Intro to Financial Accounting Exam 2 Study Guide
Intro to Financial Accounting Exam 2 Study Guide ACCY 2001
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This 23 page Study Guide was uploaded by Anika Mian on Friday April 1, 2016. The Study Guide belongs to ACCY 2001 at George Washington University taught by James T Wood in Spring 2016. Since its upload, it has received 57 views. For similar materials see Intro to Financial Accounting in Accounting at George Washington University.
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Date Created: 04/01/16
INTRO TO FINANCIAL ACCOUNTING—EXAM 2 STUDY GUIDE Chapter 6—Revenue and Receivables Quick review~ There are four main was to recognize revenue in accounting. You can recognize revenue when it’s in your FACE. o Fixed Price o Arrangement o Collection o Earned Revenue is earned once the delivery has occurred. (Title Transfer) FOB Shipping Point/ FOB Destination SALES REVENUE 10,0000 THESE THREE ARE LESS: Credit Card Discount ($100) CONTRA-REVENUE Sales Discounts ($50) ACCOUNTS. Sales Returns and Allowances ($250) THEY ARE DEBITED. NET SALES $9,600 - Net sales are located on the income statement—simply mean “gross sales”; the total sales after subtracting the discounts and allowances. Credit Card Discounts Why do companies accept credit card? Because everyone has access/owns one. It is a common form of payment. The Credit Card fees are incorporated of a percentage of sales. Sales Discounts (Open Account) Only exists if you’re a business selling to another business. Why offer Sales Discounts? Gives consumers an incentive to pay an account receivable. Example: Business A offers you terms of 2/10, n/30 for the purchase of 10 bicycle Chains for $100. 2/10 = 2% discount if paid in 10 days .02 x 100 = 2.0 o So, the charge is $98 if paid within 10 days and $100 in 30 days. Returns and Allowances Damaged Merchandise Returned Merchandise Why do companies allow returns? o Consumers trade off the risk of being stuck with an item. It occurs either as a refund or a reduction. Returns and Allowances are Accumulated and Subtracted from Sales Revenue Contra REVENUE Account Bad Debts Bad debts are incorporate customers who do not pay their debts. Methods: Matching Principle (Sales and Expense) Allowance Method (Estimate) 1. Percentage of Credit Sales—CALCULATING MIDDLE OF ADA a. For e.g. if 5% of 10,000 is not collectable, we multiply them and get 500. i. The result of 500 is the Bad Debt Expense. 2. Aging Method—CALCULATING ENDING OF ADA a. Start with some amount in Accounts Receivable (Asset), Allowance for Doubtful Accounts (Contra-Asset) and Bad Debt (Expense) b. Beginning balance in Allowance for Doubtful Accounts is the ending period we have of Accounts Receivable c. Under the Aging Method, we divide up this 10,000 and break it down to the specific periods of time it was earned. d. We distribute it through the 30/60/90 as the x-axis and we make the percentages under the values as (30 - $9,000 – 1%) (60 – 600- 5%) (90- 400 – 10%) i. We can add these values and the result is the ending value of the ending ADA e. Bad Debt Expense is the DIFFERENCE BETWEEN BEG. AND END OF ADA—in this case, it is 60. Bad Debt Expense—Income Statement o Temporary Account (Cost of Sales Expense) Allowance for Doubtful Accounts (ADA) – Balance Statement o CONTRA- ASSET ACCOUNT Percentage of Credit Sales Credit sales x Bad Debt Loss % = Bad Debt Expense Example Credit sales of $10,000 Bad Debt Loss is 1%_____ Bad Debt Expense is $100 – Calculated by multiplying (10,000 x .01) Bad Debt Expense is the total calculated percent. A/R Aging Reports Receivables 30/60/90/120 (days) past due Percentage Uncollectable—Estimated o You calculate the A/R from each receivable category and add them up o Then, you multiply the percentage by the A/R and add the values to find the ADA amount—Subtract the original ADA from the new ADA and THAT value is the BAD DEBT. Bad Debt Expense is the amount to bring ADA to Estimated Value Write-Off When amount is UNCOLLECTABLE o It doesn’t become an estimate anymore It becomes more permanent by: 1. Actually reducing Accounts Receivable 2. Reducing ADA – Which starts as an estimate. When the estimate becomes a reality, it doesn’t change the net income. Journal Entries 1. AJE to estimate Bad Debt—End of Period Dr BadDebtExpense $100 Cr AllowanceforDoubtfulAccounts $100 2. Write-Off (Not Collectable) – Any time Dr Bad Debt Expense $100 Cr Allowance for Doubtful Accounts $100 Write-Off Recoveries Segregation of Duties o To make sure that not one person has all account Elements o Custody Items that one has possession over. For e.g. Inventory can be given to another for custody Can be something that you’re not responsible for o Record Keeping Control of accounting records—can enter in records and adjust them o Authorization For e.g. Authorizing a transaction—giving a raise, or moving money into different accounts Purchasing authority/ authorization of a loan/ or checks o Reconciliation Making sure bank accounts match up with the books or what was recorded Cash Segregation Duties Receiving (Mail)- 2 people o Sending checks via mail o Recommended that 2 people open the mail and that checks are being treated well Depositing (Bank) Recording (Cash Account Books) Reconciling (Bank Reconciliations) Disbursement (Check-Signing) Receiving—Take Depositing—Take Recording—Take Reconciling—Hide Disbursement—Take Bank Reconciliation Common Differences Outstanding Checks (Not Cashed) Deposits in Transits (1-2 days) Bank Service Charges NSF (Non-Sufficient Funds) Interest Errors Chapter 7—Cost of Goods Sold and Inventory Inventory vs. COGS Inventory o Current Asset (Balance Sheet) o Actual things that we are selling o Includes related costs (Freight, Insurance, Taxes) Cost of Goods Sold (COGS)—aka Cost of Sales o Expense (Income Statement) o Expensed as a result of sale of inventory Gross Profit Margin Revenues (Sales) COGS (Inventory) Gross Margin Relates to the GROSS PROFIT RATIO Why is this ratio so important? It determines how well a company is running!! Merchandiser vs. Manufacturer Merchandiser—Buys and sells “finished” goods o Retailers—sells to public consumers o Wholesalers- Sells to retailers Inventory COGS Manufacturer—Converts “Raw Materials” into “Finished Products” RAW MATERIALS WORK IN PROGRESS FINISHED GOODS COGS COGS Formula Beg. Inventory ADD: Purchases (Additions) COG Available for Sale LESS: Ending Inventory COGS (Disbursed Inventory) Perpetual vs Periodic Perpetual o COGS Update at Each Sale o COGS and Inventory always available Ex. Wal-Mart/ Target—we can see if they have things in stock o Costly method Periodic o COGS Update at End of Period Ex. Inventory by weight—candy/bulk machine o Inexpensive method Inventory Costing Method Specific Identification FIFO (First-In, First-Out) LIFO (Last-In, First-Out) Weighted Average Specific Identification The exact item(s) PURCHASED is the exact item(s) SOLD o Ex. Car Dealership Whatever a person purchases, the exact item is the actual specific item sold. FIFO (First- In First-Out) Cost of Oldest Inventory is used FIRST even if the OLDEST is actually sold first. o For e.g. Oil o The cost of the new stuff is used in place of the old stuff Average Costing 1. Weighted Average Cost Per Unit (WACU) Cost of All Units (new and old) / Number of Units We Have 2. Ending Inventory = Units on Hand x WACU 3. Cost of Goods Sold = Units Sold x WACU Financial Statement Effects of Inventory Costing Methods Advantages of Methods 1. First-In, First-Out a. Good for having the correct asset value 2. Last-In, First-Out a. Based on income value. Lower of Cost of Market (LCM) Historical Cost vs. Market Inventory Ratios Its better if your COGS ratio is higher. LIFO Reserves AKA (Revaluation to LIFO, Excess of FIFO over LIFO cost and LIFO allowance Reported if Company uses FIFO Difference between FIFO and LIFO values Reported FIFO Value LIFO Reserve Value @ FIFO CHAPTER 8—Property, Plant, and Equipment, Intangibles, and Natural Resources Operating Assets Assets that are… NOT sold to customers Used by the business to generate REVENUE Categories Property, Plant, and Equipment Intangibles Natural Resources Long-Lived Assets Property, Plant and Equipment AKA PP&E; Fixed or Tangible Assets LAND (Property) o Unlimited Life = No Depreciation LAND IMPROVEMENT o Driveways, parking lots, fences, landscaping, lighting BUILDINGS (PLANT) o Machinery, furniture, cards ACCUMULATED DEPRECIATION (CONTRA ACCOUNT) Fixed Asset Costs Historical Cost Purchase price + costs too… PREPARE FOR USE AND LOCATE Transportation, Taxes, Demolition, Closing Costs, Insurance during Transport, Installation, Remodeling, Excavation These costs are CAPITALIZED Not Capitalized Cash Discounts Financing Charges Non-Cash Acquisitions Trade (Market Value / Consideration) Construction (Materials/ Overhead/ Interest) Revenue Expenditures—not capitalized Expenditures after an asset is in service o Maintain benefits of asset o Relate to Current Period o Frequent o Small Dollar o Do not increase “future” economic benefits o Expensed in the period incurred EXAMPLES: Regular Repair or Maintenance, Labor, Cleaning, painting, Minor parts Capital Expenditures Provide benefit in current and future periods o Extend life o Extend capacity o Increase efficiency o Improve quality EXAMPLES: Extraordinary or Major Repairs, Additions, Remodeling of Buildings, and Improvements Depreciation Systematic Allocation of Cost over Useful Life o Matching Revenues with Expenses Not LAND Depreciation Expense (Income Statement) Accumulated Depreciation (Balance Sheet) PP&E Historical Cost LESS: Accumulated Depreciation Book Value Journal Entry for Depreciation DR. Depreciation Expense $XXXX CR. Accumulated Depreciation $XXX Depreciation Methods Straight-Line Declining Balance Units of Production MEASUREMENTS Cost Residual (Salvage) Value Useful (Expected/ Beneficial) Life Get da CRU up in here. Straight- Line EQUAL amounts of depreciated (expensed) over useful life. Cost – Depreciation = Net Book Value --- The residual value equals the value left after an amount of years. Declining Balance Accelerated Depreciation Depreciation STOPS @ Residual Value Depreciation Expenses go from High to Low Double Declining “Your DNA is a DOUBLE helix” C = $1,000 | R = $100 | U = 10 years D = 2 x 1/n = 2 x 1/10 = 20% Year Double Net Value Amount of Depreciation Accumulated Percentage Expense Depreciation 1 20% $1000 $200 $200 2 20% $800 $160 $360 3 20% $640 $128 $488 4 20% $512 $102.40 $590.40 When net book value REACHES RESIDUAL, you have to STOP DEPRECIATING. Units of Production Productive (Service) capacity proportional to usage of asset Partial Years Mid-Cycle Purchases = Partial Year Depreciation Taxes Why Is This? Accelerated Depreciation = Tax Deduction = Less Taxes = Investment MACRS (Modified Accelerated Cost Recovery System) Tax Life does NOT equal the GAAP life Salvage Value is $0 Partial Year = ½ year Disposal Voluntary – The asset is no longer useful and/or sold Involuntary—The asset is lost or destroyed Journal Entries 1. Record Depreciation (To date of disposal) 2. Record Gain/Loss on Disposal Proceeds from Sale MINUS Book Value (HC – AD) = Gain or Loss Revisions to Depreciation Depreciation Revised due to Changes In: o Asset Cost o Residual Value o Useful Life 1. Net Book Value (HC – AD) 2. ADD Book Value and Capital Expenditure 3. Compute NEW Depreciation Expense using a. Revised Cost (BV + Cap Exp) b. Revised Residual Values c. Revised Useful Life Intangible Assets Have Future Economic Benefits Lack Physical Substance Legal Rights or Privileges Recording o Purchased = Cost + Fees + Legal Costs o Created In-House = Fees and Legal Costs Research & Development is Expensed (i.e. NOT Recorded on Balance Sheet) Examples: Patents, Copyrights, Trademarks, Franchises, and Goodwill Amortization Finite Life o Amortized Over Life of the Asset o Shorter of Economic or Legal Life Infinite Life o Test for Impairment Annually A company purchased a patent for $100,000 at the beginning of 2012 which it believes has an expected useful life of 5 years. Fortunately, the patent has a legal life of 20 years. How much amortization expense should be recorded in 2012? How do we figure this out? The cost of the patent is 100,000 so we divide by 5 (years) and the AE is 20,000 each year. Impairment Permanent Decline o Future Benefit o Service Potential Fair Value = Market Value or Recoverable Value Goodwill Coal, Oil, Gas, Minerals, Timber Consumed as they are USED (not fixed) Replaced and Restored by NATURE o Possible Exception Is Timber Depreciation Similar to Units of Production Journal Entry 1. Recovery of Natural Resources (i.e. Mining) DR Inventory $XXXX CR. A/Depletion** $xxx 2. Selling of Natural Resources DR COGS $XXXX CR. Inventory $XXXX Ratios CHAPTER 9- LIABILITIES Liabilities Claims or Obligations On Current or Future Assets May be… Paid with Cash, other Assets or Services Uncertain (sometimes) Probable/ Legally Enforceable (sometimes) Current vs Noncurrent Current o Maturity < One Year Operating Cycle Noncurrent o Maturity > One Year Operating Cycle Current Liabilities Due Within… o 1 operating cycle or 1 year (whichever is LONGER) Paid with... o Current Assets (cash) o Goods/Services o New Current Liabilities Examples: Accounts Payable, Notes Payable, Interest Payable, Interest Payable, Taxes Payable, Accrued Liabilities, Unearned Revenues Accounts Payable Purchase made “On Account” (i.e. Credit) No Formal Agreement No Interest (Usually) 30-60 Day Terms Accrued Liabilities Examples o Utilities o Interest (from Notes Payable) o Wages o Taxes Taxes Payable Withholding Employee o Social Security o Medicare Payroll Employer o Social Security o Medicare o FUTA Sales Tax Unearned Revenue Money from Customers Received in Advance Before goods or services delivered Earned or Returned LT Version—customer deposits Contingent Liabilities Uncertain about time, recipient, or amount Relies on a future event Recognized by journal entry when o Probable o Estimateable Definitions Probable o Likely to occur Possible o More than remote, but less than likely Remote o Slight Chance Notes Payable Borrowed Money (Bank) Formal Agreement Interest Payment Extension (re: A/P) Current and Long-Term Portions o Due <1 year = CURRENT o Due >1 Year = Long- Term Payments on Notes Payable Interest = Principal x Interest Rate x Period Principal + Interest = Total Payment Payment (Interval or Lump) Interest not Recorded until INCURRED “Zero” Percent Loans (don’t exist) Leases Operating (Rental) o No Ownership o No Risk or Benefit o Use Only Capital (Sale) o Ownership Transfer o Written Agreement “0” or “Bargain” Purchase o Ninety (90%) = Present Value of Pmts > Or Equal to Fair Value o Seventy-Five (75%) of Economic Life TIME VALUE OF MONEY Time Value of Money Applies to (in accounting) o Bonds o Leases o Pensions o LT Debts Applies to (life) o Loans o Credit Cards o Investments o Interest Compound Interest Interest is EARNED on Interest Interest Period—Time between Calculations Interest Rate -- % rate Interest Rate Calculations Adjusted from STATED to CALCULATION rate Types of TVM Calculations Future Value of $1 (single amount) Present Value of $1 (single amount) Future Value of an Annuity (Multiple) Present Value of Annuity (Multiple) Future Value of $1 What $1 today will be worth in a certain amount of periods in the future Basic Compound Interest FV = (f) (M) o Where M is found through a multiplier from FV of $1 TABLE Present Value of $1 Amount needed now ( @ rate X) to pay $1 at future date “Y”. PV = (f) x (M) o Using the present value table from the multiplier Important Notes Payments occur at the END of the period No interest earned in the 1 period Present Value of Annuity Present value of a sum of payment made until date x in the future. PVA = (f) (M) Same note regarding payments at end of period and no interest during first period. CHAPTER 10: BONDS Leverage Income from Debt > Interest on Debt Debt Pros: Fixed Payments to Lenders If Rising Inflation: $ today < $ tomorrow o Dollar is worth more tomorrow than today— o Debt payment do not change in terms of inflation Debt Cons: Inflexible Payment Schedules Bankruptcy o Lender can force you into bankruptcy if you can’t make payments Bond Terms What are Bonds? Large Debt in Small Chunks ($1k) Too large for a single lender Face Value = Par Value = Principal o Paid at Maturity (Typical) o Monthly sometimes Interest = Stated = Nominal = Coupon = Contract (Rate) o Rate on the Bond o Paid Periodically at the “Rate” Other Debt Terms Maturity Date = Final Due Date (Principal) o Back to the lender Market = Effective = Yield (Rate) Secured = Tied to Asset Unsecured = Debenture = No Asset Junk = Unsecured, Risky, High Price Callable = Borrower Early Payoff (Mkt Rate goes down) Indenture = Bond Document Notes vs. Bonds Note Bond Lenders One Many Value Vary $1,000/each Terms Vary 5+ years Traded No Yes Regular Payments Principal and Interest Interest Secured Yes Yes and No Selling Bonds Why do companies sell bonds? No effect on Company Ownership/Management No dilution of shares Interest vs. Dividends o Interest can be tax deductibles o Dividends are taken in retained earnings/ stockholders equity Underwriters (Sellers) o Determine Market Rate for Bond o Assume Risk of Bonds from Issuer (Buy) o Resell Bonds (Sell) Underwriter goes out to the market and selects a company, identifies the market rate and then decides to sell the bonds at what the amount is listed on that bond. If they go to a different lender and say that the stated rate is 10%, the market is 8%, so it would sell for less—it would be a premium. Accounting for LT Debt Cash Flows o At issue o Interest Payments o Maturity (Face Value) Bond Issue Pricing Present Value of Bond @ Maturity ADD: Present Value of Bond Interest Payment Bond Issue Price (Cash) 1. Principal Bond Value (Pv OF $1 @ market rate) 2. Interest Payments (PV of Annuity @ Market Rate) ALWAYS USE THE MARKET RATE --- Amortization Methods Amortization equals the Amount of Interest Payment + Discount/ Premium Expensed Over Time METHODS Straight Line o Equal amounts of time o Not GAAP (Except at PAR) Effective Interest o Market Rate x BV of bonds (Beg of Period) o Similar to Compound Interest Calculations o GAAP The interest payment is constant all the way down—the interest expense is also constant all the way down but is a different number— same for amortization amount all the way down. EXAMPLE: st AT&T issued 100k bonds on January 1 . The bonds sold for $96,536. The bonds have a 2-year maturity and $5,000 interest is paid semiannually. Compute using the straight-line method. The bond is a discount because they sold for less than the worth. DR Cash 96536 100,000 – 95,536 is 3464. Dr Disc. On BP 3464 Divide 3464 by 4 and get 866, which is the payment made for CR. Bond Payable 10000 Amortization. Each period, you add the amortization amt to the Beg BV to get the End BV. Journal Entries for Interest Expenses Par (Stated = Market) DR Interest 100 Expense CR Cash 100 Premium (Stated > Market) DR Interest 97 Expense DR Premium on 3 Bonds Payable CR. Cash 100 Discount (Stated < Market) DR Interest 106 Expense DR Discount On BP 6 CR. Cash 100
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