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Financial Accounting Summary

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Accounting Review for the CLEP
Chapter 1 * Accounting “links” decision makers with economic activities and with the results of their decisions * Information Users * Investors * Creditors * Managers * Owners * Customers * Employees * Regulatory agencies * SEC * IRS * EPA * Cost & Revenue Determination * Job costing * Process costing * ABC * Sales * Assets & Liabilities * Plant and equipment * Loans & equity * Receivables, payables & cash * Cash Flows * From operations * From financing * From investing * Decision Support * CVP analysis * Performance evaluation * Incremental analysis * Budgeting * Capital allocation * Earnings per share * Ratio analysis * Basic Functions of an Accounting System * Interpret and record business transactions * Classify similar transactions into useful reports. * Summarize and communicate information to decision makers. * Objectives of Financial Reporting (general to specific) * Information useful in making investment and credit decisions * Information useful in assessing amount, timing and uncertainty of future cash flows. * Information about economic resources, claims to resources, and changes in resources and claims. * The primary financial statements * Balance Sheet * Income Statement * Statement of Cash Flow * Characteristics of Externally Reported Information * A Means to an End * Broader than Financial Statements * Historical in Nature * Results from Inexact and Approximate Measures * Based on General Purpose Assumption * Usefulness Enhanced via Explanation * Internal Users of Accounting Information * Board of Directors * Chief Executive Officer * Chief Financial Officer * Vice Presidents * Business Unit Managers * Plant Managers * Store Managers * Line Supervisors * Integrity of Accounting Information * Institutional Features * Generally Accepted Accounting Principles (GAAP) * Financial Accounting Standards Board * Securities and Exchange Commission * Internal Control Structure * Audits * Professional Organizations * American Institute of Certified Public Accountants * Institute of Management Accountants * Institute of Internal Auditors * American Accounting Association * Competence, Judgment and Ethical Behavior * Certified Public Accountants (CPAs) * Certificate in Management Accounting (CMA) * Certificate in Internal Auditing (CIA) * Code of Professional Conduct

* Chapter 1 Important Notes * Accounting is the means by which information about an enterprise is communicated and, thus, is sometimes called the language of business. * Because the primary role of accounting information is to provide useful information for decision-making purposes, it is sometimes referred to as a means to an end, with the end being the decision that is helped by the availability of accounting information. * Information systems are critical to the production of quality and efficient accounting information. * The FASB and SEC are important organizations in terms of standard setting in the United States. * The FASB is a private-sector organization that works closely with the SEC, which has legal authority to designate financial reporting standards for publicly held companies. * Personal competence and professional judgment are, perhaps, the most important factors in ensuring the integrity of financial information. Competence is demonstrated by one's education and professional certification (CPA, CMA, CIA). * Professional judgment is important because accounting information is often based on inexact measurements and assumptions are required. Ethical behavior refers to the quality of accountants being motivated to "do the right thing" in applying their skills.
Chapter 2 * Introduction to Financial Statements * Companies prepare interim financial statements and annual financial statements. * Three primary financial statements. * Balance Sheet: Describes where the enterprise stands at a specific date. * Income Statement: Depicts the revenue and expenses for a designated period of time. * Revenues result in positive cash flow * Expenses result in negative cash flow * Either in the past, present, or future * Net income (or net loss) is simply the difference between revenues and expenses. * Investments by and payments to the owners are not included on the Income Statement. * Statement of Cash Flows: Depicts the ways cash has changed during a designated period of time. * Cash Flows from Operating Activities * Operating activities include the cash effects of revenue and expense transactions. * Cash received from revenues transactions * Cash paid for expenses * Cash Flows from Investing Activities * Investing activities include the cash effects of purchasing and selling assets. * Purchases * Collections * Payments * Cash Flows from Financing Activities * Financing activities include the cash effects of transactions with the owners and creditors * Investment by Owner * A business entity is separate from the personal affairs of its owner. * Assets are economic resources that are owned by the business and are expected to provide positive future cash flows * These accounting principles support cost as the basis for asset valuation * Cost Principle * Going-Concern Assumption * Objectivity Principle * Stable-Dollar Assumption * Liabilities are debts that represent negative future cash flows for the enterprise. * Owners’ equity represents the owner’s claim to the assets of the business. * Changes in Owners’ Equity * Owners’ Investments increase Owner’s Equity * Business Earnings increase Owner’s Equity * Payments to Owners decrease Owner’s Equity * Business Losses decrease Owner’s Equity * The Accounting Equation * Assets = Liabilities + Owners’ Equity * The Use of Financial Statements by Outsiders * Two concerns: * Solvency * Profitability * Notes to the financial statements often provide facts necessary for the proper interpretation of the statements

* Chapter 2 Important Notes

* Financial statements are declarations of information in financial terms about an enterprise that are believed to be fair and accurate. * The statement of financial position, or balance sheet, presents in great detail the elements of the basic accounting equation. * The three primary financial statements are based on the same underlying transactions. They are not alternatives to each other, but rather represent three different ways of looking at the financial activities of the reporting enterprise. Because they are based on the same transactions, they relate, or "articulate," very closely with each other. * Regardless of the form of organization, owner's equity represents the interest of the owner(s) in the assets of the reporting enterprise. * For a sole proprietorship, owner's equity consists only of the interest of a single owner. * For a partnership, the ownership interests of all partners are added together to determine the total owners' equity of the enterprise. * For a corporation, which usually has many owners, the total contribution to the enterprise represents its owners' equity. * In all cases, the enterprise's net income is added to owner's equity. * All important aspects of an enterprise's activities usually cannot be captured in financial terms. Financial statements typically are accompanied by notes that provide qualitative information that supplements and helps interpret the financial information included in the body of the financial statements.

Chapter 3

* The Role of Accounting Records * Establishes accountability for assets and transactions. * Keeps track of routine business activities. * Obtains detailed information about a particular transaction. * Evaluates efficiency and performance within company. * Maintains evidence of company’s business activities. * The Ledger * The entire group of accounts is kept together in an accounting record called a ledger * The ledger is an accounting record that includes all the ledger accounts - that is, a separate account for each item included in the company's financial statements. * Accounts are individual records showing increases and decreases. * The Use of Accounts * Increases are recorded on one side of the T-account, and decreases are recorded on the other side. * The left side is the DEBIT side * The right side is the CREDIT side * In the double-entry accounting system, every transaction is recorded by equal dollar amounts of debits and credits. * Assets………..Debit Balances * Liability + Owner’s Equity…………Credit Balances * The Journal * In an actual accounting system, transactions are initially recorded in the journal. * Posting Journal Entries to the Ledger Accounts * Posting involves copying information from the journal to the ledger accounts. * After Posting, the ledger format is referred to as a running balance (as opposed to simple T accounts). * Net income is not an asset; it’s an increase in owners’ equity from profits of the business. * Owner’s Equity * Capital Stocks * Retained Earnings * The balance in the Retained Earnings account represents the total net income of the corporation over the entire lifetime of the business, less all amounts, which have been distributed to the stockholders as dividends. * Revenue and Expenses * Revenue * The price for goods sold and services rendered during a given accounting period. * Increases owner’s equity. * Expenses * The costs of goods and services used up in the process of earning revenue. * Decreases owner’s equity. * The Realization Principle: When To Record Revenue * Revenue should be recognized at the time goods are sold and services are rendered. * The Matching Principle: When To Record Expenses * Expenses should be recorded in the period in which they are used up. * Investments by and Payments to Owners * Payments to owners decrease owners’ equity. * Owners’ investments increase owners’ equity. * The Accounting Cycle * Journalize transactions. * Post entries to the ledger accounts. * Prepare trial balance. * Make end-of-year adjustments. * Prepare adjusted trial balance. * Prepare financial statements. * Journalize and post closing entries. * Prepare after closing trial balance.

Chapter 3 Important Notes

* Accounting records provide the information that is summarized in financial statements, income tax returns, and other accounting reports. In addition, these records are used by the company's management and employees for such purposes as: * Establishing accountability for assets and transactions. * Keeping track of routine business activities. * Obtaining details about specific transactions. * Evaluating the performance of units within the business. * Maintaining a documentary record of the business activities. (Such a record is required by tax laws and is useful for many business purposes, including audits.) * The double-entry system of accounting takes its name from the fact that every business transaction is recorded by two types of entries. * Debit entries to one or more accounts * Credit entries to one or more accounts. * In recording any transaction, the total dollar amount of the debit entries must equal the total dollar amount of the credit entries. * The journal, or book of original entry, is the accounting record in which business transactions are initially recorded. * In a trial balance, separate debit and credit columns are used to list the balances of the individual ledger accounts. The two columns are then totaled to prove the equality of the debit and credit balances. * This process provides assurance that: * The total of the debits posted to the ledger was equal to the total of the credits. * The balances of the individual ledger accounts were correctly computed. * While a trial balance proves the equality of debit and credit entries in the ledger, it does not detect such errors as failure to record a business transaction, improper analysis of the accounts affected by the transaction, or the posting of debit or credit entries to the wrong accounts.

Chapter 4

* At the end of the period, we need to make adjusting entries to get the accounts up to date for the financial statements. * Adjusting entries are needed whenever revenue or expenses affect more than one accounting period. * Every adjusting entry involves a change in either revenue or expense and an asset or liability. * Types of Adjusting Entries * Converting assets to expenses (Transaction occur prior periods). Creates Assets * Depreciation * Supplies * Expiring Insurance Policies * Converting liabilities to revenue (Transaction occur prior periods). Creates Liabilities * Airline Ticket Sales * Sports Teams’ Sales of Season Tickets * Initially, revenues that benefit more than one accounting period are recorded as liabilities * Accruing unpaid expenses (Transaction occur future periods) Liability will be paid * Interest * Wages and Salaries * Property Taxes * Accruing uncollected revenues (Transaction occur future periods) Receivables will be collected * Interest Earned * Work Completed But Not Yet Billed to Customer * The Concept of Depreciation * Depreciable assets are physical objects that retain their size and shape but lose their economic usefulness over time. * Depreciation is the systematic allocation of the cost of a depreciable asset to expense. * The portion of an asset’s utility that is used up must be expensed in the period used * Depreciation Is Only an Estimate * Using the straight-line method, calculate the monthly depreciation expense. * Depreciation expense (per period) = Cost of the Asset
Estimated Useful Life * Accruing Income Taxes Expense: The Final Adjusting Entry * As a corporation earns taxable income, it incurs income taxes expense, and also a liability to governmental tax authorities * Adjusting Entries and Accounting Principles * Costs are matched with revenue in two ways: * Direct association of costs with specific revenue transactions. * Systematic allocation of costs over the “useful life” of the expenditure. * The Concept of Materiality * An item is “material” if knowledge of the item might reasonably influence the decisions of users of financial statements. * Many companies immediately charge the cost of immaterial items to expense.

* Chapter 4 Important Notes

* The purpose of adjusting entries is to allocate revenue and expenses among accounting periods in accordance with the realization and matching principles. * These end-of-period entries are necessary because revenue may be earned and expenses incurred in periods other than the one in which the related transactions are recorded. * Often a transaction affects the revenue or expenses of two or more accounting periods. * The related cash inflow or outflow does not always coincide with the period in which these revenue or expense items are recorded. Thus, the need for adjusting entries results from timing differences between the receipt or disbursement of cash and the recording of revenue or expenses. * When an expenditure is made that will benefit more than one accounting period, an asset account is debited and cash is credited. * The asset account is used to defer (or postpone) expense recognition until a later date. * At the end of each period benefiting from this expenditure, an adjusting entry is made to transfer an appropriate amount from the asset account to an expense account. * This adjustment reflects the fact that part of the asset's cost has been matched against revenue in the measurement of income for the current period. * Customers sometimes pay in advance for services to be rendered in later accounting periods. For accounting purposes, the cash received does not represent revenue until it has been earned. Thus, the recognition of revenue must be deferred until it is earned. * Some expenses accumulate (or accrue) in the current period but are not paid until a future period. These accrued expenses are recorded as part of the adjusting process at the end of each period by debiting the appropriate expense (e.g., Salary Expense, Interest Expense, and Income Taxes Expense), and by crediting a liability account (e.g., Salaries Payable, Interest Payable, and Income Taxes Payable). * Some revenues are earned (or accrued) in the current period but are not collected until a future period. These revenues are normally recorded as part of the adjusting process at the end of each period by debiting an asset account called Accounts Receivable, and by crediting the appropriate revenue account. * Adjusting entries are the tools by which accountants apply the realization and matching principles * The concept of materiality allows accountants to use estimated amounts and even to ignore other accounting principles if these actions will not have a material effect on financial statements.
Chapter 5 * Drafting Notes to the Financial Statements * Examples of Items Disclosed * Lawsuits pending * Scheduled plant closings * Governmental investigations * Significant events occurring after the balance sheet date * Specific customers that account for a large portion of revenue * Unusual transactions and related party transactions * Closing the Temporary Equity Accounts * The closing process gets the temporary accounts ready for the next accounting period. * Close Revenue accounts to Income Summary. * Close Expense accounts to Income Summary. * Close Income Summary account to Retained Earnings. * Close Dividends to Retained Earnings. * Since Sales Revenue has a credit balance, the closing entry requires a debit to the Sales Revenue account. * Since expense accounts have a debit balance, the closing entry requires a credit to the expense accounts. * Evaluating the Business * Evaluating Profitability * Did the business earn a profit or loss in the current period? * What is the business’s future potential for a profit? * Evaluating Solvency * Does the business have assets available to pay debts as they are due? * Focusing Management’s Attention * Are product lines profitable? * Are resources being used efficiently? * Are production processes efficient? * Many companies prepare financial statements at various points throughout the year, monthly, quarterly, annually.
Chapter 5 Important Notes * The financial statements are prepared directly from the adjusted trial balance. * The income statement is prepared by reporting all revenue earned during the period, less all expenses incurred in generating the related revenue. * The statement of retained earnings reconciles the beginning Retained Earnings account balance with its ending balance. The retained earnings statement reports any increase to Retained Earnings resulting from net income earned for the period, as well as any decreases to Retained Earnings resulting from dividends declared or a net loss incurred for the period. * The balance sheet reveals the company's financial position by reporting its economic resources (assets), and the claims against those resources (liabilities and owners' equity). * An income statement shows the revenue and expenses of a business for a specified accounting period. * Adequate disclosure is a generally accepted accounting principle, meaning that financial statements should include any information that an informed user needs to interpret the statements properly. * The appropriate disclosures usually are contained in several pages of notes that accompany the statements. * Closing entries serve two basic purposes. * The first is to return the balances of the temporary owners' equity accounts (revenue, expenses, and dividend accounts) to zero so that these accounts may be used to measure the activities of the next reporting period. * The second purpose of closing entries is to update the balance of the Retained Earnings account. * After the revenue and expense accounts have been closed, it is desirable to prepare an after-closing trial balance consisting solely of balance sheet accounts. * The after-closing trial balance, or post-closing trial balance, gives assurance that the accounts of the general ledger are in balance and ready for recording transactions for the new accounting period. * Profitability is an increase in stockholders' equity resulting from revenue exceeding expenses, whereas solvency refers to a company's ability to meet its cash obligations as they come due. * Solvency, at least in the short term, may be independent of profitability. * Financial statements are useful tools for evaluating both profitability and solvency. * When a business closes its accounts only at year-end, the revenue, expense, and owner's drawing accounts have balances representing the activities of the year to date. * To prepare an income statement for any period shorter than the year-to-date, we subtract from the current balance in the revenue or expense account the balance in the account as of the beginning of the desired period. * This process of subtracting prior balances from the current balance is repeated for each revenue and expense account and for the owner's drawing account.

Chapter 6

* Operating Cycle of a Merchandising Company * CAHS (purchase merchandise) * INVENTORY (sales of the merchandise on account) * ACCOUNT RECEIVABLE (collection of the acc receivable) * CASH………. And the cycle starts all over again) * INVENTORY * ACCOUNT RECEIVABLE ………

* Comparing Merchandising Activities with Manufacturing Activities * Merchandising Company * Purchase inventory in ready-to-sell condition. * Manufacturing Company * Manufacture inventory and have a longer and more complex operating cycle * Retailers and Wholesalers * Wholesalers buy merchandise from several different manufacturers and then sell this merchandise to several retailers. * Retailers sell merchandise directly to the public. * Cost of goods sold represents the expense of goods that are sold to customers * The cost of goods sold is subtracted from the Revenue from Sales * Gross profit is a useful means of measuring the profitability of sales transactions. * Gross Profit = Revenue from Sales – Cost of goods sold * What Accounting Information Does a Merchandising Company Need? * Financial Reporting Requirements * Revenues * Expenses * Daily Business Operating Requirements * Customer Ledgers * Special Reporting Requirements * Tax Reports * General Ledger Accounts * Although general ledger accounts provide useful information, they do not provide much of the detailed information needed in the daily business operations * Subsidiary Ledgers: A Source of Needed Details * Subsidiary Ledgers are more specific, for example in the general ledger inventory is included while in the subsidiary one each type of product offered for sale is included. * General Ledger Subsidiary Ledger
Plant Assets Each Asset
Account Payable Each Creditor
Capital Stock Each Stockholder
Sales Each department. Branch location
Cost of Good Sold Each department. Branch location
Many Expenses Account Each department incurring the account
Payroll Expenses Each employee * Two Approaches Used in Accounting for Merchandise Transactions * Perpetual Inventory System (Ex: Large Department Stores) * The inventory account is continuously updated to reflect items on hand. * The Inventory Subsidiary Ledger * At the end of the period, management compares the physical inventory count with the inventory ledger to determine inventory shrinkage. * Taking a Physical Inventory * In order to ensure the accuracy of their perpetual records, most businesses take a complete physical count of the merchandise on hand at least once a year. * Reasonable amounts of inventory shrinkage are viewed as a normal cost of doing business. Examples include breakage, spoilage and theft. * Closing Entries in a Perpetual Inventory System * Close Revenue accounts (including Sales) to Income Summary. * Close Expense accounts (including Cost of Goods Sold) to Income Summary. * Close Income Summary account to Retained Earnings. * Close Dividends to Retained Earnings. * Periodic Inventory System (Ex: Jo’s Dress Shop) * No effort is made to keep up-to-date records of either inventory or cost of goods sold. * Computing Cost of Goods Sold in a Periodic Inventory System * Cost of Goods Sold can be calculated as follows * Inventory (beginning of the year) + Purchase = * Costs of good available for sale –Inventory (end of year)= * Cost of Goods Sold * Completing the Closing Process * Close Revenue accounts (including Sales) to Income Summary. * Close Expense accounts (including Cost of Goods Sold) to Income Summary. * Close Income Summary account to Retained Earnings. * Close Dividends to Retained Earnings. * Modifying an Accounting System * Most businesses use special journals rather than a general journal to record routine transactions that occur frequently. * Credit Terms and Cash Discounts * When manufacturers and wholesalers sell their products on account, the credit terms are stated in the invoice * 2/10, n/30 * Read as “two ten, net thirty * 2 = percentage of discounts * 10 = # of Days Discount Is Available * n = Otherwise, the Full Amount Is Due * 30 = # of Days when Full Amount Is Due * Example * On July 6, Play Clothes purchased $4,000 of merchandise on credit with terms of 2/10, n/30 from Kid’s Clothes. Prepare the journal entry for Play Clothes. * 4000 (total) x 0.02 (% discount) = 80 * Therefore Play Clothes pays 4000 – 80 = 3920 within 10 or 4000 within 30 days * Credit Terms and Cash Discounts * Net Method * Purchases are recorded at their net amounts. * Purchase discounts lost are recorded when payment is made outside the discount period. * Recording Purchases at Gross Invoice Price * Gross Method * Purchases are recorded at their gross amounts. * Purchase discounts taken are recorded when payment is made inside the discount period. * Transportation Costs on Purchases * Transportation costs related to the acquisition of assets are part of the cost of the asset being acquired. * Transactions Relating to Sales * Credit terms and merchandise returns affect the amount of revenue earned by the seller. * Delivery Expenses * Delivery costs incurred by sellers are debited to Delivery Expense, an operating expense. * Accounting for Sales Taxes * Businesses collect sales tax at the point of sale. * Then, they remit the tax to the appropriate governmental agency at times specified by law. * Evaluating the Performance of a Merchandising Company * Net Sales * Trends overtime * Comparable store sales * Sales per square foot of selling space * Gross Profit Margins * Gross Profit ¸ Net Sales * Overall Gross Profit Margin * Gross Profit Margins by Department and Products

Chapter 6 Important Notes

* In general terms, a perpetual system should be used when (1) management and employees need timely information about inventory levels and product sales, and (2) the company has the resources to develop this information at a reasonable cost. A periodic system should be used when the usefulness of current information about inventories does not justify the cost of maintaining a perpetual system. * Perpetual systems are most widely used in large companies with computerized accounting systems and in businesses that sell high-cost merchandise. Periodic systems are most often used in small businesses with manual accounting systems and that sell many types of low-cost merchandise. * Buyers should record purchases at the net cost and record any cash discounts lost in an expense account. * Sellers record sales at the gross sales price and record in a contra-revenue account all cash discounts taken by customers. * Buyers record transportation charges on purchased merchandise either as part of the cost of the merchandise or as part of the cost of goods sold. * Sellers view the cost of delivering merchandise to customers as an operating expense. * Paying the sales tax to the government is payment of the liability, not an expense. * There are numerous measures used to evaluate the performance of merchandising businesses. In this chapter, we introduced three of these measures: (1) comparable store sales, which helps determine whether customer demand is rising or falling at established locations, (2) sales per square foot of selling space, which is a measure of how effectively a merchandising business is using its facilities to generate revenue, and (3) gross profit percentages, which help users of financial statements gain insight about a company's pricing policies and the demand for its products

Chapter 7

* How Much Cash Should a Business Have? * Every business needs enough cash to pay its bills! * Financial Assets * Cash * Short-term investments * Receivables * The Valuation of Financial Assets
Type of Financial Asset Basis for Valuation in Balance Sheet
Cash (and cash equivalent) Face Amount
Short-Mkt Investment (marketable security) Current Mkt Value
Receivables Net Realizable Value (Estm collectible amnt)

* Cash is defined as any deposit banks will accept. * Checks Bank Credit Card Sales * Money orders Coins and paper money * Traveler’s checks * Reporting Cash in the Balance Sheet * Cash Equivalents * Combined with cash on balance sheet * Matures within 90 days of acquisition * Stable market values * Liquid short-term investments

* “Restricted” Cash * Not available for paying current liabilities * Listed as an investment * Not a current asset * Lines of Credit * Bank agrees in advance to lend money. * Unused line of credit is disclosed in notes. * Liability is incurred when line of credit is used. * The Statement of Cash Flows * Summarizes cash transactions for an accounting period. * Includes cash and cash equivalents. * Cash Management * Accurately account for cash. * Prevent theft and fraud. * Assure the availability of adequate amounts of cash. * Avoid unnecessarily large amounts of idle cash. * Using Excess Cash Balances Efficiently * Cash available for long-term investment may be used to finance growth and expansion of the business, or to repay debt. * Cash not needed for business purposes should be distributed to the company’s stockholders. * Internal Control Over Cash * Segregate authorization, custody and recording of cash. * Prepare a cash budget. * Prepare a control listing of cash receipts. * Require daily deposits. * Make all payments by check. * Verify every expenditure before payment. * Promptly reconcile bank statements. * Cash Over and Short * Cash Over and Short is debited for shortages and credited for overages. * Bank Statements * Shows the beginning bank balance, deposits made, checks paid, other debits and credits in the month, and the ending bank balance. * Reconciling the Bank Statement * Explains the difference between cash reported on bank statement and cash balance in depositor’s accounting records. * Provides information for reconciling journal entries. * Reconciling the Bank Statement * Balance per Bank * + Deposits in Transit * - Outstanding Checks * ± Bank Errors * = Adjusted Balance * Balance per Depositor * + Deposits by Bank (credit memos) * - Service Charge * - NSF Checks * ± Book Errors * = Adjusted Balance * Petty Cash Funds * Used for minor expenditures. * Replenished periodically. * Has one custodian * Short-Term Investments * Marketable Securities are: * Bond Investments * Capital Stock Investments * Current Assets * Almost As Liquid As Cash * Readily Marketable * Mark-to-Market: A New Principle of Asset Valuation * Short-term investments in marketable securities appear on the balance sheet at their current market value as of the balance sheet date. * Forms of Securities in the Format * Classification * Management Intent * Treatment of Unrealized Holding Gains and Loses * Available for Sale Securities * Held for short terms (6-18 months) * Reported in stockholders’ equity section of the balance sheet * Trading Securities * Held for immediate resale (hours-days) * Reported in “other” revenue (expense) section of the income statement * Held to Maturity Securities * Debt securities intended to be held until they mature * Reported in stockholders’ equity section of the balance sheet * Uncollectible Accounts * If a company makes credit sales to customers, some accounts inevitably will turn out to be uncollectible. * Uncollectible Accounts Expenses are recorded with a DEBIT in the General Journal and are a Selling Expense * Allowance for Doubtful Accounts are recorded with a CREDIT in the General Journal and are a Contra-Asset Account * Accounts Receivable – Allowance for Doubtful Accounts = Net Realizable Value * Net Realizable Value of Account Receivable is the amount of accounts receivable that the business expects to collect. * Writing Off an Uncollectible Account Receivable * When an account is determined to be uncollectible, it no longer qualifies as an asset and should be written off. * Monthly Estimates of Credit Losses * At the end of each month, management should estimate the probable amount of uncollectible accounts and adjust the Allowance for Doubtful Accounts to this new estimate. * Estimating Credit Losses — The “Balance Sheet” Approach * Year-end Accounts Receivable is broken down into age classifications * Each age grouping has a different likelihood of being uncollectible. * Compute a separate allowance for each age grouping. * An Alternative Approach to Estimating Credit Losses * Uncollectible accounts’ percentage is based on actual uncollectible accounts from prior years’ credit sales. * Focus is on determining the amount to record on the income statement as Uncollectible Accounts Expense. * Uncollectible Accounts Summary * % of Receivables * Emphasis on Realizable Value; Balance Sheet Focus * Aging of Receivables * Emphasis on Realizable Value; Balance Sheet Focus * % of Sales * Emphasis on Matching; Income Statement Focus * Direct Write-Off Method * This method makes no attempt to match revenue with the expense of uncollectible accounts. * Income Tax Regulations and Financial Reporting * Taxable Income * Direct write-off method required to calculate taxable income. * Financial Statement Income * Allowance methods better match expenses with revenues. * Internal Controls for Receivable * Separate the following duties: * Maintenance of the accounts receivable subsidiary ledger. * Custody of cash receipts. * Authorization of accounts receivable write-offs. * Ways to Minimize Amounts in Accounts Receivable * Selling Accounts Receivable * Credit Card Sales * Evaluating the Quality of Accounts Receivable * Accounts Receivable Turnover Ratio * This ratio provides useful information for evaluating how efficient management has been in granting credit to produce revenue. * NET SALES AVERAGE ACCOUNT RECEIVABLE * Avg. Number of Days to Collect A/R * This ratio helps judge the liquidity of a company’s accounts receivable. * DAYS IN YEAR ACCOUNT RECEIVABLE TURNOVER RATIO

Chapter 7 Important Notes

* The objectives of cash management are accurate accounting for cash transactions, the prevention of losses through theft or fraud, and maintaining adequate--but not excessive--cash balances. * The major steps in achieving internal control over cash transactions are as follows: (1) separate cash handling from the accounting function, (2) prepare departmental cash budgets, (3) prepare a control listing of all cash received through the mail and from over-the-counter cash sales, (4) deposit all cash receipts in the bank daily, (5) make all payments by check, (6) verify every expenditure before issuing a check in payment, and (7) promptly reconcile bank statements. * The cash balance shown on the month-end bank statement usually will differ from the amount of cash shown in the depositor's ledger. The difference is caused by items that have been recorded by either the depositor or the bank, but not recorded by both. * The purpose of a bank reconciliation is to achieve the control inherent in the maintenance of two independent records of cash transactions: one record maintained by the depositor and the other by the bank. * When securities are purchased, they are recorded at cost. Interest and dividends generally are recognized as revenue when they are received. When securities are sold, the cost is compared to the sales price, and the difference is recorded as a gain or a loss. Chapter 8 * Inventory Defined * Goods owner and held for sale to customers * Current asset * The Flow of Inventory Costs * Inventory is a current asset in the balance sheet as purchase costs (manufacturing costs) are incurred * Appears in the Income Statement as a Cost of Goods Sold as good are sold * In a perpetual inventory system, inventory entries parallel the flow of costs. * A separate subsidiary account is maintained for each item in inventory. * Inventory Cost Flows * We use one of these inventory valuation methods to determine cost of inventory sold. * Specific identification * Average cost * FIFO * LIFO * Specific Identification * When a unit is sold, the specific cost of the unit sold is added to cost of goods sold * Comments * Parallels physical flows * Logical method when units are unique * May be misleading for identical units * Average-Cost Method * When a unit is sold, the average cost of each unit in inventory is assigned to cost of goods sold. * Cost of Goods Available for Sale/Units on hand on the date of sale * Comments * Assign all units the same average unit cost * First-In, First-Out Method (FIFO) * Oldest Cost----------------Cost of Goods Sold * Recent Cost---------------Ending Inventory * Comments * May overstate income in periods of rising prices; may increase income taxes due * Last-In, First-Out Method (LIFO) * Recent Cost--------------Cost of Goods Sold * Oldest Cost---------------Ending Inventory * Comments * Most conservative method during periods of rising prices, often result in lower income taxes * The Principle of Consistency * Once a company has adopted a particular accounting method, it should follow that method consistently, rather than switch methods from one year to the next. * Just-In-Time (JIT) Inventory Systems * The primary reason for taking a physical inventory is to adjust the perpetual inventory records for unrecorded shrinkage losses, such as theft, spoilage, or breakage. * LCM and Other Write-Downs of Inventory * Obsolescence * Reduces the value of the inventory. * Lower of Cost or Market (LCM) * Adjust inventory value to the lower of historical cost or current replacement cost (market). * Goods In Transit * A sale should be recorded when title to the merchandise passes to the buyer. * F.O.B. shipping point: title passes to buyer at the point of shipment. * F.O.B. destination point: title passes to buyer at the point of destination. * Periodic Inventory Systems * In a periodic inventory system, inventory entries are as follows. * Purchase with a DEBIT * Note that the Purchase entry is not made to inventory. * Account Payable with a CREDIT * The inventory on hand and the cost of goods sold for the year are not determined until year-end. * An error in ending inventory in a year will result in the same error in the beginning inventory of the next year. * The Gross Profit Method * Determine cost of goods available for sale. * Estimate cost of goods sold by multiplying the net sales by the cost ratio. * ŽDeduct cost of goods sold from cost of goods available for sale to determine ending inventory. * Inventory Turnover Rate * Measures how quickly a company sells its merchandise inventory. * Merchandise Turnover = Cost of Goods Sold/Average Inventory * Average Inventory = (Beg. Inv + End. Inv) / 2 * A ratio that is low compared to competitors suggests inefficient use of assets. Chapter 8 Important Notes * Shrinkage losses are recorded by removing from the Inventory account the cost of the missing or damaged units. The offsetting debit may be to Cost of Goods Sold, if the shrinkage is normal in amount, or to a special loss account. If inventory is found to be obsolete or unsalable, it is written down to zero (or its scrap value, if any). If inventory is valued at the lower-of-cost-or-market, it is written down to its current replacement cost, if at year-end this amount is substantially below the cost shown in the inventory records. * In the current year, an error in the costs assigned to ending inventory will cause an opposite error in the cost of goods sold and, therefore, a repetition of the original error in the amount of gross profit. For example, understating ending inventory results in an overstatement of the cost of goods sold and an understatement of gross profit. * The error has exactly the opposite effects on the cost of goods sold and the gross profit of the following year, because the error is now in the cost assigned to beginning inventory. * Both the gross profit and retail methods use a cost ratio to estimate the cost of goods sold and ending inventory. * In the gross profit method, the cost ratio is 100% minus the company's historical gross profit rate. * In the retail method, the cost ratio is the percentage of cost to the retail prices of merchandise available for sale. Chapter 9 * Plant Assets * Long-lived assets acquired for use in business operations. * The cost of plant assets is the advance purchase of services. * As years pass, and the services are used, the cost is transferred to depreciation expense. * Major Categories of Plant Assets * Tangible Plant Assets * Long Term assets having physical substance * Land, building, equipments, fixtures * Intangible Assets * Non-current assets with not physical substance * Patents, copyrights, trademarks, goodwill, franchises * Natural Resources * Sites acquired for extracting valuable resources * Oil reserves, timber, other minerals * Accountable Events * Acquisition. * Allocation of the acquisition cost to expense over the asset’s useful life (depreciation). * Sale or disposal.

* Acquisition of Plant Assets * Cost = Asset Price + Reasonable and Necessary Costs * Example of Necessary Costs * Cost for getting the asset to the desired location * Cost for getting the asset ready for use. * Special Considerations * Land * Cost includes real estate commissions, escrow fees, legal fees, clearing and grading the property. * Land Improvements * Improvements to land such as driveways, fences, and landscaping are recorded separately. * Buildings * Repairs made prior to the building being put in use are considered part of the building’s cost. * Equipment * Related interest, insurance, and property taxes are treated as expenses of the current period. * Allocation of a Lump-Sum Purchase * The total cost must be allocated to separate accounts for each asset * The allocation is based on the relative Fair Market Value of each asset purchased. * Example: Buy land with a barn and animals as a whole * Capital Expenditures and Revenue Expenditures * Capital Expenditure * Any material expenditure that will benefit several accounting periods. * To capitalize an expenditure means to charge it to an asset account. * Revenue Expenditure * Expenditure for ordinary repairs and maintenance. * To expense an expenditure means to charge it to an expense account. * Depreciation * Book Value * Cost – Accumulated Depreciation * Accumulated Depreciation * Contra-asset * Represents the portion of an asset’s cost that has already been allocated to expense. * Causes of Depreciation * Physical deterioration * Obsolescence * Half-Year Convention * In the year of acquisition, record six months of depreciation. * Straight-Line Depreciation * Depreciation = Cost – Residual Value / Years of Useful Life Expense per Year * Declining-Balance Method * Depreciation in the early years of an asset’s estimated useful life is higher than in later years. * Depreciation Expense = Remaining Book Value X Accelerated Depreciation Rate * The double-declining balance depreciation rate is 200% of the straight-line depreciation rate of 1/Useful Life. * Meaning that I should divide 100%/useful life and the multiply that by 2 to get the depreciation % of the double- declining balance * Financial Statement Disclosures * Estimates of Useful Life and Residual Value * May differ from company to company. * The reasonableness of management’s estimates is evaluated by external auditors. * Principle of Consistency * Companies should avoid switching depreciation methods from period to period. * Depreciation is an Estimated * Over the life of an asset, new information may come to light that indicates the original estimates need to be revised. * Impairment of Assets * If the cost of an asset cannot be recovered through future use or sale, the asset should be written down to its net realizable value. * Disposal of Plant and Equipment * Update depreciation to the date of disposal. * Journalize disposal by: * Recording cash received (debit) or paid (credit). * Removing accumulated depreciation (debit). * Removing the asset cost (credit). * Recording a gain (credit) or loss (debit). * If Cash > BV, record a gain (credit). * If Cash < BV, record a loss (debit). * If Cash = BV, no gain or loss. * Accounting depends on whether assets are similar or dissimilar. * Trading in Used Assets for New Ones * Dissimilar Assets * Recognize Gains? -----Yes * Recognize Losses? ----Yes * Similar Assets and Cash Paid * Recognize Gains? -----No * Recognize Losses? ----Yes * Intangible Assets * Noncurrent assets without physical substance. * Often provide exclusive rights or privileges. * Useful life is often difficult to determine. * Usually acquired for operational use. * Intangible Assets * Amortize over shorter of economic life or legal life, subject to a maximum of 40 years. * Use straight-line method. * Research and development costs are normally expensed as incurred. * Intangible Assets – Goodwill * Occurs when one company buys another company. * Only purchased goodwill is an intangible asset. * The amount by which the purchase price exceeds the fair market value of net assets acquired. * Intangible Assets – Patents * Exclusive right granted by federal government to sell or manufacture an invention. * Cost is purchase price plus legal cost to defend. * Amortize cost over the shorter of useful life or 17 years * Intangible Assets – Trademarks and Trade Names * A symbol, design, or logo associated with a business. * Internally developed trademarks have no recorded asset cost. * Purchased trademarks are recorded at cost, and amortized over shorter of legal or economic life, or 40 years. * Intangible Assets – Franchises * Legally protected right to sell products or provide services purchased by franchisee from franchisor. * Purchase price is intangible asset, which is amortized over the shorter of the protected right or 40 years. * * Intangible Assets – Copyrights * Exclusive right granted by the federal government to protect artistic or intellectual properties. * Legal life is life of creator plus 50 years. * Amortize cost over a period not to exceed 40 years. * Natural Resources * Total cost, including exploration and development, is charged to depletion expense over periods benefited. * Extracted from the natural environment and reported at cost less accumulated depletion. * Depletion of Natural Resources * Depletion is calculated using the units-of-production method. * Cost – Salvage Value / Total Unit of Capacity * Total depletion cost for a period is: * Unit Depletion Rate X Number of Unit Extracted per Period * Specialized plant assets may be required to extract the natural resource. * These assets are recorded in a separate account and depreciated. * The Units-of-Output Method * Cost per Unit of Output = Cost – Residual Value / Estimated Unit of Output * Depreciation Expense = Cost per Unit of Output X Number of Unit Produced * MACRS: The “Tax Method” * MACRS = Modified Accelerated Cost Recovery System * Based on Declining-Balance Methods * The only accelerated method allowed by the IRS when computing depreciation for tax return purposes. * Asset Cost × MACRS rate * Rates are available from tables provided by the IRS. * Most companies use Straight-Line Depreciation Method * Chapter 9 Important Notes * Plant assets are long-lived assets acquired for use in the business and not for resale to customers. * Natural Resources are also considered Wasted Assets * Depreciation is a noncash expense; cash expenditures for the acquisition of plant assets are independent of the amount of depreciation for the period. * Cash payments to acquire plant assets (and cash receipts from disposals) appear in the statement of cash flows, classified as investing activities. * Write-downs of plant assets also are noncash charges, which do not involve cash payments. Chapter 10 * The Nature of Liabilities * Defined as debts or obligations arising from past transactions or events. * Current Liabilities * Maturity = 1 year or less * Noncurrent Liabilities * Maturity > 1 year * Distinction Between Debt and Equity * Debt * Funds from creditors, with a definite due date, and sometimes bearing interest. * Equity * Funds from owner * Evaluating Liquidity * An important indicator of a company’s ability to meet its current obligations. * Two commonly used measures: * Working Capital = Current Assets - Current Liabilities * Current Ratio = Current Assets ÷ Current Liabilities * Accounts Payable * Short-term obligations to suppliers for purchases of merchandise and to others for goods and services. * Merchandise inventory invoices * Shipping charges * Office supplies invoices * Utility and phone bills * Notes Payable * When a company borrows money, a note payable is created. * Current Portion of Notes Payable * The portion of a note payable that is due within one year, or one operating cycle, whichever is longer. * Total Notes Payable = Current Notes Payable + Noncurrent Notes Payable * Interest Payable * Interest expense is the compensation to the lender for giving up the use of money for a period of time. * The liability is called interest payable. * To the lender, interest is a revenue. * To the borrower, interest is an expense. * The interest formula includes three variables that must be considered when computing interest: * Interest = Principal × Interest Rate × Time * Payroll Liabilities * Gross Pay (minus) * FICA Taxes * Medicare Taxes * Federal Taxes * State and Local Income Taxes * Voluntary Deductions (Equal) * Net Pay * Unearned Revenue * Cash is sometimes collected from the customer before the revenue is actually earned (a liability account) * Cash is received in advance * Deferred revenue is recorded. * Earned revenue is recorded. * Long-Term Debt * Relatively small debt needs can be filled from single sources. * Banks * Insurance Companies * Pension Plans * Large debt needs are often filled by issuing bonds. * Installment Notes Payable * Long-term notes that call for a series of installment payments. * Each payment covers interest for the period AND a portion of the principal. * With each payment, the interest portion gets smaller and the principal portion gets larger. * Allocating Installment Payments Between Interest and Principal * Identify the unpaid principal balance. * Unpaid Principal × Interest rate = Interest expense. * Installment payment - Interest expense = Reduction in unpaid principal balance. * Compute new unpaid principal balance. * Bonds Payable * Bonds usually involve the borrowing of a large sum of money, called principal. * The principal is usually paid back as a lump sum at the end of the bond period. * Individual bonds are often denominated with a par value, or face value, of $1,000. * Bonds Payable * Bonds usually carry a stated rate of interest, also called a contract rate. * Interest is normally paid semiannually. * Interest is computed as: * Interest = Principal × Stated Rate × Time * Bonds are issued through an intermediary called an underwriter. * Bonds can be sold on organized securities exchanges. * Bond prices are usually quoted as a percentage of the face amount. * For example, a $1,000 bond priced at 102 would sell for $1,020. * Types of Bonds * Mortgage Bonds * Convertible Bonds * Debenture Bonds * Junk Bonds * Bonds Sold Between Interest Dates * Bonds are often sold between interest dates. * The selling price of the bond is computed as: * Present Value of the Bond + * Accrued Interest since the last interest payment = * Selling Price of the Bond * The Concept of Present Value * How much is a future amount worth today? * Three pieces of information must be known to solve a present value problem: * The future amount. * The interest rate (i). * The number of periods (n) the amount will be invested. * Two types of cash flows are involved with bonds: * Periodic interest payments called annuities * Principal payment at maturity * The Present Value Concept and Bond Prices * The selling price of the bond is determined by the market based on the time value of money * If State Rate = Market Rate * Bond Price = Par Value of the Bond * Therefore there is not difference to account for * If Stated Rate < Market Rate * Bond Price < Par Value of the Bond * Therefore the difference is accounted for as a bond discount * If Stated Rate > Market Rate * Bond Price > Par Value of the Bond * Therefore the difference is accounted for as a bond premium * Early Retirement of Debt * Bonds can be retired by: * Exercising a call position * Purchasing the bond in the open market * Gains or losses incurred as a result of retiring bonds should be reported as extraordinary items on the income statement. * Lease Payment Obligations * Operating Leases * Lesser retains risks and benefits associated with ownership. * Lessee records rent expense as incurred * Capital Leases * Lease agreement transfers risks and benefits associated with ownership to lessee. * Lessee records a leased asset and lease liability. * A lease must be recorded as a Capital Lease if it meets any of the following criteria * The lease transfer ownership to the lessee * The lease has a bargain purchase option * The lease is = or > 75% of the economic life of the property * The PV of the minimum payments = 90% of the FMV of the property * Pensions * Employers offer pension plans to employees. * Retirees receive pension payments from the pension fund. * The employer makes payments to a pension fund. Usually, this is an independent entity managed by a professional fund manager. * Actuaries make the pension expense computations, based on: * Average age, retirement age, and life expectancy. * Employee turnover rates. * Compensation levels. * Expected rate of return for the fund. * The accountant then posts the entry to record pension expense and pension liability. * Other Postretirement Benefits * Many companies offer benefits to retirees other than pensions, such as health coverage or fitness club memberships. * Unfunded liability for non pension postretirement benefits * Amount to be funded next year * Current Liability * Remainder of unfunded amount * Long-Term Liability * Deferred Income Taxes * Corporations pay income taxes quarterly. * GAAP is the set of rules for preparing financial statements. * Results in… * Financial statement income tax expense. * The Internal Revenue Code is the set of rules for preparing tax returns. * Results in… * IRS income taxes payable. * The difference between tax expense and tax payable is recorded in an account called deferred taxes. * The income tax amount computed based on financial statement income is income tax expense for the period * Income taxes based on tax return income are the taxes payable for the period * Financial Leverage * Borrowing at one rate and investing at a higher rate. Chapter 11 * Corporations * An entity created by law. * Existence is separate from owners. * Has rights and privileges. * Corporations * Ownership can be * Privately, or Closely, Held * Publicly Held * Advantages of Incorporation * Limited personal liability for stockholders. * Transferability of ownership. * Professional management. * Continuity of Existence * Disadvantages of Incorporation * Heavy taxation. * Greater regulation. * Cost of formation. * Separation of ownership and management. * Publicly Owned Corporations Face Different Rules * By LAW, publicly owned corporations must: * Prepare financial statements in accordance with GAAP. * Have their financial statement audited by an independent CPA. * Comply with federal securities laws. * Submit financial information for SEC review. * Formation of a Corporation * Each corporation is formed according to the laws of the state where it is located. * The application for corporate status is called the Articles of Incorporation. * The costs associated with incorporation are usually expensed immediately, but amortized over 5 years for tax purposes. * Rights of Stockholders * Voting (in person or by proxy). * Proportionate distribution of dividends * Proportionate distribution of assets in a liquidation. * Stockholders usually meet once a year. * Stockholder ledgers are often maintained by a stock transfer agent or stock registrar * Corporate Organization * Stockholders * Board of Directors * President * Secretary * Treasurer * Controllers * Other Vice-President * Rights of Stockholders * Each unit of ownership is called a share of stock. * A stock certificate serves as proof that a stockholder has purchased shares. * When the stock is sold, the stockholder signs a transfer endorsement on the back of the stock certificate * Stockholder’s equity increases in two ways * Contribution of investors in exchange for capital stocks * Paid-in Capital * Retention of profit earned by corporation * Retained Earnings * Authorize Shares * The maximum number of shares of capital stock that can be sold to the public. * Issued shares are authorized shares of stock that have been sold. * Outstanding Shares * Outstanding shares are issued shares that are owned by stockholders. * Treasury Shares * Treasury shares are issued shares that have been reacquired by the corporation * Usually shares are sold through an underwriter. * Unissued shares are authorized shares of stock that never have been sold * Stockholders’ Equity * Par value is an arbitrary amount assigned to each share of stock when it is authorized * Common stock can be issued in three forms: * Par Value Common Stock * Let’s examine this form of stock. * No-Par Common Stock * All proceeds credited to Common Stock * Stated Value Common Stock * Treated like par value common stock * Market price is the amount that each share of stock will sell for in the market. * Issuance of Par Value Stock * Record: * The cash received. * The number of shares issued × the par value per share in the Common Stock account. * The remainder is assigned to Contributed Capital in Excess of Par. * Preferred Stock * A separate class of stock, typically having priority over common shares in . . . * Dividend distributions (rate is usually stated). * Distribution of assets in case of liquidation. * Other Features Include: * Cumulative dividend rights. * Usually callable by the company. * Normally have no voting rights. * Some preferred stock is convertible into shares of common stock. * Cumulative Preferred Stock * Cumulative * Dividends in arrears must be paid before dividends may be paid on common stock. * Non-Cumulative * Undeclared dividends from current and prior years do not have to be paid in future years. * Stock Issued for Assets Other Than Cash * Companies sometimes issue stock in exchange for non-cash assets. * Since no cash is received, record the transaction at the market value of the goods or services received. * Market Value * Accounting by the issuer. * Common stock is carried at original issue price. * Accounting by the investor. * Investments in marketable securities are carried at market value. * Market Price of Preferred Stock * Factors affecting market price of preferred stock: * Dividend rate * Risk * Level of interest rates * The return based on the market value is called the “dividend yield.” * Market Price of Common Stock * Factors affecting market price of common stock: * Investors’ expectations of future profitability. * Risk that this level of profitability will not be achieved. * Changes in market value have no impact on the books of the issuer. * Stock Splits * Companies use stock splits to reduce market price. * Outstanding shares increase, but par value is decreased proportionately. * Treasury Stock * No voting or dividend rights * Contra equity account * Treasury shares are issued shares that have been reacquired by the corporation. * When stock is reacquired, the corporation records the treasury stock at cost. Chapter 12 * Reporting the Results of Operations * Information about net income can be divided into two major categories * Normal, recurring revenue and expense transactions * Income from continuing operations. * Unusual, nonrecurring events that affect net income * The results of discontinued operations * The impact of extraordinary items. * The effects of changes in accounting principles. * Discontinued Operations * When management enters into a formal plan to sell or discontinue a segment of the business, the related gains and losses must be disclosed on the income statement. * Income/Loss from operating the segment prior to disposal. * Income/Loss on disposal of the segment. * When management enters into a formal plan to sell or discontinue a segment of the business, the related gains and losses must be disclosed on the income statement. * A segment must be a separate line of business activity or an operation that services a distinct category of customers. * Extraordinary Items * Material in amount. * Gains or losses that are both unusual in nature and not expected to recur in the foreseeable future. * Reported net of related taxes. * Accounting Changes * Change in Accounting Principle * Occurs when changing from one GAAP method to another GAAP method. * Make a catch-up adjustment known as the cumulative effect of a change in accounting principle. * The cumulative effect is reported net of taxes and after extraordinary items. * Change in Estimates * Revision of a previous accounting estimate. * The new estimate should be used in the current and future periods. * The prior accounting results should not be disturbed. * Price-earnings Ratio (P/E) * Often, the Price-Earnings Ratio is used to evaluate the reasonableness of a company’s stock price * Price Earning Ratio = Current Stock Price / Earning per Share * Earnings Per Share (EPS) * A measure of the company’s profitability and earning power for the period:
Earning per Share = Net Income / Weighted Average Number of Shares Outstanding * Weighted Average Number of Shares Outstanding * Based on the number of shares issued and the length of time that number remained unchanged. * Earnings Per Share (EPS) * If preferred stock is present, subtract preferred dividends from net income prior to computing EPS * Earning Per Share = * Net Income – Preferred Dividends / Weighted Average Number of Common Shares Outstanding * EPS is required to be reported in the income statement. * Accounting for Cash Dividends * Declared by board of directors. * Creates liability at declaration * Not legally required. * Requires sufficient Retained Earnings and Cash. * Dividend Dates * Date of Declaration * Board of directors declares the dividend. * Record a liability. * Ex-Dividend Date * The day, which serves as the ownership cut-off point for the receipt of the most recently declared dividend. * Date of Record * Stockholders holding shares on this date will receive the dividend. (No entry) * Date of Payment * Record the payment of the dividend to stockholders. * Accounting for Stock Dividends * Distribution of additional shares of stock to stockholders. * No change in total stockholders’ equity. * No change in par values. * All stockholders retain same percentage ownership. * Summary of Effects of Stock Dividends and Stock Splits | Small Stock Dividend | Large Stock Dividend | Stock Splits | Total Stockholders' Equity | No Effect | No Effect | No Effect | Common Stock | Increases | Increases | No Effect | Paid-in Capital | Increases | No Effect | No Effect | Retained Earnings | Decreases | Decreases | No Effect | Number of Shares Outstanding | Increases | Increases | Increases | Par Value per Share | No Effect | No Effect | Decreases | | | | | * Prior Period Adjustments * The correction of an error identified as affecting net income in a prior period. * Adjust retained earnings retroactively * The adjustment should be disclosed net of any taxes. * Comprehensive Income * Normally, there are 3 ways that financial position can change. * Issuance of new shares of stock. * Net Income or Net Loss * Payment of Dividends * GAAP excludes some unrealized items from income, such as the change in market value of available-for-sale debt and equity investments * GAAP requires that unrealized items that are normally reported on the balance sheet be added back to compute “Comprehensive Income.” * The accumulated amount of changes affecting Comprehensive Income is reported in equity. * There are 3 options for reporting Comprehensive Income. * As a second Income statement. * Combined with Net Income on the Income Statement. * As an element of Stockholders’ Equity.

Chapter 13 * Purpose of the Statement of Cash Flows * Provides information about the cash receipts and cash payments of a business entity during the accounting period. * Helps investors with questions about the company’s: * Ability to generate positive cash flows. * Ability to meet its obligations and to pay dividends. * Need for external financing. * Investing and financing transactions for the period. * Classification of Cash Flows * The Statement of Cash Flows must include the following three sections: * Cash Flows from Operating Activities * Inflows from: * Sales to customers. * Interest and dividends received. * Outflows to: * Suppliers of merchandise and services. * Employees. * Lenders for interest. * Governments for taxes * Cash Flows from Investing Activities * Inflows from: * Selling investments and plant assets. * Collecting of principal on loans. * Outflows to: * Payments to acquire investments and plant assets. * Purchase debt or equity investments. * Make loans. * Cash Flows from Financing Activities * Inflows from: * Short-term and long-term borrowing. * Owners (for example, from issuing stock). * Outflows to: * Repayments of borrowed funds. * Owners for dividends. * Purchase treasury stock * Cash and Cash Equivalents * Currency * Cash Equivalents * Short-term, highly liquid investments. * Readily convertible into cash. * So near maturity that market value is unaffected by interest rate changes. * The operating cash flows section can be prepared using either the direct method or the indirect method. * Direct Method Cash Received from Customers * Accrual basis revenue includes sales that did not result in cash inflows. * Direct Method Interest and Dividends Received * Interest Received = Interest Revenue * + Decrease in interest receivable * - Increase in interest receivable * Dividends Received = Dividends Revenue * + Decrease in Dividends receivable * - Increase in Dividends receivable

* Direct Method Cash Paid for Merchandise * Step 1) Purchases = COGS * + Increase in Inventory * – Decrease in Inventory * Step 2) Cash paid for merchandise = Purchases * + Decrease on A/P * – Increase on A/P * Direct Method Cash Payments for Expenses * After deducting depreciation and other noncash expenses, the cash paid for expenses is affected by * Whether the expense was prepaid, and * Whether the expense was accrued. * Cash paid for expenses = Expenses * + Increase in prepaid expenses * – Decrease in prepaid expenses * + Decrease in accrued liabilities * - Increase in accrued liabilities * Indirect Method (used by 97% of all companies) * Changes in current assets and current liabilities as shown on the following equation. * Net Income + Losses – Gains + Noncash Expenses = Cash Flow for operating activities * Examples of Noncash: Depreciation and Amortization * Indirect Method *

* Use this table when adjusting Net Income to Operating Cash Flows. * Managing Cash Flows * Cash Budgets are used by management to plan and forecast future cash flows * Cash Budgets can be used to * Force management to coordinate activities * Provide managers with advance notice of available resources * Provide targets useful in evaluating performance * Provide advance warnings of potential cash shortages * Managing Cash Flows * Increase collection of accounts receivables. * Keep inventory low. * Delay payment of liabilities. * Plan timing of major expenditures. * Invest idle cash. * The ending cash balance of one month becomes the beginning cash balance of the next month.

Chapter 14

* Purpose of Analysis * Financial statement analysis helps users make better decisions. * Internal Users * Managers * Officers * Internal Auditors * External Users * Shareholders * Lenders * Customers * Financial measures are often used to rank corporate performance * Example measures include: * Growth in sales * Return to stockholders * Profit margins * Return on equity * All these are determined by analyzing the financial statements * Financial Statements are Designed for Analysis * Classified Financial Statements * Items with certain characteristics are grouped together * Results in standardized, meaningful subtotals * Comparative Financial Statements * Amounts from several years appear side by side * Helps identity significant changes and trends * Consolidated Financial Statements * Information for the parent and subsidiary are presented * Presented as if the two companies are a single business unit * Tool of Analysis * Dollar & Percentage Changes * Dollar Change = Analysis Period Amount – Base Period Amount * Percent Change = Dollar Change / Based Period Amount * Evaluating Percentage Changes in Sales and Earnings * Sales and earnings should increase at more than the rate of inflation * In measuring quarterly changes, compare to the same quarter in the previous year * Percentage may be misleading when base amount is small * Trend Percentage * Trend analysis is used to reveal patterns in data covering successive periods. * Trend Percentage = Analysis Period Amount / Base Period Amount X100 * Component Percentages * Examine the relative size of each item in the financial statements by computing component (or common-sized) percentages. * Component Percentage = Analysis Amount / Base Amount X 100 * Base amount is in the Balance Sheet in Total Assets and in the Income Statement in Revenues * Ratios * It is a simple mathematical expression of the relationship between one item and another * Along with the dollar value and percentage changes, trend percentages and component percentages, ratios can be used to compare * Past performance to present performance * Other companies to your company * Working Capital * It is the excess of current assets over current liabilities. * Current Ratio * This ratio measures the short-term debt-paying ability of the company. * Current Ratio = Current Assets / Current Liabilities * Quick Ratio * This ratio is like the current ratio but excludes current assets such as inventories that may be difficult to quickly convert into cash. * Quick Ratio = Quick Assets / Current Liabilities * Quick assets are cash, marketable securities, and receivables. * Debt Ratio * A measure of creditor’s long-term risk. * The smaller the percentage of assets that are financed by debt, the smaller the risk for creditors. * Debt Ratio = Total Liabilities / Total Assets * Uses and Limitations of Financial Ratios * Uses * Ratios help users understand financial relationships * Ratios provide for quick comparison of companies * Limitations * Management may enter into transactions merely to improve the ratios * Ratios do not help with analysis of the company’s progress toward nonfinancial goals * Measures of Profitability * An income statement can be prepared in either a multiple-step or single-step format. * The single-step format is simpler. * The single-step format has * Proper Heading * Revenues and Gains * Expenses and Losses * The multiple-step format provides more detailed information. * The multiple-step format has: * Proper Heading * Gross Margin * Operating Expenses * Non-operating items * Return On Assets (ROA) * This ratio is generally considered the best overall measure of a company’s profitability. * ROA = Operating Income / Average Total Assets * Return On Equity (ROE) * This measure indicates how well the company employed the owners’ investments to earn income. * ROE = Operating Income / Average Total Stockholders’ Equity * Sources of Financial Information * Annual and quarterly financial reports * Can be audited or unauditabed * Reports filed with the SEC by publicly owned companies * Internet and other free sources * Detailed analysis by financial analysis

Chapter 15

* Globalization * The process of managers assessing the impact of international activities on the future of their company. * Globalization typically progresses through an outward growth path. * Exporting * Licensing & Joint Venture * Wholly Owned Subsidiaries * Global Sourcing * Environmental Forces Shaping Globalization * Political / Legal * Businesses * Transfer Risk * Control Risk * Reporting * Individuals * Tax Laws * Policies * Cultural * Individualism vs. Collectivism * Uncertainty Avoidance * ŽShort vs. Long Horizon * Power Distance * Economic * Economic System * Obtaining Capital * ŽIndustrial Organization * Exchange Rate Fluctuation * Technological * Education Level * Infrastructure * ŽKnowledge Transfer * Foreign Currencies and Exchange Rates * Each country uses its own currency for internal economic transactions. * To make transactions in another country, units of that country’s currency must be acquired. * The cost of those currencies is called the exchange rate. * Exchange Rates * Exchange rates fluctuate daily. * Daily exchange rates are published in the financial press, such as the Wall Street Journal. * The process of restating a foreign currency amount into a domestic currency amount is called “translation”. * When the US $ price of a foreign currency unit rises, we say that the US $ is “weaker”. * When the US $ price of a foreign currency unit falls, we say that the US $ is “stronger”. * Accounting for Transactions with Foreign Companies * When a transaction is denominated in a foreign currency and the transaction occurs on one date (for example a credit sale), but the cash flow is at a later date fluctuating exchange rates can result in exchange rate gains or losses.

* Adjustment of Foreign Currency Transaction at the Balance Sheet Date * Occasionally, a transaction occurs in one fiscal period, but cash is not received or paid until the next fiscal period. * At the balance sheet date, any outstanding foreign currency receivables or payables must be “remeasured” using the spot rate available on the balance sheet date. * Strategies to Avoid Losses from Rate Fluctuations * Insist that the transaction is consumated in your own currency (US $). * Headings * The practice of minimizing or eliminating risk of loss associated with foreign currency fluctuations by using forward exchange rates to offset changes in spot rates. * Spot Rates * The exchange rates that are available today. * Forward Exchange Rates * The exchange rates that can be locked in today for expected future exchange transactions * A forward contract requires the purchase of currency units at a future date at the contracted exchange rate. * Foreign Corrupt Practices Act of 1977 * Record and disclose all payments, proper or improper * Bribery of government officials is illegal * Influence peddling is illegal (1986 Amendment) * Facilitating payments are not illegal (1986 Amendment) * Maintain an adequate system of internal controls…...

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