Chapter 1-11- Accounting 211
Chapter 1-11- Accounting 211
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Acc 211 Chapter 1 review 1 Vocabulary Stockholdersowner of corporation Creditorparty that lends money Interest how creditors make money owe to creditors Dividendsportion of what company earns in the form of cash to stockholders e the org for which nancial data are to be collected 2 Management accounting INTERNAL DECISION MAKERS a Need info About company biz To operate invest and nance rms activities b Continuous detailed info bc they planmanage operations of org c Provided to managers run the company 3 Financial accounting EXTERNAL DECISION MAKERS a Need same info To assess whether company can pay backpay dividends b Periodic nancial statements amp related disclosure c Provided to stockholderscreditors evaluate company 4 a system that collects amp processes nancial info amp Reports info To decision makers a Finance gt borrowingpaying lenders amp receiving fundspaying dividends from stockholders b Investing buying selling items c Operatingprocess of purchasing manufacturing delivering collecting amp paying 5 Types of managers a Supply chaingt analyze nancial statements to see whether suppliers have resources to meet demandinvest in future development b Human resourcegt use nancial statements to contract negotiations over pay rates 6 Four basic nancial statements prepared by pro t making org a l eco Resources company owns amp sources of nancing resources i Purpose reports amount of assets liabilities and stockholders equity of an acc Entity at a particular pt in time ii Heading name of entity title of statement date of st unit of measure iii BASIC ACC EQUATION 1 ASSETS eco Resources LIABILITIES nance form creditors STOCKHOLDERS EQUITY nancing from stockholders goom vi a Shows nancial position eco Res Comp Owns nancing for them ASSETS eco Resources owned by entity 1 Cash accounts receivable promises to pay inventories amp propertyequipment LIABILITIES lamount of nancing provided by creditors 1 Company s debts obligations 2 Accounts payable purchase of gs from suppliers on credit wo contract 3 Notes payable to banks result from cash borrowing on formal written debt k w banks STOCKHOLDERS EQUITYlemount of nancing provided by owners of biz amp Reinvested earnings 1 Common stock investment of cash and other assets in biz by stockholders 2 Retained earningspro ts reinvested in the biz not given in form of dividends b lability to sell goods for more than their cost to producesell vi vii viii Reports accountant s primary measure of performance of a biz SPECIFIC PD OF TIME acc Pd Explains how operations improved or harmed nancial position Net income measures success in sales for more than cost to sell Heading name of entity title of report unit of measure speci c period of time EQUATION REVENUEEXPENSENET INCOME Revenues Amount expected to be received from c whether paid or not cash amp credit 1 Ex Sale of goods rental of prop provision of service Expenses represent of resources entity used to earn revenues 1 Reported in one acc Pd may be paid for in another 2 Income tax expense pay on subtotal income b4 income taxes Net income quotbottom linequot excess of total revenues total expense 1 Net loss total expensesgt rev 2 Net income DOES NOT equal net cash generated by op C Dreports additional contributionspayments to investors amp amount of income company reinvested for future growth i Heading name of entity title of report unit of measure ii Speci c pd of time iii EQUATION beg Retained earning Net income dividends ending retained earnings iv Retained earnings indicates relationship of income statement to balance sheet d THINGS TO KNOW i provide info About nancial condition wo which statement cannot be understood ii HOW LISTED 1 Assetsby ease of conversation to cash 2 Liabilities by maturity due date iii Monetary sign beside 1st amount in group of items amp beside group total iv Single underline above total or subtotal amp double underline below 7 Acc communication process a GENERALLY ACCEPTED ACCOUNTING PRINCIPLES i Measurement and disclosure rules used to develop the information in nancial statements ii Determined 1 Traced from Italian monk luca pacioli 2 B4 1933 each rm determine own practices little uniformity 3 US creates SEC Securities amp exchange commission a Gave measuring rules that companies give to SH 4 TODAY Financial Accounting Board FASB make detailed rules of gen acc Principles FASB acc Standards codi cation iii Importance of GAP 1 Great interest to rms that prepare n St auditors amp readers of statements iv Publication of n St 1 Effects selling price of stock amount of bonuses 2 Loss of comp Info to other companies b Accuracy of nancial st i Ponzi scheme borrowing more money amp using it to pay off his early creditors ii Avoid prey to unethical conduct 1 Identify the bene ts of a decision and who will be harmed 2 Identify alternative courses of action 3 Choose the one you would like your fam amp friends to see reported on new iii Company records accurate 1 Maintain system of controls over records and assets 2 Hire outside independent auditors to audit fairness a examination of nancial reports to ensure they represent what they claim amp conform with GAAP 3 Form a committee of board of directors to oversee integrity of these safeguards Chapter 2 Accounting 1 Primary Objective of n Reporting to external users a Provide nancial info about reporting entity that is useful to existingpotential investors lenders creditors in making decisions to provide to entity b Assess amount timing uncertainty of a biz future cash in owsout ows c Creditors assess entity s ability to i Pay interest on a loan over time ii Pay back principal on loan when its due d Investors assess entity s ability to i Be successful so stock prices rise ii Pay dividends in future 2 Qualitative characteristics of useful info a nfo useful relevant faithful representation b Consistent and comparable basis c Attributes comparability consistency veri ability timeliness understandability d Relevant information in uences decisions it is timely and has predictive andor feedback value e Faithful representation requires that info be complete neutral error free 3 Recognition amp measurement concepts a Separateentity assumptionsa biz Activities are accounted for separately from those of its owners b Continuity goingconcern assumptionbz are assumed to continue into the foreseeable future long enough to meet its contractual commitmentsplans c Stable monetary unit assumption acc Info Should be measured amp reported in the national monetary unit wo adjustment for changes in purchasing power d Historical cost principle asset is recorded at cost doesn t change balance sheet elements recorded at cash equivalent value on date of transaction 4 Elements of balance sheet a Assetsprobable future economic bene ts owned or controlled by an entity as a result of past transaction or events i In order of liquidity how soon asset is expected to be turned into cash or used ii Current assets assets that will turn into cash Min 1 year 1 Inventory prepaid expenses rent cash short term investments supplies accts receivable iii Long termnon currentused or turned into cash after 1 yr 1 Property amp equipment investments intangibles patents trademarks iv quotReceivable prepaid expensesquot b Liabilities probable future sacri ces of economic bene ts arising from present obligations of a business as a result of past transactionevents i Creditorsentities that a company owes money to ii Accounts payable to suppliers accrued expenses payable wages utilities taxes unearned revenue notes payable to creditors iii In order of maturity how soon an obligation is to be paid iv Current liabilities what entity must pay by a year v quotUnearned payablequot c Stockholders equity residual interest in assets of the entity after subtracting liabilities combination of nancing provided by owners and biz operations i Provided by owners contributed capita owners invest in biz by providing cashother assets amp receive shares of stock ii Provided by operations Earned capitalretained earnings cumulative earnings of a company that have no been distributed to the owners and are reinvested in biz What business activities cause changes in nancial statement amounts 1 Nature of business transactions a Transactions events that are recorded as part of acc Process i Record only eco Resources and debits resulting from past transaction ii Two types of events 1 External exchanges of assets goods services by 1 part FOR assets services or promises to pay from 1 parties a Ex Sale of merch to customers borrowing cash fro bank 2 Internal events that are NOT exchanges but have a directmeasurable effect on entity a E Using buildingsequip Over several years iii Employment k leases other commitmentsl recorded in notes b Account a standardized format that organizations us 0 accumulate the dollar effect of transactions on each nancial statement item i Chart of accounts list of acct titles and unique numbers 1 Organize by nancial statement a Order assets liability SE revenue amp expenses 2 Most acct aggregated though name remains same How do transactions affect accounts 1 Transaction analysis fundamental accounting modeprocess of studying a transaction to determine its economic effect on the fundamental accounting model a Two principles i Every transaction affects 2 accounts correctly identifying those accounts amp direction of the effect inc dec is critical ii Acc Eq must remain in balance after each transaction 0 b Dual effects every transaction has at least two effects on accounting equation i Involve exchange entity both receives and gives up ii Promise in exchange for goodstransaction c Balancing acc equation i Step 1 what was received amp what was given Identify acc classify by type determine incdec ii Step 2 verify if 0 iii lSSUlNG COMMON STOCK 1 Par valuelegal amount per share established by board of directorsno relationship to mkt price of stock a Establishes a min amount shareholder must contribute 2 AFFECTS 2 ACCOUNTs common stock of sharespar value ampampampampamp addition paidin capital iv REVIEW 5154 How do companies keep track of account balances 1 Firms make acc Systems to track all acc Balances acc Cycle performed during acc Pd Separately from those that occur at end of acc Pd 2 ACCOUNTING CYCLE a DURING PERIOD i Analyze transactions ii Record journal entries in general journal iii Post amount to general ledger b AT END OF PERIOD i Prepare a trial balance debitscredits ii Adjust revenues expenses Record in jour amp post 2 ledge iii Prepare finst amp Give them to users iv Close revenues expenses gains amp losses to RE record in jour amp post 2 ledger c Transactions analyzed to determine acceffects i lstleENERALjOURNAL ist in chronological order of each transaction s effects ii 2 ddetermine accbaancespost journal to accounts in GENERAL LEDGER A record of effects to and balances of each acc 3 Direction of transaction effects a TACCOUNTSefficiently display incdec of assets liabilities amp SE i Inc in assetsleft bc on left side of ase ii Inc in l amp SE right bc on right side of ase iii Debit eft side amp creditright side dr cr 1 Assets dr cr 2 liabilities dr cr 3 se common stock no dr cr investment by owners retained earnings dr dividends declared cr net income 4 Total dollar value of all DR will equal CR 4 Journal Entryan accounting method for expressing the effect of a transaction on accounts in a debitsequalcredits format a Chronological order b Ex a Cash A DR 62300 CR i Common stock SE DR CR 100 ii Additional Paidin Capital SE DRCR 62200 Acct titles debit on top credit on bottom indented Amounts debit amounts on left credit on right Reference letter or date NoUce i All must equal ii Compound entryany journal entry that affects 2 accounts iii Formaine below journal entry to explain trans iv A L SE next to acc Title 5 Taccounts a General ledger Posts transfers dollar amount to a group of accounts affected by transaction i Each page represents a different acc rhme b Accounttool for summarizing transaction effects for each account determining balances and drawing inferences about a company s activities i Ending balance put on side it represents if positivenegative amp indicated w double underline ii Start w beg balance same reference as journal iii Line across T when ready to compute iv First quarter balances from year b4 on positive side HOW IS THE BALANCE SHEET PREPARED amp ANALYZED 1 Trial balancea list of accounts with their balances to provide a check on equality of dr amp cr a Taccts in 1col l nancial statement order a l se r e i Drcr in next two col ii Accounts that changed due to changed transactionshaded 2 After trial balance balance sheet a Good heading name of company title of statement date if dollars in thousands or millions b ASSETSLlABlLlTlESl i Assets Current turned into cash win yr and non current After yr ii Liabilities Current obligations to be paidsettled win yr c Dollar signs at top and bottom of a se d Comparative date compares account balances of last year to current ones most recent on left e Most companies don t make a liabilities line 3 Under GAAP a Assets decreasing order of liquidity 4 Ratio analysis in decision making a CURRENT RATIO current A current L i Measure ability of company to pay short term onganns ii Higher ratiomore cushion to pay iii Above 1 usually good liquidity can pay iv Ratio below 1 good cash management systems Chapter 3 1 How do business activities affect the income statement a Operating cycle i LT obj cash into more cash ii 1 Purchases gs to sell on credit iii 2 Pay cash to suppliers iv 3 Sell gs to customers v 4 Receive cash from customers vi Length of tie depends on nature of biz 1 Can borrow funds ahead or customers pay later 2 Improve cash ow incentives to pay sooner vii Time period assumptionlong life of a company can be reported in shorter time periods 1 Issues w periodic income a Recognition when should effects of operating be recorded b Measurement what amounts should be recognized b Elements of the income statement i Multi step 1 subtotal l operating income amp income b4 taxes ii Operating activitiescentra focus of biz 1 Revenue foodbevpack incl supplies salarieswages occupancy rent insurance utilities other adv maitanence depreciation expense genadmin mgmt training not directly related to store iii Peripheral activities not central to focus 1 Investment incomerevenue interest revenuedividend revenueinterest or dividends earned on investing in other companies Interest expense cost of borrowing money Gain loss on disposal of assetsselling investmentsother assets a Gainincrease in asset or decrease in liabilities from peripheral trans b Lossdecrease in assets or increase in liabilities from peripheral trans c Not central to focus of biz iv Income tax expense provision for income taxes v Operating revenues result from sale of gs 1 Revenuesincreases in assetssettlements of liabilities from ongoing operations 2 Pays for good or service in advance unearneddeferred revenue liability JUN a Recognized when rm provides gs vi Operating expenses 1 2 vii Expenditureany out ow of cash for any purpose Expenses out ows or using up of assets or increase in liabilities from ongoing operations incurred to generate revenues during a period a Incurred b4 after same time as paid b Cost of goods sod cost of saIessignificant expense NOT ALL CASH EXPENDITURES ARE EXPENSES BUT EXPENSES ARE NECESSARY TO GENERATE REVNUE Income tax expenseprovision for income taxesast expense on income statement b4 net income 1 Pro tma king corp required 2 Tax rate tax expenseincome before tax viii Earnings per sharerequired in statement or notes 1 2 Used to evaluate operating performance pro tability of company Net income divided by weight avg number of shares of stock outstanding ix GAAP categorizes expenses by biz functions 2 How are operating activities recognized and measured a Cash basis accountingrecords revenue when cash received amp expenses when cash is paid may lead to incorrect interpretationnot useful to external decision makers i Do not re ect all all b Accrual accounting records revenues when earned and expenses when incurred regardless of timing of cash receipts or payments i Revenue realization principe 4 conditions must be met for revenue to be recognized 1 Delivery has occured services have been renderedsubstantially performed acts promised to cus Persuasive evidence of an arrangement for customer payment customer provide cashreceivable Price is xeddeterminable Collectionreasonaby assuredreview customers ability to pay Conditions met at point of delivery regardless of when cash is received revenue earned when gS delivered although cash can be received before same after a Before hasn t delivered gs no revenue i Create liability acct unearned revenue 1 Amount of gs owed to customer ii After delivers food records revenue amp reduces liability b Same period earning revenue cash asset amp revenue c After delivery accts rec sales revenue receipt of cash cash accts receivable 6 Timing of cash receipts doesn t dictate when biz reports revenue ii Expense matching principleexpenses be recorded when incurred in earning revenue 1 Expenses recorded as incurred regardless of cash being paid a Before costs matched with bene ts i Payment for suppliesrentinsurance supplies A cash A ii Use of srl expensesSE supplies reduced to amount yet to be used b Same period repair service i Operating expenses ESE cash A c After expense ESE accrued expenses payable L i After pay wages accrued expense payable L cash A d Accrued expenses payable L amount owed to employees at end of current pedod 3 The expanded transaction analysis model a Transaction analysis rules i Revenue A cashaccts rec or L unearned subscription revenue 1 Increase net incomeSE 2 W credits ii Expense A supplies L wages payable 1 Decrease net income SE 2 W debit iii Questions to ask 1 Was revenue earned by delivering gs a Yes credit revenue amp debit for accounts for what was received 2 Was an expense incurred to generate revenue in current period a Yes debit expense acc amp credit in accts for what was given 3 If no revenue earned or expense incurred a Identify two account change by titles classify by type determine direction 4 Verify acc equation b Analyzing chipotles transactions i To measure re acc begin w 0 balance not listed on trial balance because have no balance yet 4 How is the income state prepared and analyzed a Listed in nancial statement order on trial balance i Unadjustedljno end of period adjustment have been made b Classi ed income statement i Based on unadjusted not presented to users c Net pro t margin ratio i How effect mgmt is in generating pro t on every dollar of sales ii Net income net sales operating revenue iii Difference in biz strategies explains wide variation in ratio analysis 1 Higher may be a more effective company in generating sales iv Common sized income statementsdividing each line on income state by net sales show shifts in mgmt strategies Chapter 4 adjustments nancial statement and the quality of earnings 1 Adjusting revenues and expenses a Accounting cycle i During acct pd exchanges bwn companyparties ii Endof pd adjustments to revenueexpenses in proper periodupdate balance sheet accts for reporting purposes b Purpose of adjustments i Adjusting entries entries necessary at the end of the account period to measure all revenuesexpenses of that period 1 Revenue recorded when earned rev realization principle 2 Expenses recorded when incurred to generate rev expense matching principle 3 Assetsreport at amounts that represent probable future bene ts remaining at end of the period 4 Liabilities report at amounts that represent probable future sacri ces of assets or services owed remaining at end of the period 5 Wait until end because if do everyday costly timeconsuming c Types of adjustments i Four types 2 cash receivedpaid amp 2 cash will be receivedpaid 1 Each type two entries a Cash receiptpayment either beforeafter end of period b Adjustment to record re in the proper period Adjusting entry 2 Adjusting entries that revenue a Deferred r previously recorded L that was created when cash was received in advance amp that must be reduced for the amount of revenue actually earned during the Pd i L RSE b Accrued rr that were earned but not recorded because cash will be received after gs delivered i A RSE 3 Adjusting entries that expense a Deferred previously recorded A rent supplies equipment created when cash paid in advance and that must be reduced for amount of expense actually incurred during p through use of asset i A ESE b Accrued expenses that have been incurred but not yet recorded because cash will be paid after gs used i L ESE d Adjustment process vi Was R earned or E incurred that is not yet recorded 1 Yes credit R or debit E Was the related cash received or pad in the past or will it be received or paid in future 1 Was receivedreduce L acct bc some or all has been earned since then 2 Will be received increase receivable account which creates an accrued revenue 3 Was paidreduce A bc some A used 4 Will be paidincrease payable acct which creates an accrued expense 5 CASH NEVER AN ADJUSTING ENTRY BC RECORDED ALREADY OR WILL BE Compute amount of R earned or E incurred 1 Trial balance change add propequip Costhistorical cost amp accumulated depreciation used cost total amount of accost used in prior pds to generate revenues Deferred unearned revenues 1 Previously recorded liabilities that need to be adjusted at the end of acct pd to re ect the amount of revenue earned 2 Customer redeeming gift cards a L unearned revenue amp R for restaurant sales revenue 3 ex Subscriptions season tickets air ight tickets rent received in advance Accrued revenue previously unrecorded revenues that need to be adjusted at end of acct pd to re ect amount earned and related receivable acct 1 Interest on investments l interest receivable A investment income R SE Deferred expense previously acquired assets that need to be adjusted at the end of acct pd to re ect amount of expense incurred in using assets to generate revenue 1 Supplies I fbp expense ESEA supplies vii 2 3 Prepaid expenses l occupancy expenses E SEA prepaid expenses a Compute amount of expense l prepaid monthsprepaid months Propequipl a Increase by cost of A when acquired amp decrease by cost of A when sold b Apart of cost used to generate revenue l expense c Depreciation an allocation of an asset s cost over its estimated useful life to the organization d Contraaccountan acct that is an offset to or reduction of the primary account i Directly linked to another acct but with an opposite balance ii Contra acct for propequip is XA accumulated depreciation credit balance bc opposite e net book value carrying value an asset is the difference bwn its acquisition cost and accumulated deprecriations contra acct f Depreciation ESE accumulated depreciation XA A g Amount of expense l given annual depreciation time Accrued expenses previousy unrecorded expenses that need to be adjusted at the end of the accounting period to re ect the amount incurred and related payable account 1 2 3 Ex Salaries expense utilities expense interest expense Salarieswages l paid next quarterl sw expense ESE accrued expenses payable L Interest on deth expense ESE accrued expenses payable L a 2 parts principal amount loaned amp interest cost of loan b Principal doesn t need adjusting c NOTE UNLESS TOLD OTHERWISE interest rate is annual percentage i Principalrate per year of months12 Utilities occupancy expense ESEaccrued expenses payable L 5 Income taxesincome tax expense E SEaccrued expenses payable L a Requires computing pretax income revenue balanceexpense accts plus other adj b All adjusted RgainsElossesl understated until recorded c Compute expense l pretax income tax rate viii Each adjust entry record revenues and expenses in proper period amp INCLUDE 1 INCOME STATEMENT AND ONE BALANCE SHEET ACCT 2 Preparing nancial statements a b an BALANCE sheets permanentl RELOSSGAIN temporary start w 0 Income statement i Earnings per share net income avg number of shares of common stock 1 Denominator number of shares at beginning of pd end of pd divide by 2 Statement of SE Balance sheet i Assets listed in order of liquidity ii Liabilities are listed in order of due dates Total asset turnover ratio How ef cient is management in using assets its resources to generate sales ii Total asset turnover ratio net sales operating revenueaverage total assets iii Measures sales generated per dollar of assets 1 High ef cient mgmt of assets iv Companys ps and biz strategy contribute to TR v Assess a company s effectiveness at controlling current and noncurrent assets vi Decline ratio bc corporate policies season uctuations 3 Closing books a End of accounting cycle i Permanent real accounts balance sheet accts that carry their ending balances into the next accounting pd 1 Only time becomes 0 if no longer owned or owed ii Temporary nominal accountsincome statement accounts that are closed to RE at the end of accounting pd 1 RLossGainE accumulate data for only current pd iii Closing entrytransfers balances in temporary accounts to RE amp establishes 0 balances in temporary accts 1 Transfer balance in temp accts to RE ex lncome statement accts 2 Establish 0 balance in each temp acct to start accumulation in next acct pd 3 Dated last day of acct pd iv Temp accts with debit balances are credited and temporary accts w credit balances are debited 1 Revenues credit balances close with debits 2 Expenses have debit balances close with credits 3 CE closing entry b Post closing trial balance i Prepared as an additional step of the acct cycle to check that debits equal credits and all temp accts are closed Chapter 5 communicating interpreting acct info 1 2 Corporate governance the procedures designed to ensure that the company is managed in the interests of the shareholders SarbanesOxley act a law which strengthens US nancial reporting and corporate governance regulations a Restore investor con dence Financial statement fraud Fraud triangle a lncentive to commit fraud i Counteract clear responsibilities amp punishments b Opportunity i Counteractstrong internal controls amp oversight by directorauditor c Ability to rationalize the misdeed i Counteractstrong code of ethic fair employee dealings amp rewards Players in acc communication process a Regulators i Securities amp exchange commission SEC 1 Protect investorsmaintain integrity of the securities market 2 US Gov agency that determines n statements public companies must prove to stockholders amp measurement rules to produce statements 3 Reviews reports led for standards irregularities and punishes violators 4 ii Financial acct standards board FASB 1 Overseen by SEC 2 Private sector body that s responsibility is to make detailed rules that become generally accepted acct principles GAAP iii Public company accounting oversight board PCAOB 1 Private sector body that issues detailed auditing standards for CPASs b Managers i Chief executive of cer CEO highest of cer in company ii Chief nancial of cer highest of cer associated w nacct side of biz iii Both CEO amp CFO certify 1 All reports led by SEC 2 No weaknessesde ciencies in internal controls 3 Disclosed to auditor any weaknesses or frau iv Accounting staff prepare the details of reports 1 Have responsibility of info accuracy c Board of directors Audit committee Elected by stockholders to represent their interests Responsible for maintaining the integrity of company s nancial reports Oversees CEO and other senior mgmt Audit committee nonmgmt directors w n knowledge 1 Hires company s independent auditors 2 Meet with them to discuss mgmt compliance w n reporting d Auditorsrequired by SEC Unquali ed clean audit opinion auditors statement that the n statements are fair presentations in all material respects in conformity with GAAP 1 CPA assume part of n responsibility for fairness 2 Adds credibility amp often required by lenders and private investors 3 Lowers interest e lnfo intermediaries info services amp nancial analysis Companies le SEC forms electronically through EDGAR 1 Free service amp available after 24 hrs fact report is tagged to identify source amp meaning using XBRL language info servicesinvestors gather own company info amp monitor analyst recommendations 1 primary tool of analysts 2 important for job seekers nancial analysts 1 receive acct reports from electronic info services 2 gather info from company exec amp visits to facilitiescompetitors 3 analyst reports a forecasts of future earnings buyholdsell recommendation explain judgments b earning forecasts predictions of earnings for future acct pds 4 specialize in particular industries and evaluated based on forecast accuracy amp stock picks f users institutionalprivate investors creditors amp others institutional investors managers of pension mutual endowment and other funds that invest on behalf of others private investorsindividuals who purchase shares in companies 1 ex Venture capitalists directly invested amp small investors bought shares lenders creditors vi vii 1 ex Suppliers banks commercial credit companies 2 suppliers nancial institutions that lend money to companies 3 lenders primary external user group of nancial statements of private companies nancial statements relationship bwn suppliers amp customers 1 customers check if suppliers are uptodate reliable 2 supplier check customers to evaluate future needs and ability to pay debts public nancial disclosure loss of competitive advantage cost effectiveness requires the bene ts of acct for and reporting information outweigh the costs 1 small amounts aren t reported if not in uencing user decisionimmaterial material amounts amounts that are large enough to in uence a users decision 5 Disclosure process a Managers amp insiders are prohibited from trading company shares so no bene ts from early access b Press releases iv Written public news announcement normally distributed to major news services Provide timely info to external users amp limit possibility of leakage 1 Apple issues Min 4 weeks of end of acct pd Conference call senior managers answer analysts ques ons 1 Open to investing public 2 Learn biz strategy expectations key factors analysts consider Unexpected earnings difference between expected and actual earnings c Annual reports amp form 10k Annual reports simple doc photocopied on white bond papers amp include 1 4 basic n statements income statement balance sheet sh equity amp cash ow 2 footnotes 3 report of auditors opinion led on form 10k annual report that publicly traded companies must le with SEC 1 include a descriptionstrategy of business b nancial data for 5 yr period c mgmt discussion amp analysis of nancial conditionresults of operations d n statements and supplemental data d quarterly report amp form 10Q private companies 1 condensed fewer details amp only key notes 2 unaudited 3 cash ow amp sh equity often omitted 4 prepare for lenders public companieleOQquuarterly report that publicly traded companies must le with SEC e other SEC form 8 K 8 Kused by publicly traded companies to disclose any material event not previously reported that is important to investors 6 Close look at n Statement formatsnotes a Comparative nancial statements compare performance from pd to pd ex 2 balance sheets amp 3 income statements b Additional subtotals amp classi cations amp disclosures c Classi ed balance sheet Intangible assets no physical existence and long life ex Patents trademarks amortization expense debit and contraasset accum amortizationcredit 1 Reported net of accumulated amortization 2 Goodwill represents excess of price paid for another company over value of is identi able assets Deferred revenues liabilities created when c pay for gs before delivered 1 Apple repairs current L amp repairs in later years noncurrent L d Classi ed income statement Gross pro t gross margingt net sales COGS Operating income income from operations Gross pro t operating expenses Income before income taxes pretax earnings l income of operationsnonoperating items 1 Nonoperating items revenues expenses gains and loses 2 Except INCOME TAX EXPENSE Net income pretax earnings income tax expense Nonrecurring items discontinued operations or extraordinary items 1 Discontinued biz soldabandoned or income lost gain or loss disposal 2 Extraord gains or losses that are unusual and infrequent a Rarely reported vi EARNINGS PER SHARE 1 NET INCOME AVG OF SHARES OR COMMON STOCK OUTSTANDING DURING PD e Statement of comprehensive income i Net income lossincome 1 Change on available sale investments 2 Change on cash ow 3 Loss from pension plan 4 Currency translation difference f Gross pro t percentage i Gross pro t as percentage of sales ii GPP gross pro tnet sales iii Ability to charge premium prices amp produce gs at low cost iv Managersanalystscreditors assess effective of rms product development marketing and production strategy g Statement of SH equitynet income RE stocks issued h Notes to nancial statements i acct rules applied in company s statements 1 which acct method company has adopted 2 without impossible to analyze n results ii Add detail supporting reported s 1 Supplemental info concerning data shown 2 Revenues broken out unusual trans offer expanded detail iii Relevant nancial info not disclosed on statement 1 Impacts company nancially but not shown on statements 2 Legal matters k agreements don t result in A or L i Voluntary disclosures 7 ROA analysis framework to evaluate company performance a Return on assets evaluates company performance i How much rm earned for each of investment in A ii Broadest measure of pro tability and mgmt effectiveness III b ROA net income avg total A c ROA Pro t driver analysis amp business strategy i ROA decomposition or DuPont analysis 1 Breaks down ROA into 2 factors a Pro t drivers b Pro t levers Driven by Net pro t margin net incomenet sales a How much of every sales dollarpro t b Increased by volume price or decrease of COGSoperating expenses 4 Total asset turnover net sales avg total assets a How many sales dollars company generates w each dollar of A b Increased by centralizing distribution reduce inventory amp consolidating production facilities 5 ROA NET PROFIT MARGIN TOTAL ASSET TURNOVER a NETINCOMEAVG TOTAL ASSES NET INCOMESALES NET SALESAVG TOTAL ASSETS ii TWO business strategies 1 Highvalue or productdifferentiation a Rely on research development amp product promotion to convince c of superiority or distinctiveness of product b Higher net pro t margin 2 Lowcost strategy a Ef cient mgmt of accts receivable inventory and productive A to produce high A turnover b Higher total asset turnover 0 How transactions affect ratios i Managers closely follow effect of actual planned trans on same key n ratios ii Three steps 1 Journal transaction to determine effect on accounts 2 Determine which accts belong to n statement subtotals or totals in numerator and denominator of ratios amp direction 3 Evaluate combined effects from step 2 on ratio iii What if numerator or denominator is affected 1 Expensel decrease net income numeratorl decrease net pro t margin ratio 2 Numerator change to numerator same change to ratio inc or dec 3 Denominator change to denominator opposite change to ratio inc dec JUN iv What if both numerator and denominator are affected by different amounts 1 If transaction affects numerator more than denominator vice versa then focus only on larger effect What if numerator and denominator are affected by same amount 1 Current ratio current A current L 2 Depends on whether original ratio value was great or less than 161 a If both increasing i gt1 decrease current ratio ii lt1 increase current ratio b if both decreasing i gt1increase current ratio ii lt1 decrease current ratio Chapter 6 reporting and interpreting sales revenue receivables and cash 1 Accounting for net sales revenue a lntro i Revenue realization principle revenues be recorded when earned delivery or services rendered ii Pt at which ownership switches hand depends on shipping terms of k iii FOB free on board shipping point title recognize at shipment iv FOB destination title recognize at deliver amp seller pay shipping v Appropriate AMOUNT of revenue to report CASH EQUIVALENT SALES PRICE b Motivating sales amp collections i Variety of methods to motivate biz amp customers to buy 1 Use credit cards 2 Biz w direct credit and discounts for early payment 3 Allow returns ii All AFFECT computation of net sales revenue c CC sales to consumers i Reasons 1 Increase customer traffic 2 Avoid costs of providing credit directly to c a Recordkeeping amp bad debts 3 Lower losses due to bad checks 4 Avoid loss from fraudulent cc sales a Cc company absorbs losses ii Cc discount fee charged by cc company for services 1 Sales cc discount net sales d Sales discounts to businesses i No formal written promissory note or cc ii Credit terms abbreviated 1 n30 net sales amount Min 30 days of invoice iii sales discount cash discount offered to encourage prompt payment of an acct receivable 1 210 n3O a c may deduct 2 from invoice if paid Min 10 days b if not must pay Min 30 2 bene ts a receipt of cash reduce need to borrow b decreases customers incapability to pay 3 sales revenue sales discount tota net sales e Sales returns and allowances Reduction of sales revenues for return or allowances for unsatisfactory goods Important measure of quality of customer service f Reporting net sales Top line reported in the income statements computed as 1 Sales revenue cc discount sales discounts and sales returns and allowances 2 Measuring and reporting receivables a Classifying receivables v vi Acct receivable open accounts owed to business by trade customers Note receivable written promises that require another party to pay business under speci ed conditions time interest 1 Pay principal at maturity date 2 Speci ed interest amount charged for use of principal Trade receivable created in normal course of biz when a sale of merch service on credit occurs Nontrade receivabletransactions other than normal sale 1 Loan money for VP to nance home by job loca on Current receivablescash collected win year Noncurrent receivable cash collected after year b Accounting for bad debts Subsidiary account separate accts receivable acct for each retailer that resells merch Retailers know some CUSTOMERS WILL NOT PAY DEBTS Expense matching principle requires recording bad debt in same acct period in which related sales are made 1 End of pd sale retailer usually doesn t know which acct receivable are bad debts Allowance method bases bad debt on an estimate of uncollectible accounts Two steps for allowance method 1 Recording bad debt expense estimates a Bad debt expense expense associated w estimated uncollectible accounts receivable i Ex Doubtful uncollectible provision for uncollectible accts expense b Adjusting entry at end of acct pd c Bad debt expense ESE i Allowance for doubtful accts XA A d Selling expense acct on income statement i Decreasing net income amp SE e Allowance for doubtful accts contra asset acct containing estimated uncollectible accts receivable 2 Writing off speci c uncollectible accts a THROUGHOUT THE YEAle if determined c wont pay debt writeoff to journal b Now that speci c c identi ed use assets no XA c Allowance for doubtful accts XA A i Accts receivable A d Doesn t affect income statement bc already an adjusting entry amp didn t affect total assets vi Bad debt recovery payment for an already written off acct 1 Accts receivable A a Allowance for doubtful accts XA A 2 Cash A a Accts receivable A c Reporting accts receivable and bad debts i Report balance for allowance for doubtful accts win acct title ii Amounts of bad debt expense amp written off accts receivable l 10k d Estimating bad debts i Based on 1 of total credit sales for pd simpler to apply a weekly or monthly 2 aging of accts receivable more accurate a monthly or quarterly ii same estimate from both methods rarely occurs iii percentage of credit sales method 1 compute amount to be recorded as bad debt expense on income statement for pd in adjusting journal entry 2 bases bad debt expense on historical percentage of credit sales that results in bad debts 3 total debt losses total credit sales 4 longer company is in operation easier to compute 5 credit sales bad debt loss rate bad debt expense iv aging of accts receivable 1 estimated ending balance in allowance for doubtful accts on balance sheet a current balanceestimated balanceadjusting entry 2 estimates uncollectible based on age of each acct receivable 3 age category estimated percentage uncollectibe ending balance for allowance for doubtful accts a estimated ending balance balance in allowance before adjustment bad debt expense 4 divide into 3 categories not yet due 190 days past due over 90 days v actual write offs compared with estimates 1 if uncollectible accts written off differ from estimated amount then higherlower amount recorded next pd a estimates incorrect n values for prior acct pd are not corrected vi control over accts receivable 1 minimize bad debts a require approval of c credit history by independent person of sales and coHchons b age accts receivable periodically amp contact c w overdue payments c reward sales and collections personnel for speedy collection so they work as a team vii ending balance for XA beg balancecurrent bad debt expense for year 3 Reporting and safeguarding cash a Cash and cash equivalents de ned i Cash money or any instrument that banks will accept for deposit and immediate credit to a company s acct ii Cash equivalents ST investments with original maturities of 3 months or less that are readily convertible to cash and whose value is unlikely to change 1 Not sensitive to interest rate changes 2 Ex Bank certi cates of deposit amp treasury bills b Cash mgmt i Protect from theft fraud loss ii Accurate accounting for cash ows balances iii Controls to ensure enough cash is available to meet operating needs maturing liabilities and unexpected emergencies iv Prevent accumulation of excess amounts of idle cash no revenue c Internal control of cash i Internal controlsprocess by which company safeguards its assets amp provides reasonable assurance regarding reliability of company s nancial reporting effectivenessefficiency of its operations amp its compliance w applicable lawsregulations ii Prevent advertent errors outright fraud iii Reviewed b outside independent auditor iv Different employees perform tasks so theft requires more effort v Separation of duties 1 Complete separating of receiving cash amp distributing cash 2 Separation of procedures of accts for cash receipts amp cash disbursements 3 Separation of physical handling of cash amp all phases of acct function vi Prescribed policies amp procedures 1 All cash receipts deposited in bank daily cash on hand under strict control 2 Separate approval of purchases and actual cash payments a Prenumbered checks b Special care w electronic funds transfers bc no controlled doc checks c Assign cash payment approval amp check signing elec funds to different individuals d Require monthly reconciliation of bank accts w cash accts on company s books d Reconciliation of cash accts bank statements i Content of bank statement 1 Bank statement a monthly report from bank that shows deposits recorded checks cleared other debitscredits amp a running bank balance amp bank charges EFT electronic funds transfers a Record as paper check so no add entry 4 NSFnon sufficient funds a Make entry to debit receivables and credit cash SC service charges INTinterest earned a Bank pays interest on checking acct balances b Debit cash credit interest income ii Need for reconciliation 1 Bank reconciliation process of verifying the accuracy of both the bank statement and cash accts of business a End of each month 2 Difference exists between bank statement amp books bc timing a Some transactions affecting cash were recorded in books but not on bank statement b Some trans in bank weren t recorded in books c Errors in recording 3 Main causes of differences a Outstanding checks checks written by company recorded in ledger as credits to cash but haven t cleared with bank i Compare list of canceled checks w record of checks b Deposit in transit i Deposits sent to bank and recorded as debits in cash acct on ledger ii Bank hasn t recorded deposits iii Happen when deposits are made 1 or 2 days before close of pd covered by bank statement iv Determine by comparing deposits listed w company deposit records c Bank service charges i Expenses for bank service listed on bank statement but not on company s books JUN mu d NSF checks bad bounced check have been deposited but must be deducted from company s cash acct an rerecorded as accts receivable e lnterest aid by bank to company on bank balance f Errors especially when volume of cashlarge 4 Bank reconciliation illustrated a Company should make one after receiving bank statement Ending cash balance per books Ending cash balance XXX statement XXX interest paid by bank deposits in transit NSF checks service charges outstanding checks company errors bank errors Ending correct cash balance Ending correct cash it XXX XXX b 2 major objectives i checks accuracy of bank balance amp company cash records ii identi es unrecorded trans or changes necessary 1 any changes on book side journal entries CAS E STU DY net sales sales revenue sales discounts amp cc discounts cash sales never produce bad debts percentage estimate of bad debts a percent sales credit 4 aging of accts a ending balance of allowance for doubtful accts current balance write offs bad debt expense 5 cc discounts and cash discounts as Contra accts WNH Chapter 7 accounting 1 6 Costquality of inventory concern of manufacturersmerchandisers a Focus on COSTS OF GOODS SOLD cost of salesproducts sold amp INVENTORY Income statement amp balance sheet i nventoryCA amp cogs subtracted from net sales to get gross pro t Goal of inventory mgmt a Suf cient quantities of highquality inventory available to serve customers needs b While minimizing the costs of carrying inventory Nega ves a Low quality returnsdissatisfactiondecline in future sales b Too few units stocksoutlost revenue dissatisfaction c Too many unitsincrease storage amp interest cost Acct system plays 3 roles in inventory mgmt process a System must provide accurate info for preparation of periodic nancial statements tax returns b Provide up2date info on inventory qualities and costs to facilitate orderingmanu Decisions c Info needed to protect important assets Natur of inventory COGS a Inventorytangible property held for sale in the normal course of business or used in producing gs for sale b Merch invgoods in nished condition ready for sale c Manuf inventory 3 types i Raw materials acquired for processing into nished goods ii Work in process goods in the process of being manufactured but not complete iii Finished goods manufactured goods complete and ready for sale Costs included in inventory purchases a Originally a cost invoice price amp expenditures b Costs of selling to dealers is after inventory is ready to use so go in general expenses instead c Cease accumulating purchase costs when i Raw materialsready to use ii Merchandise inventory ready for shipment d Flow of merch Inventory i Merch inventory increase ii Goods sold COGS increasemerch inventory decrease e Flow of manufacturing cost i Raw matierals direct ii When used go from raw to work in process inventory h Diret labor earnings of employees who work directly on products being manufactured Factory overhead manufacturing costs that are not raw material or direct labor costs i Cost of heat light and power 3 statements for inventory cost ow i purchasing production activities ii acitivties result in addition to balance sheet inventory iii inventory items sold and amounts become COGS expense on income statement 7 Costs of goods sold equation a b c d e Directly related to sales revenue of units sold sales price Cogs of units x unit costs Start acct pd w BEGINNING INVENTORY i ADD NEW PURCHASES ii Beg Inventory new purchases GOODS AVAILABLE FOR SALE iii SUBTRACT ending inventory what remains unsold iv AFTER SUBTRACTION lCOGS portion of goods available for sale that is sold cogs equation BIpEI COGS ending inventory for one acct pd becomes beg inventory for next 8 perpetual inventory systems a b C purchase transactions recorded directly in an inventory acct a detailed inventory record is maintained recording each purchase and sale during acct pd each sale recorded i companion cogs entry made ii decrease inventory iii record cogs detail record shows I units and cost of beginning inventory ii units and cost of each purchase iii units and cogs for each sale iv units and cost of the goods on hand at any pt in time 9 periodic inventory system a ending inventory and cogs are determined at the end of accounting pd based on physical count b physical count of goods remaining on hand is required at C end of each pd of units of each type of merch on hand x unit cost ending inventory 10 11 12 13 0390 LIFO COGS BIPEI amount of cogs cannot be reliably determined until inventory count is complete lack of inventory information i managers not informed about lowexcess stock s ua ons inventory costing methods inventory costs change inventory items treated as soldremaining can turn pro ts to losses amp cause companies to paysave millions in taxes accepted inventory costing methods avaible for determing cogs i rst in rst out ii last in rst out iii average cost iv alt ways to assign dollar amount of goods available for sale bwn El amp cogs cost ow assumptions NOT BASED ON PHYSICAL FLOW OF GOODS FIFO i Earliest goods purchasd are the rst goods sold ii Last goods purchased El iii Oldest units to cogs amp newest to El iv Take amount away of units that equal COGS I Most recently purchased goods are sold rst and oldest are left in El ii Newest units COGS amp oldest E Average cost method i Uses weighted avg unit costs of goods available for sale for both cost of goods sold and ending inventory ii Avg cost cost og goods available fo sale of units available for sale or total cost of units Financial statement effects of inventory methods Methods differ in dollar amount of goods available for sale allocated to cogs versus El Method w highest ending inventory lowest cogs highest gross pro t income tax expense and income amounts Average cost method income and inventory amounts bwn FIFO and LIFO extremes Managers choice of inventory methods 14 15 Choose acct method based on 2 fators i Net income effect prefer to report high esrnings ii Income tax effects leastlatest rule leat amount of tax allowed by law Con ictl chose 1 method for external nancial statements amp other for tax return LIFO conformity rule lifo used on tax return must be used to calculate inventory and cogs Increasing cost inventories i LIFO used bc results in lower income taxes ii Countries that don t allow LIFO use other 2 to report higher income Decreasing cost inventories i FIFO often used lowest tax payments for companies w decreasing cost inventories ii Highest cogs lowest pretax earning lowest income tax liability Consistency in use of inventory methods i Not reuired to use same method for all inventory items but must be on a consistent basis overtime 1 Change only allowed if will improve nancial results and position Valuation at lower of cost or mkt Special care to avoid overstating assets and income i Important for 1 High technology companies 2 Companies that sell seasonal goods ii Under LCM a HOLDING loss in pd where replacement cost of an item drops rather than pd when item is sold 1 HL purchase costlower replacement cost COGS Replacement costcurrent purchase price for identical goods i Becomes inventory valuation Net realizable valueexpected sales price selling costs Lower of cost or market a valuation method departing from the cost principle serves to recognize a loss when replacement cost or net realizable value drops below cost IF REPLACEMENT COST LOWER THEN JOURNAL ENTRY i COGS 1 INVENTORY IF REPLACEMENT COST HIGHER NO JOURNAL ENTRY i REMAINS THE SAME Measuring efficiency in inventory mgmt a SUFFICIENT quantities of highquality inventory while minimizing costs of carrying inventory b Inventory turnover ratio company s success in balancing con icting goals efficient inventory mgmt activities i Cogs avg inventory inventory turnover 1 High ratio inventory moves quickly through production process a Ultimate customer reduce storage obsolescence costs 2 Ratio decline demand for product is low 16 Inventory methods and nancial statement analysis a Comparing companies i Us public companies using LIFO msut report FIFO in notes if make drastic difference b Converting income statement to FIFO i Endng inventory amp next years beg inventory will be different 1 Cogs different ii LIFO Reserve quotexcess of FIFO over LIFOquot 1 Contra asset for excess of FIFO over LIFO inventory 2 REVIEWWWWWWW 3 Cogs lower income higher a Income tax l differencetax rate b Net income increased by COGS amp decreased by income tax expense c Converting inventory on balance sheet to fo i Substitute fo values for lifo 1 Add lifo reserve to lifo value 17 L o and inventory turnover ratio Ratio is deceptive Ending inventory small bc re ect lower costs 18 Control of inventory a Internal control of inventory i Second most vulnerable to theft ii Separate responsibilities for inventory acct and physical handling of inventory iii Store inventory to protect it from theftdamage iv Limit access to inventory v Maintain perpetual inventory records vi Compare perpetual to periodic b Errors in measuring ending inventory i Measurement of El affects both balane sheet and income statement 1 Affecs net income this and next pd O39QJ Chapter 8 1 Acquisition amp maintenance of plantequipment a Classifying longlived assets i Longlived assets tangible and intangible resources owned by biz and used for several years in operation ii Tangible assets physical substance 1 Land 2 Building xtures and equipment property plant equipment or xed assets 3 Natural resources iii lntangible have special rights but not physical substance 1 Patents copyrights trademarks goodwill licenses franchises b Measuring and recording acquisition cost i All reasonablenecessary expenditures made in acquiringpreparing asset should be recorded as cost of asset ii Expenditures are capitalized when they are recorded as pa rt of cost of asset instead of expenses 1 Costs fees taxes added to purchase price 2 Special discounts subtracted 3 Interest charges expensed as incurred iii Basket purchasegt total cost allocated to each A in proportion to A s mkt value relative to total mkt value of assets as a whole c Acquisition cost net cash equivalent amount paid or to be paid for asset i Forcash 1 CASH EQUPMENT aCASH ii For debt sign note payable for aircraft amp aid cash for transport prep costs 1 FLIGHT EQUIPMENT aCASH b NOTES PAYABLE 2 Operating leases short term a Not on LA of balance sheet 3 Financingcapital lease long term a Acquisition of A on balance sheet w lease obligations iii For equity or other noncash considerations 1 Stock or rights given by rm to seller to purchase gs 2 FLIGHT EQUIPMENT a COMMMON SOTCK b ADDITIONAL PAID IN CAPITAL 0 CASH iv By construction 1 Construct A for own use instead of buying it from other 2 Include all necessary associated costs w construction 3 Capitalized interest refers to interest expenditures included in the cost of a self constructed asset 4 FIXED ASSET aCASH d Repairs maintenance improvements V Ordinary repairs and maintenance expenditures that maintain productive capacity of A during the current acct pd only and are recorded as expenses 1 Recurring in nature 2 Small amounts at each occurrence 3 Do not directly increase productive life efficiency or capacity 4 MAINTENANCE AND REPAIRS EXPENSE aCASH lmprovements increase productive life operating efficiency capacity of A and are recorded as increases in A accts not expenses 1 Occur infrequently large amounts of increase A s economic usefulness 39 2 Ex Major overhauls complete reconditioning replacement 3 FLIGHT EQUIPMENT aCASH Subjective decision about difference Capitalizing expenses 1 Increase A amp net income 2 Lower future yr income Expense 1 Lower taxes 2 Use impairment and disposal of plant amp equipment a Depreciation concepts Longlived A w useful life Except land represents prepaid cost of a bundle of servicesbene ts Expense matching principleportion of an A s costs be allocated as an expense in same pd of revenues are generate by its use iii Depreciation process of allocating the cost of buildings equipment over their lives using a systematic and rational method 1 Cost allocation 2 DEPECIATION EXPENSE a ACCUMULATED DEPRECIATION XA A i Added onto the year before 3 DEDUCTED FROM RELATED A S COST iv Net book carrying value acquisition cost accumulated depreciation b Approximation of remaining life compare book value of A to original cost i Book value 100 of cost new A ii Book value 25 of cost 25 of life remaining iii Calculate depreciation expense 3 required amounts 1 Acquisition cost 2 Estimated use life to company 3 Estimated residual value at end of A s useful life to company iv DEPRECIATION EXPENSE ESTIMATE v Estimated useful life expected service life of an asset to present owner 1 Years 0 units of capacity c Differences in estimated lives win single industry i Residual salvage value estimated amount to be recovered by company at end of A s estimated useful life 1 Value as scrap salvage or if sold to another user d Alternative depreciation methods i Match depreciation expense w revenues generated in a pd ii Choose different methods for speci c A or groups iii Straightline depreciation 1 Method allocates the depreciable cost of an A in equal periodic amounts over its useful life 1 Cost residual value X 1 useful life depreciation expense a Cost RV depreciable cost b 1UL straight line rate 2 Depreciation schedule computed amount of depreciation expense each yr over entire useful life of the machine 3 depr Expense adjusting entry on income statement at yearend 4 accum depr balance in XA after adjusting entry 5 net book value cost accum depr a last nbv equal to estimated residual value at end of useful life Side notes e depreciation expense constant each year f accum depr increases by equal amount each yr g nbv decrease by same amount each year until equals residual value h increased pro tability due to an acct adjustment i how managers choose year SL formula Depreciati Accumulat Net on ed book expense depreciatio value n 2014 62500 20000 20000 4250 2500 13 0 2015 62500 20000 40000 2250 2500 13 0 2016 62500 20000 60000 2500 2500 13 nancial reporting 1 corp managers determine which method matches revenues and expenses for any given asset 2 asset expects to provide bene ts evenly over time sl a easy to useexplain b during early yr of A life sl method reports higher income 3 pick accelerated method if A produce more revenue in early life because more ef cient in later years tax reporting 1 two sets of acct records same transactions 2 different sets of measurement rules 2 GAAP for stockholders amp other for internal revenue code a Gaap economic info about biz that is useful in future cash ow b rc raise suf cient revenues to pay for expenditures of fed Gov 3 Least and latest rule a Taxpayers want to pay lowest amount of tax that is legal and at latest possible date j 2 sets of books i legal and ethical but must re ect same transactions ii corps Use IRS approved modi ed accelerated cost recovery system to calculate depreciation expense for their tax returns 1 applied over short A lives to yield high depreciation expense 2 reduces corp taxable income 3 MACRS incentive for corps to invest in modern xed A in order to be competitive a Not acceptable for nancial reporting purposes k Disposal of property plant amp equipment i Biz can voluntarily not hold a longlived A for entire life 1 Sales trade in retirements ii lnvoluntarily result of casualty iii Disposals of LLA seldom occur on last day of acct pd iv Depreciation MUST BE RECORDED on date of disposal for amount of cost used since last time depreciation recorded v Two journals 1 Adjusting entry to update depreciation expense amp accum depreciation 2 Entry to record disposal a Cost of A amp accumulated depreciation at date of disposal must be removed from accts b Cash received book value at date of disposal gain or loss on disposal i Report on income statement ii Not operating revenue because arrives from incidentalperipheral activities iii Separated on income statement vi Update depreciation for year 17 1 Depreciation expense E 1200000 a Accumulated depreciation XA 1200000 vii Record the sale 1 Cash A11000000 2 Accumulated depreciation XA20400000 a Flight equipment A30000000 b Gain gain SE Accumulated depreciation l depreciation years Chapter 9 acc 1 Intro a Finance A with funds from i Creditors debt ii Owners equity iii Mix of debtequity capital structure b Factors managers consider when they borrow i Risk 1 Debt more risky than equity bc are company s legalongann a If not met company can go bankrupt amp require sale of A ll Cost 2 Laiboilities de ned and classi ed a Liabilities probable debtsobligations that result from past transactiong which will be paid for with A or services i lnterest that will be paid in future 1 Not included bc accrues amp becomes a L overtime b Different operating activities results in different types of liabilities c Current liabilities ST obligations paid win the current operating cycle or 1 ur whichever is longer d Liquidity ability to pay current obligations i Measure by current ratio amp working capital CACL 1 Working capital margin of safety that determines if can pay ST obligations or not e Working capital i Manage to provide liquidity wo tying up excessive amounts of in nonproductive A 1 Justintime inventoryuse statistical methods to maintain optimal levels of inventory based on forecasted needs 3 Current liabilities a Accounts payable i Transactions made on credit paid w cash after gs provided ii Normally no interest accrued iHlncenUves 1 Credit terms allow buyers to resell amp get cash before having to pay for gs iv Managers may delay to conserve cash 1 NOT GOOD BC 2 Effect postivie elationship 3 Effect quality of gs 4 Slow payment of debt 5 Concern if biz can pay creditors on time 6 Indicates nancial dif culty v Accounts payable turnover ratio evaluate effectiveness in manaing payables 1 COGSaverage accts payable 2 Higher paying on time b Accrued liabilities i Expenses that have been incurred but haven t been paid at end of acct pd 1 Include property tax electricity salaries ii Recorded as adjusting entries at yr end iii Accrued taxes payable 1 Firms pay tax on income earned 2 Major cost iv Accrued compensation amp related costs 1 Employees earn salaries that haven t been paid 2 Must report cost of unpaid bene ts as well 3 Vacation time a End of yr of performing service rather than take vacation i Compensation expense eSE 1 Accrued vacation liability L b After vacation is taken i Accrued vacation liability 1 Cash A 4 quotquot part of accrued compensation v payroll taxes 1 employee income taxemployers withhold income tax of employee a recorded as CL i bwn date deduced amp date given to gov ii FITW nderal income tax withheld 2 Employee and employer FICA a Social security taxes b Required by federal insurance ontributions act c Euql amounts on both employee and employer 3 Employer unemployment taxe a Cost of hiring employees is more than amount employees actuallr eceive b Employers charged unemployment tax to provide support to employees laid off not personal reason 4 Payroll made w two entries a FOR EMPLOYERS Compensation expense ESE i Liability for incomes taxes withheld L ii FICA payable L iii Cash A b FOR EMPLOYEES compensation expense ESE i FICA payableL ii FUTA payable L c Notes payable i Company borrows money ii Speic s amount date to be repaid interest rate iii Time value of money interest that is associated with the use of money over time iv lnterest formua principal interest ratetime v When borrow 1 Cash A a Notes payable ST L vi Interest expense recorded when incurred when used 1 Interest expense ESE a lnterest payable L vii When interest due 1 Interest expense ESE 2 Interest payable L a Cash A d Current portion of LT debt i If liability not generating ash in next acct pd GAAP says it isn t urent e Deferred revenues i Cash paid before delivery ii Revenues collected but not earned liabilities until gs have been provided f Estimated L reported on BS i Some recorded L based on estimates bc wont be known until future date ii Ex Warranty 1 Reduction from sales revenue 2 In the year of sales g Estimated L reported in notes i Events that create a possible future sacri ce but not proable ii Contingent Lpotential L from past event but is not an effective L until some future event occurs 1 Most common litigation iii Causes a contingent loss iv Whether situation is recorded or contingent L 1 Probability of future economic sacri ce 2 Ability of mgmt to estimate amount of L a If cant be estimated note b And if reasonably possible h Summary i Lprobably amp reasonably estimatedrecorded on balance sheet ii L on note reasonably possible whether estimate or not ill Remote contingencies not recorded Working capital mgmt i Working capitalCACL ii Signi cant impact on healthpro tability of company iii Atively managed to see costbene ts iv Too little risk of not being able to pay creditors v Too much tie up resources in unproductive Aincur costs 1 Too much inventory money could be invested elsewhere amp cost to store and deteoriates vi Changes in WC affects cash ow 1 Changes in WC accts related to income producing activities a part of omputing cash ows 2 Decrease in CAD on cash ow 3 Increase in CAD cash ow 4 LT Liabilities a b c d Require payment more thant 1 yr in future All entitys obligations not considered CL Secured debt liability not satis ed where the creditor may take ownership of A Unsecured debt creditor relies on borrowers integrity and earning power LT notes payable amp bonds i Private placementaising debt from nancial service organizations bank insuance companes pension plans 1 Note payablewritten promise to pay a sum at 1 or more dates maturity date ii Bonds publically traded debt 1 Companys need gt creditors ability 2 Bondholders can sell bond prior to maturity if have immediate need for cash a Provide liquidity to investors more likely to lend money to company iii Recorded when debt incurred amp interest expense recorded with passage of time iv Borrowing in foreign currency exchange rate risk 1 Companies often repay foreign currenct debt with earnings from operations in foreign country f Lease L i Operating leasedoesn t meet 4 criteria for a capital lease established by GAAP amp dosnt cause recording of AL 1 Lease A on ST basis 2 No L recorded instead RENT EXPENSE when used ii Capital lease meets at least 1 of 4 criteria and results in recording an AL 1 Lease A on LT basis 2 Accounted for as if an A 3 Criteria to be capital lease a Lease term is 75 of A expected economic life b Ownership of A is transferred to lesse at end of lease term c Lease k permits the lesse to purchase A at lower price than fair mkt value d Present value of lease payment is 90 of fair mkt value of A when lease signed 5 Present value concepts a Present value current value of an amount to be received in future a future amount discounted for ompound interest i Based on time value of b lnvesting today with a interest is diff than receiving same amount 1 yr from toay c Know dollar amount of cash ow occur in the future and determine rpesent value d Present value of a single amount i Present value11iquotn x future amount ii Nperiod amp iinterest rate 6 Present value of annuity a Annuity series of periodic cash rceiptspayments that are equal in amount each interest pd i Equal dollar amount each interest pd ii Interest pd 0 equal length iii Equal interest rate at each pd b Each year separately i Ex 100 on dec 31 20141516 1 10 interest rte 2 1st yr l 1000 1 110quot1 3 2ncl yr 1000 1110quot2 4 3rCI yr l 1000111quot3 c interest rates and interest periods 7 accounting applications of present values a compute amount of a L with a single payment I ex ii Delivery trucks APV 1 Notes payable LPV iii Each yr interest expense in adjusting entries iv Dec 31 2014 1 Interest expense ESEpvinterest a Notes payable Lpvinterest v Dec 312015 1 Interest expense ESEpvprior interest interest a Notes payable Lpvinterest vi Full payment of debt 1 Notes payable Lfuture amount a Cash Afuture amount b Compute amount of L with an annuity i 1st value per year 11iquotn pv ii printing equipment APV 1 notes payable LPV iii each year payment 1 notes payable L paymentinterest 2 interest expense ESE pvinterest a cash Aadd NP amp IE iv 2nOI yr 1 notes payable L paymentinterest 2 interest expense ESE pvprior NPinterest a cash Aadd NP amp IE c PV involving both annuitysingle payment i Compute pv separetly ii Add two amounts together d Compute amount of a lease liability i Roasting equipmetntpv 1 Lease payablepv Chapter 10 1 Intro a Provides liquidity b If lend money directly wait to be repaid but if bon can sell before maturity c By issuing more liquid debt companies reduce cost of LT borrowing 2 Characteristics of bonds payable a Raise money for LT purposes b Bonds instead of stock i Stockholders maintain controlbondholders don t share in companys earnings ii Interest expense is taxdeductibereduces the net cost of borrowing BUT stock dividends aren t tax deductible iii Impact on earning is positive c Bonds have higher risk than equity i Risk of bankruptcyinterest payment are zed and must be paid each pd whether frim earns or has loss ii Negative impact on cash owsmust be repaid at a speci c time 1 Mgmt must be able to generate cash to repay or re nance it d Bond principal face amount par value amount payable at the maturity of the bond amp on which periodic cash interest payments are computed e Stated ratethe rate of cash interest per period stated in the bond contract f Different risk and return preferences i Retired ppl lower interest rate in return for greater secur y 1 Mortgage bond a Pledges security incase rm cant pay bond ii Accept low interest rate and unsecured states for opportunity to convert bond to common stock in future g Types of bonds i Unsecured debenture no A pledged as gurantee of repayment at maturity ii Secured bondspeci c A are pledged as a gurantee of repayment at maturity iii Callable bondcalled for early retirement at option of issuer iv Convertible bond bond may be converted to common stock of the issuer h lndenturebond k that speci es the legal provisions of a bondissue i Covenants included 1 Limit company s future actions a Mgmt wants least restrictive b Creditors wan more reduce investment risk 2 In notes of nancial statements i Bond issuer creates a PROSPECTUS i Legal document that is given to potential bond investors 1 Describes company 2 Bonds 3 How proceeds of bond will be used j Bond certi catethe bond document that each bondholder receives i Each issued for a bond are identical 1 Same date interest rate and other k Trusteeindependent party to represent bondholders i Ascertain whether the issuing company has ful lled a provision of the bond indenture ii Defaut risk probablitity that bond issuer wont be able to meet requirements in speicifc indenture iii Junk bonds with ratings below BBB iv Banks mutual funds and trusts invest only in investmentgrade bonds 3 Reporting bond transactions a Two types of cash payment i Principalpar value or face valuesingle payment that is made when bond matures ii Cash interest paymentsannuity 1 Interest contract stated coupon rate 2 K specifies when will be paid 3 If interest paid more than once a yr adjust interest rate a If twice a yr divide by 2 b Market value determines price of bonds not issuer i Find present value of principal and interest payments and add them c Market interest rateyieldeffective interest ratecurrent rate of interest on a debt incurred d Pv of a bond may be i At par ii Bond premiumabove par iii Below premium bond discount e Mkt rate i Same as state at par ii Above statedbond discount iii Below stated bond premium 4 Bonds issues at par a Compute present value i Single payment par value 11interest rate per pdquotn ii Annuity interest 1interest rate per pdquotn iii Add them b Date issue record PRESENT VALUE i Cash APV ii bonds payable LPV c reporting interest expense on bonds issued at par i interest expense ESEinterest rate per period 1 cash Ainterest rate per period ii interest expense that has been incurred but not paid must be an ADJUSTING ENTRY d times interest earned i net incomeinterest expenseincome tax expenseinterest expense 1 shows amount of resources generated for each dollar of interest expense 5 bonds issued at discount Interest paid out to cash right away so amortization only added to par value a compute present values i single payment amount 11 mkt interest rate per pdquotn ii annuity interest rate based on state 11mkt interest rate per pdquotn b record i cash APV ii discount on bonds payable LparPV 1 bonds payable Lpar c amortization of bond discount results in an increase in interest expense d amortization methods i straight lineeasier to compute ii effective interestrequired by GAAP e PART A reporting interest expense on bonds issued at discount STRAIGHTLINE i Take the bond discountOf pds ii Add that number to cash payment of interest rate iii Interest expense ESEbond discount each pdinterest rate 1 Cash Ainterest rate Stated 2 Discount on bonds payable Ldiscount on BP per pd iv At maturity date unamortized discount0 f PART B reporting interest expense on bonds issued at discount EFFECTIVEINTEREST AMORTIZATION i Interest expense 1 Unpaid balancepvmkt interest rate n12 a N of months in each pd ii Compute amortization 1 Interest expensecash interest iii Discount on bonds payable changes each period iv Next period 1 Interest expense ESEpvmkt interest raten12 a Cash Ainterest rate Stated b Discount on bonds payable L subtract v With each pd pv increase by the discount on BP vi Interest expense increases whereas straight line the interest expense is the same 6 Zero coupon bonds don t pay cash interest a Deeply discounted and will sell for much less than par value 7 Bonds issued at premium a Compute present value i Single payment par value 11mkt interest ratequotn ii Annuity interest rate per month 11mkt interest ratequotn b Issue bond i Cash Apv 1 Premium on bonds payable Lpvpar 2 Bonds payable par value c PART a reporting interest expense on bonds issued at premium EFFECTIVEINTEREST AMORTIZATION i Interest expense ESEbond premium each pd interest rate ii premium on bonds payable Lpremium on BP per pd 1 Cash Ainterest rate Stated III d PART B reporting interest expense on bonds issued at premium EFFECTIVEINTEREST AMORTIZATION 1 Interest expense ESEpvmkt interest raten12 2 Discount on bonds payable Lsubtract a Cash Ainterest rate Stated 8 Debttoequity a Total liabilitiesSE b Highlj rm relies heavily on creidtors 9 Early retirement of debt a Bonds payable par value c d 10 a b c d Chapter 11 1 Intro a b Loss on bond call SE percentage of par value from 100 i Cash Aadd Buy own bond on market if have no call feature Interest rates go up bond prices fall Bonds payable Cash in ow Repayment of principalcash out ow Payment of interest not in cash ows for nancing Cash payment made to It creditors out ow nancing activities Corporations cirtical advantage because can raise large amounts of capital because both large and small investors participate Two primary sources of SH equity i Contributed capitalamount of money stockholders inested through the purchase of shares ii Retaind earnings Accumulated earnings companys pro tmaking activities 1 Cumulative net incomeamount of dividends 2 Ownership of a corporation DP00quot f Law recognizes as separate entity Continuous existence seaorate from owners Apply to state gov issued charter articles of incorporation Governed by board of directionselectd by stockholders Bene ts of stock ownership i Receive shares of stock u can sell on stock exchanges ii Voice in mgmt vote in SH meeting on major mgmt issues 1 Number of votes number of shares owne Dividends receive proportional share of dristribution of pro ts Residual claimyou will receive a proportional share of distribution of remaining A upon liquidation v Board of directors amp employes accountable to SH Authorized issued outstanding shares i Authorized of shares max number of shares of capital stock that can be issued as speci ed in charter ii lssued sharesstock sold to public iii Treasury stock stock bought back by company iv Outstanding stock owned v sharesrefer to total number of shares of by sh on any particular date Issued sharestreasury stock outstanding shares g Earnings per share ratio i Net income preferred dividendsavg number of common shares outstanding ii higher stock priceshigher eps 3 common stock transactions a common stockbasic voting stock issued by corporation i owners vote amp receive some pro t ii par valuenominal value per share of capital speci ed in charter basis for legal capital egacap aL permanent amount of capital de ned by state law that must remain invested in the biz cushion for creditors iv nopar vaue stocka capital stock that has no par value speci ed in corporate charter b initial sale of stock i two names apply to transactions 1 lPOinitial public offeringvery 1st saleof company s stock to public a Signi cant returnsrisk 2 Seasoned new issuesafter stock has been traded additional sales of new stock to public ii Cash A number of shares price per share 1 Common stock SE Number of shares par value 2 Capital in excess of par SEsubtract c Sale of stock in se condary mkts i Transactions bwn investors don t affect company nancial statements ii Managers walk stock prices cosey d Stock issued for employee compensation i Separation of ownership amp mgmt 1 Some ii Solutions managers may not act in owners interest 1 Compensation packages reward mgmt for meeting goals 2 Offer stock optiond buy stock at xed rate a b c d e Repurchase of sto Risk free investment Stock declines u have lost nothing Stock increases can sell to get more money Reported as expense ck i Less costly to give employee s repurchased stock then to issue new ones ii Treasury stock no voting dividend or sh rights while owned by company f Treasury stock SE of shares price g i CashA If resold treasury stock cant report incomeloss i PRICE ABOVE Cash Ashares current price 1 Treasury stock SEshares price when bought 2 Capital in excess SEsubtract ii PRICE BELOW Cash cash Ashares current price iii Capital in excess SEsubtract 1 Treasury stock SEshares old price 4 Dividends on common stock a Return on investment stock price appreciationdividends f i Dividend yield ratio 1 Dividends per sharemkt price per share Important dates for dividends i Declaration dateboard of directors approves dividend ii Record date the date which corp prepares list of current SH as shown on records dividends paid only to SH who own stock on that date iii Payment date the date at which a cash dividend is paid to SH of record Declaration date i Retained earnings SE of shares times dividend 1 Dividends payable L of shares times dividend payment date i Dividends payable L of shares times dividend 1 Cash A of shares times dividend Fundamental requirements of payment of cash dividend i Sufficient retained earnings 1 Laws usually limit dividends to balance in RE acct ii Sufficient cash 1 No necessary relationship exists between RE and cash In us no legal obligation to declare divdends g Exdivdend date two days before record date i If u buy stock before this date then get dividend ii If buy after original owner gets dividend 5 Stock dividends and stock splits a Stock dividends Distribution of additional shares of corporation own stock Pro rata basisadditional shares equal to of shares held 1 Percentage of company owned not numbers of shares held Increase in stock dividends fall in price of stock If sd is arge
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