Accounting

You are offered $100 at the end of three years and you want to know the PV, considering a 6% interest rate.

$100 x 0.83962 = $83.96

Five Major Groups of Accounts

(1) Assets: probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events. Assets are what we own. (2) Liabilities: Probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events. Liabilities are what we owe. (3) Equity (or Net Assets): Residual interest in the assets of an entity that remains after deducting its liabilities. In a business enterprise, the equity is the ownership interest. (4) Revenues: Inflows or other enhancements of assets of an entity or settlement of its liabilities (or a combination of both) during a period from delivering or producing goods, rendering services, or other activities that constitute the entity's ongoing major or central operations. (5) Expenses: Outflows or other using up of assets or incurrences of liabilities (or a combination of both) during a period from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity's ongoing major or central operations.

(EGMP) Basic Assumptions of Accounting (4)

(1) Economic Entity: A company is an economic unit separate and apart from its owners. (2) Going Concern: We assume that a company will continue to operate indefinitely. (3) Monetary Unit: Everything is measured in money. We also assume that inflation is insignificant and thus is ignored. (4) Periodicity: We cannot wait forever to issue financial information. Thus, economic activities of a company are divided into artificial time periods (e.g., quarter, year, month) and financial statements are issued based on the best estimates available at the end of the period.

Basic Principles of Accounting (4) (HRMF)

(1) Historical Cost: Assets should be recorded at their cost. Cost is the value exchanged at the time something is acquired. Typically, the exchange involves cash. - Note! When an asset is acquired, it is recorded at its cost in the date of acquisition and no adjustments are made to reflect changes in the market value of the asset over time. Thus, when using financial statements, users should not assume that they can determine directly the market value of a business from its balance sheet. - Note! The historical cost of acquiring an asset includes the cost necessarily incurred to bring it to the condition and location necessary for its intended use. (2) Revenue Recognition: Revenue is (generally) recorded when it is earned. And revenue is earned when the company has substantially accomplished what it must do to be entitled to the benefits represented by the revenue. Often revenue is recognized at the point of sale. (3) Matching: Costs incurred to generate revenues are expenses when the revenue is recognized. Efforts (expenses) should be matched with accomplishments (revenues). "Let the expense follow the revenue." (4) Full Disclosure: Everything that is relevant must be disclosed in the financial statements and accompanying footnotes (notes to the statements). - Full disclosure provides sufficient info that might influence the judgment and decision of an informed user (e.g., Starbucks owing Kraft over 2.7 million dollars).

ACCOUNTING IS A 3 STEP SYSTEM OR PROCESS IN WHICH WE...(3)

(1) IDENTIFY information/documentation about select economic events (our financial activities/transactions). (2) RECORD/GATHER, classify, and summarize selected economic events in an orderly and systematic manner. - To record information in a systematic way, accountants use the "double entry" accounting system, the foundation of which is the "accounting equation". - Here, we record transactions by journal entries, summarize the double entries through "T-Accounts", and create closing entries. - At the end of each cycle, we close the books. (3) COMMUNICATE that information in financial statements to people who need the information - the users of the financial statements. Analyze and interpret the reported information by explaining the uses, meaning, and limitations of reported data.

Five Basis Financial Statements (in order prepared) and Which is the Most Important?

(1) Income Statement (Statement of Earnings) (2) Statement of Owners'/Shareholders' Equity (3) Balance Sheet (Statement of Financial Position) (4) Statement of Cash Flows (5) Statement of Comprehensive Income - Note! We are not concerned with #4 or #5 for this course. Which is the most important? - It depends, who is the reader/user of the financial statement. What is the readers' purpose? - In most instances the financial statement that most shareholders or investors are interested is the income statement because the market price of the shares are driven by earnings or more specifically what the expectations are about future earnings - If you're looking at a company that is quite troubled and on brink of bankruptcy, maybe you want to look at balance sheet to see what the company has in the case of bankruptcy or perhaps the statement of cash flows is useful to show company's ability to generate cash to get out of troubles

Three Key Objectives of Accounting

(1) Keep track of our money and other things we OWN (so we won't lose them). (2) Tell us what we OWE others (so we pay them the right amounts at the right times). (3) Let us know if we are making a PROFIT (i.e. revenues are greater than expenses) or incurring a loss.

Types of Accounting (3) and What Kind do we focus on?

(1) Managerial: - Concerned mainly with how accounting can serve internal decision makers (top executives, management) and is used to monitor efficiency/performance. - Examples: Sales per labor hour, Chargeable hours per attorney, Cost accounting reports, Per store operating reports, Division operating reports. (2) Financial: - Concerned mainly with how accounting can serve external decision makers (stockholders, trade creditors, banks, governmental agencies). - Financial statements are prepared in accordance with GAAP. - Usually presents a more conservative picture, in accordance with regulatory accounting principles. This course focuses on financial accounting in accordance with generally accepted accounting principles (GAAP). (3) Tax Basis: - Tax laws' primary aim is to generate income for the government and are a patchwork of accounting theory, legal theory, and political compromises.

Constraints of Accounting (3) (MCI)

(1) Materiality: Relative significance—both quantitatively and qualitatively—must be considered. An item is material if its inclusion or omission would influence or change the judgment of a reasonable person. In short, if it doesn't make a difference, it doesn't need to be disclosed. (2) Conservatism: Accounting measurements often take place in a context of significant uncertainty. Possible errors should tend toward understatement, rather than overstatement, of assets and income. When in doubt about various potentially acceptable choices, select the answer which will be least likely to overstate assets and income. (3) Industry Practice: The peculiar nature of some industries and businesses sometimes require departure from basic theory. We will limit our discussions of these in this class, but note that industry specific matters are increasingly the focus of accounting issues and problems.

THREE QUESTIONS WHEN RECORDING A TRANSACTION:

(1) What has occurred? (2) Which accounts are affected? (3) In which direction are the balances in the affected accounts moving? (Are they increasing or decreasing?)

Flow of assets: (A) Assets over time become... (B) Inventory gets sold... (C) Property, Plans, and Equipment... (D) Intangible Assets

(A) Expenses (B) Cost of Goods Sold (C) Depreciation Expense (D) Amortization Expense

Straight Line Method: A) Define and Formula B) Example) A machine is acquired at a cost of $150,000, has an expected useful life of 8 years, and an expected salvage value of $30,000, at the end of eight years, the annual depreciation expense would be:

(A) STRAIGHT-LINE METHOD: results in an equal amount of depreciation expense being recognized during each year of the useful life of the asset. The general formula is: Depreciation Expense per Year = (Original Cost - Salvage Value) / (Estimated Useful Life in Years) (B) ($150,000 - $30,000) / 8 = $15,000 >>>Each year, a depreciation expense of $15,000 will be recognized. If the asset is put in service eight months into the current year, then a prorated amount of the annual depreciation (1/3 of $15,000 or $5,000) would be recognized in the year of acquisition with a similar adjustment at the end of the useful life.

Present Value of an Annuity: - what is it? how to calculate? - how to calculate for annuity in advance.

(A) the sum of the PV of the separate payments making up the annuity; or equivalently (B) add up the PV factors for each year in the annuity and multiple the constant annuity payment by the sum of the PV factors. - As compared to an annuity in arrears, the payments on an annuity in advance are discounted for one less period (since each payment occurs one period earlier as compared to an annuity arrears). - To determine the appropriate PV factor for an annuity in advance from the tables for the PV of an annuity in arrears, you select from the tables the appropriate factor for one period less than the number of periods in the annuity and then add one to that factor.

Assume the following: Initial Inventory 10 units at $5/unit $50 Purchase One 15 units at $6/unit $90 Purchase Two 12 units at $7/unit $84 Purchase Three 10 units at $6/unit $60 Goods Available For Sale 47 units $284 - Assume also, that during the period, the business sold 32 units, leaving 15 in inventory. The problem is how to assign the $284 total cost of goods available for sale to the units sold and to the units still in inventory. Calculate COGS under FIFO, LIFO, and Weighted Average Cost Method.

(I) FIRST IN, FIRST OUT METHOD (FIFO): it is assumed that the goods sold during the current period are the oldest goods on hand. The cost of the goods sold under FIFO would be: Units: Unit Price: Total Price: 10 $5 $50 15 $6 $90 7 $7 $49 32 $189 (COGS) This means that the cost of goods still in inventory is $95 (284 - 189). (II) LAST IN, FIRST OUT METHOD (LIFO): assumes that the goods sold during the period are the most recently acquired goods that are available for sale. LIFO is usually applied by determining the cost of the goods still in inventory and then subtracting that cost from the goods available for sale to determine COGS for the period: Units: Unit Price: Total Price: 10 $5 $50 5 $6 $30 15 $80 The ending inventory is $80 and the COGS is the cost of goods available for sale of $284 less the $80 ending inventory, or $204. (III) WEIGHTED AVERAGE COST METHOD: compromises between FIFO and LIFO. The business determines the average cost of all the units available for sale in the reporting period. The average cost is then used in computing the ending inventory and the cost of goods sold. - the average cost of the goods available for sale = $284/47 units = $6.04255 per unit. The COGS would be 32 x $6.04255 = $193.36 and the ending inventory would be 15 x $6.04255 = $90.64. - Note that both the COGS and ending inventory fall between the FIFO and LIFO values.

Brief History of Accounting and How GAAP Evolved (3 points in time)

- 1494: Luca Pacaoli a 15th century monk and mathematician wrote the accounting book which established "the accounting formula" or "accounting equation". His concept of double entry accounting (debits on left, credits on right) provided the first guidelines for collecting and reporting accounting information. - Early 20th Century: In response to some shenanigans on Wall Street, the development of generally accepted accounting principles emerged, pretty much as we know them today. - 2000-2019: Some new entities emerged to prevent further financial disasters in response to the fallout from Enron, World Com, etc., "the subprime mortgage" situation and financial markets problems of the Great Recession.

Future Value of an Annuity: - What is an annuity? - How do you calculate it? - Annuity in Arrears/Ordinary Annuity versus Annuity in Advance/Annuity Due

- Annuity: a stream of equal periodic payments rather than just a single cash flow. - E.g., a parent decides to contribute $1,000 to a child's college fund at the end of each of the next ten years. This is a ten-year annuity of $1,000. In order to compute how much will be in the account in ten years, we need to compute the FV of the annuity. FV of an Annuity is calculated by either: • (A) multiplying each payment by a future value, then add the separate future values to give the future value of the entire annuity; or equivalently... • (B) adding the appropriate future value factor for each period in the annuity and then multiply this sum of future value factors by the principle amount. Annuity in Arrears/Ordinary Annuity: payments made at the end of each year. Annuity in Advance/Annuity Due: payments are made at the beginning of the years in the annuity period. - This gets one more year's interest on each of the annuity payments. The last payment in an annuity in arrears does not earn any interest but the last payment in an annuity in advance earns interest for one year. - Most tables for FV of an annuity give the future value of annuity in arrears. - When using such tables to determine the factor for an annuity in advance, look up in the table the factor for the period one greater than the actual number of payments in the annuity and then subtract one from that factor.

POST-2016 PROCEDURE FOR INVENTORY OTHER THAN THAT VALUED USING LIFO (i.e., primarily inventory valued using FIFO or Average Cost Method):

- For inventory valued using FIFO or average cost method, market will be determined based on the net realizable value (estimated selling price in the ordinary course of business less reasonably predictable cost of completion, disposal, and transportation). - Replacement value or cost is no longer considered. - Net realizable value is the estimated selling price less any estimated costs to sell the inventory. This is how we estimate the inventory's future economic benefit.

What is meant by "GAAP"?

- GAAP is a set of rules or principles that have developed over time. In the U.S., GAAP - and the setting of accounting rules - is handled by the private sector, by various entities that are either part of the American Institute of Certified Public Accountants (AICPA) or part of an affiliated entity - The Financial Accounting Standards Board (FASB). - Increasingly, however, GAAP and the accounting profession is influenced by public sector organizations including the Securities & Exchange Commission (SEC), the Public Companies Accounting Oversight Board (PCAOB) and the Congress.

In a period of rising prices explain the significance of LIFO versus FIFO. What is the drawback of LIFO?

- In a period of rising prices, he LIFO method, as competed to FIFO, produces a LOWER ending inventory and a HIGHER cost of goods sold. - The higher COGS, the lower the income for the year. - Companies may use LIFO for computing taxable income BUT IRS requires using LIFO on financial statements if used for tax purposes. - Potential Disadvantage of LIFO: the need to avoid liquidating old layers of inventory. Over time, the use of LIFO can result in inventory being carried at book values significantly lower than the current prices.

U.S. GAAP Compared to International Financial Reporting Standards ("IFRS")

- Many countries have (or had) their own "GAAP" - e.g., U.S. GAAP is different from Canadian GAAP which is different from Korean GAAP. - IFRS is an attempt to synchronize accounting standards across the globe in order to make international comparisons more readily possible. - Increasingly, the IFRS model is being recognized around the world. The US is one of the few countries not to adopt IFRS and for U.S. reporting purposes, U.S. GAAP is still required.

What is meant by "accrual" basis (GAAP basis) accounting?

- Revenues (Sales) are recognized when earned. (The revenue is earned when the seller performs). - Expenses are recognized when they are incurred, when they help to generate revenues. (i.e., matching—record the expenses incurred in generating the revenue in the same period that revenue is recorded). - The timing of recognition of Revenues and Expenses is not necessarily based on when cash is exchanged.

Income Statement: -define -why do economists criticize it -define revenues/gains, expenses/losses

- The income statement is also called the statement of results of operations. - It reports income for a period of time, typically one year. - Income statement accounts are temporary accounts and get closed out at the end of the period. - Net Earnings/Income/Profit (or Loss) = Revenue - Expenses - E.g., a law firm, Revenue = sales (legal fee billings) minus expenses = net earnings (income) Economists have often criticized accountants for their definition of income because accountants do not include many items that contribute to general growth and well-being of an enterprise. However, if an item is not susceptible to being quantified with any degree of reliability, it cannot be included in the accountant's concept of income. REVENUES AND GAINS: • Revenue: primary source of earnings of the business, such as the proceeds from sales of products for manufacturers or merchandising operations and the revenues received for services rendered by a service type business. • Also included are miscellaneous items such as dividends and interest from investments. EXPENSES AND LOSSES: • Expenses are expired assets, or used assets, or used resources. Expenses are the costs of generating the revenue in the current period . • The principal expenses for most businesses are cost of goods sold, salaries and wages, depreciation, rent, interest, income taxes.

The End Purpose of Accounting

- To communicate financial information—in the form of financial statements—to users. - To communicate financial information that is USEFUL to users: Users should reasonably understand the accounting process, and recognize the limitations of financial statements arising from the use of estimates and judgments

Purpose of Accounting Cycle (3)

- To maintain the equality of the accounting equation (Assets = Liabilities + Equity). - Each entry results in recording an equal dollar amount of debits and credits - The assets (or resources) of an enterprise, translated in money, are balanced by the claims of the creditors and owners who provide the resources.

FIXED ASSETS/TANGIBLE LONG-LIVED ASSETS: define, principle component, are buildings always long-lived assets?

- assets which are not intended for sale but which are used in the company's ordinary course of business over multiple periods (over 1 year) - In the non-current asset section of the balance sheet, the principle component for most businesses is the property, plant, and equipment account, also called the fixed asset account. Includes land used in the business (but not land held for investment), machinery and equipment, furniture and fixtures, and buildings and other structures. - Note: A building is not automatically property, plant, equipment because might not be acquired for use in operations and might be for resale

Adjusting Entries: Types (4)

1) Accrued Revenue and Expenses 2) Deferred Revenue and (Prepaid) Expenses 3) Depreciation/Amortization Expense 4) Recognizing Cost of Goods Sold

The Accounting Process - Steps (5)

1) Source Documents 2) Journal Entries (including adjusting entries) 3) Ledgers and Posting (T Accounts) 4) Closing the Books 5) Financial Statements

What are the "Big Six"

1. Consistency 2. Revenue Recognition 3. Matching 4. Full Disclosure 5. Materiality 6. Conservatism

How to value property, plant and equipment? > What about salvaged materials? > Interest payments associated with acquiring the asset? > Do we revalue them at market? > Exception? > Example) A business acquires a new computer system. It pays $20,000 cash and issues its note payable (bearing reasonable interest) in the principal amount of $80,000. A $5,000 sales tax is incurred. The company pays $6,000 to install and test it. The journal would be:

>>>The general rule is that the total amount paid to acquire property, plant, and equipment (fixed assets) and to get such assets ready for use in the business is recorded as the initial cost of the fixed assets. >>Costs include not only the purchase price but also legal costs and other closing costs, sales taxes, delivery charges, cost of assembly and installation, costs of testing, and other incidental charges. >>>Note! If you receive cash from salvaged materials resulting from the demolition of an old building you can deduct that from land costs. >>>If part of the cost of the fixed assets is payable overtime through a credit arrangement, the cost of the fixed assets includes only the present value of the future payments, not the interest portion of the payments. >>>Historical cost accounting is used to account for fixed assets. There is no attempt to revalue the assets and maintain them at their fair market values. >>>The only exception is when an asset has experienced a reduction in value to an amount below the current book value of the asset and that loss of value is not temporary. Such a reduction would be recorded as a loss. >>>Example) Computer Equipment $111,000 Cash $31,000 Notes Payable $80,000

Depreciation and Capitalizing A) Define B) What IS depreciation and what is depreciation NOT? C) When is depreciation recognized? D) General Journal Entry? E) Does it have to be consistent for tax purposes?

A) After tangible fixed assets are acquired and recorded in the financial records, it becomes necessary to allocate and deduct as an expense the cost of the asset over the period that the asset is expected to be used in the business. (Note: intangible assets are amortized). Depreciation methods must be "systematic and rational." When a business purchases a fixed asset such as a machine, furniture, or a building, the cost of the asset is "capitalized" and recorded as an asset. Note! Land does NOT depreciate. "Capitalizing" means that a payment by a business will not be recorded immediately as an expense but will initially be recorded as an asset and will eventually be recognized as an expense through the depreciation (amortization) process. B) Depreciation IS (a) a method of cost allocation and (b) a process of allocating the cost of a tangible asset in a rational and systematic manner to those periods expected to benefit from the use of the asset. Depreciation IS NOT a matter of valuation/an attempt to revalue the fixed assets to an amount representing fair market value. C) As depreciation is recognized, the general form of the entry would be: Depreciation Expense (E) $XXX Accumulated Depreciation (C/A) $XXX D) Depreciation expense should be recognized when the asset is ready for its intended use. E) No.

On July 1, a calendar year business makes a payment of property taxed for $240,000. That payment applies to property tax year beginning on July 1 of the current year through June 30 of the next. A) On the date of payment, the $240,000 would be recorded as follows: B) At the end of the calendar year, the adjusting entry would be made:

A) Prepaid Property Taxes $240,000 Cash $240,000 B) Property Tax Expense $120,000 Prepaid Property Taxes $120,000 The remaining balance of $120,000 in Prepaid Property Taxes would be reported as a current asset in the December 31 balance sheet.

A business started the year with 75,000 units on hand and each cost $1. At the end of the year, the business conducts inventory count and determines there are now 80,000 units on hand at a cost of $1 per unit. The business has maintained a separate temporary account called "Purchases" and all the purchases of inventory items during the year will have been recorded here. The balance in the purchases account is $400,000 (400,000 units purchased). A) A summary journal for all the inventory purchase transactions would be as follows: B) Determine the COGS under the periodic inventory system. C) The following entry would be made at the end of the year to update the inventory account, close out purchases account, and enter appropriate amount in COGS account:

A) Purchases $400,000 Accounts Payable (or Cash) $400,000 B) To determine the cost of goods sold under the periodic inventory system, (1) determine total inventory that was available for sale during the year (beginning inventory plus purchases), (2) subtract from the goods available for sale the amount of the ending inventory. (3) The difference is the amount of the inventory sold (or lost) during the year. Beginning Inventory $75,000 + Purchases 400,000 = Goods Available for Sale 475,000 - Ending Inventory (80,000) = Cost of Goods Sold $395,000 C) Inventory (Ending) $80,000 COGS $395,000 Inventory (Beginning) $75,000 Purchases $400,000

Assume that a firm uses the accrual basis of accounting. For each of the following, indicate the amount of revenue the firm should recognize on a GAAP/Accrual basis for the month of March. A) Collects $1,000 in February for merchandise delivered in March. B) Collects $1,200 in March for security service that it will provide to a client over the next three months (beginning in March). C) Collects $500 in March for merchandise sold and delivered in February. D) Collects $1,200 interest on a 6-month certificate of deposit, which matures on March 15th. E) Sells and delivers $1,500 of merchandise on account in March.

A) $1,000 because we earned it in March. B) $400 = $1,200/3; we recognize what we performed at the end of March. C) $0 because we would've recognized revenue in February when we delivered the merchandise. D) HE SKIPPED THIS • E) Answer: $1,500

A) Methods of Depreciation (4) B) How do you pick? C) What is more conservative in terms of the income statement? Assume a salvage value of 15k or of 0?

A) 1) Straight Line 2) Sum of the years' digits 3) Declining Balance 4) Units of Production B) WHICH METHOD SHOULD BE USED? >>>Use the method that management believes best allocates the cost of the asset over its useful life, that best matches costs with revenue. >>>Choosing a method is very subjective (as illustrated by the Delta v. Pan Am Comparison): both companies used the straight-line method, but Pan Am said their useful life was way higher and salvage value was way higher resulting in inflated financials. >>>Conservatism: when faced with different reasonable approaches, pick the one that results in the lower net income and lower net assets. C) Zero because zero salvage value gives you a higher depreciable base which gives you more depreciation expense which gives you less income.

Cost flow assumptions with Inventory: A) What is the issue? B) T/F you can change which cost flow assumption you use from year to year for recording inventory? C) How do you pick the correct method? D) List the methods. E) T/F these are physical flow assumptions.

A) A major complicating factor in accounting for inventory is the reality that inventory items are acquired at varying costs throughout the year. B) False: There are many ways to arrive at the ending inventory balance under GAAP, but note that we have to have consistency in the use of the method we use from year to year. C) Pick the method that is best for matching with the cost or expense of the revenue you recognize! D) Specific Identification, FIFO, LIFO, Average Cost Method E) FALSE. These are cost flow assumptions and NOT physical flow assumptions.

Aged Receivables Analysis: A) Define B) Example) A company completes an analysis and determines that the appropriate amount in the allowance account should be $300,000. The amount currently in the allowance account is $275,000. Additional bad debt expense would be recorded as follows:

A) Aged Receivables Analysis: the accounts receivable are periodically divided into categories based on the age of the receivables. The amount in each category is examined and a determination is made about how much of the receivables in each category will eventually be uncollectible. The total amount expected to be uncollectible is computed and compared to the amount currently in the allowance account. The difference is recorded as an adjustment to bad debt expense and the allowance account. B) Bad Debt Expense $25,000 Allowance for Doubtful Accounts $25,000

Bad Debts: A) Define B) Policy C) Example Journal Entry: A determination were made that $50,000 should be added to an allowance for doubtful accounts... D) What about when a specific amount is determined uncollectible? E) Example) If a $5,000 receivable were determined to be uncollectible, the following entry would be made:

A) Bad Debts: unless the risk of collection is extremely high, receivables are recorded at the time of sale notwithstanding some risk that the receivables may not be collected. The business will estimate the amount of receivables that will not be collected and record an expense and an allowance for doubtful accounts in recognition of the fact that not all receivables will be collected. B) Policy: - Conservatism, full disclosure, relevance, and matching - The benefit of the allowance method is to better match expectations: Conservatism, Reliability, and Matching. C) Bad Debt Expense (E) $50,000 Allowance for Doubtful Accounts (C/A) $50,000 - The bad debt expense is recorded in the income statement as an expense or as a reduction in the revenue from the sales that gave rise to the receivables. - The allowance for doubtful accounts is a "contra account" that is deducted from the gross amount of receivables on the balance sheet to produce the net amount of receivables actually expected to be collected. D) When a specific amount is determined to be uncollectable, no additional bad debt expense is recorded. The identified account is removed from the receivables account and a like amount is removed from the allowance account with no net effect on income or on the balance sheet. Allowance for doubtful accounts $5,000 Accounts receivable $5,000

A building is purchased during 201x for $100,000. A) The purchase would be recorded as follows: B) Assume depreciation on this building for 201x is determined to be $5,000. At the end of 201x, the following adjusting entry would be made: C) Define contra-account and identify it in this example. D) What is the remaining book value of the buildings owned?

A) Buildings $100,000 Cash $100,000 B) Depreciation Expense $5,000 Accumulated Depreciation $5,000 The expense of $5,000 will be included in the determination of net income for the year. The accumulated depreciation account is a "contra-account". C) A contra-account is an offsetting account to some other account. Here, to the buildings account. It is used here to retain in the financial records the original cost of an asset and to record separately the portion of the original cost that has been transferred to an expense through the depreciation process. D) To determine the remaining carrying cost or book value of the buildings owned by the business, you subtract the amount in the accumulated depreciation account from the amount in the building's account. Thus, the remaining book value here on the Dec. 31, 201x balance sheet would be $95,000.

Inventory: Which goods to include? A) What are the key issues. B) What effect does overstating inventory have? C) Periodic inventory system (define & drawbacks)

A) Consideration is given to the legal ownership of inventory as compared to its physical location. Key Issues: when does title transfer? When do the risks of loss and the rewards of ownership shift? B) Overstating inventory normally translates in an overstatement of income. This impacts the balance sheet (inventory balance) and the income statement (COGS). C) PERIODIC INVENTORY SYSTEM: employs a periodic physical count of the inventory on hand from time to time, usually at the end of the accounting period. - Downside of periodic inventory system: there is no way to determine the COGS at interim points during the accounting period since the inventory currently on hand is not known until the end of the year.

A) You have $100 today and you want the FV of that at the end of three years, considering a 6% interest rate. B) You have $100 today and you want to know the future value at the end of three years. The 6% interest is compounded quarterly.

A) FV = $100 x 1.19102 = $119.10 B) FV = 100 x (1 + (6% / 4))^(3 x 4)

Which costs to include in inventory? A) General Rule B) Two main categories of cost.

A) GENERAL RULE: any cost incurred directly in preparing an asset for its intended use generally becomes a part of the cost of that asset. Note! This is very important and we will see this rule again with Fixed Assets. B) Two main categories of cost: 1) Period costs: Costs that are either expensed in the period acquired or capitalized and depreciated over their estimated useful life. These are costs that are not directly connected with the goods being sold and are more connected with the general operation of the business (e.g., salaries and buildings). 2) Product costs: Costs that are included in Inventory. These are costs that are directly connected with getting the goods held for sale ready for sale.

Company A which has a December 31 yearend pays its property taxes of $10,000 on March 31, 20X1 for the period April 1, 20X1 through March 31, 20X2. A) What is the journal entry to record this payment on the date of payment (March 31, 20X1)? B) What is the adjusting/closing entry at the end of the calendar year (December 31, 20X1)?

A) Journal entry #1 at March 31, 20X1 (date of payment): Prepaid Property Tax (A) $10,000 Cash (A) $10,000 To record property tax expense for the period 4/1/X1 through 12/31/X1 B) Journal entry #2 at December 31, 20X1 (end of calendar year/fiscal year): Property Tax Expense (E) $7,500 Prepaid Property Tax (A) $7,500 To record payment of property taxes for period 4/1/X1 through 3/31/X2

A) [INSERT] best characterizes the accrual basis of accounting. B) T/F Costs are expenses when incurred.

A) Matching B) FALSE: - Cost are the amount that must be paid to obtain goods or services. - Expense: Decreases in equity which result from the use of assets during the generation of revenue. - Costs aren't necessarily expenses at the time it is incurred. - E.g., a washing machine costs $100. When purchased, the cost is incurred but there is no expense recognized at that time. The cost of the machine will be recognized as an expense (depreciation) over the life of the machine.

Percentage of Sales Method: A) Define B) Example) If a company has credit sales for the period of $3,000,000 and its history suggests that 6% of credit sales will not be collected, the entry would be:

A) Percentage of Sales Method: the company determines based on experience that a certain percentage of its credit sales will not be collected. Each year, the company accrues additional bad debt expense based on the credit sales being made in the current year and adds the same amount to the allowance account. This is commonly used for companies with thousands or even millions of relatively small customers. B) Bad debt expense $180,000 Allowance for Doubtful Accounts $180,000 - Note! This entry was made without reference to the current balance in the allowance account.

Receivables: A) Define B) They are classified by (3) C) Two key accounting issues associated with receivables...

A) RECEIVABLES are claims against others for money, goods, or services provided. Receivables may be represented by formal notes or simply result from oral or written contractual arrangements of business. B) They are classified by: (1) Collection timing: - Current: expected to be paid in cash within the coming year. - Non-current: not expected to be paid within the coming year. (2) Transaction type: - Trade: ordinary course of business (most common receivable). - Non-trade: all other—not associated with typical sales or course of business. (3) Documentation type: - Accounts receivable: an "open" account or oral promise to pay. - Notes receivable: written promise to pay at a certain time. C) Two Key Accounting Issues Associated with Receivables: - (1) Recognition: when/how to record the receivables balance. - (2) Valuation: how much to reflect as an asset going forward; the amount at which to "carry" the asset; establishing a valuation allowance, an allowance for uncollectable accounts.

Matching: A) Define B) Three Basic Rules for Recognizing Expenses

A) THE "MATCHING PRINCIPLE" determines when expenses should be recognized for accounting purposes. B) • There are three basic rules for recognizing expenses: (1) The DIRECT MATCHING of expenses with related revenues: • Certain types of costs can be directly related with revenue. These costs are recognized as an expense when the related revenues are recognized. • E.g., COGS—when the sale occurs and revenue is recognized, the appropriate cost of the items sold is removed from the inventory account and recognized as an expense called cost of goods sold. (2) The IMMEDIATE RECOGNITION/WRITEOFF of expense at the time that costs are incurred: • Certain types of expenses cannot be traced to specific revenues. These types of costs are treated as expenses as they are incurred. • E.g., Salaries and wages of employees working in the general administrative function—their connection with revenue is too remote to attempt to relate to any particular revenue. (3) SYSTEMATIC AND RATIONAL ALLOCATION of costs as expense over an appropriate time period: • Some costs are not themselves directly connected with revenue but they are also not treated as expenses as incurred. These items provide a benefit that is associated with a period of time that runs beyond the current accounting year. These types of costs are allocated in a systematic and rational manner over the period that they are expected to benefit. • E.g., the cost of a building is recognized as depreciation expense over the useful life.

Trade Receivables: A) Define: B) Example: A business sells goods at a price of $100,000, with payment terms of 2/10 net 30 (the buyer is entitled to reduce the purchase price by 2% if the payment is made within 10 days—a cash discount). Payment is due in full within 30 days. (B1) Journal entry under the net method (if the buyer pays within discount period and if he does not) (B2) Journal Entry Under the gross method (if the buyer pays within discount period and if he does not)

A) TRADE RECEIVABLES result from sales or services rendered where the business agrees to defer the collection of the cash due for the sales or services. These occur in the ordinary course of business. (B1) Net Method Accounts Receivable $98,000 Sales Revenue $98,000 > If the buyer pays within the discount period, the collection of the receivable is: Cash $98,000 Accounts Receivable $98,000 >If the buyer does not pay within 10 days, the following is recorded: Cash $100,000 Accounts Receivable $98,000 Cash Discounts Not Taken $2,000 (B2) Gross Method Accounts Receivable $100,000 Sales Revenue $100,000 > If the buyer qualifies for the discount: Cash $98,000 Cash Discounts Taken $2,000 Accounts Receivable $100,000 >If the payment without discount is made: Cash $100,000 Accounts Receivable $100,000

Recognizing Cost of Goods Sold: A) Explain the concept B) Example: Assume that at the beginning of 201x, it is determined that a business has inventory of $75,000. During the year, purchases are made in total of $500,000. A summary of entries to record purchases occurring throughout the year would be: C) At the end of the year, the business conducts inventory and determines goods remaining on hand have a cost of $110,000. What is the total cost of goods available for sale? D) Cost of items sold? E) The adjusting entry would be...

A) Under a periodic inventory system, the cost of items sold is not determined at the time of each sale. The cost of all goods sold is determined at the end of the period. B) Purchases $500,000 Accounts Payable $500,000 C) The total cost of goods available for sale would be $75,000 + $500,000 = $575,000. D) Since there is inventory on hand at the end of the year of $110,000, the cost of the items sold would be $575,000 - $110,000 = $465,000. E) Inventory—Ending (A) $110,000 COGS (E) $465,000 Purchases (?) $500,000 Inventory—Beginning (A) $75,000

Lower of Cost or Net Realizable Value: A) When does this come up? B) General Rule C) Journal entry to record a writedown of inventory from cost to market or net realizable value (2 ways)

A) While by and large, we follow historical cost convention in GAAP, conservatism and matching suggest that we need to look at inventory costs relative to what we now think we can sell it for. GAAP requires that after you determine inventory at cost using one of the above cost flow assumptions, compare the cost of inventory with the market value measure of the inventory. B) The general rule is that the historical cost principle is abandoned when the asset's future utility (future economic benefit/the future revenue-producing ability) is no longer as great as its original cost. >> If it's cheaper to replace it than the original cost (market): Write Down >>If you can't break even (NRV< Cost): Write Down C) Cost of Goods Sold (E) $XXX Inventory (A) $XXX OR Loss of Inven. Writedown (E) $XXX Allowance to Reduce Inventory to NRV (CA) $XXX

DEPLETION OF NATURAL RESOURCES: A) how to account for it? B) Example) A business acquired the rights to mine coal from a particular piece of land for a total cost of $20,000,000. Since only the right to mine coal is acquired, there is no expected salvage value for these rights. It is estimated that there are $1,000,000 tons of coal that can be extracted. The depletion per ton of coal would be...Journal entry?

A) when natural resourced are mined, extracted, or otherwise consumed, depletion occurs. Depletion means consumption of the natural resources and is analogous to depreciation of buildings, equipment, etc. B) >>>$20,000,000 / 1,000,000 = $20 >>>If 60,000 tons of coal are extracted in year 1, the depletion would be $1,200,000 (60,000 x $20). The entry would be: Depletion Expense $1,200,000 Accumulated Depletion $1,200,000

Short-term prepaid expenses or prepayments A) Definition B) What are they also called? C) How are they typically amortized? D) Examples

A)Short-term prepaid expenses or prepayments are amounts paid for goods and services that are not immediately deductible as an expense but that will be recognized as an expense in the future through amortization/depreciation or write-off during the coming year. B) Note! Prepaid expenses are also called deferred charges. C) They are typically amortized on a straight-line basis over the period to which the payment applies. D) Examples: prepaid rent, prepaid insurance, prepaid subscription services, prepaid taxes, prepaid interest.

The Accounting Equation: Assets = Shareholders' Equity = Retained Earnings = Net income for Period = (2 versions)

ASSETS = LIABILITIES + SHAREHOLDERS' EQUITY CA + NCA = CL + NCL + EQUITY SHAREHOLDERS' EQUITY = CONTRIBUTED CAPITAL + RETAINED EARNINGS RETAINED EARNINGS = RETAINED EARNINGS AT BEGINNING OF PERIOD + NET INCOME FOR PERIOD - DIVIDENDS FOR PERIOD NET INCOME FOR PERIOD = REVENUE FOR PERIOD - EXPENSES FOR PERIOD # 37 HW) REVENUE - COGS - SELLING & ADMIN. EXPENSES - TAXES = NET INCOME

Assets: definition, types and time frames

ASSETS are items of future economic benefit. They include: Two Substantive Types: • (1) Tangible or Intangible property interest or legal right of the business (what you own) • E.g., cash, receivables, inventories, land, buildings and equipment, patents, trademarks, copyrights, etc. • (2) Deferred Expense (deferred charge): costs incurred by a business where the business expects to benefit from that cost over a period of time beyond the current period. (e.g., prepaid subscription of a business periodical the cost of which will be recognized as an expense over the subscription period) Two Time Frames: • Current assets (listed first): those which will generally be converted into cash or consumed by the business within the coming year. • E.g., cash, marketable securities, receivables, inventories, and prepaid expenses. • Long-term or noncurrent assets (shown next): include property, plant, and equipment, long-term intangible assets such as patents, long-term investments, and miscellaneous deferred charges.

Assets: define

ASSETS: are items of future economic benefit.

Journal Entry: Company J pays a portion of its accounts payables.

Accounts Payable (L) $10,000 Cash (A) $10,000 To record...

Journal Entry for: Company J sells inventory that was originally purchased for $5,000. It is sold on open account for $8,000. Two entries are needed to record this transaction.

Accounts Receivable (A) $8,000 Sales (R) $8,000 To record... Cost of Goods Sold (E) $5,000 Inventory (A) $5,000 To record...

A business received, on December 1, 201x, a semiannual rent payment of $30,000 giving the payor the right to use the rented property for the period from December 1, 201x through May 31 of the following year. On the date of receipt, none of the rental revenue associated with the $30,000 payment has been earned, it is prepaid rent. Record the journal entry at the time the cash is received and at Dec.31. 201x. Note! There are TWO approaches.

Approach 1) The following entry would be made at the time of receipt of the $30,000: Cash (A) $30,000 Deferred Rental Income (L) $30,000 The appropriate amount of rent revenue must be recognized as it is earned. On December 31, 201x, one-sixth of the $30,000 will have been earned and the following adjusting entry will be made: Deferred Rental Income (L) $5,000 Rental Income (or Revenue) $5,000 Similar adjusting entries would be required during the first five months of next year. Approach 2) Ignore the prepayment feature at the time of cash receipt and record the rent receipt as follows: Cash $30,000 Rental Income $30,000 This would overstate rental income for 201x. Thus, an adjusting entry would need to be made to defer the appropriate portion of the revenue: Rental Income $25,000 Deferred Rental Income $25,000 If this approach is used, then a reversing entry could be made at the beginning of next year, with no further entries necessary. Deferred Rental Income $25,000 Rental Income $25,000

Define: - Cash (what it is, what it isn't) - Cash Equivalents - Compensating Balance

CASH includes currency and coins held by the business, checking accounts of the business, savings accounts that are subject to withdrawal at any time, and negotiable checks not yet deposited or cashed. • Note! Certificates of deposit and postdates checks are NOT cash. Cash Equivalents are reported within cash (revise title to "Cash and Cash Equivalents") and are generally short term, highly liquid money market instruments with a maturity of three months or less. Examples: commercial paper, treasury bills, and money market fund securities. Because of its highly liquid status and exposure to theft, embezzlement, or other loss, the cash account is subject to extensive internal control procedures and stringent audit procedures. Compensating Balances: a restriction on cash in which banks that make loans may require customers to maintain a minimum bank account balance (compensating balance). The SEC requires that this amount be recorded separately form the general cash balance (but often in practice it is a footnote disclosure).

Current Assets include: define and main types (5)

CURRENT ASSETS are assets that are generally expected to be converted into cash or consumed in the business within the next year or within the operating cycle for the business with an operating cycle greater than one year. - Note: The operating cycle is the period of time needed to acquire raw materials or other inputs, produce and sell its goods and services, and collect the cash generated by the revenue-producing activities. - For most businesses, the primary components of current assets are (1) cash, (2) marketable securities, (3) receivables, (4) inventories, and (5) short-term prepayments.

Give the journal Entry For: Company J sells 10,000 shares of its common stock ($1 par value) for $50,000.

Cash $50,000 Capital Stock $10,000 Additional Paid-in-Capital $40,000 To record...

Journal Entry: Starbucks sells a cup of coffee for $5.00 cash. The cost of the coffee beans used to brew the cup of coffee is $0.25.

Cash (A) $5.00 Sales (R) $5.00 To record... COGS (E) $0.25 Inventory (A) $0.25 To record...

What do (A) Debits and (B) Credits do to (1) assets, (2) liabilities, (3) shareholders' equity, (4) revenue, and (5) expenses.

Debits (Left): • Increase Assets • Decrease Liabilities • Decrease Shareholders' Equity • Decrease Revenue • Increase Expenses Credits (Right): • Decrease Assets • Increase Liabilities • Increase Shareholders' Equity • Increase Revenues • Decrease Expenses

Define: - Equity/Net Assets - Gains - Book Value - Losses

Equity (or net assets) is the excess of assets over liabilities. In a business enterprise, equity is the ownership interest. Gains: increases in equity (net assets) from peripheral or incidental transactions of an entity (aka occur outside the ordinary course of business) and from all other transactions and other events and circumstances affecting the entity during a period except those that result from revenue or investments by owners. Gain represents the amounts realized on sales of assets in excess of book value of the assets sold. Book value refers to the amount at which the assets are carried in the financial reports. Losses: decreases in equity (net assets) from peripheral or incidental transactions of an entity and from all other transactions and other events and circumstances affecting the entity during a period except those that result from expenses or distributions to owners.

Footnote Disclosures

Footnotes: Alerts the readers to which of the alternative accounting procedures have been adopted by the issuer in question. They set forth additional detail about certain components of the statements and also set forth information that cannot be included on the face of the financial statements. Note! When you look at financial statements you must look at the accompanying notes!

Do you get to take a bad debt expense for tax purposes?

For tax purposes, you don't get to take a bad debt expense based on some estimate (only get to take bad debt expense at the point you deem the receivable to be uncollectable). The tax method = direct write-off method.

Lower of Cost or Net Realizable Value: How do you determine market? What is the limit? Can you change it after inventory is written down?

For this purpose, the market value of the inventory is its replacement value—the cost at which the inventory would be replaced by the business under current conditions—NOT its retail value. >> E.g., if inventory that originally cost $100 can now be purchased for $85, the lower market value of $85 would be used to determine the book value of the inventory. >>If the replacement value were $105, no adjustment would be made and the inventory would remain at its original cost of $100. Resale value is used as a limit on replacement value. >> If the replacement cost of the inventory is greater than the "net realizable value" of the inventory (its expected selling price less costs of disposal), the market value for purposes of LCM would be limited to the net realizable value. >> E.g., if the inventory item described above could only be resold for $80, then $80, not the $85 replacement cost, would become the "market value" of the inventory and the inventory would be written down to $80. >> On the other hand, the market value of inventory for purposes of LCM cannot be less than the net realizable value of the inventory reduced by a normal profit margin for the type of inventory involved. >> Policy: precludes possibility of taking excessive inventory write-downs in the current period with a corresponding increase in profit in subsequent periods. >> Once inventory is written down to market under this approach, it is NOT subsequently written back up EVEN IF market values subsequently increase.

Future Value Analysis: - What is it? Equation? - How do you calculate it? - What if interest compounds or is payable on a basis other than annually?

Future Value Analysis involves converting dollars today to an appropriate equivalent at a future date. • FV = PV x (1 + r)^n - r is the appropriate interest rate per period. - n is the number of periods for which the money will be invested. • Alternatively, turn to the future value factor table and multiply that by PV. - When interest compounds or is payable on a basis other than annually, the same process applies except that the interest rate used is the annual interest rate divided by the number of compounding periods during the year and the number of periods is the number of years multiplied by the number of compounding periods during the year.

Comparison of "Accrual" basis (GAAP basis) accounting and "Cash" basis accounting, Hypos: (1) Starbucks sells a cup of coffee on September 15, 20X1 for $5.00 cash. (2) Starbucks receives $20.00 from a customer for application to the customer's "Stored Value Card" for future purchases of beverages, etc. What about when customer comes back and buys a $5 drink? (3) On October 1, 20X1 Starbucks receives a utility bill for utilities used in September 20X1. Starbucks pays the bill on October 15, 20X1.

Hypo #1: • Cash Basis: record $5 cash and revenue. • Accrual Basis: Same as cash basis—record revenue immediately upon the time the barista gives the cup of coffee to the customer because Starbucks has earned the $5. Hypo #2: • Cash Basis: Since Starbucks got the cash, we would record the cash ($20) and would record the revenue (because you record revenue when you receive the cash). • Accrual Basis: Because we have a liability, we cannot recognize revenue (we haven't earned it). As a result, Starbucks has $20 in cash (an asset equal to our liabilities). In the future we have an obligation to provide goods/services. • When the customer comes back and buys a drink for $5 (paying with the card) on a cash basis, there is nothing to record. On an accrual basis, the liability now goes down to $15, assets reduced by cost of inputs, and Starbucks could record a revenue of $5. Hypo #3: • Cash Basis: Starbucks would have nothing to record in September because it didn't pay the bill until October. • Accrual Basis: Starbucks would record a $100 expense as an expense of September (incurred in September to generate September's revenue).

Rule of 72

If you take the number of period the money is going to be held and you multiply it by a percentage number and that number equals 72, then the money we put in is going to double

DEFERRED REVENUES AND (PREPAID) EXPENSES: define

In some situations, cash is received before revenue has been earned or cash is paid before an expense has been incurred. This results in deferred revenue or prepaid expenses and usually necessitates an entry to defer the recognition of revenue or expense to some point in time later than the receipt or payment of cash.

What is interest? What are the components of interest (3)? The higher the interest rate, the [INSERT] the money in the future is worth now.

Interest: is rent on money; the payment for the use of money. Components of interest include: - Pure rate of interest - amount a lender would charge if there was no possibility of default, no expectation of inflation (Simple Return). - Credit risk rate of interest - interest factor for risk of nonpayment by borrower (Return for taking on the risk). - Expected inflation rate of interest - component of interest rate which compensates for the loss in purchasing power due to inflation (return for taking on inflation rates). - All else being equal, the higher the interest rate, the less the money in the future is worth NOW.

Give the journal Entry For: Company J purchases inventory on open account credit for $20,000.

Inventory (A) $20,000 Accounts Payable (L) $20,000 To record...

What does inventory include? (4) What is the inventory equation?

Inventory includes (1) items that are held for sale by the business for sale in the ordinary course of business (merchandise inventory), (2) raw materials that have not yet entered the manufacturing process, (3) products of the manufacturer that are not yet ready for sale or delivery (work in process inventory), and (4) miscellaneous supplies of items that are not held for resale but are used in the business and are material in amount. Inventory Equation: Beginning Inventory + Purchases = Goods Available for Sale - Ending Inventory = COGS

Give Journal Entries & T-Accounts to Close the following Accounts: JE #1: Cash 25,000 Product Sales 25,000 To record sales from June-December. JE #2: COGS 9,000 Inventory 9,000 To record COGS (inventory purchased - ending inventory).

JE # 3A: Product Sales 25,000 Income Summary Account 25,000 Temporary account to income summary account. JE #3B: Income Summary Account 9,000 COGS 9,000 Temporary account to income summary account. JE #3C: Income Summary Account 16,000 Retained Earnings 16,000 To close Income Summary Account to Retained Earnings. ***SEE OUTLINE FOR T-Accounts.

Give the journal Entry For: A business purchases land for a total price of $100,000 with $25,000 being paid immediately in cash and $75,000 being paid by the business issuing its note payable in that amount.

Land $100,000 Cash $25,000 Notes Payable $75,000 To record....

Liabilities: definition, how they can be created (3)

Liabilities are the obligations of a business to persons other than owners of business. They may be actual cash obligations payable at some time in the future, such as accounts payable, notes payable, bonds, and mortgages. - Note! Not all obligations are liabilities (e.g., Starbucks signs contract to buy coffee in the future. This is a legal obligation but it isn't a liability because neither party has performed yet). - Current liabilities shown first: those that will be paid within the coming year. E.g., accounts payable, short-term notes payable, accrued expenses, and the portion of long-term debt that will mature in the next year. - Long term liabilities listed next: E.g., long term notes, bonds, and mortgages. Liabilities may also be created in several other ways: • Prepaid Revenues/Deferred Income/Deferred Revenue: arises where money has been collected in advance of rendering a service or delivering goods. Until that revenue is earned and included in the computation of income or loss for the period, the amount collected is shown as a liability. • Accrued Liabilities: created when a business recognizes currently an expense even though there may be no present legal obligation to pay the item as of the balance sheet date (e.g. recognition of salaries earned by employees through a balance sheet date that falls in the middle of a payroll period. • Contingent Liabilities: recognized for possible future obligations of a business where there is no current obligation and it is not clear that there will ever be an actual obligation of the business (e.g., recognizing a contingent liability for possible future litigation claims).

Non-trade Receivables

NON-TRADE RECEIVABLES are all others not associated with typical sales or course of business. - Other receivables can arise in situations where revenue or income is earned with the passage of time with cash being payable periodically. The revenue accrued between payment dates is reported in the balance sheet as a receivable. E.g., interest on loans or notes receivables, rental income.

List the three approaches for determining allowance for doubtful accounts/bad debts

Percentage of Sales Method Aged Receivables Analysis Specific Identification

Present Value Analysis: - What is it? Equation? - How do you calculate it? - What if interest compounds or is payable on a basis other than annually?

Present Value Analysis (also called "Discounting") involves converting dollars in the future to a current equivalent value. • PV = FV / ((1+ r)^n) - r is the appropriate interest rate per period. - n is the number of periods for which the money will be invested. - Alternatively, turn to the present value factor table and multiply that by FV. - Where interest compounds on a basis other than annually, the same procedures are applies except that the interest rate is the annual rate divided by the number of compounding periods during the year and the number of periods to use is the number of years multiplied by the number of compounding periods per year.

GAAP Qualitative Characteristics of Financial Information (Primary (2) and Secondary (2) Characteristics) (RRCC)

Primary Qualities: • (1) Relevancy: Information is relevant if it influences the actions of a decision maker. To be relevant, information must have predictive or feedback value, and it must be presented on a timely basis. • (2) Reliability: Information must accurately depict (or at least "fairly state") the conditions it is purported to represent. Accounting information is reliable to the extent it is verifiable, is a faithful representation and is reasonable free of error and is unbiased (i.e. accountants are concerned with "neutrality" in presentation). Secondary Qualities: • (3) Comparability: Usefulness is enhanced if the financial statements of an entity can be compared with other companies' financial statements. • (4) Consistency: Use of the same accounting principles each year enhances the ability to compare the financial statements of the same company from year to year.

Valuing/Reporting Receivables: A) Explain how they are reported in the balance sheet B) What if the amount to be collected is expected to be less than that owed?

Receivables are valued/reported in the balance sheet at their net realizable values on the balance sheet date (the net amount of cash expected to be received). If the amount expected to be collected is less than the amount owed, a valuation allowance should be recorded, equal to the amount owed to the company less the amount expected to be collected.

Give the journal Entry For: Rent for the current month in the amount of $1,000 is paid

Rent Expense (E) $1,000 Cash (A) $1,000 To record...

Closing the books: define and 4 steps

Revenue and expense accounts are temporary accounts that must be closed out at the end of the period (usually the year). This balance will then be transferred to the permanent owners' equity accounts and the revenue and expense accounts will have zero balances. Step 1) Prepare a trial balance: the balances in all the accounts (both permanent accounts and the revenue and expense accounts) are computed. Confirm debits equal credits. Step 2) Record the adjusting entries that are made at the end of the year. At this point, a second "adjusted" trial balance is prepared and the total of the debit balances is compared to the total of the credit balances. Step 3) Close out the revenue and expense accounts by posting to a temporary account used solely in the closing process called the "income summary". Step 4) Transfer the net income (revenue - expenses) from the temporary income summary account to the permanent retained earnings account (see entry below). Note that revenue and expense accounts will have zero balances carried forward to the next year.

Shareholders' Equity: define, what they typically include (3)

Shareholders' or Owners' Equity is the residual interest in the assets of an entity that remains after deducting its liabilities. It represents the amounts contributed by the owners to the business, plus the accumulated income of the business since its formation, less any amount that has been distributed to owners. For corporations, the accounts in owners equity typically include (1) capital stock, representing the par (or stated value of stock that has been issued), (2) additional paid-in-capital (representing the amount paid for stock in excess of its par or stated value), and (3) retained earnings (representing the cumulative or running balance of the net income of the business less ant distributions of dividends to the owners).

STATEMENT OF COMPREHENSIVE INCOME

Shows net earnings from the Statement of Earnings plus other income/(loss) items that impact the owners' equity interest but do not qualify for inclusion in the Statement of Earnings (income statement).

Statement of Shareholders' Equity

Shows the owners' interest in the company and how it has changed during the period.

Statement of Cash Flows

Shows where the company gets its cash and where the company spends its cash.

Simple versus Compound Interest

Simple Interest: interest is payable or accrues only on the original principal balance regardless of how often interest is paid. Compound Interest: interest is computed on the original principal balance plus any interest that has accrued and not been paid in prior periods. Note! The computations in the appendix of Nutshell are based on compound interest.

Specific Identification: Define

Specific Identification: a company goes through and looks at which clients owe what and make a judgment about how much you expect to collect. This is used in situations where you have discrete and fairly few clients. (Starbucks used this).

Revenue Recognition Principle: define and explain the two factors.

THE "REVENUE RECOGNITION PRINCIPLE" guides the determination of when to recognize for accounting purposes the revenue from the various transactions of a business. This is determined based on two factors: (1) The existence of a realization event: occurs when a business exchanges its goods or services or other assets for cash or a right to receive cash. (2) The completion of the earnings process: occurs when the business has delivered its goods, performed its services, or otherwise substantially completed the activities necessary to earn the revenues in question. - Both criteria must normally be satisfied before revenue is recognized, but in some cases, one or the other will be the primary consideration.

You want to determine the future value of a ten-year annuity in advance at an interest rate of 8%. What do you look up in the table?

The FV factor for an 11-year annuity in arrears at an 8% interest rate is 16.64549. Subtracting one from that gives 15.64549, the appropriate factor for a 10-year annuity in advance at an interest rate of 8%.

Balance Sheet (definition) What are criticisms of the balance sheet (3)? Balance Sheet Equation

The balance sheet sets forth the (1) ASSETS, (2) LIABILITIES, and (3) OWNERS' EQUITY (the investment of the owners) of a business at a particular point in time (a snapshot of the date issued). • Balance sheet accounts are permanent accounts. • It shows resources and obligations of a company. • What a Company Owns = Owes + Shareholders' Equity The balance sheet is criticized for (i) its failure to reflect current value, (ii) the extensive use of estimates in its preparation, and (iii) its failure to include items of financial value that cannot be measured objectively. ASSETS = LIABILITY + OWNERS' EQUITY

A business takes out a three-year fire insurance policy covering the three-year period beginning September 1, 201x. The business pays full cost of the policy ($90,000) on September 1, 201x. Record the journal entry at the time the cash is received and the end of the year/accounting period (there are TWO approaches).

The premium paid is a prepaid expense and the recognition of the expense in the income statement must be deferred. Approach 1) Prepaid Insurance (A) $90,000 Cash (A) $90,000 At the end of 201x, the following adjusting entry would be made in order to transfer from the asset to an expense account the portion of the insurance premium that relates to coverage in 201x. Insurance Expense (E) $10,000 Prepaid Insurance (A) $10,000 Approach 2) An alternative would be to record the entire premium as expense when paid: Insurance Expense (E) $90,000 Cash (A) $90,000 At the end of 201x, an adjusting entry would be made to reclassify the deferred potion of the insurance premium and record it in the prepaid insurance current asset account. Prepaid Insurance (A) $80,000 Insurance Expense (E) $80,000 At the beginning of the next year, a reversing entry would be made as follows: Insurance Expense (E) $80,000 Prepaid Insurance (A) $80,000 At the end of next year, an adjusting entry would be made to recognize an asset the then unexpired portion (20/36) of the premium: Prepaid Insurance (A) $50,000 Insurance Expense (E) $50,000

There are three basic issues in determining inventory cost...

There are three basic issues in determining inventory cost: (1) which goods to include, (2) which costs to include, (3) which cost flow assumptions do we make as we sell our inventory?

To determine depreciation expense you need...(3)

To determine depreciation expense, you need (1) the useful life of the asset, (2) the salvage value of the asset, and (3) a method of computing depreciation must be selected. >>>(1) Useful Life: of an asset is the period over which the asset is expected to be used in the business. This is a very subjective process and can significantly impact the amount of depreciation recognized. >>>(2) Salvage Value: of an asset is the amount that the business expects to be able to realize from a disposition of the asset at the end of its useful life as determined for depreciation purposes. The asset is not depreciated to an amount less than the expected salvage value. >>>(3) Method of Depreciation: Each method will result in the same total depreciation expense, the only difference is how that depreciation expense is allocated over the useful life.

A company collects $1,000 in February for merchandise delivered in March. Assume that the cost of the merchandise sold is $400. What are the journal entries to record the collection of cash in February and the delivery of merchandise in March?

To record collection of cash—FEBRUARY entry: Cash (A) $1,000 Deferred Rev. (L) $1,000 To record delivery of merchandise—MARCH entries: Deferred Rev. (L) $1,000 Sales (R) $1,000 Cost of Goods Sold (E) $400 Inventory (A) $400

Revenue Recognition for sale of goods or services. What about when there is a warranty or a right to return goods?

revenue associated with the sale of goods or services is generally treated as recognized when the goods are delivered to the customer. • Realization has occurred because the seller received the cash or obtained the terms of the sales contract. • The revenue is earned because the seller has substantially completed all of its obligations. • When a warranty exists, it is possible to delay recognition, but this is not normally done in practice. • Where the buyer has the right to return the goods and recover the purchase price, the recognition of revenue will usually be delayed until the right to return expires.

Inventory: SPECIFIC IDENTIFICATION method

sometimes it is possible to identify the exact inventory items that are purchased and sold and to determine the actual original cost of each specific item as sold (mostly limited to items with a very high unit cost, e.g., cars).

The factor for the PV of a 10-year annuity in advance at an interest rate of 12%. What do you look up in the table?

would be the PV factor for a 9-year annuity in arrears at a 12% interest rate (5.32825) plus one, or 6.32825.

Define Dividends and Show Journal Entry for a recorded dividend of $5,000

• Dividends are a distribution of a portion of a company's earnings to its shareholders. They are a reduction in retained earnings so they are not on an income statement. When you pay dividends, debit equity. • Example) A company recorded a dividend of $5,000: Retained Earnings (Shareholder's Equity) $5,000 Dividends Payable (L) $5,000