Accounting Final

sole proprietorship (3 forms of business organizations)

owned and controlled by one person

simple to establish

tax advantages

ex: small business, barber shops, small retail store

corporation (3 forms of business organizations)

separate legal entity

shareholders are owners (stocks)

no personal liability

higher income taxes

partnership (3 forms of business organizations)

two or more owners

shared control & simple to establish

broader skills and resources

tax advantages

financing activities (business activities)

returning or raising money through stockholders and creditors

liabilities (loans)

• Borrowing money (inflow)

• Paying dividends (outflow)

Investing activities (business activities)

purchasing resources a company needs in order to operate

buying or selling longterm resources (assets)

CASH

ex: equipment, buildings, land

• Buy equipment (outflow)

• Sell investments (inflow)

operating activities (business activities)

day-to-day business operations

revenue and expenses

Ex: inventory, accounts receivable, hiring employees, repairing equipment

• Cash from customers (inflow)

• Paying employees (outflow)

creditors

who amounts are owed to

loan money to companies

common stock

amount paid by shareholders for shares

money invested by owners in exchange for ownership

dividends

payments to stockholders

decrease retained earnings

portion of net income distributed to owners

net income

results when revenues exceeds expenses

Net income = Revenue – Expense

increases retained earnings

net loss

exists when expenses exceed revenues

decreases retained earnings

income statement (financial statements)

did we make a PROFIT

timing: period (month)

lists revenues & expenses

subtract r-e= net income

success of a business during a period of time

retained earnings statement (financial statements)

what happened to PROFIT

lists start retained earnings, add net income, minus dividends, end retained earnings

how much income was distributed and retained

timing: period (month)

retained earnings

beginning balance + net income - dividends = ending balance

B+N-D

or R-E-D

profit company makes and keeps

balance sheet (financial statements)

what company OWNS & OWES

lists assets, liabilities, & stockholders’ equity

assets = liabilities + stockholders equity

timing: point

stockholder’s equity

investors give money for shares

partial owners of company

retained earnings common + stock

RECS

cash flows (financial statements)

where cash comes from/goes

INFLOW & OUTFLOW

inc/dec of cash due to investing, operating, and financing activities

timing: period

MD&A: management discussion & analysis (components of annual report)

shows managements views on the company’s ability to:

pay obligations

fund operations & expansion

results of operations

Consists of: trends & events

Notes to Financial Statements (components of annual report)

shows a company’s operating performance & financial position

explains accounting policies and how statements are prepared

auditor’s report (components of annual report)

made by independent outside auditor (CPA)

opinion if statements provide fair representation of financial position & operations

accounting equation

A = L + SE

A = L + Common stock + Retained Earnings [Revenue – Expense – Dividends]

if asset inc

• dec another asset

• inc liability

• inc stockholder’s equity

two changes must be done to keep it balanced

accounting cycle

analyse transaction → journal → post to ledger

tabular analysis

analyzing the economic affect of a transaction

revenue recognition principle

Revenue is recognized when obligations (goods&services) are done

even if cash isn’t given

Journal Entry:

• Dr) Unearned Revenue

• Cr) Revenue

Revenue increases and Liability decrease

EX: if you sell something revenue is recognized when it’s delivered

expense recognition principle

expense recognized in the same period that related revenue is recognized

not when expense is paid for but when it is used

expense follows revenue

Generally Accepted Accounting Principles (GAAP)

set of accounting rules and practices to follow

requires accrual accounting

for the US

Securities & Exchange Commission (SEC)

oversees US financial markets and accounting standard-setting bodies

Financial Accounting Standard Board (FASB)

creates and maintains GAAP in the U.S

Public Company Accounting Oversight Board (PCAOB)

determines U.S auditing standards and reviews the performance of auditing firms

International Financial Reporting Standards (IFRS)

world-wide set accounting standards

international version of GAAP

International Accounting Standards Board (IASB)

creates and maintains IFRS

International version of FASB

accrual-basis accounting

focus on performance in a period

Revenue is recognized when you work

Expenses is recognized when resources are used

GAAP requirement

cash basis accounting

focuses on cash flow not performance

Revenue is recognized when cash is received

Expense is recognized when cash is paid

Deferrals (adjusting entries)

recognize Cash now → Rev/Exp later

Prepaid Expense (deferrals)

pay cash first, recognize expenses later

asset inc

adjusting entry: asset dec, expense inc

Unearned Revenues (deferrals)

receive cash first, recognize revenue later

liability inc

adjusting entry: liability dec, revenue inc

Accruals (adjusting entries)

recognize Rev/Exp now → Cash later

Accrued Revenues (Accruals)

recognize revenue first, receive cash later

rev and asset inc

Accrued expenses (Accruals)

recognize expense first, pay cash later

Temporary Accounts (closing entries)

Revenue, Expense, Dividends

RED

have zero balance after closing entries

doesn’t appear on post-closing trial balance

Permanent Accounts (closing entries)

Liabilities, Assets, Stockholder’s Equity

LASE

merchandising operations

buy and sell merchandise

cash → inventory → sales → accounts receivable → cash

longer than service operations

cost principle

cost of an asset is anything paid to get the inventory

ex: freight cost, shipping cost, taxes, installation fees

Purchase Returns

return goods for cash or credit

reverses the DR/CR of original selling transactions

Ex: Dr) accounts payable (dec)

Cr) inventory (dec)

(Buyer’s Perspective)

Purchase Allowances

reduction of purchase price instead of returning

Ex: allowance of $50

Dr) accounts payable 50

Cr) Inventory 50

(Buyer’s Perspective)

Purchase Discounts

encourages early payments

through credit terms

Ex: 2/10, n/30: 2% discount within 10 days or full amount is due in 30 days

(Buyer’s Perspective)

Dr) Accounts Payable

Cr) Cash & Inventory

Sales Revenue (Cash or on account)

recognized when good is delivered

Cash:

Dr) Cash Cr) Sales Rev

On account:

Dr) Accounts Receivable Cr) Sales Rev

Cost of Goods Sold (COGS)

inventory is sold, cost becomes an expense

recorded as cost of inventory not sales price

recorded at the time of sale

Dr) COGS Cr) Inventory

Perpetual Inventory System

selling inventory requires two entries at the same time

COGS recorded at time of sale

inventory amount is always known

when you sell, real-time record: sales revenue & COGS

Periodic Inventory System

Inventory updated at the end only

COGS calculated at end of period

end-of-period calculation

Recording Sales of Inventory (merchandise) under Perpetual System

entry 1: Sales Revenue

Dr) Accounts Receivable or Cash

Cr) Sales Revenue

entry 2: COGS

Dr) COGS
Cr) Inventory

Sales Returns

when seller accepts good back from buyer

opposite of purchase returns

debit inc

does not reduce sales revenue account

(Seller’s Perspective)

Sales Allowance

when seller reduces purchase price so buyer keeps the good

(Seller’s Perspective)

Sales Discount

seller offers buyer discount in order to pay earlier

Dr) Cash & Sales Discount

Cr) Accounts Receivable

(Seller’s Perspective)

Net Sales

Sales Rev - Sales Returns & Allowances - Sales Discounts

Multi-Step Income Statement

Breaks income into levels:

1. Net Sales

2. − COGS

3. = Gross Profit

4. − Operating Expenses

5. = Income from Operations

6. = Net Income

Gross Profit

Money from selling goods

Net Sales - COGS

Income from Operations

profit business has made before taxes

Gross Profit - Operating Expenses

Other revenues and expenses

NOT part of main business:

• Interest revenue/ expenses

• Gains/losses on long term assets

costs not directly tied to a company's primary, day-to-day business operations

Gross profit rate

Gross Profit ÷ Net Sales

in %

Profit margin

PM = net income / net sales

COGS

= Beginning inventory + Purchases – Ending Inventory

or = Cost of Goods Available for Sale - Ending Inventory

when company sells Inventory (asset) it becomes part of Cost of Goods Sold (expense)

Inventory Balance

unit cost * # of units

FIFO

First IN First OUT

older items sold first (top to bottom)

COGS: oldest goods

EI: newest goods

Lower COGS → higher profit

Average-Cost

total cost / total units

use FIFO method but replace price with avg cost

Net Realizable Value (NRV)

when NRV is lower than its cost → companies must reduce asset value of inventory

estimated selling price - estimated costs to sell inventory

inventory only written down when value decreases

Lower of cost or net realizable value (LCNRV)

choose lower cost between “Cost per Unit” and “NRV per Unit”

calculate inventory: unit * lower price

Notes Receivable

written promise of amounts to be received (paid)

recorded at face value (amount written on note)

• Dr) Notes Receivable

• Cr)A/R or Cash

Bad Debt Expense

customers don’t pay back sales on account

Expense on Income Statement

Direct Write-Off Method

records loss in credit when customer doesn’t pay

Writes off (removes) accounts receivables

• Dr) Bad Debt Expense (inc)

• Cr) Accounts Receivable (dec)

not used by GAAP (doesn’t match rev to exp)

Allowance Method

estimates uncollected accounts at the end of each period

BDE recorded in the period of sale (matches expenses to revenues)

Required by GAAP

• Dr) Bad Debt Expense

• Cr) Allowance for Doubtful Accounts (normal balance: credit)

Allowance for Doubtful Accounts

Amount you estimate won’t be collected

Credit normal balance

decreases Accounts Receivable

Cash Realizable Value

money you expect to collect

shown on Balance sheet

Accounts Receivable – allowance for doubtful accounts

Estimating Allowance (target balance)

Allowance for Doubtful Accounts = % * accounts receivable

unadj credit: allowance - unadjusted account = adjusted account

unadj debit: allowance + unadjusted account = adjusted account

adjusting entry:

• Dr) Bad Debt Expense

• Cr) Allowance for Doubtful Accounts

Write-Off under Allowance Method

when sure account isn’t going to be paid:

• Dr) Allowance for Doubtful Accounts

• Cr) Accounts Receivable

does not inc BDE or change assets

Interest

= Face value Annual interest rate(%) Time in years

for x days: x/360

for x months: x/12

for x years: x/1

Maturity Value

total amount collected

= Face Value + Interest

Dr) Cash

Cr) Notes Receivable & Interest Revenue

Accruing interest

earned interest BUT haven’t received cash yet

Dr) interest receivable

Cr) interest revenue

Fraud triangle

Opportunity, Financial Pressure, Rationalization

Internal control

safeguarding assets

reliable accounting records

efficient operations

compliance with laws and regulations

The Sarbanes-Oxley Act (SOX)

1. applies to U.S. public companies

2. requires an adequate internal control system

3. independent outside auditors must attest to the adequacy of internal control

4. corporate officers can face serious penalties for noncompliance

Plant Assets

Long term assets used in operations

Physical Substance

Not for Sale

• Ex: Equipment, Machinery

Types of Plant Assets: Land

buying piece of property

used for building or renting

Types of Plant Assets: Land Improvements

Adding to the land

Ex: driveways, parking lots, fences

Types of Plant Assets: Building

Building on land

Ex: buildings, houses

Types of Plant Assets: Equipment

Equipment used for business operations

Ex: furniture, machinery, computers, vehicles

Journal Entry: Cost of Plant Asset

Dr) Land or Equipment

Cr) Cash

Depreciation

use of asset over time makes it an EXPENSE

matches cost of asset with revenue it made over time

land is not depreciated

Journal Entry: Depreciation

Dr) Depreciation Expense

Cr) Accumulated Depreciation

Depreciation Expense

= (Cost − Salvage value) ÷ # of years in asset’s Useful Life

recorded on Income Statement

Cost: amount for asset

UL: If useful life is 5 years → written as 1/5 or 20%

SV: estimated value at end, if you sell how much would you make

Accumulated Depreciation

Credit normal value (contra-asset)

total decrease value of asset

Book Value

= Cost - Accumulated Depreciation

assets current worth

plant assets recorded at book value

as depreciation is recorded, book value decreases

Straight line Depreciation Method

Same depreciation expense every year over asset’s useful life

use depreciation expense = (C-SV)/UL x months if its not full year

most companies use it or they pick based on the asset’s contribution to revenue in its useful life

Disposal of plant assets

companies can dispose of plant assets by selling them

compare the Book Value and the Proceeds from the sale to determine gain/loss

• Gain: Book Value < Proceeds (less than)

• Loss: Book Value > Proceeds (greater than)

Gain on Disposal

• Cost - Accumulated Depreciation = Book Value < Proceeds from sales → GAIN

Journal Entry:

Dr) Cash (from sale)

Dr) Accumulated Depreciation-ex:Equipment (given balance)

Cr) Equipment (og cost)

Cr) Gain on Disposal of Plant Asset (what is left)

Loss on Disposal

• Cost - Accumulated Depreciation = Book Value > Proceeds from sales → LOSS

Journal Entry:

Dr) Cash (from sale)

Dr) Accumulated Depreciation-ex:Equipment (given balance)

Dr) Loss on Disposal of Plant Asset (what is left)

Cr) Equipment (og cost)

Intangible Assets

long-lived assets without physical substance

gives companies rights or privileges in form of contracts & licenses

EX: Patents, Copyrights, Trademarks, Trade names, Franchises, Goodwill

Research & Development Costs (R&D)

an EXPENSE for an intangible asset or creating something new

it is marked as an expense immediately not an asset

Journal entry:

• Dr) R&D Expense

• Cr) Cash

Amortization

Spreading the cost of an intangible asset over time

Ex: You buy a patent for $10,000. It lasts 5 years

• Amortization each year = $2,000

Journal entry:

• Dr) Amortization Expense

• Cr) Intangible Asset (or Accumulated Amortization)

Current Liabilities

Creditor’s claim that company expects to pay back in 1 year or its operating cycle (whichever is longer)

Ex: Notes payable, Unearned revenue, Current portion of long-term debt