1、Lesson ThreeCurrent Assets Aims:1.To explain the importance of cash and the accounting treatment of cash.2.To introduce four inventory valuation methods.3.To explain two systems of inventory accounting.4.To discuss the bad debt and the accounting treatment.5.To make allowance for doubtful account re
2、ceivable.6.To write off an un-collectible account receivable.3.1Introduction to Assets Assets are future economic benefits obtained or controlled by an entity as a result of past transactions or events.Assets may be physical,such as land,buildings,inventory of supplies,material,or finished products.
3、Assets may also be intangible,such as patents and trademarks.Assets are normally divided into two major categories:current assets and long-term assets.3.2Current Assets Current assets are assets:(1)in the form of cash;(2)will normally be realized in cash;(3)or conserve the use of cash during the ope
4、rating cycle of a firm or for one year,whichever is longer.3.3Cash Cash is money in the form of bills or coins,which can prompt payment for goods or services in currency or by check.Cash is listed first in the balance sheet,because it is the most liquid of all current assets.3.4Inventory Inventory r
5、efers to various assets that are stocked for the purpose of sale,production or consumption during the process of the production and operation for a business.3.5Four Common Inventory Cost Flow Methods The four methods are:(1)Specific identification;(2)First-in,first-out(FIFO);(3)Last-in,fast-out(LIFO
6、);(4)Weighted-average.Specific identification is usually used when a company buys goods that are easy to identify.Computers,airplanes,ships can serve as examples.The second method(first-in,first-out)sets that the cost of the items purchased first must be assigned to the cost of goods sold.The third
7、method(last-in,first-out)assumes that the cost of the goods purchased last is charged to the cost of goods sold.The fourth method(weighted-average)provides that the average unit cost is included in the cost of goods sold.3.6Impact on the Income Statement of the Cost Flow Method The cost flow method
8、a company uses in its accounting has a straight influence on the income statement,cost of goods sold,and the gross margin,So the income must be influenced.3.7Impact on the Balance Sheet of the Cost Flow Method Since the cost of inventory is allocated between the cost of goods sold and the ending inv
9、entory,the type of the cost flow method employed by a company has effects on the balance sheet as well as the income statement.3.8An Example of the Perpetual Inventory System Assume that a company named Youth Electric Motor had such ending balances in its accounts:Assets=ClaimsCash+Inventory=Contrib
10、uted Capital+Retained Earnings$9 000+$3 000=$9 000+$3 000 Now consider the following transactions that happened in 2012:(1)Two purchases of electric motor were made;(2)One sale of the goods took place.Beginning Inventory200 units$15=$3 000(at cost)Purchase One240 units$18=$4 320(at cost)Purchase Two
11、160 units$20=$3 200(at cost)Sale540 units$40=$21 600(at selling price)3.9FIFO Method In our example it is$21 600 for 540 electric motor sold.The revenue recognition increases both assets(Cash)and equity(Sales Revenue).The difference occurs to the cost of goods sold.Under FIFO(first-in,first-out),the
12、 later is determined by adding up the 540 electric motor that came to the company first.The first 540 units brought to Youth Electric motor consist of:200 units of the beginning inventory at the price of$15 each,240 units from the first purchase$18 each,and 100 from the second purchase$20 each.The c
13、alculation of the goods sold under FIFO is therefore as follows:Beginning Inventory200 units$15=$3 000Purchase One240 units$18=$4 320Purchase Two100 units$20=$2 000Total$9 3203.10LIFO Method As it names implies(last-in,first-out),the cost of goods sold is calculated using the costs of the electric m
14、otor that the company purchased last.The 60 units from the beginning inventory remain in Inventory.The computations are below:Purchase Two160 units$20=$3 200Purchase One240 units$18=$4 320Beginning Inventory140 units$15=$2 100Total$9 6203.11Weighted-average Method The weighted-average cost per unit
15、is$17.53(i.e.,$10 520/600 units).In our illustration,the cost to be moved from Inventory to the expense account is$9 466.2(i.e.,$17.53 540 units).3.12The Differences in the Financial Statements under the Three MethodsIncome StatementFIFOLIFOWeighted-averageSales$21 600$21 600$21 600Cost of Goods Sol
16、d(9 320)(9 620)(9 466)Gross Margin12 28011 98012 134Operating Expenses000Income before Taxes12 28011 98012 134Income Tax Expense(3 684)(3 594)(3 640)Net Income$8 596$8 386$8 494Balance SheetAssetsCashInventory$19 3961 200$19 486900$19 4401 054Total Assets$20 596$20 386$20 494Liabilities$0$0$0EquityC
17、ontributed CapitalRetained Earnings$9 00011 596$9 00011 386$9 00011 494Total Equity$20 596$20 386$20 494Statement of Cash FlowsOperating ActivitiesCash Inflow from SalesCash Outflow for InventoryCash Outflow for Tax$21 600(7 520)(3 684)$21 600(7 520)(3 594)$21 600(7 520)(3 640)Net Cash Flow from Ope
18、rating Activities$10 396$10 486$10 440Investing Activities$0$0$0Financing Activities$0$0$0Net Increase in Cash$10 396$10 486$10 440Beginning Cash Balance$9 000$9 000$9 000Ending Cash Balance$19 396$19 486$19 4403.13The Difference in the Income before Taxes under the Three Methods You have possibly n
19、oticed that the amount of income before taxes is the biggest for FIFO($12 280),and the lowest for LIFO($11 980).Why so?Consider that the ending inventories are just vise versa for the two methods(respectively,$1 200 and$900).So,the cost of goods sold for FIFO is lower($9 320)than that for LIFO($9 62
20、0).As a result,we can see the difference in the income before taxes.3.15Periodic System Under periodic system inventory records are not changed when purchases and sales occur.The amount of ending inventory is determined by a physical count of the goods remaining on hand at the end of an accounting p
21、eriod.The cost of goods sold is computed then by subtracting the amount of ending inventory from the goods available for sale.3.16The Use of the Lower of Cost or Market Rule Once the cost of ending inventory is computed,it is required to compare it with the current market value.If the market value o
22、f ending inventory is lower than the book value of such inventory,the resultant loss must be recognized in the current period.3.17Inventory Loss If the market value of an item(or items in aggregate)is lower than its cost,the company has to reduce its ending inventory by the amount of difference.3.18
23、Account Receivable(or:Debtors)Accounts receivable are very liquid assets,usually being converted into cash within a period of 30 to 60 days.Most businesses sell goods on credit terms i.e.to trade debtors.It must be recognized,however,that there is a risk that some debtors will fail to pay their debt
24、s i.e.that the debts may be uncollectible.3.19How to Create an Accounts Receivable?The customer purchases a product,but agrees to pay for it later.In such situations,the amount of money that a company expects to get in the future from a customer is called an account receivable.3.20The Allowance Meth
25、od of Accounting for Bad Debts:an Example Usually a company cannot know for sure how much of accounts receivable will be doubtful in the future.In such a case,nevertheless,it is reasonable to make an estimate.The amount of accounts receivable that is expected to be uncollectible is recorded in a spe
26、cial contra asset account called Allowance for Doubtful Debts.3.21The General Journal and T-accounts The transactions and the closing entry are shown in the general journal and T-accounts as follows:DateAccount TitlesDebitCredit1Accounts ReceivableService Revenue6 0006 0002CashAccounts Receivable3 6
27、003 6003Bad Debts ExpenseAllowance for Doubtful Debts400400ClosingEntryService RevenueBad Debts ExpenseRetained Earnings6 0004005 600Assets=Liabilities+EquityCash0Retained Earnings(2)3 600(cl.)5 600Bal.3 600Bal.5 600Accounts ReceivableServices Revenue(1)6 000(2)3 600(cl.)6 000(1)6 000Bal.2 400Bal.0A
28、llowance for DoubtfulDebtsBad Debts Expense(3)400(cl.)400(3)400Bal.0Bal.4003.22Three Financial StatementsFinancial Statements for 2012Income StatementBalance SheetStatement of Cash FlowsService Revenue6 000AssetsCashAccounts ReceivableLess:AllowanceNet Realizable Value3 6002 400(400)2 000Operating A
29、ctivitiesCash Receipts3 600Bad Debts Expense(400)Net Income5 600Investing Activities0Total Assets5 600Financing Activities0EquityRetained Earnings5 600Net Change in Cash3 600Plus:Beg.Cash Bal.0Total Claims5 600Ending Cash Balance3 6003.23How Is the Amount of Allowance for Doubtful Debts Estimated?In
30、 the illustration above we assumed the amount of allowance for doubtful debts($200).However,how is it estimated in reality?Usually,accountants use records from previous years and adjust it to current situations.3.24Direct Write-off Method For direct write-off method,there is no need for estimates,ad
31、justing entries,or use of the Allowance for Doubtful Debts account under this method.Under this method bad debts expense is recognized at the point when an account receivable is known to be uncollectible3.25Warranty A warranty of a company is its promise to do something(repair a car,accept a goods return if it is damaged,etc.)for a client during a specified period of time without a charge(for free).Even though warranties represent an uncertainty in time,amount,or customer,it is usually deemed as an obligation and must be recorded in accounting books.
