Learning Objectives

Notes

Students may be introduced to this module by recognizing the purpose and function of each of the three asset valuations that will be performed in this module. A general statement on why the accurate calculation of assets is important on financial statements may be helpful. Who is interested in the accurate calculation of assets? Some examples may be: owners, creditors, Canada Customs and Revenue Agency (CCRA), auditors, investors, managers, and others. Students should explore reasons why each may be interested.

In the GAAP, the Matching Principle, matches revenue and expenses to the period in which they are incurred. The cost of bad debts and depreciation should be estimated as closely as possible to each accounting period.

The GAAP, particularly Full/Adequate Disclosure and Consistency Principle, are reflected in the valuation of inventory. Students should realize that all information that may affect decisions must be reported on financial statements. The Consistency Principle requires the organization to report financial information using the same method from period to period. Thus in this module, it is important for students to realize that businesses cannot change the method of calculating bad debts, depreciation, or inventory without the approval and awareness of all internal and perhaps external parties (e.g., Canada Customs and Revenue Agency).

Students may review and discuss issues associated with bad debts. Topics may include:

• Should credit sales be extended?
• What amount of uncollectibles is acceptable?
• How can we avoid them?
• Should we aim for no bad debts at all?
• Others.

What does Canada Customs and Revenue Agency say about the amount of bad debt a company may claim?

Review the journal entry to record the adjustment for bad debts. The purpose and placement (on which financial statement) of each account (Bad Debts Expense and Allowance for Bad Debts) should be reviewed. Allowance for Bad Debts is a contra account to what account?

Should bad debts be directly written off as they occur or should an amount be estimated as being uncollectible (allowance) from which a bad debt may be written off when it occurs? Students may discuss the advantages and disadvantages of each method. It is the intention of this module to show two methods of estimating write offs (aging and percentage of net sales) and the journal entries for estimation and direct write off.

How is the amount of bad debt estimated (when an allowance account is established)? Two common methods are aging accounts receivable and percentage of net sales (sales minus sales returns and allowances and sales discounts). Perform numerical calculations for each method. Compare and contrast the methods. What if the estimation for the Allowance account has been too great or too little for a number of years? What action may be taken? Remind the students that there may be flexibility within a company. If the fund has a large balance after four or five years, perhaps the percentage of net sales should be decreased or perhaps the company is too lenient in its credit extension policy.

How can a computerized accounting system assist with these calculations? Is an aging feature built into Accounts Receivable software?

Prepare matching (adjusting) entries for both methods of estimating bad debts. When the expense account is debited, what does that mean? When the allowance account is credited, what does that mean?

DR. Bad Debts Expense

CR. Allowance for Bad Debts

Review the placement of each account on financial statements. Which account is real and which is nominal? By estimating a write-off, has there been any change to an account receivable account? Has an actual write-off occurred?

Prepare a write-off of an accounts receivable account from an allowance account. When the allowance account (contra account) is debited, what does that mean? Students should realize that the allowance is being used up. Posting must occur both to the general ledger and to the subsidiary ledger.

A direct write-off occurs when no estimation of uncollectible accounts receivable has occurred, thus, no adjusting entry has been made, no allowance account has been established, etc. A direct write-off may be used when a company has few accounts receivable accounts or when the company uses a cash basis instead of an accrual basis.

Prepare the journal entry for a direct write-off.

DR. Bad Debts Expense

CR. Name/Accounts Receivable

What are the implications of a direct write-off? Students may be given the example of an accounts receivable incurred last year and yet written off this year. What implications does that have for the balance sheet for the two consecutive years and for the income statement (expense account) for the two consecutive years?

After working through the technique of estimating bad debts and direct write-off, students may be able to reflect and clarify the questions asked at the beginning of this unit: should bad debts be written off as they occur or should an amount be estimated as being uncollectible (allowance) from which a bad debt may be written off when it occurs?

Under what circumstances might each method be suitable?

Learning Objectives

Notes

9.7 To review and describe the function of depreciation and the journal entries presented in Module 2.

The students should review the meaning of depreciation as discussed when the adjusting entries were prepared in Module 2, objective 2.20.

What is a fixed asset? How does the adjusting entry relate to fixed assets? What does the GAAP, the Cost Principle, say? Students should be aware that the cost of the fixed asset is to be allocated over the estimated life of the asset.

The estimation of depreciation matches the allocated cost of the fixed asset for one period to the revenue earned in that period. On which financial statement does each account appear? Accumulated depreciation is a contra account to what general ledger account? Which account is nominal and which account is real?

How is the amount of depreciation calculated? Review the straight-line method of depreciation. Students should realize there are two estimated amounts: years of life of the fixed asset and salvage value.

Review the CCA of depreciation which is required by Canada Customs and Revenue Agency. The rates that are used are prescribed by Canada Customs and Revenue Agency and should be used in this module.

Students should prepare adjusting entries for both methods. An expense and allowance account is usually open for each fixed asset.

After journalizing and posting the adjusting entry, students may analyze and record the disposal of a fixed asset. Situations to consider may be the disposal/sale of an asset for the book value of the fixed asset (cost minus accumulated depreciation); for more than the book value; for less than the book value; and, for no value. New income and expense accounts may be encountered (gain and loss on fixed assets). Their placement on financial statements should be indicated. GST may be collected and recorded on the sale of fixed assets.

Students may do calculations on one asset using both methods. What do the differences in yearly depreciation mean? Does an asset depreciate equally each year? What are the implications for yearly net income?

Why would a company use the straight-line method of estimating depreciation for financial statements for insiders and use the capital cost method of estimating depreciation for outsiders and Canada Customs and Revenue Agency? Are varying audiences receiving varying messages?

A guest such as an accountant may be invited to speak and discuss the two different methods for estimating depreciation.

Learning Objectives

Notes

Students should review the aspects of merchandise inventory presented in Module 2:

• What is merchandise inventory?
• What is physical, periodic, and perpetual inventory?

Students may give examples of both periodic and perpetual inventory usage. What types of items may be recorded using each method?

Perpetual inventory may use a subsidiary ledger. The subsidiary ledger may be a card or computer record for each inventory item.

Discuss the advantages of periodic and perpetual inventory regarding such issues as cost, ease of handling, computerization, labour hours involved, etc. Results of the analysis should determine that perpetual inventory is a much more expensive method that still requires a physical inventory at the end of the period.

The following questions may be asked:

• on what financial statements is merchandise inventory placed?
• how is a Cost of Goods Sold section prepared and what is the role of inventory?
• what is the meaning of each line in the Cost of Goods Sold section?
• what closing entries involve Merchandise Inventory?
• into what account is it closed?
• how does this affect net income/loss?

After a physical inventory is completed, costs must be assigned to the inventory. This cost will become the ending inventory for one accounting period and the beginning inventory for the next period. The amount will be used in the Cost of Goods Sold section of the Income Statement and on the Current Assets section of the Balance Sheet.

1. Specific Identification: Inventory valued would be identified by a code number indicating the cost of each item as it was received into the place of business. This method could be easily used if a computerized identification system were employed. A printout of the inventory identified as being left on the shelves could easily show the cost of each item when it was received. An example may be a clothing store or a hardware store.
   
   Students may not complete exercises using specific identification but should realize that with optical scanning devices, this method may be easily employed. Businesses, however, may not wish to use this method to value inventory even if the technology is available.
   • First-In, First-Out (FIFO): Define the method. Perform calculations.
   • Last-In, First-Out (LIFO): Define the method. Perform calculations.
   • Weighted Average: Define the method. Perform calculations.

    

It would be advantageous for the students to work through one problem using three or all four methods (FIFO, LIFO, and weighted average and specific ID if the data is available) to see the actual differences in the ending inventory amount.

Using the three or four different ending inventory amounts, students may take the calculation further to complete the Cost of Goods Sold section and Net Income on the Income Statement and to complete the Total Assets and Balance Sheet.

Further analysis may include:

• Describe some advantages and disadvantages to each method.
• How does the difference in ending inventory affect the amount of income tax paid? LIFO cannot be used for income tax purposes, thus it cannot be used to value inventory on the financial statements.
• What method might a company choose to report inventory differently to varying audiences, such as creditors, potential investors, shareholders, Canada Customs and Revenue Agency, etc.?

In small groups, students could be given a case study to examine and discuss the method of inventory valuation that a company may use. Each small group may be given different audiences to which they would be presenting the inventory information. Teachers may ask the reporter from each group for the group's response and after discussion, summarize the findings. Teachers may wish to distribute further case studies for discussion and vary the audiences for the groups of students.

Learning Objectives

Notes

9.16 To design and illustrate an example of how the value of one or all examples of the three asset classifications (accounts receivable, inventory, and fixed assets) may be altered to satisfy varying audiences. (IL)

The students may have completed a similar assignment in one of the three units. The purpose of this objective is for synthesis. Why did we learn these mathematical calculations? What relevance does a particular method have to varying audiences? The process of matching the calculation to the business and/or audience is the object of this final assignment.