Accounting Midterm 1

Reporting Process

Reporting Process

• Public companies are required to file certain reports with the Securities Exchange Commision (SEC)

• 10-K: audited annual financial statements and footnotes

• 10-Q: unaudited (but is reviewed) quarterly financial statements and footnotes

• 8-K: current events report–filed often for various types of events (restructuring, delisting from an exchange, change in fiscal period)

Fiscal Period:

• some people may choose a different fiscal beginning and end than the calendar year. Retailers have a fiscal period go from 2/1 to 1/31

  • They want people to have time to return their holiday shopping to capture the true economic value of their fiscal period

What can we find in an annual report?

• Financial statements

• Footnotes (explain how the firm came up with the numbers reported in the financial statements)

• Managements’ discussion and analysis (talks about what their company does in their industry, their strategy and opinions, etc)

• Audit opinion

Financial Statements

• 1. Balance Sheet

  • A snapshot of what the firms own and owes at a given point in time

    • “As of 12/31 2022, this is what we have”

• 2. Income Statement

  • A report of the economic performance of the firm over a time period (quarterly, annually, etc)

    • “For the year ended 12/31/22”

• 3. Statement of stockholders’ equity

  • A report of transactions with owners over a time period

    • “For the year ended 12/31/22”

• 4. Statement of cash flows

  • A report of sources and uses of cash over a time period

    • “For the year ended 12/31/22”

Balance Sheet

• assets= liabilities + stockholders’ equity

• This is accounting law

• If this equation doesn’t balance, check your work

An asset is:

• A resource owned by the entity

• A probable future benefit

• Ex: cash, property,

Liabilities

• A future obligation

• Ex: financing by creditors (ex: debt)

Stockholders’ Equity is:

• A = L + SE

• Owners' portion of assets after the liabilities have been paid

• Financing from owners of the business (common stock) and reinvested earnings (known as retained earnings)

• Aka owners’ equity, net worth, book value, net assets, etc.

• Ex: stockholder’s equity could be what we own of a house minus what we owe to the bank

Nordstrom Balance sheet

• Cash and cash equivalents: e.g. treasury bills (gov’t loan), certain short-term securities, that are “as good as cash”

  • The gov is good at paying those back

• Land property and equipment, net: e.g. buildings owned, table displays, cash registers, etc

  • Aka property, plant, equipment (PPE)

• Operating lease right of use assets:

  • buildings that they rent

• Good will

  • Intangible asset earned through acquisitions

• Merchandise inventory

  • What the company sells.

  • E.g. shirts, shoes, jewelry

• Accounts receivable, net

  • E.g. a payment they expect to be coming from someone who owes you money – a venmo request

• Prepaid expenses and other

  • E.g., rent

  • Pay rent for 5 months out. It’s an asset because you have the rights to it and it’ll bring you benefit in the future (like housing)

what is prepaid rent classified as?

an asset

Assets is split into

• Current assets;

  • Converted to cash within one year

• Non current assets

Assets are listed in order of liquidity

How fast you can convert it into cash

examples of liabilities

• wages

• accounts payable

• debt

• lease

Nordstrom balance Sheet Continued

• Accounts payable

  • E.g., outstanding venom request that needs to be paid

    • We have an IOU to pay

    • Ex: paying our suppliers on a payment system

• Accrued salaries, wages and related benefits

  • Eg: salaries that need to be paid

    • Accrued means accumulated, come about over time

    • So accrued salaries means accumulated salaries that need paid

• Long term debt is split into:

  • Current portion of Long term debt

    • Something we owe to the bank

    • E.g. portion of the loan from the bank – due in 6 months

  • Noncurrent portion of long term debt

    • E.g. loan from the bank – due in 5 years

• Non current operating lease liabilities

  • Talked about later

• Other current liabilities and other liabilities

Shareholders’ Equity

• 2 main owner’s equity accounts

  • 1. Common stock

    • Aka contributed capital

    • Contributions of cash or resources in exchange for an ownership stake in the firm (money from the investors)

      • Increases when the company sells shares

  • 2. Retained earnings

    • Aka “earned capital”

    • Accumulated net income/loss that hasn’t been returned to shareholders through dividends

    • Earned over time

    • Sitting in the bank

retained earnings

• Aka “earned capital”

• Accumulated net income/loss that hasn’t been returned to shareholders through dividends

• Earned over time

• Sitting in the bank

What is retained earnings known as if it’s negative

accumulated deficit

Common stock

• Aka contributed capital

• Contributions of cash or resources in exchange for an ownership stake in the firm (money from the investors)

  • Increases when the company sells shares

Nordstrom balance sheet part 3

• Common stock: contributed capital

• Accumulated deficit=retained earnings

  • Called deficit because it has a negative amount

  • Retained earnings if positive

• Total liabilities and shareholders’ equity will equal total assets

  • Because A = L + SE

revenues vs assets

revenues are paid to you by the customer for your product

assets are any other money or value earned from nonbusiness transactions

Classify as assets, liabilities or stockholders’ equity

• 1. Checking Account

  • Asset

    • Something we own that brings us benefit in the future

• 2. Land the ice cream shop is built on

  • Asset

    • Something we own that brings us benefit in the future

• 3. Common stock

  • Stockholders’ equity

    • Contributed capital paid by investors for ownership in the company

• 4. Accounts payable owed to dairy provider

  • Liability

    • “payable”

• 5. Accounts receivable front target

  • Asset

    • IOU

• 6. Retained earnings

  • Stockholders’ equity

    • Earned capital that they’ve made over time, stored in the bank

• 7. Waffle cone inventory

  • Asset

Income statement

• Reports revenues and expenses to illustrate the profitability of the company over a period of a time (10-k is a year, 10 q is a quarter, etc)

• Revenues minus expenses = net income

  • Revenues: amounts expected to be received from a customer for goods or services during the period

    • Accrual accounting (when we earned them), distinction from cash accounting. When we acquired them but we didn’t use it or pay it in that same period

      • RECORDING THINGS WHEN THEY HAPPEN, NOT WHEN CASH CHANGES HANDS

  • Expenses: amounts used to earn revenues during the period

    • Costs incurred to generate revenues

    • Ex: wages, rent, utilities

    • Accrual accounting (when we earned them), distinction from cash accounting. When we acquired them but we didn’t use it or pay it in that same period

      • RECORDING THINGS WHEN THEY HAPPEN, NOT WHEN CASH CHANGES HANDS

  • Net income: aka “bottom line,” or “profit” or “earnings”

Nordstrom Income statement

• Consolidated statements of earnings = income statement

• Net sales

  • Of clothing, shoes, etc

• Credit card revenues, net

  • From nordstrom credit cards

• Cost of sales (aka cost of goods sold) and related buying and occupancy costs     selling, general and administrative expenses

  • Costs incurred to generate revenues

    • Cost of sales is inventory and products

    • Selling, general and administrative expenses is non product related costs

• Interest expense, net

  • Costs associated with debt financing

• Net earnings

  • Net income, bottom line, earnings, profits

Income statements tell us

how a company is doing during a certain period of time

Statement of Stockholders’ Equity

• Reports inflows of resources from investors to the business and outflows from the business to investors over a specified period of time

• Provides extra details on stockholders’ equity section of the balance sheet

• (Beginning balance + contributed capital changes + earned capital changes (i.e. retained earnings)) = ending balance

Shareholders’ equity – retained earnings

• Beginning retained earnings + net income (-net loss) minus dividends = ending retained earnings

• Retained earrings

  • Aka “earned capital”

  • Accumulated net income/loss that has not been returned to shareholders through dividends

Nordstrom Stockholder’s Equity

• Issuance of common stock under stock compensation plans

  • Issued as compensation

• Accumulated deficit

  • Aka retained earnings if positive

• Cumulative effect of adopted accounting standards

  • Tie to income statement

• Add net earnings, subtract dividends, repurchase of common stock affects net earnings

• Total equity should tie to the amount on balance sheet

Statement of cash flow

• Reports sources of cash inflows and outflows over a period of time

• 3 categories

  • Change in cash flow from operating activities

    • E.g. selling product/service

    • Day to day

  • Change in cash flow from investing activities

    • e.g. , equipment

    • Make Expenditures to grow our business

    • Ex: capital expenditures

    • Investing activities related to long term assets

  • Change in cash flow from financing activities

    • E.g. loan, cash from investors

    • Transactions with shareholders or people who lend money

    • HOW WE FINANCE THE COMPANY

• Add the 3 changes together to arrive at the total change in cash

• Ending cash should tie to balance sheet

Income Statement equation

revenues minus expenses equals net income

Statement of Shareholders’ Equity

Beginning Equity + contributed capital (common stock) + earned capital (retained earnings) = ending equity

Ending Retained Earnings

Beginning Retained Earnings + net income - dividends

Statement of Cash flows

Beginning cash + 3 cash flows = ending cash

Classify if it’s assets, equity, liabilities and if its current or not

• cash

  • current asset

• common stock

  • equity

• accounts payable

  • current liability

• inventory

  • current asset

• accounts receivable

  • current asset

• long term debt

  • long term liability

• other assets

  • current asset

• interest payable

  • current liabiility

• retained earnings

  • equity

• prepaid expense

  • current asset

• net income

  • income statement

• Beginning balance retained earnings plus net income minus dividendeds equals ending retained earnings

  • beginning balance retained earnings = total equity minus common stock from 2020, which is 10,000-5000=5000

  • net income=revenue minus expenses=350,000-275,000=75,000

  • ending retained earnings=Assets minus liaibilites minus common stock (total equity minus common stock but we don’t have that)= 100,000-75,000-5,000=20,000

• 5000+75,000-DI=20,000

• DI=60,000

how is a gift card recorded in financial statements?

as “stored value card” recorded as a liablity and current portion of deferred revenue

reason total revenues and total expenses would increase

customers are buying more so you have to buy more as a company, and you are earning more revenue with raised prices

Assets, liabilities, or equity?

• Baking equipment

  • assets

• Retained earnings

  • Equity

    • Aka earned capital

• Note payable

  • liability

• Accounts receivable from target

  • asset

• Prepaid expense to smith brothers farms for milk used in the tres leches

  • Asset

Difference between note payable and account payable?

• Notes are long term, accounts payable are short term

• Notes payable are to a creditor, while accounts payable go to a vendor or supplier

• NOTES PAYABLE ARE FOR LOANS, ACCOUNTS PAYABLE ARE FOR INVENTORY

Business Cycles

• Financing

  • Obtaining funds for the business

    • Can be debt or equity

• Investing

  • Growing and setting up the business

• Operating

  • Running the business

    • Day to day

Accounting rules

• In the U.S. the “Financial Accounting Standards Board” (FASB) writes the accounting rules known as the “Generally Accepted Accounting Principles” (GAAP).

• • There is a push to have an international set of accounting standards. Many countries, including the EU, use IFRS (International Financial Reporting Standards).

Steps to Record Transactions

• How do we get to those ending balances on the financial statements?

  • 1. Identify transactions

    • Need to pay attention to what perspective we are thinking about. Normally we are thinking about a company’s perspective

  • 2. Determine the effect on the accounting equation and all its parts (A = L +SE)

  • 3. Determine whether to debit or credit impacted accounts

    • Debits and credits are tools in recording the transactions

  • 4. Record transaction in the journal

  • 5. Post transaction to the ledger

    • Summary of transactions

  • 6. Prepare a trial balance

    • Summary of accounts

  • 7. Prepare financial statements

coffee shop example of recording transactions and it’s steps

• Assets:

  • Inventory

  • Loans

  • Cash

• 1. Identify transactions

  • 1. Jan 1. Owners contribute $4,400 cash to form the store, they receive 100 shares of common stock

  • 2. Jan 1. Purchase pastry make equipment for $3200 and purchase inventory for $1200

  • 3. Jan 1. Receive $26000 loan to start a business

• 2.  Determine Effect on Accounting Equation

  • To preserve this, for every transaction:

    • Change in assets = change in liabilities plus change in equity

    • Entries on left = entries on the right

    • Every transaction has a dual effect: double entry bookkeeping

  • When determining the effect on the accounting equation, ask yourself:

    • 1. Accounts: which accounts are affected? Create as many individual asset and liability accounts as needed

    • 2. Direction: decrease or increase? More cash or less cash?

    • 3. Amount: by how much?

  • Ex: determine the effect on accounting equation for:  Lauren and Jeff contribute $4,400 to form Fox in the Snow. They each receive 100 shares of common stock (no par value)

• 1. Accounts: cash (A) and CS (E)

• 2. Direction: cash goes up, CS goes up

• 3. Amount: 4,400

• 4400 of cash = 4400 CS

• Ex: determine the effect on accounting equation for: Purchase pastry making equipment for $3,200 cash and purchase inventory (chocolate, coffee beans, sugar, butter, and coconut) for $1,200 cash.

  • 1. Accounts: cash (A), inventory (A), equipment (A)

  • 2. Direction: cash goes down, inventory goes up, equipment goes up

  • 3. Amount:

    • -4400 cash + 1200, +3200 = 0 + 0

• Ex: determine the effect on accounting equation for: Receive $26,000 cash from the Buckeye Accelerator program to help start the business. For class, let’s assume this $26,000 is a loan

  • 1. Accounts: cash (A), loan/note payable (L)

  • 2. Direction: cash goes up, loan/note payable goes up

  • 3. Amount

    • +26,000 = -26000 + 0

• Step 3: Determine whether to debit or credit each account

  • Changes in assets = changes in liabilities + change in equity

    • Entries on left = entries on the right

    • Debits = credits

      • Debits are everything on the left, credits are everything on the right

      • Signal increases and decreases in the account

      • Increases are everything on the far outside of the t equation

        • So for assets, increase on the left, for liabilities and equity, increases on the right

  • Are these increases or decreases

    • 1. Debit cash

      • Increase

    • 2. Credit note payable

      • increase

    • 3. Credit supplies

      • decrease

    • 4. Debit retained earnings

      • decrease

    • 5. Credit common stock

      • Increase

• Step 4: Record Transactions in the Journal

  • Journal: chronological record of all transactions affecting a firm

    • Are formal means of recording transactions using debits or credits

    • Include date, reference number, accounts impacted, by how much, and how they’re debited or credited

    • Debits appear first

    • debits=dr.

    • creditors=cr.

  • Ex: Lauren and Jeff contribute $4,400 to Fox in the Snow. They each receive 100 shares of common stock (no par value)

  • Ex: Purchase pastry making equipment for $3,200 cash and purchase inventory for $1,200 cash

Date

Ref #

Accounts

Debit

Credit

1/1

1

Equipment (A+)

Inventory (A+)

Cash (A-)

\n

3200

\n

1200

\n \n \n \n

4,400

• Received $26,000 cash from the Buckeye Accelerator program to help start the business. For class, let’s assume this $26,000 is a loan.

Date

Ref #

Accounts

Debit

Credit

1/1

1

Cash (A+)

Notes payable (L+)

26,000

\n

26,000

• Step 5. Post transaction to the ledger

  • Summary of transactions

  • A ledger

    • A system that contains all the t accounts

    • The process of transferring the debits and credits from the journal to the ledger is called posting

  • What is a t account?

    • A visual representation of each account

    • Each type of asset, liability and equity has its own account

    • Debits on the left, credits on the right

    • Contains all the journal entries

    • Shows the running total in each account

  • • Debit accounts have ending balance on the left, credit accounts have ending balance on the right

  • Ex:

    • SEE NOTEBOOK FOR EXAMPLE

• 6. Prepare a trial balance

  • Summary of accounts

  • The trial balance aggregates the ending balance of all T-accounts. We will use the trial balance to create financial statements

how would you classify a loan

a notes payable or a loan payable

debits and credits

debits on the left (increase for assets, decrease for everything else)

credits on the right (decrease for assets, increase for everything else)

what is a journal

• Journal: chronological record of all transactions affecting a firm

  • Are formal means of recording transactions using debits or credits

  • Include date, reference number, accounts impacted, by how much, and how they’re debited or credited

  • Debits appear first

  • debits=dr.

  • creditors=cr. 

  • 

• Ex: Lauren and Jeff contribute $4,400 to Fox in the Snow. They each receive 100 shares of common stock (no par value)

  • 

ledger

• Summary of transactions

• A ledger

  • A system that contains all the t accounts

  • The process of transferring the debits and credits from the journal to the ledger is called posting

• What is a t account?

  • A visual representation of each account

  • Each type of asset, liability and equity has its own account

  • Debits on the left, credits on the right

  • Contains all the journal entries

  • Shows the running total in each account

• 

  • Debit accounts have ending balance on the left, credit accounts have ending balance on the right

• Ex: 

  • 

Trial Balance

• Summary of accounts

• The trial balance aggregates the ending balance of all T-accounts. We will use the trial balance to create financial statements 

• 

• What’s wrong with this example?

  • Nordstrom buys $1,000 of shirts from Nike to sell at Nordstrom’s downtown location. It will pay Nike next month. The beginning balance in its accounts payable account is $50. Nordstrom makes the following JE: Dr. Equipment 1,000, Cr. accounts payable 1,000

Dr should be classified as inventory, not equipment. Inventory is what we sell, equipment is used to make what we sell

Financing with stock and par value and APIC

• Each share of stock is legally required in certain states to have a  minimum price listed on it, known as a par value. A Par value is completely unrelated to the actual market value of the stock

• No par value: common stock account is credited for the amount of cash received from investors

  • Debit cash, credit common stock

  • Price per share times number of shares for both credit and debit

• Par value: common stock is credited for the par value and any additional amount paid by the investor is credited to additional paid in capital (APIC)

  • Debit cash: price per share * number of shares

  • Credit common stock: par value * number of shares

  • Credit APIC: the difference

• Ex:

  • 1. DoorDash had its IPO (Initial Public Offering) in December, 2020. It issued 33 million shares at $102 per share. If the stock had no par value, the journal entry is:

    • Dr. Cash (A+) = 33 million * 102 =$3,366 million

    • Cr. Common stock (E+) = $3,366 million

  • 2. DoorDash stock actually had a par value of $0.00001 per share, so the entry is

    • Dr. Cash (A+) = $3,336 million

    • Cr. Common Stock (E+) = 0.00001 * 33 million = $330

    • Cr. APIC (E+) = 3,336 million – 330 = $336,599,670

Dividends

• As a stockholder, one benefit is that you could receive a portion of what the company earns in a form of cash dividends

  • Beginning R/E + Net income – Dividends = Ending R/E

• Benefit you can receive as investors. You get paid cash from the companies, that’s a dividend

• Come out of retained earnings

• Dividends are paid out of retained earnings, the journal entry when  dividend is declared is

  • Dr. Retained earnings…(E-)....$

    • Cr. Dividend payable…..(L+)

• When the dividend is paid

  • Dr. dividend payable….(L-)....$canceling out the credit on declaid day</p><ul><li><p>Cr. Cash….(A-).....$

When dividends are paid and declared are on different days

Dividends example

• Declaration date of November 16, 2020

  • Dr Retained Earnings (E-): 4.4 B

    • Cr Dividend Payable (L+): 4.4 B

• Payment day of december 11, 2020

  • Dr. Dividend Payable (L-): 4.4 B

    • Cr Cash (A-): 4.4 B

Recording Transaction example when you borrow $10 to buy a $9 burrito

• 1. You borrow $10 from a friend and buy a $9 burrito with it

• 2. 

  • Assets= +10 cash  +$9 burrito  -$9 cash 

  • Liability = Note Payable +10

• 3/4

  • Asset debit of $10 cash and $9 burrito and credit $9 cash 

  • Liability credit of $10 NP

• 5

  • Create 3 tables

    • 1. Cash (A)

      • 1. Debit 10

      • Credit 9 2. 

      • Ending balance: 1

    • 2. Burrito (A)

      • Credit 9 2. 

      • Ending balance: 9

    • 3. N/P (L)

      • Credit 10 1. 

      • Ending balance: 10

• 6. 

  • 

• 7.

Stock Issuance Example

• Company issues 100 shares of common stock. The par value of the stock is $0.01 and the stock is issued at $17/share. Record the journal entry for this transaction

  • Debit Cash: 17*100 = 1700 (A+)

  • Credit common stock (100*0.01) = 1 (SE+)

  • Credit Additional Paid in Capital 1700-1 = 1699 (SE+)

• If there’s no par value, just debit cash and credit common stock, no APIC

Dividends example

• Company declares a dividend for common stockholders of $0.50 per share on September 30 to be paid by November 1. There are 100 shares outstanding on the date of record

  • Date of record: snapshot of who is a shareholder as of this date

  • November 1: payment date

  • September 30: declaration date

  • Pay dividends out of retained earnings

  • On September 30

    • Debit retained earnings (E-) = $50

    • Credit dividend payable (L+) = $50

  • On November 1

    • Debit dividend payable (L-) = $50

    • Credit cash (A-) = $50

Entry for: “Austin wins a cash prize of 4,500. He decides to contribute the cash to create a company in exchange for 100 shares of common stock (par value of $1 per share)”

dr. cash (a+) 4500

cr. common stock (SE+) 100

cr additional paid in capital (SE+) 4400

• 

• Every income starts with nets sales (or revenues)

• Then cost of sales (what they paid for inventory)

• Then  Gross Margin (of Gross Profit) = Revenues Cost of Goods Sold

  • Net sales minus cost of sales

  • Tells you about the company’s markup

• Then is expenses

• Then selling general and administrative expenses (cost of running business)

• Depreciation amortization (has to do with fixed assets)

• Operating income 

• Pretax earnings 

• Net earnings 

• Income statement accounts you see the most

  • Revenues

  • Expenses

  • gains/losses

revenues and expenses inside of the balance sheet equation

• Assets = liabilities plus stockholder’s equity

  • Equity is made up of retained earnings (ending retained earnings = beginning retained earnings plus net income minus dividends) and contributed capital (common stock and APIC) 

• How all types of accounts fit into A = L + SE

  • Common stock and retained earnings debit when decreasing and credit when increasing

  • Revenues debit when they decrease and credit when they increase

  • Expenses DEBIT WHEN THEY INCREASE AND CREDIT WHEN THEY DECREASE

  • 

True or false: a transaction that impacts the income statements always impacts the equity section of the balance sheet too

• True, net income falls under retained earnings which is under the equity section

  • Everything on the income statement comes down to net income

cost of goods sold

debiting stock holders equity because expenses increased due to crediting and getting rid of inventory

is an expense account representing the amount the business paid for inventory that it has sold.at it has sold.

if inventory is worth $200 and it gets sold

• dr COGS 200

  • cr inventory 2000

Examples of revenue and expenses in the steps of recording transactions

• Recording transactions steps

  • 1. Identify transactions

    • 1. On 2/28 they paid 2,000 to rent a storefront for the month of february

      • Debit rent expense (+exp, eq-) 2000

        • When expenses go up, net income goes down, retained earnings goes down, and stockholders equity goes down 

      • Credit cash (a-) 2000

    • 2. On 2/28 we prepaid rent for March and April for 4000

      • Debit Prepaid rent (a+) 4000

      • Credit cash (a-) 4000

    • 3. On 2/10: sold pastry making tours for $50

      • When revenue goes up net income goes up retained earnings go up and stockholders equity goes up, so they all credit

      • Debit cash (a+) 50

      • Credit tour/service revenue (rev+,eq+) 50 

    • 4. Sold coffee and pastries costing 1200 to customers for 3500

      • +3500 cash (a+)

      • -1200 inventory (a-)

      • +3500 revenue (+re)

      • -1200 expenses (-re)

        • Sales side

          • Dr. cash (+A)

            • Cre. sales revenue (+REV, +NI, +SE) 

        • Costs side

          • Dr. Cost of goods sold (+EXP, -NI, -SE)

            • Cr Inventory (-A)

Accrual vs cash based accounting

• Accrual accounting doesn’t equal cash accounting

  • Cash accounting: records inflows and outflows of cash

    • Cash inflows = revenues

    • Cash outflows = expenses

    • So all the cash even before the expense is incurred? 

  • Accrual Accounting: records transactions

    • When revenues are earned

    • When expenses are incurred

    • Not all of the total cash? 

  • KEY DIFFERENCE IS TIMING

  • Cash accounting isn’t allow for public companies

• Cruise Example

  • In 9/22 you book a $5000 cruise for 3/23

  • Can it be included in the company’s income statement for 2022? 

    • Yes, under cash accounting it’s revenue

    • No, Under accrual accounting it’s not revenue until March 2023

Recording Revenue:

• Revenue recognition principle

  • Revenue should be recognized when the performance obligation has been satisfied. A company satisfies its performance obligation by performing a service or delivering a good to a customer

    • Ex: for Nordstrom: selling the clothes

    • Ex for EA Games: when the person receives the game 

    • Facebook: running ads

Revenue Recognition: 5 Step process

• Apple inc. example: you order the iphone 14 with applecare for 12 months

  • 1. Identify the contract between the company and the customer

    • Iphone 14 with 12 months warranty

  • 2. Identify the performance obligations

    • To deliver the phone and provide the warranty

  • 3. Determine the transaction price

    • 1500

  • 4. Allocate the transaction price to the performance obligation

    • Phone is 1300 and apple care is 200

  • 5. Recognize revenue when each performance obligation is satisfied

Ex: In april, Delta sells 4 tickets for a flight to Hawaii from Columbus for the 4th of July. Delta’s year end is June. When is ticket revenue recognized under the cash method. What about the accrual method?

• Cash = April

• Accrual = July

Recording Expenses: Matching Principle

• Under teh accrual method, expenses should be recognized in the same period as the revenues that they help to generate

• Ex: when nordstrom sells clothes to a customer, revenue is earned and there are costs related to generating that revenue that need to be matched such as

  • Salaries and wages during that period

  • Cost of the clothes sold during that period

  • Utilities and rent on building during that period

• Ex: In February, Buckeye donuts paid for February’s rent of 2,000 and March’s rent is 2500. How much rent expense will Buckeye donuts record in february

• 2000. Associated with the amount of revenues incurred in february 

• 2500 won’t be recognized till march

Relevance vs. Faithful representation

• Accrual accounting rules make financial statements more relevant but often sacrifice faithful representation

  • Relevance: information is more useful for understanding the firm and future performances

  • Faithful representation: the info more faithfully rerpesents the economics of the transactions; it is complete, neutral and erro free. This is harder to do with many assumptions and estimates

• Relevance vs Faithful representation

  • Cash based accounting system

    • Objective and simple

    • Faithful representation – cash is what it is

  • Accruals based accounting system

    • More assumptions and complexity

    • More relevant to economics of the firm

    • But accruals allow for more discretion

    • Discretion + incentives = manipulation

  • Is accruals based accounting actually more useful than cash based accounting?

Revenues

•  are defined as increases in assets or settlements of liabilities from the major or central ongoing operations fo the business

  • Proceeds from goods sold or services rendered

Expenses

• are defined as decreases in assets or increases in liabilities from ongoing operations incurred to generate revenues during the period

  • Expenditures (outflows) incurred to generate revenues

• 

• 8/18: Dr Accts Receivable (a+): 2000

  • Cr. revenue (rev+, eq+): 2000

•            Dr. Cost of goods sold (exp+, eq-): 1000

  • Cr. Inventory (a-): 1000

• 9/25: Dr cash (a+): 2000

  • Cr accounts receivable (a-): 2000

• 4/30: Dr. insurance expense (exp+, eq-): 250

•           Dr. prepaid insurance (a+): 250 (has future benefit)

  • Cr cash (a-): 500

• Assets: -250

• Liabilities:

• Equity: =net income = -250

• Revenue: 0

• Expenses: 250

• net income: (0-250)=-250

 true or false: the payment of dividends decreases cash and increases expenses?

• False. Paid to shareholders while (financing) expenses are the costs of operating the business. Both reduce retained earnings though

• Dividends and expenses both reduce retained earnings, but expenses relate to operating our core business whereas dividends are amounts returned to shareholders. Dividends do not appear on the income statement

• Aren’t an expense because they are a part of equity

how to record: “a company’s freeze drier malfunctions. The owner hires a mechanic to repair the freeze drier, and is invoiced 350 for the service)

• dr. operating expense (exp+, rev-) 350

  • cr. accounts payable (L+) 350

how to record: “company pays 3600 in advance for 2 year insurance policy”

• dr. prepaid insurance (a+) 3600

  • cr. cash (a-) 3600

how to record: “company receives software bill of $40, which they pay in cash”

• dr. operating exp (exp+, eq-) 40

  • cr. cash (a-) 40

how to record: “pays rent for this month and for next month totalling 1000”

• dr. prepaid rent (a+) 500

• dr. rent (exp+, eq-) 500

  • cr. cash (a-) 1000

how to record: “company receives 20,000 from backers, meaning his kickstarter goal is fully funded. Owner will deliver product evenly to customers over the next 10 months”

• dr. cash (a+) 20000

  • cr. unearned revenue (L+) 20000

unearned revenue is like deferred revenue, like a gift card

• 
  

• Should’ve recorded:

  • (since wages were earned but not yet paid)

    • Dr. wage/salaries expense (exp+,eq-)

      • Cr. wages payable (L+)

• Assets are the same. Liabilities are understated. Equity is overstated. 

Adjusting Entries

• TRYING TO GET THE STATEMENTS TO REFLECT THE TRUE ECONOMIC SITUATION

• When cash is exchanged at a different time than the expense/revenue, the accrual method requires two journal entries

  • One for the cash exchanging hands and

  • One for the revenue or expense recognition 

• The goal

  • Make sure revenue is recorded when earned

  • Make sure expenses are recorded when incurred to generate revenue

  • Make sure assets and liabilities are reported at the amount that reflects the economic situation

Situations requiring adjusting entries

• 1. Prepaid expenses (aka deferred expenses)

  • Cash has been paid but expense hasn’t been incurred

• 2. Unearned revenues (deferred revenues)

  • Cash has been received from customers but revenue hasn’t been earned

• 3. Accrued expenses

  • Expense has been incurred but hasn’t been billed and paid for (salaries)

    • Ex: Salaries: the work has been done and cash is earned but you don’t get paid for 2 weeks

• 4. Accrued revenues: 

  • revenue has been earned, but you haven’t billed and received payment from the customer yet

    • Ex: Fulfilled performance obligation but haven’t gotten the cash yet

Adjusting entries – tips

• 1. Cash is never part of the journal entry. Cash has either already been paid or will be paid in the future

• 2. All adjusting journal entries hit at least once balance sheet account (A, L, E) and one income statement account (Rev, Exp)

• 3. Ask yourself – how can I make this expense or revenue accurately represent what happened in this accounting period?

Deferred expenses – depreciation

• Depreciation expense: allocation of the property’s cost over its estimated useful life to the company

• Accumulated depreciation: sum of the asset’s depreciation taken to date. Accumulated depreciation is know as a contra account

  • Contra accounts

    • 1. Always linked to a companion account

    • 2. Always has a balance (debit or credit) opposite that of the companion account 

    • Ex: equipment (A) and accumulated depreciation (XA)

• Ex of adjusting entries: prepaid expenses

• Feb 9: Dr. Prepaid rent (a+) 4000

  • Cr. Cash (a-) 4000

• AJE: March 31: Dr. rent expense (exp+, eq-) 2000

  • Cr. Prepaid rent (a-) 2000

• AJE: April 30: : Dr. rent expense (exp+, eq-) 2000

  • Cr. Prepaid rent (a-) 2000

• Ex of adjusting entries: deferred expenses

• Initially you dr. equipment and cr. cash 

• The machinery is depreciating 

• 

• Debit depreciation expense (exp+, eq-)

  • Cr. Accumulated depreciation (xa+, a-)

  • 

    • Equipment net —> B/S. Value of equipment has decreased to 3,125

Ex of depreciation: 

• Journal entry on July 1

  • Dr. equipment (a+) 3500

    • Cr cash (a-) 3500

• AJE Journal Entry on 31

  • Dr. Depreciation expense (exp+, eq-) (250*.5)

    • Cr Accumulated depreciation (XA+, A-) (250*.5)

• Is it ok that total estimated depreciation over 12 years isn’t equal to the purchase price?

  • Yes. 250 a year times 12 years = 3000. In some cases you will depreciate the full amount and in some cases you won’t. Yes it may have a salvage value. 

• Ex:

Supplies. Not considered inventory because napkins are put with each product. Not every customer gets it with their goods

• Ex: Adjusting Entry – Supplies

Unadjusted trial balance means: before adjusting journal entries. Before AJE

• AJE

  • Dr. supplies expense (exp+, eq-) 50

    • Cr. supplies (a-) 50

Deferred Expenses and fraud

• Because there is some discretion involved, fraud it possible

• 

• What they were doing: spreading cost out over years to inflate income 

  • Dr capitalized asset (a+)

    • Cr cash (a-) 1 million

    • —------- dr. dep exp (exp+, eq-) 100k

      • Cr. a/d (XA+, A-) 100k

• What they should’ve been doing

  • Dr. expense (exp+,eq-) 1 million

    • Cr cash (a-) 1 million 

• Ex: Adjusting entries – deferred revenue

• 3/10: dr. cash (a+) 200

  • Cr. unearned revenue (L+) 200

• AJE: Later in march 3/31: dr. unearned revenue (L-) 50

  • Cr. service revenue (rev+, eq+) 50

• Adjusting entries

• • 

• Ex: Adjusting entries – accrued expenses

• AJE 3/31: dr. salaries expense (exp+, eq-) 400

  • Cr. salaries payable (L+) 400

• Later: dr. salaries payable (L-) 400

  • Cr. cash (a-) 400

types of accounts payable

• Dividends (paying shareholders), accounts (for things like equipment), and salaries payable (paying workers), notes payable (getting cash from someone)

• Ex: Adjusting entries – accrued expenses 

• 1/1/Y1: dr cash (a+) 26000

  • Cr. notes payable (L+) 26000

• 1/31Y1, 2/28/Y1, 11/30/Y2)

  • Dr. interest expense (exp+, eq-) 65

    • Cr. interest payable (L+)  65

• 12/31/Y2: 26000(*.3)=780/yr, 65 dollars a month

  • Dr. interest expense (exp+, eq-) 65

  • Dr. notes payable 26,000

  • Dr.  interest payable 1495 (23 months of interest) (will be 27560 at the end)

    • Cr. cash (a-)

• Ex: Adjusting Entries – accrued revenue

• 1/1/Y1: dr. notes receivable (a+) 26,000

  • Cr. cash (a-) 26,000

• AJE: 1/31/Y1, 2/28/YR1…11/30/Y2

  • Dr. interest receivable (a+) 65

    • Cr. interest revenue (rev+ eq+) 65

• 12/31/Y2

  • Dr. cash (a+) 27560

    • Cr interest revenue (rev+, eq+) 65

    • Cr. notes receivable (a-) 26000

    • Cr. interest receivable (a-) 1495(23 months)

Closing the temporary accounts

• Balance sheet accounts are permanent

  • They are cumulative and their balances carry from one period to the next. The ending balance in one period becomes the beginning balance in teh next period

• Income statement accounts are temporary

  • Transfer the balance in each account to retained earnings and establish  zero balance to start off the next accounting period 

• Closing entries close all temporary (income statement) accounts into retained earnings via a journal entry.

  • • Moves net income into Retained Earnings

  • • Zeros-out the Income Statement accounts to begin again next period

• Ex:

• Literally just put the same amount in for the opposite side of each account. Debit revenue and credit expenses. 

• Dr. sales revenue 10,000

• Dr. service revenue 50

  • Cr COGS 3200

  • Cr wage expense 400

  • Cr rent expense 2000

  • Cr interest expense 65000

  • Cr depreciation expense 25

• Our debits will not equal our credits, so put the remaining amount in retained earnings

  • Cr retained earnings 4360, also the same as our net income for the period

    • Retained earnings becomes 4535

• Ex:

• Dr. revenue 10,000

  • Cr cogs 5000

  • Cr rent exp 500

  • Cr wage exp 1000

  • Cr RE 3500

What is equipment and land classified as?

long term asset

Dragon Company pays dividends of $500 in Year 1. The dividends were declared in Year 0. How does the accounting equation change because of the journal entry for the payment in Year 1?

Assets decrease by 500, Liabilities decrease by 500.

originally under accounts payable when they are declared, that’s why liaiblities decrease, you get rid of the accounts payable

Indicate whether each transaction would increase (I), decrease (D), or have no effect (NE) on the total assets of the company.

Borrowed money from the bank  on a Notes Payable	I
Purchased inventory on credit	I
Purchased inventory with cash	NE
Paid off an accounts payable to a supplier	D

Collected cash on accounts receivable	NE
Issued capital stock in exchange for cash contributed by owners	I
Loaned money to an employee in exchange for a note	NE
Declared dividends	NE