1. Topics for Today Inventory valuation Manufacturing issues
Practice cost flow calculations
Inventory turnover rates
Introduce Capital Assets

2. Inventories Opening Additions Available for Sale Goods Sold Ending
Accounting Challenges
What costs go into additions?
What costs come out when goods are sold?
What happens when the value of inventory drops below cost?
Opening
Additions
Available for Sale
Goods Sold
Ending
Reported at the lower of cost and market value
cost depends on the cost-flow assumption and whether the accounting system is periodic or perpetual
market value usually is based on net realizable value
the amount the inventory is likely to be sold for

3. Inventories Opening Additions Available for Sale Goods Sold Ending
Accounting Challenges
What costs go into additions?
What costs come out when goods are sold?
What happens when the value of inventory drops below cost?
Opening
Additions
Available for Sale
Goods Sold
Ending
If market value falls below cost
Need to write-down the inventory to the lower amount
Dr. Loss on write-down of inventory (I/S expense)
Cr. Inventory

4. Inventories Manufacturing Issues Opening Additions Available for Sale
Accounting Challenges
What costs go into additions?
What costs come out when goods are sold?
What happens when the value of inventory drops below cost?
How do we track inventory manufacturing costs?
Additions
Available for Sale
Goods Sold
Ending

5. Manufacturing Issues inventories are made not just bought
Raw Materials
Work-in-Process
Manufacturing Issues
inventories are made not just bought
e.g., Beer doesn't grow in bottles
it's made from barley, sugar, water, etc.
many types of costs are incurred
materials, labour, machinery, etc.
inventories exist in various stages of completion (e.g., raw materials, work in process, finished & ready for sale)
need to assign the many types of costs to their various stages of completion
Finished Goods

6. 1. Assign Product Costs to Inventories
determining cost is a complex process
first step is to separate product costs from period costs
Why should you care?
product costs are included in inventory as an asset on the B/S
period costs are included as an expense on the I/S
potential to manipulate net income!!

7. 1. Assign Product Costs to Inventories
determining cost is a complex process
first step is to separate product costs from period costs
any costs associated with making the product
e.g., raw materials (sugar, water, etc.)
labour (line worker, foreman, etc.)
plant overhead (power, rent, plant amortization, etc.)

8. 1. Assign Product Costs to Inventories
determining cost is a complex process
first step is to separate product costs from period costs
costs associated with a time period (rather than with production)
e.g., administrative salaries
transportation out (but not in)
office equipment amortization

9. 2. Track the Flow of Product Costs
Raw Materials
Work-in-Process
Direct Labour
Overhead
Finished Goods
Cost of Goods Sold

10. 2. Track the Flow of Product Costs
Raw Materials
Work-in-Process
Direct Labour
Finished Goods
Overhead
Cost of Goods Sold

11. Tracking the Flow of Product Costs
Raw Materials
Work-in-Process
Direct Labour
Overhead

12. Tracking the Flow of Product Costs
Raw Materials
Work-in-Process
Dr. Finished Goods Inventory
Cr. Work-in-process Inventory
Direct Labour
Finished Goods
Overhead

13. Tracking the Flow of Product Costs
Raw Materials
Work-in-Process
Direct Labour
Finished Goods
Dr. Cost of Goods Sold
Cr. Finished Goods Inventory
Overhead
Cost of Goods Sold

14. Accounting Challenges
What costs go into additions?
What costs come out when goods are sold?
What happens when the value of inventory drops below cost?
How do we track inventory manufacturing costs?

15. Inventory Turnover Calculations
Cost of Goods Sold
Avg.Inventory
Cost of Goods Sold
(Op. Stock + Cl. Stock)/2 =

16. Capital Assets Capital assets include tangible and intangible assets.
Tangible assets are things that we can see and feel e.g cars, buildings etc; while intangible assets are those assets that we cannot see like intellect, brand name etc.

17. Capital Asset Reporting in Practice
Canadian Medical Laboratories Limited
Partial Balance Sheet
2001
2000
Tangible Capital Assets—Cost
Accumulated Amortization
22,130
(18,658)
3,472
14,979
(12,731)
2,248
Licenses—Cost
67,646
(13,407)
54,239
46,002
(9,316)
36,686
Goodwill—Cost
7,483
(288)
7,195

18. Capital Assets responsible for long-term success of the business
source of future operating assets
affects suppliers & creditors in the short-term
affects returns to investors in the short-term & long-term
source of financing security
frequently pledged as security for loans
what do these users want to know?
what kind of return do the capital assets produce?
what is their current value?
how long until they will have to be replaced?
will financial resources be available to replace them?

19. Capital Assets ROA = Income Before Cost of Financing
what do the financial statements tell users?
what kind of return do the capital assets produce?
ROA = Income Before Cost of Financing
Average Total Assets
= NI + Interest Expense (1 - Tax Rate)
Average Total Assets
Co. A (Debt)
Co. B (Equity)
Operating Revenues
Operating Expenses
Interest Expense
$100,000
(50,000)
(10,000) --
Net Income b/f Tax
Income Tax Expense (30%)
40,000
(12,000)
50,000
(15,000)
Net Income
28,000
35,000

20. Company A relying on long-term debt financing ...
Assuming average total assets of $350,000, what is ROA?
Company A relying on long-term debt financing ...
ROA = NI + Interest Expense (1 - Tax Rate)
Average Total Assets
= , ,000 (1 - 30%)
350,000
= , ,000
350,000
= ,000
350,000
Company B relying on equity financing ...
ROA = NI + Interest Expense (1 - Tax Rate)
Average Total Assets
= ,
350,000

21. Capital Assets what do the financial statements tell users?
what is the current value of capital assets?
tangible assets reported at historical cost less accumulated amortization
current value of tangible assets usually is not reported
self-developed intangible assets rarely reported at all under current GAAP
the costs of self-developed intangible assets are expensed when incurred

22. Capital Assets what do the financial statements tell users?
will financial resources be available to replace them?
some people believe that amortization expenses represent a “reserve”
that will ensure capital assets can be replaced in the future
two problems with this belief:
it assumes the replacement cost will not differ from historical cost
the costs of most capital assets do change over time
it assumes that net income produces cash on hand
net income = cash-on-hand (accruals, reinvestment in other assets, etc.)

23. Capital Asset Reporting (Accounting Challenges)
capital assets are recorded (i.e., "capitalized") initially at cost
the only difficult acquisition issue involves “basket purchases”
most reporting decisions occur after the initial purchase
costs incurred after acquisition, but before use
costs incurred during use
consuming the benefits of historical costs --- amortization
disposing of the asset

24. 1. Recording Capital Asset Acquisition -- "Basket Purchases"
sometimes assets are "bundled together" when bought
the accounting issue involves determining how much to record for different parts of the "basket purchase"
for example, when land and building is purchased together, how much is land & how much is building?
this question is important because land is not amortized, but buildings are amortized
generally, the amount allocated to each is based on the estimated market values of each separate part
the total of the separate parts may or may not equal the total cost of the purchase
if $800,000 is paid for land & building that are valued at $400,000 & $600,000 respectively, then 40% of the total cost is for land and 60% is for the building; thus 40% of $800,000 is recorded as land ($320,000) and the remaining 60% is recorded as building ($480,000)

25. What costs can be capitalized?
if costs are capitalized, assets increase and expenses decrease
what might be management's motives?
What does GAAP say?
2. costs incurred before commercial use
eligible costs include any reasonable costs needed to get the asset into its expected usable condition
transportation costs?
legal fees?
scrap costs during start-up period?
interest while financing construction?

26. What costs can be capitalized?
if costs are capitalized, assets increase and expenses decrease
what might be management's motives?
What does GAAP say?
3. costs incurred during use
eligible costs include any "betterments“ that
extend the asset's useful life
increase the asset's normal rate of output
lower the asset's operating costs
costs that merely restore the capital asset to its original usable condition are considered "repairs and maintenance expense" and are not eligible for capitalization

27. 4. After capitalization, amortization ...
What's the purpose?
to match the cost of an asset to the time periods served by it
not intended to reflect the asset at current values
What amount is allocated?
only the costs that are not expected to be recovered at the end of the asset's useful life (i.e., the estimated "residual value")
Over what period are the costs allocated?
only over the asset's estimated useful life
examples ...
an automobile
railway tracks into a mine
land
carpeting at movie theatres
aircraft

28. 4. After capitalization, amortization ...
What methods are used?
straight-line
most common method
allocates costs evenly over asset life
accelerated methods
production methods

29. 4. After capitalization, ... amortization
What methods are used?
straight-line
most common method
allocates costs evenly over asset life
accelerated methods
allocates greater proportion of costs to early years of asset life
production methods
allocates costs in proportion to the number of units produced by the capital asset

30. 4. After capitalization, ... amortization
How are the methods are used?
straight-line
amortization = (cost - estimated residual value)
estimated useful life of the asset
accelerated methods
amortization = (cost - accumulated amortization) x amortization rate
stop amortizing when NBV (i.e., cost - acc. amortn.) = residual value
production methods
amortization = (cost - estimated residual value) x current period output
total estimated output
Dr. Amortization Expense
Cr. Assetname--Accumulated Amortization

31. Amortization Expense:
Amortz. Example
Slow Corp.
Fast Corp.
Asset Cost
$16,000
Residual Value
$1,000
Useful Life
3 years
Amort. Method
Straight-line
Double declining
Amortization Expense:
DD:
rate = 2 x 1/3
= 66.67%
SL:
= 16, ,000
Yr. 1: = $(16,000-0) x 0.67
3 years
= $10,720
= $ 5,000 / year
Yr. 2: = $(16,000-10,720) x 0.67
= $3,520
Yr. 3: = all but $1,000 of what's left
= $(16,000-10,720-3,520)-1,000
= 760

32. Slow vs. Fast Amortization Expense