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Week 2 Resource: Chapter 1 and Chapter 2 of Financial Accounting Complete Chapter 1: Questions # 5, 12, 14, 16 and Exercise E1-10 Chapter 2: Question: # 6 Resource: Chapter 2 and Chapter 3 of Financial Accounting Complete Chapter 2: Exercises E2-10, E2-12, and Chapter 3: Problem 3-3A
· What are the differences among valuation, depreciation, amortization, and depletion? Is it appropriate to calculate depreciation using two different methods? Why?
Valuation entails that the assets, such as investments or inventories should be recorded at the current market price regardless of whether the actual value is above or below the cost. Depreciation allocates the cost of a tangible asset over its useful life. Companies depreciate long-term assets for both tax and accounting purposes and a decrease in an asset’s value is caused by negative market conditions. Amortization entails writing off an intangible asset investment over the projected life of the assets Depletion is often used with natural resources such as oil. There is only so much oil in an oil field. It is the reduction of the value of an asset on a balance sheet that comes about as a result of the physical reduction of the asset's features.
It is appropriate to calculate depreciation using two different methods. Many companies depreciate its plant assets with the straight line method on its financial statements and the accelerated method on its income tax return. The reason why is because the equipment might be depreciated over ten years for its financial statements while only 7 years on its income tax return.
Which depreciation method provides you the highest depreciation expense in the first year? Why?
Straight-line depreciation is the simplest and most-often-used technique, in which the company estimates the salvage value of the asset at the end of the period during which it will be used to generate revenues (useful life) and will expense a portion of original cost in equal increments over that period. The salvage value is an estimate of the value of the asset at the time it will be sold or disposed of; it may be zero or even negative. Salvage value is also known as scrap value or residual value.
For example, a vehicle that depreciates over 5 years, is purchased at a cost of US$17,000, and will have a salvage value of US$2000, will depreciate at US$3,000 per year: ($17,000 − $2,000)/ 5 years = $3,000 annual straight-line depreciation expense. In other words, it is the depreciable cost of the asset divided by the number of years of its useful life.
· What types of industries have unearned revenue? Why is unearned revenue considered a liability? When is the unearned revenue recognized in the financial statements?
The industries that have unearned revenue are comprised of places where people prepay for their services before using it. For example, cell phone companies and cable companies charge in advance. Unearned revenue is considered a liability due to the fact that revenue is received yet service has not been provided. The cash is recorded as an asset and liability entry is recorded until the service has been utilized. An example would be an insurance company that charges ahead of time before providing the services, at which time the liability will then be converted to earned revenue.
· Why do companies issue bonds? Would you rather buy a bond at a discount or a premium rate? Why? What is the determining factor of whether a bond is sold at a discount, face, or premium?
Companies issue bonds because they are a major source of long term finance for the company, a form of debt financing where it is interest based security. There exists a tax shield on the interest payments so companies prefer to delve bonds instead of common stock. I would rather buy the bond at a discount because it is less expensive and a higher interest rate yields than purchasing the bond at face or premium value. The determining factor of whether a bond is sold at discount, face, or premium is the interest rate reflected in the market. If the rate is equal to the rate of the bond, it will be issued at par value, if less than the rate of the bond, it will be issued at premium and if greater than the rate of the bond it will be issued at a discount.
What is the straight-line method of amortizing discount and premium on bonds payable? Provide an explanation of the process.
The straight-line method of amortizing discount spreads the discount evenly over the periods during which interest is paid for the bonds. The straight-line amortization on bonds payable involves crediting interest expense and debiting premium on bonds payable. Under this method, the bond premium amortization amount is spread consistently each month. The number of months the bond is held during the years should be divided by the number of months from the beginning of the tax period year to the bond's maturity date/call date. That result, multiplied by the bond premium, which is a reduced amount each year due to the bond amortization from earlier years yields the premium amortization amount for the year. Both will decrease until the amount reaches 0.
How would you describe the accounting procedures for notes payable and accounts payable?
Both Notes Payable and Accounts Payable are liabilities. Notes Payable occurs when companies attempt to obtain financing for under a year from lenders. Notes Payable comprises of written promissory notes. An example would be a $50,000 loan from the bank that requires a loan agreement or collateral. While the company records it in the general ledger liability account named Notes Payable, the bank records it as Notes Receivable. The borrower makes adjusting entries which debit Interest Expense and credit Interest Payable to echo the interest that has accrued but has not been paid. Payments result in entries which credits Cash and debits Interest Payable and Notes Payable. Liability for Interest Payable is first reduced and then the principle under Notes Payable is then adjusted. Accounts Payable does not involve promissory notes and recorded in the general ledger under Accounts Payable. These accounts do not accrue explicit interest and companies usually try and obtain greater funding from creditors by delaying their payments. Poor credit ratings and restrictions of future credit may arise if failure to pay off their promises occurs.