Principles of Financial Accounting
Principles of Financial Accounting ACC 212
Popular in Principles of Financial Acocunting
verified elite notetaker
verified elite notetaker
verified elite notetaker
verified elite notetaker
verified elite notetaker
verified elite notetaker
Popular in Accounting
This 50 page Bundle was uploaded by Melody Posthuma on Wednesday August 24, 2016. The Bundle belongs to ACC 212 at Grand Valley State University taught by Professor Dunn in Fall 2016. Since its upload, it has received 13 views. For similar materials see Principles of Financial Acocunting in Accounting at Grand Valley State University.
Reviews for Principles of Financial Accounting
Report this Material
What is Karma?
Karma is the currency of StudySoup.
You can buy or earn more Karma at anytime and redeem it for class notes, study guides, flashcards, and more!
Date Created: 08/24/16
Chapter 1 Current vs. Non-current: considered current if within 1 year Multi-Step Income Statement EXPENSES • Operating Expenses (all expenses besides interest and income tax) • Selling Expenses (all expenses directly related to selling the products/services) • General & Admin Expenses (everything else except interest and income tax) FORMULAS Sales Revenue - Cost of Goods Sold = Gross Proﬁt • • Sales Revenue - Operating Expenses = Operating Income +/- Interest (net interest expense against interest revenue) = Income before income tax Income before Income tax - Income tax = Net Income Accounts Payable: is money owed by a business to its suppliers shown as a liability on a company's balance sheet. It is distinct from notes payable liabilities, which are debts created by formal legal instrument documents. Considered as a liability. Accounts Receivable: is a legally enforceable claim for payment from a business to its customer/clients for goods supplied and/or services rendered in execution of the customer's order. Considered as an asset. FORMULAS CONTINUED Beginning Retained earnings + net income - dividends = ending retained earnings. This equation provides the structure of the statement of retained earnings (covers a period of time. Owners of preferred stock have priority when receiving dividends or if a company falls a part. We prepare income statement ﬁrst! Then statement of retained earnings, balance sheets, and statement of cash ﬂows. Net income and cash should be = to each other but in many cases they are not. Annual Reports: more than just ﬁnancial statements: footnotes (not disclosures), management discussion and analysis Forms of business BE PREPARED FOR AN MC QUESTION ON THE DECISION MAKING MODEL EXHIBIT 1.9 ETHICS AND ACCOUNTING. Operating cycle ends when you collect cash from customers for the goods, could be longer if credit since it takes longer to receive the cash. Accounts payable: things you bought on credit CHAPTER 2 - Balance sheet: shows what obligations will be due in near future and what assets will be available to satisfy them. - Income statement: revenues and expenses for a period of time - Statement of cash ﬂows: where cash came from and how it’s used - Notes: provide essential details about the company’s accounting policies and other key factors that affect its ﬁnancial condition and performance. - Accounting info must have/be: (1) Understandability: the quality of accounting information that makes it comprehensible to those willing to spend the necessary time. (2) Relevance: the capacity of information to make a difference in a a decision. Information may have a predictive value that helps you pre dice whether an action would be wise or not and others have a conﬁrming value that helps you conﬁrm you made the right decision. (3) Faithful representation: the quality of information that makes it complete, neutral, and free from error. (4) Comparability: the quality that allows a user to analyze two or more companies and look for similarities and differences. Depreciation is the process of allocating the cost of a long-term tangible asset over tits useful life. Each method may affect the value of the assets differently. The more uniform statements are in terms of the principles used to prepare them, the more comparable they will be.(5) Consistency: the quality that allows a user to compare two or more accounting periods for a ingle company. (6) Materiality: the magnitude of an accounting information omission or misstatement that will affect the judgment of someone relying on the information. Ask Will this error in any way affect the judgment of someone relying on the ﬁnancial statements? The threshold for determining materiality varies from one company to the next depending largely on the company’s size. (7) Conservatism: the practice of using the least optimistic estimate when two estimates of amounts are about equally likely. The practice of conservatism is reserved for those situations in which there is uncertainty about how to account for a particular item or transaction. Inventory held for resale is reported on the balance sheet at the lower-of-cost-or-market value. This rule requires a company to compare the cost of its inventory with the market price or current cost to replace that inventory, and to report the lower of the two amounts on the balance sheet at year-end. - Operating Cycle: the period of time between the purchase of inventory and collection of any receivable from the sale of the inventory. - Current assets (cash, marketable securities, accounts receivable, merchandise inventory, prepaid insurance, store supplies) vs. non-current assets (land held for future ofﬁce code (investment), land, building, store furniture and ﬁxtures, franchise agreement (intangible assets)). - Investments: securities not expected to be sold within the next year. - Current liability: an obligation will be satisﬁed within the next operating cycle or within one year if the cycle is shorter than one year vs. non-current liability. - Stockholder’s equity: represents owners’ claims on the assets of the business that arise from contributed capital and earned capital. Ex: capital stock, retained earnings, common stock, preferred stock. Dixon Sporting Goods Balance Sheet At December 31, 2014 Assets Current Assets Cash Marketable securities Accounts receivable Merchandies inventory Prepaid insurance Store Supplies Total Current Assets Investments Land held for future ofﬁce site Property, Plant, and Equipment Land Buildings Less: Accumulated depreciation Store furnitures & Fixtures Less: Accumulated depreciation Total property, plant, and equipment Intangible Assets Franchise Agreement Total Assets Liabilities Current Liabilities Accounts payable Salaries & wages Payable Income Taxes Payable Interest Payable Bank loan payable Total current liabilities Long term debt Notes payable, due December 31, 2014 Total liabilities Stockholder’s Equity Contributed Capital Capital Stock, $10 par, 5000 shares issues & outstanding Paid-in capital in excess of par value Total contributed Capital Retained Earnings Total Stockholder’s Equity Total liabilities + stockholders equity - Working capital: current assets - current liabilities - Liquidity: ability of a company to pay its debts as they come due - Current Ratio: current assets/current liabilities, the higher the ratio the more liquid the company. - Prepping a multi-step income statement: (1) Gross proﬁt = sales - cost of goods sold (2) Income from operations = total operating expenses - gross proﬁt. Operating expenses include selling, general, and administrative expenses. (3) Income before income taxes: (interest expense - interest revenue) - income from operations. Other revenue and expenses are the interest revenue and expenses. (4) Income tax expense is deducted to arrive at net income. Net income = income before income taxes - income tax expense. Dixon Sporting Goods Income Statement (multi-step) For year ended December 31, 2014 Sales Cost of Goods Gross Proﬁt Operating Expenses Selling Expense Depreciation on store furniture and ﬁxtures Advertising Salaries and wages Total Selling Expense General and administrative expenses Depreciation on buildings and amortization of trademark Salaries and wages Insurance Supplies Total General and administrative expenses Total Operating Expense Income before operations Other revenues and expenses Interest Revenue Interest Expense Excess of other Expenses over other revenue Income before income taxes Income tax expense Net income - Proﬁt Margin: net income/sales. AKA return on sales - Statement of retained earnings: explains the changes in components of owner’s equity during a period. Beginning RE + Net Income - Dividends = End RE Dixon Sports Statement of Retained Earnings For year ended December 31, 2014 Retained Earnings January 1st, 2014 Add: Net income for 2014 Less: Dividends declared and paid in 2014 Retained Earnings December 31st, 2014 - Statement of Cash Flows: (1) Investing: acquisition and sale of long term assets. (2) Operating: daily/regular activities, ex: paying taxes. (3) Financing: long-term liabilities, capital stock, and payment of dividends. Dixon Springs Statement of Cash Flows For Year Ended December 31, 2014 CASH FLOWS FROM OPERATING ACTIVITIES Cash collected from customer Cash collected in interest Total Cash Collections Cash Payments For: Inventory Salaries + wages Interest Store Supplies Insurance Advertising Income Taxes Total Cash Payments Net Cash provided from operating activities CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of land for future ofﬁce site CASH FLOWS FROM FINANCING ACTIVITIES Dividends declared and paid Proceeds from issuance of long term notes Net cash provided from ﬁnancing activities Net increase in cash Cash at beginning of year Cash at end of year - The Ratio Analysis Model for the Current Ratio: (1) Formulate the question (2) Gather the information from the ﬁnancial statements: current ratio measures liquidity (current assets from balance sheet & current liabilities from balance sheet) (3) Calculate the ratio: current assets/ current liabilities (4) Compare ratio with other ratios (5) Interpret ratios: higher ratio, the more liquid the company. - Business Decision Model for the Current Ratio: (1) Formulate question (2) Gather information from the ﬁnancial statements and other sources: balance sheet gives infer about liquidity, income statement regards proﬁtability, statement of cash ﬂows on inﬂows and outﬂows of cash. The outlook for the economy during the time the loan would be outstanding. Projections for interest rates for similar loans during the term of the loan. Alternative uses for the bank’s money. (3) Analyze the information gathered: look at trends overtime in current ratios found in the ratio analysis model. (4) Make the decision: taking into account of all various sources of information, decide either to loan money or ﬁnd an alternative use for the money. (5) Monitor your decision: monitor loan periodically if you decide to make the loan. - The Ratio Analysis Model for the Proﬁt Margin: (1) Formulate the question (2) Gather the information from the ﬁnancial statements: proﬁt margin is a measure of a company’s proﬁtability. Must know: net income fro mince statement and net sales from income statement. (3) Calculate ratio: Proﬁt margin = net income/net sales (4) Compare ratio with other ratios. (5) Interpret the ratios. A high proﬁt margin means that the company is controlling its expenses and generating revenue. - The Business Decision Model for the Proﬁt Margin: (1) Formulate question (2) Gather information from the ﬁnancial statements and other sources (3) Analyze information gathered: compare proﬁt margins between companies, look at trends over time in proﬁt margins, review projections for economic outlook. (4) Make the decision whether to buy stock or ﬁnd alternative use for money (5) Monitor decision: monitor investment periodically - its proﬁtability and other factors you considered before making investment. - Other elements of an annual report: a letter to stockholders, a section describing company’s products and markets, and the ﬁnancial report or review (ﬁnancial statements + notes to explain various items). - Auditors’ report: opinion rendered by a public accounting ﬁrm concerning the fairness of the presentation of the ﬁnancial statements. AKA report of independent accountants. Shows public opinion, presented fairly, free of material misstatement. - A company’s management and auditors must protect stockholder interest. A report that gives management the opportunity to discuss the ﬁnancial statements and provide insights concerning future trends in business can be beneﬁcial. Notes at the bottom of each ﬁnancial statement are necessary to satisfy the need for full disclosure of all facts relevant to a company’s results and ﬁnancial position. CHAPTER 3 - Event: a happening of consequence to an entity - External event: an event involving interaction b/w an entity and its environment - Internal event: an event occurring entirely within an entity - Transaction: any event that is recognized in a set of ﬁnancial statements - Source document: a piece of paper used as evidence to record a transaction Effects of Transactions on Accounting Equation - Assets = Liabilities + Owner’s Equity (1) Issuance of capital stock: increases assets and owner’s equity by the same amount. (2) Acquisition of property in exchange for a note: increases assets and liabilities by the same amount. (3) Acquisition of equipment on an open account: increases assets & liabilities by same amount. (4) Sale of monthly memberships on account: increase on accounts receivable (promise from each member to pay cash in future) & increase on stockholders’ equity (speciﬁcally retained earnings) by same amount. *the inﬂow of assets resulting from the sale of goods and services by a business is called revenue. (5) Sale of court time for cash: increase in assets (cash) & owners’ claim to the assets by the same amount, increasing revenue. (6) Payment of wages and salaries: decrease in cash and in stockholder’s equity (decrease in retained earnings). *This outﬂow of assets resulting from the sale of goods or services is called an expense. (7) Payment of utilities: decrease in assets (cash) & in stockholder’s equity. (8) Collection of accounts receivable: increase cash and decrease accounts receivable (on the asset side) (9) Payment of dividends: direct reduction of retained earnings under stockholders’ equity. *The total assets and total liabilities + stockholder’s equity must equal each other. - Cost Principle: requires that we record an asset at the cost to acquire it and continue to show this amount on all balance sheets until we dispose of the asset. - Dividends do not appear on the income statement since they are a distribution of net income of the period, not a determinant of net income as are expenses. - Account: a record used to accumulate amounts for each individual asset, liability, revenue, expense, and component of stockholders’ equity. - Chart of Accounts: a numerical list of all accounts used by a company. Assets (cash, receivables, prepaid assets, property, plant, and equipment), then liabilities (short-term liabilities, accounts payable, wages & salaries payable, taxes payable, income taxes payable, sales taxes payable, unemployment taxes payable, short-term notes payable, long-term liabilities - bonds payable). - General Ledger: a book, a ﬁle, a hard drive, or another device containing all of the accounts. Date Explanation Post. Ref. Debit Credit Balance (Account No. in top right) How to post from journal to ledger? Pg. 119 - The T-Account: The left side of an asset account is used to record increases, the right side, to record decreases. - Debits & Credits: a debit is an entry on the left side of an account and a credit is an entry on the right side of an account. To charge an account is the same thing as debiting account. Debit and credit are locational terms, they do NOT represent increases or decreases. * Debits = increase asset accounts, expense accounts * Credits = increase liability and stockholders’ equity accounts, revenue accounts * Assets (debit increases, credits decreases) = liabilities (debit decreases, credits increases) + Stockholders’ Equity (debit decreases, credits increases). * Retained earnings: debit decreases, credit increases. Revenue is an increase in retained earnings so it is increased with a credit and decreased with a debit. * Expenses: expense is a decrease in retained earnings, so expenses are increased with a debit and decreased with a credit. * Dividends: dividends decrease retained earnings, so dividends are increased with a debit and decreased with a credit. - Double-entry system: a system of accounting in which every transaction is recorded with equal debits and credits and the accounting equation is kept in balance. Every transaction is entered in at least 2 accounts on opposite sides of T accounts. - Journal: a chronological record of transactions - Posting: the process of transferring amounts from a journal to the ledger accounts (cash, land, other accounts). * Journal entry form: Debit Credit Jan. xx Cash 100,000 Capital Stock 100,000 - General journal: used in place of a specialized journal, which is used to record repetitive transactions. - Trial Balancea list of each account and its balance, used to prove equality of debits and credits. Glengarry Health Club Trial Balance January 31, 2014 Account Titles Debits Credits Cash X Accounts Receivable X Equipment X Building X Land X Accounts Payable X Notes Payable X Capital Stock X Membership Revenue X Court Fee Revenue X Wage and Salary Expense X Utilities Expense X Dividends X Totals Same Same EXAM 1 STUDY GUIDE BALANCE SHEET Company Balance Sheet Date Assets Liabilities and Stockholder’s Equity Cash Accounts Payable Accounts Receivable Capital Stock Total Assets Retained earnings Total liabilities and stockholder equity INCOME STATEMENT Company Income Statement For year ended in Revenues Total Revenue Expenses Total Expenses Net income RETAINED EARNINGS Company Statement of Retained Earnings For year ended in Retained earnings, beginning of year Add: net income for the year Deduct: Dividends for the year Retained earnings: end of year STATEMENT OF CASH FLOWS Company Statement of Cash Flows For year ended in Cash ﬂows from operating activities Cash collected from customers Cash payments Total cash payments Net cash provided by operating activities Cash ﬂows from investing activities Net cash used by investing activities Cash ﬂows from ﬁnancing activities Net cash provided by ﬁnancing activities Net increase in cash Cash at beginning of year Cash at end of year Relationship: income, retained earnings, balance sheet, and cash ﬂows CLASSIFIED BALANCE SHEET Company Classiﬁed Balance Sheet At Dec… Current Assets Total Current Assets Investments Property, plant, and equipment Intangible assets Total Assets Current liabilities Total current liabilities Long-term debt Total liabilities Contributed capital Total contributed capital Retained earnings Total Stockholders’ equity Total liabilities and stockholder’s equity MULTI-STEP INCOME STATEMENT Company Income Statement (multi-step) For year ended in Sales Cost of goods sold Gross proﬁt Operating expenses Selling expenses Total selling expenses General and administrative expenses Total operating expenses Income from operations Other revenue and expenses Excess of other expenses over other revenue Income before income taxes Income tax expense Net income TRIAL BALANCE Company Trial Balance Date Account titles Debits Credits Cash Accounts receivable All other assets Liabilities Owners Equity Revenue Expenses Dividends Totals • Debit = assets, expenses, dividends. Credit = liabilities, owners equity, retained earnings (revenue) • Assets = liabilities + owner’s equity (accounting equation) • Retailer: purchases goods from wholesaler & sells smaller quantities to customers + service providers + manufacturers • Creditor: one who buys bonds in a company or makes a loan, not permanent. vs. Investor: an individual who invests ﬁnancially in a company/product, expecting returns in the future. • Assets: a future economic beneﬁt to a business vs. Liabilities: an obligation of a business • Equity: claims on assets of an entity (owners equity vs. stockholder’s equity) • Revenue: earnings accumulated by a company, inﬂow of assets resulting from the sale of goods and services. vs. Expense: outﬂow of assets resulting from the sale of goods and services. • Retained earnings: owner’s claim on assets from earnings not paid out in dividends. • Internal (depreciation on equipment, determining income tax w/o paying) vs. external (interaction b/w entity & environments + paying out) • Assumptions for statements: (1) Understandability: the quality of accounting information that makes it comprehensible to those willing to spend the necessary time. (2) Relevance: the capacity of information to make a difference in a a decision. Information may have a predictive value that helps you pre dice whether an action would be wise or not and others have a conﬁrming value that helps you conﬁrm you made the right decision. (3) Faithful representation: the quality of information that makes it complete, neutral, and free from error. (4) Comparability: the quality that allows a user to analyze two or more companies and look for similarities and differences. Depreciation is the process of allocating the cost of a long-term tangible asset over tits useful life. Each method may affect the value of the assets differently. The more uniform statements are in terms of the principles used to prepare them, the more comparable they will be. (5) Consistency: the quality that allows a user to compare two or more accounting periods for a ingle company. (6) Materiality: the magnitude of an accounting information omission or misstatement that will affect the judgment of someone relying on the information. Ask Will this error in any way affect the judgment of someone relying on the ﬁnancial statements? The threshold for determining materiality varies from one company to the next depending largely on the company’s size. (7) Conservatism: the practice of using the least optimistic estimate when two estimates of amounts are about equally likely. The practice of conservatism is reserved for those situations in which there is uncertainty about how to account for a particular item or transaction. Inventory held for resale is reported on the balance sheet at the lower-of-cost-or-market value. This rule requires a company to compare the cost of its inventory with the market price or current cost to replace that inventory, and to report the lower of the two amounts on the balance sheet at year-end. • Roles of a Company: • Auditors: share opinions regarding fairness of ﬁnancial statements. SEC: set rules for ﬁnancial statements for company that publicly sells stock. • • Ethical decision-making model: (1) Identiﬁcation (recognize ethical dilemma) (2) Analysis (3) List alternatives & evaluate impact of each on those affected (4) Resolution (select best alternative) • Purpose of ﬁnancial reporting: provide useful information to those who must make ﬁnancial decisions on whether to provide resources to the company. • Ratio calculations and what they measure -- proﬁt margin, working capital, and current ratio Working capital: current assets - current liabilities Current Ratio: current assets/ current liabilities, the higher the ratio the more liquid the company. Proﬁt Margin: net income/ sales. AKA return on sales • Purpose of various ﬁnancial statements - what they measure/represent: - Balance sheet: shows what obligations will be due in near future and what assets will be available to satisfy them. - Income statement: revenues and expenses for a period of time - Statement of cash ﬂows: where cash came from and how it’s used - Statement of retained earnings: explains the changes in components of owner’s equity during a period. • Be able to classify transactions as to the accounts they affect and the ﬁnancial statements to which they ﬂow and their effect on the accounting equation - Effects of Transactions on Accounting Equation - Assets = Liabilities + Owner’s Equity (1) Issuance of capital stock: increases assets and owner’s equity by the same amount. (2) Acquisition of property in exchange for a note: increases assets and liabilities by the same amount. (3) Acquisition of equipment on an open account: increases assets & liabilities by same amount. (4) Sale of monthly memberships on account: increase on accounts receivable (promise from each member to pay cash in future) & increase on stockholders’ equity (speciﬁcally retained earnings) by same amount. *the inﬂow of assets resulting from the sale of goods and services by a business is called revenue. (5) Sale of court time for cash: increase in assets (cash) & owners’ claim to the assets by the same amount, increasing revenue. (6) Payment of wages and salaries: decrease in cash and in stockholder’s equity (decrease in retained earnings). *This outﬂow of assets resulting from the sale of goods or services is called an expense. (7) Payment of utilities: decrease in assets (cash) & in stockholder’s equity. (8) Collection of accounts receivable: increase cash and decrease accounts receivable (on the asset side) (9) Payment of dividends: direct reduction of retained earnings under stockholders’ equity. *The total assets and total liabilities + stockholder’s equity must equal each other. • Know which source documents represent which business activities Know the purposes and general formats of the general journal, general ledger, chart of • accounts, trial balance: - General Ledger: a book, a ﬁle, a hard drive, or another device containing all of the accounts. - General Journal: used in place of a specialized journal, which is used to record repetitive transactions, still a chronological record of transactions - Trial Balance: a list of each account and its balance, used to prove equality of debits and credits. - Chart of Accounts: a numerical list of all accounts used by a company. Assets (cash, receivables, prepaid assets, property, plant, and equipment), then liabilities (short-term liabilities, accounts payable, wages & salaries payable, taxes payable, income taxes payable, sales taxes payable, unemployment taxes payable, short-term notes payable, long-term liabilities - bonds payable). Be able to classify activities as investing, operating, and ﬁnancing: (1) Financing: • external activities that allow a ﬁrm to raise capital and repay investors, such as issuing cash dividends, adding or changing loans or issuing more stock. (2) Investing: focus on the purchase of the long-term assets a company needs in order to make and sell its products, and the selling of any long-term assets that are no longer needed by the company. (3) Operating: pertain to a company's core business activities, such as manufacturing, distributing, marketing and selling a product or service. These activities should provide the majority of a company's cash ﬂow and will largely determine whether a company is proﬁtable. • Be able to create journal entries to record transactions GENERAL JOURNAL Page No. 1 Date Acc Titles & Explanation Post ref. Debit Credit 1 GENERAL LEDGER Account No. 1 Date Explanation Post ref. Debit Credit Balance GJ1 Be able to classify assets as current and non-current, Be able to classify liabilities as • current and long-term: Current < 1 year, Non-current > 1 year or based on their operating cycle. Operating Cycle: the period of time between the purchase of inventory and collection of any receivable from the sale of the inventory. CHAPTER 4 OFACCOUNTING - Recognition: process of recording items in the ﬁnancial statements. Measurement of an item in the statements involves (1) the choice of an attribute to be measured (historical or current cost) (2) and a unit of measure. The current value is the amount of cash or its equivalent that could be received by selling an asset currently. The historical cost is the amount paid for the asset. - Accrual Basis: revenues are recognized when earned and expenses are recognized when incurred. - Cash basis: revenues are recognized when cash is received and expenses are recognized when paid. - Revenue recognition principle: revenues are inﬂows of assets or reductions of liabilities from providing G & S to customers. They must be realized and earned to be recognized. - Expense recognition and matching principle: revenues must be matched with the costs that were required in order to generate the revenue. Some costs can be directly matched with revenue, others are indirectly matched with periods in which they provide beneﬁts while other costs expire immediately and are recognized as an expense in the period incurred.Anytime a cost is incurred and asset is acquired. The expense recognition principle requires that expenses be recognized in different ways depending on the nature of the cost. Unexpired costs are called assets and expired costs are called expenses. Expenses are outﬂows of assets or incurrences of liabilities resulting from delivering goods, rendering services, or carrying out other activities. - Adjusting entries: made at the end of an accounting period, internal transactions that don’t affect the cash account. Each entry involves an adjustment to either an asset or a liability with a corresponding change in either revenue or expense.Adjusting entries are made in accrual basis of accounting only.At least one balance sheet account and one income statement account are involved in an adjusting entry. Types include: cash paid before expense is incurred (deferred expense), cash received before revenue is earned (deferred revenue), expense incurred before cash is paid (accrued liability), revenue earned before cash is received (accrued asset). Look from company’s standpoint, not customer’s when determining deferred rev./expense or accrued asset/liability. - Unadjusted trial balance: the trial balance prepared before taking into account adjusting entries. - Accounting Cycle: all steps performed each period in order to prepare a set of ﬁnancial statements. Steps: (1) Collect and analyze information from source documents (2) Journalize transactions (3) Post transactions to accounts in the ledger (4) Prepare work sheet (5) Prepare ﬁnancial statements (6) Record and post adjusting entries (7) Close the accounts (1-2: Continuously, 3: periodically or immediately in a computerized system, 4-7: end of the period) - Worksheet: device1 used at the end of the period to gather information needed to prepare ﬁnancial statements without actually recording and posting adjusting entries. It’s not a ﬁnancial statement and is optional. - Closing Process: closing entries are made at the end of an accounting period. They have two purposes (1) to return the balance of revenue, expense, and dividend accounts to zero to begin the next period (2) to transfer they net income of the period, to Retained Earnings. Two types of accounts appear on an adjusted trial balance: (1) Balance sheet accounts are called real accounts because they are permanent in nature. Real accounts are never closed and the balance in each of the mis carried over from one period to the next. (2) Revenue, expense, and dividend accounts are temporary or nominal accounts. The balances in the income statement accounts and the Dividends account are closed and not carried forward from one accounting period to the next. - Income Summary to facilitate closing process: (1)Asingle entry is made to close all of the rev. accounts. The total amount debited to the rev. accounts is credited to Income Summary (2)Asingle entry is made to close all of the expense accounts, and the offsetting debit is made to Income Summary. (3)After the rev. and expense accounts are closed, Income Summary has a credit balance if revenues exceed expenses. The credit balance in Income Summary is closed by debiting the account and crediting R.E. for the same amount. The net result of the process is that all of the revenues less expenses (net income) have been transferred to R.E. (4) The Dividends account is closed directly to R.E. Because dividends are not an expense, the Dividends account isn’t closed ﬁrst to the Income Summary account.Acredit is made to close the Dividends account with an offsetting debit to R.E. - Interim statements: ﬁnancial statements prepared monthly, quarterly, or at other intervals less than a year in duration. - Adjusting entries for depreciation: The straight-line method is the assignment of an equal amount of depreciation to each period, found by dividing the depreciable cost over the estimated useful life. The asset account is reduced, and an expense is recognized. To reduce the total amount of long-term tangible assets by the amount of depreciation, accountants use a contra account. This account has a balance that’s opposite that of a related account (cost-salvage value)/Asset's life = straight-line method CHAPTER 5 - INVENTORIES AND COST OF GOODS SOLD • The nature of inventory: 1. There are 2 types of inventory held by businesses: ini shed inventory, held by retailers and wholesalers, and materials inventory, held by manufacturers. 2. There are 3 types of inventory costs borne by manufacturers: direct materials, direct labor, and manufacturing overhead. 3. There are 3 distinct forms of inventory for a manufacturer - raw materials, work in process, and ﬁnished goods. - Two types of categories that sell inventory: Retailers and wholesalers purchase inventory in ﬁnished form and hold it for resale and manufacturers transform raw materials into a ﬁnished product prior to sale. The distinction b/w inventory and an operating asset is the intent of the owner. • Merchandise Inventory: the account wholesalers and retailers use to report inventory held for resale. • Three types of manufacturing costs: three distinct types of costs are incurred by a manufacturer - (1) direct materials: AKA raw materials (inventory of a manufacture before the addition of any direct labor or manufacturing overhead), ingredients used in making a product, (2) Direct labor: amounts paid to workers to manufacture the product. (3) Manufacturing overhead: all other costs that are related to the manufacturing process but cannot be directly matched to speciﬁc units of output. Ex: depreciation on a building and salary of supervisor. • Three Forms of Inventory: (1) Direct materials or raw materials enter a production process in which they are transformed into a ﬁnished product by the addition of direct labor and manufacturing overhead (2) At any time, including the end of an accounting period, some of the materials have entered the process and some labor costs have been incurred but the product is not ﬁnished. The cost of unﬁnished products is called work in process. (3) Inventory that has completed the production process and is available for sale is called ﬁnished goods. Finished goods is a manufacturer’s inventory that is complete and ready for sale. • Relationships between types of businesses and inventory costs pg. 229 • Net Sales of Merchandise: net sales represents sales less deductions for discounts and merchandise returned (returns and allowances) and is a key ﬁgure on the income statement. Gross Proﬁt is the net sales less cost of goods sold (gross margin), Net sales is sales revenue less sales returns and allowances and sales discounts. Sales revenue is a representation of the inﬂow of assets. • Sales Returns and Allowances: contra-revenue account used to record refunds to customers and reductions of their accounts. • Credit Terms and Sales Discounts: Sales discounts are a contra-revenue account used to record discounts given to customers for early payment of their accounts. • Cost of Goods sold: deducted from sales to determine the gross proﬁt for the period. Cost of goods sold is found by adding the purchases of the period to the beginning inventory and then deducting the ending inventory. The recognition of cost of goods sold as an expense is an excellent example of the matching principle. Sales revenue represents the inﬂow of assets, in the form of cash and accounts receivable, from the sale of products during the period. cost of goods sold represents the outﬂow of an asset, inventory, from the sale of those same products. Cost of goods sold isn’t necessarily equal to the cost of purchases of merchandise during the period. Cost of goods available for sale: beginning inventory + cost of goods purchased. Cost of goods sold is the cost available for sale minus ending inventory. - The Cost of Goods Sold Model: beginning inventory & purchases of merchandise goes into cost of goods available for sale (which goes to cost of goods sold - amount sold) & ending inventory (amount not sold) • Inventory Systems: Perpetual and Periodic: The Perpetual system is a system in which the inventory account is increased at the time of each purchase and decreased at the time of each sale. The periodic system is a system in which the inventory account is updated only at the end of the period. Businesses with a relatively small volume of sales at a high unit price have used perpetual systems. • Beginning and Ending Inventories in a periodic systems: In a periodic system, the inventory account throughout the year contains the amount of merchandise on hand at the beginning of the year. The account is adjusted only at the end of the year. The ending inventory in a periodic system is determined by counting the merchandise, not by looking at the Inventory account at the end of the period. Use of the periodic system reduces record keeping, but at the expense of a certain degree of control. Most companies that use periodic system use estimation techniques to determine inventory for monthly or quarterly statements. • Cost of Goods Purchased: Transportation-in: an adjunct account used to record freight costs paid by the buyer, AKA as freight-in. Purchases is the temporary account used in a periodic inventory system to record acquisitions of merchandise. Purchases is NOT an asset account. Purchase returns and allowances are contra-purchases account used in a periodic inventory system when a refund is received from a supplier or a reduction is given in the balance owed to a supplier. To the buyer, a cash discount is called a purchase discount and results in a reduction of the cost to purchase merchandise. The Purchase discounts account is contra to the Purchases account and thus increases net income and stockholders’ equity. • Shipping Terms and Transportation costs: the cost principle governs the recording of all assets. All costs necessary to prepare an asset for its intended use should be included in its cost. Goods are normally shipped either FOB destination point or FOB shipping point. FOB stands for free on board. The total of net purchases and transportation-in is called the cost of goods purchased. Transportation-In will be closed at the end of the period. When goods are shipped FOB destination point, the seller is responsible for the cost of delivering the merchandise to the buyer. This cost is sometimes called the transpiration-out and isn’t an addition to the cost of purchases of the seller. It’s one of the costs necessary to sell the merchandise. Transportation-out is classiﬁed as a selling expense on income statement. • Gross Proﬁt Ratio: the gross proﬁt ratio, found by dividing gross proﬁt by net sales, is an important measure of proﬁtability. It indicates a company’s ability to cover operating expenses and earn a proﬁt. Gross proﬁt ratio: gross proﬁt/net sales. - Gross Proﬁt Ratio: A. The Ratio Analysis Model: (1) Formulate the Question (2) Gather the information from the ﬁnancial statements (3) Calculate the ratio (4) Compare the ratio with other ratios (5) Interpret the ratios - The Business Decision Model: (1) Formulate the question (2) Gather information from the ﬁnancial statements and other sources (3) Analyze the information gathered (4) Make the decision (5) Monitor your decision • Inventory valuation and the measurement of income: determining the correct amount to assign to inventory when it is purchased will ultimately affect cost of goods sold and thus net income during the period in which the inventory is sold. One of the most fundamental concepts in accounting is the relationship between asset valuation and the measurement of income. Assets are unexpired costs and expenses are expired costs. The value assigned to an asset such as inventory on the balance sheet determines the amount eventually recognized as an expense on the income statement. If the ending inventory amount is incorrect, cost of goods sold will be wrong; thus, the net income of the period will be in error as well. - What should be included? Any freight costs, costs of insurance, cost of storing inventory, taxes paid. • Inventory Costing Methods with a Periodic System: A company must use one of a number of methods available in assigning costs to ending inventory and to cost of goods sold. Unless a company can speciﬁcally identify the units sold, it will need to choose among the weighted average, FIFO and LIFO methods. - Speciﬁc Identiﬁcation Method: an inventory costing method that relies on matching unit costs with the actual units sold. - Weighted average cost method: an inventory costing method that assigns the same unit cost to a lll units available for sale during the period. - First-In First-Out Method (FIFO): inventory costing method that assigns the most recent costs to ending inventory. - Last-In First-Out Method (LIFO): an inventory method that assigns the most recent costs to cost of goods sold. - Selecting an inventory costing method: the choice impacts the cost of goods sold thus the net income. A company should choose the method that results in the most accurate measure of net income for the period. The primary determinant in electing an inventory costing method should be the ability of the method to accurately reﬂect the net income of the period. - With LIFO, the most recent costs are assigned to cost of goods sold; with FIFO, the older costs are assigned to expense. In a period of rising prices, the assignment of the higher prices to cost of goods sold under LIFO results in a lower gross proﬁt under LIFO than under FIFO. During a period of rising prices, the two methods result in the following: Cost of goods sold is higher with LIFO & lower with FIFO. The gross proﬁt, income before taxes, and taxes are lower with LIFO and higher with FIFO. Cash saved from a lower tax bill with LIFO is only temporary savings, called a tax deferral, which will result in a tax bill higher than that under FIFO. • LIFO Liquidation: the result of selling more units than are purchased during the period, which can have negative tax consequences if a company is using LIFO. The LIFO conformity rule states that the IRS requirement that when LIFO is used on a tax return, it must also be used in reporting income to stockholders. • LIFO Reserve - Estimating LIFO’s effect on income and on taxes paid, EXAMPLE: (1) The excess of the value of a company’s inventory stated at FIFO over the value stated at LIFO is called the LIFO reserve. (2) If inventory is reported at a lower value on its balance sheet using LIFO, it will report a higher cost of goods sold amount on the income statement. LIFO reserve represents the excess of the inventory balance on a FIFO AND the cumulative amount by which cost of goods sold on a LIFO basis exceeds cost of goods sold on a FIFO basis. (3) The increase in LIFO reserve means that the cost of goos sold from using LIFO instead of FIFO was also this amount. Thus, income before tax was lower because the company used LIFO. (4) If we assume taxes of 35%, the tax savings from LIFO is the LIFO reserve X .35. • Costing Methods and Inventory Proﬁts: The replacement cost is the current cost of a unit of inventory. Inventory proﬁt is the portion of the gross proﬁt that results form holding inventory during a period of rising prices. The purpose of each inventory costing method is to match costs with revenue. Taking advantage of tax breaks in LIFO isn’t valid reason to change. • Inventory errors: If ending inventory is overstated, cost of goods sold will be understated and thus net income for the period overstated. The opposite effects will occur when ending inventory is understated. • Valuing Inventory at Lower of Cost or Market: the lower-of-cost-or-market (LCM) rule is a conservative inventory valuation approach that’s an attempt to anticipate declines in the value of inventory before its actual sale. It’s a departure from the historical cost principle. Accounting standards require that inventory be written down at the end of the period if the market value of the inventory is less than its cost. If the LCM rule isn’t applied, the gross proﬁt is distorted. It reports the loss in value of the inventory in the year the loss occurs and reports in the year the goods are actually sold, which isn’t affected by a change in the selling price. This violates the historical cost principle which says that assets should be carried on the balance sheet at their original cost. - Application of the LCM rule: (1) The lower the total cost or total market value for the entire inventory could be reported (2) The lower of cost or market value for each individual product or team could be reported (3) The lower of cost or market value for groups of items could be reported. - Internationally: The US GAAP and international ﬁnancial reporting standards (IFRS) require the use of the lower-of-cost-or-market rule to value inventories. The GAAP deﬁnes market value as replacement cost, subject to a maximum and minimum amount. The IFRS uses net realizable value with no upper or lower limits imposed. In the US, the new amount for the inventory is the basis, but IFRS recognizes the gain when the inventory value goes back up. • Analyzing the management of inventory: a company’s ability to sell its inventory quickly can be measured by computing the inventory turnover ratio (a measure of the number of times inventory is sold during the period). How often a company sells its inventory during a period is found by dividing cost of goos sold by average inventory. The number of days’ sales in inventory is a measure of how long it takes to sell the inventory. This is done in the interpreting ratios step. • How inventories affect the cash ﬂows statement: Changes in both inventory and accounts payable are reported on a statement of cash ﬂows prepared using the indirect method. An increase in inventory is deducted and a decrease is added back. • Inventory Costing Methods (using perpetual inventory system): the results from the LIFO method offer if a company uses a perpetual system. The same is true of the weighted average method. With a perpetual basis, FIFO is applied at the time of each sale. A LIFO cost ﬂow with the use of perpetual system creates a gap - units acquired at the earliest price and units acquired at the most recent price are on hand, but none of those at the middle price between the two remain. This situation arises because LIFO is applied every time a sale is made rather than just at the end of the year. The moving average is a name given to an average cost method when a weighted average cost assumption is used with a perpetual inventory system. Each time a purchase is made, a new wighted average cost must be computed. The ending inventory with an av. cost ﬂow differs depending on whether a periodic or perpetual system is used. • FORMULAS: Gross Proﬁt Ratio = (gross proﬁt)/(net sales) Inventory Turnover Ratio = cost of goods sold (income statement)/average inventory (balance sheet) or Average Inventory = (beginning inventory + ending inventory)/2 Number of Days’ Sales in inventory = (# of days in period)/(inventory turnover ratio) *assume 360 unless some other number is a better estimate of the number of days in the period. • Accounts Highlighted: merchandise inventory, sales revenue, sales returns and allowances, sales discounts, cost of goods sold, purchases, purchase returns and allowances, transportation-in, purchase discounts, transportation-out, loss on decline in value of inventory. CHAPTER 6 - Cash and Internal Control • What constitutes cash? regardless of the form it takes, cash reported on a balance sheet must be readily available to pay debts. Cash equivalents are those investments readily convertible to a known amount of cash. The key to the classiﬁcation of an amount as cash is that it be readily available to pay debts. - Cash equivalent: limited to those investments that are readily convertible to known amounts of cash and that have an original maturity to the investor of three months or less. - Cash & Cash Equivalents on the Bal. Sheet & Statement of Cash Flows: Beginning balance in cash and cash equivalents (1/29/11 balance sheet) Add: Cash used in operating activities Deduct: Cash used in investing activities Deduct: Cash used in ﬁnancing activities Net decrease in cash and cash equivalents Ending balance in cash and cash equivalents (1/28/12 balance sheet) * The additions and deductions are statements of cash ﬂows. • Control over cash: companies use a variety of devices to control cash. Among them are bank reconciliations and petty cash funds. - Reading a Bank Statement: 2 fundamental principles of internal control applicable to cash: (1) All cash receipts should be deposited intact daily (2) All cash payments should be made by check. A bank statement is a detailed list, provided by the bank, of all activity for a particular account during the month. An outstanding check is a check written by a company but not yet presented to the bank for payment. A deposit in transit is a despot recorded on the books, but not yet reﬂected on the bank statement. An NFS check stands for “not sufﬁcient funds.” Service charges, customer note and interest (customer pays company’s bank), and interest earned are other accounts found on bank statement. - Bank Statement Example: Mt. Etna State Bank Chicago, Illinois Statement of Account Mickey’s Marathon Sports 502 Dodge St. For the month ending account June 30, 2014 Chicago, IL 66755 Account 0371-22-514 Date Description Subtractions Additions Balance Checks, deposits, NFS checks, service charges, customer notes, interest, service fees, interest earned, etc. ____________________________________________________________________________ _________ 6-30 Statement Totals - Bank reconciliation is a form used by the accountant to reconcile or resolve any differences between the balance shown on the bank statement for a particular account with the balance shown in the accounting records. Steps: (1) Prepare a list of the deposits in transit (2) Prepare a list of the outstanding checks (3) Prepare a list of credit memoranda, additions on a bank statement for such items as interest paid on the account and notes collected by the bank for the customer. (4) Prepare a list of debit memoranda, deductions on a bank statement for items such as NSF checks and various service charges (5) Identify any errors. After completing a bank reconciliation, the company must prepare a number of adjustments in the form of journal entries on its records. The additions and deductions to the Cash account on the books should be the basis for the adjustments because these are items that the company was unaware of before receiving the bank statement. The additions and deductions to the bank’s balance (ex: deposits in transit & outstanding checks) are items that the company has already recorded in its books. - Recording Journal entries from a bank reconciliation pg. 304-305 - Establishing a Petty Cash Fund: which is money kept on hand for making minor disbursements in coin and currency rather than by writing checks. Steps: (1) A check is written for a lump-sum amount, cashed, and the coin & currency are entrusted to a petty cash custodian (2) Journal entry made to record fund establishment (3) Upon presentation of necessary documentation, employees receive minor disbursements from the bound - cash traded from fund in exchange for a receipt. (4) Periodically, the fund is replenished by writing and cashing a check in the amount necessary to bring the fund back to its original balance. (5) At the time the fund is replenished, an adjustment is made to record its replenishment and to recognize the various expenses incurred. When money is put into the petty cash fund, that fund is debited (inc. in assets) and cash is credited (dec. in assets). At the end of the period, to record replenishment of petty cash fund, all of the expenses and assets remaining are debited and cash is credited. - Bank Reconciliation Example: Mickey’s Marathon Sports Bank Reconciliation June 30, 2014 Balance per bank statement, June 30 Balance per bank statement, June 30 Add: Deposit in Transit Deduct: Outstanding Checks Adjusted balance, June 30 Balance per books, June 30 Add: Customer note collected Interest on customer note Interest earned during June Error in recording check 498 Deduct: NFS Check Collection fee on notes Service charge for lockbox Adjusted balance, June 30 • An introduction to internal control: an internal control system includes the policies and procedures necessary to safeguard assets and the reliability of the records. Improvement in internal control was a major focus of the Sarbanes-Oxley Act of 2002. - Internal control system: policies and procedures necessary to ensure that safeguarding of an entity’s assets, the reliability of its accounting records, and the accomplishment of overall company objectives. - Sarbanes-Oxley Act: an act intended to bring reform to corporate accountability and stewardship in the wake of a number of corporate scandals. - Internal control report: a report required by Sarbanes-Oxley Act to be included in a company’s annual report in which management assesses the effectiveness of the internal control structure. - Public Company Accounting Oversight Board (PCAOB): 5 member body created by Sarbanes-Oxley Act that was given the authority to set auditing standards in the US. - Board of Directors: a group of directors subset that acts as a direct contact between the stockholders and the independent accounting ﬁrm. - Audit committee: a board of directors subset that acts as a direct contact b/w the stockholders and the independent accounting ﬁrm. - The Control Environment: a manager’s operating style impacts the effectiveness of policies - autocratic style vs. decentralization. - Accounting system: methods and records used to accurately report an entity’s transactions and to maintain accountability for its assets and liabilities. • Internal Control Procedures: internal control procedures can either be administrative or accounting in nature. The former are concerned with efﬁcient operation of a business and the latter with safeguarding assets and reliability of the ﬁnancial statements. - Administrative controls: procedures concerned with efﬁcient operation of the business and adherence to managerial policies. - Accounting controls: procedures concerned with safeguarding the assets or the reliability of the ﬁnancial statements. - Some of the most important internal control procedures are: proper authorizations, segregation of duties, independent veriﬁcation, safeguarding of assets and records, independent review and appraisal, and design and use of business documents. * Proper authorizations: management grants speciﬁc departments the authority to perform various activities. * Independent veriﬁcation: the work of one department should act as a check on the work of another. * Safeguarding of assets and records: safeguards to protect assets and the accounting records from losses of various kinds. Ex: safes, lockboxes, cash registers. * Independent review and appraisal: of accounting system and people operating it. Internal audit staff is the department responsible for monitoring and evaluating the internal control system. * Design and use of Bus. Docs: Business documents are the crucial link b/w economic transactions entered into by an entity and the accounting record of those events. They are often called source documents. Ex: source doc for expense of an employee’s wages i s the timecard. Documents need to be controlled through a sequential numbering system and multiple copies to keep informed on status of outstanding orders. • Computerized Business Documents and Internal Control: Companies use a variety of documents to record purchases that are instrumental in controlling both cash and inventory. - All cash receipts should be deposited intact in the bank on a daily basis. Intact means that no disbursements should be made from the cash received from customers. All cash disbursements should be made by check. - Most merchandisers receive checks and currency from customers by cash received over the counter from cash sales and cash received in the mail from credit sales. * Cash Received Over Counter: (1) Cash registers allow the cust. to see the display (2) Locked- in cash register tape: an employee other than clerk unlocks register, removes the tape and forwards it to the acc. del. at various times and then at end of sift, the salesclerk remits the coin and currency from register to central cashier (3) Pre-numbered cust. receipts: salesclerk is accountable for all number in a speciﬁc series of receipts and met be able to explain any differences b/w the amount of cash remitted to the cashier and the amount collected per the receipts. * Cash received in mail: Employee #1 opens mails in presence of Employee #2, counts amount and preps a control list. Employee #2 takes original list and the cash to the cashier who makes the bank deposit. One copy of list is forwarded to accounting department to record increase in Cash & decrease in accounts receivable. The other copy is retained by one of the two people who opens the mail. A comparison of the list to the bank deposit slip helps detect receipts that don’t make it to the bank. Rotation of duties happens so employees don’t circumvent control process. • Role of Computerized Business Documents in controlling cash disbursements: (1) Purchase requisition: a form a dep. uses to initiate a request to order merchandise (2) Purchase order: form sent by purchasing dep. to supplier. It’s not the basis for recording a purchase and a liability. (3) Invoice: form sent by the seller to the buyer as evidence of a sale (4) Blind receiving report: a form used by the receiving department to account for the quantity and condition of merchandise received from a supplier. (5) Invoice approval form: used before making payment to document the accuracy of all information about a purchase. (6) Check with remittance advice: upon receipt of the invoice approval form from acc. dep., a clerk in ﬁnance processes a check with remittance advice attached. The clerk then forwards check to one of the company ofﬁcers authorized to sign checks. Both ofﬁcers must sight check amounts above a speciﬁed dollar limit. The remittance advice informs supplier of the nature of the payment. Expect inventory problem like worksheet from chapter 5, bank reconciliation, unadjusted trial balance to adjusted trial balance CHAPTER 4 1. Accrual accounting and concepts, information, and acc. principles: - Historical cost vs. current value: - Reliability: when something is reliable, it is without errors. We use just the accrual accounting system, not cash if that is what the company uses to make ﬁnancial statements. If there is a mix, then the information provided won’t be reliable. - Relevance: the capacity of information to make a difference in decision.Accrual basis is relevant because it makes a difference if this system is used to a cash basis. - Cost/beneﬁt: it is more costly to do because it takes more time and resources to prepare the ﬁnancial statements withAccrualAccounting, but it is more beneﬁcial because it gives a more accurate presentation of how the company is doing and h
Are you sure you want to buy this material for
You're already Subscribed!
Looks like you've already subscribed to StudySoup, you won't need to purchase another subscription to get this material. To access this material simply click 'View Full Document'