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The object of the reflection for this week is to discuss the objectives for Week One and their relation to the importance of the balance sheet to internal and external users. The objectives discussed by Learning Team A are the components of cash and cash equivalents, and the comparison and contrast of different inventory cost flow assumptions and how they are valued. The internal users are indentified as management and the external users are investors and creditors. Cash and Cash Equivalents
Cash is defined in the text as the “most liquid of assets” and is identified by companies as a current asset. (Weygandt, Kimmel, & Kieso, 2010) What has become very popular is the classification called cash and cash equivalents. FASB has determined that classification to be misleading and it will probably be eliminated from financial statements. Cash will be cash and what used to be short term cash equivalents will now be reported as temporary investments. One of the situations leading to this decision is some companies having to take large losses on auction-rated notes. These notes are liquid because they can be traded daily, but they are not short term because the terms of the notes can be lengthy, in some cases 30 years. When the economy went bad, the auctions stopped, the value went away and the companies participating had to take sizeable losses. Why inventory is important on the Balance Sheet
Inventory is an important aspect on the balance sheet. When an outsider studies the balance sheet, they have to look at the assets that the company currently has to make the inventory portion of the balance sheet make sense. The reason that the inventory shows on the balance sheet as a current asset is so outsider investors assume the inventory sells in the future when the product is complete. When investors review the balance sheet, they also like to see that the company does not have too much inventory in case they are cannot sell it, or get rid of the inventory in the future. If companies do not have an accurate amount of inventory they have to estimate it to reflect the information on the balance sheet. Calculating inventory value using Gross Profit and Retail Inventory methods
The gross profit inventory valuation method is pretty simple. Beginning inventory plus purchases minus sales at selling price less gross profit percentage equals ending inventory. The major disadvantage of this method is that it is an estimate and not actual which is why it is not a GAAP approved method unless physical inventory is done to back up the valuation (Kieso, Weygandt, & Warfield, 2010).
The retail inventory method, on the other hand, is an acceptable way to valuate inventory. Many retail stores have so many items it is really impractical to do regular inventory counts. To calculate inventory valuation this way, the store takes the beginning inventory plus purchases less sales to determine ending inventory at the retail price. Then the goods available for sale at cost amount is divided by the goods available for sale at retail amount to determine the cost-to-retail ratio; that figure is multiplied by the retail ending inventory to come up with the cost.
Internal users of accounting can include management, employees, and owners. Managers use this accounting information to view the company’s performance. Employees view accounting information for job security. Owners view accounting information to view profits from their investments. External users can insist of creditors, investors, and customers. Creditors use this information to check the company’s credit worthiness. Investors would like to earn money from their investments. Customers would like to maintain a long term company customer relationship. The balance sheet allows internal and external users to view what the business has and what the business owes. Knowing a company’s net worth is very important. Using different methods to calculate inventory for companies can be very critical.