Quick Study Sheet INTRO TO FS Financial Statements: Shows assets and liabilities and ownership equity on a specific date.

Income Statement: Shows revenues and expenses, gains and losses, during a period of time Statement of O.E. Shows the activity of owners - receipt of funds and dividends paid. Shows the earnings of the business that go to the shareholders C F Statement: Shows the source of cash and what the cash was used for this period What does each financial statement really tell you about the business? Balance Sheet: What the company has and what they owe on this date Income Statement: How much the company earned during this period of time Owners Equity: What occurred that impacted the owners of the company Cash Flows: Cash generated from day to day operations, use for, additional cash from? Retained Earnings is the amount of cumulative profits and losses kept in the company Beginning R.E. + Net Income Dividends Paid = Ending R. E. put on the balance sheet The cash flow statement has 3 separate sections: Operating Activities: directly related to earning income, changes in current assets and current liabilities Investing Activities: cash flows related to buying and selling long term assets Financing Activites: cash flows related to borrowing and repaying L/T debt, to / from owners Elements that are reported on the financial statements Asset: The companys economic resource used to operate the business company OWNS 1) Probable future economic benefit 2) Owned or controlled by the business 3) Resulting from a past transaction, something that has already occurred Liability: The companys debts and obligations What the company OWES 1) Probable use of a future economic benefit (an asset) 2) Owed 3) Resulting from a past transaction Give up an asset to pay what is owed Stockholders Equity: Earnings and financing provided by the owners (Assets Liabilities) Revenues: Earned from providing goods or services in exchange for an asset Expenses: Using an asset of the company to provide goods or services Important: Revenues and Expenses do not occur when the cash is received or paid Assets = BALANCE SHEET Quick Study Sheet The Format of the Balance Sheet: Assets: Current Assets Cash Accounts Receivable (Liabilities) Inventory Prepaid Expenses Payables Short-term Investments Short-term Notes Receivable Supplies term Debt Total Current Assets Liabilities Long-term Investments Long-term Notes Receivable Liabilities: Current Liabilities: Accounts Payable Accrued Expenses Unearned Revenues _______ Income Taxes Payable Short-term Notes Payable Current Portion of LongTotal Current Balance Sheet:

The Accounting Equation: Must always stay in balance Liabilities + O.E.

Bonds Payable Long-term Debt Long term Notes Payable Total Liabilities Property/Plant/Equipment (P/P/E): Land Building Equipment Less Accumulated Depreciation Net P/P/E Stockholders Equity: Common Stock Additional Paid in Retained Earnings less Treasury Stock Total Stockholders Equity Other Assets

Generally Accepted Accounting Principles - GAAP: Guidelines established by various standard setting groups in consultation with accounting professionals FASB IASB SEC Footnotes: Additional information provided after the financial statements

Intangible Assets Goodwill Capital Patents, net Trademarks, net Copyrights, net Total Intangible Assets

Auditors Report: A professional accountant examines the companys financial statements and gives a report that determines if the statements are fairly stated in accordance with GAAP.

Total Assets

= Total Liabilities & Stockholders Equity

of the bond - the x the last amount owed (same for End at MV periods) cash exchanged x MV all

Operating cycle the time it takes a company to spend cash to do business and get the cash back again. Buy inventory, pay expenses, sell the inventory to a customer, collect receivables The balance sheet is listed in the order of liquidity how soon it will impact cash Current means the cash is expected to be collected or paid in 1 year or less Long term/Non-current means the cash is expected to be collected or paid > 1 year The balance sheet is reported at historical cost; FM value on the date of the transaction. Quick Study Sheet Bonds Payable Bonds Payable borrow from investors who invest in the bond to earn interest income Maturity Value: Amount that must be repaid (usually in $1,000s) Maturity Date: Date the maturity value amount must be repaid Stated Interest Rate: Coupon amount paid as interest, periodically Market Yield/Effective interest rate: The interest expense the company really incurs, Regardless of what is paid at the beginning, the face value must be paid at maturity date Discount: Cash exchanged is less than face value Premium: Cash exchanged is more than face value

Quick Study Sheet Long - Term Installment Loans / Notes Payable / Mortgage Payable: Long - Term Installment Loans / Notes Payable / Mortgage Payable: Borrow money from bank, must repay periodically in equal payments. The payments must cover interest expense and repayment of principle

Difference:

Amount Owed Payment Interest 10 % principle (Carrying value) Journal entries:

to repay

Borrow: Cash Note Payable

Payments Interest Expense Note Payable Cash

Determining the price of the bond: A bond that trades at 98 means: 98% (.98) x the maturity value invested in = price If the bond price is not stated, it can be calculated using the effective interest rate, the number of periods until maturity, and the coupon rate. Total periodic coupon payment** x present value factor of an annuity + Maturity value x present value factor of a single amount = Amount paid now to get the effective interest rate return on your money

Journal Entries related to the bond payable: Cash Expense Discount/Premium Bonds Payable Interest Premium/Discount Cash

Cash Amortization Table: Effective Coupon Discount or Premium Cash money or any instrument that banks will accept for deposit to a companys account. includes checks, money orders, bank drafts Cash Equivalents investments with maturities of 3 months or less, readily Key Things to Know

Amount owedInterest Exp. - Interest = Difference +/"Carrying value" "Yield %" "Stated %" or "Market %"

Begin with the price "coupon %"

convertible into cash and whose market value is unlikely to change CDs and Treasury Bills Cash management includes: 1) ensure enough cash is on hand to pay liabilities 2) make sure excess cash is used to maximize interest earned 3) accurate tracking of cash for reports balance sheet and cash flow statement Internal Control safeguard the cash prevent fraud and theft 1) separate duties for receiving and paying cash 2) separate duties for accounting for receipts and payments 3) separate duties for handling cash and accounting for cash Required for good internal controls: 1) Deposit checks daily 2) Separate authorization of the purchase and the payment 3) Use pre-numbered checks and account for each one 4) Reconcile bank statements monthly Bank Reconciliation: Compare the ending cash balance in the companys general ledger cash account to the ending cash balance on the bank statement Should be done at the end of each month The bank statement will not agree to the general ledger balance because of timing differences related to receipts and payments and the fact that the company waits to record some items until they know the amount on the bank statement. The general ledger cash account will record each month: 1) Checks written 2) Deposits The bank statement will show the following transactions each month: 1) Checks that have cleared and been paid 2) Deposits that have been added to the account 3) Checks that did not clear (bounced) NSF checks 4) Bank fees 5) Interest earned 6) Automatic withdrawals and deposits The difference in the cash account and the bank statement will be accounted for by the items that are on one account/statement and not on the other or errors made. Items the bank has recorded - company has not yet recorded in the cash account: 1) Non sufficient funds check 2) Bank fees and service charges 3) Interest earned 4) automatic deposits and withdrawals These items are listed in the cash account column on the reconciliation Items recorded in the cash account the bank has not yet recorded 1) Outstanding checks 2) Deposits in transit These items are listed in the bank column on the reconciliation Terms to Know: Outstanding Checks: Checks written by the company, not yet cleared by the bank and not deducted from the bank balance. Compare the checks written by the company to the checks that

are cleared on the bank statement those not cleared on the bank statement are called outstanding checks Deposits in Transit: Deposits sent to the bank, not yet added to the account by the bank. Compare the deposits made by the company to the deposits that are recorded by the bank those not on the bank statement yet are deposits in transit NSF Checks non sufficient funds - a bounced check that was not deposited to the companys account because the funds were not available. The accounts receivable was not really collected Completing the bank reconciliation: Set up two columns one for cash account and one for the bank Start with the ending balance for the month for each In the cash column put the items the bank knows about and recorded that the company has not yet recorded 1) Non sufficient funds check 2) Bank fees and service charges 3) Interest earned 4) automatic deposits and withdrawals In the bank column put the items the company knows about and recorded that the bank has not yet recorded. 1) Outstanding checks 2) Deposits in transit Record any error made by either party; put the error fix in the column of the one who made the error Total the two columns to get the adjusted ending balance The two columns will agree when you have accounted for all the differences A journal entry must be made for items in the cash column that have not yet been recorded: 1) Negative items are a credit to cash 2) Positive items are a debit to cash 3) NSF checks are a debit to accounts receivable 4) Automatic deposits credit whatever the money was received for 5) Automatic payments debit whatever the money was paid for Do not put items in the bank column in the journal entry Record only the amounts you put in the cash column in the journal entry

Accounts Receivable Key Things To Know

uncollectible accounts receivable. The accounts that are used to record accounts receivable transactions are: Sales represents the amount of goods or services provided Accounts receivable represents the amount the customer owes Allowance for uncollectible accounts represents the total amount you do not expect to collect it is an estimate, you dont know who wont pay or how much Bad debt expense the current period estimate of what you wont collect

Revenue is recognized when: 1) the good or service has been provided, and 2) you expect that you will be paid Sell on credit provide them the good/service now and they pay you later. When payment is due is based on the terms agreed upon Example: 2/10, net30 means 2% discount / if pay in 10 days, or, full payment is due in 30 days net60 no discount offered, payment due in 60 days Companies offer a discount in order to collect cash quicker when they need cash It is very costly to offer a discount, but necessary if the company is not able to borrow money at a lower interest rate When a payment (cash) discount is taken it is called a sales discount Sales discounts are reported on the income statement as: Sales - Sales Discount = Net Sales

There are 4 key transactions that must be recorded for accounts receivables: 1) The sale on credit, which creates the accounts receivable 2) The collection of the accounts receivable when a customer pays 3) The estimate of bad debt expense: you dont know exactly how much wont be collected from customers, but you know you wont collect it all from past history. You must estimate the expense at the end of the period to match with sales. 4) The write off of an accounts receivable when you know who wont pay you and exactly how much wont be collected. This occurs much later after the sale.

Journal entries for the 4 transactions are: Journal entries for sales on credit and payment received when a discount is offered: (this method is referred to as the gross method of accounting for receivables) Sales A/R Sales Payment received -take discount discount taken Sales Discount Cash A/R The sales and the accounts receivable is always for the full amount of the sale. The cash is the amount actually received (sales x 1 discount % if discount is taken) The sales discount amount is: sales $ x discount % offered Payment received no Cash A/R Sales on credit receivable Accounts Receivable Sales Receivable Estimate bad debt expense: receivable: Bad debt expense uncollectible accounts Allowance for uncollectible accounts Receivable (Bad debt expense can be a credit when using the % of A/R method) Allowance for Accounts Write off accounts Cash Accounts Collect accounts

The balance sheet for accounts receivable will show: On the Balance Sheet: It means: The accounts are changed by the following transactions: Accounts Receivable: Increases when a sale is made on credit Decreases when the customer pays Decreases when an account is written off you know who wont pay and amount Allowance for Uncollectible Accounts: Increases when estimating bad debt expense using % sales

Accounts Receivable Total amount customers owe you - Allowance for Uncollectible Accounts - Amount you dont think you will collect = Net Accounts Receivable = Amount you do think you will collect The asset reported on the balance sheet, net accounts receivable, must be the amount you expect to be a future benefit. There is no benefit to an

method Increases or decreases when estimating bad debt expense using % of accounts receivable (the up or down depends on how much is already in the account) Decreases when an account is written off The allowance account represents the total estimate of what wont be collected. The company is not sure who wont pay or exactly how much. When they know who and how much wont pay, they take it out of this account and take it off the accounts receivable list and out of the accounts receivable account. Bad Debt Expense: Changes ONLY when you estimate bad debt at the end of the period If you overestimated in prior periods you can take some expense away when you are using the % of accounts receivable (aging) method.

this period Bad debt expense can be a credit when using % of A/R (aging) method Bad Debt Expense: Occurs when you do not get paid for a receivable. The bad debt expense must be recorded in the same period the sale is made. (This follows the matching principle: match revenues with all expenses) Problem: You dont know how much you wont collect in the period of the sale. You wont know until much later when the customer doesnt pay. Solution: You must estimate, (based on past history) the amount you wont collect and record this expense in the same period as the sale There are two ways to estimate the amount of bad debt expense for the current period: % of sales & % of accounts receivable % of Sales Method:

The 4 transactions change the accounts: Accounts Receivable Beg. Bal Write-offs Sales Collections ___________________ Amount customers owe ___________________

Sales X % of sales the company historically doesnt collect (given) = Bad debt expense Record the bad debt expense amount you calculated Bad Debt Expense $XXXX Allowance for uncollectible accounts $XXXX You are doing a direct match of the bad debt expense to sales. This amount is also added to the account that accumulates the total amount of accounts receivable you do not expect to collect (the allowance account).

Allowance for Uncollectible Accounts Beginning balance Write-offs Estimate of bad debt expense ___________________ ___________________ Amount you do not expect to collect

% of Accounts Receivable (aging method): X Accounts Receivable % of accounts receivable the company historically does not collect (given) = The total amount of accounts receivable the company does not expect to collect This amount must be the ending balance in the allowance for uncollectible accounts account

Sales Provide Goods

Make your journal entry for the amount (plug) it takes to get the balance in the allowance account to be the amount you calculated above. Allowance for Uncollectible Accounts Beginning balance Write-offs ___________________ ___________________ Balance before estimate

Bad Debt Expense Estimate of bad debt expense

Plug? or ___________________

Plug? ___________________ Ending Balance**

** The ending balance must be the number you calculated above The journal entry for the amount of the plug will either be: Allowance for uncollectible accounts Bad debt expense Bad debt expense or Allowance for uncollectible accounts

an expense Beginning Inventory + Purchases = Available for sale - Ending Inventory ** = Cost of Goods Sold ** Ending inventory is valued at the quantity on hand x the cost for each one The ending inventory is the amount reported on the balance sheet. On the Balance Sheet - reported inventory as the total $ of all items = quantity x cost:

When you have an aging report which shows how old the accounts are and the % that is estimated to be uncollectible for each category, you must multiply the balance x the % given for each category and add them all up to get the total amount you do not expect to collect. (See Practice As You Learn for an example). When you have the total, follow the same procedures described above.

Quantity 100 50 200 500

Each Cost 25 10 15 5

Total C 2,50 500 3,00 2,50 8,50

Inventory will be reported at a cost of $8,500 on the balance sheet Which cost do you use to value inventory when the same item is purchased at different unit costs and items are exactly the same? Example: Purchased 150 units of Item A at $24 and 200 units of Item A at $27 and 300 units of Item A at $26. You sold 550 to customers. What cost should you multiply by the total 100 quantity left to get the ending inventory amount? All items look the same and you can not tell what was actually paid for the items that are left. FASB gives you a choice of methods to use to value ending inventory when the same items are purchased at different costs: FIFO (first in first out):

The difference between the two methods: % of Sales & A/R (aging) % of Sales:

% of

You are calculating the total bad debt expense for the period You are estimating using this periods sales only You are calculating a cumulative amount that you do not expect to collect using the total amount that customers owe you from this period and all prior periods. The expense for this period is the change in the cumulative amount you dont expect to collect

% of A/R:

INVENTORY Key Things to Know Inventory: Items that you buy or make only for the purpose of selling the items to customers for a profit. Terms related to purchasing inventory that determines who owns the inventory when it is in transit (in shipment between the seller and the buyer) F.O.B. Destination: F.O.B. Shipping: Goods on Consignment: Buyer owns when they receive the goods Buyer owns at the time it is shipped (owns in transit) A company holds inventory for someone else, and does not take title. The company that has title to the inventory records the inventory.

Units purchased first are sold first. The last units purchased are the ones you have left LIFO (last in first out): Units purchased last are sold first. The first units purchased are the ones you have left Weighted Average: Inventory is valued at the average purchase cost. Total available cost divided by total available units = average cost per unit Specific Identification: Use when you are able to tell the specific cost of the item in inventory. Each method will give a different cost of goods sold expense and inventory cost. In times of inflation: FIFO gives a lower cost of goods sold and higher income than LIFO In times of deflation:

Calculating Cost of Goods Sold: The cost of the inventory sold to customers Reported on the income statement as

FIFO gives a higher cost of goods sold and a lower income than LIFO Which method gives a higher income depends on inflation/deflation of the product.

goods sold account is the same under both the periodic and perpetual methods at the end of the period.

Lower of Cost or Market (LCM) Inventory is initially valued at the purchase cost. A company may not report inventory on their balance sheet at more than they expect to benefit from the sale of the inventory. You must determine if the inventory has lost value below cost: Compare cost to market value (also called replacement cost) If cost is more than market, the reported cost must be reduced to market. If cost is less than market, no adjustment is made, do not adjust up. The journal entry to adjust for the difference down to LCM is: Cost of goods sold (or loss on inventory) Inventory (or inventory reserve) Write-down of inventory is called impairment Inventory is not increased above cost.

Journal entries for recording inventory transactions: Periodic Purchases Cash or A/P Purchase Cash or A/P Perpetual Inventory

A/P Purchase Returns

Return Inventory

A/P

A/R A/R Sales Sales CGS Inventory CGS Purchase Returns Inventory(ending) Inventory (beginning) can be Purchases

Sale price to customer original cost Adjusting Entry CGS Inventory either account the debit or credit

Two Methods for Recording Inventory transactions Periodic or Perpetual: Periodic Record inventory purchases initially as purchases - an expense Record sales without recording the change to the inventory Adjust at the end of the period to record CGS and: 1) Get inventory to what you really have 2) Get purchases to equal 0 (the real expense is CGS) ** Dont use the inventory account until the final adjustment

Inventory Errors: Inventory costs are reported as either inventory on the balance sheet or cost of goods sold on the income statement. Total cost = Inventory + Cost of Goods Sold Typically, inventory is counted and valued to determine the inventory balance and cost of goods sold is the other part of the cost. When ending inventory is incorrect, cost of goods sold and income will be incorrect also Ending inventory too high, cost of goods sold too low, income too high Ending inventory too low, cost of goods sold too high, income too low ** Income has the same error as the ending inventory error. When beginning inventory is incorrect, the opposite occurs.

Perpetual Record to the inventory account every time inventory moves Record inventory purchases initially as an asset called inventory: Record sales at the sales price and the reduction of inventory at cost: Final adjustment at the end of the period to get inventory to be what you really have on hand. A reduction in inventory is due to employee theft, damage to inventory, or the wrong thing being put into the box and shipped to the customer. This is often called shrinkage. You can not determine shrinkage using the periodic method. It is possible that inventory must go up to get to what you really have if not enough was really shipped to the customer or inventory received was incorrectly recorded. *** Notice that the balance in the inventory account and the cost of

Long Term Assets

Land sales tax, title search and transfer cost, attorneys fees, real estate commission, remove old buildings from land, bulldozing, survey fees, back taxes Buildings sales tax, title search and transfer costs, real estate commission, attorneys fees, remodel before using, architect fees, back taxes

Key Things to Know Tangible - Physical substance you can touch them Called property plant and equipment or fixed assets 3 kinds of tangible assets 1) Land not depreciated 2) Buildings, fixtures, equipment, autos, computers depreciated 3) Natural resources metals, timber, oil - depleted Intangible - Grant a right to the owner Have no physical substance, they can not be touched Copyrights, patents, franchises, licenses, trademarks, goodwill When money is spent, you must either capitalize or expense the benefit: Capitalize means call it an asset and report it on the balance sheet. Put an asset on the balance sheet and expense it over the time used The expenditure is expected to benefit future periods Expense: Used to produce revenue this period or future benefit is unpredictable General rules: Capitalize all costs necessary to get the asset to the point it can be used to produce revenues Capitalize all costs incurred before you begin using to produce revenues Capitalize costs to extend the useful life or increase productivity or increase the quality after you are using the asset (often called subsequent expenditures) Expense routine repairs and maintenance (these have to be repeated) Expense all costs that benefit this period only or no probable future benefit

Equipment sales tax, delivery costs/ freight-in/ shipping, installation, training The cost of an asset does not include damages or fines that could have been avoided Depreciation: Expense the cost of the property, plant, equipment over the period it is used to produce revenues (follows the matching concept) Residual/Salvage Value: What you estimate you will sell it for when you are done using it Depreciable Cost/Base: Cost Residual Value Estimated Useful Life: The number of years you expect to USE the asset

Methods of Depreciation: Straight-line: Cost Residual Value / Useful life in years 2 X Book Value

Double Declining Balance: 100% / life X

Book Value = Cost Accumulated Depreciation (changes each year) Units of Production: Cost - Estimated Residual Value / total estimated units = $ cost per unit then: $ Cost per unit x units produced this period = expense this period Use this journal entry for all methods of depreciation: Depreciation Expense $XXXX Accumulated depreciation $XXXX Intangible Assets Capitalize the cost associated with securing the asset if purchased - you paid someone outside the company Expense the cost if you do it yourself (ex. salaries to develop a patent) Some intangible assets have indefinite life; others do not have indefinite life: Definite life means there is a set amount of years benefit will occur

Property, Plant, Equipment: Assets used long term to produce revenues

Common items that are added to purchase price that become part of the cost of the asset

Patents 17 year life Trademarks Indefinite life Copyrights 50 year life Franchises life is the amount of time purchased Goodwill Indefinite life Goodwill: Occurs only when you purchase another company This asset has indefinite life. Price paid for the company FMV of the assets and liabilities purchased = Goodwill Intangible assets with indefinite useful life must be tested for impairment Impairment means the cost is more than the future benefit When the benefit is lower, the asset must be reduced to the future benefit Impairment Loss $XXXX Goodwill or Trademark $XXXX Intangible assets with a defined useful life must be expensed over the useful life the benefit is received. The straight-line method is used. This expense is called amortization expense Amortization Expense $XXXX Asset or Accumulated Amortization $XXXX

for future years: Total Cost include new costs added - Accumulated depreciation to date = Book value then Book Value New Residual Value New useful life from here on = new depreciation expense each year going forward

Change in fair market value of Assets: Impairment: Lost value company will never recover the cost of the asset Estimate future net cash flow, if not more than cost, reduce the asset. Loss on Impairment Asset $XXX $XXX

Never increase above historical cost

Retirement and Sale of the Assets : Follow these steps to record the sale of any long term asset: 1) Record the cash you receive 2) Credit the asset you are selling for the original total cost Natural Resources: Long term inventories Associated costs that are also part of the asset cost are geographic surveys and exploration costs Depletion: Units of production method is used: Total estimated costs / total estimated units = $ cost per unit $ Cost per unit x units produced this period = depletion expense The expense will vary with the actual units produced Depletion Expense $XXXX Asset name $XXXX Realized Loss on Sale ** Cash Accumulated Depreciation Asset Realized Gain on Sale ** ** Plug to gain (need credit) or loss (need debit) to balance the journal entry (You will not use both the gain and loss accounts, only use one of them) 3) Debit accumulated depreciation for the total up to the date you sell it If you sell it in the middle of the year, you will need to expense that part of the first year see practice problem 4) Record a realized gain or a loss for the amount that will make the journal entry balance debits equal credits

Investments Changes in estimated useful life or costs added to the asset (subsequent expenditures) after you are using the asset : You must change your depreciation calculation in order to expense the total cost over estimated total time you will use it Get the book value at time of the change and re-compute depreciation expense Key Things to Know Investors make investments for three primary reasons: 1) appreciation in market value 2) income from interest and dividends 3) significant influence and control Investments are made in bonds (debt) and equities (stocks)

The journal entry to record all types of investments is: Investment Cash $$cost, including commissions $$cost, including commissions

The investment account will be a debit when the investment goes up The investment account will be a credit when the investment goes down The other account is the opposite, debit or credit, for the same amount

There are two methods used to report investments that are related to the purpose of making the investment: Fair Market Value Method and Equity Method

Cash

Receive Dividends Dividend Income Dividend Income

Cash

Fair Market Value Method: (FASB 115) Records investments made for appreciation and income Use this method when: 1) You have no significant influence or control (usually owning < 20% indicates) 2) The market price is reliable there is a bid ask quote, traded on an exchange There are 3 categories of investments under this method: Intend to hold investments in bonds to maturity 2) Trading Securities: Intend to hold for less than one year 3) Available For Sale: Intend to hold for one year or more Held to maturity: Do not adjust to fair market value. Adjust the cost of the bond investment each period for interest using the amortization schedule, as interest is earned and received Trading Securities: Adjust the investment to fair market value at the end of each period if fair market value is reliable there is a bid ask quote The change in fair market value is reported on the income statement under other revenues and expenses unrealized gain/loss account Record dividends received as dividend income Available for Sale: Adjust the investment to fair market value at the end of the period if fair market value is reliable there is a bid ask quote The change in fair market value is reported on the balance sheet as part of owners equity accumulated gain/loss an owners equity account Record dividends received as dividend income Journal entries: Record 2 things each period 1) adjust to fair market value trading unrealized gain/loss - available for sale accumulated gain/loss 2) record dividends received Trading Available for sale 1) Held to Maturity :

Important to notice: The only difference in trading and available for sale is the account that is used to adjust to fair market value. Trading uses unrealized gain/loss which is reported on the income statement. Available for sale uses accumulated gain/loss which is reported on the balance sheet in owners equity. Equity Method: Use when you own an equity investment in a company and have significant influence Significant influence exists when you own > 20%, and you have - Access to financial information - Seat(s) on the board of directors - Influence company policies and procedures The objective of the equity method is to show the investment as if it represents the owners equity in the company you purchased. When the companys owners equity increases (earn income), your investment balance should increase. When the companys owners equity decreases (losses and dividends paid), your investment balance should decrease. The companys owners equity changes with income and loss and dividends paid. These are the things that also change your investment balance. Journal entries are: Profit Losses Profit/Loss Income Dividends Received X When you sell your investment, under both FMV and Equity methods: 1) Record the cash you get as a debit 2) Take the investment off your books at the current balance in your Investment T account times the % you are selling (credit investment) 3) Plug to realized gain (credit) or realized loss (debit) to balance the entry Investment in X Investment Expense Investment Investment in X Cash Investment in

Investment

Adjust to FMV Investment Unrealized Gain/Loss at end of period Accumulated Gain/Loss (use investment T account)

Cash (db) Realized loss (db) or realized gain (cr) Investment (cr)

Accounts that are reported on the income statement current year only: Unrealized Gain/Loss Realized Gain/Loss Dividend Income Accounts that are reported on the balance sheet cumulative balance: Investment Accumulated Gain/Loss (Owners Equity)

Gross Pay the total amount the employee earns (hrs worked x $ per hr) Net Pay the amount the employee receives after deductions are taken Payroll deductions Withholdings Employee FICA tax (Social Security) 6.2% up to a set amount Medicare tax 1.45% of total amount earned Income tax depends on how much is earned & the employees tax rate Voluntary Deductions Health insurance, union dues, pension savings Journal entry for the employees paycheck: Salary Expense * FICA tax payable Medicare tax payable Federal income tax payable Medical insurance payable Union dues payable Pension payable Salaries payable ** * Salary expense is what the employee earns hrs x rate per hr ** Salaries payable is the check to the employee after deductions Employer Payroll Taxes: Employers must pay FICA/Social Security tax and Medicare tax for the same amount the employee pays 6.2% and 1.45% Employers are required to pay unemployment taxes so that laid off workers will be able to receive unemployment benefits. This must be paid to the state (SUTA) and to the federal government (FUTA). State: usually 1% to 5.4% of the first $7,000 earned, based on history Federal: usually .8% of first $7,000 earned, considering state was paid Journal entry for recording employers taxes to be paid Payroll tax expense ** FICA/SS tax payable Medicare tax payable SUTA payable FUTA payable payables given % x earnings ** Payroll tax expense is the total of all the other that are calculated based on the

Current Liabilities Key Things to Know Liability probable future payment of assets (usually cash) or services which 1) occurs from a past transaction or event 2) is a present obligation 3) is a future payment Current or short term means it will be paid within one year of the balance sheet date Common Current or Short Term Liabilities: Accounts Payable: amounts owed to suppliers for goods or services purchased on credit, normally 30 days, no interest charged Sales Tax Payable: a tax levied on retail sales. The business must charge this and collect the money and then pay it to the state or city Each state/city sets its own %. This is not a revenue or an expense to the business. They collect the cash and have an obligation to pass it on to the city/state. Journal entry for sales tax collection and payable: Cash Sales revenue Sales Tax Payable city/state. Unearned Revenues: occurs when the company collects money from a customer before providing the goods or services they owe the customer the goods or services. This is normally short term. Short Term Notes Payable: A written promise to pay an amount borrowed, with interest Short term means the principle will be repaid in < 1 year Notes payable typically have monthly periodic payments Payroll Liabilities: and paid to the government for them: Amounts assessed to the business by the government amounts taken out of the employees check that must be $XXXX $XXXX $ XX

Part of what is collected is revenue and part is owed to

Warranty Liabilities: the sellers obligation to replace goods or provide service to defective products within a set period of time Sometimes extra is paid for the warranty and sometimes the warranty comes with the product. The matching principle requires the warranty expense to be recorded in the same period as the sale. We do not know the exact amount that will occur in the future, so we must estimate. Sales this period

x % of warranty historically occurs = warranty expense for this period Record the warranty obligation for the calculated amount: Warranty Expense Warranty liability $XXXX Contingent Liabilities: An obligation that may occur, dependant on a future event to happen, in order for you to know how much will be paid to who. Contingent liabilities may be short term or long term depending on when the estimated amount is expected to be paid. Examples: Lawsuits, environmental cleanups, debt guarantees First: Classify the obligation based on how likely it is to occur: FASB did not give a definition of each category. 1) 2) 3) obligation if possible. Sometimes a reasonable estimate can not be made. Third: Based on the classification, report the following 1) Probable record an expense and a liability for the low end of the estimated amount if you can estimate it - disclose the situation in the footnotes If you can not estimate it you do not record an expense 2) Reasonable Possible disclose the situation in the footnotes stating the low and high estimate that might be paid or state that you can not reasonably estimate the loss 3) Remote do nothing, dont expense or disclose Probable Reasonable Possible Remote $XXXX

Market Yield/Effective interest rate: The interest the company really incurs, and the investor really earns Simplified Example: $1,000 Maturity Value (MV) due to be paid in 10 years 10% Stated interest (annual coupon)

The bond will pay $100 interest ($1,000 MV * 10% stated) the amount of interest paid is in the bond contract and does not change The investor varies the rate of return they earn by what they are willing to pay. Whatever percent the investor earns is the same percent the company really incurs in interest expense. The real rate of return is the market/effective rate. If pay $1,000, actually earn 10% 10% If pay $900, actually earn 11.1% 11.1% If pay $1,100, actually earn 9.1% $100/$1000 =

$100/$900 = $100/$1100 = 9.1%

Second: Determine a high low range that may be paid for the

In most cases, the cash exchanged will not be equal to the maturity value because the market rate does not equal the stated (coupon) rate. This creates a: Discount: Premium: Cash exchanged is less than face value Cash exchanged is more than face value

Regardless of what is paid at the beginning, the face value must be paid on the maturity date. The actual bond market the bonds trade on determine the acceptable market rate that investors are willing to invest to earn. The market / effective rate changes every day. The stated coupon rate does not change.

Determining the price of the bond: Bonds trade on the open market at a percent of maturity value. A bond that trades at 98 means: 98% (.98) x the maturity value is paid For a $300,000 maturity value bond priced at 98, the investor pays $294,000 ($300,000 x .98) For a $200,000 maturity value bond priced at 125.75, the investor pays $251,500 ($200,000 x 1.2575, move the decimal point over 2 places) Note: Most Financial Accounting professors will not have you calculate the price of the bond and the bond price will be given to you as a number % or total amount. If the bond price is not stated, it can be calculated using the effective interest rate, the number of periods until maturity, and the coupon rate.

Bonds Payable and Other Long Term Liabilities Key Things to Know Bonds Payable borrow from investors who invest in the bond to earn a return of interest income The bond is a contract with the investor that loaned the money. Every bond is a contract which has the following: Amount that must be repaid (usually in $1,000s) Maturity Date: Date the maturity value amount must be repaid Stated Interest Rate: Coupon amount paid as interest, periodicallymonthly, semi-annually or annually Maturity Value:

Total periodic coupon payment** x present value factor of an annuity + Maturity value x present value factor of a single amount = Amount paid now to get the effective interest rate return on your money ** Periodic coupon payment = Maturity Value x coupon % / number of payments per year Use the PV tables to get the factor for the total number of cash payments the bond will make (years to maturity x payments each year) and the effective / market interest rate.

Interest Expense

Cash

Discount or End with the Premium maturity value

Long Term Installment Loans / Notes Payable / Mortgage Payable: Borrow money from bank Repay in equal payments. The payments must cover interest expense and repayment of principle

Journal Entries related to the bond payable: The amount received is the cash that is exchanged between the investor and the company. This is often called issuing a bond, which means borrowing money.

You must determine how much of the payment is for interest expense and how much is for repayment of loan. We use and amortization schedule for this: Example: You borrowed $800,000 at 10% and your annual payment is $89,750. Payment Interest 10% Difference: to repay principle $9,750 $10,725

Issue Bonds Premium: Cash received > MV Issue:

Issue Bonds Discount: Cash received < MV

Cash Premium Bond Payable (MV) Payable (MV) Interest paid:

Cash Discount Bond

$89,750 $89,750

$80,000 $79,025

Am (Car $ $ $

Journal entries:

Borrow: Interest Expense Premium Cash Interest Expense Discount Cash Cash Note Payable $800,000 $800,000

Interest 1st year payment Amortization Table: Use an Amortization Table to determine how much of the cash payment is interest expense and how much is a discount or premium. The interest expense uses the effective/market yield rate and the cash paid is from the coupon rate. These two rates are most likely different. ________________________________________________________ ______________ Effective Coupon Discount or Premium +/Owner's Equity Key Things to Know Corporation: A separate legal entity that owns assets and incurs liabilities. of The business applies for a charter from the state it will incorporate in. Articles of Incorporation are issued that specify the general rules for conducting the business of the corporation. The corporation acquires capital through issuing shares to stockholders Amount owedInterest Exp. - Interest = Difference Carrying value Yield % Stated % or Begin with the price coupon % the bond cash exchanged x the last x MV (not the MV) amount owed (same for all periods) Interest Expense Note Payable Cash $80,000 $ 9,750 $89,750

Interest 2nd year payment Interest Expense Note Payable Cash $79,025 $10,725 $89,750

Market % The

who then become owners of the company. Common Stock - Shares of Ownership Authorized the maximum number of shares the corporation can sell Issued the cumulative total number of shares the corporation has sold Outstanding shares currently held by investors outside the corporation This is equal to issued shares less treasury shares Par Value: a value per share that is assigned in the corporate charter 1) It is the legal capital that must be retained in the business 2) Companys set par value very low - $0.01 per share 3) It has no relationship to fair market value 4) Some states allow for a par value of 0 no-par value stock Common Stockholders: Do not participate in the day to day operations of the business Elect the BOD and vote on important issues of the Company BOD makes major decisions, hires the management of the Company Common Stockholder rights: 1) attend all stockholder meetings; vote in board members 2) share in dividends declared by the board 3) share in the proceeds of any liquidation 4) can sell their investment in shares at any time 5) have liability limited to their investment in the corporation

Dividends in Arrears: Cumulative dividends not paid to preferred shareholders - must be paid before common shareholders are paid

When a company issues stock to raise capital: CASH shares Common Stock (par) shares Paid in Capital - CS and FMV $ = FMV per share x # $ = Par Value per share x # The difference in par value

** The total value received by the company is CS + Paid in Capital (PIC) ** When one investor sell stock to another investor, there is no impact on the corporation and no entry is recorded. For preferred shares issued, use the same journal entry and replace CS with PS

Treasury Stock: The company buys back its own stock from investors to 1) reissue the shares to employees as compensation 2) reduce the number of shares outstanding to increase earnings per share 3) show other investors they have confidence in the value of the company The treasury stock account is a contra owners equity. It is subtracted from owners equity. A company cannot create an asset by investing in itself. When treasury stock is sold back to investors there is no gain or loss. The gain or loss is reported as an addition or subtraction of paid in capital Purchase Treasury Stock: record at what was paid the original cost Treasury Stock Cash $XXX $XXX

Preferred stock may also be issued to raise capital. Preferred stockholders give capital in return for income and are not seeking voting ownership. Preferred stock typically has a stated fixed dividend rate. Preferred Stockholders get: 1) preference for receiving dividends (before common) 2) No voting rights

Preferred Dividends are computed as: Number of shares x Par Value x Stated % Dividends paid to preferred shareholders must be declared by the board of directors before they are paid

Sell treasury stock back to investors: Cash received) Treasury Stock share x # shares) PIC TS (FMV amount (at original cost per **

Cumulative: If not declared this year, the board may declare this years dividend at some point in the future

Non-cumulative: If not declared this year, the board may not declare in the future

** Record the difference in FMV and original cost to balance the J/E When a debit is needed to balance you may debit PIC TS for up to the amount you have in the account and then the rest must be a debit to R.E.

received by the company. Dividends: Distributions to shareholders, can be cash or additional shares of stock Declaration date: The date the board of directors officially declares the dividend Record Date: The date the corporation prepares the list of owners that will be paid the dividend if you own on this date you get paid Payment Date: The date the payment is made to shareholders on record Declaration Date: $XXX Payable Record Date: Payment DateCash $XXX for a cash dividend: $XXX Retained Earnings Dividend $XXX No J/E Dividends Payable Cash Flow Statement: Key Things to Know Shows what the Company does with their cash Reconciles cash basis to accrual basis Used to determine: - the companys ability to generate future cash flows - the companys ability to repay debt - how much cash was spent investing in assets - how much cash was received from borrowing Cash Equivalents: Short term, highly liquid CDs, 3 month treasury, money market Treated the same as cash on the cash flow statement The par value is divided and the number of shares increases by the ratio determined by the board of directors. Example: 2:1 split amount doubled par value is now half the issued shares are now

Cash Flow

Stock Dividend: The corporation issues to current shareholders additional shares issued as a percentage of what is already held Example: 20% stock dividend when there are 1,000,000 shares issued means that 200,000 additional shares will be issued Declaration Date: $XXX Payable Record Date: Payment DateRetained Earnings Dividend $XXX No J/E

The cash flow statement is separated into three sections: Operating Activities: Relates to the production and delivery of goods/services: Net Income (revenues less expenses) Show Non-cash revenues and expenses separately Changes in current assets and current liabilities Investing Activities: Long term assets - investments, p/p/e, intangibles - purchases and sales of long-term assets

Dividends Payable $XXX for a stock dividend: Common stock $XXX PIC CS $XXX common stock is at par PIC CS is the

difference, a plug The question is what amount is recorded to retained earnings? Is the company giving stock for fair market value or for par value Large > 20-25% Debit R.E. for Par value of stock x # shares Small < 20-25 % Debit R.E. for Fair MV of stock x # shares The result of a stock dividend is no change to total owners equity. The amounts in the owners equity accounts are moved from one account to another Stock Split Does not change owners equity. Nothing is issued or

Financing Activities: Long term liabilities and Owners equity - borrow and repay debt - pay dividends to shareholders - issue stock - repurchase treasury stock

**** For Investing and Financing Activities only the cash received or paid from the transaction is reported on the cash flow statement

Cash from operating activities can be reported using the direct method or the indirect method. Investing and financing activities are reported the same under both methods.

Sales or other revenue + beginning receivable - ending receivable = Cash collected from customers

Format of the Direct Method: Cash received from: customers selling goods and services dividend income from investments interest income from investments Total cash received: - Cash paid for: purchases of goods (inventory) and services salaries and wages to employees income taxes to the government interest expense to lenders other cash expenses Total cash paid:

Collected from investments dividend and interest income: Dividend/Interest Income + beginning receivable - ending receivable = Cash collected from dividends/interest

Paid to suppliers: = Cash flow from operating activities Cost of Goods Sold - Beginning Inventory + Ending Inventory + Beginning A/P - Ending A/P = Cash Paid to Suppliers Format of the Indirect Method: Net Income + - Non cash revenues (-) and expenses(+) gains(-) and losses (+) + - changes in current assets and liabilities = Cash flow from operating activities Paid for all other expenses: Expense + Beginning matching payable - Ending matching payable = Cash Paid for expense Expense - Beginning matching asset + ending matching asset = Cash paid for expense

Preparing the Cash Flow Statement using the Indirect Method: Net Income +Adjustments for Noncash Items - add expenses and losses - subtract revenues and gains +Change in Current Assets and Liabilities Assets: increase from prior year subtract decrease from prior year- add **assets and liabilities are opposite Liabilities: increase from prior year add decrease from prior year subtract ______________________________________ = Cash from operating activities Always: + Beginning Ending, except when matching an asset with an expense

Noncash Activities:

Trade an asset for another asset or liability A transaction where no cash is involved This is not reported in the cash flow listed at the bottom of

statement and is the statement

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Preparing the Cash Flow Statement using the Direct Method: Collected from customers:

Quick Study Sheet INCOME STATEMENT

Format of the Single Step Income Statement: For a period of time Total revenues list them out and total them Total expenses list them out and total them Total revenues less total expenses = net income Format of the Multi-step income statement: For a period of time Sales - Cost of Goods Sold =Gross Profit - Operating Expenses: General and Administrative Selling Research & Development Restructuring = Operating Income + - Other Revenues & Expenses: (gains/losses/interest/rent income) = Income Before Taxes: - Tax Expense = Income from Continuing Operations + - Discontinued Operations: + - Extraordinary Items = Net Income Operating income: earned from primary day to day operations Income from continuing operations: earnings from all activities expected to continue Discontinued Operations: Selling or disposing of a major part of the business Extraordinary Item: Both Unusual and Infrequent not expected to happen again Net Income: Total earnings of the company for this period Accrual Basis required by GAAP Revenues: record when earned; the goods or services are provided Expenses: record when incurred; use up an asset or a service was provided to the company