1. Accounting, Fifth Edition
7 – 10 Review
Accounting, Fifth Edition

2. Designing an Internal Control System
Control environment – does the corporate culture value integrity?
Risk assessment – evaluate areas of risk and decide how to manage them.
Control activities – design policies and procedures to address risks.
Information and communication – capture and communicate pertinent information to all relevant internal and external parties.
Monitoring – review and assess effectiveness of internal controls. Adjust internal controls as needed.
LO 1 Define fraud and internal control.

3. The BACKBONE of Internal Controls
Establishment of responsibility
Separation of duties
Documentation procedures
Physical controls
Independent internal verification
Human resource controls
LO 1 Define fraud and internal control.

4. Control Features: Use of a Bank
Reconciliation Procedures
Illustration 7-8
+ Deposit in Transit
- Outstanding Checks
+/- Bank Errors
+ Notes collected by bank
- NSF (bounced) checks
- Check printing or other service charges
+/- Company Errors
CORRECT BALANCE
CORRECT BALANCE
LO 5 Prepare a bank reconciliation.

5. Valuing Accounts Receivable
Estimating the Allowance
Under the percentage of receivables basis, management establishes a percentage relationship between the amount of receivables and expected losses from uncollectible accounts.
Helpful Hint Where appropriate, the percentage-of-receivables basis may use only a single percentage rate.
LO 3 Describe the methods used to account for bad debts.

6. Valuing Accounts Receivable
Aging the accounts receivable - customer balances are classified by the length of time they have been unpaid.
Illustration 8-7
LO 3 Describe the methods used to account for bad debts.

7. Allowance Method for Uncollectible Accounts
Companies estimate uncollectible accounts receivable.
To set aside reserves for uncollectible accounts:
Bad Debts Expense $xxx
Allowance for Doubtful Accounts $xxx
(a contra-asset account).
When a SPECIFIC account is determined uncollectible and written off:
Allowance for Doubtful Accounts $xxx
Accounts Receivable $xxx
Allowance for Doubtful Accounts (CA) + - 2. 3. 1.
LO 3 Describe the methods used to account for bad debts.

8. Determining the Cost of Plant Assets
Cost - cash paid in a cash transaction or the cash equivalent price paid.
Cash equivalent price is the
fair value of the asset given up or
fair value of the asset received,
whichever is more clearly determinable.
International Note IFRS is flexible regarding asset
valuation. Companies revalue to fair value when they believe this information is more relevant.
LO 1 Describe how the historical cost principle applies to plant assets.

9. Determining the Cost of Plant Assets
All necessary costs incurred in making land ready for its intended use increase (debit) the Land account.
Land
Costs typically include:
cash purchase price,
closing costs such as title and attorney’s fees,
real estate brokers’ commissions, and
accrued property taxes and other liens
on the land assumed by the purchaser.
LO 1 Describe how the historical cost principle applies to plant assets.

10. Determining the Cost of Plant Assets
Land Improvements
Includes all expenditures necessary to make the improvements ready for their intended use.
Examples: driveways, parking lots, fences, landscaping, and underground sprinklers.
Limited useful lives.
Expense (depreciate) the cost
of land improvements over their
useful lives.
LO 1 Describe how the historical cost principle applies to plant assets.

11. Determining the Cost of Plant Assets
Includes all costs related directly to purchase or construction.
Buildings
Purchase costs:
Purchase price, closing costs (attorney’s fees, title insurance, etc.) and real estate broker’s commission.
Remodeling and replacing or repairing the roof,
floors, electrical wiring, and plumbing.
Construction costs:
Contract price plus payments for architects‘fees,
building permits, and excavation costs.
LO 1 Describe how the historical cost principle applies to plant assets.

12. Determining the Cost of Plant Assets
Equipment
Include all costs incurred in acquiring the equipment and preparing it for use.
Costs typically include:
Cash purchase price.
Sales taxes.
Freight charges.
Insurance during transit paid by the purchaser.
Expenditures required in assembling, installing, and testing the unit.
LO 1 Describe how the historical cost principle applies to plant assets.

13. Accounting for Plant Assets
Depreciation
Process of allocating to expense the cost of a plant asset over its useful (service) life in a rational and systematic manner.
Process of cost allocation, not asset valuation.
Applies to land improvements, buildings, and equipment, not land.
Depreciable, because the revenue-producing ability of asset will decline over the asset’s useful life.
Helpful Hints
Land does not depreciate because it does not wear out.
Depreciation expense is reported on the income statement. Accumulated depreciation is reported on the balance sheet.
LO 2 Explain the concept of depreciation.

14. Computing Depreciation
Factors in Computing Depreciation
Illustration 9-6
1) Cost
2) Useful
Life
3) Salvage
Value
Depreciation fulfills the Matching Principle by aligning revenues with expenses
LO 2 Explain the concept of depreciation.

15. Accounting for Plant Assets
Depreciation Methods
Management selects the method it believes best measures an asset’s contribution to revenue over its useful life.
Examples include:
Straight-line method – easiest, but least accurate.
Declining-balance method – moderately complicated, moderately accurate.
Units-of-activity method – most complicated, but most accurate.
Illustration 9-7
Use of depreciation methods in major U.S. companies
LO 3

16. Straight-Line Method Straight-Line
Expense is same amount for each year.
Depreciable cost = Cost less salvage value.
Illustration 9-8
LO 3 Compute periodic depreciation using the straight-line method, and contrast its expense pattern with those of other methods.

17. Straight Line Method Illustration: (Straight-Line Method) 2014
$ 12,000
20%
$ 2,400
$ 2,400
$ 10,600
2015
12,000 20
2,400
4,800
8,200
2016
12,000 20
2,400
7,200
5,800
2017
12,000 20
2,400
9,600
3,400
2018
12,000 20
2,400
12,000
1,000
Journal Entry
Depreciation expense 2,400
Accumulated depreciation (contra asset) 2,400
LO 3 Compute periodic depreciation using the straight-line method, and contrast its expense pattern with those of other methods.

18. Time-Based so Pro-Rate for a midyear purchase
Partial Year
Straight Line Method
Time-Based so Pro-Rate for a midyear purchase
Assume the delivery truck was purchased on April 1, 2014.
LO 3

19. Accounting for Plant Assets
Illustration: (Declining-Balance Method)
Illustration 9A-2
2014
13,000
40%
$ 5,200
$ 5,200
$ 7,800
2015
7,800 40
3,120
8,320
4,680
2016
4,680 40
1,872
10,192
2,808
2017
2,808 40
1,123
11,315
1,685
2018
1,685 40
685*
12,000
1,000
Journal Entry
Depreciation expense 5,200
Accumulated depreciation 5,200
* Computation of $674 ($1,685 x 40%) is adjusted to $685.
LO 3

20. Appendix 9A Illustration: (Declining-Balance Method) Partial Year
Purchased on 4/1/14
Appendix 9A
Illustration: (Declining-Balance Method)
LO 9 Compute periodic depreciation using the declining- balance method and the units-of-activity method.

21. NOT Time-Based so no Pro-Rating for a midyear purchase
Units of Activity
NOT Time-Based so no Pro-Rating for a midyear purchase
Companies estimate total units of activity to calculate depreciation cost per unit.
Expense varies based on units of activity.
Depreciable cost is cost less salvage value.
Illustration 9A-3
LO 3 Compute periodic depreciation using the straight-line method, and contrast its expense pattern with those of other methods.

22. Units of Activity
Illustration 9A-4
2014
15,000
$ 0.12
$ 1,800
$ 11,200
2015
30,000
0.12
3,600
5,400
7,600
2016
20,000
2,400
7,800
5,200
2017
25,000
3,000
10,800
2,200
2018
10,000
1,200
12,000
1,000
Depreciation expense 1,800
Accumulated depreciation 1,800
Journal Entry
LO 3 Compute periodic depreciation using the straight-line method, and contrast its expense pattern with those of other methods.

23. Accounting for Plant Assets
Expenditure During Useful Life
REVENUE EXPENDITURE – ordinary repairs
Debit - Repair (or Maintenance) Expense.
expenditures to maintain the operating efficiency and productive life of the unit.
DOES NOT increase productivity
DOES NOT extend useful life
If amount is not material most companies will just expense the item.
LO 4 Describe the procedure for revising periodic depreciation.

24. Accounting for Plant Assets
Expenditure During Useful Life
CAPITAL EXPENDITURE – Addition/improvement
Debit - the plant asset affected.
costs incurred to increase the operating efficiency, productive capacity, or useful life of a plant asset.
Major overhaul
Extends useful life
LO 4 Describe the procedure for revising periodic depreciation.

25. Plant Asset Disposals
Companies dispose of plant assets in three ways —Retirement, Sale, or Exchange (appendix).
Illustration 9-16
Record depreciation up to the date of disposal.
Eliminate asset by (1) debiting Accumulated Depreciation, and (2) crediting the asset account.
LO 5 Explain how to account for the disposal of a plant asset.

26. Plant Asset Disposals Retirement of Plant Assets No cash is received.
Decrease (debit) Accumulated Depreciation for the full amount of depreciation taken over the life of the asset.
Decrease (credit) the asset account for the original cost of the asset.
Loss (no gain possible) is equal to the difference between the Cost basis of the asset and accumulated depreciation taken to date.
LO 5 Explain how to account for the disposal of a plant asset.

27. Intangible Assets
Intangible assets are rights, privileges, and competitive advantages that result from ownership of long-lived assets that do NOT possess physical substance.
Limited life or an indefinite life.
Common types of intangibles:
Patents
Copyrights
Franchises (not amortized) or licenses
Trademarks (not amortized)
Trade names
Goodwill (not amortized)
LO 7 Identify the basic issues related to reporting intangible assets.

28. Intangible Assets Accounting for Intangibles Limited-Life Intangibles:
Amortize to expense.
Credit asset account or accumulated amortization.
Indefinite-Life Intangibles (i.e goodwill, trademarks):
No foreseeable limit on time the asset is expected to provide cash flows.
No amortization.
LO 7 Identify the basic issues related to reporting intangible assets.

29. Types of Intangible Assets - Patents
Exclusive right to manufacture, sell, or otherwise control an invention for a period of 20 years from the date of the grant.
Capitalize costs of purchasing a patent and amortize over its 20-year life or its useful life, whichever is shorter.
Expense any R&D costs in developing a patent.
Legal fees incurred successfully defending a patent are capitalized to Patent account.
LO 7 Identify the basic issues related to reporting intangible assets.

30. Allocation Terminology
Summary of LT Asset Cost Allocations
Asset Type
Allocation Terminology
Calculation Methods
Property, Plant & Equipment (except Land)
Depreciation
a) Straight Line
b) Double-Declining Balance
c) Units of Production
Natural Resources (i.e. gold, oil, ore, etc.)
Depletion
Units of Production
Intangible Assets (except Goodwill)
Amortization
Straight Line