117_Financial Statements

Balance Sheet or Statement of FinancialP osition

indicates what a business owns and what it owes at one point in time.

Current assets

Also known as fixed assets

Assets= Liabilities + Owner’s Equity

The fundamental balance sheet equation or the basic Accounting equation

Assets

are defined as valuable resources that are owned or controlled by the business and acquired at a measurable cost.

cash, accounts receivables, delivery vans, computers

Examples of Assets

Categories-current assets and noncurrent assets

Two types of Assets

Current assets

are those that will be sold, consumed or converted to cash within the current operating cycle of the business (which is usually 1 year).

Current assets

are listed in the balance sheet in the order of their liquidity or the ease with which they are converted to cash.

cash, accounts receivable, prepaid expenses and short –term investments, inventories.

The current assets commonly appearing in the balance sheets of pharmacies include

Delivery trucks > inventory > accounts receivable > jewelry > cash

Question? Arrange these assets in the order of increasing liquidity:

accounts receivable, inventory, jewelry, delivery trucks , cash

Cash

Refers to coins, currency and other items such as personal checks, charge cash receipts, and traveler’s checks, which banks will accept for deposit.

Cash

is the most liquid asset

Accounts receivable

Are amounts owed to the pharmacy by its customers as a result of the ordinary extension of credit. In other words, accounts receivables are the customers’ promises to pay for merchandise that they have purchased on credit from the pharmacy.

Accounts receivable

• May be divided to those arising from credit sales and those arising from third-party sales.

• Credit sales are charged sales made to customers who themselves have to pay for the merchandise they have purchased on credit.

• Third party sales are charge sales made to a customer of the pharmacy but paid for by a third party –usually an insurance company, a managed care organization or Medicaid. Most third party sales are for prescriptions.

Inventory

Aggregate of items of tangible personal property which 1) are held for sale in the ordinary course of business,2) are in the process of production for such sales 3) or are to be currently consumed in the production of goods or services to be available for sale

1. Merchandise inventory

2. Supplies inventory

Types of Inventory

Merchandise inventories

[Type of Inventory[

Consists of goods that the pharmacy has purchased for resale, e.g. OTC and prescription drugs, cosmetics, and first aid supplies.

Supplies inventories

[Type of Inventory]

consists of goods that were purchased for use in the business rather than for resale. Supplies have low unit value and will be consumed within the year. Examples of supplies include bags, pens and prescription labels and vials

Short-term investments

• assets that a business can quickly sell for cash when needed, usually within a year.

• or temporary investments or marketable securities

• When need arise, these investments may be sold within the current operating cycle of the business.

• hen the business has more cash than it needs to conduct its business, it may invest its cash in money markets, stocks, bonds, or certificate of deposit which earn higher rates of interest than checking account.

Prepaid expenses

• Prepaid expenses are payments made in advance for goods or services that will be used in a future period. They are recorded as assets until the benefit is received. Examples include prepaid rent, insurance, or subscriptions.

Arise from payments made for a good or service in an accounting period prior to the one during which the good or service is actually used

Prepaid rent

Example of Prepaid Expenses

Noncurrent asset

Are those that under normal condition are not sold, consumed or converted to cash within the normal operating cycle of the business or 1 year. These are assets that have been purchased for use in the business, which usually have high costs, and which are expected to last for several years.

Examples include land, building, fixtures, cars and computers. Also called fixed assets or as fixtures and equipment.

Example of Noncurrent asset

• Leaseholds

• leasehold improvements

• goodwill

• franchise

• organization cost

Examples of Intangible Assets

Leasehold

A property rented for an extended period of time, a contract (lease) is established between the the owner (Lessor) and the tenant (Lessee). If a nonrefundable deposit is paid, this amount shouldbe included as an intangible asset termed leasehold.

Leasehold improvements

Improvements or alterations that must be made to leased property to make it more suitable for use.

Goodwill

Payment in excess of market value of the asset in recognition that asset will produce more than the average returns.

Franchise

• Gives an opportunity to own a business under the aegis of an established company

• Amortized over the period of usefulness of the business

Organization cost

• Legal fees, license fees and incorporation fees incurred in theorganization of the business.

• Charged to an asset account initially and then amortizd over a period of time.

Intellectual Property

Patents, Copyrights, Industrial design, trademarks

A business may purchase an asset as a speculative investment or a previously acquired asset may be removed from service and held for possible sale.When either of these events occurs, the asset is classified as an investment in the other assets section of the balance sheet . Even though such assets commonly are fixed assets, e.g. buildings, land and equipment, once they cease to be functional in the operation of the business, they must be reclassified in the balance sheet.

Liabilities

are the business debts. They arise from purchasing goods or services on credit or from borrowing money to finance the business’s operations. As with assets, they are classified as either current or noncurrent.

Current liabilities

Consists of those debts that will come due during the current operating cycle of the business.

accounts payable, short term notes, accrued expenses, and the current portion of long-term debts.

For a pharmacy, the most commonly occurring current liabilities include

Accounts payable

Are debts that arise from purchase of goods or services on credit. Example of purchase of accounting or janitorial services on credit (from other companies) would lead to an account payable.

Trade payables

For a pharmacy vast majority of accounts payable come from purchase of merchandise inventory. This is also called

Current or short-term notes payable

Are debts evidence by formal, signed agreements called promissory notes.

Notes payable

arise when the pharmacy borrows money. When it does so, it must sign a written agreement that specifies when repayment must be made and at what rate of interest.

Acrued expenses

Are amounts for goods or services that have been used during the accounting period but for which payment has not been made. Example accrued salaries.

Noncurrent liabilities

Are debts that will come due after the current operating cycle of the business. It may also be recorded as notes payable (long term), mortgage or long term debts.

Example include car loans that are paid over 5 years and mortgages that are paid off over 20 years

Example of noncurrent liabilities

Owner’s Equity

is the amount left over after liabilities are subtracted from assets. It may also be called net worth, stockholders’ equity or capital. It arises from two sources- invested capital and retained earnings.

Invested capital

Consists of cash invested into the business by its owners. For a corporation, it is called common or capital stock

Accountants make a strict distinction between the finances of the business and the finances of the owners of the business

Equities

The right of financial claim to the assets.

Belongs to those who supply the assets

Relationship between assets and equities:

Assets = Equities meaning

Total value of items owned by business= total claims against the assets

Owner’s equity-the claim of business owners

Liabilities- claim of creditors

Retained earning

Are profits (or losses) that the business has made during its years of operation and that has been left in the business. Profits increase retain earnings while losses decrease them

Income statement

Also called the profit and loss statement reports the net income of the business for a specific period of time. This period may be a month, a quarter a year. A pharmacy will have an income statement made at least once per year.

Many pharmacies generate monthly income statement to allow them to more closely monitor sales and expenses.

Revenue-Expenses = Net income

The basic income statement is

Revenue

Are sales of merchandise normally sold by the business. Include both cash and credit sales.

Expenses

Are costs that the business incurs to make sales or earn revenues. Expenses include all costs of operating the business. Examples are the cost of merchandise sold, salaries, utilities and interests payments.

Not expense- repayment of the principal part of the loan nor would owner’s withdrawal from the business.

Depreciation expense

• Is an estimate of the amount of noncurrent assets’ value that has been used up during the current operating cycle.

• Needs no direct cash payment

Net income

• Is defined as the difference between revenues and expenses for a specific period of time.

• Also called net profit or earnings

Classify the following as either assets, liability, owner’s equity, revenue, or expense

1. Rent expense

2. Salaries expenses

3. Accounts payable liability

4. Cash assets

5. Accounts receivable assets

6. Depreciation charge expense

7. Mortgage liability

8. Retained earnings owner’s equity

9. Credit sales revenue

10. Goodwill assets (intangible)

1. Decrease (debit bcs it will affect owner’s equity)

2. Decrease

3. Decrease

4. No effect (credit, see transaction record, no effect; accounts payable)

Indicate effect on owner’s equityincrease/decrease/no effect

1. owner’s withdrew $350 from the business for personal use.

2. Business paid dividends of $3,000

3. Business had a net loss of $4,000 for the year.

4. Business purchased inventory on credit.

1. OE = $5000

2. $250,000

3. $20,000

4. No change, 50, 000

Sample Problem

1. 
   Assets=$50,000,liabilities=$45,000 and OE=?

2. OE= $10,000, liabilities=$240,000,and assets=?

3. Revenues=$500,000, expenses=$480,000 and net income=?

4. Owner’s equity at the beginning of the year was $50,000, no additional owner’s investment or withdrawal was made during the year . OE at the end of the year is?

Service Firm

A service firm is one that sells a service rather than a product. Examples include physicians’ and dentists’ practices, plumbers and exterminators, and consultants.

Merchandising Firm

is one that sells a tangible product. Examples include supermarkets, hardware stores, automobile dealerships, and pharmacies

• Service firm: The income statement for a service firm focuses on service revenue (income earned from providing services) and operating expenses (such as salaries, rent, and utilities). There is no cost of goods sold (COGS) since no physical products are sold.

• Merchandising firm: The income statement for a merchandising firm includes sales revenue from selling products, as well as cost of goods sold (COGS), which represents the cost of purchasing the goods that were sold. It also includes operating expenses similar to those of a service firm.

Service vs Merchandising?

Cost of Good Sold

• BI beginning inventory

• P all purchases made during the year

• EI inventory on hand at the end of the year

Statement of Retained Earnings

Reports how the retained earnings of the business have changed over some period.

The statement lists the amount of retained earnings at the beginning of the period and major changes to retained earnings over the period. These include dividends payments or net losses which decrease retained earnings and net income and additional owner investments, which increase retained earnings.

*insert slide 44

Capital Statement

For sole proprietorships and partnerships, a comparable statement is the capital statement. It shows how the owner’s equity (also called capital) has changed over some period. Net income and owner’s investment increase owner’s equity, whereas net losses and owner’s withdrawals decrease it.

Sources and Uses Statement

• Shows how a pharmacy obtained cash during the year and how it uses that cash.

• Also called cash flow statement or statement of changes in financial position

Cash and Accrual Accounting

• Accounting period=1 year

• Two methods of determining the time period in which revenue or expense should be recorded

period, revenue & expense

Cash method vs Accural method

Cash method

Revenues are recognized or recorded in the period during which cash is received and expenses are recognized in the period during which cash is paid out.

Though simple to understand and use it is not commonly used.

Accrual method

More commonly used

In the accrual system, revenues are recognized in the period during which goods are delivered or services rendered. Not necessarily the same period cash is received.

In the accrual system ,both cash and credit sales are recognized as revenues at the time the sale is made, not necessarily when payment is received.

There are two ways of determining when expenses are recognized in the accrual system.

Accrual method

First expenses are recognized in the same accounting period as the associated revenue.

A second way of defining expense recognition is that expenses are recognized in the period when the associated good or service is used

The accrual method allows for the accurate matching of the revenues of an accounting period with the expenses required to generate those revenues. In other words, this method allows for the accurate measurement of net income.

Depreciation slide 52

True

[T/F] all assets are depreciated except land

Depreciation

Is the process of systematically and rationally determining how much of a noncurrent asset’s initial cost is recognized as an expense in each year of its life.

1. Asset acquisition cost

2. Asset’s useful life

3. Asset’s residual or salvage value

3 items needed for calculating Depreciation

Asset acquisition cost

amount paid for the asset including any reasonable cost incurred in acquiring the asset and putting it into operation ,e.g. transportation, taxes and set-up cost/renovation cost.

1. Straight line method

2. Accelerated methods

Two methods in selecting the depreciation method

Straight line method

• simplest and most straightforward

• assumes that assets wear out or are used up at constant rate. As a result depreciation expense is the same in each year of the asset’s life.

Accelerated methods

> because they take off proportionally more of an asset’s value in the early years of its life and proportionally less in later years. Based on the assumption that the asset is more efficient or that it loses more of its value in the early years of its life. This is a rather more reasonable assumption for many types of noncurrent assets.

slide 56

slide 60:

1. C. bottle of maalox

2. C. $1,500 (value of asset minus negative depreciation)

3. D. All give the same depreciation expense over the entire life of the asset