Classroom Notes ACCT 6361
Popular in Financial Accounting
Popular in Accounting
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Date Created: 02/01/15
Financial Accounting 09092014 Pa rt 1 Overview 0 1st example WorldCom largest nancial fraud in American history telecommunications grew through acquisitions consistently undercut ATampT in public utilities 0 Revenue Expense Income bottom line earnings Largest expense in telecomm industry is line costs to provide the services competitors would lease the existing lines major cost as part of expenses so it reduces income 0 WorldCom wouldn t expense lines they capitalized them as assets accrual accounting same costs were incurred but not taken from revenue instead they were added as assets THIS IS FRAUD up to 11 billion over 8 years Independent Auditors were Arthur Anderson 0 Caught by internal auditor reported to CFO everybody went to jail didn t make any money but stock value went way up Index pages for WorldCom 23 102 124 564449 0 How did they make Market Analysts predict EPS earnings per share once quarterly earnings are released if they are higher than predicted the stock goes up so they found a way to make sure their earnings were always higher than predicted meaning their stock always went up as well Chapter 1 Financial Accounting amp Its Economic Context 0 The role of Financial Reporting in Investment Decisions see for de nitions 0 Who uses nancial statements Shareholders investors nancial institutions governments taxing authorities 0 all based on past numbers then we make predictions on future performance 0 Most pro table product in history Tobacco 0 Company has idea what happens next Need capital how do you capitalize Find investors Stockholders are equity investors IPO Initial Public Offering is rst instance of equity investment issuing common stock as ownership interest What is the goal of a company To pay dividends this creates money for its investors Other type of investment DEBT Why is common stock better You don t have to pay it back 0 Contents of Financial Reports o 10K First page shows it s a 10K SEC Form required to be led within 45 days after year end 0 Auditor s Report p 77 of SBux 10K Reports are the responsibility of management most important phrase quotfair presentationquot of the nancial position of the company 0 Because of negligence by large auditing rms Congress passed SOX that required systems of internal controls to be reviewed and opinions given on their quality and effectiveness enriching the same rms that caused the problem 0 Management Letter Ensure that quottransactions are executed as authorized and are recorded and reported properlyquot important standard The system of controls is based on people and therefore subject to human error and vice 0 Financial Statements Balance Sheet Listing of nancial position at a point in time Income Statement Revenue Expenses Income shows results of operations over a period of time Balance Sheet covers a point in time Income Statement covers a period of time Shareholder Equity describes the changes in SH equity from one year to the next shows DIVIDENDS Cash Flow summarizes the increases and decreases in cash over a period of time D SBux 10K p 46 D What is an asset It has to be something that can produce revenue When it cannot produce revenue then you write it down 0 Footnotes integral part of Financial Statements explain the policies and assumptions used to prepare the nancials SBux p 4876 Footnotes Note 1 Signi cant Accounting Policies Note 2 Acquisitions amp Divestitures Note 3 Derivative Financial Instruments Note 4 Fair Value Measurements Note 5 Inventories etc Summarize There are a lot and they contain good information 0 Analysis of Financial Statement p 1113 we ll cover this more completely later in the semester 0 O O 0 Cash position Earning power Ratio Analysis Forms of Investment Debt Loan Equity Ownership Providers of Capital Roles 0 Provide Capital Equity capital through stock investments stockholders Debt capital through bond and loan investments creditors 0 Receive returns Equity investors receive dividends Creditors and bond investors receive interest 0 Stock equity investors choose board of directors 0 Board of Directors Select corporate of cers management Set company policy Select audit committee Set management amp Board compensation 0 Management runs the company Reporting Entities are the companies and with subsidiaries they are the consolidated reports 0 Industry is important to understand when analyzing nancial statements Capital Markets value the publicly traded equity and debt securities o Financials are a component of the information that the markets use to value company s securities along with a number of non nancial measures 0 The market reacts to nancial and other information as it is released by management Debt covenants when a company borrows money there are restrictions in the terms of the contract depending on the respective bargaining strength of the parties Management compensation usually performance based on income or stock price goals aligns management decisionmaking with the company s goals Regulations amp Standards p 18 0 SEC governs nancial reporting FASB sets the GAAP for nancial statements See Figure 17 on page 20 and Figure 19 p 22 Audit committee members must have nancial expertise Must have majority independent board members 0000 o SOX p 21 0 Legal Liability auditors can be sued by Shareholders management and board can also be sued also face criminal indictments p 22 0 Professional Reputation amp Ethics p 23 0 Increased emphasis since 2002 0 Exam Example discussion p 29 If duty is to maximize shareholder value then you may be violating that duciary duty if you re only looking to maximize shareholder value for a short term basis According to the Prof you should maximize shareholder value for a long period of time o For Saturday Start at 830 am go over one problem ID 15 Numbers to deal with read it and try to relate it to balance sheet and income statement discuss possible explanations for the nancial results Also look in SBux Income Statements for 3 years look closely and identify any situations that don t make sense 0 Discussion SBux Income went down litigation fee for mediation Look to the footnotes commitments amp contingencies for explanation Problem ID 15 Did they pay down debt Yes that s why sales went up but shareholder equity remained at as we came out of recession the sales went up paid out dividends equal to pro ts so also reason why shareholders equity remained at during the same period 0 Discussion P 17 quottaking companies privatequot Why Onerous responsibility to be publicly traded if you go private there are no reporting requirements from Govt Chapter 2 Financial Statements 0 3 types of activities Operations selling goods and services Investing acquisition and sale of productive assets and Financing issue and repayment of liabilities and debt 0 Balance Sheet nancial position at a point in time aka Statement of Financial Position Components see de nitions 0 Assets stuff the Company owns must produce revenue Current assets will be used up in year or less in order of liquidity U Cash a Short term investments n Accounts receivable n Inventory hardest account to deal with most easily open to fraud o Liabilities What a company owes a Prepaid expenses Long term investments stocks bonds etc PPampE when you say capitalize it means you re adding it to assets this is where your trucks are listed and as it produces revenues you depreciate the asset Intangibles goodwill brandreputation intellectual property in acquisitions it means you paid over market value the gap in what you paid over market is goodwill for de nitions Current liabilities n Accounts payables under cash basis there are no payables but under accruals you have accounts payable because the liability is counted when its incurred a Wages n Interest In Shortterm notes a Current maturities of longterm debt only that portion that is paid in the next 12 months to be current this is important to liquidity O good rule of thumb on this is 2 to 1 this means you have to pay your current liabilities n Deferred revenuessales services yet to be performed for which payments have already been collected by a Company D Other payables Longterm Liabilities o Shareholders Equity value of the ownership of the company should be amount contributed plus money earned Contributed Capital the amount of contributed by the shareholders for which they receive common stock Earned Capital the earnings and accumulated income shown on balance sheet as retained earnings opposite of retained earnings is accumulated de cit Statement of Shareholders Equity basic SSE formula n Beginnings Shareholders equity a Plus Issuance of stock a Plus Net Income In Less Dividends n Ending shareholders equity n SEbegin lssue Nl D SEend Statement of Retained Earnings quotaccumulated income and lossesquot subset of the SSE n Beginning retained earnings a Plus Net Income In Less Dividends n Ending retained earnings n REbegin Nl Div RE end IFRS main difference is fair value and the value of assets on the balance sheet Prof doesn t like because it adds one more estimate used throughout Europe Income Statement measures operating performance over a period of time 0 Operating Revenues Sales Fees Earned Other revenues ie gain of sale of assets 0 Operating Expenses Cost of Goods sold COGS Wages Rent Selling expense Depreciation Amortization Other expenses ie loss of sale of assets extraordinary items are very unusual like hurricane damage in North Dakota 0 Gross pro t RevenueSales Cost of Goods Sold this is also NET income LESS the operating expenses Operating Income Revenue Less Cost of Sale Gross Pro t Less Operating Expenses Operating Income 0 Statement of Cash Flows 0 Cash ows from operating activities Cash ows from buying and selling a company s products and services Collections from sales Cash paid to suppliers employees etc 0 Cash ow from investing activities 0 Cash ow from nancing activities 0 See Flow of capital 0 See Exercise 23 p 61 Balance Sheet and Income Statement aka PampL must know which accounts go into which statement relationship between them Take Net Income from PampL and put it into Retained earnings to make the balance sheet balance correctly Balance Sheet goes on forever but PampL is closed out at end of period and quotzeroed outquot called closing the books what is left over is the retained earnings 0 for good de nition of retained earnings as a concept it is a measure of pro table operations Problem P29 p 67 0 Current Ratio relates to liquidity 0 Debt to equity ratio important because it should be decreasing don t want to see a trend moving debt to equity upwards 0 Return on equity ratio tells you of the invested in the company what the return is Part 2 Overview principles of accounting assumptions etc Framework in which accounting operates o 2 companies can account for things differently but the profession strives for consistency Prof too much leeway allowed called quotearnings managementquot Chapter 3 Measurement Fundamentals Basic assumptions 0 Economic entity must have a corporate entity to analyze 0 Fiscal period must be an arti cial period on which to report 0 Going concern assume the company will continue on 0 Stable dollar usually achieved by hedging Valuations on the balance sheet o 4 types of valuation bases present value fair market value replacement cost original historical cost 0 Principles of Financial Accounting Measurements o Objectivity must be veri able and backed by documentation 0 Matching quotexpense follows the revenuequot focuses on the timing of recognition of expenses the efforts of a given period expenses should be matched against the bene ts revenues they generate ie cost of inventory is initially capitalized as an asset on the balance sheet it is not recorded in COGS expense until the sale is recognized 0 Revenue Recognition determines when revenues can be recognized amp triggers the matching principle which is necessary for determining the measure of performance most common point is when goods amp services are transferred or provided to the buyer at delivery Example 35 McKey should recognize the 40k upon delivery in February 4 revenue recognition criteria 1 Company has completed a signi cant portion of the production and sales effort 2 The amount of revenues can be objectively measured 3 The title of goods has transferred to the buyer and 4 Cash collection is reasonably assured Example ENRON worked quarter to quarter to keep share price up consistently They were looking at a down quarter so they decided to sell the Nigerian barges for the exact amount extra that they needed to make their quarterly numbers Called Merrill Lynch and asked them to buy them for the exact amount they needed and Merrill Lynch agreed to buy them for the gain they needed on the quarter ONLY IF Enron guarantees to buy them back in 6 mos for an even greater gain this type of fraudulent transaction is called parking 0 Consistency GAAP needs to be applied consistently from yea r to yea r Exceptions to the basic principles O O Materiality must be large enough to make a different to nancial statement users if its not then it s immaterial it s the amount that would change the decision of a nancial statement user Conservatism when in doubt nancial statements should understate assets overstate liabilities accelerate the recognition of losses and delay recognition of gains e lower of cost or market is used to value inventory Problem Some managers have abused the conservatism constraint in earnings management See pages 78 amp 80 for discussion examples Example P37 Part A Book value of building at 112014 90000 because Barry paid exactly that on that day Net book value at end of rst year Cost is 90000 less salvage value of 40000 less depreciation value of 5000 for one year so net book at end of year one is 45000 Economic Value PV of Cash in ows the building will generate in the future less the present value of the cash out ows the building will cost in the future PV of net cash in ows is 122891 PV from sale of building is 15421 so total PV of building is 138000 so yes this was a wise investment Part B Income Statement n Revenue 65000 a Expenses 45000 a Depreciation 5000 a Net Income 15000 Part B Balance Sheet In LeftDebit Side 0 Cash 20000 Net income depreciation 0 Building PPampE 90000 0 Less accum depreciation 50000 0 Net 85000 0 Total 105000 20000 85000 a RightCredit Side 0 Liabilities 0 0 Equity 90000 Retained Earnings 15000 0 Total 105000 90000 15000 0 Example lD38 You shouldn t correct 2 year of errors in one quarter adjustment entry violates the consistency principle didn t accurately re ect nancial results in 2008 and a reader would not see the results in the correct period violating the scal period should have restated all of 2008 and 2009 statements should match revenues and expenses within the same scal period Chapter 4 Mechanics of Financial Accounting 0 1st step is transaction analysis use spreadsheet approach 0 See Example E42 Debits Assets Expenses Credits Liabilities Equity Revenue 0 No assignment for Tuesday 0 Overall picture of how accounts are kept 0 General Journal big black book every transaction is written in the General Journal 0 General Ledger accumulate the debits and credits and at end of period you post it to the general ledger T account each page is one account rst page is Cash at end of month is balance 0 Financial Statements created by taking each page from General Ledger and putting it into the correct nancial statement Assets aka Debits or Left Hand Liabilities Equity aka Credits or Right Hand 0 Double entry accounting 0 Debit means an entry to the left hand side 0 Credit means an entry to the right hand side of an account 0 Doesn t indicate increase or decrease Journal Entries 0 e Cash to buy inventory credit cash debit inventory Rules Assets have normal debit balances and increase with a debit Liabilities have normal credit accounts and increase with a credit Expenses have normal debit balances and increase with a debit Dividends have a normal debit balance and increase with a debit Revenues have normal credit balances and increased with a credit Taccounts see examples on O O 0 Running tally of the affect of transactions on an account in the General Ledger We call this process posting to the GL The running tally makes it possible to complete trial balances and nancial statements Recognizing Gains and Losses this is not revenue that is an opera 0 O O tional term Investments and noncurrent assets are sold for more or less than the amounts at which they are carried on the balance sheet at such point a gain or loss must be recognized Different than revenue and expenses Bottom of income statement both gains and losses are posted to the income statement Periodic Adjustments 0 Prepared at the end of the accounting period to align revenues and expenses matching principle so that net income for the period will be the result of proper matching of revenues and expenses within the period 3 forms accruals deferrals revaluations just called adjustments serve to restate accounts to keep recorded values with existing facts ie short term investments accounts receivable bad debt inventories Usually NO document ow to trigger recording doesn t take any cash or transaction to trigger this but you must accrue the entries anyway 0 Interest and accrued wages are perfect examples of accruals 0 Example Accrual of Revenues Rental revenue where the rental payment has not yet been received For revenues that have not yet been recorded at the end of the period 0 Deferral of expenses 0 Asset capitalization and the matching principle Occurs when a cost with future economic bene t is incurred an asset is recognized at that time As the asset contributes to the generation of revenue revenue recognition the related cost is recognized as an expense classic matching principle 0 Expense or capitalize o Fine Host example same as WorldCom but they were caught by auditors they were aggressive but they weren t hiding anything unethical but wasn t convicted of fraud 0 Example Problem P45 on page 152 0 Prepare balance sheet and Income Statement with your group iv r rvv77ihmw 7 r r a u was 1 swagr ngBsWquot 27239 39 km 4x rr away 7 r 7 U 39 W E n a Fiat m 39 Next week 90 minutes of lecture followed by midterm quiz Look at Test Bank online maybe 25 multiple choice questions over Chapters 14 Skipping Chapter 5 for right now straight to Chapter 6 Chapter 6 Current Asset Classi cation Cash and Accounts Receivable Current Asset classi cation 0 Current asset any asset that is intended to be converted into cash within one year or the company s operating cycle whichever is longer Current ratio current assets current liabilities can you pay your bills Liquidity 0 Limitations of the Current Assets not always relevant or up to date information 0 Proper Management of Cash amp Restrictions Restrictions placed on company s access to its cash are typically imposed by creditors to help ensure interest and principal payments Compensating balances are sometimes required Record control over cash Physical control over cash 0 Accounts Receivable For next time Homework ID 62 Accounts receivable arise from selling goods or services to customers on account Recorded at face amount to be collected However we must also re ect the fact that a portion of AR may not be collected We adjust to Net Realizable Value Reasons for lack ofpartial collection a Sales discounts cash discounts a Sales returns a Sales allowances n Uncollectible AR bad debt Net Realizable Value a How do you estimate NRV Percentage of sale or 0 Aging schedule of AR See examples on ID 62 and ID 65 p 265266 ID 611 page 268 A Any deviation from the ultra conservative methods would harm their rep B By recognizing the pro ts early on they re shortchanging their future long term reports however they are probably recognizing the pro ts as part of overall corporate scheme which affects the department and executives bonus portions based on performance C It s a grey area arguably the accountants are functioning properly because they are within GAAP and their own internal protocols however it s against the spirit of the COC Class Discussion Would affect performance based compensation by maximizing it on the short term Prof thinks the accounting principle might be wrong but if you have a contract they may not have any credit risk for these clients No matching Doing it this way means you have to keep it up quarter after quarter to sustain income and shareholder value ID 65 Increasing the reserve would signal to the market that they re expecting the default in subprime mortgages and by coupling those reserve accounts they can effectively hide the oncoming drop A signi cant drop in the GDP could result in layoffs and RIFS that would then affect subprime mortgages for those persons who were already atrisk when they received nancing ID 611 By limiting cash ow and tightening credit many capital and real estate intensive projects were put on hold thus the real estate projects internationally slowed and would further slow the payments to a construction company signi cantly reducing their cash ow and thus causing them to write off bad debts for underfunded or cancelled projects The other side of that bad debt expense is vendors and customers customers who don t pay and vendors who don t get paid or who can t deliver and because the cash ow is not as expected the income statements suffer and the balance sheet is reduced because liabilities increase If bad debt expense is increasing across the industry then it signals a slow in construction projects and a reduction in income statements because projects have been put on hold Chapter 7 Inventory Most dif cult account dif cult to value audit keep up with easily manipulated etc 0 To calculate COGS Beginning Inventory Purchases Ending Inventory 0 Reserves are NOT inventory they are not even part of the accounting process it s just reported in an unaudited footnote 0 Inventory items held for resale to customers gets its value from demand Inventory you purchase retailers wholesaler quotmerchandise inventoryquot Inventory you manufacture manufacturers raw materials work in process nished goods BofA has no inventory bc it s all cash manufacturing amp retailers have large inventory to total asset ratios 0 Four important inventory issues O O O 0 Acquiring inventory what costs to capitalize Recording inventory activity which method Selling inventory which cost ow assumption Ending inventory lowerofcost or market valuation 0 Acquiring Inventory O O 0 What items or units to include General rule complete or unrestricted ownership Ownership is usually possession however there are excep ons Consignments consignee takes physical possession but does not take ownership Goods in transit n FOB shipping point seller is responsible for owns goods only until they are loaded on the common carrier n FOB destination seller is responsible for goods until they arrive at the destination buyer Which costs to attach Will be more than the item itself anything related to getting the item ready for sale is part of cost of inventory Freightin adds to the cost of inventory Purchase returns reduce the cost of purchases for returned inventory Purchase allowances reduce the cost of inventory 0 Carrying Inventory O Perpetual Method maintaining a continuous record Figure 73 0 Cash ow assumptions 0 O 0 Given Beg Inventory Purchases net Ending Inventory COGS Management must decide how to assign costs of in ows BI Pnet to El and COGS Methods Speci c identi cation most accurate rarely used Average for both COGS and El FIFO rst in rst out for COGS D And LISH lastin still here for El LIFO last in rst out for COGS D And FISH rst in still here for El 0 US Companies Surveyed 33 LIFO 63 FIFO 23 averaging Effect on FinancialsTaxes o In an in ationary period rising prices which most periods re FIFO has the highest inventory balance lowest COGS and highest income LIFO has the lowest inventory balance highest COGS and lowest income a This means that LIFO pays the least taxes Choosing an Inventory Cost Flow Assumption Tradeoffs 0 Income and Asset management 0 Economic Consequences Income Taxes and Liability Bookkeeping costs LIFO liquidation and inventory purchasing practices Debt and Compensation Practices The Capital Markets Ending Inventory Applying the LowerofCostorMarket Rule 0 Applying the lower of cost or market rule to ending inventory is accomplished by comparing the cost allocated to ending inventory with the market value of the inventory If the market value exceeds the cost no adjustment is made and the inventory remains at cost If the market value is less than the cost the inventories are written down to market value with an adjusting journal entry quotwriting it downquot Ethics inventory fraud ID 77 Thinning inventories Sell off existing inventory cash ow increases for capital projects when credit tightens they still have cash ow not replacing inventory this improves cash ow you ll see inventory in balance sheet and look for detail in the footnote Bring Starbucks 10K for next time Saturday team projects too Chapter 8 Investments in Equity Securities Companies make investments in equity securities by buying and selling stock on the open market even if they aren t involved in that particular business 0 Historical cost principle is NOT followed with investment securities use marktomarket rule carried on the balance sheet if convertible into cash in one year if there is a gain or loss it s recognized as such and re ected in retained earnings 0 NOT part of operations and therefore NOT part of revenue Longterm Equity Investments o Treated differently depending on percentage of ownership 0 Equity method recognizes dividends as equity income not re ected in revenue 0 MampA in Consolidated Fin Statements o Acquisitions one company buys the controlling interest in another 0 Merger 2 or more companies come together to form a single legal entity Goodwill o Goodwill is a noncurrent intangible asset created when a company pays an amount to acquire a controlling interest of another company that is more than the fair market value of net assets 0 Prior to 2002 goodwill was amortized over 40 years after 2002 goodwill cannot be amortized but rather is subject to an impairment test each year to see if the balance sheet amount ofthe goodwill exceeds its estimated fair market value 0 Special Purpose Entities 0 Created by companies to carry out activities or transactions directly related to speci c purposes 0 Key question is whether you should consolidate the nancials 0 Can be very subjective re who owns the SPE Chapter 9 Long lived assets PPE net meaning accumulated depreciation has been taken off 0 Land 0 Inde nite life so not depreciated Historical cost purchase price closing costs costs to get ready for intended use 0 Land improvements Have de nite life so are depreciated parking lots etc 0 Buildings 0 De nite life are depreciated o Proportionate share of purchase price or construction cost closing cost architect attorney s fees 0 Machinery equipment furniture amp xtures 0 Purchase price net of cash discounts freight amp handling insurance while in transit installation Intangible assets 0 Rights privileges and bene ts of possession o No physical existence 0 Includes cost and the cost to defend them 0 Amortized over useful life if inde nite life no amortization Big Question Do you capitalize or expense the cost 0 Revenue expenditures Merely maintain a given level of success should be expensed 0 Capital Expenditures Provide future bene ts useful life is greater than one year Matching principle Should be capitalized Construction Costs of longlived assets What to capitalize 0 Direct materials labor overhead interest during construction tacquisition expenditures Betterments or maintenance o Maintains current level of productivity repairs amp maintenance expense as incurred o Betterments one of the following must apply lncrease useful life beyond the initial estimate lmprove quality of output lncrease quantity of output Reduce costs of operating the asset Cost allocation Amortizing capitalized costs 0 The costs are to be matched against the bene ts produced by the asset Estimate useful life based on physical obsolescence Estimate a salvage value based on amount that can be recovered Choose a cost allocation depreciation method a Straightline method assumed use of machine is constant a Accelerated depreciation accelerates at the beginning of the life of the asset depreciates the most at rst like a car a Activity method allocates cost to future periods on the basis of its activity Intangible Assets o Characterized by lack of physical substances and higher uncertainty about future bene ts 0 Patents 20 year legal life May capitalize the cost of acquiring an externally developed patent n Filing fees for internally or externally developed patents n The legal fees for acquiring and successfully defending a patent internal or external Cannot capitalize legal fees for unsuccessfully defending a patent most research and development costs for an internally developed patent 0 Software Development costs capitalize the costs of developing software for sale or lease expense software development costs if for internal use 0 Goodwill recognized when one company purchases another company causes include reputation good customer relations superior product development etc To calculate purchase price paid for the company versus the fair market value of the net assets acquired goodwill the excess amount paid No longer amortized instead subjected to an impairment test 0 Example Customer relationships as characterized sounds like goodwill Customer relationships is a subcategory of goodwill it was developed internally and it was purchased Group Project Liberty Manufacturing SBUX Form 10K handout Part 4 Chapter 10 Liabilities What is a liability FASB de nition on 0 Reporting Liabilities on the Balance Sheet 0 Economic consequences Shareholders and investors a Interest expense is tax deductible but more debt means more risk to shareholders In Equity ownership is subordinated to creditors 0 Current liabilities Expected to require the use of current assets expect to pay it in a year Valuing on balance sheet ignore present value and report at face value Reporting primary problem is ensuring that all existing current liabilities are reported on the balance sheet 0 Determinable liabilities accounts payable short term debts dividends payable unearned revenues third party collections income taxes incentive compensation o Contingent liabilities lawsuits warranties amp o Accrued Liabilities accrue expenses and liability at the end of the current period and usually paid sometime during the next year ie wages payable salary payable interest payable rent payable etc Incentive compensation o Contingent Liabilities contingent on some future event of activity in order to know the exact amount ie warranties coupons and lawsuits Changes in estimate may be made in subsequent period when future event is concluded Loss contingencies 0 Warranties Uncertain future costs Record estimated expenses and liability when products are sold matching concept 0 Retirement costs incurs a liability for matching 401k de ned bene t plans etc o Deferred Taxes generated by the discrepancy between income and expenses for taxation speci ed by IRS and nancial reporting speci ed by GAAP Use accelerated depreciation for taxes for book income record current and deferred tax rates washes out over life of the asset Chapter 11 Long Term Liabilities basic de nitions amp different contractual terms 0 Many companies nance their operations and growth through use of long term debt 0 Notes formal borrowing agreement 0 Bonds issued to bondholders smaller dollar amounts and larger amount of notes 0 Leasehold obligations future cash payments for use of an asset Economic Consequences of Reporting LongTerm Liabilities 0 Improved credit ratings can lead to lower borrowing costs 0 Management has strong incentive to manage the balance sheet by using quotoffbalancesheet nancingquot Incentive to keep as much debt off the books as possible 0 Long Term Liabilities Notes Bonds and Leases 0 Long term liabilities are recorded at the present value of the future cash ows 0 Two components determine the time value of money Interest discount rate Number of periods of discounting 0 Types of activities that require PV calculations Notes payable 0 Bonds payable and bond investments Capital leases Present Value of a Single Sum o All present value calculations presume a discount rate i and a number of periods discounting n There are 3 different ways you can calculate the PV1 Formula PV1 FV111in Tables near back of book Financial Calculator time value of money Bond terminology 0 Accounting for Bonds Payable 0 Use effective interest rate Bonds payable at a discount 0 If bonds are issued at a discount the carrying value will be below face value at the date of issue 0 The discount on BP account has a normal debit balance and is a contra to BP similar to the Discount on WP o The Discount account is amortized with a credit Note that the different between Cash Paid and Interest Expense is still the amount of amortization 0 Interest Expense for bonds issued at a discount will be greater than cash paid 0 The amortization table will show the bonds amortized up to face value Leases o A contract grants use or occupation of property during a speci ed period of time in exchange for rent payments Land Buildings Machinery Equipment Avoid risks associated with ownership 0 Operating Leases pure rental agreement where the lessor maintains all ownership expenses Off balance sheet nancing 0 Capital Leases risks and bene ts of ownership have effectively transferred to lessee Capital Lease Criteria n The lease transfers ownership of the property to thelessee n The Lease contains a bargain purchase option a The lease term is 75 or more of the useful life of the property 0 n The present value of the lease payments equals or exceeds 90 of the FMV of the property 0 Determine the effective actual rate of return 0 Determine the required rate of return 0 Determine the RiskFree return 0 Determine the Risk Premium 0 Compare the Effective Rate to the Required Rate 0 Ethics Chapter 12 Shareholder s Equity 0 How to nance a corporation 0 Borrow Notes bonds leases The debt holders are legally entitled to repayment of their principal and interest claims 0 Issue Equity Common amp preferred stock The shareholders as owners have voting rights limited liability and a residual interest in the corporate assets 0 Retained Earnings pro table operations Debt amp Equity Distinguished Characteristics Debt amp Equity Distinguished 0 Debt Formal legal contract Fixed maturity date Fixed periodic payments Security in case of default No voice in management Interest expense deductible 0 Equity No legal contract No xed maturity date Discretionary dividends Residual asset interest Voting rights common Dividends not deductibles Double taxation Distinctions between Debt amp Equity Economic Consequences Associated with Accounting for SH equity 0 Key business ratios rely on SH equity which affects credit ratings and analysts evaluation of a company Preferred Stock don t worry about it Example of Stock Split page 519 o IZM Company has 100000 shares of 2 par value stock authorized 10000 shares issued and outstanding o The SE section of the balance sheet shows Common stock 20000 Retained Earnings 80000 0 The market price of the outstanding shares is 50 per share before the split is distributed Stock Options o Gives employees typically executives the right to purchase company stock at a given price for a period of time o The idea is that if the stock price rises the executives purchase stock at a price less than its market value thereby getting a bene t 0 Since value is given up in the lower than market stock price amp existing stockholders give up a of ownership GAAP requires that an exercise be booked when the options are granted What is Par Value 0 Little economic or legal consequence 0 Some nancial accounting value Retained Earnings 0 RE beg unadjusted AddSubtract Prior Period Adjustment RE beg restated Add Net Income Less Dividends Cash dividends Common Cash dividends preferred Stock dividends Property dividends 0 Less Adjustments for TS transactions Appropriation of RE 0 RE ending Page 509 Question 1 amp 2 Stock dividends vs Stock splits don t worry about OOOO Ethics Chapter 13 the Compete Income Statement Income is the most common measurement of a company s performance 0 A measure of a change in value 0 As compared to equity which measures the level of value or wealth It is not net cash ow It is a measure of performance 0 There are different income measures which relate to different objectives GAAP provides for various measures to be presented The measurement of income different measures for different objectives 0 Comprehensive Income change in equity net assets during a period from transactions and other events and circumstances from nonowner sources includes all changes in equity during a period except those resulting from investments by owners and distributions to owners broken down into 2 categories Net income revenues expenses gains and losses Other comprehensive income 0 Figure at bottom of page The Income Statement 0 Operating Section Sales Revenue less COGS less Selling Expenses less Administrative Expenses o Nonoperating Section Add Other Revenues and Gains Less Other Expenses and Losses 0 Income Tax 0 lrregular ltems Discontinued operations net of tax Extraordinary ltems net of tax unusual and infrequent 0 Net Income 0 Earnings Per Share Two Different Concepts of Income 0 The Matching Process Revenues Expenses Net Income 0 Fair Market Value approach FMV Net Assets end FMV Net Assets beginning Net Income 0 Earnings Per Share required disclosure 0 Problems The numerator can be manipulated by a of earning management techniques The denominator can be manipulated by stock buybacks treasury stock The whatif presentation of diluted EPS is a ctitious number it can never actually happen 0 Income Statement categories useful for decisions but subjective Earning persistence is the concept that some earnings dollars are likely to continue in the future but others are not those that do provide future cash ow are valued higher by external users of nancial statements 0 Ethics
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