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tala rafii

tala rafii

Description

School: Tulane University
Department: Business
Course: Financial Accounting
Professor: Christine smith
Term: Summer 2015
Tags: InternalControls, Fraud, cashflows, StockholdersEquity, stock, commonstock, and Preferredstock
Cost: 50
Name: Study Guide -Midterm3
Description: Study Guide covering Chapters 7, 12 and 11. Includes notes from the textbook and from class.
Uploaded: 12/04/2016
48 Pages 180 Views 4 Unlocks
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2) What was the cash used for?




1) Where did the cash come from?




???? What is the difference between fraud and theft?



Bold: key word Green: definition Red: formula Blue: question Blue: to remember Yellow: important ????: Therefore, in consequence Chapter 7 Fraud, Internal Control, and Cash ???? What is the difference between fraud and theft? Fraud= dishonest act by employee that results in personal benefit to the employee at  a cost to the employer. Key distinctiWe also discuss several other topics like vygotsky parenting styles
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on: in fraud, there’s an attempt to cover it up through an alteration of  records. In the past decade, there has been a significant amount of financial fraud???? users  suffered greatly due to false information. All of these years, companies were self-regulated. However, a new regulation was put  in place to reduce or stop fraud: Sarbanes-Oxley Act. SOX did 2 things: 1) Required that publicly traded companies’ managers put in place a system of  internal control over financial reporting.  The CFO and COO of the company are required to sign, “we attest to the  correctness of this material” ???? they are accountable. 2) As in the public accounting profession, accountants now have to evaluate the  system of control in the company and say whether it’s efficient or not.  Most popular explanation for fraud: Internal Control Internal control= a process designed to provide reasonable assurance regarding the  achievement of company objectives related to operations, reporting, and compliance.  Objectives: 1. Safeguard assets Example: a physical inventory safeguard, surveillance cameras, insurance. 2. Enhance reliability of accounting records.  Access controls to accounting records (ex: passwords, user ID) to make sure  that only personnel has access. 3. Increase of operations. 4. Ensure compliance with laws and regulations. The 5 primary internal control components: 1. A control environment 2. Risk assessment 3. Control activities 4. Information and communication 5. Monitoring Segregation of Duties Custody Authorizing Record Keeping Technology ???? In an ideally established internal control environment, the employee responsible  for custody of asset is not the same responsible for authorizing, not the same  recording, not the same setting up the technological parameters related to the asset ???? segregation of duties. In reality, most businesses do not have an ideal segregation of duties, because it’s  cost-prohibitive. ???? In environments lacking segregation of duties, they should have  mitigating controls= a way that management can control what’s going on in an asset  to reduce risks of fraud. The 6 Principles of Internal Control Activities: o Establishment of responsibility: control is most effective when only one  person is responsible for a given task. o Segregation of duties: 2 common applications: - Different individuals should be responsible for related activities - The responsibility for recordkeeping for an asset should be separate from  the physical custody of the asset. o Documentation procedures: companies should use pre-numbered documents,  and all documents should be accounted for. o Physical controls: relate to safeguarding of assets. o Independent internal verification: involves the review of date prepared by  employees.- Companies should verify records periodically or on a surprise basis. - An employee who is independent of the personnel responsible for the  information should make the verification. - Discrepancies and exceptions should be reported to a management level  that can take appropriate corrective action. o Human resource controls: - Bond employees who hand cash. - Rotate employees’ duties and require employees to take vacations. - Conduct thorough background check. Bank Reconciliation Bank reconciliation= the process of comparing the bank’s cash balance with the  company’s balance, and explaining the difference to make them agree. The bank has physical custody of the cash, which is good control. In general, there’s a difference between the General Ledger Cash balance, and the  bank balance. This is for example due to accrued interest, outstanding checks, etc. We can categorize differences between Bank and General Ledger: 1. Deposits in Transit 2. Outstanding Checks???? example: we increase our Cash account when we  present the check, but money is not withdrawn until 3 months later. ???? Both are timing differences. 3. Errors. Made by record-keepers or bank. 4. Bank memorandums: when interest is posted into our account, it’s reflected  in our Bank Statement but not our General Ledger, until we make an adjusting  entry.  Example: We get a Cash Balance of $13,870. However, the Bank Statement shows a balance of $14,556. ???? We have to perform a bank reconciliation= a control of cash we perform to ensure there is no fraudulent  activity going on with cash.  Sandler Corporation Bank Reconciliation As at April 30 Balance per Bank  04/30 $14,556 Balance per G/L  04/30 $13,870 Add: Deposits in Transit 1,425 A)Error in check1#811 <54> Less: Outstanding  Checks2 B)Interest Earned 60 #797 450 C) NSF Check <500>                                                         1 We have to create an adjusting entry. 2 It’s a timing difference. We will not change the G/L account. All these checks have  already been credited in the G/L.#812 948 D) Service Charge <40> #815 372 #816 875 <2,645> New Balance $13,336 New Balance $13,336 Check #811: 326-272= 54 ???? to align Bank balance with G/L balance, we make the  following entry: Debit Credit DeliveryVanExpense 272  Cash 272 We need to subtract 54 from Cash, therefore, we make the following entry: Debit Credit DeliveryVanExp 54  Cash 54Chapter 12 Statement of Cash Flows Usefulness of the Statement of Cash Flows: Purpose of the Statement: Answer 3 questions:  1) Where did the cash come from? 2) What was the cash used for? 3) What was the change in the cash balance? ???? It fills in the details about how and why cash changed. It reports the cash receipts and payments from operating, investing, and financing  activities during a period. The information in a Statement of Cash Flows helps investors, creditors, and others  assess the following: o The entity’s ability to generate future cash flows. o The entity’s ability to pay dividends and meet obligations. o The reasons for the difference between net income and net cash provided  (used) by operating activities. o The cash investing and financing transactions during the period.  Content and Format: 3 different activities: 1. Operating 2. Investing 3. Financing Cash flow from Operations: • High amount ???? company able to generate sufficient cash to pay its bills,  purchase necessary materials for ongoing operations. • Low amount ???? company may have to borrow or issue equity security to pay  bills. Cash enables us to continue to operate. However, if we’re producing a low amount of  cash from our operations, we will have to:  • Borrow funds from a financial institution or • Sell stock. ???? However, no one will be interested in buying stock from us.  The information to prepare this statement usually comes from 3 sources:  1. Comparative Balance Sheets 2. Current Income statement. 3. Additional information. Preparing the Statement of Cash Flows involves 3 steps: 1) Determine net cash provided/used by operating activities by converting net  income from an accrual basis to a cash basis.  2) Analyze changes in non-current asset and liability accounts and record as  investing and financing activities, or disclose as non-cash transaction.3) Compare the net change in cash on the Statement of Cash Flows with the  change in the Cash account reported on the Balance Sheet to make sure the  amounts agree.  Statement of Cash Flows Cash Flows from operating activities $ XXX Cash Flows form investing activities XXX Cash Flows from financing activities XXX Net increase in Cash $ XXX Comments: • If the activity goes into the determination of net income, it’s an operating  activity. • Financing activities: they involve activities with non-trade creditors and  owners. Example of cash inflow: company sells stock. Example of cash  outflow: drawing/company pays cash dividends.  Preparation: GAAP let’s us choose between 2 methods to calculate the cash flows of the  Operating Activities Section.  Operating Cash Receipts  <Operating Cash Disbursements> Net Cash Flows from Operating Activities This method requires us to go to our Cash account in the General Ledger and  check/identify every single operating activity. ???? In the real world, using this  method is impractical.  Our goal is to identify cash flows generated by operations. We will start with a  measure of success we already have: the Net Income.  However, Net Income is NOT cash, because we used the accrual basis of  accounting. We start with Net Income, and make a series of adjustments to arrive to Net Cash  provided by Operating Activities. ???? much easier method to calculate the  operating section.  Net Income +Non-cash charges to Expense  –Non-cash credits to Revenue  Net Cash provided by operating activities Comments: Depreciation expense is a non-cash expense that appears on Income Statement.  Midwest Beverage Company Statement of Cash Flows As at October 31, 2016 Operating Activities: We will use the indirect method/reconciliation method. • The increase in $10,000 in Accounts Receivable had nothing to do with cash,  but it increased Net Income. ???? It increased Revenue by $10,000. • The $5,000 Accounts Payable increase leads to a decrease in Net Income. ???? When calculating cash flows, we add back $5,000. • There is a $4,000 depreciation expense. However, this transaction does not  involve cash ???? we add back $40,000.We can’t conclude whether or not $75,000 from operations is good or not. We need to  compare: to previous months, competitors, industry, benchmarks, etc. Investing Activities: Purchase of equipment for $8,000 ???? cash outflow ???? we represent it as negative.  Financing Activities: Proceeds from notes payable: $20,000 ???? cash inflow. Dividends paid: $5,000 ???? cash outflow. ???? At the end, we add up the net cash flows from each of the 3 buckets, and we get:  what was the change in cash during the period. Our change in cash on our cash flows should equal our ending Cash balance in our  General Ledger/Balance Sheet. See Handout E5-14 Dividends of 23,000 were declared/accrued ???? it is NOT a cash transaction. ???? Non-cash transactions are represented in a separate footnote in the back of the  financial statements. With this limited information, we will make the Statement of Cash Flows. We will use the indirect method/reconciliation method to do the Operating Activities  section.  The Statement of Cash Flows answers these questions: ⮚ Where did the cash come form? ⮚ Where did it go? ⮚ What was the net change? We can know it by comparing 2 consecutive  Balance Sheets (and looking at the Cash account in specific).Constantine Inc. Statement of Cash Flows For the year ended December 31st, 2016 Cash Flows from Operating Activities  Net Income $44,000  Adjustments to reconcile Net Income to cash provided by/used in operating  activities:  Depreciation Expense3 $6,000  Increase in Accounts Receivable <3,000>  Increase in Accounts Payable 5,000  8,000 Cash provided by operating activities $52,000 Equipment 22,000 17,000 39,000 Comments:  Accumulated Depreciation11,000 6,000 17,000 - When we credit Accumulated Depreciation for 6,000, we debit Depreciation  Expense for 6,000. - Since we did not sell/dispose of equipment during the period, we know for sure that  Equipment was not credited and Accumulated Depreciation was not debited. Debit Credit Accounts Receivable 3,000  Revenue 3,000 Debit Credit Asset/Expense 5,000  Accounts Payable 5,000                                                         3 We started with 11,000 and ended with 17,000???? 6,000. Cash Flows from Investing Activities4  Purchase of Equipment $<17,000> Cash Flows from Financing Activities  Issuance of Common Stock $20,000  Payment of Cash Dividends <23,000> Cash flows used in financing activities $<3,000>  Net increase in Cash 32,000 ???? we will add this  amount to our beginning cash balance  Cash at the beginning of the year 13,000  Cash at the end of the year $ 45,0005                                                         4 Involves the purchase or sale of long-term operational assets. 5 It equals the Cash account in our General Ledger and Balance Sheet.All the financial statements are related: Income  Statement Stockholder's  Equity Balance Sheet Statement of Cash  Flows Revenue Beginning Balance Assets +-Operating <Expense> +Net Income = +- Investing Net Income <Draw/Dividends> Liablities +- Financing +Owner's  Ending Balance Equity Increase/Decrease Cash +Beginning Balance Ending balance6 When we have a sale of an equipment, we deal with the proceed in the Investing  Activities section, but we deal with the gain or loss in the Operating Activities  Section.                                                         6 We have the same Cash amount as in the Balance Sheet.Chapter 11 Stockholder’s Equity Equity= ownership interest in the company. It is the excess of assets as compared to  liabilities.  Assets –Liabilities = Owner’s Equity Net Assets = Owner’s Equity Depending on how an entity forms itself (sole proprietorship, partnership,  corporation), it is going to dictate the name and numbers of Owner’s Equity.  In a sole proprietorship, there are 2 owners accounts: Owner Capital account and  Drawing account. Before we get to the accounting, we need to talk about the attributes related to the  corporate form of business: • Corporation: Advantages:  - Limited liability ???? the owner’s liability is the amount they invested. Worse  case scenario: market value of that stock goes to 0. Ex: if I put $10,000 in the  company, it becomes 0 ???? this brings up a broad range of potential investors  ???? it’s easier for a corporation to accumulate capital.  - The transfer of ownership interest. - It is a separate legal entity: it can sue and be sued ???? it’s subject to many  regulatory agencies. Disadvantages: - Owners have much less control. - Increased exposure to governmental regulations. Ex: double taxation ???? they  tax the earnings AND the owners’ dividend income.  Income Statement Owner's Equity Revenue Dividend  Checks to  <COGS> Gross Profit Operating Expense Operating Income +- Non Operating  Act Income before tax <Income tax  expense> Net Incomeowners: Dividend  Income <Income  Taxes> Assets –Liabilities = Equity ???? Net Assets7 = Equity Equity=Net Assets=Stockholders’ Equity = Owners’ Equity ???? Synonyms Comments: There are 2 types of owners’ claims against the assets: Earned Capital and  Contributed Capital.  At a minimum, a company will have Common Stock ???? a designated number of  corporate share. Every corporation must have a class of common stock, but they don’t need to have  preferred stock.  Common Stock Common stock represents the most common type of stock issues by companies and  entitles shareholders to participate in the profit and growth of the company they invest  in. When looking at investing in the stock market for the most part you are buying  common shares in a company. The two main income drivers for common stock are that they deliver appreciation (through growth in value of the company) and through dividends paid out of the  company to shareholders. Dividend payments can change over time so predicting cash  flows through common stock holdings can be difficult. Common stock holders are typically allowed to vote on issues like electing the board  of directors or other issues put to a vote. This is not always the case, however, so it  may be important to refer to the specific features of a class of shares you are investing  in.                                                         7 We say Net Assets because we assume that Assets>Liabilities.Holding common stock also comes with ‘pre-emptive rights' to maintain the same  proportion of ownership should a company issue a new stock offering. This means  that holding common stock will entitle you to pre-emptively buy new shares should  the company be completing an issuance. Preferred Stock Preferred stock often does not have voting rights and do not provide an ability to  participate in the appreciation in the value of the company. Often, they come with  specific payment terms that take precedence over common stock, with say a set  dividend being paid out monthly, quarterly, or annually. Preferred stockholders typically have first access when it comes to dividends and also  in a bankruptcy situation, where after creditors are paid preferred stockholders will be  compensated before common shareholders. Preferred stock can also have set  redemption terms, where a holder can have them redeemed at a favorable price for  either cash or sometimes even common shares. Common Stock vs. Preferred Shares Often the decision between investing in common shares vs. preferred stock comes  down to a risk and reward relationship. Common stock is riskier, you may lose it all,  but often provides a better chance to participate in the growth of a successful  company. Preferred stock come with less risk (assuming they have preference rights  over common shares) but come with set dividend and repayment terms. Ultimately the  choice comes down to weighing the risks and what your opinion is on the future of  the company being considered. Par value= the face value of a bond. Par value for a share refers to the stock value  stated in the corporate charter.  Par is not informative as to what the current market price is. If a company has a par or  stated value associated with its Common Stock or Preferred Stock, that does not equal  its market value.  Additional paid-in capital: the extent to which market value exceeds par/stated  value. In a sole proprietorship or partnership, Net Income went straight to the Capital  account.  In a corporation, we put Net Income in Retained Earnings.  Example: Assume R Corporation issues 19,000 shares of Common Stock for  $152,000. ???? Market Price per share = 152,000/19,000 = $8/share. First, we need to know if these shares have a par/stated value. Scenario 1: Assume that each share has a $2 par value: Debit Credit Cash 152,000  Common Stock, $2 par 38,000 (19,000 x 2) Additional Paid-In Capital, Common Stock 114,000 (152,000- 38,000) or (19 x 6,000) Scenario 2: Stated value of $5.  Debit Credit Cash 152,000  Common Stock, $2 par 95,000 (19,000 x 5)  Additional Paid-In Capital, Common Stock 57,000 (19 x 3,000) Scenario 3: $0 par or stated value. Debit Credit Cash 152,000  Common Stock 152,000 In a private company, it happens to exchange ownership shares for land or buildings.  Scenario:  R Corporation issues 5,000 shares of $10 par Common Stock in exchange for:  Land 35,000 Building 70,000 Increase in Assets 105,000 5k x $10 par CS 50,000 APIC, CS 55,000 Journal Entries: Debit Credit Land 35,000 Building 70,000  CS, $10 par 50,000  APIC, CS 55,000 We were talking about the 2 different types of capital (contributed capital and earned  capital). When owners withdraw money (pay dividends) ???? Assets decrease, and Owner’s  Equity simultaneously decreases:  Assets = Liabilities + Owner’s Equity There are 2 ways owners see returns in their investment: 1) Through dividends 2) Through capital gain (if the value of the company’s shares appreciates)Return on Investment Via Dividends There are 3 types of dividends: 1. Cash ???? most common form. 2. Property: less frequent and can only occur in a private company. 3. Stock: a company can issue a stock dividend= give the stockholder more  stock.-0 GAAP requires companies to disclose ownership interests (there are 2 types of shares:  common or preferred). The Number of Shares ???? When does a company establish the number of shares in total that it has? When it  is incorporated.  The company will choose how many shares are authorized, if there is a par value, if  the shares are common or preferred. We have to distinguish between the following 3: 1. Authorized shares –in the charter 2. Issued shares: shares sold 3. Outstanding shares8: shares still owners by outside owners Issued shares – Outstanding shares = Treasury Stock Treasury stock= when the company goes to the market and buys the shares it had  sold.  ???? Who chooses to give out dividends? The Board of Directors: only they can decide  to declare and pay dividends. When they do that, 3 dates are important: 1) Declaration date: the board meets, votes on a resolution: (for example) they  obligate the company to pay a $2/share dividend ???? Accountants will have to  record a Dividends Payable entry (Credit) and Cash Dividends (Debit).  2) Date of record: during the declaration date, the board says “We will pay  shareholders as of ”. Example: if you were a shareholder as of July 1, you get  a dividend on July 31.  3) Payment date: accounts make an entry: Dividends Payable (Debit) and Cash  (Credit).  In-Class Problem 1: Uzi Company received a charter granting the right to issue 200,000 shares of $1 par  value common stock and 10,000 shares of $50 par value preferred stock. 2013 Feb 19 Issued 45,000 shares of common stock at par for cash. 22 Gave the corporation’s promoters 30,000 shares of common stock for  their services in getting the corporation organized. The directors  valued the services at $50,000.                                                         8 Shares still owned by stockholders in the market. Mar 30 Exchanged 100,000 shares of common stock for the following assets at fair market values: land, $25,000; building, $100,000; and machinery, $125,000. Dec 31 Closed the Income Summary account. A $25,000 loss was incurred. 2014 Jan 12 Issued 1,000 shares of preferred stock at $75 per share. Dec 15 The board of directors declared an 8% dividend on preferred shares and $0.10 per share on outstanding common shares, payable on January 31 to the January 17 stockholders of record. Dec 31 Closed the Income Summary. A $69,000 net income was earned. 2015 Jan 31 Paid the previously declared dividends. Journal Entries: Trans.  Date 19- Num Account Debit Credit Feb 1 Cash 45,000  Common Stock, $1par 45,000 ???? There is no Additional Paid-In Capital account because we issued/sold the stock  at par.  Trans.  Date 22- Num Account Debit Credit Feb 2 Organizational Expense 50,000  Common Stock, $1par 30,000  APIC9, CS10 20,000 ???? We are issuing ownership shares. Instead of paying the bill, the company offers  ownership interest in the company. ???? Because we have an APIC, it’s as if we were issuing these shares not at $1/share  but more.  Trans.  Date 30- Num Account Debit Credit Mar 3 Land 25,000                                                         9 Additional Paid-In Capital 10 Common StockBuilding 100,000 Machinery 125,000  Common Stock, $1par 100,000  APIC, CS 150,000 ???? We see that the price market exceeds par value by $150,000. Trans.  Date 31- Num Account Debit Credit Dec 4 Retained Earnings 25,000  Income Summary 25,000 ???? GAAP makes corporations distinguish between contributed and earned capital.  ???? By debiting Retained Earnings ???? Owner’s Equity (owner’s claims against the  assets) decreases. Trans.  Date Num Account Debit Credit 12-Jan 5 Cash 75,000  Preferred Stock, $50 par 50,000  APIC, PS 25,000 Trans.  Date 15- Num Account Debit Credit Dec 6 Retained Earnings 21,500  CS, Dividends Payable 17,500  PS, Dividends Payable 4,000 ???? To get these numbers, we did:  Common Stock = 175,000 (here, outstanding shares = issued shares) 175,000 x 0.10 = 17,500 Total par value of our Preferred Stock = 50,000 x 8% = 4,000Date 31- Trans.  Num Account Debit Credit Dec 7 Income Summary 69,000  Retained Earnings 69,000 Now, we prepare our financial statements because it’s the end of the year.  Uzi Corporation Balance Sheet As of 12/31/14 ASSETS LIABILITIES STOCKHOLDER’S EQUITY 8% Preferred stock, $50 par $ 50,000 100,000 shares authorized, 1,000 shares 25,000 issued and outstanding11 APIC, Preferred Stock 175,000 Common Stock, $1 par 200,000 shares authorized, 175,000 shares  issued and outstanding APIC, Common Stock 170,000  Total Paid-In Capital 420,000 Retained Earnings 22,500  Total Stockholder’s Equity 442,50012 Treasury Stock Reminder:  There are 2 types of capital: • Earned capital • Contributed/donated/paid-in capital ???? arises when potential investors  purchase ownership interest (stock). In a corporation, contributed capital is split in 2 different accounts: ▪ Ownership interest at par ▪ Additional amount paid ???? this happens when there’s a stated or par value on  stock and with the market price exceeding that value.  Earned capital is in the Statement of Stockholders’ Equity as Retained Earnings.                                                          11 Because we have no treasury shares 12 We do not double underline because we will add to Total Liabilities.We measure success via Net Income, at the end of the period, we dump it into our  capital (Retained Earnings) account. Stockholders’ Equity has one more account called Treasury Stock. Treasury shares= shares purchased by the company and held in the treasury for  some future purpose.  GAAP requires the company to declare 3 numbers related to shares: 1. Authorized shares: total number of share that the company could sell ???? found  in the charter. 2. Issued shares: number of shares the company sold since the beginning. 3. Outstanding shares: the number of shares owned right now by owners. Issued shares – Outstanding shares = Treasury shares ???? When the number of shares outstanding decreases, the number of treasury shares  automatically increases.  ???? Why would a company buy Treasury shares?  ⮚ If it thinks it’s undervalued. ⮚ To prevent a hostile takeover. Under GAAP, companies use the Cost Method ???? treasury shares are measured at the  price we paid for them. In-Class Problem 2 The difference between this exercise and the previous one: in the previous one, we  were beginning a business. If shares issued = shares outstanding ???? there are no treasury shares. When doing the General Ledger, we must establish the beginning balances first. We  know for sure that Assets = Liabilities + Stockholders’ Equity ???? we can therefore  deduct the Asset balance, the Cash balance to be more precise. In fact, if we assume  that Liabilities =0, we have total Liabilities + Stockholders’ Equity= 920,000. ???? thus, the beginning Cash balance is 920,000. We have to add these in the General  Ledger before adding the new entries. 1) Journal Entries Trans.  Date Num Account Debit Credit 6-Jun 1 Treasury Stock, CS13 40,000  Cash 40,000                                                         13 We have to distinguish Common Stock treasury shares and Preferred Stock treasury  shares.???? We Debit a contra-equity account called Treasury Stock ???? owner’s claims against  the assets decrease, and assets decrease.  ???? Now, number of shares outstanding= 24,000-1,000= 23,000 Trans.  Date Num Account Debit Credit 23-Jun 2 Retained Earnings 11,500  CS, Dividends Payable 11,500 ???? 23,000 x $0.50/share = 11,500 ???? CS, Dividends Payable is a current obligation. Trans.  Date Num Account Debit Credit 25-Jul 3 CS, Dividends Payable 11,500  Cash 11,500 10-Aug 4 Cash 22,500  Treasury Stock, CS  (500x40)14 20,000  APIC, Treasury Stock  (500x5) 2,500 ???? Now, we have 23,500 shares outstanding. Trans.  Date Num Account Debit Credit 20-Oct 5 Cash 12,000 APIC, Treasury Stock15 2,500 Retained Earnings 1,500  Treasury Stock, CS(400x40) 16,000 ???? The company sells treasury shares for $10/share less than what it cot us to buy it  ???? it really needs the cash.  ???? Treasury Stock goes in at cost and out at cost.  ???? We have a decrease in Owner’s Equity of $4,000. Trans.  Date Num Account Debit Credit 15-Dec 6 Retained Earnings 11,950  CS, Dividends Payable 11,950 ???? Calculate the declared dividend: $0.50/share x number of shares outstanding =  0.50 x 23,900 = 11,950                                                         14 We Credit the Treasury Stock at cost ???? this is why cost acts like par. 15 Because there’s already a balance in APIC, TS we can Debit it ???? the remaining  Debit will be to decrease Retained Earnings.Date Trans.  Num Account Debit Credit 31-Dec 7 Income Summary 60,000  Retained Earnings 60,000 ???? Step 1: close all our Revenue accounts ???? we Debit them. ???? Step 2: close all our Expense accounts ???? we Credit them. ???? We hope that Income Summary has a Credit Balance ???? Revenue > Expense. 2) Now, we’re ready to prepare our financial statements: Austin Corporation Retained Earnings Statement For the year ended December 31, 2013 Retained Earnings January 1, 2013 $ 230,000 Plus: Net income 60,000 Less: Common Stock Dividends Declared 23,450 Less: Treasury shares sold below cost 1,500 Retained Earnings December 31, 2013 $ 265,030 ???? This is the bridge statement, because it connects the Net Income Statement and the  Balance Sheet. It shows the change in retained earnings from the beginning of the year to the end of  the year ???? it’s the cumulative effect of the company running the business.  3)  Austin Corporation Balance Sheet December 31, 2013 STOCKHOLDERS’ EQUITY  Common Stock, $25 par, 30,000 shares authorized, $ 600,000  24,000 issued, 23,900 outstanding.  Additional Paid-In Capital, Common Stock 90,000  Total Paid-In Capital 690,000  Retained Earnings 265,050  Treasury shares at Cost, 100 shares <4,000>  Total Stockholders’ Equity 951,050 Earnings Per Share = (Net Income – Preferred Dividends) / Weighted Average  number of Common Stock outstanding Stock Splits We had talked about 3 types of dividends: cash, equipment, stock.  However, stock splits are another way for owners to own more stock. ???? We do not  have to make an entry to record a stock split. In a 2 for 1 stock split: - The par value of the shares is cut in half.  - The number of shares outstanding is doubled.  If the par value of a company is at a very high price, the company makes a stock split  to reduce the price and entice owners to buy stock. ???? For most of the investing public, they get excited about stock splits, but in an  accounting point of view, it changes nothing. ???? We don’t make a journal entry for stock split, but we need to make a note in our  chart of accounts and change the par value and indicate the new number of Common  Stock. Bold: key word Green: definition Red: formula Blue: question Blue: to remember Yellow: important ????: Therefore, in consequence Chapter 7 Fraud, Internal Control, and Cash ???? What is the difference between fraud and theft? Fraud= dishonest act by employee that results in personal benefit to the employee at  a cost to the employer. Key distinction: in fraud, there’s an attempt to cover it up through an alteration of  records. In the past decade, there has been a significant amount of financial fraud???? users  suffered greatly due to false information. All of these years, companies were self-regulated. However, a new regulation was put  in place to reduce or stop fraud: Sarbanes-Oxley Act. SOX did 2 things: 1) Required that publicly traded companies’ managers put in place a system of  internal control over financial reporting.  The CFO and COO of the company are required to sign, “we attest to the  correctness of this material” ???? they are accountable. 2) As in the public accounting profession, accountants now have to evaluate the  system of control in the company and say whether it’s efficient or not.  Most popular explanation for fraud: Internal Control Internal control= a process designed to provide reasonable assurance regarding the  achievement of company objectives related to operations, reporting, and compliance.  Objectives: 1. Safeguard assets Example: a physical inventory safeguard, surveillance cameras, insurance. 2. Enhance reliability of accounting records.  Access controls to accounting records (ex: passwords, user ID) to make sure  that only personnel has access. 3. Increase of operations. 4. Ensure compliance with laws and regulations. The 5 primary internal control components: 1. A control environment 2. Risk assessment 3. Control activities 4. Information and communication 5. Monitoring Segregation of Duties Custody Authorizing Record Keeping Technology ???? In an ideally established internal control environment, the employee responsible  for custody of asset is not the same responsible for authorizing, not the same  recording, not the same setting up the technological parameters related to the asset ???? segregation of duties. In reality, most businesses do not have an ideal segregation of duties, because it’s  cost-prohibitive. ???? In environments lacking segregation of duties, they should have  mitigating controls= a way that management can control what’s going on in an asset  to reduce risks of fraud. The 6 Principles of Internal Control Activities: o Establishment of responsibility: control is most effective when only one  person is responsible for a given task. o Segregation of duties: 2 common applications: - Different individuals should be responsible for related activities - The responsibility for recordkeeping for an asset should be separate from  the physical custody of the asset. o Documentation procedures: companies should use pre-numbered documents,  and all documents should be accounted for. o Physical controls: relate to safeguarding of assets. o Independent internal verification: involves the review of date prepared by  employees.- Companies should verify records periodically or on a surprise basis. - An employee who is independent of the personnel responsible for the  information should make the verification. - Discrepancies and exceptions should be reported to a management level  that can take appropriate corrective action. o Human resource controls: - Bond employees who hand cash. - Rotate employees’ duties and require employees to take vacations. - Conduct thorough background check. Bank Reconciliation Bank reconciliation= the process of comparing the bank’s cash balance with the  company’s balance, and explaining the difference to make them agree. The bank has physical custody of the cash, which is good control. In general, there’s a difference between the General Ledger Cash balance, and the  bank balance. This is for example due to accrued interest, outstanding checks, etc. We can categorize differences between Bank and General Ledger: 1. Deposits in Transit 2. Outstanding Checks???? example: we increase our Cash account when we  present the check, but money is not withdrawn until 3 months later. ???? Both are timing differences. 3. Errors. Made by record-keepers or bank. 4. Bank memorandums: when interest is posted into our account, it’s reflected  in our Bank Statement but not our General Ledger, until we make an adjusting  entry.  Example: We get a Cash Balance of $13,870. However, the Bank Statement shows a balance of $14,556. ???? We have to perform a bank reconciliation= a control of cash we perform to ensure there is no fraudulent  activity going on with cash.  Sandler Corporation Bank Reconciliation As at April 30 Balance per Bank  04/30 $14,556 Balance per G/L  04/30 $13,870 Add: Deposits in Transit 1,425 A)Error in check1#811 <54> Less: Outstanding  Checks2 B)Interest Earned 60 #797 450 C) NSF Check <500>                                                         1 We have to create an adjusting entry. 2 It’s a timing difference. We will not change the G/L account. All these checks have  already been credited in the G/L.#812 948 D) Service Charge <40> #815 372 #816 875 <2,645> New Balance $13,336 New Balance $13,336 Check #811: 326-272= 54 ???? to align Bank balance with G/L balance, we make the  following entry: Debit Credit DeliveryVanExpense 272  Cash 272 We need to subtract 54 from Cash, therefore, we make the following entry: Debit Credit DeliveryVanExp 54  Cash 54Chapter 12 Statement of Cash Flows Usefulness of the Statement of Cash Flows: Purpose of the Statement: Answer 3 questions:  1) Where did the cash come from? 2) What was the cash used for? 3) What was the change in the cash balance? ???? It fills in the details about how and why cash changed. It reports the cash receipts and payments from operating, investing, and financing  activities during a period. The information in a Statement of Cash Flows helps investors, creditors, and others  assess the following: o The entity’s ability to generate future cash flows. o The entity’s ability to pay dividends and meet obligations. o The reasons for the difference between net income and net cash provided  (used) by operating activities. o The cash investing and financing transactions during the period.  Content and Format: 3 different activities: 1. Operating 2. Investing 3. Financing Cash flow from Operations: • High amount ???? company able to generate sufficient cash to pay its bills,  purchase necessary materials for ongoing operations. • Low amount ???? company may have to borrow or issue equity security to pay  bills. Cash enables us to continue to operate. However, if we’re producing a low amount of  cash from our operations, we will have to:  • Borrow funds from a financial institution or • Sell stock. ???? However, no one will be interested in buying stock from us.  The information to prepare this statement usually comes from 3 sources:  1. Comparative Balance Sheets 2. Current Income statement. 3. Additional information. Preparing the Statement of Cash Flows involves 3 steps: 1) Determine net cash provided/used by operating activities by converting net  income from an accrual basis to a cash basis.  2) Analyze changes in non-current asset and liability accounts and record as  investing and financing activities, or disclose as non-cash transaction.3) Compare the net change in cash on the Statement of Cash Flows with the  change in the Cash account reported on the Balance Sheet to make sure the  amounts agree.  Statement of Cash Flows Cash Flows from operating activities $ XXX Cash Flows form investing activities XXX Cash Flows from financing activities XXX Net increase in Cash $ XXX Comments: • If the activity goes into the determination of net income, it’s an operating  activity. • Financing activities: they involve activities with non-trade creditors and  owners. Example of cash inflow: company sells stock. Example of cash  outflow: drawing/company pays cash dividends.  Preparation: GAAP let’s us choose between 2 methods to calculate the cash flows of the  Operating Activities Section.  Operating Cash Receipts  <Operating Cash Disbursements> Net Cash Flows from Operating Activities This method requires us to go to our Cash account in the General Ledger and  check/identify every single operating activity. ???? In the real world, using this  method is impractical.  Our goal is to identify cash flows generated by operations. We will start with a  measure of success we already have: the Net Income.  However, Net Income is NOT cash, because we used the accrual basis of  accounting. We start with Net Income, and make a series of adjustments to arrive to Net Cash  provided by Operating Activities. ???? much easier method to calculate the  operating section.  Net Income +Non-cash charges to Expense  –Non-cash credits to Revenue  Net Cash provided by operating activities Comments: Depreciation expense is a non-cash expense that appears on Income Statement.  Midwest Beverage Company Statement of Cash Flows As at October 31, 2016 Operating Activities: We will use the indirect method/reconciliation method. • The increase in $10,000 in Accounts Receivable had nothing to do with cash,  but it increased Net Income. ???? It increased Revenue by $10,000. • The $5,000 Accounts Payable increase leads to a decrease in Net Income. ???? When calculating cash flows, we add back $5,000. • There is a $4,000 depreciation expense. However, this transaction does not  involve cash ???? we add back $40,000.We can’t conclude whether or not $75,000 from operations is good or not. We need to  compare: to previous months, competitors, industry, benchmarks, etc. Investing Activities: Purchase of equipment for $8,000 ???? cash outflow ???? we represent it as negative.  Financing Activities: Proceeds from notes payable: $20,000 ???? cash inflow. Dividends paid: $5,000 ???? cash outflow. ???? At the end, we add up the net cash flows from each of the 3 buckets, and we get:  what was the change in cash during the period. Our change in cash on our cash flows should equal our ending Cash balance in our  General Ledger/Balance Sheet. See Handout E5-14 Dividends of 23,000 were declared/accrued ???? it is NOT a cash transaction. ???? Non-cash transactions are represented in a separate footnote in the back of the  financial statements. With this limited information, we will make the Statement of Cash Flows. We will use the indirect method/reconciliation method to do the Operating Activities  section.  The Statement of Cash Flows answers these questions: ⮚ Where did the cash come form? ⮚ Where did it go? ⮚ What was the net change? We can know it by comparing 2 consecutive  Balance Sheets (and looking at the Cash account in specific).Constantine Inc. Statement of Cash Flows For the year ended December 31st, 2016 Cash Flows from Operating Activities  Net Income $44,000  Adjustments to reconcile Net Income to cash provided by/used in operating  activities:  Depreciation Expense3 $6,000  Increase in Accounts Receivable <3,000>  Increase in Accounts Payable 5,000  8,000 Cash provided by operating activities $52,000 Equipment 22,000 17,000 39,000 Comments:  Accumulated Depreciation11,000 6,000 17,000 - When we credit Accumulated Depreciation for 6,000, we debit Depreciation  Expense for 6,000. - Since we did not sell/dispose of equipment during the period, we know for sure that  Equipment was not credited and Accumulated Depreciation was not debited. Debit Credit Accounts Receivable 3,000  Revenue 3,000 Debit Credit Asset/Expense 5,000  Accounts Payable 5,000                                                         3 We started with 11,000 and ended with 17,000???? 6,000. Cash Flows from Investing Activities4  Purchase of Equipment $<17,000> Cash Flows from Financing Activities  Issuance of Common Stock $20,000  Payment of Cash Dividends <23,000> Cash flows used in financing activities $<3,000>  Net increase in Cash 32,000 ???? we will add this  amount to our beginning cash balance  Cash at the beginning of the year 13,000  Cash at the end of the year $ 45,0005                                                         4 Involves the purchase or sale of long-term operational assets. 5 It equals the Cash account in our General Ledger and Balance Sheet.All the financial statements are related: Income  Statement Stockholder's  Equity Balance Sheet Statement of Cash  Flows Revenue Beginning Balance Assets +-Operating <Expense> +Net Income = +- Investing Net Income <Draw/Dividends> Liablities +- Financing +Owner's  Ending Balance Equity Increase/Decrease Cash +Beginning Balance Ending balance6 When we have a sale of an equipment, we deal with the proceed in the Investing  Activities section, but we deal with the gain or loss in the Operating Activities  Section.                                                         6 We have the same Cash amount as in the Balance Sheet.Chapter 11 Stockholder’s Equity Equity= ownership interest in the company. It is the excess of assets as compared to  liabilities.  Assets –Liabilities = Owner’s Equity Net Assets = Owner’s Equity Depending on how an entity forms itself (sole proprietorship, partnership,  corporation), it is going to dictate the name and numbers of Owner’s Equity.  In a sole proprietorship, there are 2 owners accounts: Owner Capital account and  Drawing account. Before we get to the accounting, we need to talk about the attributes related to the  corporate form of business: • Corporation: Advantages:  - Limited liability ???? the owner’s liability is the amount they invested. Worse  case scenario: market value of that stock goes to 0. Ex: if I put $10,000 in the  company, it becomes 0 ???? this brings up a broad range of potential investors  ???? it’s easier for a corporation to accumulate capital.  - The transfer of ownership interest. - It is a separate legal entity: it can sue and be sued ???? it’s subject to many  regulatory agencies. Disadvantages: - Owners have much less control. - Increased exposure to governmental regulations. Ex: double taxation ???? they  tax the earnings AND the owners’ dividend income.  Income Statement Owner's Equity Revenue Dividend  Checks to  <COGS> Gross Profit Operating Expense Operating Income +- Non Operating  Act Income before tax <Income tax  expense> Net Incomeowners: Dividend  Income <Income  Taxes> Assets –Liabilities = Equity ???? Net Assets7 = Equity Equity=Net Assets=Stockholders’ Equity = Owners’ Equity ???? Synonyms Comments: There are 2 types of owners’ claims against the assets: Earned Capital and  Contributed Capital.  At a minimum, a company will have Common Stock ???? a designated number of  corporate share. Every corporation must have a class of common stock, but they don’t need to have  preferred stock.  Common Stock Common stock represents the most common type of stock issues by companies and  entitles shareholders to participate in the profit and growth of the company they invest  in. When looking at investing in the stock market for the most part you are buying  common shares in a company. The two main income drivers for common stock are that they deliver appreciation (through growth in value of the company) and through dividends paid out of the  company to shareholders. Dividend payments can change over time so predicting cash  flows through common stock holdings can be difficult. Common stock holders are typically allowed to vote on issues like electing the board  of directors or other issues put to a vote. This is not always the case, however, so it  may be important to refer to the specific features of a class of shares you are investing  in.                                                         7 We say Net Assets because we assume that Assets>Liabilities.Holding common stock also comes with ‘pre-emptive rights' to maintain the same  proportion of ownership should a company issue a new stock offering. This means  that holding common stock will entitle you to pre-emptively buy new shares should  the company be completing an issuance. Preferred Stock Preferred stock often does not have voting rights and do not provide an ability to  participate in the appreciation in the value of the company. Often, they come with  specific payment terms that take precedence over common stock, with say a set  dividend being paid out monthly, quarterly, or annually. Preferred stockholders typically have first access when it comes to dividends and also  in a bankruptcy situation, where after creditors are paid preferred stockholders will be  compensated before common shareholders. Preferred stock can also have set  redemption terms, where a holder can have them redeemed at a favorable price for  either cash or sometimes even common shares. Common Stock vs. Preferred Shares Often the decision between investing in common shares vs. preferred stock comes  down to a risk and reward relationship. Common stock is riskier, you may lose it all,  but often provides a better chance to participate in the growth of a successful  company. Preferred stock come with less risk (assuming they have preference rights  over common shares) but come with set dividend and repayment terms. Ultimately the  choice comes down to weighing the risks and what your opinion is on the future of  the company being considered. Par value= the face value of a bond. Par value for a share refers to the stock value  stated in the corporate charter.  Par is not informative as to what the current market price is. If a company has a par or  stated value associated with its Common Stock or Preferred Stock, that does not equal  its market value.  Additional paid-in capital: the extent to which market value exceeds par/stated  value. In a sole proprietorship or partnership, Net Income went straight to the Capital  account.  In a corporation, we put Net Income in Retained Earnings.  Example: Assume R Corporation issues 19,000 shares of Common Stock for  $152,000. ???? Market Price per share = 152,000/19,000 = $8/share. First, we need to know if these shares have a par/stated value. Scenario 1: Assume that each share has a $2 par value: Debit Credit Cash 152,000  Common Stock, $2 par 38,000 (19,000 x 2) Additional Paid-In Capital, Common Stock 114,000 (152,000- 38,000) or (19 x 6,000) Scenario 2: Stated value of $5.  Debit Credit Cash 152,000  Common Stock, $2 par 95,000 (19,000 x 5)  Additional Paid-In Capital, Common Stock 57,000 (19 x 3,000) Scenario 3: $0 par or stated value. Debit Credit Cash 152,000  Common Stock 152,000 In a private company, it happens to exchange ownership shares for land or buildings.  Scenario:  R Corporation issues 5,000 shares of $10 par Common Stock in exchange for:  Land 35,000 Building 70,000 Increase in Assets 105,000 5k x $10 par CS 50,000 APIC, CS 55,000 Journal Entries: Debit Credit Land 35,000 Building 70,000  CS, $10 par 50,000  APIC, CS 55,000 We were talking about the 2 different types of capital (contributed capital and earned  capital). When owners withdraw money (pay dividends) ???? Assets decrease, and Owner’s  Equity simultaneously decreases:  Assets = Liabilities + Owner’s Equity There are 2 ways owners see returns in their investment: 1) Through dividends 2) Through capital gain (if the value of the company’s shares appreciates)Return on Investment Via Dividends There are 3 types of dividends: 1. Cash ???? most common form. 2. Property: less frequent and can only occur in a private company. 3. Stock: a company can issue a stock dividend= give the stockholder more  stock.-0 GAAP requires companies to disclose ownership interests (there are 2 types of shares:  common or preferred). The Number of Shares ???? When does a company establish the number of shares in total that it has? When it  is incorporated.  The company will choose how many shares are authorized, if there is a par value, if  the shares are common or preferred. We have to distinguish between the following 3: 1. Authorized shares –in the charter 2. Issued shares: shares sold 3. Outstanding shares8: shares still owners by outside owners Issued shares – Outstanding shares = Treasury Stock Treasury stock= when the company goes to the market and buys the shares it had  sold.  ???? Who chooses to give out dividends? The Board of Directors: only they can decide  to declare and pay dividends. When they do that, 3 dates are important: 1) Declaration date: the board meets, votes on a resolution: (for example) they  obligate the company to pay a $2/share dividend ???? Accountants will have to  record a Dividends Payable entry (Credit) and Cash Dividends (Debit).  2) Date of record: during the declaration date, the board says “We will pay  shareholders as of ”. Example: if you were a shareholder as of July 1, you get  a dividend on July 31.  3) Payment date: accounts make an entry: Dividends Payable (Debit) and Cash  (Credit).  In-Class Problem 1: Uzi Company received a charter granting the right to issue 200,000 shares of $1 par  value common stock and 10,000 shares of $50 par value preferred stock. 2013 Feb 19 Issued 45,000 shares of common stock at par for cash. 22 Gave the corporation’s promoters 30,000 shares of common stock for  their services in getting the corporation organized. The directors  valued the services at $50,000.                                                         8 Shares still owned by stockholders in the market. Mar 30 Exchanged 100,000 shares of common stock for the following assets at fair market values: land, $25,000; building, $100,000; and machinery, $125,000. Dec 31 Closed the Income Summary account. A $25,000 loss was incurred. 2014 Jan 12 Issued 1,000 shares of preferred stock at $75 per share. Dec 15 The board of directors declared an 8% dividend on preferred shares and $0.10 per share on outstanding common shares, payable on January 31 to the January 17 stockholders of record. Dec 31 Closed the Income Summary. A $69,000 net income was earned. 2015 Jan 31 Paid the previously declared dividends. Journal Entries: Trans.  Date 19- Num Account Debit Credit Feb 1 Cash 45,000  Common Stock, $1par 45,000 ???? There is no Additional Paid-In Capital account because we issued/sold the stock  at par.  Trans.  Date 22- Num Account Debit Credit Feb 2 Organizational Expense 50,000  Common Stock, $1par 30,000  APIC9, CS10 20,000 ???? We are issuing ownership shares. Instead of paying the bill, the company offers  ownership interest in the company. ???? Because we have an APIC, it’s as if we were issuing these shares not at $1/share  but more.  Trans.  Date 30- Num Account Debit Credit Mar 3 Land 25,000                                                         9 Additional Paid-In Capital 10 Common StockBuilding 100,000 Machinery 125,000  Common Stock, $1par 100,000  APIC, CS 150,000 ???? We see that the price market exceeds par value by $150,000. Trans.  Date 31- Num Account Debit Credit Dec 4 Retained Earnings 25,000  Income Summary 25,000 ???? GAAP makes corporations distinguish between contributed and earned capital.  ???? By debiting Retained Earnings ???? Owner’s Equity (owner’s claims against the  assets) decreases. Trans.  Date Num Account Debit Credit 12-Jan 5 Cash 75,000  Preferred Stock, $50 par 50,000  APIC, PS 25,000 Trans.  Date 15- Num Account Debit Credit Dec 6 Retained Earnings 21,500  CS, Dividends Payable 17,500  PS, Dividends Payable 4,000 ???? To get these numbers, we did:  Common Stock = 175,000 (here, outstanding shares = issued shares) 175,000 x 0.10 = 17,500 Total par value of our Preferred Stock = 50,000 x 8% = 4,000Date 31- Trans.  Num Account Debit Credit Dec 7 Income Summary 69,000  Retained Earnings 69,000 Now, we prepare our financial statements because it’s the end of the year.  Uzi Corporation Balance Sheet As of 12/31/14 ASSETS LIABILITIES STOCKHOLDER’S EQUITY 8% Preferred stock, $50 par $ 50,000 100,000 shares authorized, 1,000 shares 25,000 issued and outstanding11 APIC, Preferred Stock 175,000 Common Stock, $1 par 200,000 shares authorized, 175,000 shares  issued and outstanding APIC, Common Stock 170,000  Total Paid-In Capital 420,000 Retained Earnings 22,500  Total Stockholder’s Equity 442,50012 Treasury Stock Reminder:  There are 2 types of capital: • Earned capital • Contributed/donated/paid-in capital ???? arises when potential investors  purchase ownership interest (stock). In a corporation, contributed capital is split in 2 different accounts: ▪ Ownership interest at par ▪ Additional amount paid ???? this happens when there’s a stated or par value on  stock and with the market price exceeding that value.  Earned capital is in the Statement of Stockholders’ Equity as Retained Earnings.                                                          11 Because we have no treasury shares 12 We do not double underline because we will add to Total Liabilities.We measure success via Net Income, at the end of the period, we dump it into our  capital (Retained Earnings) account. Stockholders’ Equity has one more account called Treasury Stock. Treasury shares= shares purchased by the company and held in the treasury for  some future purpose.  GAAP requires the company to declare 3 numbers related to shares: 1. Authorized shares: total number of share that the company could sell ???? found  in the charter. 2. Issued shares: number of shares the company sold since the beginning. 3. Outstanding shares: the number of shares owned right now by owners. Issued shares – Outstanding shares = Treasury shares ???? When the number of shares outstanding decreases, the number of treasury shares  automatically increases.  ???? Why would a company buy Treasury shares?  ⮚ If it thinks it’s undervalued. ⮚ To prevent a hostile takeover. Under GAAP, companies use the Cost Method ???? treasury shares are measured at the  price we paid for them. In-Class Problem 2 The difference between this exercise and the previous one: in the previous one, we  were beginning a business. If shares issued = shares outstanding ???? there are no treasury shares. When doing the General Ledger, we must establish the beginning balances first. We  know for sure that Assets = Liabilities + Stockholders’ Equity ???? we can therefore  deduct the Asset balance, the Cash balance to be more precise. In fact, if we assume  that Liabilities =0, we have total Liabilities + Stockholders’ Equity= 920,000. ???? thus, the beginning Cash balance is 920,000. We have to add these in the General  Ledger before adding the new entries. 1) Journal Entries Trans.  Date Num Account Debit Credit 6-Jun 1 Treasury Stock, CS13 40,000  Cash 40,000                                                         13 We have to distinguish Common Stock treasury shares and Preferred Stock treasury  shares.???? We Debit a contra-equity account called Treasury Stock ???? owner’s claims against  the assets decrease, and assets decrease.  ???? Now, number of shares outstanding= 24,000-1,000= 23,000 Trans.  Date Num Account Debit Credit 23-Jun 2 Retained Earnings 11,500  CS, Dividends Payable 11,500 ???? 23,000 x $0.50/share = 11,500 ???? CS, Dividends Payable is a current obligation. Trans.  Date Num Account Debit Credit 25-Jul 3 CS, Dividends Payable 11,500  Cash 11,500 10-Aug 4 Cash 22,500  Treasury Stock, CS  (500x40)14 20,000  APIC, Treasury Stock  (500x5) 2,500 ???? Now, we have 23,500 shares outstanding. Trans.  Date Num Account Debit Credit 20-Oct 5 Cash 12,000 APIC, Treasury Stock15 2,500 Retained Earnings 1,500  Treasury Stock, CS(400x40) 16,000 ???? The company sells treasury shares for $10/share less than what it cot us to buy it  ???? it really needs the cash.  ???? Treasury Stock goes in at cost and out at cost.  ???? We have a decrease in Owner’s Equity of $4,000. Trans.  Date Num Account Debit Credit 15-Dec 6 Retained Earnings 11,950  CS, Dividends Payable 11,950 ???? Calculate the declared dividend: $0.50/share x number of shares outstanding =  0.50 x 23,900 = 11,950                                                         14 We Credit the Treasury Stock at cost ???? this is why cost acts like par. 15 Because there’s already a balance in APIC, TS we can Debit it ???? the remaining  Debit will be to decrease Retained Earnings.Date Trans.  Num Account Debit Credit 31-Dec 7 Income Summary 60,000  Retained Earnings 60,000 ???? Step 1: close all our Revenue accounts ???? we Debit them. ???? Step 2: close all our Expense accounts ???? we Credit them. ???? We hope that Income Summary has a Credit Balance ???? Revenue > Expense. 2) Now, we’re ready to prepare our financial statements: Austin Corporation Retained Earnings Statement For the year ended December 31, 2013 Retained Earnings January 1, 2013 $ 230,000 Plus: Net income 60,000 Less: Common Stock Dividends Declared 23,450 Less: Treasury shares sold below cost 1,500 Retained Earnings December 31, 2013 $ 265,030 ???? This is the bridge statement, because it connects the Net Income Statement and the  Balance Sheet. It shows the change in retained earnings from the beginning of the year to the end of  the year ???? it’s the cumulative effect of the company running the business.  3)  Austin Corporation Balance Sheet December 31, 2013 STOCKHOLDERS’ EQUITY  Common Stock, $25 par, 30,000 shares authorized, $ 600,000  24,000 issued, 23,900 outstanding.  Additional Paid-In Capital, Common Stock 90,000  Total Paid-In Capital 690,000  Retained Earnings 265,050  Treasury shares at Cost, 100 shares <4,000>  Total Stockholders’ Equity 951,050 Earnings Per Share = (Net Income – Preferred Dividends) / Weighted Average  number of Common Stock outstanding Stock Splits We had talked about 3 types of dividends: cash, equipment, stock.  However, stock splits are another way for owners to own more stock. ???? We do not  have to make an entry to record a stock split. In a 2 for 1 stock split: - The par value of the shares is cut in half.  - The number of shares outstanding is doubled.  If the par value of a company is at a very high price, the company makes a stock split  to reduce the price and entice owners to buy stock. ???? For most of the investing public, they get excited about stock splits, but in an  accounting point of view, it changes nothing. ???? We don’t make a journal entry for stock split, but we need to make a note in our  chart of accounts and change the par value and indicate the new number of Common  Stock.

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