Financial Accounting 210 (Scott Anderson)

Financial

External users of financial statements; follow GAAP

Managerial Accounting

Internal users; no GAAP

SEC

Securities and Exchange Commission

IRS

Internal Revenue Service

FASB

Financial Accounting Standards Board

GAAS

Generally Accepted Auditing Standards

GAAP

Generally Accepted Accounting Principles

CPA

Certified Public Accountant

Controller

Typically the top accounting person in a company

Entity

Organizational element about which accounting information is collected

Cost

All costs are historical

Objectivity

Arm's length negotiation

Going Concern

Company will be around long enough to use up assets and pay all liabilities

Revenue Recognition

Earned: Rendered goods and services

Recognized: expectation of payment

Matching

Match expenses with revenue in the period they occur

Consistency

Follow the same procedures each accounting period so can compare financial statements

Conservatism

If multiple options exist, pick the least favorable

Materiality

If you knew the fact, it could change your mind; 5% of something

Full Disclosure

"Full Monty" must disclose all relevant information

Accounting Equation

Assets = Liability + Stockholders' Equity

Assets

Something of future economic value

Are all assets shown on the balance sheet? If not, why not?

No. Assets must be objectively quantifiable to be recorded on the balance sheet.

Liability

Something owed

Are all liabilities shown on the balance sheet? If not, why not?

No. Liabilities must be objectively quantifiable to be recorded on the balance sheet.

Contingent liability

Liability that cannot be objectively quantifiable.

Stockholder's Equity

Capital plus retained earnings

Capital

Investment by the stockholders

Retained Earnings

Earnings retained in the business

Equation for Retained Earnings

Ending RE = Beginning RE plus NIAT(net income after tax) minus Dividends

Dividend

Distribution of retained earnings to stockholders

Expense

Expired asset

Revenue

Rendered goods and/or services with the expectation of payment

Accounting process

Recording, classifying, reporting, interpreting

Chart of Accounts

"Accountant's Bible" or "Index"--list of the names and account numbers for all accounts

General Journal

"Book of Original Entry"--shows the debits and credits for each accounting transaction

General Ledger

List of all transactions for the accounting period sorted by account number

Debit

Entry on the left side of a general ledger account

Credit

Entry on the right side of a general ledger account

Trial Balance

List of all accounts showing that the total debits equals the total credits

Adjusting Entry

Reconciles a general ledger account to a backup schedule

Closing Entries

At end of period, all revenue and expense accounts closed to Retained Earnings

Reversing Entries

Reversing an accrual entry from a pervious period

Contra account

Account used to keep the balance in another account visible

"Close" or "Close the books"

At the end of the period, close (move) all the revenue and expense account balances on the income statement to retained earnings; resets the income statement to zero to begin the next period.

Accrual Basis vs. Cash Basis

Accrual basis; accounting based on transactions

Cash basis; accounting based on cash in/cash out (i.e. Real World)

Income Statement

Matches revenue with expense over a period of time

SG&A

Selling, general, and administrative expense (aka operating expenses)

Cost of goods sold: Equation

beginning inventory plus net purchases minus ending inventory

Non-cash charges

Deduction on income statement but no cash paid; Examples: Depreciation, amortization, depletion, gain or loss on asset sale

Gross Profit

Net Revenue minus cost of goods sold

Operating income

Gross profit minus S,G & A; income from the core business

Balance Sheet

Shows assets equals liabilities plus stockholders equity at a point in time (financial snapshot)

Current

within 12 months or one operating cycle

Current assets

assets that will be used up or converted to cash within one year

Current liabilities

liabilities which are due within one year

Statement of Changes in Cash Position

Difference between two balance sheets expressed in cash

"Capitalize It" versus "Expense It" versus "Write It Off"

Capitalize it - put the amount on the balance sheet

(generally as an asset to be depreciated or amortized)

Expense it = Write It Off - deduct the amount on the income statement

Common stock versus Preferred stock

Common stock: Basic stock ("common") stock of the company sold to stockholders,

rights by state law

Preferred stock: Hybrid stock (may possess bond like characteristics) sold to specific investors;

rights by contract.

Stock: Authorized versus Issued versus Treasury versus Outstanding

Authorized: stock authorized for sale by stockholders in the Article of Incorporation

Issued: sold or exchanged for value

Treasury: stock bought back by the company (i.e. in the treasury of the company)

Outstanding:

Issued minus Treasury;

stock held by investors;

most important: Vote and receive dividends (if any paid)

Fixed (plant) assets (aka PPE—property, plant, and equipment)

Assets with an estimated useful life of more than one year

Impairment

Irreversible reduction in the value of asset below its book value

Goodwill

Amount paid above the identifiable assets of a transaction

Long term liabilities

Liabilities due beyond more than one year

Book value of an asset vs. market value of an asset

Book value of an asset: original cost minus accumulated depreciation

Market value of an asset: value paid by a willing buyer and willing seller

Book value of a company vs. market value of an company

Book value of a company: Common stockholders' equity

Market value of a company: Value paid by a willing buyer and willing seller

Sales vs. Revenue

There is no difference

Accrued

Estimated

Gross revenue vs. net revenue (which is more important and why?)

Gross revenue (i.e. Price x Quantity)

(Sales returns and allowances)

(Sales discounts)

Net revenue: Net revenue is most important because that is what you expect to collect

Gross accounts receivables versus net account receivables (which is more important and why?)

Gross accounts receivable

(Allowance for doubtful accounts)

Net accounts receivable: Net accounts receivable is most important because that is what you expect to collect

Net Income

Revenue minus expense

Expense

Expired asset

Prepaid expense

Paid cash but have not yet received the goods and services

Unearned revenue (aka customer deposits)

Received cash but have not yet rendered the goods and services

Depreciation, Amortization, and Depletion

Method of cost allocation of long term assets over the estimated useful life under the Matching Principle

- does NOT represent wear and tear or loss of value

Depreciation

Allocation of original costs over the estimated useful life of a tangible asset

Amortization

Allocation of original costs over the estimated useful life of an intangible asset

Depletion

Allocation of original costs over the estimated useful life of a natural resource asset

Depreciation, amortization or depletion versus accumulated depreciation, amortization, or depletion

Expense for the period (I/S) versus sum of the expense across all periods since the asset was placed in service (contra asset account on the B/S).

Fiscal Year vs. Calendar Year

Calendar year: accounting year ends December 31

Fiscal year: accounting years ends on any other month

Cash Discount vs. Trade Discount

Cash discount: prompt payment discount—to get customers to pay faster(interest expense on I/S)

Trade discount: reduction from retail price to get wholesale price (not on financial statements)

Period Inventory vs. Perpetual Inventory

Periodic: every so often, i.e. daily, weekly, monthly, quarterly, annually

Perpetual: every transaction (i.e. scanner)

Other Income and Expense

Interest income and interest expense

Capital gains and losses

Gain: sale of non-operating asset at greater than book value

Loss: sale of non-operating asset at less than book value

(Only operating asset = inventory)

Dividend vs. Expense

Dividend: distribution to stockholders from retained earnings (B/S - S/H Equity)

Expense: expired asset (I/S - SG&A)

Tax Expense

- Expense to company

-appears on income statement

- examples: income tax, employer payroll taxes, sales tax paid by company on its purchases

Tax Pass Through

- taxes collected on behalf of a governmental entity and passed through to the entity

- neither a revenue nor an expense

- may appear on balance sheet as liability if not yet paid

-examples: sales taxes, excise taxes, employee payroll taxes

Basis (tax term)

Value from which tax gains and tax losses are measured (similar to book value)

Freight In versus Freight Out

• Normal assumption: buyer pays freight

• FOB: "Free on Board" (maritime reference)

point at which title transfers: FOB Plant, FOB destination

not to be confused with who ultimately pays the shipping cost

Freight In:

part of inventory which is a current asset on B/S

cost of getting materials to the plant or warehouse

Freight Out:

part of SG&A - sales/marketing expense of getting product to the customer; deduction from gross profit on I/S

Bad Debts Expense versus Allowance for Doubtful Accounts (aka ADA - Allow for Bad Debts)

• Bad debt expense - the net (squeeze)adjustment to the ADA account; part of S,G &A on the income statement

• ADA - the estimate of accounts that are uncollectible; contra account to A/R in current assets

• "Bad debts go to the ADA to die"

• Direct Write Off - bad debts go directly to I/S since there is no ADA history.

What is the purpose of a for-profit and a not-for-profit entity?

What is the purpose of a non-governmental entity?

To satisfy a customer demand.

How can a company "make" money and not have any cash?

The company keeps its books on the accrual basis which follows transactions but the Real World operates on the cash basis of cash in/cash out

Why does a company need to make a profit?

To reward the stockholders for taking the investment risk

Does a not-for-profit entity need to make a "profit"?

Yes, the cash donations to a not-for-profit must exceed the cash paid out for the entity in order to build reserves and to fund future activities.

Who pays the corporation or business entity income taxes?

The customer pays the taxes. Revenue must cover all expenses which includes taxes. An increase in taxes is an increase in expense which requires an increase in revenue for the company to make a profit.

What is the difference between a for-profit entity and a not-for-profit entity?

Not-for-profit entity: pays no income taxes

For profit entity: pays taxes and thereby subsidizes non-for-profit entities

Do taxes matter? Why?

Yes. Taxes represent unavoidable cash out which makes the cash unavailable for reinvestment in the business.

Fair

• in general usage - unit of emotional measure without objective reference

e.g. "that's not fair!!", "do it for the children!"

• in accounting -

>estimate of value based on references to other objective values (e.g. fair value accounting)

>auditors opinion after considering all management assertions in the financial statements (e.g. presents fairly)

• in baseball - a ball hit on the ground between first and third base

Simple Interest

Interest for one period, not interest on interest

I = PRT

I = Interest amount

P= Principle

R = Annual rate of interest

T = Time (portion of a year)

Days in each month

Thirty days hath September,

April, June, and November;

February has twenty-eight alone,

All the rest have thirty-one,

Excepting leap year, that's the time

When February's days are twenty-nine.

Compound Interest

Interest over multiple periods; interest on interest

Solvency versus Liquidity

Solvency: capacity to pay bills (e.g. debt/equity, current ratio)

Liquidity: ability to pay bills (e.g. quick ratio, DSO)