MGA201Binder

MGA201Binder - Chapter 2 Reporting Investing and Financing...

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Unformatted text preview: Chapter 2 Reporting Investing and Financing Results on the Balance Sheet PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA p , , Fred Phillips, Ph.D., CA Edited by: Muriel Anderson, MBA, CPA Learning Objective 1 Identify financial effects of Id tif fi i l ff t f common financing and g investing activities. 2-2 Financing and Investing Activities Assets Companies rely on Invest in Assets two sources of financing: = Liabilities Debt Financing & + Stockholders' Equity E it 2-3 Equity Financing q y g Learning Objective 2 Apply transaction analysis t A l t ti l i to financing and investing g g transactions. 2-4 Study the Accounting Methods A systematic accounting process is used to capture and report the financial effects of a p p company's transactions. 1 Analyze 2 Record 3 Summarize A transaction is a business activity that affects the basic accounting equation. Duality of Effects Every transaction has at least two effects on the basic accounting equation. ti ti A = L SE L+ Assets must equal liabilities plus stockholders' equity for every accounting transaction. ti t ti 2-5 Step 1: Analyze Transactions The chart of accounts is a summary of account names and corresponding account numbers tailored to each company's business. Pizza Aroma's Chart of Accounts (Partial) Account Number 101 113 135 201 222 301 310 2-6 Account Name Cash Cookware Equipment Accounts Payable Note Payable Contributed Capital Retained Earnings Description Dollars amount of coins, paper money, funds in bank Cost of cutlery, pizza pans dishes, ets. Cost of pizza ovens, restaurant booths, dishwasher, etc. Owed to suppliers for goods and services bought on credit Owed to lenders, as per terms of promissory note. Stock issued for contributions made to the company Accumulated earnings (not yet distributed as dividends) Step 1: Analyze Transactions (a) Issue Stock to Owners. Mauricio Rosa i M i i R incorporates Pi t Pizza A Aroma I Inc., on A August 1. The company issues t 1 Th i stock to Mauricio and his wife as evidence of their contribution of $50,000 cash, which is deposited in the company's bank account. 1. Pizza Aroma receives $50,000 Cash. 2. Pizza Aroma gives $50,000 Stock (Contributed Capital). Assets (a) Cash +$50,000 = Liabilities + Stockholders' Equity Contributed Capital + $50,000 2-7 Step 1: Analyze Transactions (b) Investment in Equipment. Pizza Aroma pays $42,000 cash to buy restaurant booths and other equipment. 1. Pizza Aroma receives $42,000 of Equipment. $ , q p 2. Pizza Aroma gives $42,000 Cash. Assets = (b) Equipment +$42,000 Cas $ ,000 Cash -$42,000 Liabilities + Stockholders' Equity 2-8 Step 1: Analyze Transactions (c) Obtain Loan from Bank. Pizza Aroma borrows $20,000 from a bank depositing those funds in its bank account and signing a formal agreement to repay the loan in two years. 1. 1 Pizza Aroma receives $20,000 Cash $20 000 Cash. 2. Pizza Aroma gives a note, payable to the bank for $20,000. Assets (c) Cash +$20,000 = Liabilities + Stockholders' Equity = Note Payable +$20,000 2-9 Step 1: Analyze Transactions (d) Investment in Equipment. Pizza Aroma purchases $ $18,000 in pizza ovens and other restaurant equipment, paying $16,000 in cash and giving an informal promise to pay $2,000 at the end of the month. 1. Pizza Aroma receives $18,000 in equipment (pizza ovens). 2. Pizza Aroma gives a Cash of $16,000 and Accounts Payable of $2,000. Assets = Liabilities + Stockholders' Equity (d) Cash -$16,000 = Accounts Payable +$2,000 Equipment +$18,000 E i $18 000 2-10 Step 1: Analyze Transactions (e) Order Cookware. Pizza Aroma orders $630 of pans, dishes, and other cookware. None have been received yet. 1. An exchange of only promises is not a transaction. 2. This does not affect the accounting equation. Assets No Impact = = Liabilities No Impact + Stockholders' Equity No Impact 2-11 Step 1: Analyze Transactions (f) Pay Suppliers. Pizza Aroma pays $2,000 to the equipment supplier from transaction (d). 1. Pizza Aroma gives cash to settle its debt to the supplier. 2. Pizza Aroma receives a release from its promise to pay. Assets (f) Cash -$2,000 = Liabilities + Stockholders' Equity = Accounts Payable -$2,000 2-12 Step 1: Analyze Transactions (g) Receive Cookware. Pizza Aroma receives $630 of the cookware ordered in (e) and promises to pay for it next month. 1. Pizza Aroma receives cookware with a cost of $630. 2. Pizza Aroma gave a promise to pay $630 on account. Assets = Liabilities + Stockholders' Equity (g) Cookware +$630 = Accounts Payable +$630 2-13 Learning Objective 3 Use journal entries and T-accounts to show how transactions affect the balance t ti ff t th b l sheet. 2-14 Step 2 and 3: Record & Summarize The D bit C dit Framework Th Debit & Credit F k ASSETS + ASSETS Increase Using Debit Decrease Using Credit = LIABILITIES + LIABILITIES Decrease Increase Using Using Debit Credit + STOCKHOLDERS' EQUITY STOCKHOLDERS EQUITY + STOCKHOLDERS' EQUITY + Decrease Increase Using Using Debit Credit Asset accounts increase on the left or debit side and decrease on the right or credit side. Liability accounts increase on the right or credit side and decrease on the left or debit side. Stockholders' equity accounts increase on the right or credit side and decrease on the left or debit side. 2-15 Normal Account Balances "Tip Slide" After Eating Dinner Downtown Downtown, s x i E s p v B e e i I t n d T s s e e n s d s Let s Let's Really Rock th Culture the i e e o a t v n b a e t i i n r l n u i i e e b t d s u i t e E e s a d r n C I a n p g i s t a l Club R E D I T Steps 2 & 3: Record and Summarize 1 Analyze 2 Record R d Date General Journal G lJ l Account Title and Explanation Ref. Debit Page G1 Credit 3 Summarize 2-17 Steps 2 & 3: Record and Summarize 1 Analyze 2 Record R d Date 2010 8/1 General Journal G lJ l Account Title and Explanation Cash Contributed Capital (Financing from stockholders) Ref. Debit Page G1 Credit 101 50,000 301 50,000 3 Summarize General Ledger General Ledger Acct. 101 Ref. G1 Debit 50,000 Credit Balance 50,000 Account: Contributed Capital Date 2010 8/1 p Explanation Ref. G1 Debit Credit Acct. 301 Balance Account: Cash Date 2010 8/1 p Explanation 50,000 50,000 2-18 Steps 2 & 3: Record and Summarize 1 Analyze 2 Record R d (a) dr Cash (+A) p ( ) cr Contributed Capital (+SE) 50,000 50,000 , 3 Summarize General Ledger General Ledger Acct. 101 Ref. G1 Debit 50,000 Credit Balance 50,000 Account: Contributed Capital Date 2010 8/1 p Explanation Ref. G1 Debit Credit Acct. 301 Balance Account: Cash Date 2010 8/1 p Explanation 50,000 50,000 2-19 Steps 2 & 3: Record and Summarize 1 Analyze 2 Record R d (a) dr Cash (+A) p ( ) cr Contributed Capital (+SE) 50,000 50,000 , 3 Summarize General Ledger General Ledger Acct. 101 Ref. G1 Debit 50,000 Credit Balance 50,000 Account: Contributed Capital Date 2010 8/1 p Explanation Ref. G1 Debit Credit Acct. 301 Balance Account: Cash Date 2010 8/1 p Explanation 50,000 50,000 2-20 Pizza Aroma's Accounting Records (a) Issue Stock to Owners. Mauricio Rosa incorporates Pizza Aroma Inc., on August 1. The company issues stock to Mauricio and his wife as evidence of their contribution of $50,000 cash, which is deposited in the company's bank account. 1 Analyze Assets (a) Cash +$50,000 = Liabilities + Stockholders' Equity Contributed Capital + $50,000 2 Record (a) dr Cash (+A) cr Contributed Capital (+SE) cr Contributed Capital (+SE) 3 Summarize 50,000 50,000 50 000 2-21 Pizza Aroma's Accounting Records (b) Investment in Equipment. Pizza Aroma pays $42,000 cash to buy restaurant booths and other equipment. y y 1 Analyze Assets = ( ) (b) Cash -$42,000 , Equipment + $42.000 Liabilities + Stockholders' Equity 2 Record (b) dr Equipment (+A) cr Cash (A) 3 Summarize 42,000 42,000 2-22 Pizza Aroma's Accounting Records (c) Obtain Loan from Bank. Pizza Aroma borrows $20,000 from a bank depositing those funds in its bank account and signing a formal agreement to repay the loan in two years years. 1 Analyze Assets (c) ( ) Cash +$20,000 , = Liabilities + Stockholders' Equity Note Payable +$20,000 y , 2 Record (c) dr Cash (+A) cr Note Payable (+L) 3 Summarize 20,000 20,000 2-23 Pizza Aroma's Accounting Records (d) Investment in Equipment. Pizza Aroma purchases $18,000 in pizza ovens and other restaurant equipment paying $16 000 in cash and giving an informal promise to pay equipment, $16,000 $2,000 at the end of the month. 1 Analyze Assets (d) Cash -$16,000 Equipment +$20,000 = Liabilities Accounts Payable +$2,000 + Stockholders' Equity q y 2 Record R d (d) dr Equipment (+A) cr Cash (A) y ( ) cr Accounts Payable (+L) 18,000 16,000 2,000 , 3 Summarize 2-24 Pizza Aroma's Accounting Records (f) Pay Suppliers. Pizza Aroma pays $2,000 to the equipment supplier from y the last transaction. 1 Analyze Assets (f) Cash -$2,000 $2 000 = Liabilities Accounts Payable - $2 000 $2,000 + Stockholders' Equity 2 Record (f) dr C Accounts Payable (L) cr Cash (A) 3 Summarize 2,000 2,000 2-25 Pizza Aroma's Accounting Records (g) Receive Cookware. Pizza Aroma receives $630 of the cookware previously ordered and promises to pay for it next month. 1 Analyze Assets (g) Cookware +$630 = Liabilities Accounts Payable + $630 + Stockholders' Equity 2 Record (g) dr Cookware (+A) cr Accounts Payable (+L) 3 Summarize 630 630 2-26 T-Accounts for Pizza Aroma Cash Beg. Bal. (a) (c) End. Bal. End Bal 50,000 20,000 10,000 10 000 Accounts Payable 2,000 2,000 630 630 42,000 16,000 2,000 (b) (d) (f) Beg. Bal. (g) ( ) End. Bal. Supplies 630 630 (f) Beg. Bal. (d) (g) End. Bal. Beg. Bal. (b) (d) End. Bal. Equipment 42,000 18,000 60,000 Notes Payable Beg. Bal. 20,000 20 000 (c) 20,000 End. Bal. Contributed Capital Beg. Bal. 50,000 (a) 50,000 End. Bal. 50 000 End Bal 2-27 Learning Objective 4 Prepare a classified balance sheet. h t 2-28 Preparing a Balance Sheet (Trial Balance is prepared from ending balances in T-accounts) Pizza Aroma, Inc. Trial Balance August 31, 2010 August 31 2010 Debit $ 10,000 630 60,000 Credit Cash Cookware Equipment Accounts Payable Note Payable N t P bl Contributed Capital Totals $ 70,630 $ 630 20 000 20,000 50,000 $ 70,630 2-29 Classified Balance Sheet Pizza Aroma, Inc. Balance Sheet At August 31, 2010 Current Assets: Current Assets: Cash Cookware Total Current Assets Property, Plant, and Equipment: Property Plant and Equipment: Equipment Total Assets: Liabilities and Stockholders' Equity: Current Liabilities: Accounts Payable LongTerm Liabilities: y Note Payable Total Liabilities: Stockholders' Equity Contributed Capital Total Liabilities and Stockholders Equity Total Liabilities and Stockholders' Equity $ 10,000 630 10,630 60,000 $ 70,630 Current assets will be used up or converted into cash within the next 12 months. Long-term assets include resources that will be used or turned into cash more than 12 months after the balance sheet date. $ 630 20,000 20,630 50,000 $ 70,630 $ 70 630 2-30 Learning Objective 5 Interpret the balance sheet using the current ratio and an understanding of related d t di f l t d concepts. p . 2-31 Assessing the Ability to Pay Pizza Aroma, Inc. Balance Sheet At 8/31/2010 Current Assets: Cash Cookware Total Current Assets Total Current Assets Property, Plant, and Equipment: Equipment Total Assets: Liabilities and Stockholders' Equity: Li biliti d St kh ld ' E it Current Liabilities: Accounts Payable LongTerm Liabilities: Note Payable Total Liabilities: Stockholders' Equity Contributed Capital Total Liabilities and Stockholders' Equity $ 10,000 630 10,630 60,000 $ 70,630 Current Ratio = Current Assets Current Liabilities = $ 10,630 $ 630 16.9 $ 630 20,000 20,630 50,000 $ 70,630 = 2-32 Balance Sheet Concepts and Values Pizza Aroma, Inc. Balance Sheet At 8/31/2010 Current Assets: Cash Cookware Total Current Assets Total Current Assets Property, Plant, and Equipment: Equipment Total Assets: Liabilities and Stockholders' Equity: Li biliti d St kh ld ' E it Current Liabilities: Accounts Payable LongTerm Liabilities: Note Payable Total Liabilities: Stockholders' Equity Contributed Capital Total Liabilities and Stockholders' Equity $ 10,000 630 10,630 60,000 $ 70,630 What is (is not) recorded? What amounts recorded? $ 630 20,000 20,630 50,000 $ 70,630 2-33 Chapter 2 Exercises M2-13, M2-14, M2-15, M2-16, E2-4, E2-6 M2-13 Identifying Transactions and Preparing Journal Entries, p. 76 J.K. Builders was incorporated on July 1, 2010. Prepare journal entries for the following events from the first month of business. If the event is not a transactions, write "no transaction." a. b. c. c Received $55,000 cash invested by owners and issued stock. Bought an unused field from a local farmer by paying $45,000 cash. As a construction site for smaller projects it is estimated to be worth $50,000 to J.K. Builders. A lumber supplier delivered lumber to J K Builders for future use The lumber would have J.K. use. normally sold for $10,000, but the supplier gave J.K. Builders a 10% discount. J.K. Builders has not received a bill from the suppliers. 2-35 M2-13 Identifying Transactions and Preparing Journal Entries d. e. Borrowed $25,000 from the bank with a plan to use the funds to build a small workshop in August. The loan must be report in two years. One of the owners sold $10,000 worth of his stock to another shareholder for $11,000 cash. 2-36 M2-14 Identifying Transactions and Preparing Journal Entries, p. 76 Joel Henry founded bookmart.com at the beginning of August, which sells new and used books online. He is passionate about books but does not have a lot of accounting experience. Help Joel by preparing journal entries for the following events. If the event is not a transaction, write "no transaction." a. b. The company purchased bookshelves for $2,000 cash. The bookshelves are expected to be used for ten or more years. Joel's business bought $8,000 worth of books from a publisher. The company will pay the publisher within 45-60 days. 2-37 M2-14 Identifying Transactions and Preparing Journal Entries c. Joel's friend Sam lent $4,000 to the business. Sam had Joel write a note promising that bookmart.com would repay the $4,000 in four months. Because they are good friends, Sam is not going to charge Joel interest. The company paid $1,500 cash, for books purchased on account earlier in the month. Bookmart.com c. Bookmart com repaid the $4,000 loan established in c $4 000 d. e. e 2-38 M2-15 Identifying Transactions and Preparing Journal Entries, p. 76 Katy Williams is the manager of Blue Light Arcade. The company provides entertainment for parties and special events. Prepare j journal entries for the following events relating to the year ended g g y December 31. If the event is not a transaction, write "no transaction." a. b. c. Blue Light Arcade received $50 cash on account for a birthday party held two months ago. g y y g Agreed to hire a new employee at a monthly salary of $3,000. The employee starts work next month. Paid $2,000 for a table top hockey game purchased last month on account. 2-39 M2-15 Identifying Transactions and Preparing Journal Entries Katy Williams is the manager of Blue Light Arcade continuation. Prepare journal entries for the following events relating to the year ended December 31. If the event is not a transaction, write "no transaction." d. e. Repaid a $5,000 bank loan. (Ignore interest). The company purchased an air hockey table for $2,200, paying $1,000 cash and signing short-term note for $1,200. 2-40 M2-16 Identifying Transactions and Preparing Journal Entries, p. 76 Sweet Shop Co. Is a chain of candy stores that has been in operation for the past ten years. Prepare journal entries for the g y following events, which occurred at the end of the most recent year. If the event is not a transaction, write "no transaction." a. b. b c. Ordered and received $12,000 worth of cotton candy machines from Candy Makers, Inc., which Sweet Shop Co. Will pay for in 45 days. Sent S t a check f $6,000 t C d M k h k for $6 000 to Candy Makers, I Inc. F th cotton candy machines f For the tt d hi from ( ) (a) Received $400 from customers who bought candy on account in previous months. 2-41 M2-16 Identifying Transactions and Preparing Journal Entries d. e. To help raise funds for store upgrades estimated to cost $20,000, Sweet Shop Co. Issued 1,000 shares of $15 each to existing stockholders. Sweet Shop Co. bought ice cream trucks for $50,000 total, paying $10,000 cash and signing a long-term note for $40,000. 2-42 E2-4 Determining Financial Statement Effects of Several Transactions, p. 79 The following events occurred for Favata Company: a. Received $10,000 cash from owners and issued stock to them. b. Borrowed $7,000 cash from a bank and signed a note. p g c. Purchased land for $12,000; paid $1,000 in cash and signed a note for the balance. d. Bought $800 of equipment on account. e. Purchased $3,000 of equipment, paying $1,000 in cash and signing a note for the rest. Required: For each of the events ( a) through ( e), perform transaction analysis and indicate the account ) g ) p y amount, and direction of the effect ( for increase and for decrease) on the accounting equation. Check that the accounting equation remains in balance after each transaction. Assets (a) Cash (b) Cash ( c) Land Cash ( ) q p (d) Equipment (e) Equipment Cash 2-43 + +10,000 +7,000 +12,000 1,000 +8,000 , +3,000 1,000 Liabilities Notes Payable +7,000 + Stockholders' Equity Contributed Capital +10,000 Notes Payable +11,000 Accounts Payable +8,000 y , Notes Payable +2,000 E2-6 Recording Investing and Financing Activities, p. 80 The following events occurred for Favata Company: a. Received $10,000 cash from owners and issued stock to them. b. Borrowed $7,000 cash from a bank and signed a note. c. Purchased land for $12,000; paid $1,000 in cash and signed a note for the balance. d. Bought $800 of equipment on account. e. Purchased $3,000 of equipment, paying $1,000 in cash and signing a note for the rest. Required: For each of the events, prepare journal entries, checking that debits equal credits. 2-44 E2-6 Recording Investing and Financing Activities The following events occurred for Favata Company: a. Received $10,000 cash from owners and issued stock to them. b. Borrowed $7,000 cash from a bank and signed a note. c. Purchased land for $12,000; paid $1,000 in cash and signed a note for the balance. d. Bought $800 of equipment on account. e. Purchased $3,000 of equipment, paying $1,000 in cash and signing a note for the rest. Required: For each of the events, prepare journal entries, checking that debits equal credits. 2-45 End of Chapter 2 Chapter 4 Adjustments, Financial Statements, and Financial Results PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA p , , Fred Phillips, Ph.D., CA Edited by: Muriel Anderson, MBA, CPA Learning Objective 1 Explain why adjustments are needed. d d 4-2 Why Adjustments Are Needed Cash is not always received in the period in which the company earns the related revenue; likewise, cash is not always paid in the period in which the company incurs the related expense. Solution: Adjustments are made to the accounting records at the end of the period to state assets, liabilities, revenues, and expenses at appropriate amounts. 4-3 Adjustments Are Needed To Ensure: Income Statement Revenues are recorded when earned. Expenses are recorded in the same period as the revenues t which to hi h they relate. Balance Sheet Assets are reported at amounts representing the economic benefits that remain at the end of the period. Liabilities Li biliti are reported at amounts owed at the end of the period. 4-4 1. Deferral Adjustments Deferral adjustments are used to decrease dt d balance sheet accounts and increase corresponding income statement accounts. Each deferral adjustment involves: a) one asset, and b) one expense account, OR c) one liability, and d) one revenue account. 4-5 2. Accrual Adjustments Accrual adjustments are used to record revenue or expenses when they occur prior to receiving or paying g p y g cash, and to adjust corresponding balance sheet accounts accounts. Each accrual adjustment involves: a) one asset, and b) one revenue account, OR c) one liability, and d) one expense account. 4-6 Learning Objective 2 Prepare adjustments needed at the end of the period. t th d f th i d 4-7 Adjustment Analysis, Recording and Summarizing 1 Analyze ete e the ecessa y adjustments a e Determine t e necessary adjust e ts to make to the accounting records. 4-8 Exhibit 4.4 (Carried over from Chapter 3: Exhbiit 3.9) 4-9 Deferral Adjustments (a) Supplies Used during the Period. Of the $1,600 in supplies received in early September, $400 remain on hand at September 30. 1 Analyze Assets (a) Supplies -1,200 = Liabilities + Stockholders' Equity Supplies Expense (+E) -1,200 2 Record R d (a) dr Supplies Expense (+E, SE) cr Supplies (A) 3 Summarize 1,200 1,200 4-10 Deferral Adjustments (b) Rent Benefits Expired during the Period. Three months of rent were prepaid on September 1 for $7,200, but one month has now expired, leaving only two months prepaid at September 30. 1 Analyze Assets (b) Prepaid Rent -2,400 = Liabilities + Stockholders' Equity Rent Expense (+E) -2,400 2 Record R d (b) dr Rent Expense (+E, SE) cr Prepaid Rent (A) 3 Summarize 2,400 2,400 4-11 Deferral Adjustments (c) Depreciation Is Recorded for Use of Equipment. The restaurant equipment, which was estimated to last five years, has now been used for one month, representing an estimated expense of $1,000. Depreciation is the process of allocating the cost of p p g buildings, vehicles, and equipment to the accounting periods in which they are used. A contra-account is an account that is an offset to, or reduction of, another account. 4-12 Deferral Adjustments (c) Depreciation Is Recorded for Use of Equipment. The restaurant equipment, which was estimated to last five years, has now been used for one month, representing an estimated expense of $1,000. 1 Analyze Assets (c) Accumulated Depr. +1,000 = Liabilities + Stockholders' Equity Depreciation Expense (+E) +1,000 2 Record (c) dr Depreciation Expense (+E, SE) 1,000 cr Accumulated Depreciation (+xA, A) 3 Summarize 1,000 4-13 Depreciation Note 1 Accumulated Depreciation Balance Sheet Depreciation Expense Income Statement Note 2 Accumulated Depreciation Total Amount Depreciated Equipment Original cost Note 3 ContraAccount Opposes account it offsets 4-14 Note 4 Depreciation Amount Depends on method used Deferral Adjustments (d) Gift Cards Redeemed for Service. Pizza Aroma redeemed $160 of gift cards that customers used to pay for pizza. 1 Analyze Assets (d) = Liabilities Unearned Revenue -160 + Stockholders' Equity Pizza Revenue (+R) +160 2 Record R d (d) dr Unearned Revenue (L) cr Pizza Revenue (+R, +SE) 3 Summarize 160 160 4-15 Accrual Adjustments (e) Revenues Earned but Not Yet Recorded. Pizza Aroma provided $40 of Pizza to Mauricio's close friend on the last day of September, with payment to be received in October. 1 Analyze Assets (e) Accounts Receivable +40 = Liabilities + Stockholders' Equity Pizza Revenue (+R) +40 2 Record R d (e) dr Accounts Receivable (+A) cr Pizza Revenue (+R, +SE) 3 Summarize 40 40 4-16 Accrual Adjustments (f) Wages Expense Incurred but Not Yet Recorded. Pizza Aroma owes $900 of wages to employees for work done in the last three days of September. 1 Analyze Assets (f) = Liabilities Wages Payable +900 + Stockholders' Equity Wages Expense (+E) -900 2 Record R d (f) dr Wages Expense (+E, SE) cr Wages Payable (+L) 3 Summarize 900 900 4-17 Accrual Adjustments (g) Interest Expense Incurred but Not Yet Recorded. Pizza Aroma has not paid or recorded the $100 interest that it owes for this month on its note payable to the bank. 1 Analyze Assets (g) = Liabilities Interest Payable +100 + Stockholders' Equity Interest Expense (+E) -100 2 Record R d (g) dr Interest Expense (+E, SE) cr Interest Payable (+L) 3 Summarize 100 100 4-18 Accrual Adjustments (h) Income Taxes Incurred but Not Yet Recorded. Pizza Aroma pays income tax at an average rate equal to 40 percent of the company's income before taxes. 1 Analyze Assets (h) = Liabilities Income Tax Payable +400 + Stockholders' Equity Income Tax Expense (+E) -400 2 Record R d (h) dr Income Tax Expense (+E, SE) cr Income Tax Payable (+L) 3 Summarize 400 400 4-19 Accrual Adjustments (h) Income Taxes Incurred but Not Yet Recorded. Income Tax calculation: $1,000 x 40% = $400 4-20 Pizza Aroma's Accounting Records (i) Dividend Declared and Paid. Pizza Aroma declares and pays a $500 cash dividend. 1 Analyze Assets (i) Cash -500 = Liabilities + Stockholders' Equity Dividends Declared (+D) -500 2 Record R d (i) dr Dividends Declared (+D, SE) cr Cash (A) 3 Summarize 500 500 4-21 Additional Comments Adjusting t i Adj ti entries always l include one balance sheet and one income statement account. Adjusting journal entries never involve cash. Dividends are not expenses. Instead, they are a reduction of the retained earnings. 4-22 Learning Objective 3 Prepare an adjusted trial balance. b l 4-23 PIZZA AROMA Adjusted Trial Balance As of September 30, 2010 Debit Credit Cash $ 7,600 Accounts Receivable 240 Supplies 400 Prepaid Rent 4,800 Cookware 630 Equipment 60,000 Accumulated Depreciation $ 1,000 Accounts Payable 1,030 Unearned Revenue 140 Wages Payable 900 Income Tax Payable 400 Interest Payable 100 Note Payable 20,000 Contributed Capital p 50,000 , Retained Earnings Dividends Declared 500 Pizza Revenue 15,700 Wages Expense 9,000 Rent Expense 2,400 2 400 Supplies Expense 1,200 Depreciation Expense 1,000 Utilities Expense 600 Advertising Expense 400 Interest E pense Expense 100 Income Tax Expense 400 Total $ 89,270 $ 89,270 4-24 See Exhibit 4.9 in test for full set of T-accounts Partial Li ti P ti l Listing of T-accounts fT t Learning Objective 4 Prepare financial statements. p 4-25 PIZZA AROMA Adjusted Trial Balance As of September 30, 2010 Debit Credit Cash $ 7,600 Accounts Receivable 240 Supplies 400 Prepaid Rent 4,800 Cookware 630 Equipment 60,000 Accumulated Depreciation $ 1,000 Accounts Payable 1,030 Unearned Revenue 140 Wages Payable 900 Income Tax Payable 400 Interest Payable 100 Note Payable 20,000 Contributed Capital p 50,000 , Retained Earnings Dividends Declared 500 Pizza Revenue 15,700 Wages Expense 9,000 Rent Expense 2,400 2 400 Supplies Expense 1,200 Depreciation Expense 1,000 Utilities Expense 600 Advertising Expense 400 Interest E pense Expense 100 Income Tax Expense 400 Total $ 89,270 $ 89,270 4-26 PIZZA AROMA, INC. Income Statement For the Month Ended September 30, 2010 Revenues Pizza Revenue $ 15,700 Total Revenue 15,700 Expenses Wages Expense Rent Expense Supplies Expense Depreciation Expense Utilities Expense Advertising Expense Interest Expense Income Tax Expense Total Expenses Net Income 9,000 9 000 2,400 1,200 1,000 600 400 100 400 15,100 600 $ PIZZA AROMA, INC. Statement of Retained Earnings For th M th E d d S t F the Month Ended September 30, 2010 b 30 Retained Earnings, Sept. 1, 2010 $ Add: Net Income 600 Subtract: Dividends Declared (500) Retained Earnings, Sept. 30, 2010 g $ 100 PIZZA AROMA Adjusted Trial Balance As of September 30, 2010 Debit Credit Cash $ 7,600 Accounts Receivable 240 Supplies 400 Prepaid Rent 4,800 Cookware 630 Equipment 60,000 Accumulated Depreciation $ 1,000 Accounts Payable 1,030 Unearned Revenue 140 Wages Payable 900 Income Tax Payable 400 Interest Payable 100 Note Payable 20,000 Contributed Capital p 50,000 , Retained Earnings Dividends Declared 500 Pizza Revenue 15,700 Wages Expense 9,000 Rent Expense 2,400 2 400 Supplies Expense 1,200 Depreciation Expense 1,000 Utilities Expense 600 Advertising Expense 400 Interest E pense Expense 100 Income Tax Expense 400 Total $ 89,270 $ 89,270 4-27 PIZZA AROMA, INC. Balance Sheet At September 30, 2010 Assets Current Assets Cash Accounts Receivable Supplies Prepaid Rent Cookware Total Current Assets Equipment Accumulated Depreciation Total Assets Liabilities Current Liabilities Accounts Payable Unearned Revenue Wages Payable Income Tax Payable Interest Payable Total Current Liabilities Note Payable Total Liabilities Stockholders' Equity Contributed Capital Retained Earnings Total Stockholders' Equity 50,000 100 50,100 $ 1 030 1,030 140 900 400 100 2,570 20,000 22,570 $ 60,000 (1,000) 59,000 $ 72,670 $ 7,600 240 400 4,800 630 13,670 Liabilities and Stockholders' Equity Total Liabilities and Stockholders' Equity $ 72,670 Learning Objective 5 Explain the closing p p g process. 4-28 Closing Temporary Accounts Revenues Ex xpenses Liabiliti ies Div vidend ds Assets Equity E Temporary Accounts Permanent Accounts Temporary accounts T t track financial results for a limited period of time. 4-29 Permanent accounts P t t track financial results from year to year. Closing Temporary Accounts Two closing journal entries are needed. needed Debit Revenue accounts and credit Expense accounts. Debit or credit the difference to Retained Earnings. Earnings Credit Dividends Declared and debit Retained Earnings. 4-30 PIZZA AROMA Adjusted Trial Balance As of September 30, 2010 Debit Credit Cash $ 7,600 Accounts Receivable 240 Supplies 400 Prepaid Rent 4,800 Cookware 630 Equipment 60,000 Accumulated Depreciation $ 1,000 Accounts Payable 1,030 Unearned Revenue 140 Wages Payable 900 Income Tax Payable 400 Interest Payable 100 Note Payable 20,000 Contributed Capital p 50,000 , dr Retained Earnings (-SE) Retained Earnings cr Dividends Declared (-D) Dividends Declared 500 Pizza Revenue 15,700 dr Pizza Revenue (-R) Wages Expense 9,000 cr Wages Expense (-E) Rent Expense 2,400 2 400 cr Rent Expense ( E) (-E) Supplies Expense 1,200 cr Supplies Expense (-E) Depreciation Expense 1,000 cr Depreciation Expense (-E) Utilities Expense 600 cr Utilities Expense (-E) Advertising Expense 400 cr Advertising Expense (-E) Interest E pense Expense 100 cr Interest Expense (-E) Income Tax Expense 400 cr Income Tax Expense (-E) Total $ 89,270 $ 89,270 500 500 15,700 9,000 2,400 2 400 1,200 1,000 600 400 100 400 600 cr Retained Earnings (+SE) 4-31 Closing Temporary Accounts dr Pizza Revenue (-R) cr Wages Expense (-E) cr Rent Expense (-E) ( E) cr Supplies Expense (-E) cr Depreciation Expense (-E) cr Utilities Expense (-E) cr Advertising Expense (-E) ( E) cr Interest Expense (-E) cr Income Tax Expense (-E) cr Retained Earnings (+SE) 15,700 9,000 2,400 2 400 1,200 1,000 600 400 100 400 600 dr Retained Earnings (-SE) cr Dividends Declared (-D) 500 500 After posting these closing entries, all entries the income statement accounts and the dividend account will have a zero balance. 4-32 Post-Closing Trial Balance Final check that all debits still equal credits and that all temporary accounts have been closed. Contains balances for only permanent accounts. Is the last step in the accounting process. process 4-33 Learning Objective 6 Explain how adjustments affect financial results. ff t fi i l lt 4-34 Adjusted Financial Results Adjustments help to ensure that all revenues and expenses are reported in the period in which they are earned and incurred. Without adjustments, the financial statements present an i incomplete and misleading picture l d i l di i of the company's financial performance. 4-35 Chapter 4 Exercises M4-5 & M4-6 (combined), M4-10, M4-18 M4-5 & M4-6 Determine Accounting Equation Effects of Adj t t dR di Adj ti E ti Adjustments and Recording Adjusting Entries For each of the following transactions for the Sky Blue Corporation, give the accounting equation effects of the adjustments required at the end of the month on December 31, 2009, and prepare the adjusting journal entries required on December 31, 2009: a. Collected $1,200 C ll t d $1 200 rent f th period D t for the i d December 1 2009 t b 1, 2009, to February 28, 2010, which was credited to Unearned Rent Revenue on December 1, 2009. 4-37 M4-5 & M4-6 Determine Accounting Equation Effects of Adjustments and Recording Adjusting Entries b. Paid $2,400 for a two-year insurance premium on December 1, 2009; debited Prepaid Insurance for that amount. 4-38 M4-5 & M4-6 Determine Accounting Equation Effects of Adj t t dR di Adj ti E ti Adjustments and Recording Adjusting Entries c. Used a machine purchased on December 1, 2009 for $48,000. The company estimates annual depreciation of $4,800. 4-39 M4-10 Preparing Journal Entries for Deferral Transactions and Adjustments Adj t t For each of the following independent situations, prepare journal entries to record the initial transaction and the adjustment required at the end of the month indicated indicated. a. Magnificent Magazines received $12,000 on December 30, 2010, for subscriptions to magazines that will be published and distributed in January through December 2011 2011. December 30, 2010: January 31, 2011 AJE: 4-40 M4-10 Preparing Journal Entries for Deferral Transactions and Adjustments b. Walker Window Washing paid $1,200 cash for supplies on December 30, 2010. As of January 31, 2011, $200 of these supplies had been used up up. December 30, 2010: January 31, 2011 AJE: 4-41 M4-10 Preparing Journal Entries for Deferral Transactions and Adjustments c. Indoor Raceway received $3,000 on December 30, 2010, from race participants for three races. One race is held January 31, 2011, 2011 and the other two will be held in March 2011 2011. December 30, 2010: January 31, 2011 AJE: 4-42 M4-18 Preparing and Posting Adjusting Journal Entries At December 31, the unadjusted trial balance of H&R Tacks reports 31 Prepaid Insurance of $7,200 and Insurance Expense of $0. The insurance was purchased on July 1 and provides coverage for 12 months. months Prepare the adjusting journal entry on December 31 In 31. separate T-accounts for each account, enter the unadjusted balances, post the adjusting journal entry, and report the adjusted balance. + Prepaid Insurance (A) - Bal. 7,200 End. 4-43 + Insurance Expense (E) - Bal. 0 End. End of Chapter 4 Chapter 3 Reporting Operating Results on the Income Statement PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA p , , Fred Phillips, Ph.D., CA Edited by: Muriel Anderson, MBA, CPA Learning Objective 1 Describe common operating transactions and select appropriate i i t income statement t t t account titles. 3-2 Operating Activities Operating activities include buying goods and services from suppliers and employees and selling goods and services to customers and then collecting cash from them. them 3-3 Income Statement Accounts 3-4 Cash Basis Accounting Cash basis accounting records revenues when cash is received and expenses when cash is paid. 3-5 Learning Objective 2 Explain and apply the revenue and matching principles. d t hi i i l 3-6 Accrual Basis Accounting Accrual Basis Accounting A ti GAAP Records revenues when they are earned and expenses when they are incurred, regardless of the timing of p p y cash receipts or payments. 3-7 Revenue Principle--Revenue Recognition **Record revenues as they are earned** Record earned Timing of Reporting Revenue vs. Cash Receipts 1 2 3 3-8 Cash is received in the same period as the goods or services are provided. Cash is received in a period before goods or services are provided. Cash is received in a period after goods or services are provided. Matching Principle--Expense Recognition **Record Expenses in the same period as the associated Record Revenues** Timing of Reporting Expenses vs. Cash Payments 1 2 3 3-9 Cash is paid at the same time as the cost is incurred to generate revenue. Cash is paid before the expense is incurred to generate revenue. Cash is paid after the cost is incurred to generate revenue. Learning Objective 3 Analyze, record, and summarize the effects of operating transactions, using the accounting , g g equation, journal entries, and T accounts. T-accounts 3-10 The Expanded Accounting Equation Revenues are are credits Expenses are debits are debits 3-11 Pizza Aroma's Accounting Records (a) Provided services for cash. In September, Pizza Aroma delivered pizza to customers for $15,000 cash. 1 Analyze Assets (a) Cash +$15,000 = Liabilities + Stockholders Stockholders' Equity Pizza Revenue (+R) + $15,000 2 Record R d (a) dr Cash (+A) cr Pizza Revenue (+R, +SE) 3 Summarize 15,000 15,000 3-12 Pizza Aroma's Accounting Records (b) Receive cash for future services. Pizza Aroma sold three $100 gift cards at the beginning of September. 1 Analyze Assets (b) Cash +$300 = Liabilities Unearned Revenue +$300 + Stockholders' Equity 2 Record R d (b) dr Cash (+A) cr Unearned Revenue (+L) 3 Summarize 300 300 3-13 Pizza Aroma's Accounting Records (c) Provide services on credit. Pizza Aroma delivers $500 of pizza to a college organization, billing this customer on account. 1 Analyze Assets (c) Accounts Receivable +$500 = Liabilities + Stockholders' Equity Pizza Revenue (+R) +$500 2 Record R d (c) dr Accounts Receivable (+A) cr Pizza Revenue (+R, +SE) 3 Summarize 500 500 3-14 Pizza Aroma's Accounting Records (d) Receive payment on account. Pizza Aroma received a $300 check from the college organization, as partial payment of its account balance. 1 Analyze Assets (d) Cash +$300 Accounts Receivable -$300 = Liabilities + Stockholders' Equity 2 Record R d (d) dr Cash (+A) cr Accounts Receivable (A) 3 Summarize 300 300 3-15 Pizza Aroma's Accounting Records (e) Pay cash to employees. Pizza Aroma wrote checks to employees, totaling $8,100 for wages related to hours worked in September. 1 Analyze Assets (e) Cash -$8,100 = Liabilities + Stockholders' Equity Wages Expense (+E) -$8,100 2 Record R d (e) dr Wages Expense (+E, SE) cr Cash (A) 3 Summarize 8,100 8,100 3-16 Pizza Aroma's Accounting Records (f) Pay cash in advance. On September 1, Pizza Aroma paid $7,200 in advance for September, October, and November rent. 1 Analyze Assets (f) C h Cash -$7,200 $7 200 Prepaid Rent +$7,200 = Liabilities + Stockholders' Equity 2 Record R d (f) dr Prepaid Rent (+A) cr Cash (A) 3 Summarize 7,200 7,200 3-17 Pizza Aroma's Accounting Records (g) Pay cash in advance. On September 2, Pizza Aroma wrote a check for $1,600 for pizza sauce, dough, cheese, and paper products. 1 Analyze Assets (g) Cash -$1,600 Supplies +$1,600 = Liabilities + Stockholders' Equity 2 Record R d (g) dr Supplies (+A) cr Cash (A) 3 Summarize 1,600 1,600 3-18 Pizza Aroma's Accounting Records (h) Incur cost to be paid later. Pizza Aroma received a bill for $400 for running a newspaper ad in September. The bill will be paid in October. 1 Analyze Assets (h) = Liabilities Accounts Payable +$400 + Stockholders' Equity Advertising Expense (+E) -$400 2 Record R d (h) dr Advertising Expense (+E, SE) 400 cr Accounts Payable (+L) 400 3 Summarize 3-19 Pizza Aroma's Accounting Records (i) Pay cash for expenses. Pizza Aroma received and paid bills totaling $600 for September utilities services. 1 Analyze Assets (i) Cash -$600 = Liabilities + Stockholders' Equity Utilities Expense (+E) -$600 2 Record R d (i) dr Utilities Expense (+E, SE) cr Cash (A) 3 Summarize 600 600 3-20 Learning Objective 4 Prepare an unadjusted trial balance. b l 3-21 Unadjusted Trial Balance Cash Ledger Account 3-22 Review of Revenues (1) Cash is received before the company earns revenue. dr. Cash cr. Unearned Rev. Earn Revenue Earn Revenue (3) Cash is received after the company earns revenue revenue. dr. Cash cr. Accounts Rec. $ dr. Unearned Rev. cr. _______ Revenue dr. Accounts Rec. cr. ________ Revenue $ (2) Cash is received in the same period the company earns revenue. p y $ Earn Revenue dr. Cash cr. ________ Revenue 3-23 Review of Expenses (1) Cash is paid before the expense is incurred. dr. Prepaid Expense cr. Cash Use-up Benefits (3) Cash is paid after the expense is incurred. dr. Accounts Payable Use-up Benefits cr. Cash $ dr. _________Expense cr. Prepaid Expense dr. _________ Expense cr. Accounts Payable $ (2) Cash is paid in the same period the expense is incurred. incurred $ Use-up Benefits dr. _________ Expense cr. Cash 3-24 Learning Objective 5 Describe limitations of the income statement. i t t t 3-25 Income Statement Limitations NI Cash NI V l Value NI Exact 3-26 Chapter 3 Solved Exercises M3-2, M3-3, M3-4, M3-5, M3-13, M3-14 M3-2 Identifying Revenues y g The following transactions are July 2010 activities of Bill's Extreme Bowling Inc., which operates several bowling centers. If revenue is to be recognized in July, indicate the amount. If revenue is not to be recognized in July, explain why. Activity a. Bill's collected $12,000 from customers for games played in July. b. Bill's billed a customer for $250 for a party held at the center on the last day of July. The bill is to be paid in August. c. Bill's received $1,000 from credit sales made to customers last month (in June). d. The men's and women's bowling leagues gave Bill s advance payments leagues gave Bill's advance payments totaling $1,500 for the fall season that starts in September. Amount or Explanation 3-28 M3-3 Identifying Expenses y g The following transactions are July 2010 activities of Bill's Extreme Bowling, Inc., which operates several bowling centers. If an expense is to be recognized in July, indicate the amount. If an expense is not to be recognized in July, explain why. Activity e. Bill s paid $1,500 to plumbers for e Bill's paid $1 500 to plumbers for repairing a broken pipe in the restrooms. f. Bill's paid $2,000 for the June electricity bill and received the July bill for $2,500, which will be paid in August. g. Bill s paid $5,475 to employees for work g Bill's paid $5 475 to employees for work in July. Amount or Explanation 3-29 M3-4 Recording Revenues For each of the transactions in M3-2 write the journal entry using M3-2, the format shown in the chapter. 3-30 M3-5 Recording Expenses For each of the transactions in M3-3 write the journal entry using M3-3, the format shown in the chapter. 3-31 M3-13 Preparing Journal Entries for Business Activities Q i k Cleaners, I h been i b i l Quick Cl Inc. (QCI) has b in business f several for years. It specializes in cleaning houses but has some small business clients as well. Prepare journal entries for the following transactions, transactions which occurred during a recent month: a. Incurred $600 of heating and electrical costs this month and will pay them next month. b. Issued $25,000 of QCI stock for cash. 3-32 M3-13 Preparing Journal Entries for Business Activities c Paid wages for the current month totaling $2 000 c. month, $2,000. d. Performed cleaning services on account worth $2,800. e. Some of Quick Cleaners' equipment was repaired at a total cost of $150. The company paid the full amount immediately. 3-33 M3-14 Preparing Journal Entries for Business Activities Junktrader is an online company that specializes in matching buyers and sellers of used items. Buyers and sellers can purchase a membership with Junktrader, which provides them advance notice of potentially attractive offers. Prepare journal entries for the following transactions, which occurred during a recent month. a. Junktrader provided online advertising services for another company for $200 on account. b. On the last day of the month, Junktrader paid $50 cash to run an ad promoting the company's services. The ad ran that day in h local newspaper. d i the l l 3-34 M3-14 Preparing Journal Entries for Business Activities c. Received $200 cash in membership fees for the month from $ p new members. d. Received an electricity bill for $85, for usage this month. The bill will be paid next month. e. Billed a customer $180 for helping them sell their junk. The customer is expected to pay by the end of next month. 3-35 End of Chapter 3 Chapters 5 and 6 (select topics) Controlling Cash & certain sales transactions PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA p , , Fred Phillips, Ph.D., CA Edited by: Muriel Anderson, MBA, CPA Learning Objective 2 (CH 5) The fi Th financial reporting i l ti environment and the Sarbanes-Oxley Act. 5-2 Accounting Fraud Incentive (Why?) The Fraud Triangle Ti l Oppo tu ty Opportunity (How?) 5-3 C a acte Character (Who?) The Sarbanes-Oxley (SOX) Act Counteract Incentives I ti SOX Reduce Opportunities 5-4 Encourage Good Character Ch t Learning Objective 2 (CH 6) Explain E l i common principles i i l and limitations of internal control. 6-5 Internal Control All companies include as part of their operating activities a variety of procedures and policies that are referred to as internal controls. controls. Internal controls are the methods a company uses to: 1. Protect 1 P t t against the theft of assets. i t th th ft f t 2. Enhance the reliability of accounting information. information 3. Promote efficient and effective operations. 4. 4 Ensure compliance with applicable laws and regulations. 6-6 Common Control Principles Principle Establish responsibility Segregate duties Explanation Assign each task to only one person. Do not make one employee responsible for all parts of a p process. Do not provide access to assets or information unless it is needed to fulfill assigned responsibilities. Prepare documents to show activities that have occurred. Check others' work. Examples Each Wal Mart cashier uses a Wal-Mart different cash drawer Wal-Mart cashiers, who ring up sales, do not approve price changes. g Wal-Mart secures valuable assets such as cash and access to its computer systems (passwords, firewalls). Wal-Mart pays suppliers using prenumbered checks. Wal-Mart compares cash balances in its accounting records to the cash balances reported by its bank, and accounts for any differences. Restrict access Document procedures Independently verify 6-7 Control Limitations Internal controls can never completely prevent and detect errors and fraud. df d Human Error or Fraud Benefits vs Cost vs. 6-8 Learning Objective 3 (CH 6) Apply internal control A l i t l t l principles to cash receipts and p p p payments. 6-9 Cash Received in Person Segregate Duties Cashier Recording Custody 6-10 Cash Received from a Remote Source Cash Received by Mail Cash Received Electronically 6-11 Cash Payments Cash Payments Writing a Check Electronic Funds Transfer A voucher system is cash to their approving Most companies pay a process foremployees and documenting all purchases and g through EFTs, whichp are known by payments direct deposits. employees as on account. 6-12 Learning Objective 4 Perform the key control of P f th k t l f reconciling cash to bank g statements. 6-13 Bank Procedures and Reconciliation Banks provide services that help businesses to control cash in several ways: Restricting Access Documenting Procedures Independently Verifying A bank reconciliation is an internal report prepared to verify the accuracy of both the bank statement and the cash accounts of a business or individual. 6-14 Bank Statement 1 2 3 4 5 6-15 Reconciling Differences Your Bank May Not Know About . . . 1. 1 Errors made by the bank bank. 2. Time lags: a. Deposits that you made recently. b. Ch k th t b Checks that you wrote recently. t tl 3. 4. 5. 5 6. 7. You May Not Know About . . . Interest the bank has put into your account. Electronic funds transfer (EFT) S Service charges taken out of your account. i h t k t f t Customer checks you deposited but that bounced. Errors made by you. 6-16 Bank Reconciliation To determine the appropriate cash balance, these balances need to be b l th b l dt b reconciled. 6-17 Bank Reconciliation Bank Reconciliation Goals 1.Identify the deposits in transit. 2.Identify the outstanding checks. 3.Record 3 Record other transactions on the bank statement statement. 4.Determine the impact of errors. 6-18 Bank Reconciliation 6-19 Learning Objective 6 (CH 6) Sales transaction issues 6-20 Sales Transactions Merchandisers earn revenues by transferring ownership of merchandise to a customer, either for cash or on credit. For a merchandiser who is shipping goods to a customer, customer the transfer of ownership occurs at one of two possible times: 1. FOB shipping point --the sale is recorded when the goods leave the seller's shipping department. 2. FOB destination --the sale is recorded when the goods reach their destination (the customer). 6-21 Sales Transactions Every merchandise sale has two components, each of which requires an entry in a perpetual inventory system. Selling Price Cost 6-22 Sales Transactions Assume Wal-Mart sells two Schwinn mountain bikes for $400 cash. The bikes had previously been recorded in Wal-Mart's Inventory at a total cost of $350. p y y 1 Analyze Assets (a) Cash +400 (b) Inventory -350 = Liabilities + Stockholders Stockholders' Equity Sales Revenue (+R) +400 Cost of Goods Sold (+E) -350 2 Record 6-23 Sales Returns and Allowances When goods sold to a customer arrive in damaged condition or are otherwise unsatisfactory, the customer can ( ) (1) return them for a full refund or (2) keep them and ask for a reduction in the selling price, called an allowance. 6-24 Sales Returns and Allowances Suppose that after Wal-Mart sold the two Schwinn mountain bikes, the customer returned one to Wal-Mart. Assuming that the bike is still like new, Wal-Mart would g refund the $200 selling price to the customer and take the bike back into inventory. 1 Analyze Assets (a) Cash -200 (b) Inventory +175 = Liabilities + Stockholders Stockholders' Equity Sales Returns and Allowances (+xR) -200 Cost of Goods Sold (-E) +175 2 Record 6-25 Sales on Account and Sales Discounts A sales discount is a sales price reduction given to customers for prompt payment of their account balance. 6-26 Sales on Account and Sales Discounts Suppose Wal-Mart's warehouse store (Sam's Club) sells printer paper on account to a local business for $1 000 with payment terms of 2/10 n/30 The paper cost $1,000 2/10, n/30. Sam's Club $700. 1 Analyze Assets (a) Accounts Receivable +1,000 (b) Inventory -700 = Liabilities + Stockholders Stockholders' Equity Sales Revenue (+R) +1,000 Cost of Goods Sold (+E) -700 2 Record 6-27 Sales on Account and Sales Discounts To take advantage of this 2% discount, the customer must pay Wal-Mart within 10 days If the customer does so it will deduct the $20 discount (2% $1 000) from the days. so, $1,000) total owed ($1,000), and then pay $980 to Wal-Mart. 1 Analyze Assets Cash +980 Accounts Receivable -1,000 = Liabilities + Stockholders Stockholders' Equity Sales Discounts (+xR) -20 2 Record (2% $1 000) $1,000) 6-28 Summary of Sales-Related y Transactions The sales returns and allowances and sales discounts introduced in this section were recorded using contra-revenue accounts. 6-29 Learning Objective 7 (CH 6) Analyze a merchandiser's multistep i lti t income statement. t t t 6-30 Gross Profit Percentage Gross Gross Profit = 100 Profit % Net Sales 6-31 Comparing Operating Results Across Companies and Industries G oss o t e ce tage Gross Profit Percentage by Industry 40.0% 35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% 6-32 Chapter 6 Exercises E6-5, E6-10, E6-17 E6-5 Preparing a Bank Reconciliation and Journal Entries, and Reporting Cash Hills Company's June 30, 2010, bank statement and the June ledger account for cash are summarized here: Required: 1. 1 Prepare a bank reconciliation. A comparison of the checks written reconciliation with the checks that have cleared the bank shows outstanding checks of $700. Some of the checks that cleared in June were written prior to June. No deposits in transit were noted in May, but a p p y, deposit is in transit at the end of June. 6-34 E6-5 Preparing a Bank Reconciliation and Journal Entries, and Reporting Cash HILLS COMPANY Bank Reconciliation June 30, 2010 Bank Statement Ending balance per bank statement...................... Additions: Deposit in transit................ Deductions: Outstanding checks............ Up-to-date cash balance.... *$19,000 $18,000 = $1,000. 700 1,000* 1 000* 7,070 Company's Books Ending balance per Cash account........................... Additions: None 6,400 Deductions: Bank service charge...... 30 $6,070 $6,400 $6,370 Up-to-date cash balance...... $6,370 6-35 E6-5 Preparing a Bank Reconciliation and Journal Entries, and C Reporting Cash 2. Give any journal entries that should be made as a result of the bank reconciliation. dr Office Expenses (+E,-SE)................................................................ cr Cash (-A) .................................................................... To record bank service charges. 30 30 3. 3 What is the balance in the Cash account after the reconciliation entries? $6,370 ($6,400 - $30) 4. In addition to the balance in its bank account, Hills Company also has $300 cash on hand. This amount is recorded in a separate T-account called Cash on Hand. What is the total amount of cash that should be reported on the balance sheet at June 30? Balance sheet (June 30, 2008): Current assets C rrent assets: Cash ($6,370 + $300) ........................................................ 6-36 $6,670 E6-10 Recording Journal Entries for Net Sales with Credit Sales and Sales Discounts Using the information in E6-9, prepare journal entries to record the transactions, assuming Solitare uses a perpetual inventory system. Jan. 6 Sold goods for $100 to Wizard Inc. with terms 2/10, n/30. The goods cost Solitare $70. 6 Sold goods to SpyderCorp for $80 with terms 2/10, n/30. The g py p , goods cost Solitare $60. 14 Collected cash due from Wizard Inc. Feb. 2 Collected cash due from SpyderCorp. 28 Sold goods for $50 to Bridges with terms 2/10, n/45. The goods cost Solitare $30. Jan. 6 dr Accounts Receivable (+A) ...................................... cr Sales Revenue (+R,+SE) .................................. ( ) dr Cost of Goods Sold (+E,-SE) ................................. cr Inventory (-A) .................................................... 100 100 70 70 6-37 E6-10 Recording Journal Entries for Net Sales with Credit Sales and Sales Discounts Using the information in E6-9, prepare journal entries to record the transactions, assuming Solitare uses a perpetual inventory system. Jan. 6 Sold goods for $100 to Wizard Inc. with terms 2/10, n/30. The goods cost Solitare $70. 6 Sold goods to SpyderCorp for $80 with terms 2/10, n/30. The g py p , goods cost Solitare $60. 14 Collected cash due from Wizard Inc. Feb. 2 Collected cash due from SpyderCorp. 28 Sold goods for $50 to Bridges with terms 2/10, n/45. The goods cost Solitare $30. Jan. 6 dr Accounts Receivable (+A) ...................................... cr Sales Revenue (+R,+SE) .................................. dr Cost of Goods Sold (+E,-SE) ................................. cr Inventory (-A) .................................................... 80 80 60 60 6-38 E6-10 Recording Journal Entries for Net Sales with Credit Sales and Sales Discounts Using the information in E6-9, prepare journal entries to record the transactions, assuming Solitare uses a perpetual inventory system. Jan. 6 Sold goods for $100 to Wizard Inc. with terms 2/10, n/30. The goods cost Solitare $70. 6 Sold goods to SpyderCorp for $80 with terms 2/10, n/30. The g py p , goods cost Solitare $60. 14 Collected cash due from Wizard Inc. Feb. 2 Collected cash due from SpyderCorp. 28 Sold goods for $50 to Bridges with terms 2/10, n/45. The goods cost Solitare $30. Jan. 14 dr Cash (+A) ($1,000 x 98%)...................................... dr Sales Discounts (+xR,-SE) ($1,000 x 2%) ............. cr Accounts Receivable (-A).................................. 98 2 100 6-39 E6-10 Recording Journal Entries for Net Sales with Credit Sales and Sales Discounts Using the information in E6-9, prepare journal entries to record the transactions, assuming Solitare uses a perpetual inventory system. Jan. 6 Sold goods for $100 to Wizard Inc. with terms 2/10, n/30. The goods cost Solitare $70. 6 Sold goods to SpyderCorp for $80 with terms 2/10, n/30. The g py p , goods cost Solitare $60. 14 Collected cash due from Wizard Inc. Feb. 2 Collected cash due from SpyderCorp. 28 Sold goods for $50 to Bridges with terms 2/10, n/45. The goods cost Solitare $30. Feb. 2 dr Cash (+A) ............................................................... cr Accounts Receivable (-A).................................. 80 80 6-40 E6-10 Recording Journal Entries for Net Sales with Credit Sales and Sales Discounts Using the information in E6-9, prepare journal entries to record the transactions, assuming Solitare uses a perpetual inventory system. Jan. 6 Sold goods for $100 to Wizard Inc. with terms 2/10, n/30. The goods cost Solitare $70. 6 Sold goods to SpyderCorp for $80 with terms 2/10, n/30. The g py p , goods cost Solitare $60. 14 Collected cash due from Wizard Inc. Feb. 2 Collected cash due from SpyderCorp. 28 Sold goods for $50 to Bridges with terms 2/10, n/45. The goods cost Solitare $30. Feb. 28 dr Accounts Receivable (+A) ...................................... cr Sales Revenue (+R,+SE) .................................. dr Cost of Goods Sold (+E,-SE) ................................. cr Inventory (-A) .................................................... ( A) 50 50 30 30 6-41 E6-17 Inferring Missing Amounts Based on Income Statement Relationships Supply the missing dollar amounts for the income statement of Williamson Company for each of the following independent cases: Case A Sales Revenue ......................................... Sales Returns and Allowances ................. Net Sales ............................................ Cost of Goods Sold................................... Gross Profit ............................................ $ 8,000 150 7,850 5,750 $ 2,100 Case B $ 6,000 500 5,500 4,050 $ 1,450 Case C $ 6,195 275 5,920 5,400 $ 520 6-42 End of Chapters 5 & 6 selected topics Chapter 7* p *you may exclude supplemental info at end of chapter Reporting and Interpreting Inventories and Cost of Goods Sold PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA p , , Fred Phillips, Ph.D., CA Edited by: Muriel Anderson, MBA, CPA Learning Objective 1 Describe the issues in managing different types of inventory. 7-2 Inventory Management Decisions The primary goals of inventory managers are to: 1. Maintain a sufficient quantity to meet customers' needs customers 2. Ensure quality meets customers' expectations and company standards 3. Minimize the costs of acquiring and carrying the inventory 7-3 Types of Inventory Merchandisers . . . Buy finished goods. Sell finished goods. Manufacturers . . . Buy raw materials. Produce and sell finished goods. Raw Materials Work in Process Finished goods Completed products awaiting sale Partially complete products 7-4 Merchandise inventory Materials waiting to be processed Perpetual Inventory System In a perpetual inventory system, the inventory records are updated "perpetually," "perpetually " that is, every is time inventory is bought, sold, sold or returned. Perpetual returned systems often use bar codes and optical scanners. p Physical inventory counts are taken to confirm inventory balances. i t b l 6-5 Periodic Inventory System In a periodic inventory system, the inventory records are updated "periodically," y y that is, at the end of the accounting period. To determine how much merchandise has been sold, periodic systems require that inventory be i di t i th t i t b physically counted at the end of the period. 6-6 Learning Objective 2 Explain how t report E l i h to t inventory and cost of g y goods sold. 7-7 Balance Sheet and Income Statement Reporting 7-8 Cost of Goods Sold Equation BI + P CGS = EI American Eagle Outfitters' beginning inventory was $4,800. During the period, the company purchased inventory for $10,200. The cost of goods sold for the period is $9,000. Compute the ending inventory. Cost of Goods Sold Calculation Beginning Inventory $ 4,800 Purchases P rchases 10,200 10 200 Cost of Goods Available for Sale 15,000 Sold , Cost of Goods sold 9,000 Ending Inventory $ 6,000 Still have + = = 7-9 Learning Objective 3 Compute costs using four inventory costing methods. i t ti th d 7-10 Inventory Costing Methods Specific identification First-in, first-out (FIFO) Last-in, first-out (LIFO) Weighted g average 7-11 Inventory Costing Methods Consider the following information May 3 y May 5 May 6 May 8 Purchased 1 unit for $70 $ Purchased 1 more unit for $75 Purchased 1 more unit for $95 Sold 2 units for $125 each May 6 $95 cost May 5 $75 cost May M 3 $70 cost Specific Identification This Thi method individually id tifi and records th cost of th d i di id ll identifies d d the t f each item sold as part of cost of goods sold. If the items sold were identified as the first and third purchases, the p , total cost of those items ($70 + 95 = $165) would be reported as Cost of Goods Sold. The cost of the remaining item ($75) would be reported as Inventory on the balance sheet at the end of the period. 7-12 Inventory Costing Methods (assume two units sold @ $125 each) FIFO May 6 $95 cost May 5 $75 cost LIFO Weighted average May 6 $95 cost May 5 $75 cost May 6 $95 cost May 5 $75 cost May 3 $70 cost $240 = $80 per unit 3 Still th here Sold May 3 $70 cost t So old May 3 $70 cost Still th here Income Statement Net Sales $ 250 Cost of Goods Sold 145 Gross Profit $ 105 Balance Sheet Inventory $ 95 Income Statement Net Sales $ 250 Cost of Goods Sold 170 Gross Profit $ 80 Income Statement Net Sales $ 250 Cost of Goods Sold 160 Gross Profit $ 90 Balance Sheet Inventory $ 80 Sold Balance Sheet Inventory $ 70 Still there 7-13 Inventory Costing Methods Summary FIFO Oldest cost Newest cost Weighted LIFO Average Newest cost Average cost Oldest cost Average cost Cost of Goods sold (Income Statement) Inventory (Balance sheet) Let's consider a more complex example. Date Oct 1 Oct 3 Oct 5 Oct 6 Description Beginning Inventory Purchase Purchase Sales Ending Inventory # of Units Cost per Unit 10 7 30 8 10 10 ( ) (35) To calculate 15 To calculate Total Cost $ 70 240 100 To calculate To calculate 7-14 Inventory Cost Flow Computations FIFO Beginning Inventory g g y + Purchases 10 units 30 units 10 units Cost of Goods Available for Sale Ending Inventory = Cost of Goods Sold $ 7 = $ 70 $ 8 = 240 $ 10 = 100 $ 410 140 $ 270 (10 units @ $10) + (5 units @ $8) (10 units @ $7) + (25 units @ $8) 7-15 Inventory Cost Flow Computations LIFO Beginning Inventory g g y + Purchases 10 units 30 units 10 units Cost of Goods Available for Sale Ending Inventory Cost of Goods Sold $ 7 = $ 70 $ 8 = 240 $ 10 = 100 $ 410 110 $ 300 (10 units @ $7) + (5 units @ $8) (10 units @ $10) + (25 units @ $8) 7-16 Inventory Cost Flow Computations Weighted Average Description Beginning Inventory Purchase Purchase Cost of Goods Available for Sale # of Units 10 30 10 50 Cost per Unit 7 8 10 Total Cost $ 70 240 100 $ 410 Weighted = Average Cost Weighted = Average Cost 7-17 Cost of goods Available for Sale Number of Units Available for Sale $410 50 units = $8.20 per unit Inventory Cost Flow Computations Weighted Average Beginning Inventory + Purchases 10 units 30 units 10 units Cost of Goods Available for Sale Ending Inventory Cost of Goods Sold $ 7 = $ 70 $ 8 = 240 $ 10 = 100 $ 410 123 $ 287 15 units @ $8.20 35 units @ $8.20 7-18 Financial Statement & Tax Effects Effects on the Income Statement Sales Cost of Goods Sold Gross Profit Operating Expenses Income from Operations Other Revenue (Expenses) Income before Income Tax Expense Income Tax Expense (30%) Net Income Effects on the Balance Sheet Inventory 7-19 FIFO $ 525 270 255 125 130 20 150 45 $ 105 LIFO $ 525 300 225 125 100 20 120 36 $ 84 Weighted Average $ 525 287 238 125 113 20 133 40 $ 93 $ 140 $ 110 $ 123 Learning Objective 4 Value and report inventory at the l th lower of cost or market. f t k t 7-20 Lower of Cost or Market The value of inventory can fall below its recorded cost for two reasons: 1. it's easily replaced by identical goods at a lower cost, or 2. it's become outdated or damaged. When the value of inventory falls below its recorded cost the amount recorded for cost, inventory is written down to its lower market value. This is known as the lower of cost or market (LCM) rule. 7-21 Lower of Cost or Market Cost per Item $165 20 Market Value per Item $ 150 25 LCM Total Lower per of cost Total Item Quantity or Market cost Writedown $ 150 1,000 1 000 $ 150 000 $ 165 000 $ 15 000 150,000 165,000 15,000 20 400 8,000 8,000 - Item Leather coats Vintage jeans 1 Analyze = Liabilities + Stockholders' Equity Cost of Goods sold (+E) 15,000 Assets Inventory 15,000 2 Record 7-22 Learning Objective 5 Analyze and record inventory purchases, t h transportation, t ti returns and allowances, and , discounts (perpetual inventory method). method) 7-23 Inventory Purchases American Eagle Outfitters purchases e ca ag e Ou e s pu c ases $10,500 of vintage jeans on credit. 1 Analyze A l Assets Inventory +10,500 = Liabilities + Accounts Payable +10,500 Stockholders' Equity 2 Record 7-24 Transportation Cost American Eagle pays $400 cash to a trucker who e ca ag e $ 00 cas o uc e o delivers the $10,500 of vintage jeans to one of its stores. 1 Analyze A l Assets Cash - 400 Inventory + 400 = Liabilities + Stockholders' Equity 2 Record 7-25 Purchase Returns and Allowances American Eagle returned some of the vintage jeans to the supplier and received a $500 reduction in the balance owed. 1 Analyze Assets Inventory - 500 = Liabilities Accounts Payable - 500 + Stockholders' Equity 2 Record 7-26 Purchase Discounts American Eagle's vintage jeans purchase for $10,500 had terms of 2/10, n/30. Recall that American Eagle returned 2/10 n/30 inventory costing $500 and received a $500 reduction in its Accounts Payable. American Eagle paid within th di t i d the discount period. 1 Analyze Assets Cash - 9,800 Inventory -200 = Liabilities + Accounts Payable -10,000 Stockholders' Equity 2 Record 7-27 Summary of Inventory Transactions 7-28 Learning Objective 6 Evaluate inventory management by computing and i t d interpreting th i ti the inventory t turnover ratio. 7-29 Inventory Turnover Analysis 7-30 Comparison to Benchmarks 7-31 Chapter 7 Exercises M7-6, E7-10 M7-6 Calculating Cost of Goods Available for Sale, Ending Inventory, Sales, Cost of Goods Sold, and Gross Profit under Periodic FIFO, LIFO, and Weighted Average Cost Given the following information, calculate cost of goods available for sale and ending inventory, then sales, cost of goods sold, and gross profit, under (a) FIFO, FIFO (b) LIFO, and (c) weighted average. Assume a periodic inventory LIFO average system is used. 7-33 M7-6 Calculating Cost of Goods Available for Sale, Ending Inventory, Sales, Cost of Goods Sold, and Gross Profit under Periodic FIFO, LIFO, and Weighted Average Cost a. a FIFO Beginning Inventory 100 units $ 10 = $1,000 + Purchase 500 units $ 13 = 6,500 Cost of Goods Available for Sale 7,500 Ending Inventory (400 $13) = 5,200 = Cost of Goods Sold (100 $ $10) + (100 $ $13) = $ 2,300 7-34 M7-6 Calculating Cost of Goods Available for Sale, Ending Inventory, Sales, Cost of Goods Sold, and Gross Profit under Periodic FIFO, LIFO, and Weighted Average Cost b. b LIFO Beginning Inventory 100 units $ 10 = $1,000 + Purchase 500 units $ 13 = 6,500 Cost of Goods Available for Sale 7,500 Ending Inventory (100 $10) + (300 $13) = 4,900 $13) = Cost of Goods Sold (200 $ = $ 2,600 7-35 M7-6 Calculating Cost of Goods Available for Sale, Ending Inventory, Sales, Cost of Goods Sold, and Gross Profit under Periodic FIFO, LIFO, and Weighted Average Cost c. Weighted Average Beginning Inventory 100 units $ 10 + Purchase 500 units $ 13 Cost of Goods Available for Sale Ending Inventory (400 $12.50) = Cost of Goods Sold (200 $12.50) Weighted Average Cost 7-36 = $1,000 = 6,500 7,500 7 500 = 5,000 = $ 2,500 = $7,500 600 units = $12.50 per unit M7-6 Calculating Cost of Goods Available for Sale, Ending Inventory, Sales, Cost of Goods Sold, and Gross Profit under Periodic FIFO, LIFO, and Weighted Average Cost Sales (200 units @ $15) Cost of Goods Sold Gross Profit FIFO $ 3,000 2,300 $ 700 Weighted LIFO Average $ 3,000 $ 3,000 2,600 2,500 $ 400 $ 500 7-37 E7-10 Reporting Inventory at Lower of Cost or Market Peterson Furniture Designs is preparing the annual financial statements dated December 31, 2009. Ending inventory information about the five major items stocked for regular sale follows: Quantity on Hand 50 75 10 30 400 Ending Inventory, 2009 Unit Cost When Replacement Cost LCM Acquired (FIFO) (Market) at Year-End Per Item $ 15 $ 12 40 40 50 52 30 30 10 6 Total LCM Item Alligator Armoires Bear Bureaus Cougar Beds Dingo Cribs Elephant Dressers Required: 1. 1 Complete the final t o col mns of the table and then comp te the two columns compute amount that should be reported for the 2009 ending inventory using the LCM rule applied to each item. Item It Alligator Armoires Bear Bureaus Cougar Beds Dingo Cribs Elephant Dressers Quantity Q tit 50 75 10 30 400 Total Total C t T t l Cost $15 = $ 750 40 = $ 3,000 500 50 = $ 900 30 = $ 10 = $ 4,000 $ 9,150 Total M k t T t l Market $12 = $ 600 40 = 3,000 52 = 520 30 = 900 6 = 2,400 LCM Per It P Item $ 12 40 50 30 6 LCM Valuation V l ti $ 600 3,000 500 900 2,400 $ 7,400 $1,750 7-38 E7-10 Reporting Inventory at Lower of Cost or Market Peterson Furniture Designs is preparing the annual financial statements dated December 31, 2009. Ending inventory information about the five major items stocked for regular sale follows: Quantity on Hand 50 75 10 30 400 Ending Inventory, 2009 Unit Cost When Replacement Cost LCM Acquired (FIFO) (Market) at Year-End Per Item $ 15 $ 12 40 40 50 52 30 30 10 6 Total LCM Item Alligator Armoires Bear Bureaus Cougar Beds Dingo Cribs Elephant Dressers Required: 2. 2 Prepare the jo rnal entr that Peterson F rnit re Designs would record journal entry Furniture o ld on December 31, 2009. dr Cost of Goods Sold (+E, -SE) cr Inventory (-A) 1,750 1,750 7-39 E7-10 Reporting Inventory at Lower of Cost or Market Peterson Furniture Designs is preparing the annual financial statements dated December 31, 2009. Ending inventory information about the five major items stocked for regular sale follows: Quantity Item on Hand Alligator Armoires 50 Bear Bureaus 75 Cougar Beds 10 Dingo Cribs 30 Elephant Dressers 400 Ending Inventory, 2009 g y Unit Cost When Replacement Cost LCM Acquired (FIFO) (Market) at Year-End Per Item $ 15 $ 12 40 40 50 52 30 30 10 6 Total LCM Required: Req ired 3. If the market values recovered by June 30, 2010, to greater than original cost, would the journal entry in requirement 2 be reversed under GAAP? Under IFRS? GAAP does not allow inventory to be written up, even when the circumstances that necessitated the write-down no longer exist. IFRS, on the other hand, does require that a company record a recovery in the inventory's market value back to its original cost. That is, the previous write-down may be reversed, but only to g , p y , y the point where the ending inventory is reported at the lower of cost or market. 7-40 End of Chapter 7 Chapter 8 Reporting and Interpreting Receivables, Bad Debt Expense, and Interest Revenue PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA p , , Fred Phillips, Ph.D., CA Edited by: Muriel Anderson, MBA, CPA Learning Objective 1 Describe the trade-offs of extending credit. t di dit 8-2 Pros and Cons of Extending Credit Advantage 1. Increases the seller's revenues. Disadvantages g 1. Increased wage costs. 2. 2 Bad debt costs. costs 3. Delayed receipt of cash. 8-3 Learning Objective 2 Estimate and report the effects of uncollectible accounts. f ll tibl t 8-4 Accounts Receivable and Bad Debts Jan. Jan 1 Record sales on account dr Accounts Receivable cr Sales Revenue Balance Sheet Cash Accounts Receivable Inventory ... Income Statement Sales Revenue Cost of Goods Sold Gross Profit ... 8-5 Accounts Receivable and Bad Debts Jan. Jan 1 Jan. Jan 31 Record sales on account Record estimate of bad debts dr Accounts Receivable cr Sales Revenue Balance Sheet (excerpt) Balance Sheet Cash Cash Accounts Receivable Accounts Receivable Less: Allowance for Doubtful Accounts L All f D btf l A t Inventory Accounts Receivable, Net ... Inventory ... dr Bad Debt Expense (+E, SE) cr Allowance for Doubtful Accounts (+xA, A) Income Statement Income Statement (excerpt) Sales Revenue Cost of Goods Sold Gross Profit Bad Debt Expense ... ... 8-6 Accounts Receivable and Bad Debts Jan. Jan 1 Jan. Jan 31 Record sales on account Record estimate of bad debts Bad debt known dr Accounts Receivable cr Sales Revenue dr Bad Debt Expense (+E, SE) cr Allowance for Doubtful Accounts (+xA, A) dr Allowance for Doubtful Accounts (xA) d All f D btf l A t ( A) cr Accounts Receivable(A) Balance Sheet No effect on the net realizable value of Accounts Receivable because the reduction in Accounts Receivable is offset by the reduction in Allowance for Doubtful Accounts. Income Statement No effect on net income because bad debt expense was already recorded in the period that the credit sale initially occurred. the credit sale initially occurred 8-7 Allowance Method The allowance method follows a two-step two step process, described below: 1. Make an end-of-period adjustment to record the estimated bad debts in the period credit sales occur. i d dit l 2. 2 Remove ( write off ) specific customer ("write off") balances when they are known to be uncollectible. 8-8 1. Adjust for Estimated Bad Debts Assume that Skechers estimates $900 in bad debts at the end of the accounting period. 1 Analyze Assets Allowance for Doubtful Accounts (+xA) -900 = Liabilities + Stockholders' Equity Bad Debt Expense (+E) -900 2 Record dr Bad Debt Expense (+E) (SE) cr Allowance for Doubtful Accounts (+xA) (A) 900 900 8-9 1. Adjust for Estimated Bad Debts 8-10 2. Remove (Write-off) Specific Customer Balances (actual bad debt now known) Skechers writes off $800 receivable from Fast Footwear because the company could not pay its account. 1 Analyze Assets = Allowance for Doubtful Accounts (-xA) (+A) +800 Accounts Receivable (-A) -800 Liabilities + Stockholders' Equity 2 Record dr Allowance for Doubtful Accounts (xA) (+A) 800 cr Accounts Receivable (A) 800 8-11 Posting of Estimate and Write-off dr Bad Debts Expense (+E) (SE) cr Allowance for Doubtful Accounts (+xA) (A) 900 900 dr Allowance for Doubtful Accounts (xA) (+A) 800 cr Accounts Receivable (A) 800 dr + Accounts Receivable (A) cr Beg. Bal. 200,800 800 Writeoff End. Bal. 200 000 E d B l 200,000 dr Allow. For Doubtful Accts (xA) cr + 14,900 Beg. Bal. Writeoff 800 900 Est. 15,000 End. Bal. 8-12 dr + Bad Debt Expense (E, SE)) cr Beg. Bal. Est. 900 End. Bal. 900 Methods for Estimating Bad Debts There are two acceptable methods of estimating the bad debts in th b d d bt i a given period under th i i d d the Allowance method: 1. Percentage of Credit Sales Method. 2. Aging of Accounts Receivable. g g Simpler to apply. More accurate 8-13 Percentage of Credit Sales Method The percentage of credit sales method estimates bad debt expense by multiplying the historical percentage of bad debt losses by the current period's credit sales. Net credit sales for the period Historical bad debt loss rate = Bad debt expense of the period. 8-14 Percentage of Credit Sales Method Skechers has experienced bad debt losses of of 1 percent of credit sales in prior periods. Credit sales in January t t l $120,000, J total $120 000 Credit sales for January Historical bad debt rate Bad debt expense for January Bad debt expense for January $ 120,000 0.75% $ 900 $ 2 Record dr Bad Debt Expense (+E) (SE) cr Allowance for Doubtful Accounts (+xA) (A) ( )( ) 900 900 8-15 Aging of Accounts Receivable While the percentage of credit sales method focuses on estimating Bad Debt Expense (income statement approach) for the period, the aging of accounts receivable method focuses on estimating the ending balance in the Allowance for Doubtful Accounts (balance sheet approach) approach). The aging method gets its name because it is based on the "age" of each amount in Accounts Receivable at the end of the period. The older and more overdue an account receivable becomes, the less likely it is to be collectible. 8-16 Aging of Accounts Receivable Skechers applies the aging of accounts receivable method to its Accounts Receivable balances on March 31, the end of its fiscal quarter. The method includes three steps: (1) Prepare an aged list of accounts receivable, (2) Estimate bad debt loss percentages for each category, and (3) Compute the total estimated bad debts. Number of Days Unpaid Total 030 3160 6190 Over 90 $ 700 $ $ $ 400 $ 200 $ 100 $ $ 2,300 $ 2,300 6,000 4,000 2,000 189 000 97 600 49 800 37 900 3 700 189,000 97,600 49,800 37,900 3,700 $ 198,000 $ 102,000 $ 52,000 $ 38,000 $ 6,000 $ 17,240 $ 2,040 $ 5,200 $ 7,600 $ 2,400 $ 17 240 $ 2 040 $ 5 200 $ 7 600 $ 2 400 Age Accounts Receivable. Customer Adam's Sports d ' Backyard Shoe Zoom Athletics All other customers All other customers Total accounts receivable Estimated uncollectible ($) Estimated uncollectible ($) Step 1 8-17 Aging of Accounts Receivable Customer Adam's Sports Backyard Shoe Zoom Athletics All other customers Total accounts receivable Estimated uncollectible (%) Estimated uncollectible ($) Number of Days Unpaid y p Total 030 3160 6190 Over 90 $ 700 $ 400 $ 200 $ 100 2,300 $ 2,300 6,000 4,000 2,000 189,000 97,600 49,800 37,900 3,700 $ 198,000 $ 102,000 $ 52,000 $ 38,000 $ 6,000 2% 10% 20% 40% $ 17,240 $ 2,040 $ 5,200 $ 7,600 $ 2,400 Step 2 8-18 Estimate bad debt loss percentages for each category. Aging of Accounts Receivable Customer Adam's Sports Backyard Shoe Zoom Athletics All other customers Total accounts receivable Estimated uncollectible (%) Estimated uncollectible ($) Number of Days Unpaid y p Total 030 3160 6190 Over 90 $ 700 $ 400 $ 200 $ 100 2,300 $ 2,300 6,000 4,000 2,000 189,000 97,600 49,800 37,900 3,700 $ 198,000 $ 102,000 $ 52,000 $ 38,000 $ 6,000 2% 10% 20% 40% $ 17,240 $ 2,040 $ 5,200 $ 7,600 $ 2,400 Step 3 8-19 Compute the total estimated bad debts. Aging of Accounts Receivable Customer Adam's Sports Ad ' S t Backyard Shoe Zoom Athletics All other customers All other customers Total accounts receivable Estimated uncollectible (%) Estimated uncollectible ($) Estimated uncollectible ($) Number of Days Unpaid Total 030 3160 6190 Over 90 $ 700 $ $ $ 400 $ 200 $ 100 $ $ 2,300 $ 2,300 6,000 4,000 2,000 189 000 97 600 49 800 37 900 3 700 189,000 97,600 49,800 37,900 3,700 $ 198,000 $ 102,000 $ 52,000 $ 38,000 $ 6,000 2% 10% 20% 40% $ 17,240 $ 2,040 $ 5,200 $ 7,600 $ 2,400 $ 17 240 $ 2 040 $ 5 200 $ 7 600 $ 2 400 dr Allow. For Doubtful Accts (xA) cr + 15,000 Beg. Bal. ? AJE 17,240 End. Bal. AJE = ($17,240 - $15,000) = $2,240 8-20 Aging of Accounts Receivable Prepare the AJE for Bad Debt Expense at March 31. 1 Analyze Assets Allowance for Doubtful Accounts (+xA) ( A) -$2,240 $2 240 = Liabilities + Stockholders' Equity Bad Debt Expense (+E) -$2,240 2 Record dr Bad Debt Expense (+E, SE) cr Allowance for Doubtful Accounts (+xA, A) 2,240 2,240 3 Summarize 8-21 Other Issues Account Recoveries -- C ll ti of a previously written A tR i Collection f i l itt off account is called a recovery and it is accounted for in two parts. First, p the receivable back on the books by p , put y recording the opposite of the write-off. Second, record the collection of the account. 8-22 Other Issues Let's assume that Skechers collects the $800 from Fast Footwear that was previously written off. This recovery would be recorded with the following journal entries: (1) Reverse the write-off. (2) Record the collection. 8-23 Learning Objective 3 Compute and report interest on notes receivable. t i bl 8-24 Notes Receivable and Interest Revenue A company reports Notes Receivable if it uses a promissory note t document its right to collect money i t to d t it i ht t ll t from another party. Unlike accounts receivable, which do not charge interest until they've become overdue, notes receivable charge interest from the day they are created to the day they are due (their maturity date). 8-25 Calculating Interest Interest (I) = Principal (P) Interest Rate (R) Time (T) The amount of the note receivable The annual interest rate charged on the note The time period for interest calculation Information Given Terms of Note Terms of Note Interest Period Interest Period $10,000, 6%, due in two years Jan 1 Mar 31 $10,000, 6%, due in one year Mar 1 Mar 31 $ , , %, $10,000, 6%, due in 100 days y Mar 1 Mar 31 Interest Calculation Principal Rate Time Interest $ 10,000 6% 3/12 = $ 150 10,000 6% 1/12 = 50 , 10,000 6% 1/12 = 50 % / 8-26 Recording Notes Receivable and Interest Revenue The four key events that occur with any note receivable are: Date of Note Receivable Annual Interest Rate Amount of the Note Maturity Date of Note Year End of Company 8-27 November 1, 2009 6% $100,000 October 31, 2010 December 31, 2009 (1) Establishing a Note Receivable Assume that on November 1, 2009, Skechers lent $100,000 to a researcher by creating a note that required the researcher to pay Skechers 6 percent interest and the $100,000 principal on October 31, 2010. 1 Analyze Assets Notes Receivable +$100,000 Cash -$100,000 = Liabilities + Stockholders' Equity 2 Record dr Notes Receivable (+A) cr Cash (A) 100,000 100,000 8-28 (2) Accruing Interest Earned Accrue the interest earned at year-end, December 31, 2009. Principal (P) Interest Rate (R) Time (T) = Interest (I) $100,000 6% 2/12 = $1,000 8-29 (2) Accruing Interest Earned Accrue the interest earned at year-end, December 31, 2009. 1 Analyze Assets Interest Receivable ( ) (+A) +$1,000 , = Liabilities + Stockholders' Equity Interest Revenue ( , (+R, +SE) ) +$1,000 , 2 Record dr Interest Receivable (+A) cr Interest Revenue (+R, +SE) 1,000 1,000 8-30 (3) Record Interest Received Record interest received at maturity, October 31, 2010. $5,000 $5 000 Interest Principal (P) Interest Rate (R) Time (T) = Interest (I) $ $100,000 6% 12/12 = $6,000 , $ , 8-31 (3) Record Interest Received Record interest received at maturity, October 31, 2010. 1 Analyze Assets Cash (+A) +$6,000 Interest Receivable (-A) -$1,000 = Liabilities + Stockholders' Equity Interest Revenue ( (+R, +SE) ) +$5,000 $5 000 = $100 000 6% 10/12 $5,000 $100,000 2 Record dr Cash (+A) cr Interest Receivable (A) cr Interest Revenue (+R, +SE) I t tR (+R +SE) 6,000 1,000 5 000 5,000 8-32 (4) Recording Principal Received The principal amount of the note is received on October 31, 2010. 1 Analyze Assets Cash (+A) ( A) $100,000 Note Receivable (-A) $100,000 = Liabilities + Stockholders' Equity 2 Record dr Cash (+A) cr Note Receivable (A) 100,000 100,000 8-33 Learning Objective 4 Compute and interpret the receivables t i bl turnover ratio. ti 8-34 Receivables Turnover Analysis The receivables turnover ratio indicates how many times, times on average this process of selling and collecting average, is repeated during the period. The higher the ratio, the faster the collection of receivables. Rather than evaluate the number of times accounts receivable turn over, some people find it easier to think in terms of the number of days to collect receivables (called days to collect). 8-35 Receivables Turnover Analysis Receivable Turnover Ratio = Net Sales Revenue Average Net Receivables $500,000 = 10 times $ 50,000 (Beginning net receivables + Ending net receivables) 2 Days to = Collect C ll t 365 Receivable T R i bl Turnover R ti Ratio 365 = 36.5 days 10 8-36 Comparison to Benchmarks 8-37 Speeding Up Collections Factoring Receivables One way to speed up collections is to sell outstanding accounts receivable to another company (called a factor). Your company receives cash for the receivables it sells to the factor (minus a factoring fee). Credit Card Sales Another A h way to avoid l id lengthy collection periods i to allow customers to h ll i i d is ll pay for goods using national credit cards. This not only speeds up the seller's cash collection, but also reduces losses from customers writing bad checks. Credit card company charges a fee checks fee. 8-38 Chapter 8 Supplement 8A pp Direct Write-Off Method Direct Write-Off Method The direct write-off method, does not estimate bad debt. Instead, it reports Sales when they occur and bad debt expense when it is discovered. This method is not acceptable for GAAP. The reason the method isn't considered GAAP is because it breaks the conservatism concept by not reporting receivables at realizable value. g principle by recording bad debt p y g The method also violates the matching p expense in the period the customer's account is determined to be bad. 8-40 Direct Write-Off Method On October 13, 2009, we sold merchandise on account to Fast Footwear for $1,000. On February 1, 2010, Fast Footwear declared bankruptcy and had made no payments toward the $1,000 balance in its account receivable. February 1, 2009 2 Record dr Bad Debt Expense (+E, SE) cr Accounts Receivable ( A) 1,000 1,000 8-41 Chapter 8 Exercises M8-10, E8-7, C8-1 M8-10 Using the Interest Formula to Compute Interest Complete the following table by computing the missing amounts (?) for the following independent cases. Principal Amount of Principal Amount of Note Receivable a. $ 100,000 , b. ? c. $ 50,000 Annual Interest Rate 10% 10% ? Time Period Time Period in Months 6 12 9 Interest Earned ? $ 4,000 $ 3,000 Case a. $100,000 10% (6/12) = $5,000 Case b [$4 000 10%] (12/12) = $40 000 b. [$4,000 $40,000 Case c. $3,000 [$50,000 (9/12)] = 8% 8-43 E8-7 Computing Bad Debt Expense Using Aging of Accounts p g p g g g Receivable Method Brown Cow Dairy uses the aging approach to estimate Bad Debt Expense. The balance of each account receivable is aged on the basis of three time periods as follo s (1) 1 30 da s old $12 000 (2) 31 90 da s old $5 000 follows: 130 days old, $12,000; 3190 days old, $5,000; and (3) more than 90 days old, $3,000. Experience has shown that for each age group, the average loss rate on the amount of the receivable due to uncollectibility is ( ) 3 p y (1) percent, ( ) 15 p (2) percent, and ( ) 30 p (3) percent, respectively. At December 31, 2010 (end of the current year), the Allowance for Doubtful Accounts balance was $800 (credit) before the endof-period adjusting entry is made. Required: 1. Prepare a schedule to estimate an appropriate year-end balance for the Allowance for doubtful accounts. 2. What amount should be recorded as Bad Debt Expense for the current year? 3. If the unadjusted balance in the Allowance for Doubtful Accounts was a $600 debit balance, what would be the amount of Bad Debt Expense in 2010? 8-44 E8-7 Computing Bad Debt Expense Using Aging of Accounts Receivable Method Req. 1 Total $ 20,000 $ 2,010 130 $ 12,000 3% $ 360 3190 $ 5,000 15% $ 750 >90 $ 3,000 Estimate Balance in Allowance 30% Existing Credit Balance in Allowance $ 900 Adjusting Journal Entry Amount $ 2,010 800 $ 1,210 Req. Req 2 Allowance for Doubtful Accounts Allowance for Doubtful Accounts 800 Unadj. Bal. 1,210 AJE 2 010 Bal 2,010 Bal. Allowance for Doubtful Accounts Unadj. Bal. 600 j 2,610 AJE 2,010 Bal. Req. 3 8-45 CP8-4 Accounting for Accounts and Notes Receivable g Transactions Execusmart Consultants has provided business consulting services for several years. The company uses the percentage of credit sales method to estimate bad debts for internal monthly reporting purposes. At the end of each quarter the company adjusts its purposes quarter, records using the aging of accounts receivable method. The company entered into the following selected transactions during the first quarter of 2010. a. During January, the company provided services for $200,000 on credit. b. b On January 31 the company estimated bad debts using 1 percent of credit sales 31, sales. c. On February 4, the company collected $100,000 of accounts receivable. d. On February 15, the company wrote off a $500 account receivable. e. During February, the company provided services for $150,000 on credit. f. f On February 28 the company estimated bad debts using 1 percent of credit sales 28, sales. g. On March 1, the company loaned $12,000 to an employee who signed a 10% note, due in 3 months. h. On March 15, the company collected $500 on the account written off one month earlier. earlier i. On March 31, the company accrued interest earned on the note. j. On March 31, the company adjusted for uncollectible accounts, based on the aging analysis shown on the next screen. Allowance for Doubtful Accounts has an unadjusted credit balance of $6 000 $6,000. 8-46 CP8-4 Accounting for Accounts and Notes Receivable T ti ( ti d) Transactions (continued) Required: 1. For items a j, analyze the amount and direction (or) of effects on specific financial statement accounts and the overall accounting equation and prepare journal entries. 2. Show how the receivables related to these transactions would be reported in the p current assets section of a classified balance sheet. 3. Name the accounts related to Accounts Receivable and Notes Receivable that would be reported on the income statement and indicate whether they would appear before, p or after, Income from Operations. 8-47 CP8-4 Accounting for Accounts and Notes Receivable Transactions Req. 1 8-48 CP8-4 Accounting for Accounts and Notes Receivable Transactions Req. 1 8-49 CP8-4 Accounting for Accounts and Notes Receivable Transactions Req. 1 8-50 CP8-4 Accounting for Accounts and Notes Receivable Transactions Req. 1 8-51 CP8-4 Accounting for Accounts and Notes Receivable Transactions Req. 1 8-52 CP8-4 Accounting for Accounts and Notes Receivable Transactions Req. 1 Req Desired $8,390 Current -$6000 = Adjustment $2,390 Total Accounts Receivable Total Accounts Receivable Estimated Uncollectible (%) Estimated Uncollectible ($) Total 030 3160 6190 >90 $ 90,000 $ 36,500 $ $ 90 000 $ 36 500 $ 42 400 $ 5 100 $ 6 000 42,400 $ 5,100 $ 6,000 2% 10% 20% 40% $ 8,390 $ 730 $ 4,240 $ 1,020 $ 2,400 8-53 CP8-4 Accounting for Accounts and Notes Receivable Transactions Req. 2 Assets A t Current Assets: Accounts Receivable Less: Allowance for Doubtful Accounts Less: Allowance for Doubtful Accounts Accounts Receivable, Net of Allowance Note Receivable Interest Receivable $ 90,000 8 390 8,390 $ 81,610 12,000 100 Req. 3 q Execusmart Consultants would report Bad Debt Expense above income from Operations, and Interest Revenue below Income for Operations. 8-54 C8-1 Comprehensive Exercise for Recording and Reporting Credit Sales and Bad Debts Using the Aging of Accounts Receivable Method Okay Optical, Inc. (OOI) began operations in January 2010 selling inexpensive sunglasses to large retailers like Walgreen's and other smaller stores. Assume the following transactions occurred during its first six months of operations. January 1 - Sold merchandise to Walgreen s for $20 000; the cost of goods to OOI was $12,000. Walgreen's $20,000; $12 000 February 12 - Received payment in full from Walgreen's. March 1 - Sold merchandise to Tony's Pharmacy on account for $3,000; the cost of goods to OOI was $1,400. April 1 - Sold merchandise to Travis Pharmaco on account for $8,000. The cost to OOI was $4,400. May 1 - Sold merchandise to Anjuli Stores on account for $2,000; the cost to OOI was $1,200. June 17 - Received $6,500 on account from Travis Pharmaco. Required: 1. Complete an aged listing of customer accounts for the four months ended June 30. 2. 2 Estimate the Allowance for Doubtful Accounts required at June 30, 2010, assuming the following 30 2010 uncollectible rates: one month, 1 percent; two months, 5 percent; three months, 20 percent; more than three months, 40 percent. 3. Show how OOI would report its accounts receivable on its June 30 balance sheet. What amounts would be reported on an income statement prepared for the six-month period ended June 30, 2010? J 30 4. Bonus Question: In July 2010, OOI collected the balance due from Tony's Pharmacy but discovered that the balance due from Travis Pharmaco needed to be written off. Using this information, determine how accurate OOI was in estimating the Allowance for Doubtful Accounts needed for each of these two customers and in total. 8-55 C8-1 Comprehensive Exercise for Recording and Reporting Credit Sales and Bad Debts Using the Aging of Accounts Receivable Method Req. 1 Customer Anjuli A j li Tony's Travis Walgreen s Walgreen's Total Total $ 2 000 $ 2,000 3,000 1,500 $ 6,500 June (1 Month) May (2 Months) $ $ 2 000 2,000 April (3 Months) > 3 Months $ 3,000 1,500 $ Total $ 6,500 $ 1,600 $ 2,000 2 months 2 months $ 2,000 5% $ 100 $ 1,500 3 months 3 months $ 1,500 20% $ 300 $ 3,000 > 3 months > 3 months $ 3,000 40% $ 1,200 Req. Req 2 Accounts Receivable Estimated Uncollectible (%) Estimated Uncollectible ($) 8-56 C8-1 Comprehensive Exercise for Recording and Reporting Credit Sales and Bad Debts Using the Aging of Accounts Receivable Method Req. 3 OKAY OPTICAL, INC. Partial Balance Sheet At June 30, 2010 Accounts Receivable, Net of Allowance of $1,600 $4,900 OKAY OPTICAL, INC. Partial Income Statement For the Six Months Ended June 30, 2010 Sales Revenue Cost of Goods Sold Gross Profit Bad Debt Expense Income from Operations 8-57 $30,000 19,000 14,000 1,600 1 600 $12,400 C8-1 Comprehensive Exercise for Recording and Reporting Credit Sales and Bad Debts Using the Aging of Accounts Receivable Method Req. 4 OOI did not accurately estimate the precise amounts that would be collected from each customer, yet the total estimate was reasonably accurate at $1,600. OOI underestimated the amount bl t t $1 600 d ti t d th t collectible from Tony's Pharmacy (40% of $3,000, or $1,200, was estimated uncollectible where it later turned out to be collectible in full) It overestimated the amount collectible from full). Travis Pharmaco (20% of $1,500, or $300, was estimated uncollectible where it later turned out to show that $1,500 was uncollectible). uncollectible) Looking at Travis Pharmaco and Tony's Tony s Pharmacy combined, the estimated bad debt for both customers was $1,500, which is only $100 less than the amount the company wrote off. p y 8-58 End of Chapter 8 Chapter Ch t 9* Reporting and Interpreting Long-Lived Tangible and Intangible Assets *You may exclude the Supplemental Material PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA p , , Fred Phillips, Ph.D., CA Edited by: Muriel Anderson, MBA, CPA Learning Objective 1 Define, classify, and explain the t th nature of long-lived assets. fl li d t 9-2 Definition and Classification Actively U d i O A ti l Used in Operations ti Will not be used up within the next year Tangible T ibl Physical Substance 9-3 Intangible No Physical Substance Learning Objective 2 Apply the A l th cost principle t t i i l to the acquisition of long-lived q g assets. 9-4 Acquisition of Tangible Assets Acquisition cost includes: q 1. purchase price, and 2. all expenditures needed to prepare the asset for its intended use. Recording costs as R di t assets is called capitalizing the costs costs. 9-5 Acquisition of Tangible Assets Land Purchase cost Legal fees Surveying fees Broker's commissions Purchase/construction cost Buildings Legal fees Appraisal fees Architectural fees Purchase/construction cost Equipment Sales taxes Transportation costs Installation costs 9-6 Cash Purchase Cedar Fair purchased a new ride for $26 000 000 less a $26,000,000 $1,000,000 discount. Cedar Fair paid $125,000 for transportation and $625,000 for installation of the ride. Prepare the journal entry for the acquisition assuming Cedar Fair paid cash for the new ride. 1 Analyze 2 Record 9-7 Credit Purchase Instead of paying cash, assume that Cedar Fair issued a note for the new ride, but paid cash for the transportation and installation of the ride. Prepare the journal entry for the acquisition. acquisition 1 Analyze 2 Record 9-8 Basket Purchase The total cost of a combined purchase of land and building is h f l d d b ildi i allocated in proportion to their relative market values. On January 1, Jones purchased land and building f $400 000 b ildi for $400,000 cash. The appraised h Th i d values are building, $325,000, and land, $175,000. How much of the $400,000 purchase price will be charged to the building and land accounts? 9-9 Basket Purchase The total cost of a combined purchase of land and building is allocated in proportion to their relative market values. l ti k t l Asset A t Land Building Total Appraised Value V l a $ 175,000 325,000 325 000 $ 500,000 % of Value V l b* Purchase Price P i Apportioned Cost C t c b c 35% $ 400,000 = $ 140,000 65% 400,000 400 000 = 260,000 260 000 100% $ 400,000 $ , $ , % * $175,000 $500,000 = 35% $325,000 $500,000 = 65% 9-10 Maintenance Costs Incurred Type of Expenditure Accounting Treatment Expense Identifying Characteristics Ordinary 1. Relatively small, recurring expenditures repairs and that maintain normal operating condition maintenance 2. Do not increase productivity y g 3. Do not extend life beyond original estimate Extraordinary 1. Relatively large, infrequent expenditures repairs, repairs such as major overhauls or replacements replacements, of major components and additions 2. May extend useful life 3. May increase productivity or efficiency Capitalize 9-11 Depreciation Expense Depreciation is a cost allocation process that matches costs of operational assets with periods benefited by their use. Acquisition Cost Balance Sheet Expense Cost Allocation Income Statement Depreciation Expense Accumulated Depreciation 9-12 Depreciation for the current year Total of depreciation to date for an asset Income Statement Balance Sheet Depreciation Expense The effects of $130 of depreciation on the accounting equation and the journal entry to record them follow: 1 Analyze 2 Record Depreciation calculations require three amounts for each asset: Acquisition cost. Estimated useful life. Estimated residual value. 9-13 Depreciation Expense 2008 Depreciation Includes $130 for 2008 Book value 2008 9-14 Learning Objective 3 Apply A l various d i depreciation i ti methods as economic benefits are used up over time. 9-15 Depreciation Methods Straight-line Units-of-production Declining balance We will use the following information to illustrate the three methods of depreciation: At the beginning of the year Cedar Fair purchased year, a new Go-Cart Ride for $62,500 cash. The ride Gohas an estimated useful life of 3 years and an estimated residual value of $2,500. 9-16 Straight-Line Method ($62,500 - $2,500) 1 3 = $20,000 per year Depreciation Accumulated Expense Depreciation Year (debit) (credit) 1 2 3 $ 20,000 20,000 20,000 20 000 $ 60,000 $ 20,000 20,000 20,000 20 000 60,000 Accumulated Undepreciated Depreciation Balance (credit balance) (book value) $ 62,500 $ 20,000 42,500 40,000 22,500 60,000 60 000 2,500 2 500 $ 9-17 Units-of-Production Method The ride has a 100,000-mile estimated useful life. 100,000If the ride is used 30,000 miles in the first year, what is the amount of depreciation expense? 30,000 100,000 ($62,500 - $2,500) = $18,000 9-18 Units-of-Production Method Depreciation Depreciation Expense Expense (debit) $ 18,000 30,000 30 000 12,000 60,000 Accumulated Depreciation (credit balance) Balance $ 18,000 48,000 48 000 60,000 Undepreciated Balance (book value) $ 62,500 44,500 14,500 14 500 2,500 Year 1 2 3 Miles 30,000 50,000 50 000 20,000 100,000 $ 9-19 Double-Declining Balance Method What is the amount of amount of depreciation for each of the first two years? First Year Second Year ($62,500 ($62 500 - $0) 2 3 2 3 = = $41,667 $41 667 $13,889 ($62 500 - $41 667) ($62,500 $41,667) Cost Accumulated Depreciation Annual computation ignores residual value. 9-20 Double-Declining Balance Method Depreciation Depreciation Expense Expense (debit) (debit) $ $ 41,667 41,667 13,889 13,889 , 4,629 4,444 60,185 60,000 Accumulated Accumulated Undepreciated Undepreciated Depreciation Balance Depreciation Balance Balance (credit balance) (book value) (book value) $$ 62,500 62 500 62,500 $$ 41,667 20,833 41,667 20,833 55,556 6,944 55,556 , 6,944 , 60,185 2,315 60,000 2,500 Year Year 1 1 2 2 3 3 $ $ Below residual value Depreciation expense is limited to the amount that 2 ($62,500 - $55,556) = $4,629 reduces book value to the estimated residual value. Third Year 3 9-21 Partial Year Depreciation Calculations When a plant asset is acquired during the year, depreciation is year calculated for the fraction of the year the asset is owned. 9-22 Summary of Depreciation Methods 9-23 Tax Depreciation For tax purposes, most corporations use the Modified Accelerated Cost Recovery y System (MACRS). MACRS depreciation provides for rapid write-off of an asset's cost in order to stimulate new investment investment. 9-24 Learning Objective 4 Explain the ff t f E l i th effect of asset t impairment on the financial p statements. 9-25 Asset Impairment Losses Impairment is the loss of a significant portion of the utility of an asset through . . . Casualty. Casualty Obsolescence. Lack of demand for the asset's services. A loss should b recognized when an asset suffers a permanent l h ld be i d h t ff t impairment. Cedar Fair recorded a write down of $3 200 000 on equipment write-down $3,200,000 equipment. 1 Analyze 2 Record 9-26 Learning Objective 5 Analyze the disposal of longlived tangible assets. li d t ibl t 9-27 Disposal of Tangible Assets Update depreciation to date of disposal disposal. Record the disposal. dr Cash (+A) dr Accumulated Depreciation (xA) cr Equipment (A) cr Gain on Disposal (+R +SE) Gain on Disposal (+R, +SE) Gain if cash received is greater than asset's book value Book value 9-28 Disposal of Tangible Assets Update depreciation to date of disposal disposal. Record the disposal. dr Cash (+A) dr Loss on Disposal (+E, -SE) (+E dr Accumulated Depreciation (xA) cr Eq ipment ( A) Equipment (A) Loss if cash received is less than asset's book value 9-29 Book value Disposal of Tangible Assets Cedar Fair sold a hotel for $3,000,000 cash at the end of its 16th year of use. The hotel originally cost $20,000,000, and was depreciated using the straight-line method with zero straightresidual value and a useful life of 20 years. The amount of depreciation per Th t fd i ti year is: a. b. c. d. 9-30 $0. $500,000. $ $1,000,000. $2,000,000. Annual Depreciation: ($20,000,000 - $0) 20 Years = $1 000 000 per year $1,000,000 Disposal of Tangible Assets Cedar Fair sold a hotel for $3,000,000 cash at the end of its 16th year of use. The hotel originally cost $20,000,000, and was depreciated using thetstraight-line method with zero Accumulated Depreciation = A l straight- i ti dD residual value and a useful life of 20 years. (16 yrs. $1,000,000) = $16,000,000 The equipment's - Accumulated at date BV = Cost book value Depreciation of sale is: BV = $20,000,000 - $16,000,000 = $4,000,000 a. b. c. d. 9-31 $4,000,000. $3,000,000. $17,000,000. $16,500,000. Disposal of Tangible Assets Cedar Fair sold a hotel for $3,000,000 cash at the end of its 16th year of use. The hotel originally cost $20,000,000, and was depreciated using the straight-line method with zero straightresidual value and a useful life of 20 years. The equipment's sale resulted in: Th i t' l lt d i a. b. c. d. al loss of $1,000,000. f $1 000 000 a gain of $3,000,000. a gain of $ $1,000,000. a loss of $5,000,000. Loss = Cash Received - Book Value Loss = $3,000,000 - $4,000,000 = $1,000,000 9-32 Disposal of Tangible Assets Analyze and prepare the journal entry to record Cedar Fair's sale of the hotel Fair s hotel. 1 Analyze ay e 2 Record 9-33 Learning Objective 6 Analyze th acquisition, use, A l the i iti and disposal of long-lived p g intangible assets. 9-34 Intangible Assets Noncurrent assets without physical substance. Often provide exclusive rights or privileges. Intangible g Assets Useful life is often difficult to d determine. i 9-35 Usually acquired for operational use. Intangible Assets Record at current cash R d t t h equivalent cost, including purchase price, legal fees, and fili f d filing fees. Amortize intangibles with limited lives over the shorter of their economic lives or legal lives using the straightstraight-line method. 9-36 Trademarks and Copyrights A trademark is a symbol, design, or logo associated with a business. Internally developed trademarks have no recorded asset cost. Purchased trademarks are recorded at cost. d d t t A copyright is an exclusive right granted by the federal government to protect artistic or intellectual properties. Legal life is life of creator plus 70 years. 9-37 Amortize cost over the period benefited. Patents and Licensing Rights A patent is an exclusive right granted by the federal government to sell or manufacture an invention. Cost is purchase p price plus legal p g cost to defend. Amortize cost over the shorter of useful life or 20 years. Licensing rights grant limited permission to use a product or service according to specific terms and conditions. You may be using computer software that is made available to you through a campus licensing agreement. 9-38 Franchises A franchise provides legally protected rights to sell products or provide services purchased by a franchisee from the franchisor. 9-39 Goodwill Purchase Price > Fair Market Value of Net Assets Acquired Occurs when one company buys another company. Only purchased goodwill is an intangible asset. Is impairment tested and may be written down. Is not amortized. 9-40 Amortization of Limited Life Intangible Asset Assume Cedar Fair purchased a patent for an uphill water-coaster waterfor $800,000 and intends to use it for 20 years. Each year, the company would record $40,000 in Amortization Expense ($800,000 20 years). 1 Analyze Assets Patent (-A) $40,000 ( A) = Liabilities + Stockholders' Equity Amortization Expense (+E, -SE) -40,000 2 Record dr Amortization Expense (+E, SE) cr Patent (A) 40,000 40,000 9-41 Summary of Accounting Rules for Long-Lived Assets Stage Subject Acquisition Purchased Asset Use Repairs/maintenance Ordinary Extraordinary Depreciation/ amortization Limited lif Li it d life Tangible Assets Capitalize all related costs Intangible Assets Capitalize all related costs Expense related costs Capitalize related costs straight-line t i ht li units-of-production declining-balance Do not depreciate land Write-down if necessary Not applicable Not applicable Typically T i ll use straight line only t i ht li l Unlimited life Impairment test Disposal Do not amortize Write-down if necessary Receive more (less) on disposal than book value Report gain or (loss) when . . . Receive more (less) on disposal than book value 9-42 Learning Objective 7 Interpret the fixed asset turnover ratio. t ti 9-43 Turnover Analysis Fixed = Asset A t Turnover Net Sales Revenue Average Net Fixed Assets This ratio measures the sales dollars generated by each dollar invested in fixed assets. assets For the year 2008, Cedar Fair had $1,000,000 of y , $ , , revenue. End-of-year fixed assets were $1,800,000 and beginning-of-year fixed assets were $1,940,000. (All numbers in millions.) 9-44 Turnover Analysis Fixed = Asset Turnover Fixed = Asset Turnover Net Sales Revenue N tS l R Average Net Fixed Assets $1,000,000 ($1,800,000 $1,940,000) ($1 800 000 + $1 940 000) 2 = 0.53 2008 Fixed Asset Turnover Comparisons Yahoo! 5.68 9-45 Six Flags 0.64 Cedar Fair 0.53 Learning Objective 8 Describe th f t D ib the factors t to consider when comparing p g companies' long-lived assets. 9-46 Impact of Depreciation Differences Accelerated depreciation, in the early years of an asset's useful life, results in higher depreciation expense, lower net income, and lower book value than would result , using straight-line depreciation. Selling an asset with a low book value, resulting from accelerated depreciation, might result in a gain. Selling the same asset with a higher book value, g g p , g resulting from straight-line depreciation, might result in a loss. 9-47 Chapter 9 Exercise E9-7 E9-7 Computing Depreciation under Alternative Methods Sonic Corporation purchased and installed electronic payment equipment at its drive-inn restaurants in San Marcos, TX, at a cost of $27,000. The equipment has an estimated residual value of $1,500. The equipment is expected to process 255,000 payments over its three-year useful life. Per year, expected payment transactions are 61,200, year 1; 140,250, year 2 and 53 550 year 3 tt ti 61 200 1 140 250 2; d 53,550, 3. Required: Complete a depreciation schedule for each of the alternative methods. 1. Straight-line. g 2. Units-of-production. 3. Double-declining-balance. 1. Straight-line ($27,000 - $1,500) 9-49 1 3 = $8,500 per year E9-7 Computing Depreciation under Alternative Methods 1. Straight-line Depreciation Accumulated Expense E Depreciation D i ti Year (debit) (credit) 1 2 3 $ 8 500 8,500 8,500 8,500 $ 25,500 , $ 8,500 8 500 8,500 8,500 25,500 , Accumulated Undepreciated Depreciation D i ti Balance B l (credit balance) (book value) $ 27,000 $ 8,500 8 500 18,500 18 500 17,000 10,000 25,500 1,500 $ 9-50 E9-7 Computing Depreciation under Alternative Methods 2. Units-of-production 2 U it f d ti t Year D 1st Y Depreciation i i ($27,000 - $1,500) 2nd Year Depreciation ($27,000 $1,500) ($27 000 - $1 500) p 3rd Year Depreciation ($27,000 - $1,500) 9-51 61,200 255,000 140,250 255,000 53,550 255,000 = $6,120 = $14,025 = $5,355 E9-7 Computing Depreciation under Alternative Methods 2. Units-of-production 2 U it f d ti Year 1 2 3 Payments 61,200 140,250 140 250 53,550 255,000 Depreciation Expense (debit) $ 6,120 14,025 14 025 5,355 25,500 Accumulated Depreciation (credit balance) $ 6,120 20,145 20 145 25,500 Undepreciated Balance (book value) $ 27,000 20,880 6,855 6 855 1,500 $ 9-52 E9-7 Computing Depreciation under Alternative Methods 3. Double-declining-balance 3 D bl d li i b l 1st Y Year D Depreciation i ti ($27,000 - $0) 2nd Year Depreciation ($27,000 $18,000) ($27 000 - $18 000) 3rd Year Depreciation [$27,000 ($18,000 + $6,000)] 9-53 2 3 2 3 2 3 = $18,000 = $6,000 $6 000 = $2,000 E9-7 Computing Depreciation under Alternative Methods 3. Double-declining-balance 3 D bl d li i b l Year 1 2 3 Depreciation p Expense (debit) $ 18,000 6,000 1,500 2,000 25,500 26,000 Accumulated Depreciation (credit balance) Balance $ 18,000 24,000 25,500 26,000 Undepreciated p Balance (book value) $ 27,000 27 000 9,000 3,000 1,500 1,000 $ Below residual value Depreciation expense is limited to the amount that reduces book value to the estimated residual value. 9-54 End of Chapter 9 Chapter 10* 10 Reporting and Interpreting Liabilities *You may exclude all Supplemental Material PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA p , , Fred Phillips, Ph.D., CA Edited by: Muriel Anderson, MBA, CPA Learning Objective 1 Explain the l f liabilities in E l i th role of li biliti i financing a business. g 10-2 The Role of Liabilities Liabilities are created when a company: Buys goods and services on credit Obtains short-term loans Issues long-term debt Current liabilities are short-term obligations that will be paid with current assets within the company's current operating cycle or within one year of the balance sheet date whichever is longer date, longer. 10-3 The Role of Liabilities The liability section of the General Mills 2007 and 2008 comparative balance sheets. 10-4 Learning Objective 2 Explain how t account f E l i h to t for common types of current yp liabilities. 10-5 Current Liabilities Accounts Payable Increases (Credited) Decreases (Debited) when a company receives goods or i d services on credit when a company pays on it account its t Accrued Liabilities Liabilities that have been incurred but not yet paid. 10-6 Accrued Payroll 1. 1 Payroll Deductions create a current liability for the requested by employees and company. Examples include: 1. Income tax 2. Employer Payroll Taxes 2. 2 FICA tax 3. Other deductions (charitable donations, union dues, etc.) Payroll Liabilities Payroll Deductionsor voluntarily Payroll deductions are either required by law 10-7 Accrued Payroll Gross Pay Payroll Deductions: Federal Income Taxes FICA Taxes Other Total Payroll Deductions Total Payroll Deductions Net Pay 10-8 $ 600.00 $ 58.00 48.80 10.00 116 80 116.80 $ 483.20 Accrued Payroll Adam Palmer earned gross pay of $600 in the current payroll period. General Mills withheld $58 in Federal income taxes, $48.80 for FICA, and $10 for United Way, resulting in net pay of $483.20. 1 Analyze Assets = Liabilities + Stockholders' Equity Cash (-A) -$483.20 FIT Withheld (+L) +$58.00 Payroll Expense FICA Payable (+L) +$48.80 (+E, -SE) -$600.00 United W ( L) U it d Way (+L) +$10.00 $10 00 2 Record dr Wages and Salaries Expense (+E, SE) cr Withheld Income Taxes Payable (+L) cr FICA Payable (+L) cr United Way Payable (+L) cr Cash (A) 600.00 58.00 48.80 10.00 483.20 10-9 Accrued Payroll Employer Payroll Taxes Employers have other liabilities related to payroll. 1. FICA tax (a "matching" contribution) 2. 2 Federal unemployment tax 3. State unemployment tax Assume General Mills was required to contribute $16,400 for FICA, $250 f f d l unemployment t l t tax, and $1 350 f state unemployment t d $1,350 for t t l t tax. for federal 1 Analyze Assets = Liabilities + Stockholders' Equity FICA Payable (+L) +16,400 Payroll Tax Expense FUTA Payable (+L) +250 (+E, -SE) -18,000 SUTA Payable (+L) +1,350 2 Record dr Payroll Tax Expense (+E, SE) cr FICA Tax Payable (+L) cr Federal Unemployment Tax Payable (+L) cr State Unemployment Tax Payable (+L) 18,000 16,400 250 1,350 10-10 Accrued Income Taxes Corporations calculate taxable income by subtracting tax-allowed expenses from revenues. This taxable income is then multiplied by a tax rate, which for most large corporations is about 35 percent. General Mill calculated taxable income to be $1 000 000 and is subject to $1,000,000, a 35% tax rate, so income taxes owed are $350,000 ($1,000,000 35%) 1 Analyze Assets = Liabilities Income Tax Payable (+L) +350,000 + Stockholders' Equity Income Tax Expense (+E, -SE) +350,000 2 Record dr Income Tax Expense (+E, SE) cr Income Tax Payable (+L) 350,000 350,000 10-11 Notes Payable Four key events occur with any note payable: 1. establishing the note, 2. accruing interest incurred but not paid, 3. recording interest paid, and 4. recording principal paid. 10-12 Notes Payable 1. Establish the note on November 1, 2009. Assume that on November 1, 2009, General Mills borrowed $100 000 cash 1 2009 $100,000 on a one-year note that required General Mills to pay 6 percent interest and $100,000 principal, both on October 31, 2010. 1 Analyze Assets Cash (+A) $100,000 = Liabilities Notes Payable (+L) $100,000 + Stockholders' Equity 2 Record dr Cash (+A) cr Notes Payable (+L) 100,000 100,000 10-13 Notes Payable 2. Accrue interest owed but not paid on December 31, 2009. $100 000 6% 2/12 = $1 000 accrued interest $100,000 $1,000 1 Analyze Assets = Liabilities Interest Payable (+L) $1,000 + Stockholders' Equity Interest Expense (+E, -SE) $1,000 2 Record dr Interest Expense (+E, SE) cr Interest Payable (+L) 1,000 1,000 10-14 Notes Payable 3. Record interest paid on October 31, 2010. $100 000 6% 12/12 = $6 000 interest paid $100,000 $6,000 1 Analyze Assets Cash (-A) -$6,000 = Liabilities Interest Payable (-L) -$1,000 + Stockholders Stockholders' Equity Interest Expense (+E, -SE) $5,000 2 Record dr Interest Expense (+E, SE) dr Interest Payable ( L) dr Interest Payable (L) cr Cash (A) 5,000 1,000 6,000 10-15 Notes Payable 4. Record principal paid of $100,000 on October 31, 2010. 1 Analyze Assets = Liabilities Cash (-A) -$100,000 NotePayable (-L) -$100,000 + Stockholders' Equity 2 Record dr Note Payable (L) cr Cash (A) 100,000 100,000 10-16 Current Portion of Long-Term Debt Long-Term Debt Current Portion of Long-term Debt Noncurrent Portion of Long-term Debt Borrowers must report in Current Liabilities the portion of long-term debt that is due to be paid within one year. l t d bt th t i d t b id ithi 10-17 Additional Current Liabilities Sales Tax Payable Payments collected from customers at time of sale create a liability that is due to the state government. Unearned Revenue Cash received in advance of providing services creates a liability of services due to the customer. 10-18 Additional Current Liabilities Best Buy sells a television for $1,000 cash plus 5 percent sales tax. $1,000 5% = $50 sales tax collected 1 Analyze Assets Cash (+A) +$1,050 = Liabilities + Stockholders' Equity Sales Tax Payable (+L) +$50 Sales Revenue (+R, +SE) +$1,000 2 Record dr Cash (+A) cr Sales Tax Payable (+L) cr Sales Revenue (+R, +SE) 1,050 50 1,000 When Best Buy pays the sales tax to the state government its government, accountants will reduce Sales Tax Payable (with a debit) and reduce Cash (with a credit). 10-19 Additional Liabilities On October 1 IAC, an internet provider, received $30 cash for threethreemonths of internet access, paid in advance. 1 Analyze Assets Cash (+A) +$30 = Liabilities Unearned Revenue (+L) $30 + Stockholders' Equity 2 Record dr Cash (+A) cr Unearned Revenue (+L) cr Unearned Revenue (+L) 30 30 10-20 Additional Liabilities At the end of October, IAC provided one month of internet service to its customer. $30 3 months = $10 per month 1 Analyze Assets = Liabilities Unearned Revenue ( L) $10 (-L) + Stockholders' Equity Subscription Revenue (+R, +SE) $10 2 Record dr Unearned Revenue (L) cr Subscription Revenue (+R, +SE) 10 10 10-21 Learning Objective 3 Analyze and record bond liability transactions. transactions 10-22 Long-Term Liabilities Common Long-Term Liabilities g 1. Long-term notes payable 2. Bonds payable Bonds are financial instruments that outline the future payments a company promises to make in i exchange f receiving a sum of money now. h for i i f 10-23 Bonds Key Elements of a Bond 1. Maturity date 2. Face value 3. Stated interest rate Interest Computation 12 $1,000 6% 12 = $60 Bond Pricing The bond price involves present value computations and is the amount that investors are willing to pay on the issue date for the bonds. 10-24 Bonds Balance Sheet Reporting of Bond Liability Relationships b t R l ti hi between I t Interest R t and B d P i i t Rates d Bond Pricing 10-25 Bonds Bonds Issued at Face Value General Mills receives $100 000 cash in exchange for issuing $100,000 100 bonds at their $1,000 face value, so the bonds are issued at total face value (1,000 $1,000 = $100,000). 1 Analyze Assets = Liabilities + Stockholders' Equity Cash (+A) +$100,000 Bonds Payable (+L) $100,000 2 Record dr Cash (+A) cr Bonds Payable (+L) 100,000 100,000 10-26 Bonds Bonds Issued at a Premium General Mills issues 100 of its $1,000 bonds at a price of 107.26 percent of face value, the company will receive $107,260 (100 $1,000 1.0726). 1 Analyze Assets = Liabilities + Stockholders' Equity Cash (+A) +$107,260 Bonds Payable (+L) $100,000 Premium on Bonds Payable (+L) $7,260 2 Record dr Cash (+A) cr Bonds Payable (+L) cr Premium on Bonds Payable (+L) 107,260 100,000 7,260 10-27 Bonds Bonds Issued at a Discount General Mills receives $93,376 for bonds with a total face value of $100,000, th cash$100 000 the cash-equivalent amount is $93 376 which represents h i l t t i $93,376, hi h t the liability on that date. These bonds are issued at a discount because the cash received is less than the face value of the bonds. 1 Analyze Assets = Liabilities + Stockholders' Equity Cash (+A) +$93,376 $100,000 Bonds Payable (+L) $100,000 - $93,376 = $6,624 discount Discount on Bonds Payable (+xL, -L) $6,624 2 Record dr dr Cash (+A) Discount on Bonds Payable (+xL, L) cr Bonds Payable (+L) 93,376 6,624 100,000 10-28 Interest on Bonds Issued at Face Value General Mills issues bonds on January 1, 2010, at their total face value of $100,000. The bonds have an annual stated interest rate of 6 percent payable in cash on December 31 of each year, General year Mills will need to accrue an expense and liability for interest at the end of each accounting period. The end of the first accounting period is January 31 2010 31, 2010. 1 Analyze Assets $100,000 6% 1/12 = $500 interest = Liabilities + Stockholders' Equity Interest Payable (+L) $500 I t I t tP bl ( L) Interest Expense (+E, -SE) $500 tE ( E SE) 2 Record dr Interest Expense (+E, SE) cr Interest Payable (+L) 500 500 10-29 Bond Retirement General Mills' bonds were retired with a payment equal to their $100,000 face value. Let's analyze and record this transaction. 1 Analyze Assets = Liabilities + Stockholders' Equity Eq it Cash (-A) -$100,000 Bonds Payable (-L) $100,000 2 Record dr Bonds Payable ( L) Bonds Payable (L) cr Cash (A) 100,000 100,000 10-30 Bond Retirement The early retirement of bonds has three financial effects. The company 1. pays cash, 2. eliminates the bond liability, and 3. reports either a gain or a loss. Assume that in 2000, General Mills issued $100,000 of bonds at face value. Ten years later, in 2010, the company retired the bonds early. At the time, the bond price was 103, so General Mills made a payment of $103,000. 1 Analyze Cash Payment $103,000 Assets = Liabilities + Stockholders' Equity Carrying Value (-L) $100,000 Loss on Bond 100,000 Cash (-A) -$103,000 Bonds Payable Loss on Retirement $3,000 Retirement (+E, -SE) $3,000 $3 000 2 Record dr dr Bonds Payable (L) Loss on Bond Retirement (+E, SE) cr Cash (A) 100,000 3,000 103,000 10-31 Learning Objective 4 Describe how to account for contingent liabilities. ti t li biliti 10-32 Contingent Liabilities Contingent liabilities are potential liabilities that arise from past transactions or events, b their ultimate resolution d but h i l i i l i depends d (is contingent) on a future event. 10-33 Learning Objective 5 Calculate d interpret th C l l t and i t t the q quick ratio and the times interest earned ratio. 10-34 Evaluate the Results Two financial ratios are commonly used to assess a company's ability to g p y y generate resources to p y pay future amounts owed: 1. Quick ratio 2. 2 Times interest earned ratio Quick Ratio = (Cash + Short-term Investments + Accounts Receivable, Net) Current Liabilities Times Interest = Earned Ratio (Net Income + Interest Expense + Income Tax Expense) Interest Expense 10-35 Evaluate the Results In 2008, General Mills reported $661 million of cash and cash equivalents, no short-term investments, and $1,082 million of net accounts receivable. The company reported $4,856 million in total current liabilities. (Cas (Cash + S o e Investments + Accounts Receivable, Net) Short-term es e s ccou s ece ab e, e ) Current Liabilities Quick Ratio Q i k R ti = $661 + 0 + 1 082 1,082 4,856 = 0.359 10-36 Evaluate the Results In 2008, General Mills reported net income of $290 million and interest expense of $ $100 million, and income tax expense of $ $230 million. Let's calculate the times interest earned for 2008. Times Interest = Earned Ratio (Net Income + Interest Expense + Income Tax Expense) Interest Expense $290 + $100 + $230 $100 = 6.20 times 10-37 Chapter 10 Exercises E10-2, E10-8, E10-10 E10-2 Recording a Note Payable through Its Time to Maturity g y g y Many businesses borrow money during periods of increased business activity to finance inventory and accounts receivable. Target Corporation is one of America's largest general merchandise retailers. Each Christmas, Target builds up its inventory to meet the needs of Christmas shoppers. A large portion of Christmas sales are on credit. As a result, Target often collects cash from the sales several months after Ch i t ft Christmas. A Assume th t on N that November 1 2010 T b 1, 2010, Target b t borrowed d $6 million cash from Metropolitan Bank and signed a promissory note that matures in six months. The interest rate was 7.5 percent payable at maturity. The accounting period ends December 31 maturity 31. Required: 1. Give the journal entry to record the note on November 1, 2010. 2. 2 Give any adjusting entry required on December 31 2010 31, 2010. 3. Give the journal entry to record payment of the note and interest on the maturity date, April 30, 2011, assuming that interest has not been recorded since December 31, 2010. 10-39 E10-2 Recording a Note Payable through Its Time to Maturity November 1, 2010: Borrowed on 6-month, 7.5%, note payable. December 31 2010 ( d of th accounting period): D b 31, (end f the ti i d) Adjusting entry for 2 months' accrued interest ($6 000 000 x 7 5% x 2/12 = $75 000) months ($6,000,000 7.5% $75,000). April 30, 2011 (maturity date): Paid note plus interest at maturity maturity. 10-40 E10-8 Preparing Journal Entries to Record Issuance of g Bonds at Face Value, Payment of Interest, and Early Retirement On January 1, 2010, Innovative Solutions, Inc., issued $200,000 in bonds at face value. The bonds have a stated interest rate of 6 percent. The bonds mature in 10 years and pay interest once per year on December 31. Required: 1. Prepare the journal entry to record the bond issuance. 2. Prepare the journal entry to record the interest payment on December 31, 2010. Assume no interest has been accrued 31 2010 earlier in the year. 3. Assume the bonds were retired immediately after the first interest payment at a q p y quoted p price of 102. Prepare the p journal entry to record the early retirement of the bonds. 10-41 E10-8 Preparing Journal Entries to Record Issuance of Bonds at Face Value, Payment of Interest, and Early Retirement Req. 1 dr Cash (+A) 200,000 cr Bonds Payable (+L) y ( ) 200,000 , Req. 2 dr Interest Expense (+E, -SE) cr Cash (-A) ($200,000 x 6% x 12/12) = $12,000 12,000 12,000 Req. 3 dr Bonds Payable (-L) 200,000 dr Loss on Bonds Retired (+E, -SE) 4,000 cr Cash (-A) ( A) 204,000 ($200,000 x 102%) = $204,000 10-42 E10-10 Calculating and Interpreting the Quick Ratio and Times I t tE d R ti Interest Earned Ratio According to its Web site, Kraft Foods Inc. sells enough Kool-Aid mix to make 1,000 gallons of the drink every minute during the summer and over 560 million gallons each year. At December 31, 2008, the company reported no short-term investments but did report the following amounts (in millions) in its financial statements: Cash and Cash Equivalents C h dC hE i l Accounts Receivable, Net Total Current Liabilities Interest Expense Income Tax Expense I T E Net Income 2008 $ 1 244 1,244 4,704 11,044 1,240 728 2,901 2007 $ $ 567 5,197 17,086 604 1 002 1,002 2,590 Required: 1. Compute the quick ratio and times interest earned ratio (to two decimal places) for 2008 and 2007 2007. 2. Did Kraft appear to have increased or decreased its ability to pay current liabilities and future interest obligations as they become due? How can you explain the seemingly conflicting findings of your ratio analysis? 10-43 E10-10 Calculating and Interpreting the Quick Ratio and Times Interest Earned Ratio Req. 1 Req. 2 10-44 E10-10 Calculating and Interpreting the Quick Ratio and Times Interest Earned Ratio Req. 3 The times interest earned ratio has decreased from 6.95 to 3.93, gg g y g suggesting a decline in Kraft's ability to cover its interest through profitable operations. The quick ratio has increased from 0.34 in 2007 to 0.54 in 2008, suggesting Kraft is in a better position to quickly pay its current liabilities at the end of 2008. These findings seem to conflict, but can be explained as follows. In 2008, when the economy was suffering, Kraft realized that it could no longer rely as much on obtaining short-term financing to cover cash needs. Consequently, Consequently Kraft borrowed more funds through long term debt long-term debt, which doubled the amount the company held in Cash and Cash Equivalents. Obtaining more long-term debt financing came at a cost, however, cost however as indicated by the doubling of Interest Expense The Expense. results of these shifts were an increase in the quick ratio (associated with the increase in Cash) and a decrease in the times interest ( p ) earned ratio (associated with the increase in Interest Expense). 10-45 End of Chapter 10 Chapter 11* *You may exclude the Supplemental Material Reporting and Interpreting Stockholders' Equity PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA p , , Fred Phillips, Ph.D., CA Edited by: Muriel Anderson, MBA, CPA Learning Objective 1 Explain the role of stock in financing a corporation. 11-2 Corporate Ownership The major advantage of the corporate form of business is the ease of raising capital as both large and small investors can participate in corporate ownership. Simple to become an owner Easy to transfer ownership hi Provides limited liability li bili Because a corporation is a separate legal entity it can entity, Own assets. Incur liabilities. Sue S e and be s ed sued. Enter into contracts. 11-3 Corporate Ownership Voting rights Dividends Stockholder Benefits Residual claims Preemptive rights 11-4 Equity vs. Debt Financing q y g Advantages of equity Equity does not have to be repaid. Dividends are optional. Advantages of debt Interest on debt is tax deductible. Debt does not change stockholder control. 11-5 Learning Objective 2 Explain and analyze common stock transactions. t kt ti 11-6 Common Stock Transactions Two primary sources of Stockholders' Equity Contributed Capital Common Stock 11-7 Retained Earnings Additional Paid in Paid-in Capital Authorization, Issuance, and Repurchase of Stock fS Authorized Shares The maximum number of shares of capital stock that can be issued to the public. 11-8 Authorization, Issuance, and Repurchase of Stock fS Authorized Shares Issued I d Unissued U i d shares are shares of The maximum number authorized stock are of of sharesshares of capital that shares stockstock that can be never that have issued have been to the public. been distributed to distributed to stockholders. stockholders. 11-9 Authorization, Issuance, and Repurchase of Stock fS Authorized Shares Outstanding shares are issued shares that are owned by stockholders. Issued I d Unissued U i d shares are shares of Outstanding The maximum number Unissued authorized stock are Shares of of Shares sharesshares of capital that shares stockstock that can be never that have issued Treasury shares are have been to the public. been Treasury T issued shares distributed to distributed to that have Shares been reacquired by the stockholders. stockholders. corporation. corporation Issued I d Shares 11-10 Stockholders Stockholders' Equity Section 11-11 Stock Authorization Par value is an arbitrary amount assigned to each share of stock when it is authorized authorized. Market price is the amount th t each t that h share of stock will sell for in the market. No-par Stock Some states do not require a par q p value to be stated in the charter. 11-12 Stock Issuance Initial public offering ( (IPO) ) Seasoned new issue The first time a corporation issues stock to the public. Subsequent issues of new stock to the public. National Beverage issues stock stock. 11-13 Stock Issuance National Beverage issued 100,000 shares of $0.01 par value common stock for $10 per share. 1 Analyze 2 Record 11-14 Stock Exchanged b/t Investors Transactions between two investors do not affect the corporation's accounting records. I'd like to sell 100 shares of National Beverage stock. g I'd like to buy 100 shares of National Beverage stock. 11-15 Stock Repurchase National Beverage repurchases its own stock (Treasury stock) Stockholders 11-16 Stock Repurchase A corporation repurchases its stock to: Send a signal that the company believes its stock is undervalued. Obtain shares to reissue for the purchase of other companies. companies Obtain shares to reissue to employees as part of stock purchase or stock option plans plans. 11-17 Stock Repurchase No voting or dividend g rights Treasury stock is not an asset. Contra equity account When stock is reacquired the corporation reacquired, records the treasury stock at cost. 11-18 Stock Repurchase National Beverage reacquired 50,000 shares of its common stock at $25 per share. 1 Analyze 2 Record 11-19 Treasury Stock Reissuance National Beverage reissued 5,000 shares of the Treasury Stock at $26 per share share. 1 Analyze 2 Record No profit or loss is recognized on treasury stock transactions. 11-20 Learning Objective 3 Explain d E l i and analyze cash l h dividends, stock dividends, , , and stock split transactions. 11-21 Common Stock Dividends Declared by board of directors Not legally required Creates liability at declaration Requires sufficient Retained Earnings and Cash 11-22 Restrictions on Retained Earnings If I loan your company $1,000,000, I will want you to restrict your retained earnings to limit dividend payments. Loan agreements can include restrictions on paying dividends below a certain amount of retained earnings earnings. 11-23 Dividends Dates 11-24 Dividends Dates National Beverage declares an $0.80 dividend on each share of its 46,000,000 shares of common stock outstanding. 1 Analyze 2 Record 11-25 Cash Dividends National Beverage paid the previously declared $0.80 dividend on its shares of common stock outstanding outstanding. 1 Analyze 2 Record 11-26 Stock Dividends Distribution of additional shares of stock to stockholders No change in total g stockholders' equity No change in g par values All stockholders retain same percentage ownership Corporations issue stock dividends to: Remind stockholders of the accumulating wealth in the company. Reduce the market price per share of stock. Signal th t th company expects strong financial performance Si l that the t t fi i l f in the future. 11-27 Stock Dividends Small Stock dividend < 20 25% Large Stock dividend > 20 25% Record at current market value of stock. Record at par value of stock. The journal entry moves an amount from j y Retained Earnings to other equity accounts. 11-28 Stock Dividends National Beverage issued a 20 percent stock dividend on g 38,000,000 outstanding shares of its $0.01 par value common stock and accounted for it as a large stock dividend dividend. 1 Analyze 2 Record 11-29 Stock Splits An increase in the number of shares and a corresponding decrease in par value p share. Retained earnings is not affected. p per g A stock split creates more pieces of the same pie f Assume that a corporation had 5 000 shares of $1 par value 5,000 common stock outstanding before a 2for1 stock split. Before Split 5,000 $ 1.00 $ 5,000 After Split 10,000 $ 0.50 $ 5,000 Common Stock Shares Par Value per Share Total Par Value 11-30 Increase Decrease No Change Comparison of Distributions to Stockholders Stockholders' E it St kh ld ' Equity Contributed Capital Number of common shares outstanding Par value per common share Common stock, at par Additional paid-in capital Retained Earnings Total stockholders' equity Before B f After 2-for-1 Stock 100% Stock Split S lit Dividend Di id d $10,000 Cash Dividend Di id d 1,000,000 $ 0.01 0 01 $ 10,000 30,000 650,000 $ 690,000 2,000,000 $ 0.005 0 005 $ 10,000 30,000 650,000 $ 690,000 2,000,000 $ 0.01 0 01 $ 20,000 30,000 640,000 $ 690,000 1,000,000 $ 0.01 0 01 $ 10,000 30,000 640,000 $ 680,000 11-31 Learning Objective 4 Describe the characteristics of preferred stock and analyze transactions affecting t ti ff ti p preferred stock. 11-32 Preferred Stock Issuance Priority over common stock Preferred Stock Usually has a fixed dividend rate Usually has no voting rights 11-33 Preferred Stock Issuance National Beverage issued 10,000 shares of its $1 par value preferred stock for $5 per share al e share. 1 Analyze A l 2 Record 11-34 Preferred Stock Dividends Current Dividend Preference: The current preferred dividends must be paid before paying any dividends to common stock. Cumulative Dividend Preference: Any unpaid dividends from previous years ( (dividends in arrears) must be paid before ) p common dividends are paid. If the preferred stock is noncumulative, any dividends not declared in previous years are lost p y permanently. 11-35 Preferred Stock Dividends In addition to its common stock National Beverage stock, has $1 par value cumulative preferred stock with a 7 percent dividend rate Assume 100 000 of these rate. 100,000 shares are outstanding, one year of dividends are in arrears, and the board of directors just declared j total dividends of $400,000. How much will each class of stock receive? 11-36 Preferred Stock Dividends Total dividend declared Preferred stock (cumulative) In Arrears ($1 par 7% 100,000 shares) Current Yr. ($1 par 7% 100,000 shares) Remainder Common stock Remainder $ $ 7,000 7,000 $ $ 400,000 14,000 386,000 386 000 386,000 - 11-37 Retained Earnings (deficit) Total cumulative amount of reported net income less any net losses and dividends declared since the company started operating. Baker Company Comparative B l C i Balance Sh Sheets (Partial) (P i l) For Year Ended December 31 2008 Stockholders' Equity Common Stock Additional Paid-in Capital Retained Earnings (Deficit) Total Stockholders' Equity $ 100,000 750,000 50,000 900,000 $ 2009 100,000 750,000 (70,000) 780,000 Baker Company incurred a loss of $120 000 in 2009 that $120,000 resulted in an Accumulated Deficit in Retained Earnings. 11-38 Learning Objective 5 Analyze the earnings per share (EPS), return on equity (ROE), d i / (ROE) and price/earnings i ( (P/E) ratios. ) 11-39 Earnings Per Share (EPS) Earnings per share is probably the single most widely watched financial ratio Net Income EPS = Average Number of Common Shares Outstanding National Beverage s income for 2008 was Beverage's $22,500,000 and the average number of shares outstanding during the year was 45,900,000. $22,500,000 45,900,000 S Shares EPS = = $0.49 per share 11-40 Return on Equity (ROE) Return on equity is the amount earned for each dollar invested by stockholders y ROE = Net Income Average Stockholders' Equity Stockholders National Beverage s income for 2008 was Beverage's $22,500,000 and the average Stockholders' Equity was $151,000,000. $22,500,000 $151,000,000 $151 000 000 ROE = = 14.9 percent p 11-41 Price/Earnings (P/E) Ratio The P/E ratio is a measure of the value that investors place on a company's common stock company s stock. P/E = Current Stock Price (per share) Earnings Per Share (annual) E i P Sh ( l) National Beverage's stock price was $7 74 when N ti lB ' t k i $7.74 h the company reported its 2008 EPS of $0.49. P/E = $ 7.74 $ 0 49 0.49 = 15.8 11-42 Comparison of EPS, ROE, and P/E Ratios National Beverage EPS $ 0 49 0.49 2008 ROE 14.9% 14 9% P/E 15.8 15 8 Pepsico $ 3.26 34.8% 16.0 11-43 Chapter 11 Exercises M11-4, M11-8, E11-3, E11-6, E11-8 M11-4 Analyzing and Recording the Issuance of Common Stock To expand operations, Aragon Consulting issued 100,000 shares of previously unissued common stock with a par value of $1. The price for the stock was $75 per share. Analyze the accounting equation effects and record the journal entry for the stock issuance. 1 Analyze A l Cash Assets + 7,500,000 = Liabilities + Stockholders' Equity Common Stock + 100,000 Additional Paid-in dd t o a a d Capital + 7,400,000 2 Record R d dr Cash (+A) cr Common Stock (+SE) ( ) cr Additional Paid-in Capital (+SE) 7,500,000 100,000 7,400,000 11-45 M11-4 Analyzing and Recording the Issuance of Common Stock Would your answer be different if the par value were $2 per share? If, so, analyze the accounting equation effects and record the journal entry for the stock issuance with a par value of $2. The effects on total assets and total stockholders' equity would not differ, but the amounts within the individual stockholders' equity accounts would differ. 1 Analyze Cash Assets + 7,500,000 = Liabilities + Stockholders' Equity Common Stock + 200,000 Additional Paid-in Capital + 7,300,000 2 Record R d dr Cash (+A) cr Common Stock (+SE) ( ) cr Additional Paid-in Capital (+SE) 7,500,000 200,000 7,300,000 11-46 M11-8 Determining the Amount of a Dividend Netpass Company has 300,000 shares of common stock authorized, 270,000 shares issued, and 100,000 shares of treasury stock. The company's board of directors declares a dividend of 50 cents per share of common stock. What is the total amount of the dividend that will be paid? Dividends are paid on shares that are issued and outstanding. Dividends are not paid on treasury stock. Shares issued Less treasury stock Shares outstanding Dividend per share Total dividends paid 270,000 100,000 170,000 $ 0.50 $ 85,000 11-47 E11-3 Preparing the Stockholders' Equity Section of the Balance Sheet North Wind Aviation received its charter during January 2010. The charter authorized the following capital stock: During 2010, the following transactions occurred in the order given: a. a Issued a total of 40,000 shares of the common stock to the company s 40 000 company's founders for $11 per share. b. Issued 5,000 shares of the preferred stock at $18 per share. c. Issued 3,000 shares of the common stock at $14 per share and 1,000 shares of the preferred stock at $28. d. Net income for the first year was $48,000. Required: Prepare the stockholders' equity section of the balance sheet at December stockholders 31, 2010. 11-48 E11-3 Preparing the Stockholders' Equity Section of the Balance Sheet North Wind Aviation Stockholders' Equity December 31, 2010 Contributed Capital: Preferred Stock, 8%, $10 par, 20 000 shares authorized, P f d St k 8% 20,000 h th i d 6,000 shares issued and outstanding $ 60,000 Additional Paid-in Capital, Preferred 58,000 Common Stock, $ par, 50,000 shares authorized, $7 43,000 shares issued and outstanding 301,000 Additional Paid-in Capital, Common 181,000 5,000 5 000 shares ($18 $10) + 1,000 shares ($28 $10) 1 000 Total Contributed Capital 600,000 Retained Earnings ($11 $7) + 3,000 shares ($14 $7) 48,000 40,000 shares Total Stockholders' Equity 648,000 11-49 E11-6 Recording and Reporting Stockholders' Equity Transactions AvA School of Learning obtained a charter at the start of 2010 that authorized 50,000 shares of no-par common stock and 20,000 shares of preferred stock, par value $10. During 2010, the following selected transactions occurred: a. Collected $40 cash per share from four individuals and issued 5,000 shares of common stock to each. b. Issued 6,000 shares of common stock to an outside investor at $40 cash per share share. c. Issued 8,000 shares of preferred stock at $20 cash per share. Required: 1. Give the journal entries indicated for each of these transactions. 2. Prepare the stockholders' equity section of the b l 2 P h kh ld ' i i f h balance sheet at h December 31, 2010. At the end of 2010, the accounts reflected net income of $36,000. No dividends were declared. 11-50 E11-6 Recording and Reporting Stockholders' Equity Transactions Required: 1. Give the journal entries indicated for each of these transactions. (a) Collected $40 cash per share from four individuals and issued 5,000 shares of common stock to each. dr Cash (+A) (5,000 $40 4) cr Common Stock (+SE) 800,000 800,000 (b) Issued 6,000 shares of common stock to an outside investor at $40 cash per share. dr Cash (+A) (6,000 $40) cr Common Stock (+SE) 240,000 240,000 11-51 E11-6 Recording and Reporting Stockholders' Equity Transactions Required: 1. Give the journal entries indicated for each of these transactions. (c) Issued 8,000 shares of preferred stock at $20 cash per share. dr Cash (+A) (8,000 $20) 160,000 cr Preferred Stock (+SE) cr Additional Paid-in Capital, Preferred (+SE) p , ( ) 80,000 80,000 , 11-52 E11-6 Recording and Reporting Stockholders' Equity Transactions Required: 2. Prepare the stockholders' equity section of the balance sheet at December 31, 2010. At the end of 2010, the accounts reflected net income of $36,000. No dividends were declared. AvA School of Learning Stockholders' Equity December 31, 2010 Contributed Capital: Preferred Stock $10 par 20 000 shares authorized, Stock, par, 20,000 authorized 8,000 shares issued and outstanding Additional Paid-in Capital, Preferred Common Stock, no par, 50,000 shares authorized, 26,000 shares issued and outstanding Total Contributed Capital 8,000 shares ($20 $10) e a ed a gs Retained Earnings (20,000 shares $40) + Total Stockholders' Equity (6,000 shares ($40) 11-53 $ 80,000 80,000 1,040,000 1,200,000 36,000 1,236,000 E11-8 Recording Treasury Stock Transactions and Analyzing Their Impact During 2010, the following selected transactions affecting stockholders' equity occurred for Corner Corporation: Feb. 1 Purchased 400 shares of the company's own common stock at $22 p y cash per share. Jul. 15 Issued 100 of the shares purchased on February 1, 2010, for $24 cash per share. Sept. Sept 1 Issued 60 more of the shares purchased on February 1 2010 for 1, 2010, $20 cash per share. Required: 1. Show the effects of each transaction on the accounting equation. 2. Give the indicated journal entries for each of the transactions. 3. What impact does the purchase of treasury stock have on dividends paid? 4. 4 What impact does the issuance of treasury stock for an amount higher than the purchase price have on net income? 11-54 E11-8 Recording Treasury Stock Transactions and Analyzing Their Impact Required: 1. Show the effects of each transaction on the accounting equation. 1 Analyze Cash Cash Assets - 8,800 = Liabilities + Stockholders' Equity Treasury Stock (+xSE) - 8,800 Date Feb. 1 Jul, 15 + 2,400 Treasury Stock (-xSE) Additional Paid in Paid-in Capital treasury treasury Treasury Stock (-xSE) Additional Paid-in Capital treasury + 2,200 + 200 + 1,320 - 120 Sept. 1 Cash + 1,200 11-55 E11-8 Recording Treasury Stock Transactions and Analyzing Their Impact Required: 2. Give the indicated journal entries for each of the transactions. 2 Record Feb 1 Feb. d r Treasury Stock (+xSE) (-SE) cr Cash (-A) (400 $22) 8,800 8,800 2 Record July 15 dr Cash (+A) (100 $24) cr Treasury Stock (-xSE) (+SE) (100 $22) cr Additional Paid-in Capital Treaasury (+SE) 2,400 2 400 2,200 200 2 Record Sept. 1 dr Cash (+A) (60 $20) dr Additional Paid-in Capital Treaasury ( SE) d Additi l P id i C it l (-SE) cr Treasury Stock (-xSE) (+SE) (60 $22) 1,200 120 1,320 11-56 E11-8 Recording Treasury Stock Transactions and Analyzing Their I t Impact Required: 3. What impact does the purchase of treasury stock have on dividends paid? Dividends are not paid on treasury stock. Therefore, the total amount of cash dividends paid is reduced when treasury stock is purchased. 4. What impact does the issuance of treasury stock for an amount higher than the purchase price have on net income? The sale of treasury stock for more or less than its original purchase price does not have an impact on net income. The transaction affects only balance sheet accounts. 11-57 End of Chapter 11 Chapter 12* 12 *You may exclude the Supplemental Material Reporting and Interpreting the Statement of Cash Flows PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA p , , Fred Phillips, Ph.D., CA Edited by: Muriel Anderson, MBA, CPA Learning Objective 1 Identify cash flows arising from operating, investing, operating investing and financing activities. 12-2 Business Activities and Cash Flows The Statement of Cash Flows focuses attention on: tt ti Operations p Cash received and paid for day-to-day activities day-towith customers suppliers customers, suppliers, and employees Investing Cash paid and received from buying and selling long-term assets 12-3 Financing Cash received and paid for exchanges with lenders and stockholders Business Activities and Cash Flows Checking and Savings Accounts A t Cash C h Currency y Cash Equivalents Highly liquid short-term investments within three months of maturity. maturity 12-4 Classifying Cash Flows UNDER ARMOUR, INC Condensed Statement of Cash flows For the Year Ended December 31, 2008 (in millions) Net cash provided (used) by Operating Activities Net cash provided (used) by Investing Activities Net cash provided (used) by Financing activities Net change in Cash and Cash Equivalents Cash and Cash Equivalents, beginning of year Cash and Cash Equivalents, end of year $ $ 79 (38) 21 62 40 102 12-5 Operating Activities Cash inflows and outflows that directly relate to revenues and expenses reported on the income statement. 12-6 Direct and Indirect Reporting of Operating Cash Flows fO C Same result S lt We will concentrate on the indirect method in this class. 12-7 Investing Activities Under Armour's 2008 Investing Activities 12-8 Financing Activities Under Armour's 2008 Financing Activities 12-9 Relationships Between Classified Balance Sheet and Statement of Cash Flow (SCF) Categories ( ) g SCF Categories Operating Investing Financing Classified Balance Sheet Categories Current Assets Noncurrent Assets Current Liabilities Noncurrent Liabilities Stockholders' Equity 12-10 Relationship to Other Financial Statements Information needed to prepare a Statement of Cash Flows: Comparative Balance Sheets Income Statement Additional details concerning selected accounts 12-11 Relationship to Other Financial Statements Recall that the basic Balance Sheet equation is: We can recast the equation as follows: q The following equation is true: g q From this basic Balance Sheet equation, we develop our model to solve for the change in cash: 12-12 Learning Objective 2 Report cash fl R t h flows f from operating activities, using p g , g the indirect method. 12-13 Cash Flows from Operating Activities - Indirect Method The indirect method adjusts net income by analyzing noncash items Changes in current assets and current liabilities Net N t Income + Noncash expenses such as depreciation and amortization 12-14 Cash Flows from Operating f O ti Activities Indirect Method + Losses and - Gains Relationships to the Balance Sheet and the Income Statement S S Change in account balances during the year Increase Decrease Current Assets Subtract from net income. Add to net i income. Current Liabilities Add to net income. Subtract from net i income. Use this t bl U thi table when adjusting Net Income to Operating h dj ti N t I t O ti Cash Flows using the indirect method. 12-15 Statement of Cash Flows Indirect Method Example Use the following financial statements for Under Armour, f U d A Inc. and prepare the Statement of Cash Flows for the year ended December 31 31, 2008. 12-16 Statement of Cash Flows Indirect Method Example UNDER ARMOUR, INC. Balance Sheet (in millions) December 31, 2008 December 31, 2007 Change Ch ASSETS Current assets: Cash & Cash Equivalents Accounts Receivable Inventories Prepaid Expenses Total Current Assets Equipment Less: Accumulated depreciation Intangible and Other Assets Total Assets 12-17 $ $ 102 81 182 31 396 120 (47) 18 487 $ $ 40 94 166 22 322 84 (31) 16 391 62 (13) 16 9 36 (16) 2 Statement of Cash Flows Indirect Method Example UNDER ARMOUR, INC. Balance Sheet (in millions) December 31, 2008 December 31, 2007 Change LIABILITIES & STOCKHOLDERS' EQUITY Current Liabilities: Accounts Payable $ Accrued Liabilities Total Current Liabilities Long-term Debt Total Liabilities Stockholders' Equity: Contributed Capital Retained Earnings Total St kh ld ' E it T t l Stockholders' Equity Total Liab. & Stockholders' Equity 12-18 72 61 133 23 156 175 156 331 487 $ 55 41 96 14 110 163 118 281 391 17 20 9 12 38 Statement of Cash Flows Indirect Method Example UNDER ARMOUR, INC. Income Statement (in millions) Net l N t sales Cost of sales Gross profit Operating expenses: Selling, general, and administative expenses Depreciation Total operating expenses Income from Operations Interest Expense Income before Income Tax Expense Income Tax Expense Net income N ti Year ended Dec. 31, 2008 $ 725 370 355 262 16 278 77 7 70 32 38 The Statement of Cash Flows using the indirect method will begin with Under Armor, Inc.'s net income from the Income Statement. $ 12-19 Indirect Reporting of Operating Cash Flows fO C Net Income Items included in net income that do not involve cash + Depreciation Changes in operating assets and liabilities + Decreases in current assets Increases in current assets Decreases in current liabilities + Increases in current liabilities Net cash provided (used) by operating activities When using the indirect method, start with accrual basis net income and adjust it for: ti d dj t f 1. items that are included in net income but do not involve cash, and 2. items that are not included in net income but do involve cash. 12-20 UNDER ARMOUR, INC. Statement of Cash flows For the Year Ended December 31, 2008 (in millions) Cash Flows from Operating Activities: Net Income $ 38 Next, adjust for the non-cash items included in t i i net income. For Under Armour, the only non-cash adjustment is f d i for depreciation. i ti 12-21 UNDER ARMOUR, INC. Statement of Cash flows For the Year Ended December 31, 2008 (in millions) Cash Flows from Operating Activities: Net Income Adjustments to reconcile net income to net j cash provided by operating activities: Depreciation $ 38 16 Accumulated Depreciation increased by $16 from $31 in the $16, 2007 Balance Sheet to $47 in the 2008 Balance sheet. The same $16 is shown as Depreciation in the 2008 Income Statement. Statement To complete the cash flows from operating activities section, we must examine comparative balance sheets to determine the changes in current assets and current liabilities from the beginning of the period to the end of the period. 12-22 UNDER ARMOUR, INC. Statement of CashCash flows Indirect Flows Statement of MethodFor the Year Ended December 31, 2008 Example These five items were shown earlier in the current portions of (in millions) Under Armour's comparative Balance Sheets for 2007 and 2008 Cash Flows from Operating Activities: Net Income $ Current Assets Current Liabilities 38 Subtract from Adjustments to reconcile net income to net Add to j Increase net i t income. net i t income. cash provided by operating activities: Subtract from Add to Decrease net income. Depreciation net income. 16 Changes in current assets and current liabilities: g Decrease in Accounts Receivable 13 Increase in Inventory (16) Increase in Prepaid Expense p p ( ) (9) Increase in Accounts Payable 17 Increase in Accrued Liabilities 20 Net cash provided (used) by operating activities $ 79 12-23 Learning Objective 3 Report cash flows from investing activities. i ti ti iti 12-24 Reporting Cash Flows from Investing Activities I i A i ii We will need this additional data to prepare the investing portion of the statement. 1. No disposals or impairments of equipment or intangibles occurred 2. 2 Equipment costing $36 million and intangibles costing $2 million were purchased with cash. 12-25 Reporting Cash Flows from Investing Activities I i A i ii UNDER ARMOUR, INC. Statement of Cash flows For the Year Ended December 31, 2008 (in millions) Net cash provided (used) by operating activities Cash Flows from Investing Activities: Purchase of equipment Purchase of intangible and other assets Net cash provided (used) by investing activities $ 79 (36) (2) (38) Cash Armour, Inc., has two Under Flows from Financing Activities: debtinvesting 16 g g Additional borrowings of long-term long-term activities on the S debt i iPayments on h Statement of C h Fl i f Cash Flows(7) h that Proceeds from stock issuance 12 required provided by (usedcash: activities the use of in) financing Net cash 21 62 1. Net increase (decrease) in cash & cash and 1 Purchase of equipment ofequivalents equipment, period Cash & cash equivalents at beginning 40 Cash & cash equivalents at end of period $ 102 2. Purchase of intangible and other assets. 12-26 Learning Objective 4 Report cash flows from financing activities. fi i ti iti 12-27 Reporting Cash Flows from Financing A i i i Fi i Activities We will need this additional data to prepare the financing portion of the statement. 1. No dividends 1 N di id d were d l d or paid. declared id 2. Long-term debt of $7 million was paid. g 3. $16 million in new long-term loans were issued. 4. Shares of stock were issued for $12 million. 12-28 Reporting Cash Flows from Financing A i i i Fi i Activities UNDER ARMOUR, INC. Statement of Cash flows For the Year Ended December 31, 2008 (in millions) Net cash provided (used) by operating activities Cash Flows from Investing Activities: Purchase of equipment Purchase of intangible and other assets Net cash provided (used) by investing activities $ 79 (36) (2) (38) Cash Flows from Financing Activities: Additional borrowings of long-term debt 16 Payments on long-term debt (7) Proceeds 12 Long- from debt increased because of $16 in Long-term stock issuance Net cash provided by (used in) financing activities 21 new loans during the year. equivalents -term debt The long longNet increase (decrease) in cash & cash q ( ) 62 Cash & cash equivalents at beginning of period 40 increase is a cash inflow. Cash & cash equivalents at end of period $ 102 12-29 Reporting Cash Flows from Financing A i i i Fi i Activities UNDER ARMOUR, INC. Statement of Cash flows For the Year Ended December 31, 2008 (in millions) Net cash provided (used) by operating activities Cash Flows from Investing Activities: Purchase of equipment Purchase of intangible and other assets Net cash provided (used) by investing activities $ 79 (36) (2) (38) Cash Flows from Financing Activities: Additional borrowings of long-term debt 16 Payments on long-term debt (7) Proceeds from stock issuance 12 Payments on long-by (used in) financing activities a cash outflow of long-term debt resulted in Net cash provided 21 Net increase (decrease) in cash & cash two long-term debt ) q 62 $7. The ( net effect of these equivalents longg Cash & cash equivalents long-term debt 40 transactions increasedat beginning of period by $9, from $14 on longCash & cash equivalents at end of period $ 102 the 2007 Balance sheet to $23 on the 2008 Balance Sheet. 12-30 Reporting Cash Flows from Financing A i i i Fi i Activities UNDER ARMOUR, INC. Statement of Cash flows For the Year Ended December 31, 2008 (in millions) Net cash provided (used) by operating activities Cash Flows from Investing Activities: Purchase of equipment Purchase of intangible and other assets Net cash provided (used) by investing activities $ 79 (36) (2) (38) Cash Flows from Financing Activities: Additional borrowings of long-term debt 16 Payments on long-term debt (7) Proceeds from stock issuance 12 Net cash provided by (used in) financing activities 21 TheNet increase (decrease) in cash &the issuance of common stock third financing activity is cash equivalents ( ) q 62 resulting in a cashequivalents at beginning of period Capital increased from $12. Contributed Cash & cash inflow of $ 40 Cash 2007 equivalents at end to $175 $ 102 $163 in the& cash Balance Sheet of period in the 2009 Balance Sheet. 12-31 Reporting Cash Flows from Financing A i i i Fi i Activities UNDER ARMOUR, INC. Now we can reconcile the of Cash flows cash to the ending change in Statement $102 cash balance Year Ended December 31,the Balance Sheet. For the that appears on 2008 (in millions) Net cash provided (used) by operating activities Cash Flows from Investing Activities: Purchase of equipment Purchase of intangible and other assets Net cash provided (used) by investing activities Cash Flows from Financing Activities: Additional borrowings of long-term debt Payments on long-term debt Proceeds from stock issuance Net cash provided by (used in) financing activities Net increase (decrease) in cash & cash equivalents ( ) q Cash & cash equivalents at beginning of period Cash & cash equivalents at end of period 12-32 $ 79 (36) (2) (38) 16 (7) 12 21 62 40 102 $ Noncash Investing and Financing A i i i Fi i Activities Required Supplemental Information: (in millions) 1. Cash paid for taxes and interest. Cash Flows from Investing Activities: Purchase of equipmentcash 2. Significant non-cash investing non Purchase of intangible and other assets financing activities. Net cash provided (used) by investing activities Net cash provided (used) by operating activities $ 79 and (36) (2) (38) 16 (7) 12 21 62 40 102 7 12 Cash Flows from Financing Activities: Additional borrowings of long-term debt long term Payments on long-term debt Proceeds from stock issuance Net cash provided by (used in) financing activities Net increase (decrease) in cash & cash equivalents Cash & cash equivalents at beginning of period Cash & cash equivalents at end of period Supplemental Disclosures Cash paid for interest Cash paid for income tax 12-33 $ $ Learning Objective 5 Interpret cash flows from I t t h fl f operating, investing, and p g, g, financing activities. 12-34 Evaluating Cash Flows Operating cash flows must be positive over the long-run for a company to be successful. An upward trend in operating cash flows over time indicates growth and efficient operations. 12-35 Evaluating Cash Flows Quality of Income I Ratio = Net Cash Flow from Operating Activities p g Net Income A measure for determining what portion of a company's income was generated in cash. A ratio near 1.0 indicates a high likelihood that revenues are realized in cash and that expenses are associated with cash outflows. i d ih h fl Quality of Income Ratio 12-36 = 79 38 = 2.08 for Under Armour in 2008 Evaluating Cash Flows Capital Acquisitions = Ratio Net C h Flow f N t Cash Fl from Operating Activities O ti A ti iti Cash Paid for Property, Plant, and Equipment A measure for determining whether a company is generating enough cash internally to purchase long-term assets. A ratio greater than 1.0 indicates that outside financing was not needed to purchase long-term assets longassets. Capital Acquisitions = Ratio 12-37 79 36 = 2 19 for Under Armour in 2008 2.19 Chapter 12 Exercises E12-2, E12-3, E12-4, E12-5, E12-6 E12-2 Understanding the Computation of Cash Flows from Operating A ti iti (I di t M th d) Activities (Indirect Method) Suppose your company sells services of $150 in exchange for $100 cash and $50 on account. q Required: 1. Show the journal entry to record this transaction. Record dr Cash (+A) dr Accounts Receivable (+A) cr Service Revenue (+R) (+SE) 100 50 150 2. Identify the amount that should be reported as net cash flows from operating activities. The $100 increase in cash is reported as net cash flows from operating activities. 12-39 E12-2 Understanding the Computation of Cash Flows from Operating A ti iti (I di t M th d) Activities (Indirect Method) Required: 3. Identify the amount that would be included in net income. y $150 of service revenue would be included in net income. 4. Show how the indirect method would convert net income (requirement 3) to net cash flows from operating activities (requirement 2) 2). Net Income Less: Accounts Receivable increase Net Cash Flow from Operating Activities $ 150 (50) $ 100 5. What general rule about converting net income to operating cash flows is revealed by your answer to requirement 4? When Accounts Receivable increases, Sales Revenue is greater than cash received, so subtract the increase to convert Net Income to Cash Flow from Operating Activities Activities. 12-40 E12-3 Understanding the Computation of Cash Flows from Operating A ti iti (I di t M th d) Activities (Indirect Method) Suppose your company sells services for $300 cash this month. Your company also pays $100 in wages, which includes $20 that was payable at the end of the previous month and $ for wages of this month. p $80 g Required: 1. Show the journal entries to record these transactions. Record dr Cash (+A) cr Service Revenue (+R) (+SE) 300 300 Record dr Wages Payable ( ) g y (-A) dr Wages Expense (+E) (-SE) cr Cash (-A) 20 80 100 12-41 E12-3 Understanding the Computation of Cash Flows from Operating A ti iti (I di t M th d) Activities (Indirect Method) Required: 2. Identify the amount that should be reported as Net Cash Flows from Operating Activities. The $200 increase in Cash ($300 $100) should be reported as Net Cash Inflow from Operating Activities. 3. Identify the amount that would be included in Net Income. $300 of Service Revenue would be included along with Wages Expense of $80, for a Net Income of $220. 4. Show how the indirect method would convert Net Income (requirement 2). 3) to Net Cash Flows from Operating Activities (requirement 2) Net Income g y Less: Wages Payable decrease Net Cash Flow from Operating Activities 12-42 $ 220 ( ) (20) $ 200 E12-3 Understanding the Computation of Cash Flows from Operating Activities (Indirect Method) Required: 5. What general rule about converting Net Income to operating cash flows is revealed by your answer to requirement 4? When Wages Payable decreases, subtract that decrease to convert Net Income to Cash Flow from Operating Activities. Increase Decrease Current Assets Subtract from net i t income. Add to net income. Current Liabilities Add to net i t income. Subtract from net income. 12-43 E12-4 Understanding the Computation of Cash Flows from Operating A ti iti (I di t M th d) Activities (Indirect Method) Suppose your company sells services of $150 in exchange for $100 cash and $50 on account. Depreciation of $40 also is recorded. Required: 1. Show the journal entries to record these transactions. Record dr Cash (+A) dr Accounts Receivable (+A) cr Service Revenue (+R) (+SE) 100 50 150 Record dr Depreciation Expense (+E) (-SE) cr Accumulated Depreciation (+xA) (-A) 40 40 12-44 E12-4 Understanding the Computation of Cash Flows from Operating A ti iti (I di t M th d) Activities (Indirect Method) Required: 2. Identify the amount that should be reported as Net Cash Flows from Operating Activities. The $100 increase in cash should be reported as Net Cash Flows from Operating Activities. 3. Identify Income. 3 Identif the amount that would be included in Net Income amo nt o ld incl ded Net Income would include $150 of Service Revenue and $40 of Depreciation Expense, or $110 in total. 4. Show how the indirect method would convert Net Income (requirement 3) to Net Cash Flows from Operating Activities (requirement 2). Net Income Add: Depreciation Less: Accounts Receivable increase Net Cash Flow from Operating Activities 12-45 $ 110 40 (50) $ 100 E12-4 Understanding the Computation of Cash Flows from Operating Activities (Indirect Method) Required: 5. What general rules about converting Net Income to operating cash flows are revealed by your answer to requirement 4? yy q Two general rules are revealed: 1.Always add back the amount of depreciation subtracted in the Income Statement to convert Net Income to Cash Flow from Operating Activities. 2.When 2 When Accounts Receivable increases Sales Revenue is increases, greater than cash received, so subtract the increase to convert Net Income to Cash Flow from Operating Activities. 12-46 E12-5 Understanding the Computation of Cash Flows from Operating A ti iti I di t M th d) Activities Indirect Method) Suppose your company sells goods for $300, of which $200 is received in cash and $100 is on account. The goods cost your company $125. Your company also recorded wages of $70, of which only $30 has been paid in cash. Required: 1. Show the journal entries to record these transactions Record dr Cash (+A) dr Accounts Receivable ( A) (+A) cr Sales Revenue (+R) (+SE) 200 100 300 Record dr Cost of Goods Sold (+E) (-SE) cr Inventory (-A) 125 125 12-47 E12-5 Understanding the Computation of Cash Flows from Operating A ti iti (I di t M th d) Activities (Indirect Method) Required: 1. Show the journal entries to record these transactions Record dr Wages Expense (+E) (-SE) cr Wages Payable (+L) cr Cash (-A) 70 40 30 2. Identify the amount that should be reported as Net Cash Flows from y p Operating Activities. Net Cash Flows from Operating Activities would be $170, which equals the $200 received from customers minus the $30 paid to employees. p p y 3. Identify the amount that would be included in Net Income. Net income would be $105, which equals $300 of Sales Revenue minus C t of G d Sold ($125) and W i Cost f Goods S ld d Wages E Expense ($70) ($70). 12-48 E12-5 Understanding the Computation of Cash Flows from Operating A ti iti (I di t M th d) Activities (Indirect Method) Required: 4. Show how the indirect method would convert Net Income (requirement 3) to Net Cash Flows from Operating Activities (requirement 2). Net Income Add: Inventory decrease Wages Payable increase W P bl i Less: Accounts Receivable increase Net Cash Flow from Operating Activities $ 105 125 40 (100) $ 170 5. What general rules about converting Net Income to operating cash flows are revealed by your answer to requirement 4? Three general rules are revealed: 1.Add back decreases in noncash Current Assets. 2.Add back increases in Current Liabilities 3.Deduct i 3D d increases i noncash current A in h Assets. 12-49 E12-6 Preparing and Evaluating a Simple Statement of Cash Flows (I di t M th d) (Indirect Method) Suppose your company's Income Statement reports $105 of Net Income, and its comparative Balance Sheet indicates the following. Required: 1. Prepare the operating activities section of the Statement of Cash Flows, using the indirect method. 2. Identify the most important cause of the difference between the company's Net Income and Net Cash Flows from Operating Activities. 12-50 E12-6 Preparing and Evaluating a Simple Statement of Cash Flows (Indirect Method) Required: 1. Prepare the operating activities section of the Statement of Cash Flows, using the indirect method. First, let's determine the changes in Balance Sheet accounts. Beginning Ending Change ASSETS Current assets: Cash Accounts Receivable Inventory Total Current Assets Wages Payable Retained Earnings Total Assets 12-51 $ 35 75 260 370 10 360 370 $ 205 175 135 515 50 465 515 170 100 (125) 40 105 $ $ E12-6 Preparing and Evaluating a Simple Statement of Cash Flows (Indirect Method) Required: 1. Prepare the operating activities section of the Statement of Cash Flows, using the indirect method. Cash Flows from Operating Activities: Net Income Changes in current assets and current liabilities: g Accounts Receivable increase Inventory decrease Wages Payable increase Net cash provided (used) by operating activities $ 105 (100) 125 40 $ 170 Increase Decrease Current A C t Assets t Subtract from net income. Add to net income. Current Li biliti C t Liabilities Add to net income. Subtract from net income. 12-52 E12-6 Preparing and Evaluating a Simple Statement of Cash Flows (Indirect Method) Required: 2. Identify the most important cause of the difference between the company's Net Income and Net Cash Flows from Operating Activities. Cash Flows from Operating Activities: Net Income Changes in current assets and current liabilities: g Accounts Receivable increase Inventory decrease Wages Payable increase Net cash provided (used) by operating activities $ 105 (100) 125 40 $ 170 The most important cause of the difference is the $125 decrease in Inventory. The Inventory decrease indicates that Cost of Goods Sold (deducted in the Income Statement) was $125 more than the cash paid to purchase Inventory. I other words, the company sold I In th d th ld Inventory but did not t b t t replace it, creating a net cash inflow for the period. 12-53 End of Chapter 12 Chapter 13* *You may exclude the Supplemental Material Measuring and Evaluating Financial Performance PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Fred Phillips, Ph.D., CA Edited by: Muriel Anderson, MBA, CPA Learning Objective 1 Describe the purpose and uses of horizontal, vertical, and ratio analyses. 13-2 Horizontal, Vertical, and Ratio Analyses Horizontal (trend) analyses help financial statement users recognize important financial changes that unfold over time. For example: Trend Analysis in Gross Profit $ and/or % from 2009 to 2010 Vertical analyses focus on important relationships between items on the same financial statement. For example: 2010 Amount Percent Sales Cost of Goods Sold Gross Profit 13-3 $200,000 150,000 $ 50,000 100% 75% 25% Horizontal, Vertical, and Ratio Analyses Ratio analyses are conducted to understand relationships among various items reported in one or more of the financial statements. Receivable Turnover Ratio = Net Sales Revenue Average Net Receivables It is essential to understand that no analysis is complete unless it leads to an interpretation that helps financial statement users understand and evaluate a company's financial results 13-4 Learning Objective 2 Use horizontal (trend) analysis to recognize financial changes that unfold over time. 13-5 Horizontal (Trend) Computations Trend analyses are usually calculated in terms of year-to-year dollar and percentage changes. (Current Year's Total Prior Year's Total) Year-to-Year Change This Year = 100 Change (%) Prior Year's Total Let's look at an example 13-6 Horizontal (Trend) Computations $48,230 $48,283 100 $48,283 Now let's calculate the percentage Calculate lookchangeremainderandNet Now let's the at the thedollars for the Can you calculate in dollar of change in Net Sales Revenue between Sales analysis of the Income Statement. trend Revenue betweenCost of Sales? percentage change for 2009 and 2008. 2009 and 2008. 13-7 Learning Objective 3 Use vertical (common size) analysis to understand important relationships within financial statements. 13-8 Vertical (Common Size) Computations Vertical, or common size, analysis focuses on important relationships within financial statements. Income Statement Balance Sheet Sales = 100% Total Assets = 100% Cost of Sales 100 Net Sales Revenue 13-9 Learning Objective 4 Calculate financial ratios to assess profitability, liquidity, and solvency. 13-10 Ratio Computations Ratio analysis compares the amounts for one or more line items to the amounts for other line items in the same year. Ratios are classified into three categories . . . Profitability ratios examine a company's ability to generate income. Liquidity ratios help us determine if a company has sufficient current assets to repay liabilities when due. 13-11 Solvency ratios examine a company's ability to pay interest and repay debt when due. Common Profitability Ratios 13-12 Common Liquidity Ratios 13-13 Common Solvency Ratios 13-14 Learning Objective 5 Interpret the results of financial analyses. 13-15 Interpreting Horizontal and Vertical With 60 new stores opened, Lowe's had Analyses a 7.9% increase in inventory, and a 6.4% increase in Property and Equipment. Lowe's grew by 5.9% in fiscal 2009. 13-16 Interpreting Horizontal and Vertical Analyses The Company's cash position weakened between fiscal 2007 and 2008. There was a large increase in the inventory carried by the company. The accumulation of inventory is a sign of a weakening business outlook. 13-17 Interpreting Horizontal and Vertical Analyses Cost of sales and operating expenses Much of the decline in fiscal 2008 Net Income is explained by the increase in Cost of Sales and Operating Expenses. are the most important determinants of the company's profitability. 13-18 Interpreting Horizontal and Vertical Analyses Lowe's has experienced a 0.4% increase Lowe's did not do a good job of controlling its operating expenses between 2007 and 2008. The company is faced with lower gross profit and poor operating expense control. in its cost of goods sold from fiscal 2007 to 2008. Increasing cost of sales means lower gross profit. 13-19 Ratio Calculations 13-20 Ratio Calculations 13-21 Profitability Ratios Net Profit Margin Lowe's faced a challenging economic environment in 2008 as shown by the decline in Net Profit Margin. Gross Profit Percentage Lowe's gross profit percentage indicates how much profit was made on each dollar of sales after deducting the Cost of Goods Sold. 13-22 Profitability Ratios Asset Turnover Ratio indicates the amount of sales revenue generated for each dollar invested in assets during the period. Fixed Asset Turnover indicates how much revenue the company generates in sales for each dollar invested in fixed assets. Home Depot 2008 fixed asset turnover ratio was 2.65 13-23 Profitability Ratios Return on Equity (ROE) Compares the amount of net income to average stockholders' equity. ROE reports the net amount earned during the period as a percentage of each dollar contributed by stockholders and retained in the business. Earnings Per Share (EPS) Shows the amount of earnings generated for each share of outstanding common stock. 13-24 Profitability Ratios Quality of Income Quality of income ratio relates operating cash flows (from the Statement of Cash Flows) to net income. Home Depot 2008 Quality of Income Ratio was 2.45 Price /Earnings (P/E) Ratio Shows the relationship between EPS and the market price of one share of the company's stock. 13-25 Liquidity Ratios Let's change our attention to an examination of liquidity ratios. The analyses in this section focus on the company's ability to survive in the short term, by converting assets to cash that can be used to pay current liabilities as they come due. Receivable Turnover Ratio Most retail home improvement companies have low levels of accounts receivable relative to sales revenue because they collect the majority of their sales immediately in cash. Receivable Turnover Ratio 13-26 = Net Sales Revenue Average Net Receivables Liquidity Ratios Inventory Turnover Ratio The inventory turnover ratio indicates how frequently inventory is bought and sold. The "days to sell" indicates the average number of days needed to sell each purchase of inventory. Home Depot sells its inventory in an average of 87 days in 2008. Current Ratio The current ratio measures the company's ability to pay its current liabilities 13-27 Liquidity Ratios Quick Ratio The quick ratio is a much more stringent test of short-term liquidity than is the current ratio. Lowe's quick ratio increased slightly in 2008, just as its current ratio did. Referred to as "quick assets." Let's examine some Solvency Ratios Solvency ratios focus on a company's ability to survive over the long term, that is, to repay debt when it matures, pay interest until that time, and finance the replacement and/or expansion of long-term assets. 13-28 Solvency Ratios Debt to Assets Ratio indicates the proportion of total assets that creditors finance. In 2008, The Home Depot had a debt-to-assets ratio of 57 percent. Times Interest Earned indicates how many times the company's interest expense was covered by its operating results. 13-29 Solvency Ratio Capital Acquisition Ratio compares cash flows from operations with cash paid for property and equipment. 13-30 Learning Objective 6 Describe how analyses depend on key accounting decisions and concepts. 13-31 Underlying Accounting Decisions and Concepts Accounting Decisions Difference in Strategies, e.g. type of financing. Difference in Operations, e.g. quality of items sold. Difference in Accounting Methods, e.g. FIFO vs. LIFO. 13-32 Accounting Concepts Companies may elect to use any acceptable generally accepted accounting principle (GAAP) as long as they apply the principle consistently. 13-33 Conceptual Framework for Financial Accounting and Reporting Objective of External Financial Reporting To provide useful financial information to external users for decision making (Ch. 1) It must be relevant and a faithful representation of the business. It is more useful if it is comparable, verifiable, timely, and understandable. Elements to be Measured and Reported Assets, Liabilities, Stockholders' Equity, Revenue, Expenses (Ch. 1) Concepts for Measuring and Reporting Information Assumptions: Unit of Measure (Ch. 1), Separate Entity (Ch. 1) Going Concern, Time Period (Ch. 3) Principles: Cost (Ch. 2), Revenue Recognition (Ch. 3), Matching (Ch. 3), Full Disclosure Exceptions Cost-Benefit, Materiality (Ch. 5), Industry Practices 13-34 Factors Contributing to Going-Concern Problems Factors that commonly contribute to going-concern problems are listed below. 13-35 Chapter 13 Exercises M13-6, E13-1, E13-3, E13-4, E13-10, E13-13 M13-6 Inferring Financial Information Using Gross Profit Percentage and Year-over-Year Comparisons A consumer products company reported a 25 percent increase in sales from 2009 to 2010. Sales in 2009 were $200,000. In 2010, the company reported Cost of Goods Sold in the amount of $150,000. What was the gross profit percentage in 2010? Round to one decimal place. Sales ($200,000 1.25) Cost of Goods Sold (given) Gross Profit $ 250,000 (150,000) $ 100,000 100.0% -60.0% 40.0% $100,000 100 = 40.0% $250,000 13-37 E13-1 Preparing and Interpreting a Schedule for Horizontal and Vertical Analyses The average price of a gallon of gas in 2008 jumped $0.45 (16 percent) from $2.81 in 2007 (to $3.26 in 2008). Let's see whether these changes are reflected in the income statement of Chevron Corporation for the year ended December 31, 2008 (amounts in billions). Required: 1. Conduct a horizontal analysis by calculating the year-over-year changes in each line item, expressed in dollars and in percentages (rounded to one decimal place). How did the change in gas prices compare to the changes in Chevron Corp.'s total revenues and costs of crude oil and products? 2. Conduct a vertical analysis by expressing each line as a percentage of total revenues (round to one decimal place). Excluding income tax and other operating costs, did Chevron earn more profit per dollar of revenue in 2008 compared to 2007? 13-38 E13-1 Preparing and Interpreting a Schedule for Horizontal and Vertical Analyses Req. 1 The 16% increase in the average gas price was less than the 23.5% increase in total revenues and the 28.6% increase in cost of crude oil and products. It appears from this analysis that the increase in gas prices explains only part of Chevron's increase in total revenues. Note that the percentage increase in total revenues was less than the percentage increase in the cost of crude oil and products, suggesting the costs of crude oil really did increase a lot in 2008, necessitating the increase in gas prices. 13-39 E13-1 Preparing and Interpreting a Schedule for Horizontal and Vertical Analyses Req. 2 As a percent of total revenues, Chevron's cost of crude oil and products was higher in 2008 (62.6%) than in 2007 (60.2%). This implies that Chevron earned less profit (excluding income tax and other operating costs) per dollar of revenues in 2008 than in 2007. 13-40 E13-3 Preparing and Interpreting a Schedule for Horizontal and Vertical Analyses According to the producer price index database maintained by the Bureau of Labor Statistics, the average cost of computer equipment fell 20.9 percent between 2007 and 2008. Let's see whether these changes are reflected in the income statement of Computer Tycoon Inc. for the year ended December 31, 2008. Required: 1. Conduct a horizontal analysis by calculating the year-over-year changes in each line item, expressed in dollars and in percentages (rounded to one decimal place). How did the change in computer prices compare to the changes in Computer Tycoon's sales revenues? 2. Conduct a vertical analysis by expressing each line as a percentage of total revenues (round to one decimal place). Excluding income tax, interest, and operating expenses, did Computer Tycoon earn more profit per dollar of sales in 2008 compared to 2007? 13-41 E13-3 Preparing and Interpreting a Schedule for Horizontal and Vertical Analyses Req. 1 The 20.9% decrease in the average price of computer equipment was more than the 18.8% decrease in total revenues. It appears from this analysis that the 20.9% decrease in computer prices was partially offset by an increase in Computer Tycoon's sales volumes, leaving an overall decrease in sales revenues of 18.8%. 13-42 E13-3 Preparing and Interpreting a Schedule for Horizontal and Vertical Analyses Req. 2 Excluding income tax, interest, and operating expenses (i.e., looking at gross profit), we see that Computer Tycoon earned 40.1% gross profit in 2008, which is down from 41.2% in 2007. In other words, Computer Tycoon earned 1.1 cents less (40.1 41.2) per dollar of revenues in 2008 than in 2007. 13-43 E13-4 Computing Profitability Ratios Use the information in E13-3 to complete the following requirements. Required: 1. Compute the gross profit percentage for each year (one decimal place). Assuming that the change for 2007 to 2008 is the beginning of a sustained trend, is Computer Tycoon likely to earn more or less gross profit from each dollar of sales in 2009? 2. Compute the net profit margin for each year (expressed as a percentage with one decimal place). Given your calculations here and in requirement 1, explain whether Computer Tycoon did a better or worse job of controlling operating expenses in 2008 relative to 2007. 3. Computer Tycoon reported average net fixed assets of $54,200 in 2008 and $45,100 in 2007. Compute the fixed asset turnover ratios for both years (round to two decimal places). Did the company better utilize its investment in fixed assets to generate revenues in 2008 or 2007? 4. Computer Tycoon reported average stockholders' equity of $54,000 in 2008 and $40,800 in 2007. Compute the return on equity ratios for both years (expressed as a percentage with one decimal place). Did the company generate greater returns for stockholders in 2008 or 2007? 13-44 E13-4 Computing Profitability Ratios Req. 1 If these results are the beginning of a sustained trend, then it is likely that Computer Tycoon will have lower total revenues in 2009, and a slight decline in gross profit percentage. The gross profit percentage of 40.1% means that the company generated 40.1 cents of gross profit on each dollar of sales in 2008, which was down a little more than one cent from 2007. If this continues, the company could be expected to generate even less gross profit from each dollar of sales in 2009. 13-45 E13-4 Computing Profitability Ratios Req. 2 Computer Tycoon did a worse job of controlling expenses (other than the cost of goods sold) in 2008 relative to 2007 because the net profit margin decreased 4.8% (5.9 1.1) at the same time that the gross profit percentage decreased only 1.1% (from 41.2% to 40.1%). This also is evident from the horizontal analysis in E13-3, which indicates that while sales and cost of sales decreased by 18.8% and 17.2%, operating expenses actually increased slightly (by less than 0.1%). 13-46 E13-4 Computing Profitability Ratios Req. 3 The company did not better utilize its investment in fixed assets in 2008. Its fixed asset turnover ratio fell from 2.70 in 2007 to 1.82 in 2008. The 2008 ratio means that the company generated $1.82 of sales revenue for every dollar invested in fixed assets. 13-47 E13-4 Computing Profitability Ratios Req. 4 No, the company did not generate better returns for stockholders in 2008 (2.1%) than in 2007 (17.7%). This decline in ROE is caused by the significant decrease in net income (over 84% as shown in E13-3) coupled with an increase in stockholders' equity of 32.4% [($54,000 40,800) 40,800 x 100]. 13-48 E13-10 Inferring Financial Information from Profitability and Liquidity Ratios Dollar General Corporation operates approximately 8,400 general merchandise stores that feature quality merchandise at low prices to meet the needs of middle-, low-, and fixed-income families in southern, eastern, and mid-western states. For the year ended January 30, 2009, the company reported average inventories of $1,352 (in millions) and an inventory turnover of 5.47. Average total fixed assets were $1,272 (million), and the fixed asset turnover ratio was 8.22. Required: 1. Calculate Dollar General's gross profit percentage (expressed as a percentage with one decimal place). What does this imply about the amount of gross profit made from each dollar of sales? TIP: Work backward from the fixed asset turnover and inventory turnover ratios to compute the amounts needed for the gross profit percentage. 2. Is this an improvement from the gross profit percentage of 28.2 percent earned during the previous year? 13-49 E13-10 Inferring Financial Information from Profitability and Liquidity Ratios Req. 1 We can get the net sales number from the fixed assets turnover ratio and the cost of goods sold number from the inventory turnover ratio, as shown below. Fixed asset turnover = Net sales Average fixed assets 8.22 = Net sales $1,272,000,000 8.22 x $1,272,000,000 = Net sales $10,455,840,000 = Net sales Inventory turnover = Cost of goods sold Average inventory 5.47 = Cost of goods sold $1,352,000,000 5.47x $1,352,000,000 = Cost of goods sold $7,395,440,000 = Cost of goods sold So, Gross profit percentage = (Net sales cost of goods sold) Net sales = 0.293 or 29.3% 13-50 E13-13 Analyzing the Impact of Selected Transactions on the Current Ratio The Sports Authority, Inc., is the country's largest private full-line sporting goods retailer. Stores are operated under four brand names: Sports Authority, Gart Sports, Oshman's, and Sportmart. Assume one of the Sports Authority stores reported current assets of $88,000 and its current ratio was 1.75. Assume that the following transactions were completed: 1) paid $6,000 on accounts payable, 2) purchased a delivery truck for $10,000 cash, 3) wrote off a bad account receivable for $2,000, and 4) paid previously declared dividends in the amount of $25,000. Required: Compute the updated current ratio rounded to two decimal places, after each transaction. 13-51 E13-13 Analyzing the Impact of Selected Transactions on the Current Ratio 13-52 End of Chapter 13 ...
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MGA201Binder - Chapter 2 Reporting Investing and Financing...

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