ACCOUNTING FINAL
methods for making financial comparisons
1. comparing across time 2. comparing across companies
sales revenue less: (3)
1. credit card discounts (contra-revenue) 2.sales discount (contra rev) 3. sales returns and allowances (contra rev)
adjusting entries that increase expenses
1. deferred expenses 2. accrued expenses
adjusting entries that increase revenue
1. deferred revenue 2. accrued revenues
upon acquisition of intangible assets, managers must decide whether separate inangibles have:
1. definite life 2. indefinite life
purchase price allocation method (2 steps)
1. estimate FV of company's tangible assets, intangible assets and liabilities 2. compute goodwill
which 2 companies is conservatism constraint important to?
1. high tech companies that manufacture goods for which costs of production and selling price are declining (HP) 2. companies that sell seasonal goods such as clothing (american eagle outfitters), the value of which drops dramatically at the end of each selling season fall or spring
valuation alternatives for mixed attribute measurement model
1. historical cost 2. adjusted historical cost 3. market value/fair value 4. present value 5. net realizable value
3 types of long lived tangible assets
1. land 2. PPE 3. natural resources
2 primary steps in employing the allowance method:
1. making the end of period adjusting entry to record estimated bad debt expense 2. writing off specific accounts determined to be uncollectible during the period
managers choice of accounting methods (2)
1. net income effects (managers prefer to report higher earnings) 2. income tax effects (managers prefer to pay the least amount of taxes allowed by law as late as possible)
types of loans (3)
1. non interest bearing notes 2. installment notes 3. bonds payable/note payable
estimating bad debts methods- 2
1. percentage of credit sales method 2. an aging of accounts receivable
Coupon Rate
(Stated Rate, Contract Rate, Nominal Rate)
straight line formula
(cost-residual value)/useful life
sales discount (2/10,n/30)
- 2% is the discount - 10 = number of days within which payment is due in order to receive the discount - n = net payment - 30 = days within which payment is due
why do companies wait until the end of the accounting period to do adjusting entries?
daily adjustments would be very costly and time consuming
solvency ratio- long term perspective
debt to equity ratio
remote contingencies
don't require any type of disclosure
names for bad debt expense - 3
doubtful accounts expense, uncollectible accounts expense, provision for uncollectible accounts
bade debt expense is
estimated uncollectible
if intangible assets are developed, they are...
expensed when incurred
bond principle
face value, par value, maturity value
cost of intangible asset with indefinite life
fair value method
total asset turnover ratio
higher=better
intangible assets are recorded at
historical cost only if they have been purchased
when is it best to us declining balance depreciation
if an asset is considered to be more efficient or productive when its newer
secured debt
if company defaults on loan, bank has right to take ownership of assets
when is an asset impaired
if net book value>estimated future cash flows
how are assets listed
in order of liquidity
How are liabilities listed on the balance sheet?
in order of maturity (how soon an obligation is to be paid)
EPS
inc = good
GP MARGIN
inc=good
inventory turnover ratio
inc=good
in summary, revenues
increase with credits, accounts have credit balances
in summary, expenses
increase with debits, accounts have debit balances
finished goods
inventory is sold and the amounts become cost of goods sold expense on the income statement
bond purchasers
invest money by buying the bonds
equity
invested by owners
cash flows from investing activities
investments, PPE
debt to equity- helps us understand how company is funding its assets by debt or equity
larger ratio means more debt
the least latest rule of thumb
managers prefer to pay the least amount of taxes allowed by law as late as possible
bond discount
market rate is greater than coupon rate
bond premium
market rate is less than coupon rate
par
market rate=coupon rate
a liability that is: 1. probable but amount can't be estimated 2. reasonably possible regardless of whether amount can be estimated
must be disclosed in footnote
raw materials
must be purchased; when these are used, the cost of these materials is removed from the raw materials category and moved into the work in process inventory
is depreciation exact?
no! it's an estimate!
does the coupon rate change over time
nooooo
what are deffered expenses
previously recorded assets
how to calculate interest for the period
principal x annual interest rate x #of months/12months
how to calculate goodwill
purchase price minus the difference of fair value and liabilities
current ratio
ratio greater than 1 is good
quality of income
ratio higher than 1 indicated high quality income
write offs are
realized uncollectible
a liability that is both probable and reasonably estimable must be
recorded and reported on balance sheet
How are ordinary repairs and maintenance accounted for?
recorded as expenses.
how are improvements accounted for
recorded as increases in asset accounts, not as expenses.
2 requirements of useful accounting information
relevance and faithful representation
expense recognition (matching) principle
requires that a portion of an asset's cost be allocated as an expense in the same period that revenues are generated by its use
financing provided by operations
retained earnings/earned capital
NET SALES=
sales minus contra rev accounts (cc discount, sales returns, sales discount)
how to find common stock
shares x par value
cost of intangible asset with definite life
straight line basis (amortization)
as a contra-asset, the balance in allowance for doubtful accounts is subtracted from
the balance of the asset accounts receivable, thus the entry decreases the net book value of accounts receivable and total assets
holding loss
the difference between the purchase cost and the lower replacement cost
when is the only time to record goodwill
the only way to record and report goodwill as an asset is to purchase another business
synergy
the operations of two companies together may be more profitable than the combined profitability of the companies as separate entities
horizontal growth
these acquisitions involve companies at the same level in the channels of distribution
why do companies offer sales discount?
to encourage customers to pay more quickly
when is the specific identification method appropriate?
when dealing with expensive, unique items like houses or fine jewelry *not appropriate when large quantities of similar items are stocked
when are intangible assets recorded?
when purchased
market rate
yield rate, effective interest rate
aging of accounts receivable method
Estimates uncollectible accounts based on the age of each account receivable.
copyright
Exclusive right to publish, use, and sell a literary, musical, or artistic work.
improvements
Expenditures that increase the productive life, operating efficiency, or capacity of an asset
Ordinary Repairs and Maintenance
Expenditures that maintain the productive capacity of an asset during the current accounting period only
bad debt expense
Expense associated with estimated uncollectible accounts receivable.
accrued liabilities
Expenses that have been incurred but have not been paid at the end of the accounting period.
component percentages
Express each item on a particular financial statement as a percentage of a single base amount.
decreasing cost inventories
FIFO is most often used for both the tax return and financial statements
operating revenues
Increases in assets or settlements of liabilities from the major or central ongoing operations of the business.
relevant information
Information that can influence a decision; it has predictive and/or feedback value.
indefinite life
Intangible assets with indefinite lives are not amortized
capitalized interest
Interest expenditures included in the cost of a self-constructed asset.
which method results in lower taxes?
LIFO
increasing cost inventories
LIFO is used on the tax return because it normally results in lower income taxes
when unit costs are declining...
LIFO produces higher income and higher inventory valuation than FIFO (lower COGS)
when unit costs are rising...
LIFO produces lower income and a lower inventory valuation than FIFO (higher COGS)
cash flows from financing activities
LONG TERM DEBT, BORROWING, REPAYING, DIVIDENDS, BUYING/SELLING STOCK
post closing trial balance
Prepared as an additional step in the accounting cycle to check that debits equal credits and all temporary accounts have been closed.
time value of money
Principle that a given amount of money deposited in an interest-bearing account increases over time.
LIFO conformity rule
The IRS requirement that when LIFO is used on a tax return, it must also be used in reporting income to stockholders.
lessor
The party that owns a leased asset.
lessee
The party that pays for the right to use the leased asset.
market interest rate
The rate of return investors demand for a company's bonds on the date the bonds are issued, and the rate used to compute the bond's interest expense each period.
what is declining balance deprection?
accelerated depreciation
Net Book Value (Carrying or Book Value) of a long lived assets
acquisition cost minus accumulated depreciation from its acquisition date to the balance sheet date
definite life
allocated on a straight-line basis each period over its useful life (amortization)
alternate names for allowance for doubtful accounts
allowance for bad debts, allowance for uncollectible accounts
accrued expense
an expense incurred in operating a business during an accounting period, but not yet paid.
transaction analysis model includes (5):
assets,liabilites,SH equity,revenues,expenses
how are intangible assets recorded when purchased?
at historical cost
comparison of the 2 bad debt methods
1. percentage of credit sales- directly compute the amount to be recorded as BDE on the income stmt for the period in the adjusting journal entry 2. aging of AR- compute the estimated ending balance we would like to have in the ADA on the balance sheet after we make the necessary adjusting entry. The difference between the current balance in the account and the estimated balance is recorded as the adjusting entry for BDE for the period
diff between preferred and common stock (3)
1. preferred stock typically doesn't have voting right 2. preferred stock is less risky 3. preferred stock typically has a fixed dividend rate
market ratio
1. price earnings ratio 2. dividend yield ratio
Whether a contingent liability is reported on the balance sheet, in the footnotes, or not at all depends on two factors:
1. probability of future economic sacrifice 2. the ability of management to estimate the amount of the liability
businesses can earn a high rate of return through which 2 strategies
1. product differentiation 2. cost differentiation
2 benefits of sales discount
1. prompt receipt of cash from customers reduces the necessity to borrow money to meet operating needs 2. because customers tend to pay bills providing discounts first, a sales discount also decreases the chances that the customer will run out of funds before the companies' bill has been paid
3 types of inventory
1. raw materials 2. work in process 3. finished goods
profitability ratios (6)
1. return on equity 2. return on assets 3. gross profit margin ratio 4. net profit margin ratio 5. earnings per share 6. quality of income ratio
disadvantages to issuing bonds
1. risk of bankruptcy 2. negative impact on cash flows
financial accounting assumptions (4)
1. seaparate entity assumption- business separate from its owners 2. going concern- business will continue to operate 3. monetary unit- report uses national monetary unit 4. time period- companies report info in a shorter time period
4 inventory costing methods
1. specific identification 2. FIFO 3. LIFO 4. weighted average
reasons why companies issue bonds
1. stockholders maintain control 2. a portion of interest expense is tax deductible 3. issuing bonds can increase the return to shareholders
3 depreciation methods
1. straight line 2. units of production 3. declining balance
ratio analysis
An analytical tool that measures the proportional relationship between two financial statement amounts.
deferred expense
An asset created when a business makes advance payments of future expenses. (prepaid rent)
trademark
An exclusive legal right to use a special name, image, or slogan.
specific identification method
An inventory costing method that identifies the cost of the specific item that was sold.
perpetual inventory system
An inventory system in which a detailed inventory record is maintained, recording each purchase and sale during the accounting period.
periodic inventory system
An inventory system in which ending inventory and cost of goods sold are determined at the end of the accounting period based on a physical inventory count.
debentures
An unsecured bond; no assets are specifically pledged to guarantee repayment.
if a lease meets any of the following 5 criteria, it is considered a finance lease:
1. the lease transfers ownership of the underlying asset to the lessee by the end of the lease term 2. the lease grants the lessee an option to purchase the underlying asset that the lessee is reasonably certain to exercise 3. the lease term is for the major part of the remaining economic life of the underlying asset 4. the present value of the sum of the lease payments and any residual value guaranteed by the lessee equals or exceeds substantially all of the fair value of the underlying asset 5. the underlying asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term
2 purposes of closing entries
1. to transfer the balance in the temporary accounts (income stmt accounts) to retained earnings 2. to establish a zero balance in each temporary account to start accumulation for next accounting period
asset turnover ratios (2)
1. total asset turnover ratio 2. inventory turnover ratio
reasons for acquiring control (>50%) of a company
1. vertical integration 2. horizontal growth 3. synergy
benefits of stock ownership
1. voice in management 2. dividends 3. residual claim
how to mitigate bad debt -3
1.require approval of customers credit history by a person independent of the sales and collections function 2. age AR periodically and contact customers with overdue payments 3. reward both sales and collections personnel for speedy collections so that they work as a team
double declining balance (USED FOR TAX)
2xNBV/useful life
WHAT KIND OF BALANCE will the closing entries have
A CREDIT BALANCE for retained earnings to represent net income!
franchise
A contractual right to sell certain products or services, use certain trademarks, or perform activities in a geographical region.
deferred revenue
A liability created when a business collects cash from customers in advance of completing a service or delivering a product.
indirect method
A method of presenting the operating activities section of the statement of cash flows that adjusts net income to compute cash flows from operating activities.
direct method
A method of presenting the operating activities section of the statement of cash flows that reports components of cash flows from operating activities as gross receipts and gross payments.
contingent liability
A potential liability that has arisen as the result of a past event; it is not a definitive liability until some future event occurs.
sales returns and allowances
A reduction of sales revenues for return of or allowances for unsatisfactory goods
accrued revenue
A revenue that has been earned but for which the cash has not yet been collected aka accounts receivable
AFS vs trading
AFS sells but not for a while, trading is bought to sell so very current
AR NET=
AR GROSS- ADA
Percentage of Credit Sales Method
Bases bad debt expense on the historical percentage of credit sales that result in bad debts.
callable bond
Bonds that may be called for early retirement at the option of the issuer.
convertible bonds
Bonds that may be converted to other securities of the issuer (usually common stock).
cash flows from operating activities
Cash inflows and outflows directly related to earnings from normal operations; OPERATIONS AND INTEREST
Allowance for Doubtful Accounts
Contra-asset account containing the estimated uncollectible accounts receivable.
dividends in arrears
Dividends on cumulative preferred stock that have not been paid in prior years.
use the coupon to find the interest rate and then
EFF THE COUPON RATE
finance lease
Effective control of the leased asset is transferred to the lessee.
operating lease
Effective control of the leased asset remains with the lessor.
adjusting entries
Entries necessary at the end of the accounting period to measure all revenues and expenses of that period.
credit card discount
Fee charged by the credit card company for its services.
goodwill
For accounting purposes, the excess of the purchase price of a business over the fair value of the acquired business's assets and liabilities.
patent
Granted by the federal government for an invention; gives the owner the exclusive right to use, manufacture, and sell the subject of the patent.
P/E ratio (price/earnings)
HIGH ratio indicates earnings are expected to grow rapidly
ROA
INC=GOOD; larger the better
technology
Includes costs for computer software and website development.
straight-line depreciation
Method that allocates the depreciable cost of an asset in equal periodic amounts over its useful life.
units of production depreciation
Method that allocates the depreciable cost of an asset over its useful life based on the relationship of its periodic output to its total estimated output.
declining balance depreciation
Method that allocates the net book value (cost minus accumulated depreciation) of an asset over its useful life based on a multiple of the straight-line rate, thus assigning more depreciation to early years and less depreciation to later years of an asset's life.
computation of impairment loss
NBV-FV
Does equity have a maturity date?
NO
are unadjusted trial balances presented to external users?
NO!
if inventory is written down at cost, do you need a write down entry?
NO! only if it changes to NRV
does the first journal entry of ADA (dr ada and cr ar) affect total assets?
NO! only recording BDE!!!
are balance sheet accounts reduced to 0 at the end of an accounting period?
NO! these accounts are permanent
for BDE, if estimates are found to be incorrect, are prior financial statements values corrected?
NOOOOOO!!
licenses and operating rights
Obtained through agreements with governmental units or agencies; permit owners to use public property in performing their services.
asset turnover ratios
Ratios that capture how efficiently a company uses its assets.
profitability ratios
Ratios that compare income with one or more primary activities.
liquidity ratios
Ratios that measure a company's ability to meet its currently maturing obligations.
solvency ratios
Ratios that measure a company's ability to meet its long-term obligations.
market ratios
Ratios that relate the current price per share of a company's stock to the return that accrues to stockholders.
accrual basis accounting
Records revenues when earned and expenses when incurred, regardless of the timing of cash receipts or payments.
cumulative dividend preference
Requires any unpaid dividends on preferred stock to accumulate. These cumulative preferred dividends must be paid before any common dividends can be paid.
current dividend preference
Requires that dividends be paid to preferred stockholders before any dividends are paid to common stockholders.
expense recognition principle
Requires that expenses be recorded in the same time period when incurred in earning revenue.
faithful representation
Requires that the information be complete, neutral, and free from error.
Revenue Recognition Principle (2)
Revenues are recognized (1) when the company transfers promised goods or services to customers (2) in the amount it expects to be entitled to receive.
cash equivalents
Short-term investments with original maturities of three months or less that are readily convertible to cash and whose value is unlikely to change.
secured bond
Specific assets are pledged as a guarantee of repayment at maturity.
separate entity assumption
States that business transactions are separate from the transactions of the owners.
preferred stock
Stock that has specified rights over common stock.
what is post closing trial balance concerned with
TEMPORARY ACCOUNTS
comparative financial statements
To allow users to compare performance from period to period, companies report financial statement values for the current period and one or more prior periods.
primary objective of reporting to external users
To provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity.
average cost method
Uses the weighted average unit cost of the goods available for sale for both cost of goods sold and ending inventory.
lower of cost or NRV
Valuation method departing from the cost principle; it serves to recognize a loss when net realizable value drops below cost.
liabilities and stockholders equity normally have
credit balances
does market rate change over time
YES
vertical integration
a company acquires another at a different level in the channels of distribution
liquidity ratios
current ratio
which is the only non-temporary account
balance sheet! balance sheet is permanent
unsecured debt
bank relies primarily on borrower's integrity and general earning power to repay the loan
COGS equation
beginning inventory + purchases - ending inventory
ROE
bigger=better
net profit margin ratio
bigger=better
debt
borrowed from creditors
bond issuers
borrowing money by issuing bonds
what areas affect the stmt of cash flows
cash received from operations, investing, and financing only
for inventory located in countries that don't allow LIFO for tax purposes or don't have a LIFO conformity rule...
companies w increasing costs most often use FIFO or average cost to report higher income on the income statement
non interest bearing note
company accrue interest expense and interest payable until principal and interest are paid 100% at end of loan
Qualitative Characteristics of Accounting Information
comparability, verifiability, timeliness, and understandability
ratios can only be interpreted by
comparing them to other ratios or a benchmark value
what must be presented when a company acquires another and both companies continue their separate legal existence
consolidated financial statements
what kind of account is ADA
contra-asset
financing provided by owners
contributed capital
work in process
cost of raw materials plus direct labor and factory overhead cost are added into work in process inventory