Accounting Exam 3

effect on balance sheet

decrease assets (by amount of cash paid to reacquire the stock) and decrease equity (since the account treasury stock is a contra-equity account)

effects of depreciation on balance sheet

decrease assets (by increasing contra asset - accumulated depreciation) and decrease retained earnings

effects of revenue expenditure on balance sheet

decrease cash decrease retained earnings

Over time, what happens to the book value of an asset?

decrease each year because the amount of accumulated depreciation gets larger each year

As the compounding frequency increases, what happens to the present value?

decreases

treasury stock effects on balance sheet

decreases total stockholders' equity

key point using straight line method

depreciation expense is the same amount each year of the asset's life using the straight line method

how does the entry to record the reacquisition of treasury stock affect net income, balance sheet, and cash flows?

doesn't affect net income. assets & equity on balance sheet are decreased. cash paid to reacquire stock is a financing cash outflow.

in the first year, which method will give an income tax advantage?

double declining balance - in the first year, double declining balance shows larger amount of expense. thus shows smaller amount of net income, thus pay less income tax

in the last year, which method will show the highest net income?

double-declining balance

compound interest

earns interest on both principal invested as well as all previously earned interest

Future Value of an Ordinary Annuity

payment * future value annuity factor(i,n) **the payment represents the amount of each individual, equal payment. do not add payments together **FV & PV not reciprocal

Present Value of an Ordinary Annuity formula

payments * present value annuity factor(i,n) **the payment represents the amount of each individual, equal payment. do not add payments together **FV & PV not reciprocal

is it easier to compare the different alternatives using present or future values?

present

to record annual amortization of the leased asset (if ownership reverts to lessee)

present value / economic value

cash flow impact

proceeds from issuance are a financing cash inflow

how does the acquisition of an asset impact the income statement?

none

to record the depreciation of the leased asset

debit amortization expense credit leased asset

effects of depreciation on statement of cash flow

none - depreciation is a non-cash expense

effects of revenue expenditure on statement of cash flow

operating cash outflow

dividends are paid on...

outstanding shares. no dividends are paid on treasury stock.

total preferred stock dividend

par value per share x % * # shares outstanding

preferred stock dividend

par value per share x % per share dividend

to record annual amortization of the leased asset

debit amortization expense credit leased asset calculate by: present value / lease term

recording depreciation expense

debit depreciation expense, credit accumulated depreciation

to record the inception of the lease

debit leased asset credit lease liability

to record first lease payment

debit: interest expense lease liability credit: cash

to record first mortgage payment

debit: interest expense mortgage payable credit: cash

present value of a lump sum

Present Value = Future Value * Present Value Factor(i,n)

At what amount should PPE be recorded when it is purchased?

-at cost -cost is the purchase price plus all costs incurred in getting the asset ready for use -costs incurred in getting the asset ready for use include sales tax, freight costs, installation costs, repair costs incurred prior to use, assembly costs, fees such as closing costs and recording fees

transactions involving our own stock effect on net income

never affect

treasury stock account balance

# of shares reacquired * reacquisition cost

units of production formula

((Cost - Residual Value) / (total estimated usage) = depreciable cost per unit ----> (depreciable cost) * (actual usage for current year) = depreciation expense

average total assets

(Beginning Total Assets + Ending Total Assets) / 2

times interest earned ratio formula

(Net Income + Interest Expense + Income Tax Expense) / Interest Expense

straight line depreciation

(cost-residual value)/useful life in years **residual value is also referred to as salvage value

Earnings Per Share (EPS)

(net income - preferred stock dividends) / # of common shares outstanding measures the amount of net income associated with each share of common stock

double declining balance depreciation key points

- book value at the beginning of the first year is the cost of the asset since the balance in accumulated depreciation at the beginning of the asset's useful life is zero - in subsequent years, book value is the difference between cost and accumulated depreciation at the beginning of the year - residual value is ignored in calculating the amount of depreciation expense

Accumulated Depreciation

- causes decrease in assets - contra asset account - normal balance is credit - found on the balance sheet directly under the asset being depreciated - represents the total amount of the of the building or equipment 'used up' since it was acquired by the company

depreciation expense

- classified as an expense account - found on the income statement - reduces net income - represents the amount of the building or equipment 'used up' in the current year

effect on income statement

none

characteristics of cash dividends

-dividends must be declared by the board of directors before they can be paid -the corporation is not legally required to declare (and subsequently pay) dividends -dividends are not classified as an expense and do not impact net income. rather, dividends are paid out of net income -classified as a contra-equity account because they reduce equity (specifically retained earnings) - cash dividends require sufficient cash and retained earnings to cover the dividend -normal balance is debt -once a dividend is declared, a liability is created

lessee accounting

-lessee records a leased asset and a lease liability on their balance sheet equal to the present value of the lease payments -the leased asset is depreciated -the lease liability is amortized (gradually reduced) over the lease term down to a zero balance

amortization of the lease liability

-reduces the liability each time a payment is made. at the end of the lease term, the liability balance must be zero -each payment is separated into two components - interest expense and principle reduction (i.e. reduction of the lease liability) -set up an amortization table

depreciation of the leased asset

-referred to as amortization -typically calculated using straight-line method -assume residual value = 0 -if the lease agreement calls for the asset to be returned to the lessor at the end of the lease, the lessee uses the lease term as the asset's life -if the lease agreement calls for the ownership of the asset to be transferred to the lessee at the end of the lease, the lessee uses the economic life of the asset as the asset's life

record during the asset's useful lifetime

-report depreciation expense on income statement and accumulated depreciation on the balance sheet -additional capital expenditures added to capitalized amount on the balance sheet and cash spent reported as an investing activity on the statement of cash flows -additional revenue expenditures are expensed on the income statement and cash spent reported as an operating activity on the statement of cash flows

when a change in estimate is made

1. No corrections or changes are made to amounts previously recorded as depreciation expense 2. The new estimates are incorporated into the current and future years depreciation calculations only

Four Accountable Events in the Life Cycle of PPE

1. account for the acquisition of PPE 2. account for any capital expenditures made during the life of the asset 3. account for the depreciation of buildings and equipment 4. account for the sale of disposal of PPE

expenditures during the life of the asset

1. capital expenditures 2. revenue expenditures

To record the sale of a plant asset, there are 4 items that must be accounted for:

1. cash received from sale 2. eliminate asset sold from balance sheet at its cost 3. eliminate accumulated depreciation related to the asset sold from the balance sheet

3 important dates relating to dividends

1. date of declaration 2. date of record 3. date of payment

4 time value of money cases

1. future value of a lump sum 2. present value of a lump sum 3. future value of an annuity 4. present value of an annuity

2 types of capital stock

1. preferred stock 2. common stock

3 common depreciation methods

1. straight line 2. double declining balance 3. units of production

effects of capital expenditure on income statement

none

Future Value of a Lump Sum

Future Value = Present Value * Future Value Factor (i,n)

Return on Equity (ROE)

Net Income / Average Equity measures the amount of profit earned for each dollar of stockholder investment

once an asset is in use, what costs are capitalized?

Once an asset is in use, only those costs that significantly improve the asset or substantially extend its life are capitalized

cumulative preferred stock

Preferred stockholders must be paid both current and prior years unpaid dividends before common stockholders receive any dividends

dividends in arrears

Prior years unpaid preferred stock dividends. Do not represent actual liabilities and thus are not recorded in the accounts, but must be disclosed in the notes to the financial statements

recording recurring, ongoing costs

Recurring, ongoing costs such as repairs after the asset is in use, maintenance and insurance are expensed as incurred (i.e., they are not capitalized).

to determine the new annual depreciation expense

The book value (cost - accumulated depreciation) of the asset at the date of the change less any salvage value is depreciated based on the number of years remaining in the useful life

lease

a contract that specifies the terms under which the owner of an asset agrees to transfer the right to use the asset to another party

annual depreciation is based on

a declining book value (cost - accumulated depreciation)

recording at disposal

a gain or loss, if any, is reported on the income statement. the asset is removed from the balance sheet at its cost. the accumulated depreciation related to the asset sold is also removed from the balance sheet. the cash received is reported as an investing cash inflow in the statement of cash flows

par value

a monetary amount assigned to each class of stock for accounting purposes only -when stock is sold to owners (stockholders), the stock account is only recorded at par value --- the excess of the selling price of the stock over the par value is recorded in the equity account called: --- > paid-in capital

annuity

a series of equal payments (either amounts to be received or paid) with each payment having the same time interval between them

capitalization

all of these costs incurred in getting the asset ready for use are recorded on the balance sheet as part of the cost of the asset

annuity due

an annuity with payments occurring at the beginning of each period

ordinary annuity

an annuity with payments that occur at the end of each period

making the lease balance equal to zero

because of rounding errors, for the last year, make the reduction of principal equal to the lease balance and force out the interest.

advantage

best adheres to matching concept problem is that the estimates involved can be very difficult to develop for most plant assets

to calculate double declining balance depreciation

book value at beginning of year * (2/asset's life)

in the last year, in the first year, which method will show the highest total assets on the year-end balance sheet?

both will be same

effect on cash flow

cash paid to reacquire stock is financing outflow

common stock

common stockholders have voting privileges -election of board of directors -vote on significant activities of management dividend rates are determined by the board of directors based on the corporation's profitability -receive dividends after preferred stockholders

treasury stock

considered issued stock but not outstanding stock does not have voting rights cannot receive dividends recorded at its reacquisition cost no gains or losses are ever recorded

treasury stock account

contra equity account normal balance is debit

book value formula

cost of asset - accumulated depreciation

recording acquisition

cost reported as an asset on the balance sheet and amount paid in cash reported as an investing cash outflow on the statement of cash flows

Factors in Calculating Depreciation

cost, useful life, residual value

capital expenditures

costs incurred to increase the: -operating efficiency of the asset -productive capacity of the asset -the expected useful life of the asset -usually substantial in amount and occur infrequently during the period of ownership -capitalized (the capital expenditure is added to the cost of the asset that has been improved or bettered

Revenue expenditure

expenditures made to keep an asset in good working order: -ordinary repairs to an asset usually small in amount and usually occur frequently throughout the life of the asset have no effect on the useful life of the asset not capitalized. rather they are expensed immediately (repair expense)

discounting

figuring out how much a future amount is worth today

preferred stock

has dividend preference - means if a dividend is paid the preferred stockholders must be paid in full before common stockholders can receive a dividend the preferred stock dividend is set at a fixed percentage preferred stockholders typically do not have voting rights

adjustment to i & n when interest is compounded in any way other than annual

i / # of compounds per year n * # of compounds per year

gain on sale

if the cash received exceed the book value -revenue account -recorded on income statement -increases net income (thus retained earnings)

loss on sale

if the cash received is less than the book value -expense account -recorded on income statement -decreases net income (thus retained earnings)

adjusting book value when it falls below residual

in the year that the book value falls below the residual, stop depreciating once the book value hits the residual value depreciation costs - depreciation expenses in the previous years - x = residual

how does the acquisition of an asset impact the balance sheet?

increase PPE decrease cash

effects of capital expenditure on balance sheet

increase PPE & decrease cash

balance sheet impact

increase assets (by amount of cash received) and increase equity (both common stock & paid-in capital)

effects of depreciation on income statement

increase depreciation expense and decrease net income

effects of revenue expenditure on income statement

increase repair expense decrease net income

As the compounding frequency increases, what happens to the present value?

increases

effects of capital expenditure on cash flow

investing cash outflow

how does the acquisition of an asset impact the statement of cash flows?

investing cash outflow

how does units of production differ from the other 2 methods?

it is not based on time. it is based on actual usage.

double declining balance depreciation

known as an accelerated depreciation method

land & depreciation

land does not depreciate since its usefulness and revenue producing ability generally remain intact (never gets used up)

Price Earnings Ratio

market price per share of stock / earnings per share measures investors' expectations regarding the growth potential and earnings stability of a company

asset turnover ratio

measures how efficiently a company uses its assets to generate sales net sales revenue / average total assets

return on assets (ROA)

measures the amount of profit earned for each dollar invested in assets net income / average total assets

Time Interest Earned Ratio

measures the companies' ability to meet its interest payments as they come due can be thought of as a 'margin of safety' provided to creditors the higher the ratio, the more income the company has to pay its interest and the less likely the company is to default on these payments

debt-to-equity ratio

measures the percentage of funds being provided by creditors vs stockholders measures how protected creditors are in the event the company is unable to pay its debts (insolvency) all things being equal, the higher the debt to equity ratio, the higher the risk to creditors the higher the ratio, the more debt we have than equity, the greater proportion of credit we have, and thus higher likelihood an individual creditor would not be paid in full if the company can't meet its obligations additionally, higher ratio typically results in a higher rate of interest charged by lenders to accommodate for the added risk

accelerated depreciation method records what

more depreciation in the early years of an asset's life and less depreciation in the later years. thus, these methods show a declining amount of depreciation each year

to find the future value of an annuity due table factor

multiply the ordinary annuity factor by (1+i)

to find the present value of an annuity due table factor

multiply the ordinary annuity factor by (1+i)

re-issuance of treasury stock: when the re-issue price > reacquisition cost

record the excess in the equity account Paid-in capital - treasury when treasury stock is re-issued, always remove the treasury stock from the balance sheet at its reacquisition cost

re-issuance of treasury stock: when the re-issue price < reacquisition cost

reduce paid-in capital -- treasury by debiting the account for the difference. however it cannot go past zero. if a deficit still exists after debiting the paid-in capital - treasure account, reduce retained earnings for the remaining deficit

once an asset is fully depreciated, its ending book value is equal to what amount?

residual (salvage) value

treasury stock

stock that has been reacquired

in the first year, which method will show the highest net income?

straight line -in the first year, records lower amount of depreciation than accelerated

in the last year, in the first year, which method will give an income tax advantage?

straight-line

in the first year, which method will show the highest total assets on the year-end balance sheet?

straight-line - lower depreciation in first year, therefore accumulated depreciation in first year is less. thus since accumulated depreciation is a contra asset, straight-line will show lower reduction of assets in first year and thus a higher amount of total assets

how to determine the cost assigned to each individual asset purchased

the cost is allocated to the individual assets purchased by determining the percentage of total market value made up by each asset and then allocating the cost to those assets based on that percentage

date of payment

the date on which a corporation pays dividends to its stockholders debit dividends payable credit cash income statement not affected cash flow is financing outflow balance sheet - assets decrease and liabilities decrease

date of record

the date on which a stockholder must own one or more shares of stock in order to receive the dividend no accounting entry required

date of declaration

the date the corporation's board of directors formally decides to pay a dividend to stockholders debit dividends credit dividends payable balance sheet effects - liabilities increased & equity decreased no effect on income statement or cash flow

difference between issued and outstanding shares

the difference represents shares of stock issued by the company and then reacquired by the company (i.e. the company buys back the stock)

compounding

the frequency with which interest is added to the principal

lessor

the owner of property that is leased to another party

lessee

the party that is granted the right to use property under the terms of a lease

depreciation

the systematic allocation of the cost of a plant asset to expense over its useful life

outstanding shares

the total number of shares actually in the hands of stockholders

issued shares

the total number of shares of stock that have been sold to the public

authorized shares

the total number of shares of stock that the company is allowed to sell to the public

debt-to-equity ratio formula

total liabilities/total stockholders equity

Present Value of an Ordinary Annuity

want to know the value today of a series of equal payments to be made or received in the future

lump sum (basket) purchase

when a company purchases more than one asset for one, lump-sum amount

When is a cost capitalized?

when it is recorded as part of an asset on the balance sheet rather than as an expense on the income statement