The accounting environment in the USA - Essay Example

? Connie Johnson Client Understanding Paper August 19, of Phoenix In accounting there are a lot of concepts, theories, and principlesthat must be considered by an accounting staff when performing accounting work. Accountants in the United States must comply with the generally accepted accounting principles (GAAP). There different interpretation of accounting rules which can alter the outcome of the books of a company. It is important to remember that the accounting books of a company must comply with the consistency principle. I have identified four topics that your accounting staff must understand clearly in order to avoid any confusion and to ensure that that the staff complies with the generally accepted accounting principles. The four accounting topics that will be discussed in this report are: 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 cost of market inventory on valuation The amount of inventory in the warehouse of a company can decrease in value as prices of goods can go down in price due to market fluctuations. A good example of this phenomenon can be visualized in agricultural crops. These crops vary in price on a daily basis as their prices are traded in the open market as commodities. In any type of industry the market of value of inventory can vary and as a consequence it can distort the current assets account balance. Inventory is part of current assets. Accountants should always keep in mind the conservatism principle which states that when in doubt an accountant should choose the method that is less likely to overstate the assets or income of a company. The application of lower of cost or market is aligned with the conservatism constraint. Valuing inventory at lower of cost or market implies writing down inventory when the value of inventory is lower than its costs. There is a contra account in the balance sheet called Allowance to Reduce Inventory to LCM that is used to make the necessary adjustment. “This balance sheet account is used to report the amount that the inventory's market amount is below the inventory's cost amount” (Accountingcoach, 2011). The LCM method defines the market price of an item as the current replacement cost. An example of how to apply the method and its corresponding journal entry is illustrated below: Inventory value = $10000 Current replacement cost = $9500 $10000 – $9500 = $500 The $500 is considered a loss Journal Entry: Loss from Reducing Inventory to LCM $500 Allowance to Reduce Inventory to LCM $500 Capitalizing interest on building construction One of the characteristics of the construction industry is that projects take a long time to complete. Typically in business interest costs associated with financing any project are categorized as an expense. The Financial Accounting Standards Board (FASB) created a special rule for the construction industry that allows accountants to capitalize interest on construction project. FASB Statement No. 34 stipulates the guidelines that must be followed to calculate capitalization of interest in construction projects. It also states the disclosure requirements for capitalized interest in the financial statements of a company. The interest on any loan may only be capitalized while the construction occurs. There are certain criteria that must be met in order to be able to capitalize construction interest. The three criteria are: qualifying expenditures must already have been made activities to prepare assets for use must be in progress The firm must actually be paying interest (Young, 1994). At the moment that any of these three conditions seize to exist the company becomes ineligible to capitalize interest associated with construction projects. Any inventory used that is routinely manufactured or produced on a repetitive basis does not qualify for capitalization of interest if the inventory is purchased through debt (Young, 1994). Recording gain or loss on asset disposal The accounting records record the value of an asset in the balance sheet as the original cost minus accumulated depreciation. The subtraction of cost minus accumulated depreciation is referred to as the book value of an asset. When a company decides to sell an asset the sale of the asset may result in a loss or gain. The book value is the parameter used to determine loss or gain. If an asset is sold for a price that is higher than the book value the asset is sold at a gain. A second possibility is to sell an asset at a price that is lower than the book value which would result in a loss. If a loss or gain occurs from the sale of an asset an adjustment must be made in the cash flow statement in the operating section to the net income account. There are different scenarios under which an asset may be disposed of. The first scenario is to dump the asset. When an asset is dump the entire book value is written off and the company takes a loss in the amount of the book value of the asset. The second scenario is the most common is to sale the asset for cash and to obtain a gain or loss in the sale of the asset. The third scenario is for the asset to be disposed off in the form of a trade. When trade occur the market value of the two assets is compared. If the asset obtained in the trade has lower value a loss is incurred and it must be recognized immediately, but if gain occurs in the barter the recognition of the gain is deferred. Adjusting goodwill for impairment Goodwill can be defined as the value of all favorable attributes that relate to a business enterprise. Goodwill is recorded only when there is a transaction that involves the purchase of an entire business in which case the goodwill is the excess of cost over the fair market of the net assets acquired (Weygandt, Kimmel, Kieso, 2002). The goodwill of a company may become impaired due to different circumstances. In cases in which there is indication goodwill may have been impaired the remaining goodwill must be estimated and based on that estimate if the market value is less than the book value of the goodwill an impairment loss must be recorded in the accounting books (Accounting-financial-tax, 2009). When a company has an impaired goodwill that has not been adjusted the total assets of the company are overstated. Conclusion The accounting environment has been changing a lot during the past decade. Ethics have become more important than ever as regulations such as the Sarbanes-Oxley Act has increased the accountability of the profession. The topics that were discussed in this report are very important for all business since complying with these rules is essential to be in compliance with GAAP. The lowest of cost or market inventory is a technique that is useful to keep up with the true value of inventory. In businesses that have low inventory turnover rates some companies may keep the same inventory for periods of six months or higher. These companies may have purchased their inventory at high values that may not represent the current replacement cost of the inventory. The ability to capitalize interest on construction projects is a concession that given by the FASB to the construction industry based on FASB Statement No. 34. When an asset is sold the firm must determine if a loss or gain occurred from the transaction. The accountant determines if a loss or gain occurred by comparing the sales price to the book value of the asset. Adjusting goodwill for impairment is a necessary accounting practice to eliminate any overstatements of assets in the balance sheet. References Accountingcoach.com (2011). Lower of Cost or Market (LCM). Retrieved August 19, 2011 from http://www.accountingcoach.com/online-accounting-course/27Xpg05.html Accounting-financial-form.com (2009). How are Goodwill Impairment Losses Accounted? Retrieved August 19, 2011 from http://accounting-financial-tax.com/2009/02/how-are-goodwill-impairment-losses-accounted/ Weygandt, J., Kieso, D., Kimmel, P. (2002). Accounting Principles (6th ed.). New York: John Wiley & Sons. Young, A.G. (1994). Capitalization of interest during construction. Retrieved August 19, 2011 from http://www.allbusiness.com/accounting/464117-1.html Read More