7 Chapter ?? Appendix B: Ratio Analysis—Accounts Receivable Turnover

176



Cash and Receivables



An explora on is available on the Lyryx system. Log into your Lyryx course to run Accounts

Receivable Turnover Ra o.



Summary of Chapter 7 Learning Objec ves

LO1 – Define internal control and explain how it is applied to cash.

The purpose of internal controls is to safeguard the assets of a business. Since cash is a par cularly

vulnerable asset, policies and procedures specific to cash need to be implemented, such as the

use of cheques and electronic funds transfer for payments, daily cash deposits into a financial

ins tu on, and the prepara on of bank reconcilia ons.



LO2 – Explain and journalize pe y cash transac ons.

A pe y cash fund is used to pay small, irregular amounts for which issuing a cheque would be

inefficient. A pe y cash custodian administers the fund by obtaining a cheque from the cash

payments clerk. The cheque is cashed and the coin and currency placed in a locked box. The pe y

cash custodian collects receipts and reimburses individuals for the related amounts. When the

pe y cash fund is replenished, the receipts are compiled and submi ed for entry in the accoun ng

records so that a replacement cheque can be issued and cashed.



LO3 – Explain the purpose of and prepare a bank reconcilia on, and record related adjustments.

A bank reconcilia on is a form of internal control that reconciles the bank statement balance

to the general ledger cash account, also known as the book balance. Reconciling items that affect the bank statement balance are outstanding deposits, outstanding cheques, and bank errors.

Reconciling items that affect the book balance are collec ons made by the bank on behalf of the

company, NSF cheques, bank service charges, and errors. Once the book and bank statement balances are reconciled, an adjus ng entry is prepared based on the reconciling items affec ng the

book balance.



Summary of Chapter 7 Learning Objectives



177



LO4 – Explain, calculate, and record es mated uncollec ble accounts receivable

and subsequent write-offs and recoveries.

Not all accounts receivable are collected, resul ng in uncollec ble accounts. Because it is not

known which receivables will become uncollec ble, the allowance approach is used to match the

cost of es mated uncollec ble accounts to the period in which the related revenue was generated. The adjus ng entry to record es mated uncollec bles is a debit to Bad Debt Expense and

a credit to Allowance for Doub ul Accounts (AFDA). The income statement method and the balance sheet method are two ways to es mate and apply the allowance approach. The income

statement method calculates bad debt expense based on a percentage of credit sales while the

balance sheet method calculates total es mated uncollec ble accounts (aka the balance in AFDA)

using an aging analysis. When receivables are iden fied as being uncollec ble, they are wri en

off. If write-offs subsequently become collec ble, a recovery is recorded using two entries: by

reversing the write-off (or the por on that is recoverable) and then journalizing the collec on.



LO5 – Explain and record a short-term notes receivable as well as calculate related interest.

A short-term notes receivable is a promissory note that bears an interest rate calculated over the

term of the note. Short-term notes receivable are current assets that mature within 12 months

from the date of issue or within a business’s opera ng cycle, whichever is longer. Notes can be

issued to a customer at the me of sale, or a note receivable can replace an overdue receivable.



LO6 – Explain and calculate the acid-test ra o.

The acid-test ra o is a strict measure of liquidity. It is calculated as quick current assets divided by

current liabili es. Quick assets include cash, short-term investments, and accounts receivable.



LO7 – Explain and calculate the accounts receivable turnover.

The accounts receivable turnover is a measure of liquidity and demonstrates how efficiently receivables are being collected. It is calculated as net sales divided by average accounts receivable.

Average accounts receivable are the sum of the beginning accounts receivable, including shortterm notes receivable from customers, plus ending receivables, divided by two.



Chapter 8

Long-lived Assets

...



Long-lived assets or property, plant, and equipment (PPE) assets are used in the normal operating ac vi es of the business and are expected to provide benefits for a period in excess of one

year. Long-lived assets covered in this chapter consist of three types: property, plant, and equipment (PPE), intangible assets, and goodwill. Also discussed are deprecia on and amor za on,

techniques to allocate the cost of most long-lived assets over their es mated useful lives.



Chapter 8 Learning Objec ves

LO1 – Describe how the cost of property, plant, and equipment (PPE) is determined, and

calculate PPE.

LO2 – Explain, calculate, and record deprecia on using the units-of-produc on, straight-line,

and double-declining balance methods.

LO3 – Explain, calculate, and record deprecia on for par al years.

LO4 – Explain, calculate, and record revised deprecia on for subsequent capital expenditures.

LO5 – Explain, calculate, and record the impairment of long-lived assets.

LO6 – Account for the derecogni on of PPE assets.

LO7 – Explain and record the acquisi on and amor za on of intangible assets.

LO8 – Explain goodwill and iden fy where on the balance sheet it is reported.

LO9 – Describe the disclosure requirements for long-lived assets in the notes to the financial

statements.



Concept Self-Check

Use the following as a self-check while working through Chapter 8.

1. What is the dis nc on between capital expenditures and revenue expenditures?

2. How do generally accepted accoun ng principles prescribe what amount should be capitalized?

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180



Long-lived Assets



3. How is par al period deprecia on recorded?

4. What is the formula for calcula ng revised deprecia on?

5. What is the difference between a tangible and intangible long-lived asset?

6. What different methods can be used to calculate deprecia on for property, plant, and equipment?

7. How are disposals of property, plant, and equipment recorded in the accoun ng records?

8. How is the impairment of a long-lived asset accounted for?

9. How are intangible assets amor zed?

10. What is goodwill and what is its accoun ng treatment?



8.1



Establishing the Cost of Property, Plant, and Equipment (PPE)



LO1 – Describe

how the cost

of

property,

plant, and equipment (PPE) is

determined, and

calculate PPE.



Property, plant, and equipment (PPE) are tangible long-lived assets that

are acquired for the purpose of genera ng revenue either directly or indirectly. They are held for use in the produc on or supply of goods and

services, have been acquired for use on a con nuing basis, and are not intended for sale in the ordinary course of business. Because PPE assets are

long-lived or have a life greater than one year, they are non-current in nature, also known as long-term assets. Examples of PPE assets include land,

office and manufacturing buildings, produc on machinery, trucks, ships or

aircra used to deliver goods or transport passengers, salespersons’ automobiles owned by a company, or a farmer’s produc on machinery like

tractors and field equipment. PPE assets are tangible assets because they

can be physically touched. There are other types of non-current assets

that are intangible – exis ng only as legal concepts – like copyrights and

patents. These will be discussed later in this chapter.



Capital Expenditures

Any cash disbursement is referred to as an expenditure. A capital expenditure results in the acquisi on of a non-current asset, including any addi onal costs involved in preparing the asset for

its intended use. Examples of various costs that may be incurred to prepare PPE for use are listed

below.



8.1. Establishing the Cost of Property, Plant, and Equipment (PPE)



Costs to Acquire PPE



Costs to Prepare PPE for

Use



Land

Purchase

. price

Commission to real

estate agent

Legal. fees



Capital Expenditures

Building

Purchase price

Commission to real

estate agent

Legal fees



Costs of draining,

.

clearing, and

landscaping;

demoli on

Assessments for

streets and

sewage system



Repair and

remodelling costs

before use

Payments to tenants

for premature

termina on of

lease



181



Equipment

Invoice cost

Transporta on

Insurance (during

transporta on)

Assembly

Installa on

(including wages

paid to company

employees)

Special floor

founda ons or

supports

Wiring

Inspec on

Test run. costs



.



To demonstrate, assume that equipment is purchased for $20,000. Addi onal costs include transporta on costs $500, installa on costs $1,000, construc on costs for a cement founda on $2,500,

and test run(s) costs to debug the equipment $2,000. The total capitalized cost of the asset to put

it into use is $26,000.

Determining whether an outlay is a capital expenditure or a revenue expenditure is a ma er of

judgment. A revenue expenditure does not have a future benefit beyond one year. The concept

of materiality enters into the dis nc on between capital and revenue expenditures. As a ma er

of expediency, an expenditure of $20 that has all the characteris cs of a capital expenditure would

probably be expensed rather than capitalized, because the me and effort required by accoun ng

staff to capitalize and then depreciate the item over its es mated useful life is so much greater than

the benefits derived from doing so. Capitaliza on policies are established by many companies to

resolve the problem of dis nguishing between capital and revenue expenditures. For example,

one company’s capitaliza on policy may state that all capital expenditures equal to or greater

than $1,000 will capitalized, while all capital expenditures under $1,000 will be expensed when

incurred. Another company may have a capitaliza on policy limit of $500. Addi onally, a company

may have a different capitaliza on policy for different types of plant and equipment assets – hand

tools may have a capitaliza on policy limit of $200 while the limit might be $1,000 for furniture.

Not all asset-related expenditures incurred a er the purchase of an asset are capitalized. An

expenditure made to maintain PPE in sa sfactory working order is a revenue expenditure and

recorded as a debit to an expense account. Examples of these expenditures include: (a) the cost

of replacing small parts of an asset that normally wear out (in the case of a truck, for example:

new res, new muffler, new ba ery); (b) con nuing expenditures for maintaining the asset in

good working order (for example, oil changes, an freeze, transmission fluid changes); and (c)

costs of renewing structural parts of an asset (for example, repairs of collision damage, repair or

replacement of rusted parts).