Accounting Final Exam Study Guide
Accounting Final Exam Study Guide BMGT220
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Accounting Final Exam Study Guide (Warren Edition) Chapter 1: Introduction toAccounting and Business I. Nature of Business &Accounting 1. business - organization in which basic resources, such as materials and labor provide output 2. proﬁt - difference between amounts received from customers and amount paid for inputs B. 3 types of business 1. Service business - provide services rather than products to customers 2. Merchandising business - sell products they purchase from other business to customers 3. Manufacturing business - change basic inputs into products sold C. Accounting - information system that provides reports to users about economic activities 1. Accounting as an information system a) Identify users b) Assess users information needs c) Design accounting information system to meet users’needs d) Record economic data about business activities and events e) Prepare accounting reports for users 2. Types of accounting a) Managerial accounting - internal users of accounting info b) Private accounting - managerial accounts employed by a business c) Prepare accounting reports for users D. General purpose ﬁnancial statements 1. ﬁnancial accounting report that is distributed to external users E. Ethics - moral code of conduct 1. Sarbanes-GreyAct of 2002 - created Public CompanyAccounting Oversight Board 2. public accounting - accounting provides service on fee basis 3. GAAP - generally accepted accounting principles follow FASB (FinancialAccounting Standards Board) II. Business Entity Concept - limits data in an accounting system to data related to business activities A. Types of Entities 1. Proprietorship - owned by 1 individual (70% of all businesses) a) easy, cheap, all proﬁt goes to owner; limited resources, full liability 2. Partnership - is owned by 2 or more partners (10% of all businesses) a) combines skill, share liability, partner can buy out; split revenues 3. Corporation - a company authorized to act like its own legal entity (20% of all businesses and 90% of all business revenues) a) legal entity which shields owners from liability, pays taxes, sell shares of stock 4. Limited Liability Company - partnership that functions like a corporation B. Accounting Equation 1. Assets - resources a business owns (e.g. cash, land, buildings, equipment) 2. Liabilities - rights of creditors to claim assets 3. Stockholders/Owner’s Equity - rights of owners to claim assets 4. Assets = Liabilities + Stockholders’Equity Chapter 2:Analyzing Transactions I. UsingAccounts to Record Transactions A. Account - separate record that shows increases & decreases in accounting equation a) Title - name of accounting equation element recorded in account b) space for recording increases in the amount of the element c) space for recording decreases in the amount of the element 2. T-account - left side = debit, right side = credit 3. Dead Colr - mnemonic device to remember whether to debit or credit increases in an account a) Debit - Expenses, Assets, Dividends b) Credit - Owner’s Equity, Liabilities, Revenues 4. balance of the account - excess debits or credits a) debit balance = excess debits, credit balance = excess credits B. Chart ofAccounts 1. ledger - group of accounts for a business entity 2. chart of accounts - list of accounts in that ledger, in order that they appear 3. Balance sheet -Assets -> Liabilities -> Owner’s Equity 4. Income Statement - Revenues, Expenses 5. Assets - resources owned by business (e.g. Cash, Supplies,Accounts Receivable, Prepaid Expenses, Land) 6. Liabilities - debts owed to creditors (e.g.Accounts, Notes & Wages Payable, Unearned Revenue) 7. Owner’s Equity - stockholders’rights to assets - balance of capital stock and retained earnings 8. Revenues - increases in equity as a result of selling products to customers (e.g. Rent Revenue, Fees Earned) 9. Expenses - using up assets or services (e.g. Wages expense, Rent Expense, Utilities Expense, Supplies Expense, Miscellaneous Expenses) C. Balance SheetAccount Order 1. Assets - Cash,Accounts Receivable, Supplies, Prepaid Insurance, Land, Ofﬁce Equipment 2. Liabilities -Accounts Payable, Unearned Rent 3. Stockholders’Equity - Capital Stock, Retained Earnings, Dividends D. Income Statement Order 1. Revenue - Fees Earned, Rent Revenue 2. Expenses - Wages Expenses, Rent Expense, Utilities Expense, Supplies Expense, Misc. II. Double-EntryAccounting System 1. double-entry system - based on accounting equation 2. every business transaction recorded in at least two accounts 3. total debits recorded for each transaction = total credits recorded B. Balance SheetAccounts 1. Assets - debit for increase, credit for decrease 2. Liabilities - debit for decrease, credit for increase 3. Equity - debit for increase, credit for decrease C. Income StatementAccounts 1. Revenue - debit for decrease, credit for increase 2. Expense - debit for increase, credit for decrease D. Dividends 1. Dividends - debit for increase, credit for decrease E. Journalizing 1. journal - where transactions are originally entered and recorded 2. e.g. Nov. 5 Land (debit->) 20000 Cash (credit->) 20000 3. Term Debit Credit a) Received cash for services provided Cash Fees Earned b) Services provided on account Accounts Rec. Fees Earned c) Received cash on account Cash Accounts Rec. d) Purchased on account AssetAccount Accounts Pay. e) Paid on account Accounts Payable Cash f) Paid cash Asset/Expense Cash g) Issued capital stock Cash Capital Stock h) Paid dividends Dividends Cash III.Posting Journal entries toAccounts 1. posting - transferring debits and credits from journal entries to accounts B. Trial Balance - method to check that debits = credits C. Errors 1. transposition & sliding 2. unposted Chapter 3: TheAdjusting Process I. Nature of theAdjusting Process 1. Accounting period concept - revenues/expenses reported in correct period 2. Accrual basis of accounting - revenues reported only after they are earned 3. Revenue recognition concept - revenue reported after service/product provided 4. matching concept - report revenues and related expenses in same period B. TheAdjusting Process 1. Some expenses are not recorded daily because they don't need to be 2. Some revenues and expenses are incurred as time passes rather than separate transactions 3. some revenues and expenses may be unrecorded, such as unpaid wages C. Types ofAccounts RequiringAdjustment 1. Prepaid Expenses a) advance payment of future expenses are recorded as assets when cash is paid b) become expenses over time or during normal operations c) Transaction: Cash is paid for prepaid expense (cash credited, prepaid expense debited) d) Adjustment: Expense is increased by amount prepaid is decreased; expense debited, prepaid credited 2. Unearned Revenues a) advance receipt of future revenues and are recorded as liabilities when cash is received b) Unearned revenues become earned revenues over time or during normal operations c) Transaction:Advance receipt for future services, liability of unearned revenue; cash -> unearned revenue d) Adjustment: Unearned revenue debited for amount revenue earned; Unearned-> earned 3. Accrued Revenues a) unrecorded revenues that have been earned and for which cash is yet to be received b) fees for services that an attorney or doctor has provided and has not yet billed c) Transaction: Revenues been earned but not yet recorded/received - No entry d) Adjustment: asset receivable debited for amount earned, Revenue acct. credited 4. Accrued Expenses a) unrecorded expenses that have been incurred and for which cash has yet to be paid b) Wages owed to employees at the end of the of a period but not yet paid is an accrued expense c) Transaction: an expense incurred, but not yet recorded/paid - No entry d) Adjustment: Debit the expense and credit the liability (payable) 5. Depreciation Expense a) Fixed assets - long term asset but depreciates over time b) Depreciation expense - periodic expense comes from cost of asset depreciation c) Accumulated depreciation - credited in contra accounts d) Debit Depreciation Expense, CreditAccumulated Depreciation Chapter 5:Accounting for Merchandising Businesses I. Nature of Merchandising Business 1. service business: fees earned - operating expenses = net income 2. Merchandising business: cost of merchandise sold = gross proﬁt (-expenses = net income) 3. Fees earned = revenues from services 4. Net income = fees earned - operating expenses 5. Sales - revenue from merchandise sold 6. Cost of merchandise sold - cost of selling merchandise recorded as an expense 7. Gross proﬁt - the amount of proﬁt made before subtracting operating expenses 8. Merchandise inventory - merchandise on hand (not sold) at end of accounting period II. Merchandising Transactions 1. Subsidiary ledger - large number of individual accounts with common characteristics 2. General ledger - primary ledger which contains all balance sheet & income state accts. B. Purchases Transactions 1. perpetual inventory system - each purchase and sale of merchandise is recorded in the inventory and related subsidiary ledger 2. periodic inventory system - does not show amount of merchandise available for sale and sold, instead a physical inventory used to determine cost of merchandise C. Purchases Discounts 1. to encourage the buyer to pay before the end of the credit period offer discount 2. Ex. Buyer purchases 3000 worth of merchandise on account on terms (2/10, n/30) 3. This means it is a 2 % discount payable within 10 days, and no discount w/in 30 days 4. Dr. Merchandise Inventory 3000 a) Cr.Accounts Payable - (buyer name) 3000 5. Dr.Accounts Payable - (buyer) a) Cr. Cash 2940 and Merch Inv. 60 6. This is to keep track of both inventory and payment D. Purchases Returns &Allowances 1. purchases returns & allowances - buyer requests allowance for merchandise return (defective, parts missing, etc.) III. Freight A. FOB Shipping Point 1. buyer pays for the freight costs from the shipping point to ﬁnal destination 2. Buyer would record the delivery transaction, seller would not 3. Dr. Delivery Expense (example) a) Cr. Cash B. FOB Destination 1. seller pays for the freight costs from the shipping point to the buyer’s ﬁnal destination 2. Seller would record the delivery transaction, buyer would not IV. Miscellaneous A. Sales taxes 1. Seller collects sales taxes temporarily and then pays to the government 2. If a state has a 6% sales tax and buyer pays on account, for example: 3. Dr.Accounts Receivable 106 a) Cr. Sales 100, Sales Tax Payable 6 4. When it comes time to pay to the government 5. Dr. Sales Tax Payable a) Cr. Cash B. Adjusting for Shrinkage 1. inventory shrinkage - when amount of inventory on hand is less than the balance of merchandise inventory 2. usually due to shoplifting, employee theft or error in account 3. Dr. Cost of Merchandise Sold a) Cr. Merchandise Inventory Chapter 6: Inventories I. Control of Inventory A. Safeguarding Inventory 1. Purchase order - authorizes the purchase of the inventory from an approved vendor 2. Receiving report - establishes initial record of the receipt of the inventory, is compared with the purchase order to make sure the inventory received is the same as what’s ordered and ﬁnally compared with a Vendor’s Invoice 3. Subsidiary inventory ledger - keeps track of the amount of inventory B. Reporting Inventory 1. Physical inventory - physical count of inventory II. Inventory Cost FlowAssumptions A. Cost FlowAssumption 1. speciﬁc identiﬁcation inventory cost ﬂow method - when units are sold, the speciﬁc cost of the unit sold is added to cost of goods sold 2. First-in, First-Out (FIFO) - Cost ﬂow is in the order in which costs were incurred 3. Last-in, First-Out (LIFO) - Cost ﬂow is in the reverse order in which costs incurred 4. WeightedAverage Cost - Cost ﬂow is an average of the costs III. Inventory Costing Methods Under a Perpetual Inventory System A. First-in, First Out (FIFO) 1. costs included in cost of merchandise sold in same order they were purchased 2. ﬁrst units purchased are assumed to be sold and the ending inventory is made up the most recent purchases 3. produces roughly same results as speciﬁc identiﬁcation method B. Last-in, First-Out (LIFO) 1. cost of the units sold is the cost of the most recent purchases 2. the last units purchased are assumed to be sold and the ending inventory is made up of the most recent purchases 3. LIFO is most widely used even when it does not represent the physical ﬂow of units 4. When LIFO is used, subsidiary inventory ledger is sometimes maintained in units only, units are converted to dollars when ﬁnancial statements are prepared at end C. WeightedAverage Cost Method 1. The weighted average unit cost for each item is calculated each time a purchase is made (the cost of individual units would be the average of all the prices of all the units) IV. Inventory Costing Methods Under a Periodic Inventory System A. First-in, First-Out (FIFO) 1. Under periodic FIFO, a physical count is taken of inventory and the ﬁrst purchased are the ﬁrst to be sold, and they are sold at the same cost at which they were purchased 2. The ending inventory is made up of the most recent costs B. Last-in, First-Out (LIFO) 1. Under periodic LIFO, the cost of the merchandise on hand at the end of the period is made up of the earliest costs 2. The ending inventory is made up of the earliest costs C. WeightedAverage Cost Method 1. Average Unit Cost = Total Cost of UnitsAvailable for Sale / UnitsAvailable for Sale D. Inventory Calculations 1. Beginning Inventory + Purchases = Cost of GoodsAvailable for Sale 2. Cost of GoodsAvailable for Sale - Ending inventory = Cost of Goods Sold 3. Beginning Inventory + Purchases = Cost of Goods Sold + Cost of Ending Inventory V. Comparing Inventory Costing Methods A. Costing under Increasing Prices (High / Low) 1. Cost of Goods Sold: LIFO / FIFO 2. Gross Proﬁt: FIFO / LIFO 3. Net Income: FIFO / LIFO 4. Ending Inventory: FIFO / LIFO B. Costing under Decreasing Prices (High / Low) 1. Cost of Goods Sold: FIFO / LIFO 2. Gross Proﬁt: LIFO / FIFO 3. Net Income: LIFO / FIFO 4. Ending Inventory: LIFO / FIFO C. Inventory Proﬁts 1. Inventory Proﬁts (Illusory Proﬁts) - FIFO reports higher gross proﬁt and net income than LIFO with rising costs, yet in periods of rapid rise, the inventory sold must be replaced faster and at higher costs 2. During rising costs, LIFO matches more recent costs against sales on the income statement, and can be argued that LIFO method more nearly matches current costs with current revenues D. Taxing under Costing Methods 1. Under rising prices LIFO results in lower gross proﬁt, which means less taxable net income 2. Conversely, under decreasing prices, LIFO results in higher gross proﬁt, which means more taxable net income 3. Weighted average is a compromise between LIFO and FIFO, in terms of taxation VI.Reporting Merchandise Inventory in the Financial Statements A. Valuation at Lower of Cost or Market 1. Lower-of-cost-or-market method (LCM) - used to value the inventory based on the cost or replacing inventory and any declines can be determined by the following a) Each item in the inventory b) Each major class or category of inventory c) Total inventory as a whole 2. The amount of any price decline is included in the cost of merchandise sold, which reduces gross proﬁt and net income in the period in which the price decline occurs 3. If a unit can be replaced at a lower cost than its purchase price, that is LCM and vice versa B. Valuation at Net Realizable Value 1. Net Realizable Value - price of merchandise that is old or damaged can only be sold for lower than original value 2. Net Realizable Value = Estimated Selling Price - Direct Costs of Disposal C. Merchandise Inventory on the Balance Sheet 1. In addition to CurrentAssets, the following are reported a) method of determining cost of inventory (FIFO, LIFO, or weighted average) b) method of valuing the inventory (cost or the lower of cost or market) D. Effect of Inventory Errors on the Financial Statement 1. Reasons for errors: a) Physical inventory on hand miscounted b) Costs were incorrectly assigned to inventory (e.g. FIFO or LIFO was incorrectly applied) c) Inventory in transit was incorrectly included or excluded from inventory d) Consigned inventory was incorrectly included or excluded from inventory 2. Consigned inventory - when manufacturers (consignors) sells to retailers (consignee) on consignment and consignor retains title until goods are sold (if unsold at year-end, consignee should not include in inventory, consignor should include in inventory) E. Effect of Inventory Error on Current Period Income Statement 1. Beginning Inventory is Understated: a) Cost of Goods Sold = Understated b) Gross Proﬁt = Overstated c) Net Income = Overstated 2. Beginning Inventory = Overstated a) Cost of Goods Sold = Overstated b) Gross Proﬁt = Understated c) Net Income = Understated 3. Ending Inventory = Understated a) Cost of Goods Sold = Overstated b) Gross Proﬁt = Understated c) Net Income = Understated 4. Ending Inventory = Overstated a) Cost of Goods Sold = Understated b) Gross Proﬁt = Overstated c) Net Income = Overstated F. Effect of Inventory Errors on Current Periods Balance Sheet 1. Ending Inventory = Understated a) Merchandise Inventory = Understated b) CurrentAssets = Understated c) TotalAssets = Understated d) Stockholder’s Equity = Understated 2. Ending Inventory = Overstated a) Merchandise Inventory = Overstated b) CurrentAssets = Overstated c) TotalAssets = Overstated d) Stockholder’s Equity = Overstated VII. FinancialAnalysis and Interpretation: Inventory Turnover and Number of Days’Sales A. Inventory Turnover 1. Inventory Turnover = Cost of Goods Sold /Average Inventory B. Number of Days’Sales in Inventory 1. Number of Days’Sales in Inv. =Avg. Inventory /Avg. Daily Cost of Goods Sold 2. Avg. Daily Cost of Goods Sold = Cost of Goods Sold / 365 3. Lower number of days’sales in inventory, the more efﬁcient it is managing inventory Chapter 8: Receivables I. Classiﬁcation of Receivables A. Accounts Receivable 1. Accounts Receivable - selling merchandise or services on account (on credit), classiﬁed as current asset B. Notes Receivable 1. Notes Receivable - amounts that customers owe for which a formal written instrument of credit has been issued C. Other Receivables 1. Include interest receivable, taxes receivable, and receivables from other employees 2. If collected within one year, considered current assets 3. If collection is expected beyond one year, considered noncurrent assets, and reported as investments II. Uncollectible Receivables A. Bad Debt Expense 1. Bad Debt Expense (UncollectibleAccounts Expense) - amount of credit sales that are not expected to be received within the accounting period, which may occur because: a) Receivable is past due b) Customer does not respond to company’s attempts to collect c) Customer ﬁles for bankruptcy d) Customer closes its business e) Company cannot locate customer (1) If left unpaid, account can be turned over to collection agency 2. Direct Write-Off Method a) records bad debt expense only when the account is determined to be worthless b) not accepted under GAAP 3. Allowance Method a) records bad debt expense by estimating uncollectible accounts at the end of the accounting period, allowed under GAAP III. Direct Write-Off Method for UncollectibleAccounts 1. Under direct write-off method, Bad Debt Expense is not recorded until customer’s account is determined to be worthless.At that time account receivable is written off 2. To write off: Dr. Bad Debt Expense a) Cr.Accounts Receivable 3. Later if paid: Dr.Accounts Receivable, Cr. Bad Debt Expense and Dr. Cash forAR IV. Allowance Method for UncollectibleAccounts 1. Allowance for DoubtfulAccounts - contra asset account which is credited for the estimated bad debts 2. Dr. Bad Debt Expense a) Cr.Allowance for DoubtfulAccounts 3. affects income statement and balance sheet 4. Net Realizable Value is the amount of receivables reduced to the amount that is expected to be received (subtracting allowance for doubtful accounts) B. Write-Offs to theAllowanceAccount 1. Allowance for DoubtfulAccounts will normally have a balance based on an estimate 2. Credit balance if the write-offs during the period are less than the beginning balance 3. Debit balance if the write-offs exceed the beginning balance 4. If account receivable that has been written off against allowance account is collected again a) Dr.Accounts Receivable (1) Cr.Allowance for DoubtfulAccounts; Dr. Cash 4AR C. Estimating Uncollectible 1. Percent of Sales Method a) Uncollectible accounts can be estimated as a percent of credit sales to sales, applied to total sales or net sales b) Bad Debt Expense = Credit Sales * Bad Debt as a percent of credit sales 2. Analysis of Receivables Method a) Step 1: due date of account receivable determined b) Step 2: number of days each account is past due is determined c) Step 3: Each account is placed in an aged class according to days past due d) Step 4: Totals for each aged class is determined e) Step 5: Total for each aged class is multiplied by an estimated percentage of uncollectible accounts for that class f) Step 6: The estimated total of uncollectible accounts is determined as the sum of the uncollectible accounts for each aged class g) This process is called aging the receivables and helps determine that the longer an account is outstanding, the less likely it will be collected and a percentage is given for each age class D. Comparing Estimation Methods 1. Under percent of sales method, bad debt expense is focus of estimation process as well as matching expense and revenue and thus the income statement 2. Under analysis of receivables method, allowance for doubtful accounts is focus of estimation process, as well as net realizable value and thus the balance sheet V. Comparing Direct Write-Off andAllowance Methods A. Direct Write-Off: records bad debt expense when uncollectible a) Dr. Bad Debt Expense (1) Cr.Accounts Receivable b) Dr. Cash, Bad Debt Expense (1) Cr.Accounts Receivable B. Allowance Method: bad debt expense based on % sales or analysis, allowance acct. used a) Dr.Allowance for DoubtfulAccounts (1) Cr.Accounts Receivable b) Dr. Cash,Allowance for DoubtfulAccounts (1) Cr.Accounts Receivable VI. Notes Receivable A. Characteristics of Notes Receivable (promissory note used when): 1. The maker is the party making the promise to pay 2. The payee is the party to whom the note is payable 3. The face amount is the amount for which the note is written on its face 4. The issuance date is the date a note is issued 5. The term of a note is the amount of time between issuance and due dates 6. The interest rate is that rate of interest that must be paid on the face amount for term B. Interest 1. Interest = FaceAmount * Interest Rate * (Term / 360 days) 2. Maturity value - amount that must be paid at the due date of the note (sum + interest) C. Accounting for Notes Receivable 1. Dr. Notes Receivable (when note issued) a) Cr.Accounts Receivable 2. Dr. Cash (at due date) a) Cr. Notes Receivable, Interest Revenue 3. Dr.Accounts Receivable (if note dishonored or not paid in time) a) Cr. Notes Receivable, Interest Revenue Chapter 9: FixedAssets and IntangibleAssets I. Nature of FixedAssets A. FixedAssets 1. long-term or relatively permanent assets such as equipment, machinery, buildings, and land 2. Characteristics: a) They exist and are therefore tangible assets b) They are owned and used by the company in its normal operations c) They are not offered for sale as part of normal operations B. Classifying Costs 1. Is purchased item long-lived? a) No = item is recorded as an expense b) Yes = item is recorded as an asset on balance sheet (1) Is asset used in normal operations? (a) No = asset is recorded as an investment (b) Yes = asset is recorded as a ﬁxed asset C. The Cost of FixedAssets 1. Potential causes of expenses: a) Vandalism b) Mistakes in installation c) Uninsured theft d) Damage during unpacking and installing e) Fines for not obtaining proper permits from governmental agencies D. Capital and Revenue Expenditures a) Revenue expenditures - costs that only beneﬁt the current period and don't provide additional beneﬁt b) Capital expenditures - costs that improve an asset or extend its useful life 2. Ordinary Maintenance and Repairs a) costs related to the ordinary maintenance and repairs of a ﬁxed asset and are recorded as an expense of the current period b) Dr. Repairs and Maintenance Expense (1) Cr. Cash 3. Asset Improvements a) After a ﬁxed asset has been placed into service, costs may be incurred to improve the asset; a key improvement is made to improve productivity, efﬁciency of the asset: b) Dr. (Name of Capital expenditure) (1) Cash 4. Extraordinary Repairs a) After ﬁxed asset has been placed into service, costs may be incurred to extend asset’s useful life. b) Dr.Accumulated Depreciation (1) Cr. Cash E. Leasing FixedAssets 1. Lease - a contract for the use of an asset for a certain amount of time a) Lessor - one who owns asset b) Lessee - one who receives right to use asset, granted by lessor 2. Capital Lease - accounted for as if the lessee has purchased the asset, lessee debits an asset account for the fair market value of the asset and credits a long-term lease liability account 3. Operating Lease - accounted for as if the lessee is renting the asset for the lease term, where the lessee records operating lease payments by Dr. Rent Expense, Cr. Cash II. Accounting for Depreciation A. Depreciation - periodic recording of the cost of life 1. Physical depreciation - wear and tear during use or from exposure to weather 2. Functional depreciation - obsolescence and changes in customer needs that cause the asset to no longer provide services for which it was intended B. Factors in Computing Depreciation Expense 1. Assets initial cost 2. Asset’s expected useful life 3. Asset’s estimated residual value a) Residual value (salvage/trade-in value) - ﬁxed asset at the end of its useful life is estimated at the time the asset is placed into service C. Straight-Line Method 1. Annual Depreciation = (Cost - Residual Value) / Useful Life D. Units-of-Output Method 1. Depreciation per Unit = (Cost - Residual Value) / Total Units of Output 2. Depreciation Expense = Depreciation per Unit * Total Units of Output Used E. Double-Declining-Balance Method 1. Double-Declining Rate = 2*Straight-Line Percentage = (100/Years of Useful Life)*2 2. Book value = cost minus accumulated depreciation F. Comparing Depreciation Methods 1. Straight-Line Method a) Useful Life = Years; Dep. Cost = Cost - residual val; Exp. = Constant 2. Units-of-Output a) Useful Life = Units of Output, Dep. Cost = Cost - residual val; Exp. = Variable 3. Double-Declining-balance a) Useful Life = Years; Dep. Cost = Declining book value, not below; Exp. = Decln. G. Depreciation for Federal Income Tax 1. ModiﬁedAccelerated Cost Recovery System (MACRS) a) IRS uses MACRS to compute depreciation for tax purposes, using 5-year-class depreciation rates b) for both ﬁnancial statement and tax purposes H. Revising Depreciation Estimates 1. Estimates of residual values and useful lives of ﬁxed assets may change due to abnormal wear and tear or obsolescence III. Disposal of FixedAssets A. Discarding FixedAssets 1. If a ﬁxed asset is no longer used and has no residual value, it’s discarded a) Dr.Accumulated Depreciation - Equipment (1) Cr. Equipment 2. Selling FixedAssets: a) Dr. Depreciation Expense (1) Cr.Accumulated Depreciation 3. If sold at book value: a) Dr. Cash,Accumulated Depreciation, Loss on Sale of Equipment (1) Cr. Equipment 4. If sold below book value: a) Dr. Cash,Accumulated Depreciation, Loss on Sale of Equipment (1) Cr. Equipment 5. If sold above book value: a) Dr. Cash,Accumulated Depreciation (1) Cr. Equipment, Gain on Sale of Equipment IV. Natural Resources 1. Depletion - process of transferring the cost of natural resources to an expense account 2. Depletion Rate = Cost of Resource / Estimated Total Units of Resource a) Dr. Depletion Expense (1) Cr.Accumulated Depletion V. IntangibleAssets 1. Assets that do not exist physically, that are used in the operations of a business and not held for sale B. Patents 1. Patents - exclusive rights that government issues to inventors to produce and sell goods with one or more unique features 2. Amortization - the amount of cost to transfer to expense that is written off over the years of a patent’s expected life a) Dr.Amortization Expense (1) Patents C. Copyrights and Trademarks 1. Copyright - exclusive right issued by the federal government to publish and sell a literary, artistic, or musical composition, this may be purchased and will be recorded at the price paid for it; amortized over useful life 2. Trademark - a name, term or symbol used to identify a business and its products, can be purchased from another business and its cost is recorded as an asset; when a trademark is impaired, should be written down and recognized as a loss D. Goodwill 1. Goodwill - intangible asset of a business that is created from such favorable factors such as location, product quality, reputation, and managerial skill 2. GAAP - allow goodwill to be recorded if it is objectively determined by a transaction a) Dr. Loss from Impaired Goodwill (1) Cr. Goodwill VI. FinancialAnalysis and Interpretation: FixedAsset Turnover Ratio A. Ratio 1. FixedAsset Turnover Ratio = Net Sales /Average Book Value of FixedAssets 2. The higher the ﬁxed asset turnover, the more efﬁciently a company is using it ﬁxed assets in generating sales Chapter 11: Corporations: Organization, Stock Transitions, and Dividends I. Nature of a Corporation A. Characteristics of a Corporation 1. Corporation - legal entity, distinct and separate from individuals who own it; can acquire, own, and dispose of property in its own name and can sell stocks 2. Stocks - shares of ownership, gives corporations ability to raise large amounts of capital 3. Stockholders - those who own company’s stock and have part ownership; can buy and sell stock without affecting the corporation’s operations 4. Public corporations - shares can be traded in public markets 5. Nonpublic/Private corporations - shares cannot be traded publicly, usually owned by a small group of investors 6. Limited liability - creditors may not go beyond assets of the corporation to satisfy claims = ﬁnancial loss limited to amount invested 7. Large shareholders can control a corporation by electing a board of directors, who meet periodically to establish corporate policies; may select CEO as well 8. Because they are considered a separate identity, corporations must pay taxes (e.g. federal income taxes on income and stockholders pay tax on dividends they receive = double taxation a) Advantages: (1) Separate legal existence (2) Continuous life = exists past life of owner/indeﬁnitely (3) Can easily raise large amounts of capital (4) Ownership rights easily transferred = sell stocks (5) Limited liability = no liability for owner b) Disadvantages (1) Owner is separate from management = more closely tied to management (2) Double taxation of dividends (3) Regulatory costs B. Forming a Corporation 1. Application of incorporation 2. Charter/articles of incorporation - granted by the state once application approved II. Paid-In Capital from Issuing Stock A. Characteristics of Stock 1. Authorized shares - amount shares of stock a company is authorized to have by government charter 2. Issued shares - number of shares actually sold to stockholders 3. Outstanding shares - number of shares remaining to sell to stockholders 4. Par-value - optional dollar value assigned in stock certiﬁcate 5. No-par - stocks issued with no par B. Classes of Stock 1. Common stock - one class of stock, each share has equal rights 2. Preferred stock - one or more classes of stock that have various preference rights compared to common stockholders such as dividends 3. Cumulative preferred stock - has a right to receive regular dividends that were not declared in previous years (in arrears) C. Issuing Stock 1. Separate account is used for each class of stock issued to investors in a corporation a) Dr. Cash (1) Cr. Preferred Stock, Common Stock 2. If stock is sold at price more than par, it is sold at premium 3. If stock is sold at price less than par, it is sold at discount D. Premium on Stock 1. Dr. Cash a) Cr. (Preferred/Common) Stock, Paid-in Capital in Excess of Par—(Preferred Stock/Common) E. Discount on stock 1. Dr. Cash, Discount on (Preferred/Common) Stock a) Cr. (Preferred/Common Stock) F. No-par Stock 1. Dr. Cash a) Cr. (Preferred/Common Stock) III. Accounting for Dividends A. Cash Dividends 1. Cash dividends - cash distribution of earnings by a corporation to its shareholders, when sufﬁcient earnings and cash is available 2. Dividend announcement = Date of declaration, date of record, date of payment 3. Declaration Date: a) Dr. Cash Dividends (1) Cr. Cash Dividends Payable 4. Date of record: a) No entry 5. Date of payment: a) Dr. Cash Dividends Payable (1) Cr. Cash B. Stock Dividends 1. Stock dividend - percentage value for the distribution of shares of stock to stockholders, normally only common stock and to common stockholders 2. Record stock dividend: a) Dr. Stock Dividends (1) Cr. Stock Dividends Distributable, Paid-In Capital in Excess of Par 3. Record Issuance of stock dividend: a) Dr. Stock Dividends Distributable (1) Cr. Common Stock 4. (1 + Stock dividend %) * (# of Shares issued) = new total # of shares 5. (e.g. Stock Dividend of 4% for 1000 shares; New total issued = (100*1.04)=104 IV. Treasury Stock Transactions A. Treasury stock - stock that corporation has issued and then reacquired 1. May repurchase to provide shares for resale to employees, reissue as bonuses or to support the market price of the stock 2. Record the purchase of treasury stock a) Dr. Treasury Stock (1) Cr. Cash 3. Record the sale of treasury stock (increase in PIC): a) Dr. Cash (1) Cr. Treasury Stock, Paid-In Capital from Sale of Treasury Stock 4. Record the sale of treasury stock (decrease in PIC) a) Dr. Cash, Paid-in Capital from Sale of Treasury stock (1) Cr. Treasury Stock V. Reporting Stockholders Equity A. Stockholders Equity on the Balance Sheet 1. Reporting Retained Earnings a) Separate retained earnings statement - net income gain added, net loss subtracted b) Combined income and retained earnings statement c) Statement of stockholders’equity d) Restrictions (1) Legal - state laws may require a restriction of retained earnings (2) Contractual - corporation may enter into contracts that require restrictions of retained earnings (3) Discretionary - a corporation’s board of directors may restrict retained earnings voluntarily e) Prior PeriodAdjustments (1) Prior period adjustments - mathematical correction of a prior period’s error 2. Statement of Stockholders’Equity a) Statement of Stockholders’Equity - changes in stock and paid-in capital VI. Stock Splits 1. Stock splits - corporation reduces the par or stated value of its common stock and issues a proportionate number of additional shares (total shares determined by charter cannot be changed) 2. When market value of shares go too high, a corporation can perform a stock split (e.g. 5 for 1 split = 4 shares at $100 par would now be 20 shares at $20 par; same total par value) 3. No journal entry required (disclosed in other ﬁnancial statements) VII. FinancialAnalysis and Interpretation: Earnings per share 1. Earnings per common share (EPS) - basic earnings per share (proﬁtability) 2. EPS = (Net Income - Preferred Dividends) / (Avg. # of Common Shares Outstanding) 3. Outstanding stock is subtracted from net income (reported on income statement) 4. Numerator represents only earnings available to common stockholders Chapter 12: Long-Term Liabilities: Bonds and Notes I. Financing Corporations A. Financing Sources 1. Short-term debt = purchasing goods or services on account 2. Long-term debt = issuing bonds or notes payable 3. Equity = issuing common or preferred stock B. Bonds 1. Bond - interest-bearing note requiring periodic interest payment 2. Bondholders claim on corporate assets rank ahead of stockholders, with the face amount paid at maturity date 3. EPS = (Net Income - Preferred Dividends) / (Avg. # of Common Shares Outstanding) II. Nature of Bonds Payable A. Bond Characteristics and Terminology 1. Bond indenture - underlying contract between the company issuing bonds and the bondholders 2. Principal - face amount of individual bonds (amt. due at maturity date) 3. Types of bonds a) Term bonds - bonds all mature same date b) Serial bonds - bonds all mature at different dates c) Convertible bonds - bonds that can be exchanged for securities d) Callable bonds - bonds that corporation reserves right to redeem before maturity e) Debenture bonds - bonds issued on basis of the general credit of the corporation B. Proceeds from Issuing Bonds 1. Sources of proceeds a) Face amount of bonds - amount due at maturity date b) The interest rate c) The market rate of interest for similar bonds 2. Contract/coupon rate - interest rate to be paid on the face amount of the bond 3. Market/effective rate of interest - determined from sales and purchases of similar bonds 4. If market rate > contract rate = Sold at discount 5. If market rate = contract rate = sold at face amount 6. If market rate < contract rate = sold at premium 7. Price of bond quoted as a percentage (e.g. 98 means bond sold at 98% of fair value) III. Accounting for Bonds Payable A. Bonds Issued at FaceAmount a) Dr. Cash (1) Cr. Bonds Payable 2. Record semiannual interest payment a) Dr. Interest Expense (1) Cr. Cash b) (e.g. $100,000 * 12% * 1/2) = $6000 3. Record payment of face value at maturity a) Dr. Bonds Payable (1) Cr. Cash B. Bonds Issued at Discount 1. Dr. Cash, Discount on Bonds Payable a) Cr. Bonds Payable C. Amortizing a Bond Discount 1. Record the amortization of a bond discount: a) Dr. Interest Expense; Cr. Discount on Bonds Payable (1) When combined with a semi-annual interest payment: (a) Dr. Interest Expense i) Cr. Discount on Bonds Payable, Cash 2. Computing amortization of bond discount a) Straight-line method (1) Semi-annual amortization = Discount on bonds payable / (Term of bonds * 2) (2) (e.g. Discount on bonds over bond life = $4000, term = 5 yrs: 4000/10=400) (3) (Semi-annual amortization + Semi-annual interest expense) * (2 * term of bond)=Interest Expense over life of bond D. Bonds Issued at a Premium 1. Dr. Cash a) Cr. Bonds Payable, Premium on Bonds Payable E. Amortizing a Bond Premium 1. Record the amortization of a bond premium: a) Dr. Premium on Bonds Payable; Cr. Interest Expense (1) When combined with a semi-annual interest payment (a) Dr. Interest Expense, Premium on Bonds Payable i) Cr. Cash (2) Semi-annual amortization = Premium on bonds payable / (Term of bonds * 2) (3) (e.g. Premium on bonds over bond life = $4000, term = 5 yrs: 4000/10=400) (4) (Semi-annual interest expense - Semi-annual amortization) * (2 * term of bond)=Interest Expense over life of bond F. Bond Redemption 1. Callable bonds can be redeem by the issuing corporation within the term 2. Normally call price is above the face value 3. Carrying amount - face amount of bounds less unamortized discount/plus premium 4. Gain is recorded if the price paid for redemption is below carrying amount 5. Loss is recorded if the price paid for redemption is above carrying amount 6. Recording gain on redemption of bonds with premium: a) Dr. Bonds Payable, Premium on Bonds Payable (1) Cr. Cash, Gain on Redemption of Bonds 7. Recording loss on redemption of bonds with premium: a) Dr. Bonds Payable, Premium on Bonds Payable, Loss on Redemption of Bonds (1) Cr. Cash 8. Recording gain on redemption of bonds with discount: a) Dr. Bonds Payable (1) Cr. Discount on Bonds Payable, Gain on Redemption of Bonds, Cash 9. Recording loss on redemption of bonds with discount: a) Dr. Bonds Payable, Loss on Redemption of Bonds (1) Cr. Discount on Bonds Payable, Cash IV. Installment Notes A. Installment Note - debt that requires borrower to make equal periodic payments to lender 1. Payment of a portion of the amount initially borrowed, called principal 2. Payment of interest on the outstanding balance 3. Mortgage note - installment secured by an asset, considered collateral and can be repossessed if mortgage note not paid, and sold to pay debt (think home mortgage) B. Issuing an Installment Note 1. Dr. Cash a) Cr. Notes Payable C. Annual Payments 1. Record the issuance of the note: a) Dr. Cash (principal) (1) Cr. Notes Payable (principal) 2. Annual payment (AP) calculated using present value (will be given to you) 3. Record ﬁrst payment: a) Dr. Interest Expense (principal*interest %), Notes Payable (AP - IE) (1) Cr. Cash (annual payment) 4. Record second payment, Notes Payable a) Dr. Interest Expense ((principal-AP))*interest %), Notes Payable (AP-IE) (1) Cr. Cash (annual payment) 5. Record third payment: a) similar to last payment, continue to subtractAP from principal for every year that passes and multiply by interest % and debit that IE; NP=AP-IE; creditAP (do until ﬁnal year) V. Reporting Long-Term Liabilities 1. Bonds payable and notes payable reported as liabilities on balance sheet 2. Any portion of those due within one year are reported as a current liability 3. Any remaining bonds or notes are reported as a long-term liability 4. Any unamortized premium is reported as an addition to face amount 5. Any unamortized discount is reported as a deduction from face amount VI. FinancialAnalysis and Interpretation 1. Assets of a company are subject to claims of creditors and rights of owners 2. # times Interest Charges are Earned = (Income before tax + IE) / IE Chapter 13: Investments and Fair ValueAccounting I. Why Companies Invests A. Purposes 1. Investing in current operations 2. Investing in temporary investments to earn additional revenue 3. Investing in long-term investments in stock of other companies for strategic reasons B. Investing Cash in Current Operations 1. Use cash to pay: a) expenses b) suppliers of merchandise and other assets c) interest to creditors d) dividends to stockholders C. Investing Cash in Temporary Investments 1. Debt securities - notes and bonds that pay interest and have a ﬁxed maturity date 2. Equity securities - preferred and common stock that represent ownership 3. Investments in debt and equity securities are reported in CurrentAssets section of balance sheets 4. Objectives of investing in temporary investments a) earn interest revenue b) receive dividends c) realize gains from increases in the market price of the securities D. Investing Cash in Long-Term Investments 1. Purposes: a) Reduction of costs - combined company may be able to reduce admin expenses b) Replacement of management - purchased company mismanaged, acquiring company can allow replacement of management to improve proﬁts c) Expansion - purchasing company can expand d) Integration - may integrate operations by acquiring a supplier or customer II. Accounting for Debt Investments A. Purchase of Bonds 1. Record purchase of treasury bonds: a) Dr. Investments, Interest Receivable (1) Cr. Cash B. Interest Revenue 1. Interest revenue - amount earned from interest payment less accrued interest 2. Interest Receivable = portion of interest payment accrued from previous period 3. Pay attention to the beginning and ending of the periods and date of payment C. Sale of Bonds 1. Sale exceeds book value = gain 2. Sale less than book value = loss 3. Value of sale determined by percentage of face value 4. Record loss on sale of investment a) Dr. Cash, Loss on Sale of Investment (1) Cr. Investments—US Treasury Bonds III. Accounting for Equity Investment A. Less than 20% Ownership 1. If investors purchases less than 20% of outstanding stock of investee, no control over investee; Use Cost method 2. Purchase of Stock a) Dr. Investments—(Company) (1) Cr. Cash [(# of shares * cost)+brokerage fee] 3. Receipt of Dividends a) Dr. Cash (1) Cr. Dividend Revenue (# of shares * dividend $ per share) 4. Sale of Stock a) Gain = proceeds exceed book value b) Loss = proceeds less than book value c) Subtract brokerage fee from sale d) Record gain on sale (1) Dr. Cash (a) Cr. Gain on Sale of Investments, Investments e) Record loss on sale (1) Dr. Cash, Loss on Sale of Investments (a) Cr. Investments B. Between 20%-50% Ownership 1. If investors purchases between 20% and 50% of outstanding stock of investee, signiﬁcant inﬂuence over investee; Use Equity method 2. Purchase of Stock a) Record purchase (1) Dr. Investment (a) Cr. Cash 3. Recording Investee Net Income a) Dr. Investment (1) Cr. Income (% ownership * net income of corporation) 4. Recording Investee Dividends a) Dr. Cash (1) Cr. Investment (Investee Net Income * % ownership) 5. Recording % of Corporation net income and dividends increases investment account by (Net income of investee - % of cash dividends) 6. Sale of Stock a) Record gain: (1) Dr. Cash (a) Cr. Investment, Gain on Sale b) Record loss: (1) Dr. Cash, Loss on Sale (a) Cr. Investment C. More than 50% ownership 1. If investors purchase more than 50% of outstanding stock of investee, control over investee; Use Cost method 2. This is considered a business combination 3. Corporation owning majority of voting stock is parent company to its subsidiary 4. Financial statements of both companies are combined to form consolidated ﬁnancial statements IV. Valuing and Reporting Investments A. Trading Securities 1. Trading Securities - debt and equity securities purchased to earn short0term proﬁts from changes in their market prices (change in income statement) 2. Fair value - market price that company would receive for a security if it were sold 3. Unrealized gain or loss - change in the fair value of portfolio 4. Adjusting entry to record gain in fair value of portfolio: a) Dr. ValuationAllowance for Trading Investments (1) Cr. Unrealized Gain on Trading Investments 5. Adjusting entry to record loss in fair value of portfolio: a) Dr. Unrealized Loss on Trading Investments (1) Cr. ValuationAllowance for Trading Investments B. Available-for-Sale Securities 1. Available-for-Sale Securities - debt and equity securities not held to maturity or for trading (included in balance sheet) 2. Adjusting entry to record gain in fair value ofAFS a) Dr. ValuationAllowance forAvailable-for-Sale Investments (1) Cr. Unrealized Gain (Loss) onAvailable-for-Sale Investments b) Credit balance in Unrealized Gain (Loss) onAvailable-for-Sale Investments is added to stockholders equity, while debit balance is subtracted C. Held-to-Maturity Securities 1. Held-to-Maturity Securities are debt investments such as notes or bonds that companies hold until maturity; purchased to earn interest revenue 2. Recorded at cost for a premium or discount; amortized over life of bonds 3. Reported on balance sheets V. Fair ValueAccounting A. Fair value - price that would be received to sell an asset or pay off a liability 1. follows GAAP 2. Purchase price = historical cost allocated to income over useful life thru depreciation B. Effect of Fair ValueAccounting on Financial Statements 1. Balance Sheet a) When asset or liability is reported at fair value, difference recorded in Valuation account 2. Income Statement a) Unrealized gain or loss reported on income statement VI. FinancialAnalysis and Interpretation: Dividend Yield 1. Dividend yield measures rate of return to stockholders based on cash dividends 2. Dividend Yield = Dividends per share of common stock/Market Price per share of Common Stock Chapter 14: Statement of Cash Flows I. Reporting Cash Flows A. Cash Flows 1. Statement of Cash Flows - reports company’s inﬂows and outﬂows for a period a) Purposes (1) Generate cash from operations (2) Maintain and expand its operating capacity (3) Meet its ﬁnancial obligations (4) Pay dividends b) Types of cash ﬂow activities (1) Cash ﬂows from operating activities - transactions that affect net income (2) Cash ﬂows from investing activities - transactions that affect investments in noncurrent assets (3) Cash ﬂows from ﬁnancing activities - transactions that affect the debt and equity of the company B. Cash Flows from OperatingActivities 1. Methods of reporting cash ﬂows a) Direct method - reports operating cash inﬂows and cash outﬂows from cash receipts and payments b) Indirect method - reports operating activities by beginning with net income and adjusting it for revenues and expenses that don't involve receipt and payment of cash C. Cash Flows from InvestingActivities 1. Show cash inﬂows and outﬂows related to changes in a company’s long-term assets 2. Reported as follows: a) Cash inﬂows from investing activities $XXX b) Less cash used for investing activities XXX (1) Net cash ﬂows from investing activities $XXX 3. Cash inﬂows normally come from selling ﬁxed assets, investments and intangible assets 4. Cash outﬂows normally include payments to purchase ﬁxed assets, investments, and intangible assets D. Cash Flows from FinancingActivities 1. Cash ﬂows from ﬁnancing activities show the cash inﬂows and outﬂows related to changes in a company’s long-term liabilities and stockholders’equity 2. Reported same as investing activities (replace with ﬁnancing activities) E. Non cash Investing and FinancingActivities 1. Acompany may enter into transactions involving investing and ﬁnancing activities that do not directly affect cash (e.g. issuing common stock to retire long-term debt) 2. Does not directly affect cash but eliminates future cash payments for interest F. No Cash Flow per Share 1. Cash ﬂow per share - reported in ﬁnancial press - normally computed as cash ﬂow from operations per share; not reported in statement of cash ﬂows II. Statement of Cash Flows—Indirect Method A. Indirect Method (think t-accounts) 1. Analyzing changes in non cash balance sheet accounts, any change in cash account can be indirectly determined a) Assets = Liabilities + Stockholders’Equity b) Cash + NoncashAssets = Liabilities + Stockholders’Equity c) Cash = Liabilities + Stockholders’Equity - NoncashAssets d) Change in Cash = Change in Liabilities + Change in SE - Change in N-CAssets B. Retained Earnings 1. Net income - Cash dividends = Retained Earnings C. Adjustments to Net Income 1. Expenses that do not affect cash are added; decrease net income but do not involve cash payments so are added 2. Losses on disposal of assets are added and gains on disposal are deducted a) disposal (sale) of assets is an investing activity not operating; reported in net income 3. Changes in current operating assets and liabilities are added or deducted as follows: a) Increases in non cash current operating assets are deducted b) Decreases in non cash current operating assets are added c) Increases in current operating liabilities are added d) Decreases in current operating liabilities are deducted D. Dividends 1. T-Accounts: a) Dividends Payable 2. Reported in ﬁnancing activities section as: a) Cash paid for dividends E. Common Stock 1. T-Accounts: a) Common Stock b) Paid-in Capital in Excess of Par—Common Stock 2. Reported in ﬁnancing activities section as: a) Cash received from sale of common stock F. Bonds Payable 1. T-Accounts: a) Bonds Payable 2. Reported in ﬁnancing activities section as: a) Cash paid to retire bonds payable G. Building 1. T-Accounts: a) Building b) Accumulated Depreciation—Building 2. Reported in investing activities section as: a) Cash paid for purchase of building H. Land 1. T-Accounts: a) Land 2. Reported in cash ﬂows from investing activities as: a) Cash received from sale of land III. Statement of Cash Flows—The Direct Method A. Cash Received from Customers 1. Sales (reported on income statement) a) Add a decrease inAccounts Receivable b) Subtract an increase inAccounts Receivable B. Cash Payments for Merchandise 1. Cost of Goods Sold (reported on income statement) a) Add an increase in Inventories b) Subtract a decrease in Inventories c) Add a decrease inAccounts Payable d) Subtract an increase inAccounts Payable C. Cash Payments for Operating Expenses 1. Operating Expenses other than depreciation (reported on income statement) a) Add a decrease in accrued expenses payable b) Subtract an increase in accrued expenses payable D. Gain on Sale of Land 1. Proceeds from sale reported as part of cash ﬂows from investing activities E. Interest Expense 1. Interest Expense (reported on income statement) a) Add a decrease in interest payable b) Subtract a decrease in interest payable F. Cash Payments for Income Taxes 1. Income tax expense (reported on income statement) a) Add a decrease in income tax payable b) Subtract an increase in income tax payable
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