### Operating Assets

Module 6
Reporting and Analyzing
Operating Assets
Accounts Receivable
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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
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.

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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.
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.
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:
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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
Average collection Period for
Selected Industries
Inventories

Very Expensive.

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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
Inventory Costing Methods

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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
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 market and creates the following financial
statement effects:

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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.
Inventory Turnover Rates for
Selected Companies
Property, Plant, & Equipment
Use of PPE generates revenues
Consider with ownership:
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Control quality and usage
Fixed expenses: depreciation, maintenance,
insurance, property taxes
Risk of technology change
Depreciation Methods

All depreciation methods have the
following general formula:

Depreciation Methods:
1.
2.
Straight-line method
Accelerated Methods (Double-decliningbalance method)
Straight-line Depreciation Example

For the straight-line method, we use our illustrative
asset to assign the following amounts to the
depreciation formula:
Double-declining-balance method

Double-declining-balance method. For the doubledeclining-balance (DDB) method, we use our illustrative
asset to assign the following amounts to the depreciation
formula:
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:
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
 Taxable
gains/losses occur on a sale
 On like kind trades: flows to next asset
 SO, trade your like-kind gains, sell
Asset Impairments

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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.)
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.
Analysis of Useful life and
Percent Used Up
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Estimated useful life =
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Percent used up =