April 22, 2013
To complete the analysis of the current clients’ work papers certain information must be gathered to review. The requested information will be on the following topics (1) adjusting lower cost of market inventory on valuation, (2) capitalizing interest on building construction, (3) recording gain or loss on asset disposal, and (4) adjusting goodwill for impairment. An analysis of each topic will be discussed in this paper to help alleviate the customers concerns in regards to the reason the information was requested.
Inventory Cost Adjustments The purpose of this information being requested is because of a requirement by the accounting standards board. Inventory cost adjustments are a requirement because the current value of inventory must be reported. Incorrectly reporting the inventory values at a higher level is a fraudulent act, which even for a small amount such as five dollars is a punishable event. There must be a review of the valuation of all inventories to make sure that there is not a violation in regards to the reported values. The “GAAP requires that all inventory reserves be stated and valued using either the cost or the market value method- whichever is lower” (Investopedia Staff, 2009).
Capitalizing Interest on Building Construction “ASC 835-20 states that institutions are required to capitalize the interest cost incurred during the acquisition process or construction of the asset. The capitalized interest would be added to the historical cost of the asset, and therefore depreciate over its useful life” (Ashish Patel, 2010). If a building were to be purchased after it was completed, the sales price would include all costs including the monies paid to the seller. Part of the cost in building something is of course the borrowing costs as well as the other costs of building. By adding the loan to the other costs, you are capitalizing the interest expense. This creates a higher cost basis for the building; however, it can be recovered through depreciation over the life of the building. “The capitalization of interest expense on a project can sometimes be overlooked, which would cause the asset value to be understated. Although the capitalization of interest can seem counter intuitive at times, it is required by GAAP and the Internal Revenue Code” (Ashish Patel, 2010).
Recording a Gain or Loss on Asset Disposal As with anything, a productive asset that is in use by a company over time may no longer be needed by the company and a decision will be made to dispose of the asset. Whichever way the asset is disposed of by abandonment, sale, or exchange, there is a necessity to update the depreciation calculations through the date of disposal. When you sell an asset, the proceeds are compared to the current book value of that asset. Whether it is a gain or a loss, it is reported on the income statement.
One of the rules in preparing a statement of cash flows is that the entire proceeds received from the sale of a long-term asset must be reported in the second section of the statement, the investing activities section. This presents a problem because any gain or loss on the sale of an asset is also included in the company's net income, which is reported in the first section—operating activities. To avoid double counting, each gain is deducted from net income and each loss is added to net income in the operating activities section of the cash flow statement (Accounting Coach, LLC, 2006).
Adjusting Goodwill for Impairment
Goodwill impairment generally occurs when a company pays more than book value for a set of assets and must later adjust for the book value of the goodwill. Goodwill is an asset that unlike other assets does not amortize or depreciate over time. The GAAP requires companies to test goodwill every year for impairment. When you purchase a business you are not just buying the business, you are purchasing