Client Understanding Paper Free Essays

University of Phoenix ACC/541 Client Understanding Paper As per your request of an analysis of the following topics: Adjusting lower of cost or market inventory on valuation, Capitalizing interest on building construction, Recording gain or loss on asset disposal, and Adjusting goodwill for impairment. The Financial Accounting Standards Board (FASB) established clear guidelines addressing the items mentioned above. I will outline that FASB generally accepted accounting standards (GAAP) affect each area, and how these improvements to the company will benefit the company’s financial health (FASB, 2010). We will write a custom essay sample on Client Understanding Paper or any similar topic only for you Order Now The methods of inventory valuation are different according to companies, but at the end of the day the chosen method should be consistent each year according to the general accepted accounting principles. A manufacturing company will generate inventories for finished product, raw materials and work in progress, so lowering the cost of market inventory can be very intimidating and consuming. Inventories and prepaid expenses present some additional valuation issues. With the emphasis on net income reporting, the inventory valuation process has become secondary to the matching of expired inventory costs to sales. The use of any of the acceptable inventory flow assumption techniques prescribes the amount that remains on the balance sheet, and it is likely that each of these flow assumptions will result in different inventory valuations in fluctuating market conditions. In addition, the accounting convention of conservatism requires that a lower of cost or market valuation be used for inventories (Schroeder, Clark, Cathey, 2005). Using the first-in-first out (FIFO) or the last-in-first-out (LIFO) method is the perfect way to identify the cost of each inventory item. â€Å"A valuation method (e. g. LIFO, FIFO, average cost and specific identification) is used to compute the cost of the inventory dollar amounts and then it is compared to the market dollar amount. † LIFO is not commonly used because the last goods purchased are the first to be sold. The inventory at the beginning of the year will have the earliest goods purchased acquiring a valuation of an early price. FIFO is better used for lowering cost especially during periods of increase prices. It is also important to identify a method for valuing the items in the inventory and calculating the cost of goods sold. This can be done through the cost method, the lower of cost or market and the retail method. â€Å"A valuation method is used to compute the cost of the inventory dollar amounts and then it is compared to the market dollar amount. The lower of the two amounts must be used when recording inventory. † The cost method involves all direct and indirect costs to acquire the inventory. The cost of the products purchased consists of the invoiced purchase price minus discounts or trade with and addition of transportation, shipping additional cost incurred for attaining the product. Lower of cost or market method â€Å"determine the market value of each item on hand as of the inventory date, compare the market value with the cost of each item, and use the lower of the two as the inventory value of that item† (Hagen, 2005). The American Institute of Certified Public Accountants (AIPCA) in conjunction with the Financial Standards Accounting Board (FASB) issued ARB No. 3 that lower of    cost or market rule apply to all inventories. Lower of cost or market aspect (LCM) is also supported and defined by SFAC No. two and SFAC No. 6. The LCM rule considers the market that purchases and sells the inventory. In general, the conservatism principle applies to LCM method of accounting. Conservatism principle directs a company to choose the more â€Å"conservative† dollar amount when considering two amounts that represent inventories. This helps a Company to report accurate losses on their income statement. To determine LCM, one must also consider net realizable value (NRV). This value represents the selling price of inventories minus the fees associated with completion of sales. The NVR is key to determining true LCM. Conclusion of market value also refers to an items current replacement cost. This cost falls between the NRV (ceiling value) and the floor value (NRV- normal profit). Inventory cost adjustments are required by accounting standards. Incorrectly reporting inventory values at higher levels is a fraudulent act (with harsher penalties under Sarbanes Ox). Inventory valued at $10 with a true value of $5 is a punishable event (FASB, 2010). When a building asset is developed, a vast amount of time is required between the start and completion of the project. Normally the cost of should include all cost to prepare the asset for its useful life of the asset or for sale. The capitalization of interest cost on a building give a guideline on the amount of interest to be capitalized and for the financial statement disclosure. The expenditures must be qualified ahead of time, activities must be in progress and the company must be paying interest. Capitalization ends when the building fully constructed and is in use. Interest is not capitalized on inventories manufactured on a repeated basis or if the building is acquired using gifts or grants under restriction by the donor or grantor. â€Å"When additional financing is incurred after construction expenditures have begun, a firm may capitalize interest on construction expenditures either using an end-of-period average interest rate that includes all financing outstanding at the end of the period (general or specific, as appropriate) or using only the finance outstanding when the construction expenditure was made. Scofield, 2004) The average capitalized rate can be computed using the weighted-average or the specific method. If you were to purchase a building after it was completed, the sales price would include all costs (plus a profit to the seller). Part of the costs in building something is the interim borrowing costs†¦ in this case, the construction loan. Adding the loan to the other costs (brick, mortar, labor) is called â€Å"capitali zing† the interest expense. This creates a higher cost basis for the building and can be â€Å"recovered† through the depreciation expense deduction (over the life of the building). The three main events in the life of an asset are the acquisition, useful life, and disposal or retirement. At the end of an asset’s life, gain or loss of its disposal is recorded. A gain or loss will take place at the disposal of any assets and should be logged as journal entry along with any related incidental cost. The unrealized gains and losses are noticed according to its earnings. All changes whether upward or downward that involves investment shares are shown as income or losses with a change in market value that requires an adjustment to its carry value. At the time disposal there can either be a gain or loss or no gain or loss. Schroeder, Clark and Cathey states that all unrealized gains and unrealized losses will be valued the same for asset valuation purposes. For trading securities, the gains and losses are noticed in those periods in which they occur; for these assets the method is consistent with other accrual accounting requirements. A consistency with the SFAC No. six definition of comprehensive income is determined because comprehensive income is determined by the changes in net assets and would include changes in the market values of assets. For trading securities, no further masking of gains against losses that occurred under the aggregate valuation approach of SFAS No. twelve is needed. Goodwill for impairment must be assessed by companies at least once per year. If an impairment of goodwill the carried amount will be lessened and there will be recognition of impairment loss. Goodwill for impairment test must be recorded as reporting units. These could be the company’s operating segments identified under SFAS 131, or a â€Å"component† of a reportable operating segment as defined in paragraph 30 of SFAS 142. (Huefner and Largay III, 2008). Goodwill is comparing each unit’s estimated fair value of the reporting unit with the unit’s fair values of its identifiable net assets. This process and the process of allocating purchase price differentials of asset acquired, goodwill and liabilities assumed is very similar. The total of the tentative assignments of goodwill to reporting units can surpass the total goodwill recorded by the total entity but when this occurs, the tentative unit assignments are reduced in some reasonable fashion to make the sum equal to the total recorded goodwill (Huefner and Largay III, 2008). Losses on impairment cannot be changed but according to Schroeder, Clark and Cathey, an impairment loss for goodwill should be reversed only if the specific external event that caused the recognition of the impairment loss reverses. A reversal of an impairment loss should be recognized as income in the income statement for assets carried at cost and treated as a revaluation increase for assets carried at revalued amount. At the end of the developing period, the annual impairment test is done on an aggregate basis, which means an increase in goodwill on some books annot offset impairments found in other units. Huefner and Largay III also states that given the potential significance of the change in the accounting treatment of a major asset, the authors expected to observe numerous large impairment write-offs due to implementing the new standard, and large increases in net income because of eliminating goodwill amortization as an expense. In conclusion assets involving current assets, long-term investments, fixed assets, and intangible assets at some point can be changed into cash. Intangible assets except goodwill can either be determinable or indeterminable useful lives. Schroeder, Clark and Cathey explain that those with determinable useful lives are written off over the period of benefit. The cost of acquiring goodwill as well as intangible assets with indeterminate useful lives, is not amortized. References Schroeder, Richard G. , Clark, Myrtle W. , and Cathey, Jack M. (2005). Financial Accounting Theory and Analysis, The Development of Accounting Theory. Financial Accounting Standards Board. 2010). Financial Accounting Standards Board home. Retrieved April 5, 2010 from, http://www. fasb. org/. Scofield, B. (1994) Full disclosure of interest capitalization decisions. The National Public Accountant. Retrieved on April 5, 2010 from http://www. allbusiness. com/accounting. Huefner, R. J. , Largay J. A. (2008). The CPA Journal. The Effect of the New Goodwill Accounting Rules on Financial Statements. Retrieved on April 5, 2010 from http://www. nysscpa. org/cpaj ournal/2004/1004/essentials/p30. htm How to cite Client Understanding Paper, Papers Client Understanding Paper Free Essays Client Understanding Paper ACC/541 April 01, 2013 Abstract As a newly hired Staff I there will be a responsibility to analyze the work papers for the organization’s clients. In this situation a client is not clear about why a Staff I is asking for information on adjusting lower of cost or market inventory valuation, capitalizing interest on building construction, recording gain or loss on asset disposal, and adjusting goodwill for impairment and requires explanations on these topics. An explanation of each is provided to include sources from accounting websites, Generally Accepted Accounting Principles (GAAP), and accounting pronouncements. We will write a custom essay sample on Client Understanding Paper or any similar topic only for you Order Now In addition to the explanation for each accounting practice there is also an explanation of the impact it will have on the financial statements and examples of calculations to aid with real-world application. Client Understanding Paper When beginning a job in the accounting field it is likely that the newly hired staff will be responsible for analyzing the documentation of clients within the organization. If a client becomes confused why certain documents are required to be analyzed explanations will need to be provided to the client for his or her understanding. Within this paper is an explanation of some of the topics a newly hired accountant may encounter when working with clients. These topics cover adjusting lower of cost or market inventory on valuation, capitalizing interest on building construction, recording gain or loss on asset disposal, and adjusting goodwill for impairment. Adjusting Lower of Cost or Market Inventory on Valuation A requirement of Generally Accepted Accounting Principles (GAAP) is that inventory is recorded at the lower of cost or the market value and is known as Lower of Cost and Market (LCM). This pronouncement is covered under Accounting Research Bulletin No. 43 (ARB). The need for LCM typically occurs because the inventory has become obsolete, it has deteriorated, or the market prices have declined for the inventory. When using LCM inventory cannot be reported higher than the net realizable value less expenses known as ceiling and cannot be reported lower than the net realizable value plus normally attainable profit known as the floor (Investopedia, 2013). Net realizable value (NRV) is defined by AccountingCoach (2013) as â€Å"the expected selling price in the ordinary course of business minus the cost necessary for completion and disposal† (para. 08). NRV is considered to be a main component when determining market value. The definition of market found in the term â€Å"lower of cost or market† is considered to be the cost upon replacement. However, as mentioned above the market amount must fall between the market ceiling and floor. For example, if the replacement cost is in the middle of the ceiling and floor that figure will be the market cost. If the cost is above ceiling, the ceiling will be the market value, and if the replacement cost is below the floor, the floor amount will become the market value. Once LCM is determined GAAP permits it to be applied in three ways: inventory total basis, item by item basis, or inventory categories basis. Inventory total basis will yield the smallest loss on the income statement and smallest reduction of cost to inventory, and the loss is reported in the accounting period when the loss took place. Item by item basis is the opposite of inventory total basis because it results in the largest loss reported on the income statement and largest reduction of cost to the inventory. Item by item basis is also reported in the accounting period when the loss took place. Inventory category basis settles in the middle of inventory total basis and item by item basis, and reports loss on the income statement when the market value drops below cost (AccountingCoach, LLC. , 2013). Capitalizing Interest on Building Construction There is an inquiry for capitalizing interesting on building construction because the interest created from the debt for the assets construction is added to the cost of the construction instead of expensing on the income statement of the current period. According to, the Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 34, Capitalization of Interest Cost the interest will be added to the construction cost and reported on the balance sheet. It eventually will be reported on the income statement but will show as part of the assets depreciation expense. The ability to capitalize on the interest ends upon completion of the assets creation and does not include minor modifications. For example, if multiple pieces of equipment are in construction and after each is completed it is prior to the completion of others then the interest may be capitalized on each individual unit upon completion. Recording Gain or Loss on Asset Disposal Under GAAP when a company disposes of a long-term asset at a cost different from the book value of the asset the difference will require an adjustment to net income on the cash flow statement. The difference between the disposal price and book value is considered either a gain or loss. For example, if a vehicle has a cost of $20,000 less accumulated depreciation of $17,000 the book value will be the difference equating to $3,000. If the vehicle is disposed of for $3,500 the difference between the book value and disposal amount equates to $500. This $500 is recognized as a gain on the sale of the asset and increases net income. Using the same example if the asset sold for $2,000 a loss of $1,000 would be recognized on the asset resulting in a reduction of net income. In the operating section of the cash flow statement any gain recognized will need to be deducted and any loss will need to be added. These additions and deductions must occur to avoid double counting because a requirement of asset disposal is that the proceeds recognized from the sale must be reported in the investing activities section of the cash flow statement that directly follows the operating activities section. If no loss or gain occurs because there are no proceeds and the asset has been fully depreciated a debit will be made to accumulated depreciation, and a credit will be made to fixed assets. Adjusting Goodwill for Impairment When a company purchases an intangible asset for more than the assets book value then goodwill impairment occurs. The difference between the purchase price of the asset and the book value is the goodwill and will require an adjustment. For example, if ABC Insurance is sold for $10 million to Progressive Insurance but only has a book value of $8 million then the difference of $2 million is considered goodwill and is reported as an asset on Progressive’s balance sheet. If after the sale occurs Progressive decides to remove all of ABC Insurance’s local offices and designates them as an online company only resulting in a loss in sales of 50% this may result in a drop in fair market value to $5 million. The drop in fair market value will require Progressive to make a goodwill impairment. Progressive will combine the current market value of $5 million to the goodwill of $2 million comparing the total of $7 million to the purchase price of $10 million. The difference created of $3 million must be reflected in the books by reducing goodwill by $3 million. Recording goodwill impairments is important because it can represent a large portion of a company’s net worth. If these changes are not reported the net worth can seem overinflated and mislead investors. This very reason is why companies are required to have their goodwill tested annually, comparing the actual value of the assets in question to their recorded value and adjusting for the difference every year (InvestingAnswers Inc. 2013). In summary, clients may have limited accounting background and may require explanations of accounting terms and documentation, accounting authority, accounting procedures, and the purpose and impact of certain accounting practices. Explained within this paper is a brief overview regarding common accounting practices, such as LCM to include NRV, how to apply LCM, and the impact it will have on the financial statements. Also included is when and what interest can be capitalized on building construction, how to record gain or loss on the disposal of an asset, a definition of goodwill, and how and why it must be adjusted if there is an impairment. References AccountingCoach, LLC.. (2013). Lower of Cost or Market. Retrieved from http://www. accountingcoach. com/online-accounting-course/27Xpg01. html InvestingAnswers, Inc.. (2013). Goodwill Impairment. Retrieved from http://www. investinganswers. com/financial-dictionary/financial-statement-anal How to cite Client Understanding Paper, Papers