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Chapter 4: Analyzing Investing Activities :red_flag:, Capitalizing vs…

- - - - Recent Cost = Cost of Goods Sold
      - Oldest Cost = Ending Inventory
    - - when a unit is sold, the average cost of each unit in inventory assigned to cost of goods sold
    - - Oldest Cost = Cost of Goods Sold
      - Recent Cost = Ending Inventory
    - - Beginning inventories + Net purchases - Cost of goods sold = Ending inventories
  - - - In period of rising price, assuming company not previously liquidated older layers of inventories, LIFO reports ending inventories at price that lower than replacement cost.
        
        Resulted to balance sheet for LIFO companies not accurately represent the current investment that company has in its inventories.
    - - Market = current replacement cost through either purchase or reproduction
      - Cost = acquisition cost of inventory
      - implies if inventory declines in market value below its cost for any reason such as obsolescence, damage and price change, the inventory is written down to reflect its loss
    - - Gross profit affected by company’s choice of inventory costing method
        
        In period of rising price, FIFO produces higher gross profit than LIFO
        
        - FIFO’s phantom profits (gross profit which actually sum of two components ; economic profit and holding gain)
        - Economic profit= num of unit sold x (sales price - replacement cost of inventories)
        
        Holding gain (increase in replacement cost) , function of inventory turnover and rate of inflation
        = num of unit sold x (current replacement cost - original acquisition cost)
    - - Components of cost of inventories for manufacturing
        
        Raw material
        
        Labour
        
        Overhead
      - Effect of production increase
        
        Increase in production levels causes ending inventories to increase. Overhead costs remain while profitability increase.
        
        Inventory quantities decrease, income statement is burdened by current and previous overhead cost and lowering profit.
    - - When reduction in inventory quantities occurs, which can occur as a company becomes leaner or downsizes, companies dip into earlier cost layers to match against current selling prizces.
        
        For FIFO inventory costing, this does not present a significant problem as ending inventories are reported at the most recently acquired costs and earlier cost layers do not differ significantly from current cost.
        
        For LIFO inventories, however, ending inventories can be reported at much older costs that may be significantly lower or higher than current loss.
        
        In periods of rising prices, this reduction in inventory quantities, known as LIFO liquidation will arise and results in an increase gross profit that is similar to the effect of FIFO inventory costing.
        
        In periods of declining prices, however, the reduction of inventory quantities can lead to a decrease in reported gross profit as higher cost inventories are matched against current sales.
      - Analytical Restatement
        
        Analytical Restatement of LIFO to FIFO
        
        Analytical Restatement of FIFO to LIFO
- - - - Not all receivables are collected
        
        Management usually estimate the amount that is collectible and make allowance for uncollectible amounts
        
        Uncoleectible amounts are written against the allowance account (will be deducted from receivablein the SOFP)
  - - - Any substantial change in prepaid expenses need to be
        scrutinized
- - - - Also include intangible assets such as patents, trademarks, copyrights, and goodwill.
  - - - Hard assets: PPE
        
        recorded at the purchase price and all incidental costs that relate to the asset.
      - Soft assets: R&D, advertising & wage cost
        
        capitalization are more problematic
      - Research cost: costs incurred during the research phase
        
        recognized as expenses in the period they are incurred.
      - Technical feasibility: ability to use or sell, generate future economic benefits
        
        cost can be measured realiably
- - - - For example: coal,oil,minerals or timber
    - - more production yields, more depletion expense
  - - - Straight line method
        Annual depreciation expense = (Cost - Salvage value) / Useful life
      - Accelerated method
        
        Step 1 :
        Straight line depreciation rate =
        100% / Useful life
        
        Step 2 :
        Double declining balace rate =
        2 x Straight line depreciation
        
        Step 3 :
        Depreciation expense =
        (Double declining balance rate) x (Beginning periood book value [ignore salvage value])
  - - - Average total life span
        =Gross plant and equipment assets/ Current year depreciation expense.
      - Average age
        =Accumulated depreciation/ Current year depreciation expense
      - Average remaining life
        =Net plant and equipment assets/ Current year depreciation expense
      - Average total life span
        =Average age + Average remaining life
- - - - any likely bias is in the direction of less amortization and can call for adjustments
    - - often missvalued and most likely exist off-balance-sheet
  - - - Separately identified and linked with specific rights or privileges having limited benefit periods
        
        Example : patents, trademarks, copyrights and franchise
    - - Assets that are either developed internally or purchased but are not identifiable and often possess indefinite benefits periods
        
        Example : Goodwill
    - - Subsequently amortized over the benefits periods
        
        The length of benefit period depends on the type of intangible, demand conditions, competitive circumtances and any other legal, contactual, regulatory or economic limitations
        
        For example : patents are exclusive rights conveyed by governments to investors for a specific period
- - - - The extent cash & cash equivalent are invested in equity securities.
        
        If the market value of those investment decline, then company is at risk of reducing liquidity
        
        sometimes required to maintain the compensating balances to support existing borrowing arrangements or as collateral for indebtedness.