FFiinnaanncciiaall AAccccoouunnttiinngg && RReeppoorrttiinngg 44

Finan

cial

Acc

ounting &

Rep

ort

ing 4

1. Working capital and its components ................................................................................. 3

2. Inventories ................................................................................................................. 20

3. Fixed assets................................................................................................................ 33

4. Depreciable assets and depreciation ............................................................................... 40

5. Fixed asset impairment ................................................................................................ 51

6. Homework reading: Enhanced outlines and expanded examples of inventory........................ 53

7. Homework reading: Transfers and servicing of financial assets (SFAS No. 140)..................... 72

8. Class questions ........................................................................................................... 75

F4-2

Becker CPA Review Financial Accounting & Reporting 4

2009 DeVry/Becker Educational Development Corp. All rights reserved. F4-3

WORKING CAPITAL AND ITS COMPONENTS

I. INTRODUCTION TO WORKING CAPITAL

A. WORKING CAPITAL

Working capital is defined as current assets minus current liabilities. It is often a measure of the solvency of a company and is used in many financial ratios for analysis purposes.

1. Working Capital

Current Assets Current Liabilities 2. Current Ratio

Current Assets Current Liabilities

3. Quick Ratio

Cash + Net Receivables + Marketable Securities

Current Liabilities

B. CURRENT ASSETS

Current assets are those resources that are reasonably expected to be realized in cash, sold, or consumed (prepaid items) during the normal operating cycle of a business or one year, whichever is longer. Current assets typically consist of:

1. Cash,

2. Trading securities,

3. Other short-term investments (individual available-for-sale securities if liquidation is anticipated within the operating cycle or one year, whichever is longer),

4. Accounts and notes receivable,

5. Trade installment receivables,

6. Inventories (discussed later in this module),

7. Other short-term receivables,

8. Prepaid expenses, and

9. Cash surrender value of life insurance. Cash surrender value of life insurance can be a current asset or a non-current asset depending on intent. If the policy owner intends to surrender the policy for its cash surrender value during the normal operating cycle, it would be a current asset; if the policy owner does not intend to surrender the policy, as is normal, it would be a non-current asset. If an insurance policy has a cash surrender value, any portion of the premium payment that does not add to that cash surrender value is expensed.

WORKING CAPITAL

CURRENT ASSETS

Financial Accounting & Reporting 4 Becker CPA Review

F4-4 2009 DeVry/Becker Educational Development Corp. All rights reserved.

C. CURRENT LIABILITIES

Current liabilities are obligations whose liquidation is reasonably expected to require the use of current assets or the creation of other current liabilities. Obligations for items that have entered the operating cycle should be classified as current liabilities. The concept of current liabilities includes estimates or accrued amounts that are expected to be required to cover expenditures within the year for known obligations (1) when the amount can be determined only approximately (e.g., provision for accrued bonuses payable), or (2) where the specific person(s) to whom payment will be made is unascertainable (e.g., provision for warranty of a product).

Current liabilities are an important indication of financial strength and solvency. The ability to pay current debts as they mature is analyzed by interested parties both within and outside the company.

1. Sources of Current Liabilities

Current liabilities may arise from regular business operations (as is the case of accounts payable and wages payable) or to meet cash needs through bank borrowings.

2. Types of Current Liabilities

Current liabilities typically consist of:

a. Trade accounts and notes payable,

b. Current portions of long-term debt,

c. Cash dividends payable,

d. Accrued liabilities,

e. Payroll liabilities,

f. Taxes payable, and

g. Advances from customers (deferred revenues if expected to be recognized within one year).

3. Classification of Short-Term Obligations Expected to Be Refinanced

A short-term obligation may be excluded from current liabilities and included in noncurrent debt if the company intends to refinance it on a long-term basis and the intent is supported by the ability to do so as evidenced either by:

a. The actual refinancing prior to the issuance of the financial statements, or

b. The existence of a noncancelable financing agreement from a lender having the financial resources to accomplish the refinancing.

The amount excluded from current liabilities and a full description of the financing agreement shall be fully disclosed in the financial statements or notes thereto.

CURRENT LIABILITIES

Becker CPA Review Financial Accounting & Reporting 4

2009 DeVry/Becker Educational Development Corp. All rights reserved. F4-5

CASH __

CASH EQUIVALENTS

II. CASH AND CASH EQUIVALENTS

Cash includes both currency and demand deposits with banks and/or other financial institutions. It also includes deposits that are similar to demand deposits (can be added to or withdrawn at any time without penalty). The term cash equivalents broadens the definition of cash to include short-term, highly liquid investments that are both readily convertible to cash and so near their maturity when acquired by the entity (90 days or less from date of purchase) that they present insignificant risk of changes in value.

A. EXAMPLES OF CASH AND CASH EQUIVALENTS

1. Coin and currency on hand (including petty cash)

2. Checking accounts

3. Savings accounts

4. Money market funds

5. Deposits held as compensating balances against borrowing arrangements with a lending institution that are NOT legally restricted

6. Negotiable paper

a. Bank checks, money orders, traveler's checks, bank drafts, and cashier's checks

b. Commercial paper and Treasury bills

c. Certificates of deposit (having original maturities of 90 days or less)

B. ITEMS NOT CASH OR CASH EQUIVALENTS

1. Time certificates of deposit (if original maturity over 90 days)

2. Legally restricted deposits held as compensating balances against borrowing arrangements with a lending institution

C. RESTRICTED OR UNRESTRICTED

Cash is classified as unrestricted or restricted. Restricted cash is cash that has been set aside for a specific use or purpose (e.g., the purchase of property, plant, and equipment). Unrestricted cash is used for all current operations. The nature, amount, and timing of restrictions should be disclosed in the footnotes.

1. If the restriction is associated with a current asset or current liability, classify as a current asset but separate from unrestricted cash.

2. If the restriction is associated with noncurrent asset or noncurrent liability, classify as a noncurrent asset but separate from either the Investments or Other Assets section.

3. Examples of restrictions

a. If any portion of cash and cash equivalents is contractually restricted because of financing arrangements with a credit institution (called a compensating balance), that portion should be separately reported as "restricted cash" in the balance sheet.

b. If any portion of cash and cash equivalents is restricted by management, it should be reported as restricted cash and as a current or long-term asset (depending on the anticipated date of disbursement).

c. Some industries (such as public utilities) report the amount of cash and cash equivalents as the last asset on the balance sheet because they report assets in inverse order of liquidity.

Financial Accounting & Reporting 4 Becker CPA Review

F4-6 2009 DeVry/Becker Educational Development Corp. All rights reserved.

EXA

MPL

E

Items Included in Cash Balance

Smith Corporation's cash ledger balance on December 31, Year 7, was $160,000. On the same date Smith held the following items in its safe:

A $5,000 check payable to Smith, dated January 2, Year 8 that was not included in the December 31 checkbook balance.

A $3,500 check payable to Smith, deposited December 22 and included in the December 31 checkbook balance, that was returned NSF. The check was re-deposited January 2, Year 8 and cleared January 7.

A $25,000 check, payable to a supplier and drawn on Smith's account, that was dated and recorded December 31, but was not mailed until January 15, Year 8.

In its December 31, Year 7 balance sheet, what amount should Smith report for cash?

Smith's cash balance is calculated as follows:

Unadjusted balance of Smith's Cash Ledger Account, December 31, Year 7 $160,000

Add: Check Payable to supplier dated and recorded on December 13, Year 7, but not mailed until January 15, Year 8 25,000

Less: NSF check returned by bank on December 30, Year 7 (3,500)

Adjusted balance, Dec