Module 6

1. Module 6 Reporting and Analyzing Operating Assets

2. Accounts Receivable • Offer sales on credit as a customer service that increases sales & build relationships • If interest is charged, then can earn income • BUT, increases risk and results in bad debt expense

3. Aging Analysis Example • GAAP requires companies to disclose the amount of the allowance for uncollectible accounts, either on the face of the balance sheet or in the notes.

4. Bad Debt Expense • Bad Debt Expense is equal to the needed increase in the allowance for uncollectible accounts. • In our previous example, if the current balance of $2,200 existed in the allowance for uncollectible accounts, the company would record a bad debt expense of $700 and increase the allowance to $2,900.

5. Write-off of Uncollectible Accounts • The write-off of an uncollectible account does not affect income. The amount written-off is reflected as a reduction of the account receivable balance and the allowance for uncollectible accounts: • NOTE: For income tax purposes, only the direct write-off of accounts may be deducted as bad debts expense.

6. Receivables Turnover Rate and Days Sales in Receivables • The accounts receivables turnover (ART) rate is defined as • The accounts receivable turnover rate reveals how many times receivables have turned (been collected) during the period. • More turns indicate that receivables are being collected quickly. • A companion ratio is the Average Collection Period:

7. Example • Suppose that • sales are $1,000 • average accounts receivable are $200. • Then: • Accounts Receivable Turnover = $1,000/200 = 5 • Average Collection Period = 200/ (1,000/365) = 200/2.73957 = 73 days or 365 days / 5 turns = 73

8. Average collection Period for Selected Industries

9. Inventories • Very Expensive. • Costs of holding: space, insurance, counts • Inventories deteriorate and/or become obsolete • No returns for investment • Mistakes are hidden in inventories • In concept: Only need one of each item to show to customers or use plus a way to make or purchase another quickly

10. Inventory Costing Methods • First-In. First-Out (FIFO).Costs of the first units purchased are the first in cost of goods sold. • Last-In, First-Out (LIFO).Costs of the last units purchased are the first in cost of goods sold. • Average cost.Computes COGS and ending inventories as the weighted average of costs. • NOTES: • During inflation, LIFO results in the lowest taxable income • If LIFO, then must disclose FIFO are LIFO reserve • LIFO not allowed in IFRS, many companies are dropping LIFO

11. Lower of Cost or Market • Companies must write down the carrying amount of inventories on the balance sheet if the reported cost exceeds market value (replacement costs in US and NRV in IFRS). • This process is called reporting inventories at the lower of cost or marketand creates the following financial statement effects: • Inventory book value is written down to current market value; reducing inventory and total assets. • Inventory write-down is reflected in cost of goods sold on the income statement.

12. Inventory Turnover Rates for Selected Companies

13. Property, Plant, & Equipment • Use of PPE generates revenues • Consider with ownership: • Control quality and usage • Fixed expenses: depreciation, maintenance, insurance, property taxes • Business volume fluctuation • Risk of technology change

14. Depreciation Methods • All depreciation methods have the following general formula: • Depreciation Methods: • Straight-line method • Accelerated Methods (Double-declining-balance method)

15. Straight-line Depreciation Example • For the straight-line method, we use our illustrative asset to assign the following amounts to the depreciation formula:

16. Double-declining-balance method • Double-declining-balance method. For the double-declining-balance (DDB) method, we use our illustrative asset to assign the following amounts to the depreciation formula:

17. Double-declining-balance method • The asset is reported on the balance sheet as follows: • In the second year, $24,000 ($60,000  40%) of depreciation expense is recorded in the income statement and the NBV of the asset on the balance sheet follows:

18. Tax Issues • MACRS Depreciation: DDB • Asset Life: 3, 5, 7, 10, 15, 30 • Assumes the asset purchased/disposed half way through period, then determines the DDB rates for each life asset • Sales and Trades: • Taxable gains/losses occur on a sale • On like kind trades: flows to next asset • SO, trade your like-kind gains, sell your losses

19. Asset Impairments • Impairment of plant assets other than goodwill is determined by comparing the sum of the expected future (undiscounted) cash flows generated by the asset with its net book value. • Companies must recognize a loss if the asset is deemed to be impaired. (Impairment not recognized for tax purposes until sold. Loss may be reversed for IFRS.)

20. Analysis • PPE Turnover: analysis of the productivity of long-term assets Lowe’s: 48,815/(22,089+22,499))/2 = 2.19 Home Depot: 67,997/(25,060+25,550)/2= 2.69 Home Depot earns $2.69 for each dollar of fixed assets.

21. Analysis of Useful life and Percent Used Up • Estimated useful life = • Percent used up =