $4,000. The effect is to increase liabilities and increase cost of goods sold, which is an expense

Recording Purchase Returns in a Periodic System Daisy’s returns $850 of merchandise to Nike for credit on Daisy’s account. The return decreases both liabilities and purchases. Because a return reduces purchases, it has the effect of reducing expenses and increasing net income and stockholders’ equity

Purchase Discounts in a Periodic System On March 13,there is a purchase of merchandise for $500, with credit terms of 1/10, n/30

Purchase Discounts A contra-purchases account used to record reductions in purchase price for early payment to a supplier

Shipping Terms and Transportation Costs Cost principle: All costs necessary to prepare an asset for its intended use should be included in its cost FOB destination point: seller incurs the transportation costs FOB shipping point: buyer incurs the transportation costs FOB stands for ‘‘free on board’’

Recording Transportation-In in a Periodic System Assume that on delivery of a shipment of goods, Daisy’s pays an invoice for $300 from Rocky Mountain Railroad. The terms of shipment are FOB shipping point

Inventory Valuation and Measurement of Income Value assigned to inventory on balance sheet determines the amount eventually recognized as an expense on income statement Incorrect ending inventory will affect cost of goods sold and net income

Inventory Costs Cost: price paid or consideration given to acquire an asset Includes expenditures directly or indirectly incurred in bringing to its existing condition and location Examples: Freight costs incurred to bring inventory to the place of business Cost of insurance when inventory is in transit Cost of storing inventory before it is ready to be sold Taxes paid—excise and sales taxes

Inventory Costing Methods in a Periodic System The choice of an inventory method will impact cost of goods sold and thus net income A company should choose the method that results in the most accurate measure of net income for the period The primary determinant in selecting an inventory costing method should be the ability of the method to accurately reflect the net income of the period Specific Identification Last-in, First-out (LIFO) First-in, First-out (FIFO) Weighted Average

Specific Identification Method Relies on matching unit costs with the actual units sold Example: Determining Ending Inventory and Cost of Goods Sold Using Specific Identification

Ending Inventory and Cost of Goods Sold Using Specific Identification (continued)

Weighted Average Cost Method Assigns the same unit cost to all units available for sale during the period Cost of Goods Available for Sale Units Available for Sale Weighted Average Cost = Weighted Average Cost Number of Units in Ending Inventory Ending inventory = ×

Determining Ending Inventory and Cost of Goods Sold Using Weighted Average

First-In, First-Out Method (FIFO) Assigns the most recent costs to ending inventory Example: Determining Ending Inventory and Cost of Goods Sold Using FIFO

Determining Ending Inventory and Cost of Goods Sold Using FIFO (continued)

Last-In, First-Out Method (LIFO) Assigns the most recent costs to cost of goods sold Example: Determining Ending Inventory and Cost of Goods Sold Using LIFO

Determining Ending Inventory and Cost of Goods Sold Using LIFO (continued)

Income Statements for the Inventory Costing Methods

Taxes Saved by Using LIFO Instead of FIFO Assume a 40% tax rate, income tax expense under LIFO is only $2,000, compared with $2,600 under FIFO, a savings of $600 in taxes

FIFO vs LIFO during a Period of Rising Prices

Inventory Errors If ending inventory is overstated, cost of goods sold will be understated and thus net income for the period overstated The opposite effects will occur when ending inventory is understated Different types of inventory errors Mathematical errors Physical count of inventory at year-end Cutoff problems—in-transit—at year-end LO 8

Effect of an Inventory Error on Net Income

Effect of Inventory Error on Retained Earnings

Effect of an Inventory Error on the Balance Sheet

Lower-of-Cost-or Market Rule A conservative inventory valuation approach Require that inventory be written down at the end of the period if the market value of the inventory is less than its cost Can be applied to: Entire inventory Individual items Groups of items Required under both U.S. GAAP and IFRS U.S.GAAP Define market value as replacement cost, subject to a maximum and a minimum amount New amount becomes basis for future adjustments IFRS Uses net realizable value with no upper or lower limits Write-downs of inventory can be reversed in later periods

Inventory Turnover Ratio Measures company’s ability to sell its inventory quickly Number of times inventory is sold during a period Cost of Goods Sold Average Inventory Inventory Turnover Ratio = LO 10

Number of Days’ Sales in Inventory Measures of how long it takes to sell inventory Number of Days in the Period Inventory Turnover Ratio = Number of Days’ Sales in Inventory

Inventory Costing Methods with the Use of a Perpetual Inventory System LO 12

Determining Ending Inventory Using FIFO with a Perpetual System

Determining Ending Inventory Using LIFO with a Perpetual System

Determining Ending Inventory Using Moving Average with a Perpetual System