Unformatted text preview: AFM 101 Final Exam-AID Package Fall 2011 Students Offering Support AFM 101 Final Exam Aid Fall 2011 Prepared by Jenifer Lee December 5th, 2011 Contents 1) 2) 3) 4) 5) Chapter 1-6 material with examples Chapters 7 13 material with examples Article Summaries for Chapter 7-13 articles Extra Practice Problems Extra Practice Problems Solutions AFM 101 Final Exam-AID Package Fall 2011 Chapter 1: Financial Statements and Business Decisions Four Major Financial Statements 1) The Balance Sheet The company's financial position at a point in time Assets (list all assets) Total Assets ABC Co. Balance Sheet December 31, 2009 $XX $XX XX XX XX Liabilities (list all liabilities) Owner's Equity/Shareholder's Equity (list owner's equity components) Total Liabilities and Owner's Equity Assets Economic resources of the company, listed in order of liquidity i.e. what the company owns Liabilities The company's obligations, listed in order of when the liabilities come due i.e. what the company owes Owner's Equity/Shareholder's Equity Two parts: o The amount of financing provided by the owners of the company through share capital o The earnings from the business operations from retained earnings 2) Income Statement How the company operated during the accounting period ABC Co. Income Statement For the Period Ended December 31, 2009 Revenue (List all sources of revenue) $XX Total Revenue XX Expenses (List all Expenses) $XX Total Expenses XX Net Income XX AFM 101 Final Exam-AID Package Fall 2011 Revenue Money received from sale of goods, or providing a service Expenses Resources used up by the entity to run the business and generate revenue 3) Statement of Retained Earnings (Statement of Shareholders' Equity) Used to calculate the ending retained earnings number for the balance sheet ABC Co. Statement of Retained Earnings For the Period Ended December 31, 2009 Beginning Retained Earnings $XX Add Net Income for period XX Subtract Dividends paid to owners XX Ending Retained Earnings XX When net income is earned every year, the company can choose to: o Distribute all (or a portion) to shareholders in the form of dividends o Retain all (or a portion) to continue to run the day to day business Retained Earnings: the accumulation of all net income NOT distributed as dividends since the first year of business 4) Statement of Cash Flows Used to show all inflows and outflows of company cash during the year Used to calculate the cash balance on the balance sheet ABC Co. Statement of Cash Flow For the Period Ended December 31, 2009 Cash flows from Operating Activities (List details) $XX Cash flows from Investing Activities (List details) $XX Cash flows from Financing Activities (List details) $XX Net Increase/Decrease in Cash XX Cash balance beginning of period (Jan 1, 2009) XX Cash Balance end of period (Dec 31, 2009) XX 5) Notes to the Financial Statements Required by accounting standards (GAAP) Further explain the numbers in the financial statements Explain accounting policies used by the management of the company Contain supporting schedules and calculations Additional important non-quantitative disclosures AFM 101 Final Exam-AID Package Fall 2011 Ratio Analysis = Represents the "value" an investor thinks this company is worth Investors will multiply the P/E ratio by the company's net income to determine a price one would pay for the company The higher the P/E ratio, the greater confidence investors have in this company's abilities to generate income Chapter 2: Investing and Financing Decisions and the Balance Sheet The Conceptual Framework The conceptual framework is used to make connections to lead us from the purpose of financial statements to the components and characteristics of Financial Statements and the methods and assumptions management use to create the Financial Statements. Objectives of Financial Reporting (creating financial statements) To provide useful information to external users of the financial statements so they can make business decisions Elements of the financial statements Assets, liabilities, shareholder's equity, revenue, expenses, etc. Qualitative Characteristics of good financial statements Understandability, relevance, reliability, comparability Underlying Assumptions of accounting information Separate entity: each business is accounted for as an individual organization Unit-of-measure: a business accounts for its operations and reports the results using the monetary unit of the country in which it is operating On-Going concern: a business is expected to continue to operate in the foreseeable future; there is nothing to suggest it will go out of business soon Basic Accounting Principles (GAAP) Cost Principle Revenue Recognition Matching Full Disclosure Constraints of financial reporting Cost-benefit: sometimes we want to collect as much information as possible, but we need to view it on a cost-benefit basis; is it worth the costs to collect the extra information? Materiality: information from the financial statements that will affect/influence a user's decision is considered material in nature AFM 101 Final Exam-AID Package Fall 2011 Elements of a Classified Balance Sheet Assets Economic resources arising from past transactions Future benefits (i.e. conversion to cash) can be obtained Current Assets Assets that can generally be "converted" to cash within one year very liquid o Cash and cash equivalents o Short term investments (i.e. shares in other companies, can sell very easily) o Accounts receivable (a promise to pay from a customer or another party) o Note Receivable o Inventory o Prepaid expenses (expenses paid before they are actually used) Non-Current Assets Assets that are generally converted to cash after more than one year o Long term investments o Property, plant, equipment (reported on a net of amortization basis) o Intangible assets (patents, trademarks, licenses, franchises) o Goodwill Liabilities Debts and obligations owed to other parties, which will be paid off using assets in the future Current Liabilities Obligations that will be paid within one year o Accounts Payable o Accrued liabilities (i.e. unearned revenue) o Current portion of long-term debt Long Term Liabilities Obligations that will take longer than a year to pay off o Long term debt o Mortgage payable o Bonds payable Shareholder's Equity Share Capital Money received from the company issuing its own shares, purchased by the shareholders of the company A form of "equity financing", also known as raising money through equity Retained Earnings The accumulation of net income not distributed as dividends since the company began operations Dividends are paid out of retained earnings and distributed to the shareholders as a return on their investment in the company AFM 101 Final Exam-AID Package Fall 2011 Example of a Classified Balance Sheet Ratio Analysis - - = Measures how much debt has been used to finance the company (versus financing through the owners/shareholders of the company Companies need to pay back debt before they can pay dividends to owners, so a high debt-to-equity ratio means there is a higher risk that a company may not be able to meet its financial obligations E.g. the D/E ratio of the above balance sheet is: 481,000 / 289,000 = 1.66 AFM 101 Final Exam-AID Package Fall 2011 Business Transactions and Journal Entries Business Transactions Whenever a transaction occurs, it changes the financial position of the company, so the transaction must be recorded External events: exchanges of assets and liabilities between the business and other parties Internal events: adjustments, unforeseeable events, they do not involve external parties but must still be recorded as the transactions affect the financial position of the company Double Entry Accounting Every time a transaction occurs, at least two accounts are affected The total debits = total credits in a transaction The fundamental accounting equation remains in balance after each transaction An increase to an asset account is a debit entry An increase to a liability account is a credit entry An increase to a shareholder's account is a credit entry Since dividends decrease shareholder's equity, thus an increase to dividends is a debit entry Debits are always on the left side of a transaction entry Credits are always on the right side of a transaction entry Whenever a transaction occurs record in General Journal All transactions are posted to general ledger accounts, or we use t-accounts for simplicity. The ending balances to each t-account form the balances on the Balance Sheet. AFM 101 Final Exam-AID Package Fall 2011 Chapter 3: Operating Decisions and the Income Statement The Operating Cycle The cycle of activities that goes from paying suppliers for goods and materials to generating inventory to selling the inventory to customers to collecting the cash from customers (for a manufacturing/merchandising company) At the end of every operating cycle, a set of "year-end" financial statements are made This supports the periodicity assumption: the operations of a company are reported in specified periods (usually a year) Elements of an Income Statement Revenue/Sales Results of selling a good or providing a service A company can have more than one source of revenue; if this is the case, then the revenue section should have more detailed line items Cost of Goods Sold The cost to the company for obtaining the product to sell Gross Profit Revenue Cost of Goods Sold Operating Expenses The expenses incurred to operating the business o Salaries expense o Utilities expense o Administrative expenses o Rent expense o Insurance expense o Amortization expense Operating Income Subtotal of operating revenues- operating expenses Other Expenses Other expenses incurred that do not directly relate to the daily operations of the business o Interest Expense o Investing Expenses Earnings Before Income Tax Operating Income other expenses Income Tax Expense Calculated by tax professionals, often calculated from a percentage Net Income Net Income = Earnings before income tax-income tax expense AFM 101 Final Exam-AID Package Fall 2011 Earnings Per Share = Required to be disclosed on the bottom of the income statement Accrual vs. Cash Basis of Accounting GAAP specifies the Accrual basis of accounting, where revenue is only recorded when it's "earned" and expenses are recorded when "incurred" This timing can be quite different from the Cash basis of accounting, where revenue is recorded when cash is received and expenses are recorded when cash is paid Revenue Recognition Principle Revenue should be recognized on the income statement when the following 3 criterion are satisfied: o Earnings process is complete or almost complete: the company providing the good or service must have completed its services o An exchange of transaction: the customer must have already paid or have promised to pay in the near future (price agreed upon by both parties) o Collection of payment is reasonably assured: if the customer has agreed to pay in the near future, then there is a low risk of default Matching Principle Expenses should be recorded in the same period as the revenue it helped to earn All expenses of a company either directly or indirectly contribute to the company's abilities to earn revenue; thus, expenses should be recorded when they are used up **Note: Even if
revenue isn't recognized or expenses haven't been incurred, we still need to record any business transaction as a journal entry (it just won't affect a revenue or expense account yet; that's what adjusting entries are for in chapter 4) ** Comparison of Accrual vs. Cash Basis of Accounting Cash is paid before expense is incurred th On September 30 ABC Co just made a $3,000 cash payment for the next 6 months of rent Cash Basis Accrual Basis Rent Expense 3,000 Prepaid Rent (Asset) 3,000 Cash 3,000 Cash 3,000 Cash is received before revenue is earned th On Nov 25 TIX Co, a ticketing service agency received $5,000 worth of payments from customers for a Broadway show later in the year Cash Basis Accrual Basis Cash 5,000 Cash 5,000 Revenue 5,000 Unearned Revenue (L) 5,000 Expenses are incurred before cash is paid AFM 101 Final Exam-AID Package Fall 2011 The company received a $500 hydro bill on December 31 , they didn't make the payment until the next fiscal period Cash Basis Accrual Basis NO ENTRY Utilities Expense 500 Utilities Payable (L) 500 Revenue is earned before cash is received You own a lawn-mowing business and you've mowed $200 worth of lawns, yet your clients have promised to pay within the next week Cash Basis Accrual Basis NO ENTRY Accounts Receivable (A) 200 Revenue 200 ***More adjusting entries in Chapter 4 Ratio Analysis = Average Total Assets = [last year's total assets + this year's total assets] / 2 Measures how much sales is generated for every $1 of assets A high ratio is favourable = Measures management's effectiveness at utilizing assets to generate income A high ratio is favourable st Chapter 4: Adjustments, Financial Statements and the Quality of Earnings Unadjusted Trial Balance A list of ALL of the company's accounts, used for internal purposes Contains both balance sheet and income statement accounts The total columns for debits and credits must be equal After closing entries, all revenue and expense accounts will have zero balances, leaving only balance sheet accounts AFM 101 Final Exam-AID Package Fall 2011 ABC Co. Trial Balance December 31, 2009 Debit Credit Cash XX Accounts Receivable XX Inventory XX .... .... Accounts Payable XX Income Tax Payable XX Accrued Liabilities XX .... .... Share Capital XX Retained Earnings XX Revenue XX Other Revenue XX Cost of Goods Sold XX Salaries Expense XX Rent Expense XX .... .... Totals XX XX Adjusting Entries Throughout the normal course of business, we record all transactions as journal entries Adjusting entries transfer amounts to different accounts, allowing us to properly recognize revenue and record expenses Adjusting entries NEVER affect cash At the end of the business cycle, we record entries to close revenue and expense accounts, and prepare the final financial statements Types of Adjusting Entries Deferred Revenue (unearned revenue) Cash was received before revenue is earned During operations, when cash was received DR Cash CR Unearned Revenue (Liability) AFM 101 Final Exam-AID Package Fall 2011 Adjusting entry, when revenue is earned DR Unearned Revenue (erases the liability account) CR Revenue (recognizes the revenue) st E.g. On Jan 1 , ABC Co signed a contract stating they will provide 2 months of services. They received $1,200 payment up front. st Jan 1 During Operations DR Cash 1,200 CR Unearned Revenue 1,200 st Jan 31 Adjusting Entry DR Unearned Revenue 600 CR Revenue 600 First month of revenue is earned th Feb 28 Adjusting Entry DR Unearned Revenue 600 CR Revenue 600 Second month of revenue is earned **Note: because we were told the contract was for 2 months of services, we are able to adjust at the end of every month; usually, we would recognize the revenue and erase the liability for the entire amount when revenue was deemed earned. Deferred Expense (Prepaid Expenses) Cash is paid for expenses to be incurred in the future (specified amount of time) Includes prepaid rent, prepaid insurance Adjustments are made at the end of every month when expenses are incurred During operations, when payment was made DR Prepaid Expenses (Current Asset) CR Cash Adjusting entry, when expenses are incurred DR Expense CR Prepaid Expenses (decline in the value of the asset as expenses are incurred) th E.g. On April 30 , ABC Co paid for 8 months worth of insurance for $2,400 th April 30 When payment was made DR Prepaid Insurance 2,400 CR Cash 2,400 st May 31 Adjusting Entry DR Rent Expense 300 CR Prepaid Insurance 300 First month of rent expense th June 30 Adjusting Entry DR Rent Expense 300 AFM 101 Final Exam-AID Package Fall 2011 CR Prepaid Insurance 300 Second month of rent expense **Same entries made for months 3 8 Accrued Revenue (receivables)
Revenue is earned before payment is received from customer During operations, when service was performed/product was sold DR Accounts Receivable (customer has yet to pay) CR Revenue Adjusting entry, when cash is received DR Cash CR Accounts Receivable (erases the receivable) E.g. On Mar 1 , ABC Co provided services worth $500, the customer subsequently paid on Apr 24 st Mar 1 When service was performed DR Accounts Receivable 500 CR Revenue 500 th Apr 24 Adjusting Entry DR Cash 500 CR Accounts Receivable 500 Payment is received from customer Accrued Expenses (Payables) Expenses are incurred before the company makes a payment During operations, when expenses were incurred DR Expense CR Accounts Payable (company has yet to pay) Adjusting entry, when cash is paid DR Accounts Payable (erases the payable) CR Cash E.g. The company pays their employees on a bi-weekly basis. Total salaries expense for each period is $20,000. nd st The next payday is Jan 2 . Dec 31 is the company's year end. st Dec 31 Adjusting entry to accrue for expenses at year end DR Salaries Expense 16,000 CR Salaries Payable 16,000 Expenses must be accrued at year end, but the company has not paid anything yet nd Jan 2 Entry to record payment of salaries DR Salaries Payable 16,000 (to erase payable) DR Salaries Expense 4,000 CR Cash 20,000 Payment is made st th AFM 101 Final Exam-AID Package Fall 2011 Amortization The matching principle states that a company needs to match expenses to the revenue it helped generate Capital assets (machinery, equipment, plant, etc.) are used to help the company generate revenue Thus, portions of the assets' costs are allocated as amortization expense The cost principle states that assets must be listed on the balance sheet at their historical cost (i.e. purchase price) Therefore, the amortization expense is accumulated in a contra asset account: accumulated amortization On the balance sheet, the capital assets are presented in the non-current assets section at their net value: Equipment 15,000 Less: Accumulated Amortization Equipment 5,000 10,000 The amount of amortization expense each year: [ - } = st E.g. On April 1 , ABC Co purchased equipment for 80,000 on account. It was assumed this equipment would have a salvage value of 8,000 and a useful life of 9 years. Record the journal entry on purchase date and the requirement adjusting entry at year end. Annual Amortization Expense = [80,000 8,000] / 9 = 8,000 Amortization expense for this year (9 months) = 8,000 * 9 / 12 = 6,000 Journal Entry to record amortization expense: Amortization Expense 6,000 Accumulated Amortization Equipment 6,000 Accrued Interest on Bonds or Notes Payable Companies borrow money by issuing bonds or notes to third parties (creditors) Before they pay back the amount borrowed, companies need to pay interest on the amount borrowed Since interest payment days do not usually correspond with year end dates, accrued interest must be recorded at each year end E.g. On April 1 , ABC Co issued a $10,000 bond paying 6% interest semi annually; interest is paid every September th st 30 and March 31 st April 1 Company issues the bond (incurs the liability) Cash 10,000 Bond Payable 10,000 th Sept 30 First interest payment Interest Expense 300 Cash 300 Every 6 months, the company needs to pay 0.06 * 10,000 * 0.5 = $300 st December 31 Year end, need to adjust for the interest expense incurred (but not paid) Interest Expense 150 Interest Payable 150 st AFM 101 Final Exam-AID Package Fall 2011 March 31 Second interest payment Interest Expense 150 Interest Payable 150 Cash 300 Closing Entries Relationship between the Balance Sheet and Income Statement: o Net Income each year adds to the Retained Earnings account on the Balance Sheet At the end of each operating cycle, we need to transfer the net income earned during the period to Retained Earnings o T...
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