• Approximate number of days inventory is held
• Avg. Days Inventory=365/inventory turnover ratio

• manufacture the inventories they sell, rather than buying them in finished form.
• Inventory in 3 categories:
• Raw Materials
• Work-in-process
• Finished goods

• "First-In, First-Out" the first units purchased (first in) are th first ones sold (first out).
• Most closely approximates actual physical flow of inventory
• During periods of rising costs, FIFO results in 1) higher ending inventory, 2) lower COGS, 3) higher reported profit than does LIFO

• "Last-In, First-Out" the last units purchased (last in) are the first ones sold (first out).
• Primary benefit is Tax Savings
• When inventory costs rising, LIFO results in lowest amount of reported profits (taxable income)

• both the cost of goods sold and ending inventory consist of a random mixture of all the goods available for sale
• weight-avg. cost=total cost of goods for sale/# units available for sale

• Requires that company using LIFO for tax reporting to also use LIFO for financial reporting.
• Companies must report difference in amount of inventory if it were to use FIFO

• FOB="freight on board"
• FOB Destination: title of inventory doesn't transfer to buyer until it has reached destination (seller pays shipping)
• FOB Shipping Point: title of inventory transfer when shipped (buyer pays shipping)

• Freight charges on incoming shipments from suppliers
• We add the cost of freight-in to the balance of inventory
• When that inventory is sold, those freight charges become part of COGS

Multi-step income begins by reporting that a company's

Gross Profit= (sales revenues) - (COGS)

Measures profitability from normal operations

Operating Income=(gross profit)-(operating expenses)

Difference between all revenues and all expenses for the period

Net Income=(income before income taxes)-(income tax expense)

Lower-of-Cost-or-Market

(LCM) Method

• Method where companies report inventory in the balance sheet at the lower of cost or market value, where market value=replacement cost
• When market value<cost, we adjust down the balance of inventory from cost to MV.

Shows # of times the firm sells its average inventory balance during a reporting period

Inventory Turnover Ratio=COGS/avg. inventory

Higher ratio is BETTER, indicates greater effectiveness

Measures the amount by which the sale priec of inventory exceeds its cost per dollar of sales

Gross Profit Ratio=gross profit/net sales

• Not a current asset
• Rule- we record long-term asset at cost + expenditures necessary to get asset ready for use
• Two Types: 
• 1) Tangible Assests: visible
• 2) Intangible Assets: invisible

• Record an expenditure as an asset (put on balance sheet rather than expense immediately)
• All costs needed to get the asset ready for its intended use
• Salvaged materials decrease cost of long-term asset

Refers to interest costs we add to the asset account rather than recording them as interest expense.

mathcing principle: expense are to be matched (included on same income statement as) the revenues they help to create

• Exclusive right to manufacture a product or to use a process
• If purchased, record purchase price + other expenses

• If developed internally, expense R&D costs as it incurs them

Represents the value of a company as a whole, over and above the value of its identifiable net assets

Goodwill=(Purchase Price)-(Fair value of identifiable net assets)

Cost of replacing a major compenent of an asset.

Capitalize to equipment account

• Item is said to be material if it is large enough to influence a decision.
• Goods w/ value over cerain level
• if not, expense immediately
• if so, does it increase future benefits?

Accounting definition=allocation of an asset's cost to an expense the cost of an asset over its service life

Allocation of the cost of a tangible asset over its service life

Allocate an equal amount of the depreciable cost to each year of the asset's service life

Depreciation Expense=depreciable cost/service life

An accelerated depreciation method. However, both it and straight-line method will result in same total depreciation

Double-Decling Method

Depreciation Rate=2/service life

Depreciation Expense=(book value)(depreciation rate)

Instead of measuring depreciation on time, we instead allocate an asset's cost based on its use

Depreciation Rate=depreciable cost/total units to be produced

Depreciation Expense=(depreciation rate)(# untis of activity)

Allocating cost of intangible assets to expense

residual value of most intangible assets=0

measure of profitability

ROA=net income/avg. total assets

Indicates the earnings per dollar of sales

Profit Margin=net income/net sales

Measures sales per dollar of assets invested

Asset Turnover=net sales/avg. total assets

• occurs when the future cash flows (future benefits) generated for a long-term asset fall below its book value (BV=cost-accumulated depreciation)
• 1) If estimated that future cash flows are below book value, asset is impaired
• 2) Impairment Loss=(book value)-(fair value)

Payable within one year, and long-term liabilities are payable more than 1 year from now

Firms would rather repot liability as long-term (less risk)

Interest=(Face value)(Annual interest rate)(fraction of the year)

-Record interest expense in the period in which we incur it, rather than in the period in which we pay it

An informal agreement that permits a company to borrow up to a prearranged limit w/o having to follow formal loan procedures and prepare paperwork

-works like a note payable except the company is able to borrow w/o having to go through procedures/paperwork

If a company borrows from another company, rather than from a bank, note is referred to as "Commercial Paper"

• Sold w/ maturitieis ranging from 30 to 270 days
• Since borrowing directly from another company, interest rate on commercial paper is usually lower than on a bank loan

Named for Federal Insurance Contribution Act, collectively refers to Social Security and Medicare Taxes

7.65%

Additional employee benefits paid for by the employer.

Employers often pay for employees' insurance premiums, & make contributions to savings, retirement, etc.

Also includes extra benefits (free skiing if you work for a ski resort)

Current Liability

1. Receive cash in advance (debit: cash, credit: unearned revenues)
2. When revenues occur (debit: unearned revenues, credit: sales revenue)

When a company collects the sales tax, increases (debits) cash and increases (credits) Sales Tax Payable

-sales taxes are not an expense; they are a liability

The amount to be paid  within the next year. Important: provides info for management to budget cash flow and provides investors/lenders w/ info about liquidity (risk)

-reports as a current liability on balance sheet

• May not be a liability, depends on whether an uncertain event that might result in a loss occurs or not
• Only recorded if: a loss is probable and the amount can be reasonably estimated

An existing uncertain situation that might result in a gain, which often is the flip side of contingent liabilities

-we don't record contingent gains until they are certain

Working Capital=(current assets)-(current liabilities)

-Large positive working capital is an indicator of liquidity (whther the company will be able to pay its current debts)

Current Ratio=(current assets)/(current liabilities) 

• Current Ratio > 1=acceptable level of liquidity
• Higher the ratio, greater the liquidity
• current ratio=1, current assets=current liabilities
• High ratio is better, however, not always apositive signal
• companies having difficulty collecting receivables or holding excessive inventory will also have higher current ratio.

Acid-Test Ratio=(cash+current investments+accts receivable)/current liabilities

-quick ratio, similar to current ratioe, but based on more conservative measure of current assets available=>>"quick assets"/current liabilities

Includes only cash, current investments and accounts receivable.

-By eliminating current assets that are less readily available to convert into cash (inventory, prepaid expenses, etc.), the acid-test ratio may provide a better indication of a company's liquidity