Accounting & Financial Reporting BUSG 503Michael Dimond
Let’s review… • Exercises E6-22-30 & 36
d. The allowance for uncollectible accounts has decreased as a percentage of gross accounts receivable from 3.66% in 2009 to 2.76% in 2010 (see part b). One way to gauge the adequacy of the allowance account is to look at write-offs as a percentage of the allowance account at the beginning of the year. In 2009, this percentage is 37% ($206/$553) and for 2010 it is 30% ($191/$629). HPQ’s write-offs as a percentage of the allowance decreased from 2009 to 2010. By this measure as well, it appears that HP is accurately accruing for anticipated credit losses. Further insight might be gained by comparing HPQ’s allowance account to those of its peers. The provision (increase in the allowance account arising from bad debts expense recorded on the income statement) decreased from 2009 following the high write-offs in that year. Over the three-year period, HPQ accrued $588 million ($226 + $282 + $80) of bad debt expense and wrote off $541 million ($144 + $206 + $191) of uncollectible accounts receivable. The difference between the expense and the write-offs is small. Thus, it appears that HP is accurately accruing for anticipated credit losses.
d. 1. In most circumstances, the first-in, first-out method most closely reflects the physical flow of inventory. First-in, first-out physical flow is critical when inventory is perishable or in situations in which the earliest items acquired are moved out first because of risk of deterioration or obsolescence such as technology products and retail items. 2. Last-in, first-out yields the highest cost of goods sold expense during periods of rising unit costs, which in turn, results in the lowest taxable income and the lowest income tax. 3. The first-in, first-out method results in the lowest cost of goods sold, and the largest amount of income, in periods of rising prices. Of course, this assumes that prices will continue to rise as they have in the past. Companies cannot change inventory costing methods without justification, and the change may be restricted by tax laws as well.
Securities owned by corporations are categorized into three portfolios: “Trading,” “Available for Sale,” and “Held to Maturity.” An unrealized holding gain (or loss) is an increase (or decrease) in the fair value of an investment security which is still owned. “Significant influence” (owning 10%-50% of voting rights) gives the owner of the stock the ability to significantly influence the operating and financing activities of the company whose stock is owned. More than 50% is considered a “controlling interest.” Consolidated financial statements portray the financial position, operating results, and cash flows of affiliated companies (those in which the firm has a controlling interest) as a single economic unit so that the scope of the combined entity is more realistically conveyed. Intercorporate Investments
Google uses historical cost to account for investments in non-marketable securities. Google monitors the value of these investments and writes them down to market value if they suffer a permanent decline in value. If such an investee company ever goes public, Google will change its accounting method. Google’s disclosure of fair value gains & losses
Investments are recorded at their purchase cost. Dividends received are treated as a recovery of the investment and, thus, reduce the investment balance (dividends are not reported as income). The investor reports income equal to its percentage share of the investee’s reported net income; the investment account is increased by the percentage share of the investee’s income or is decreased by the percentage share of any loss. Changes in fair value do not affect the investment’s carrying value. Equity method investments
Consolidation has replaced the investment balance with the assets and liabilities to which it relates, and P&G will replace the equity income it would report with the sales and expenses of Gillette. P&G’s allocation of Gillette purchase
For next week… • Exercises E7-27, 28, 29, 32, 33 & 37. We will go through these in class • Read Chapter 8 & preview the Mini Exercises