MGMT 2000 Final Memorization (Cumulative)

Double-entry Accounting

Double-entry Accounting

Each journal entry must have debits equal to credits. This ensures the accounting equation (Assets = Liabilities + Equity) remains balanced

Accounting Equation:

Assets = Liabilities + Equity. Equity can be viewed as Assets minus Liabilities.

Changes in Accounts (Assets, Liabilities, Equity):

If an asset account increases, there must be a corresponding increase in either a liability or an equity account, or a decrease in another asset. Similarly, if a liability increases, it’s typically recorded as a credit, and an increase in equity is also recorded as a credit.

Debits and Credits by Account Type:

• Asset accounts increase with debits and decrease with credits.

• Liability and equity accounts increase with credits and decrease with debits.

  • Revenue accounts increase with credits; Expense and Dividend accounts increase with debits.

Revenue Recognition Principle:

Recognize revenue when it is earned and realizable, not necessarily when cash is received. For example, revenue can be recognized when providing services or delivering goods, even if cash was received earlier (deferred revenue) or will be received later (accounts receivable).

Deferred (Unearned) Revenue:

Cash received in advance of providing goods or services is initially recorded as a liability (Unearned Revenue). When the service/product is delivered, reduce that liability and recognize revenue. This may involve a debit to Unearned Revenue and a credit to Revenue, rather than always debiting an asset.

Prepaid Expenses:

Payments made for expenses before they are incurred (e.g., prepaid rent) are recorded as assets. As time passes or benefits are realized, these assets are expensed.

Depreciation Expense:

Allocating the cost of long-lived assets over their useful life is recorded as a non-cash expense. Depreciation does not affect operating cash flows directly; it only reduces net income on the income statement.

Balance Sheet: Purpose, Key Equation, Content, and Subcategories

• Purpose: Show’s a snapshot of the firm’s current financial statement

• Key Equation: Assets = Liabilities + Equity

• Context: Shows what the company owns and owes

• Subcategories

  • Assets: Cash, Inventory, Property Plant Equipment (PPE), & accounts receivable

  • Liabilities: Loans & Accounts Payable

  • Equity: Retained Earnings, Stock

Income Statement: Purpose, Key Equation, Content, and Subcategories

• Purpose: Firm’s financial performance (profitability) over a period of time

• Key Equation: Net Income = Revenues - Expenses + Gains - Losses

• Context: Includes revenue, expenses, gains, looses, and calculates net income (or net loss)

  • These are all temporary accounts

• Subcategories

  • Revenues: Sales, Service Income

  • Expenses: Cost of Goods Sold (COGS), Operating Expenses, & Taxes

Statement of Cash Flows: Purpose, Key Equation, Content, and Subcategories

• Purpose: Tracks cash generation/usage from operations, investing, and financing over a period of time

• Key Equation: \Delta \text{Cash} = \text{Operating Cash Flow} + \text{Investing Cash Flow} + \text{Financing Cash Flow}

• Context: Uses Cash from operations, investing, and financing actives to explain changes in cash

• Subcategories

  • Operating Activates: Anything from core business activities

  • Investing: Cash from buying/selling assets (Like PPE)

  • Financing Activities: Cash from issuing stock, paying dividend, or borrowing money

Dividends and Operating Cash Flows:

Paying dividends does not reduce operating cash flows. Dividends are classified as financing cash flows.

Closing Entries:

Temporary accounts (revenues, expenses, and dividends) are reset to zero at the end of each accounting period to measure performance anew. Permanent accounts (assets, liabilities, and equity) carry their ending balances into the next period.

Permanent vs. Temporary Accounts:

• Permanent accounts: Assets, Liabilities, and Equity (including Retained Earnings)

• Temporary accounts: Revenues, Expenses, and Dividends

Classification of Cash Flows:

• Operating: Related to day-to-day core operations (cash from customers, cash paid to suppliers)

• Investing: Related to buying or selling long-term assets (equipment, land)

• Financing: Related to borrowing, repaying debt, issuing stock, or paying dividends

Impact of Transactions on the Accounting Equation:

Every transaction affects at least two accounts, ensuring the equation stays balanced. For example, investing cash into the business increases both assets and equity. Paying off a liability reduces both liabilities and assets. Recognizing previously deferred revenue reduces a liability and increases equity.

R&D and Expense Impact:

Paying salaries for research and development reduces cash (an asset) and reduces retained earnings (equity) when recorded as an expense.

Differences Between Revenue and Cash Receipts:

Revenue recognized does not always equal cash collected. Changes in Accounts Receivable or Deferred Revenue explain timing differences. Similarly, Cost of Goods Sold may differ from the actual cash paid to suppliers due to changes in Inventory and Accounts Payable.

Gains and Losses on Asset Sales:

Selling an asset for more or less than its book value affects net income (via a gain or loss) but the cash inflow from the sale is reported in investing activities. The gain or loss does not directly change operating cash flows.

Negative Retained Earnings:

If losses and dividends exceed cumulative profits, retained earnings can become negative, reflecting an accumulated deficit.

Accounts Receivable (A/R):

• Represent amounts owed by customers for goods or services already provided.

• Reported at net realizable value on the balance sheet (gross A/R minus the Allowance for Doubtful Accounts).

• Not recorded when customers pay in advance (that would be Deferred Revenue), and not cash received in the future for yet-to-be-provided services

Allowance for Doubtful Accounts (ADA):

• A contra-asset account that reduces Accounts Receivable to their net realizable value

• Increases when bad debt expense is recorded (to reflect estimated uncollectible amounts) and decreases when specific accounts are written off

• Not a liability; it’s paired with A/R on the balance sheet

Bad Debt Expense:

• An expense recognizing the cost of estimated uncollectible accounts

• Increases ADA (a credit to ADA, a debit to Bad Debt Expense), reducing net A/R and equity

• Does not affect operating cash flows directly when recorded; cash is impacted only when A/R is ultimately collected or fails to be collected

Write-offs of Uncollectible Accounts:

• Remove specific uncollectible amounts from A/R and reduce ADA, with no net effect on total assets or equity at the time of write-off

• Does not affect net income or cash at the moment of write-off; the expense was already recognized

FIFO

• First in first out: oldest inventory items are sold first

• COGS is based on oldest inventory prices

• Ending Inventory reflects most recently bought purchases

LIFO

• Last in first out: newly bought inventory is sold first

• COGS is based on most recent inventory purchases

• Ending inventory reflects oldest purcahses

LIFO Reserve:

• The difference between the inventory balance reported under LIFO and what it would have been under FIFO

• Can be used to adjust LIFO-based financials to a FIFO perspective, impacting reported earnings and tax expense

Inventory and Cost of Goods Sold (COGS):

• COGS = Beginning Inventory + Purchases − Ending Inventory

• Inventory methods (FIFO, LIFO) impact the reported COGS and thus net income, especially in periods of changing prices

• Under LIFO, during rising prices, COGS tends to be higher and net income lower. FIFO results in lower COGS and higher net income in such periods

  • LIFO creates higher COGS and lower net income which CAN provides tax benefits

Depreciation

• Depreciation expense allocates the cost of a fixed asset over its useful life

• Reported as an expense on the income statement, reducing net income but not directly affecting operating cash flow

• Accumulated depreciation is a contra-asset account reducing the book value of fixed assets on the balance sheet. It’s permanent and carries forward each period

Repairs and Maintenance Costs:

• Typically expensed as incurred since they maintain rather than enhance the value or extend the life of the asset

• Increase expenses and reduce net income and equity in the period recognized

Property, Plant, and Equipment (PPE) Transactions:

• Buying/Selling PPE is an cash outflow/inflow recorded in investing activities of statement of cash flows

• Depreciation does not affect cash flows directly (reduces net income but is not a cash outflow)

• Gains or losses on the sale of PPE arise when the sale proceeds differ from net book value

  • Formula: PPE = cost - accumulated depreciation

Impairments of Long-lived Assets:

• If the sum of expected future cash flows is less than the net book value, the asset is written down to fair value

  • Asset cannot be written up higher than it’s original net book value

• Record impairment loss as an expense, reducing net income and the asset’s carrying amount

• No direct current-period cash effect, but it may impact future depreciation expense

Goodwill:

• Goodwill arises when one company acquires another for more than the fair value of net identifiable assets (including any identifiable intangible assets)

• Goodwill is an intangible asset that is not amortized but tested for impairment

• Represents the excess purchase price attributable to synergies, brand name, or other intangible factors not separately identifiable

Net Book Value

• Net book value is the value of an asset minus depreciation, amortization, and impairment

• Depreciation is a $ value associated with the wear and tear of an asset over time

  • Depreciation = \frac{\text{Original Cost} - \text{Salvage Value}}{\text{Useful Life}}

• Amortization is depreciation but for intangible assets

  • Amortization = \frac{\text{Original Cost}}{\text{Useful Life}}

• Impairment happens when a firm finds the asset no longer useful to them, making the market value drop

  • Impairment Loss = \Delta NBV

Salvage Value and Depreciation Calculations:

• Salvage value is the estimated amount to be recovered at the end of an asset’s useful life

• Annual depreciation = (Cost − Salvage Value) / Useful Life

• Changes in salvage value or remaining life impact the expense recognized each period

Cash Flow Classifications:

• Operating: Day-to-day business activities (not influenced by depreciation or write-offs directly)

• Investing: Purchase or sale of long-term assets (PPE purchases are outflows; PPE sales are inflows)

• Financing: Transactions with creditors and owners (not covered extensively here, but includes dividends, issuing stock, and borrowing money)

Asset Impairment Tests:

• Compare undiscounted future cash flows from the asset to its carrying amount

• If carrying amount > sum of future cash flows, write down asset to fair value, recognizing an impairment loss (reducing equity and the asset)

Acquisition Accounting:

• When purchasing another company, allocate purchase price to identifiable assets and liabilities at their fair values

• Goodwill is recognized for any excess purchase price over these net identifiable assets

Retained Earnings:

• Definition: Amount of net profit the company is keeping for itself (to reinvest within) and not give out as a dividend

• Formula: Retained Earnings = Beginning Retained Earnings + Net Income (or Loss) − Dividends Paid

  • It can be reduced by dividends or losses. It can become negative if accumulated losses and dividends exceed profits

• Retained earnings is component of equity on the accounting equation

Contingent Liabilities

• Examples of Contingent Liabilities are Potential: Lawsuit, warranties, remediation / legal fines

• If Probable: Record the lowest estimate as a liability on the balance sheet

• If Reasonably Possible: Do not accrue (do not record in financials) a liability but disclose in financial statement footnotes

• If Remote: Do not accrue liability or disclose in footnotes

Gain Contingencies

• Realizing you might gain money from a future event (like winning a lawsuit)

• It’s NEVER recognized until the gain is actually given or highly certain

• If probable, you may disclose in financial footnotes

Lease Liabilities

• Cost of a lease is right-of-use asset and lease liability on balance sheet

  • Incremental payments for the lease are recorded on Statement of cash flows

• Discount Rate = Interest Rate

Shares & Dividents

• Shares represent ownership of a company and show up under the contributed capital equity section of a balance sheet

  • Par value is the minimum face value a firm must sell their stock for (no impact on calculations)

• Dividends are payments a firm gives to shareholders to reward investors

  • Dividends Rate Formula: Dividend Yield = (Dividend per share)/(Stock Price per share) * 100

  • Payment can be in more stock or (normally) cash

• Treasury Stock: Shares a firm buys back from investors & a contra-equity account

Principle & Interest Payments

• Principle payment is the requested amount for a loan (without interest)

  • Debits cash (asset) and credits lone payable (liability)

  • Financing activities on statement of cash flows

• Interest payments are a “fee” for borrowing, usually a percent of the principle amount paid over a period of time

  • As principle amount is paid back, interest decreases bc interest is a function of principle

  • Paying back is a credit to cash on balance sheet and does not affect liabilities

  • Incremental payment is on operating activities statement of cash flows

Principle & Interest Payments Formulas

1. Principle Payment = Principle - Interest

   1. Interest Expense = Outstanding Principle * interest Rate

2. Present Value = \frac{\text{Future Value}}{(1+r)^n}

   1. Future Value is the principle amount to be paid back at maturity

   2. Where r is the interest rate, n is the number of years of maturity

Bonds & Coupon Rate

• Bonds are “Firm needs to borrow money, I’ll pay you (creditor) back with an interest rate”

• Goes into investing cash flows & liabilities in balance sheet

• Paid BEFORE shareholders, lower risk but fixed interest rate

• Coupon rate is a bond’s interest rate

Share based compensation

• Definition: payments made to employees in the form of shares, stock options, or other forms of equity (Father dearest with that NVIDIA soinksss)

• Expense is reported on income statement over/per the vesting period (not all at once)

• Vesting Period: Employees will receive the stock over time period & must be employed during that time

  • emp. might need to stay with the company for 3 years to "vest" fully in their stock options