Accounting Final

Front 1

Sold inventory costing $25,000 for $45,000. All sales were on credit.

Back 1

A/R 45,000
Sales Revenue 45,000

CoGS 25,000
Inventory 25,000

Front 2

Adjusting entry for depreciation

Back 2

Assets:
- 3,000
(Property &
equipment-Accumulated
depreciation)

Liabilities:
- 3,000
depreciation expense (RE)

Front 3

Adjusting entry for rent
3 months: $3,000/4 = 750

Back 3

Assets:
- 750
(Prepaid rent)

Equities:
-750
rent expense (RE)

Front 4

Adjusting entry for interest

Back 4

Liabilities:
+ 600
(Interest
payable)

Equities:
-600
Interest expense (RE)

Front 5

Revenue Recognition

Back 5

Earnings process substantially complete

Exchange must have taken place (arm’s length transaction)

Collection must be reasonably certain

Front 6

Expense Recognition

Back 6

MATCHING

Recognize all expenses associated with the revenues that have been recognized

Product costs
Period costs

Front 7

The Accounting Cycle

Back 7

Analyze transactions
Record transactions
Make adjusting entries at the end of the period
Close temporary accounts
Prepare Financial Statements

Front 8

Operating activities

Back 8

converts the items reported on the income statement from the accrual basis of accounting to cash.

Front 9

Investing activities

Back 9

reports the purchase and sale of long-term investments and property, plant and equipment.

Front 10

Financing activities

Back 10

reports the issuance and repurchase of the company's own bonds and stock and the payment of dividends.

Front 11

depreciation

Back 11

the systematic expensing of the cost of assets such as buildings, equipment, furnishings and vehicles

Front 12

amortization

Back 12

systematic expensing of other long-term costs such as bond issue costs and organization costs

Front 13

Owners’ (Stockholders’) Equity

Back 13

Paid-In Capital (aka Contributed Capital or Common Stock)
Par value
Additional Paid-in-Capital

Retained Earnings (RE)

(Accumulated Other Comprehensive Income)

Front 14

Why do we need adjusting entries

Back 14

To ensure that assets, liabilities, and owners’ equity are properly stated

Accrual accounting
Revenue recognition
Matching principle

Front 15

Why do we need adjusting entries?

Back 15

Most transactions are recorded when they occur (explicit transactions)

Adjusting entries record events (implicit transactions) that are not routinely recorded in the course of the accounting period

Front 16

The Adjustment Process

Back 16

Each adjusting entry affects at least one Balance Sheet account and at least one Income Statement account.

Adjusting entries DO NOT involve debits and credits to cash.

Front 17

On July 1, 2008 R&S purchased a truck for $53,000. The truck has useful life of 5 years and is expected to be worth $3,000 at the end of year 5. On July 1, 2010, R&S sold the truck for $45,000.

What would R&S show on its Balance Sheet and Income Statement for fiscal year ending
Dec. 31, 2008?
Dec. 31, 2009?
Dec. 31, 2010?

Back 17

Balance Sheet
Gross PPE (truck) $53,000
Accumulated Depreciation $5,000
or
Net PPE (truck) $48,000

Income Statement
Depreciation Expense $5,000

Front 18

Correcting an Error

Back 18

Two-step process:
Reverse the identified wrong entry.
Record the correct entry.

You can also make one overall journal entry but it must accomplish both steps.
If you choose to take this approach, please do so ONLY if you are SURE that you have the correct answer!

Front 19

Analyzing Working Capital

Back 19

Accounts Receivable:

A/R turnover = (Sales on account)/(average A/R)

Relates sales on account to balance in A/R
Average A/R is used because it is a stock measure from the balance sheet and sales is a flow amount from an income statement.
$ tied up in A/R might be better employed elsewhere

Days receivable outstanding = 365/(A/R turnover)

Front 20

Matching Principle

Back 20

Expenses are recognized in the same period as the related revenues are recognized (i.e., matched with the revenue they generated)

Product costs: naturally linked with revenues (e.g. cost of goods sold)
Period costs: expenses incurred over a particular time period (e.g. rent)

Front 21

Warranties-
On March 15, 2011 R&S sold 10 TV sets at $250 per unit (cash sale). R&S purchased the TV sets for $180 per unit. The TV sets are under warranty for one year. R&S estimates that is will incur $40 of warranty costs for each TV sold.

Back 21

Dr. Cash 2,500
Cr. Sales Revenue 2,500

Dr. COGS 1,800
Cr. Inventory 1,800

Dr. Warranty Expense 400
Cr. Estimated Liability under Warranty 400

Front 22

GROW: Closing Entries(close to Income Summary and then to RE

Back 22

c5) Income summary 125.0
SG&A 125.0

(c6) Income summary 7.0
Tax expense 7.0

(c7) Income summary 5.7
R&D expense 5.7

(c8) Income summary 0.4
Retained earnings 0.4

Front 23

Time Value of Money

Back 23

Money has time value which implies need of a procedure to compare dollar amounts at different points in time.

A dollar today is not equivalent to a dollar received a year from now. (How to decide if X dollars right now (time 0) is preferred to Y dollars t periods in the future.)

Front 24

Finding the Future Value

Back 24

Let: t = number of periods
r = rate of interest
D = initial deposit

Then the future value, FV, of an initial deposit of D left to accumulate interest at rate r per period for t periods is given by
FV = D*(1+r)t

Front 25

Interest

Back 25

Interest is the charge (price paid) for the ability to transfer cash across time periods.

i.e., it is the charge levied to postpone the payment or receipt of funds

Front 26

FUTURE VALUE: example

Back 26

83.96 will grow to $89 = 83.96*(1.06) in one period when the interest rate is 6% (.06) per period

$83.96 will grow to $94.33 in two periods (89.0*(1.06) = 83.96*(1.06)*(1.06) = 83.96*(1.06)2

$83.96 will grow to $100 = 83.96*(1.06)3 at the end of three periods (t=3) if no funds are withdrawn

Front 27

Present Value

Back 27

If the future value is given by
FV = D*(1+r)t

When the interest rate is r per period and t is the number of periods, then
D = FV/(1+r)t

Where D is the initial deposit (the Present Value or PV)

Front 28

Firm A sells a widget right now (time 0). In return the buyer agrees to pay A $119.10 three years from now (Firm A normally sells widgets for $100. Firm A normally earns 6% on its investments.)

Record the sale (at time 0, suppose January1, year 1):

Accounts receivable…….. 100
Sales revenue…………..100

Back 28

At the end of the first year there is an adjusting entry for interest revenue recognition:

Interest receivable…….. 6 (.06*100)
Interest revenue…………..6

At the end of the second year the adjusting entry for interest revenue is:

Interest receivable……. 6.36 (.06*106)
Interest revenue…………. 6.36
Balance in Interest receivable account will now be $12.36

Front 29

Calculating Interest Expense

Back 29

Interest expense (revenue) recorded on an accrual basis
Interest expense (revenue) = (book value of the obligation (receivable) entering the accounting period) x (historical rate of interest)

The difference between interest expense (revenue) and the cash payment in the period is an adjustment to the book value of the liability (receivable)

Front 30

Value Creation

Back 30

Operating view of value creation
Value is created if:
Income – (cost of capital) x (investment) > 0

Therefore, to create value one should
Divest investment not returning the cost of capital
Make new investment only if you expect to earn the cost of capital or more (Net Present Value of the project is greater than zero

Front 31

Cash flow from investing

Back 31

Usually:

Growth: Cash flows from investing should be negative. Growing businesses must acquire new assets, and must spend cash for them.

Stable: Cash flows from investing should be negative, because assets that are retired must be replaced to keep the business in a steady state.

Shrinking: In a shrinking business, cash flows from investing should be zero or even positive if assets can be sold.

Front 32

Cash flow from financing

Back 32

Growth: In a growing business, cash flows from financing should usually be positive. Growing businesses must acquire new assets, and often seek long term financing for them.

Stable: Cash flows from financing should be close to zero or a little negative, because cash from operations should be sufficient to fund replacements of assets and the firm might be paying off some indebtedness with excess cash flow.

Shrinking: In a shrinking business, cash flows from financing should be negative. That is, creditors should be getting repaid and resources should be distributed to owners. Assets are not being replaced.

Front 33

Cash flow from operations

Back 33

Usually:

Growth: In a rapidly growing business cash flows from operations is usually negative.

Stable: In a steady business, cash flows from operations should usually be slightly more than net income.

Shrinking: In a shrinking business, cash flows from operations usually should be greater than net income. Not only does the income include a deduction for depreciation, but the investment in working capital such as accounts receivable and inventory, should be getting returned.

Front 34

Cash Flows from Operating Activities (“CFO”)

Back 34

Examples of Cash Inflows:
From sale of goods or services (“cash collections from customers”)
From return on investment in loans (interest)
From return on investment in equity securities (dividends)
Examples of Cash Outflows:
Payments for acquisitions of inventory (“cash payments to suppliers”)
Payments to employees
Payments to governments (taxes)
Payments of interest expense
Payments for other expenses

Front 35

Cash Flows from Investing Activities (“CFI”)

Back 35

Examples of Cash Inflows:
From sale of property, plant and equipment
From sale of debt or equity securities of other corporations
From receipts from collecting loans
Examples of Cash Outflows:
From purchase of property, plant, and equipment
From purchase of debt or equity securities of other entities
From loans to other entities

Front 36

Cash Flows from Financing Activities (“CFF”)

Back 36

Examples of Cash Inflows:
From issuance (sale) of equity securities
From issuance (sale) of bonds, mortgages, notes, and other short- or long-term borrowings
Examples of Cash Outflows:
Payment of dividends
Reacquisition of firm’s own stock
Payment of amounts borrowed

Front 37

Approaches to Calculating CFO

Back 37

Two approaches may be used to compute CFO

Direct method: Lists cash receipts and cash payments for each major operating activity

Indirect method: Adjusts Net Income to reflect only cash receipts and cash payments related to operating activities

Front 38

Direct Method:

Back 38

Cash collected from Customers

– Cash paid to Suppliers

– Cash paid for Expenses

…

= Net Cash Flow from Operations

Front 39

Indirect Method:

Back 39

Net Income

+ Depreciation/Amortization, etc.

– Non-cash component of Sales
(e.g., change in AR account)

+ Cash not paid for COGS (e.g., change in Inv account)

+ Cash not paid for Expenses (e.g., change in AP account)

…

= Net Cash Flow from Operations

Front 40

Indirect Method: Intuition

Back 40

Assets = Liabilities + Owners’ Equity
ΔAssets = ΔLiabilities + ΔOwners’ Equity
ΔCash + ΔOCA + ΔPPE = ΔCL + ΔLTDebt + ΔPIC + ΔRE
ΔCash = ΔCL + ΔLTDebt + ΔPIC + ΔRE - ΔOCA - ΔPPE

Front 41

Since,

ΔRE = NI – Cash Dividends

Back 41

ΔCash = ΔCL + ΔLTDebt + ΔPIC + (NI – Dividends) - ΔOCA - ΔPPE

Front 42

ΔCash =

Back 42

NI + Depreciation – Gain(Loss) on Sale of PPE– ΔOCA + ΔCL CFO

- Purchase of PPE + Cash from Sale of PPE CFI

+ ΔLTDebt + ΔPIC– Dividends CFF

Front 43

Adjust for changes in the current asset and current liability accounts pertaining to the firm’s operating activities. Relative to Net Income

Back 43

An increase in a current asset (other than cash) indicates lower cash
A decrease in a current asset (other than cash) indicates higher cash
A decrease in a current liability indicates lower cash
An increase in a current liability indicates higher cash

Front 44

Grow Cash Flow: Indirect Method

Back 44

Interest expense: since interest payable went up by 2.0 during the year, cash outflow to pay interest is 2.0 less than the expense
Similarly, taxes payable increased by 4.2 from the beginning to the end of the period. This means that cash outflow to make tax payments was 4.2 less than tax expense on the income statement
R&D expense was stated to be a cash flow, so no adjustment is necessary (and there is no associated accrual account on the balance sheet)

Front 45

Price vs. Net Assets

Back 45

Net Assets = Assets – Liabilities
MVE = Price per Share * # Shares Outstanding

Front 46

Ratios

Back 46

Ratios provide a method of standardization

Time series analysis
One company over a sequence of time periods
Why care?

Cross sectional analysis
Different companies at a particular point in time
Why care?

Front 47

Why Ratios are important

Back 47

Activity – asset management and efficiency
Liquidity – short-term solvency
Debt & Solvency – debt financing and coverage
Profitability – performance
Industry-specific

Front 48

Activity Ratios

Back 48

Short-term
Inventory turnover
Receivables turnover
Payables turnover

Long-term
Fixed Asset turnover (Sales / Average Fixed Assets)
Total Asset turnover (Sales / Average Total Assets)

Front 49

Purchases = .?

Back 49

CoGS + ∆ Inv

Front 50

Liquidity

Back 50

Current Ratio (Current Assets / Current Liabilities)

Quick Ratio ([Cash + Marketable Securities + AR] / Current Liabilities)

CFO to Current Liabilities (CFO / Current Liabilities)

Front 51

Debt Ratios

Back 51

Assets = Liabilities + Owner’s Equity

Debt / Total Assets
Debt / Owners Equity

Short- vs. Long-term Debt?

Front 52

Profitability

Back 52

Gross Profit Margin (Gross Profit / Sales)

Operating Income Margin (Operating Profit / Sales)

Profit Margin (Net Income / Sales)

Earnings per Share (Net Income / # Shares Outstanding)

Front 53

Return on Assets (ROA):

Back 53

ROA = [Net Income + Interest Expense (net of Income Tax savings)] / Average Total Assets

Front 54

A decrease in the current liability Income Taxes Payable

Back 54

OCF- a decrease in a current liability means a decrease in cash

Front 55

The proceeds from issuing additional Common Stock

Back 55

FCF- Issuance of common stock leads to an increase and cash

Front 56

The amortization of the cost of an intangible asset

Back 56

OCF- non-cash expense that must be added back since cash is not reduced by amortization

Front 57

The exchange/conversion of long-term bonds into common stock

Back 57

Supplemental information

Front 58

What effect does an increase in current assets have on the SCF?

Back 58

It has a negative effect on cash

Front 59

What effect does the increase in a current asset has on the SCF?

Back 59

It will increase cash

Front 60

The proceeds from the sale of equipment formerly used in the business

Back 60

A decrease in non-cash Asset accounts will increase cash

Front 61

An increase in the current liability Income Taxes Payable

Back 61

An increase in a current liability will lead to an increase in cash, since it means the company did not pay off a liability that was deducted from net income.

Front 62

A decrease in Accounts Payable

Back 62

A decrease in a current liability means it was paid off with cash. Cash will always move in the direction of a liability.

Front 63

OCF- An increase in Accounts Receivable

Back 63

Decrease in cash

Front 64

SCF- What is the effect of the Gain on the Sale of Equipment formerly used in the business

Back 64

Decrease in cash, since the proceeds of the sale in total will be counted in the investing section, thus we need to avoid double counting

Front 65

For a recent year a corporation's financial statements reported the following:

Net Income $100,000
Depreciation Expense 10,000
Increase in Accounts Receivable 30,000
Decrease in Accounts Payable 15,000

Based on the above information, what amount will the corporation report as Cash Provided by Operating Activities on the cash flow statement?

Back 65

$65,000

Front 66

Another name for the balance sheet is

Back 66

Statement of Financial Position

Front 67

The balance sheet heading will specify a

Back 67

Point in time

Front 68

working capital

Back 68

Current asset MINUS current liabilities is the

Front 69

current ratio

Back 69

Current assets DIVIDED BY current liabilities

Front 70

quick ratio

Back 70

(Cash+Temporary Investments+Accounts Receivable)/Current Liabilities

Front 71

Inventory Turnover

Back 71

Cost of Goods sold/ Inventory

Front 72

Accounts Receivable turnover ratio

Back 72

credit sales/ accounts receivable

Front 73

On average how many days of sales were in Accounts Receivable during 20XX?

Back 73

365/ accounts receivable ratio

Front 74

On average how many days of sales were in Inventory during 20xx?

Back 74

365/ inventory ratio

Front 75

Times interest earned?

Back 75

Earnings before income and taxes/ interest expense

Front 76

After tax return on stockholder's equity?

Back 76

Net Income after tax/avg. stockholders equity

Front 77

Free Cash Flow

Back 77

cash provided by operating activities minus cash used by financing activities.

Front 78

gross profit

Back 78

Net Sales minus the Cost of Goods Sold