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Property, plant, and equipment are tangible resources of a relatively permanent nature that are being used in the business and not intended for sale. Current liabilities are obligations that will be paid within the coming year or operating cycle, whichever is longer. Long-term liabilities are obligations that will be paid after one year.
There are three characteristics: Short-term creditors are primarily interested in the liquidity of the company. In contrast, long-term creditors and stockholders are primarily interested in the profitability and solvency of the company.
Working capital and current ratio. Debt to assets and free cash flow. Earnings per share. Debt financing is riskier than equity financing because debt must be repaid at specific points in time, whether the company is performing well or not.
Thus, the higher the percentage of assets financed by debt, the riskier the company. Questions Chapter 2 Continued An increase in the current ratio signals good news because the company improved its ability to meet maturing short-term obligations.
The higher the free cash flow, the more solvent the company. The enhancing qualities are comparability, consistency, verifiability, timeliness, and understandability. Jantz is correct. Consistency means using the same accounting principles and accounting methods from period to period within a company.
Without consistency in the application of accounting principles, it is difficult to determine whether a company is better off, worse off, or the same from period to period. Comparability results when different companies use the same accounting principles.
Consistency means using the same accounting principles and methods from year to year within the same company. The cost constraint allows accounting standard-setters to weigh the cost that companies will incur to provide information against the benefit that financial statement users will gain from having the information available.
Accounting standards are not uniform because individual countries have separate standard- setting bodies. Currently many non-U. Accounting relies primarily on two measurement principles. Fair value is sometimes used when market price information is readily available.
However, in many situations reliable market price information is not available. In these instances, accounting relies on historical cost as its basis. The economic entity assumption states that every economic entity can be separately identified and accounted for.
This assumption requires that the activities of the entity be kept separate and distinct from 1 the activities of its owners the shareholders and 2 all other economic entities. A shareholder of a company charging personal living costs as expenses of the company is an example of a violation of the economic entity assumption.
Accumulated depreciation— equipment Predictive value. DO IT! Earnings per share should not be compared across companies because the number of shares issued by companies varies widely. Monetary unit assumption 2. Faithful representation 3.
Economic entity assumption 4. Cost constraint 5. Consistency 6. Historical cost principle 7. Relevance 8. Periodicity assumption 9. Full disclosure principle Materiality Going concern assumption Comparability Accumulated depreciation—buildings Accumulated depreciation— Buildings Accumulated depreciation— buildings Accumulated depreciation—equipment Total current assets Net loss The debt to assets ratio would increase from Looking at additional financial data, I would note that Barfield reported a significant loss for the current year which would lead me to question its ability to make interest and loan payments and even remain in business in the future.
I would not make the proposed sale unless Barfield convinced me that it would be capable of earnings in the future rather than losses. I would also consider making the sale but requiring a substantial down- payment and smaller note. Its current ratio decreased from 2. Nordstrom would be considered much more liquid than Best download for the recent year.
Satisfaction of current obligations usually requires the use of current assets. If a company has more current assets than current liabilities it is more likely that it will meet obligations as they become due. Since working capital and the current ratio compare current assets to current liabilities, both are measures of liquidity.
Neither work- ing capital nor the current ratio indicate the composition of current assets. However, doing so just to improve the year-end current ratio could be considered unethical if this action misled creditors. Its debt to assets ratio remained constant from to It was generat- ing plenty of cash from operations to cover its investing needs. In , American Eagle Outfitters experienced negative free cash flow. This deficiency could have been covered by issuing stock or debt. The inventory was written up to its fair value when it should have remained at cost.
The treatment of the transaction treats Sal Garcia and Garcia Co. The cash used to download the truck should have been treated as part of salaries and wages expense. This assumption states that the economic life of a business can be divided into artificial time periods months, quarters, or a year.
By adding two more weeks to the year, Garcia Co. The company should use a 52 week year. Net income Total expenses The lower the percentage of debt to assets, the lower the risk is that a company may be unable to pay its debts as they come due. Another measure of solvency, free cash flow, also indicates that Bosch is more solvent. Both measures indicate an improvement in liquidity during This suggests an improvement in solvency, thus we have conflicting measures of solvency.
This indicates a decline in profitability during The liquidity of the corporation as shown by the working capital and the current ratio has improved slightly. Also, the corporation improved its solvency by improving its debt to assets ratio as well as free cash flow. Profitability—Earnings per share should not be used to compare profitability between companies because of the difference in the number of shares outstanding.
It provides information in the form of finan- cial statements and additional disclosures that is useful for decision making. The accounting rules and practices that have substantial authoritative support and are recognized as a general guide for financial reporting purposes are referred to as generally accepted accounting principles GAAP. These characteristics consist of relevance, faithful representation, comparability, consistency, verifiability, timeliness, and understand- ability.
They apply to accounting information rather than the scientific findings that Sue wants to include. Accumulated depreciation The lower the percentage of debt to assets, the lower the risk that a company may be unable to pay its debts as they come due. More free cash flow indicates that Wise will be better able to finance more capital expendi- tures without taking on more debt.
Both measures indicate a slight decline in liquidity during Free cash flow. The overall liquidity of the corporation has dropped as shown by the slight decrease in the current ratio. Also, the corporation appears to be increasing its debt burden as its debt to assets ratio increased slightly indicating a decrease in solvency. Comparing free cash flow, we find a drop in this measure of solvency also.
The income statement presents the revenues and expenses and resulting net income or net loss of a company for a specific period of time. The retained earnings statement summarizes the changes in retained earnings for a specific period of time.
Finally, the cash flow statement provides information about the cash inflows and cash outflows for a specific period of time. Liquidity ratios include the calculation of working capital current assets minus current liabilities and current ratio current assets divided by current liabilities.
These solvency ratios include debt to assets total liabilities divided by total assets and free cash flow cash provided by operations minus dividends paid and capital expenditures. If revenues earned by Biscuits exceed expenses incurred, then Biscuits is profitable.
One profitability ratio is earnings per share net income minus preferred dividends divided by average common shares outstanding. By looking at the balance sheet and cash flow statement and calculating solvency ratios we are able to determine whether a company has the ability to repay its long-term debt. Profitability ratios will help in determining whether a company is able to pay its interest expense.
The more profitable the company the better able it is to repay its long- term obligations as well as the amount of interest it is paying on its debt. The financial statements may prove to be a good indicator of what will happen in the future but remember that is not necessarily guaranteed. There are other issues that Natalie must consider as well. Does she have the ability to meet the demands of Biscuits?
Will she be able to produce 1, dozen cookies a week? Does she have enough staff to enable her to do so? Does she have a large enough oven to do so? Does she have enough cash to pay her staff, download supplies, and cover operating expenses until she receives payment from Biscuits? As you will learn in a later chapter, inventories are considered to be less liquid than receivables. Thus, they are listed below receivables and before prepaid expenses.
Solvency Based on the debt to assets ratio, Tootsie Roll is more solvent. They also believe it would make it easier to raise capital around the world. The predetermined overhead rate is based on the relationship between estimated annual overhead costs and expected annual operating activity. This relationship is expressed in terms of a common activity base such as direct labor costs, direct labor hours, or machine hours. The formula for the predetermined overhead rate is: The use of a predetermined overhead rate enables the company to determine the approximate total cost of each job when the job is completed.
In recent years, more companies are using machine hours as the activity base due to increased reliance on automation in manufacturing operations. At the end of each month, the balance in Work in Process Inventory should equal the sum of the costs shown on the job cost sheets for unfinished jobs.
Assigning Costs to Finished Goods Finished Goods Inventory is a control account that controls individual finished goods records in a finished goods subsidiary ledger. Cost of goods sold is recognized when the sale occurs by a debit to Cost of Goods Sold and a credit to Finished Goods Inventory along with a debit to Accounts Receivable or Cash and a credit to Sales. At the end of a period, financial statements are prepared that present aggregate data on all jobs manufactured and sold.
The cost of goods manufactured schedule has one new feature: The cost of goods manufactured schedule is prepared directly from the Work in Process Inventory account. Under- or Overapplied Manufacturing Overhead When Manufacturing Overhead has a debit balance, overhead is said to be underapplied. Underapplied overhead means that the overhead assigned to work in process is less than the overhead incurred. When manufacturing overhead has a credit balance, overhead is overapplied. Overapplied overhead means that the overhead assigned to work in process is greater than the overhead incurred.
At the end of the year, any balance in Manufacturing Overhead is eliminated through an adjusting entry, usually to Cost of Goods Sold. Underapplied overhead is debited to Cost of Goods Sold. Overapplied overhead is credited to Cost of Goods Sold. Cost Accounting Systems. Cost accounting involves the measuring, recording, and reporting of product costs.
From the data accumulated, companies determine both the total cost and the unit cost of each product. A cost accounting system consists of accounts for the various manufac- turing costs.
An important feature of a cost accounting system is the use of a perpetual inventory system that provides immediate, up-to-date information on the cost of a product. There are two basic types of cost accounting systems: A job order system, where the company assigns costs to each job or to each batch of goods, and b.
A process cost system, used when a company manufactures a large volume of similar products. The managers of a diversified company thought they were making money, but a consulting firm found that the company had seriously underestimated costs. What type of costs do you think the company had been underestimating? It is most likely that the company failed to estimate and track overhead. Job Order Cost Flow. The flow of costs direct materials, direct labor, and manufacturing overhead in job order cost accounting parallels the physical flow of the materials as they are converted into finished goods.
Emphasize the two steps of 1 accu- mulating manufacturing costs incurred, and then 2 assigning accumulated costs to products. Accumulating the manufacturing costs incurred; these costs are accumulated in three accounts: Three entries are made to accumulate the manufacturing costs incurred. When the company receives the raw materials it has downloadd, it debits the costs of the materials to Raw Materials Inventory.
Raw Materials Inventory is a control account. The subsidiary ledger consists of individual records for each item of raw materials. The cost of factory labor consists of gross earnings of factory workers, employer payroll taxes, and fringe benefits sick pay, pensions, and vacation pay incurred by the employer. Companies debit labor costs to Factory Labor as they incur those costs.
Factory labor is assigned to work in process and manufacturing overhead at the end of the period. A company may record overhead costs periodically through adjusting entries by debiting Manufacturing Overhead. Manufacturing Overhead is a control account and the subsidiary ledger consists of individual accounts for each type of cost factory utilities, factory repairs, etc. Assigning Manufacturing Costs to Work in Process. A job cost sheet is a form used to record the costs chargeable to a specific job and to determine the total and unit costs of the completed job.
The job cost sheets constitute the subsidiary ledger for the Work in Process Inventory account. Three entries are made in assigning the manufacturing costs to work in process.