MGT201 FINAL REVIEW

sole proprietorships

A business structure where a single individual owns and operates the business. They have complete control and are personally liable for all debts and obligations.

→ HAS TAX ADVANTAGES

corporations

a legal entity formed by individuals or shareholders to conduct business activities. It has its own rights, liabilities, and obligations separate from its owners. It provides limited liability protection to its shareholders, meaning their personal assets are generally not at risk.

Net Income

When Revenue > Expenses

Net Loss

When Expenses > Revenue

Order of Financial Statements: (4)

1. Balance sheet / statement of financial position

2. Income statement

3. Statement of changes in Equity

4. Cash Flow statement

What does the Balance sheet show?

Statement of Financial Position

→ reports ASSETS/ LIABILITIES/ EQUITY owned by a company

Income Statement

Reports performance wellbeing of a company

→ Report its REVENUE/ EXPENSES/ INCOME

What does ‘Past Net Earnings’ show? Why does it matter?

Provides investors with information about the company’s ABILITY to earn future income

Statement of changes in Equity

Reports HOW much of the company’s earnings are retained to the business

→ after dividends are distributer

→ after how much shares are issued/ repurchased

→… after other changes in equity overtime

Statement of Cash Flow

Reports what companies used their cash ON

What is the Accounting Equation?

Assets = Liabilities + ShareHolder’s Equity

Define General Ledger

A collection of all individual financial statements accounts that a company uses

What is POSTING?

POSTING is the process of transferring information from the journalised transaction to the general ledger

LAND DOES NOT…?

LAND DOES NOT DEPRECIATE

What are Current Assets? What do they consist of?

Current Assets consists of cash + other assets that will be converted into cash.

What do

• account receivable

• cash

• inve

Accounting Cycle steps (7)

1. ANALYZE transactions

2. JOURNAL transactions

3. post to ledger

4. prepare a TRIAL BALANCE

5. *make necessary adjustments to trial balance

6. prepare financial statements

7. prepare closing entries+ post closing trial balance

3 steps to Transaction Analysis

1. Accounting equation: Assets = Liabilities+ SE. EQUITY

2. Identify what factors in the balance sheet are affected

3. Determine whether the factors affected increased/ decreased, comparison to previous financial statements

In Double Entry what is the effect for ASSETS

DEBIT INCREASE

→ credit decrease

In Double Entry what is the effect for LIABILITIES

debit decrease

→ CREDIT INCREASE

In Double Entry what is the effect on SH. EQUITY

CREDIT INCREASE

,

debit decrease

What does the trial balance show? And what doesn’t it show?

Trial balance only proves the equality between debit & credit.

where debit=credit.

→ Trial Balance will NOT detect any errors of analysis

What are the order of active accounts?

1. Assets

2. Liabilities

3. Shareholder’s Equity

4. Revenue

5. Expense

What are the effects to Liabilities when Dividends are declared?

Liabilities increase

What is the effect on the journal entries when Dividends are declared and paid for?

On the journal entries, it requires 2 separate entries.

1. Declaring it, CREDIT dividends payable

2. Actually paying it , DEBIT dividends paid

After the trial balance, and we make final adjustments what are the two types of Accounting we can choose from?

1. Cash Basis Accounting

OR

2. Accrual Basis Accounting

Cash basis accounting records revenue when_____

When Cash is RECEIVED

→ regardless if revenue is earned

Accrual basis accounting records revenue when ______

Transactions are recorded when revenue is EARNED

→ unrelated to when cash is received or not

What are the Recognition principle? (4)

*Recognition principle determines when revenue is recorded/reported

1. Significant risks+ rewards of ownership must have been transferred FROM seller to purchaser

2. Amount of revenue+cost MUST be RELIABLY measured

3. Managerial involvement should NOT be retained by the seller; seller should NO LONGER have any effective controls over goods sold

4. Economic benefits must be made possible to be flowed to the seller

What is Auditing?

→ process of reviewing the accuracy of the financial statement

*each company must have INTERNAL control over financial reporting

What is the key difference between Internal Audit vs. External Audit?

Internal auditing is performed from an internal department or sector of a company, they perform checkups before sending financial statements to external auditing.

→ Where as external auditing has no affliction with the company itself

Effects on errors caught during the External auditing process

Stock price will be affected due to any errors detected in the auditing process; depends how big of an error it is

Define ‘MONITORING‘

Process of tracking potential & actual problems in the internal control system

What are ELEMENTS of Internal control (4)

• understanding the business’s CONTROL ENVIRONMENT

  → RISK ASSESSMENT

  →in order to design CONTROL activities to eliminate risks regarding company’s assets

  → Monitoring activities

Who uses Accounting information?

External decision makers - government/ banks/ investors/ suppliers

Internal decision makers - board of director/ CFO/CEO

What is the auditing process?

= Internal + External Audits

What is the foundation of the market control system?

Control Environment

Control Activities follow one of the 6 categories

1. authorization of transactions

2. documentation adequacy

3. segregation of duties

4. physical controls

5. independent checks on performance

6. human resource controls

What category of control activities is refunding part of?

Refunding is an example of authorisation of transactions: requires authorization to the quality of the item to be resold

What does segregation of duties do to benefit the company?

• To increase likelihood of errors being detected

• to eliminate risk of major theft

• increase efficiency

What category of control does the procedure of apple and best buy follow?

Physical Controls

• Physical protection for its assets

→safeguarding requires physical protection of the asset

Examples of independent checks on performance:

• Number of records

• Number of Inventory

5 categories of Ratio Analysis

1. short term liquidity ratio

2. debt management ratio

3. asset efficiency ratio

4. profitability ratios

What category of ratio analysis does current ratio/quick ratio fall under?

SHORT TERM LIQUIDITY RATIO

What is the difference between Current Ratio and Quick Ratio?

Current ratio is often measured within a yearm whereas quick ratio is measured less than a year

What category of Ratio Analysis does Debt to Equity ratio / Times interest earned Ratio fall under?

DEBT MANAGEMENT RATIOS

Should concerns arise from higher debts in ‘Debt vs. Equity Ratio‘ ?

No higher debts does NOT mean the company is going under, it can sometimes mean new investment is taking place hence the current liabilities being higher in comparison

What does the Times Interest Earned Ratio shows?

‘Times interest earned‘ ratio measures the firm’s ability to repay its debts from recurring expenses

Define TURNOVERS: What does it measure?

Turnovers: average length of time required for an asset to be consumed/replace.

• The more occurrence of turnovers=the higher the efficiency

• Measure of efficiency, efficiency of how a company utilises its assets

Formulas will be given to you on the exam, but how do you calculate the AVERAGE accounting receivable?

Ending # + Beginning of year #

/2

• since they are the same number

• (2x)/2

• ans/2

What does Account payable turnover ratio measure?

Measures the company’s effectiveness at managing amounts owing to trade creditors.

What is the disadvantage of paying back too fast?

USING FREE MONEY

• when a company is paying fast, they might be using all the $ they have to pay back, in which they could have delayed a bit where they have more money in their bank to grow their business. Don’t need to rush when you don’t need to.

What are the effects for companies to pay too slow? (2)

• higher interest expense overtime

• poor relationship

What relationship does the PROFITABILITY RATIOS show?

Shows the relationship of profits in total investment & investment by shareholders

Why don’t we expect a major change in Profitability Ratios?

Because it shows the profit in total investment as well as investment by shareholders. We hops the #s stays consistent, if not better.

EPS:

Earnings per share

What are the 2 important notes for EPS

1. EPS cannot be compared externally since every company have a different # of shareholders

2. Can only be compared INTERNALLY

What is the aim of CASH FLOWS?

To have the ability to produce future FRESH cash flows

Cash FLOWS from _______ Activity

Cash FLOWS from OPERATING ACTIVITIES

What is considered idea in CASH FLOWS?

• WHAT does a NEGATIVE cash flow imply?

• Cash inflow > cash outflow = positive cash flow (ideal)

*However, a negative cash flow overall does NOT mean business is going under, it means its not sustainable in the LONG RUN atm.

Reporting and analyzing cash flows from… 

1. Investing Activities

! NEGATIVE cash flow is considered GOOD

• since it means company is acquiring/ disposing OPERATING assets & investments in other companies (lending $ etc.)

  → signifies the company is doing good

Where as Financing Activities…

• Obtaining resources from creditors + owners 

• NEGATIVE CASH FLOW DOES NOT MEAN BAD 

Eg. not paying dividends BUT paying off debts & repurchasing company’s shares 

-> small companies differs as new start ups might have a positive cash flow

FORMAT of cash flows 

1. Cash flows from OPERATING ACTIVITIES

• Cash inflow 

• Cash out

• Net cash provided (used by operating activities )

2. Cash flow from INVESTING ACTIVITIES 

• Cash inflow , cash outflow, $ (used for investing activities)

3. … from FINANCING ACTIVITIES

   • Debit expense 

   • Credit appreciation  

Indirect method starts with…

Indirect method starts off with NET-INCOME

What does the indirect method focus on?

Focus on the difference between Net Income

& Operating cash flow

What does the indirect method NOT show?

The indirect method does not report individual cash inflows

Does Depreciation affect Cash Flow?

NO.

What do we Substract (-) from Net income  (4)

(-)

• Non Cash REVENUES 

• Accounting GAINS 

• Increased # in current assets 

• Decreased # in current liabilities

5 conditions for revenue to be recognized

1. Significant risks and rewards of ownership has been transferred to purchaser from seller 

2. Seller has not retained continuing managerial involvement / effective control over the goods sold 

3. Probable that the economic benefits associated with the transaction will flow to the s;;er 

4. Cost incurred to the transaction can be reliably measured 

5. #$ revenue can be readily measured

4 changes to sales revenue

1. Sales discounts 

2. Credit card discounts

3. Sales returns 

4. Sales allowance 

   • Sales discounts- standard notation to state discount+credit terms 

   • -> : 2/10 , n/30

• 2/10=pay within 10 days, 2% discount 

• n/30=pay within 30 days, 0 discounts

(2) methods to record BAD DEBT EXPENSE 

:when consumers do not pay their account receivables

1. Direct write off method 

2. Allowance method

Direct Write-Off Method

Waits until an account is determined to be uncollectible, before a drop in account receivable & receive bad- debt expense.

• (inconsistent w/ concept so we focus more upon Allowance method)

Allowance method:

: bad debt expense is recorded in the period of sales 

  -> allows it to be properly match with revenues

-> recognized before the actual default

Define: Allowance for Doubtful accounts

An account to store potentially uncollectible accounts

Under allowance method, there are 2 ways to estimate the # of bad debt expense:

1. % of credit sales method 

2. Aging method

Difference between Accounts Receivables & Notes Receivables

Notes payable requires an formal contract + longer period of due date + accumulated interest expense

Under Aging Method, how does the jounal entry look?

DEBIT bad dept expense

CREDIT allowance for doubtful accounts

Under Aging Method, if a consumer calls and tell you they won’t be able to pay you, the journal entry will look:

DEBIT allowance for doubtful accounts

CREDIT account receivables

Difference between Straight Line method and Declining Balance method

Straight line method multiplies a depreciation rate by the depreciable cost of asset

(yes but remember you have to deduct any residual or salvage value and you pro-rate if it is not a full year). 

• Meaning it records an equal amount # of depreciation expense evenly throughout the period of Asset's life. 

Whereas under declining balance method, we do not depreciate below the residual value!!!

• because we are calculating the deprecation value with the assumption that the asset loses its value faster in earlier years, and that the value of depreciation will be smaller overtime/ over the years.

The third method is units of production method. Define it:

It follows the concept that if the asset is used more often; the value of depreciation expense will be bigger.

What is another name for Share Capital?

Common shares

What does the Shareholder Equity show?

Represents the shareholders/owner's residual claims of asset, after all liabilities has been deducted.

Share Capital / Common shares is basically…

Where you put money into the business and the company gives you 1 share. This is where you record it.

→ That is about it for this course.

Retained Earnings is basically…

The money the company made that was kept in the business meaning no dividends but kept in the business to help the business grow. 

What is the process of % of Credit Sales method?

Using past experience, the company estimates the % of current credit sales that will eventually uncollectable.

What is the equation for % of Credit Sales method?

( total credit sales ) x ( % credit sales estimated )

= estimated bad debt expense

Is Inventory an current asset?

NO. It is a long term asset.

• Once a company sell its inventory, the cost of inventory turns into the cost of goods sold

What is the equation for Gross Profit, and what is the equation for it Gross profit:

• Gross profit is a key performance measure

• = Revenue - cost of goods sold

3 categories of INVENTORY

1. Raw materials inventory eg.wood/lumber

2. 2.Work in process inventory eg.labor eg.cut/furnish wood in process

3. Finished good inventory eg.wood dining table

Cost of goods sold model

Beginning inventory 

+purchases 

= 

Cost of goods available for sale 

-Ending inventory 

= 

Cost of goods sold

What are the 2 Types of Inventory SYSTEMS?

• Perpetual

• Periodic

Perpetual inventory system is when cost of goods sold is ____

…recorded with each sale

Periodic inventory system is when cost of goods sold is ____

… recorded only at the end of a period (periodically)

What additional cost will recording inventory in the perpetual systam include?

Cost of inventory will include the purchase price + other incidental costs

• incidental cost such as the delivery cost/ transportation cost of delivering the merchandise to warehouse

Define Freight cost

= Transportation cost

: expense of moving inventory from one place to another

What does FOB stand for?

Free On Board

Where is the F.O.B. shipping points?

Ownership of inventory passed from seller to buyer

What does the term Freight In mean?

Buyers pay transportation cost at FOB shipping point.

What does the term Freight OUT mean?

Sellers pay transportation cost at shipping point.

What does the Inventory costing methods determine?

Determines how costs are allocated to cost of goods sold & ending inventory