Accounting EDU

Part of an accountant’s job may be to advise management when there is excess profit. One way to invest extra cash is in bonds. A bond is a loan given to another company that bears interest.

Bonds are a short-term investment strategy because they can easily be converted to cash when needed. Bonds can be sold at discount or premium. Here are three possible variations-

1. Bonds sold at par: Bonds are sold at the face value stated on the bond certificate. The stated interest rate is the same as the market interest rate.
2. Bonds sold at a discount: These bonds have a lower stated interest rate than the market interest rate. The bond will be sold at less than face value to compensate for offering a non-competitive interest rate.
3. Bonds sold at a premium: These bonds have a higher stated interest rate than the market interest rate. This occurs because the seller of the bond will not sell when the stated amount of interest to be paid is greater than what is being paid in the market.

Types of Bonds

This is a list of bonds typically sold on the market.

• Coupon Bonds: They come with detachable coupons that are cashed in at specific dates. They are not very common today.

• Registered Bonds: These are registered in the name of the owner and require the presentation of the bond certificate at the time of maturity.

• Serial Bonds: They are issued to mature at dates spread out over time.

• Convertible Bonds: These bonds can be exchanged by the holder for a specified number of shares of corporate stock.

• Callable Bonds: These bonds allow the company to buy back the bonds at a specified price before the bonds’ maturity date. The company will often exercise this option when the market interest drops significantly below the stated rate.

Recording depreciation is an important part of accounting for long-term assets. Assets undergo wear and tear and their depreciating value must be tracked. There are three methods to choose from and among those choices are the Declining Balance Methods.

The main way this method differentiates from the others is that it charges more depreciation expense in the early years of an asset’s life than do other methods. The reasoning behind this accounting method is that a business uses up more of the asset in its earlier years. Assets tend to have less repair and maintenance in their earlier years. Most repairs tend to be made in the later years of the asset’s usage.

Two Types of Declining Balance Methods

• Double Declining Balance Method: An accelerated depreciation method is based on the declining book value of the asset. Net book value is the historical cost of the asset less its accumulated depreciation. The Double Declining Balance method initially ignores salvage value which is an estimate of the amount a business anticipates receiving at the end of the asset’s life.

   There are two ways to calculate the annual depreciation rate-

1. Calculate the straight-line expense and double it.
2. Calculate the expense by dividing 2 by the Estimated Useful Life and then multiplying it by the book value.

• Sum-of-the-Years’-Digits Depreciation Method: This accelerated depreciation method uses the number of years of the asset’s expected life as a fraction. “The numerator is the number of years of estimated life remaining as of the beginning of the year, and the denominator is the sum of all digits and is the same for each annual computation” (Berry, Leonard Eugene. Financial Accounting Demystified. The McGraw-Hill Companies, Inc. 2011).

Selecting a method for calculating and recording depreciation will determine what is reflected in the accounting ledger. In fact, an accountant may keep one record using a particular method for tax purposes and another record using a different depreciation method for the company’s purposes. This is a legal practice.

The Generally Accepted Accounting Principles (GAAP) has different requirements than the tax laws when it comes to recording depreciation. This is because the two entities have different objectives. The company’s purpose for financial reporting is to measure it’s economic activity by matching revenues and expenses for a given period of time. The government’s purpose for tax laws is to collect revenue and to stimulate the economy.

Therefore, often accountants will choose the accelerated depreciation method for tax purposes because they offer the greatest tax deductions. But when it comes to using a depreciation method for company purposes, they may choose the straight-line depreciation method.

Steps for Recording Depreciation Expense

1. Estimate the useful life of the asset: This amount is typically determined when the asset is new. It is measured in years or units of output.
2. Estimate the salvage value: This is an estimation of the amount the company anticipates receiving at the end of the asset’s useful life.
3. Compare the depreciation expense: Choose from the methods below. it is important to select a method and use it consistently throughout accounting practices. Typically, except when using the double declining method, the salvage value is deducted from the cost of the asset to determine the depreciable base.
4. Enter the depreciation expense in the journal: Credit a contra-asset account called Accumulated Depreciation. This account reflects how much depreciation has been accumulated over the asset’s life.

Depreciation Methods

• Straight-line depreciation

• Units-of-output depreciation

• Declining balance depreciation (This method can be broken down into 2 other categories).
• Double declining balance depreciation
• Sum-of-the years’-digits depreciation

An important accounting function is tracking cash flow.This involves the inflow of cash through sales, services and investment interest and the outflow of cash in the form of expenses and other financial activities. Investing excess cash in securities, either short-term or long-term, is beneficial to the company.

Long-Term Investments

Long-term investments are defined as investments made to earn income. Or, investments made in order to exert significant influence on another company.

• Available-for-Sale Securities

These include debt and equity securities. Because these securities are held until maturity and are normally for a time period exceeding a year, they are classified as noncurrent on the balance sheet. They are reported at fair value and as a separate component of stockholders’ equity under Other Comprehensive Income. This entry is below the Retained Earnings line on the balance sheet.

Even though the available-for-sale securities experience changes in market value, these changes are considered an unrealized gain or loss. This means that a security can gain or lose market value but this is not accounted for because the security hasn’t yet been sold.

• Investment in Equity Securities to Gain Control & Influence

A company may seek to influence another company’s policy by purchasing a large quantity of long-term investments in the form of equity in that company. The Financial Accounting Standards Board (FASB) has created guidelines to define this type of control sought by an investing company.

The company with the investment has…

• Little Influence: With holdings of less than 20%. Account for these using the fair value similar to available-for-sale securities.

• Significant Influence: With holdings between 20% to 50%. Account for these using the equity method. The investor records the initial investment at cost and includes a proportional share of the investee’s income on its income statement each period.

• Controlling Interest: With holdings of more than 50%.  The financial statements of the investee are consolidated with those of the owner-investor because of their large portion of stock ownership.

Tracking the use of a company’s cash is important. Most every company provides some form of petty cash to have on hand for minor business expenses. Not only is the accountant responsible to record cash flow but he must also assess the amount of any excess cash to be invested in order to maximize the asset’s return to the company.

Cash is the most liquid asset a company has in its possession. Investments of excess cash in short-term investments earn interest. In larger companies, cash management may fall under the treasurer’s function. However, the accountant must provide the necessary information so the treasurer can correctly perform his job.

Determining a Cash Budget

A treasurer will use the cash budget determined by the accountant. A cash budget is necessary to establish the appropriate amount of cash to have on hand. This includes petty cash which is the small amount of cash available for small purchases by employees or for giving change to customers.

In regards to the company’s long-term financial goals, the cash budget also sets a cash level to help conclude if there is excess cash to be re-invested. Excess cash should then be invested in short-term investments.

• Cash Equivalents: Investments in securities maturing within 90 days. It is advisable that these securities have a low risk of loss of value. This includes money market accounts, government bonds, Treasury bills, and commercial paper.

• Short-term Investments: Investments in securities maturing in excess of 90 days but within one year.

These cash investments can be converted to cash immediately so they are reported at face value in the Current Asset section of the balance sheet. It is not necessary to list the individual types of cash equivalents. If desired, further explanation can be provided in a footnote.

It is a well-known practice for a company with excess cash to invest it in short-term or long-term investments as a way of increasing their profit. In fact, Apple has a separate office designated for the reinvestment of their profits located in Reno, Nevada. This is a strategic way to maintain a positive cash flow.

When a company considers reinvesting some of its profits, it must wisely select from among short-term and long-term investments. Management must establish the time frame of the investment and its purpose. This will aid in determining a proper selection.

Short-Term Investments

Short-term investments are defined as investments by a company that can be converted to cash within the year. There are two types of short-term investments: Held-to-Maturity Securities and Trading Securities.

• Held-to-Maturity Securities: These securities are purchased with the goal of earning interest or of reselling in the future for profit. They are debt securities that the company is able to hold to maturity. Most often, these securities are classified as noncurrent assets like bonds. Occasionally, they are recorded as a current asset such as when a company purchases Treasury Bills or Corporate Notes that will mature within one year.  To report these securities, enter the cost less any impairment like amortized cost plus any accrued interest.

• Trading Securities: These include debt and equity securities purchased with the purpose of reselling with a quick turn around, usually within days or weeks.  At the end of a reporting period, enter the trading securities at fair market value based on the mark-to-market principle. This established principle requires that securities reflect the current market value rather than the book value. Trading securities are classified as current assets on the balance sheet. Don’t forget to adjust the Trading Securities account for unrealized gain or loss in market value.

Most businesses usually extend some form of credit to attract customers. It may be a retail store offering to sell their goods on credit cards or a vendor who allows payment for goods sometime after they are delivered. With offering goods on credit comes the inevitable- not all customers will repay the full amount of their debt.

The Generally Accepted Accounting Principles (GAAP) require that a business reports only receivables on which it expects to receive payment. Therefore, the uncollectible accounts must be provided for in some other way in the accounting ledger.

Accounting for Uncollectible Receivables

• Direct Write-Off Method

This is the simplest method but not always the most accurate. The uncollectible account is written off and the expense recognized in the period in which the receivable becomes worthless. Although it is a straightforward way of handling an uncollectible account, it is not recognized as GAAP. The only time it would be considered appropriate i,

• Allowance Method

Because the direct write-off method contains some discrepances, accountants have developed the allowance method. It is an estimation of uncollectible accounts at the end of each accounting period. When the amount has been determined, the Uncollectible Accounts Expense is debited while the account Allowance for Uncollectible Accounts is credited.

An accountant can use either two methods to determine the estimation of uncollectible accounts expense: the percentage-of-sales method and the accounts receivable aging method.

• The Percentage-of-Sales Method functions by deciding the total sales for the period based on the income statement. Then, an estimation is made as to how much of these sales will be uncollectible. It isn’t necessary to determine exactly which accounts will fall into this category.
• The Accounts Receivable Aging Method not only estimates but pays attention to how long the account has been outstanding. It sets up an aging schedule. From there, it can be determined just how much of each age’s balance will not be collectible.

Remarkably, the world’s most profitable tech company, Apple, has developed tax strategies which have helped them avoid paying billions in taxes. This isn’t unusual for technology companies. Their products aren’t necessarily physical goods but royalties or patents in this digital age. The American tax system seems a bit outdated for companies such as these.

Because technology companies’ products are predominately digital, they can more easily relocate to low-tax overseas countries in order to avoid paying higher taxes on American soil. Technology is now one of America’s leading industries. But because the nation’s tax system is based on company structure from the industrial age, many of these technology companies are among the least taxed.

“Over the last two years, the 71 technology companies in the Standard & Poor’s 500-stock index — including Apple, Google, Yahoo and Dell — reported paying worldwide cash taxes at a rate that, on average, was a third less than other S.& P. companies’” (Duhigg, C. & Kocieniewski, D. (2012, April 28). How Apple Sidesteps Billions of Taxes. The New York Times).

Tax Avoidance Tactics

• Collect Company Profits in a Low-Tax State

Apple has a small office in Reno, Nevada where they collect their profits and reinvest them. Their headquarters are in California. But by shifting profits across the state border, they save 8.84% in California taxes. How? The tax-rate in Nevada is 0%.

• Double Irish with a Dutch Sandwich

This accounting technique carries this name because taxes are reduced by routing profits through Irish subsidiaries and the Netherlands and then to the Caribbean. Apple was the inventor of this method which many other corporations have put into practice.

Some hold Apple’s tactics responsible for the lack of funding needed from taxes for State programs. However, Apple claims they have a high ethical standard and have done nothing wrong.

In accounting, business transactions must be entered regularly into the accounting records. The place where the original entry is made is called a General Journal. This is the catch-all for transactions that don’t necessitate entry in specialized journals. In large companies, where there might be thousands of transactions, specialized journals are a necessity.

Specialized journals are used to record repetitive transactions. Furthermore, businesses use subsidiary accounts. “Transactions are first recorded into a specialized or the general journal; then they are posted to a ledger account (usually a control account) periodically, and finally, if appropriate, they are posted to a subsidiary account daily” (Berry, Leonard Eugene. Financial accounting Demystified. USA: The McGraw-Hill Companies, 2011. p. 74).

Four Specialized Journals

• Sales Journal

The Buffett Rule drew a near-party-line vote last Monday, April 16, 2012. Named after billionaire Warren Buffett, the measure proposed that high earners pay at least 30% in federal income tax. Warren Buffett publicly commented he pays a lower tax rate than his secretary. Hence, the measure carries his name as an example.

The vote was split 51 for the measure with 45 opposed. In order to advance, 60 votes are needed. Democratic Senate candidates are trying to stir up support using Facebook ads and Google themself to promote its passage. An online petition is even in circulation.

However, Republicans caution “it is a bad idea to raise taxes on investors and job creators, especially in a fragile economy” (Bendavid, N. (2012, April 17). ‘Buffett Rule’ Tax Proposal Fails in a Senate Test Vote. The Wall Street Journal. pp. A4.).

Obama issued a statement on the counter-attack where he criticized Republicans for “choosing once again to portect tax breaks for the wealthiest few Americans at the expense of the middle class” (Bendavid, N. (2012, April 17). ‘Buffett Rule’ Tax Proposal Fails in a Senate Test Vote. The Wall Street Journal. pp. A4.). Clearly, this is a partisan issue. Senators seem to want to use tax policy as a way to promote their party’s arguments ahead of the fall election.

Currently, the top marginal tax rate is 35% but many high earners pay a much lower rate. In fact, there are 1,470 families making more than $1 million a year that pay absolutely no federal income taxes. Although the Republicans and Democrats in the Senate seem to be fairly well divided on the issue, 60% of the American voters said in polls that they support raising taxes on millionaires.