Unit 4

Investing Activities-Statement of Cash Flows

Activities that include making and collecting loans and acquiring and disposing of investments (both debt and equity) and property, plant, and equipment. These generally involve long-term assets. (noncurrent assets: long-term investments, PP&E, intangibles) Inflows of cash: -sale of PP&E -sale of debt or equity securities of other entities -collection of loans to other entities Outflows of cash: -purchase of PP&E -purchase of debt and equity securities of other entities -loans to other entities e.g., purchase and sale of investments and PP&E, making and collecting loans

Financing Activities-Statement of Cash Flows

Activities that involve liability and owners' equity items. They involve liability and stockholder equity items. (long-term liabilities: bonds and notes payable; equity: common stock, treasury stock, dividends) Inflows of cash: -issuance of equity securities -issuance of debt (bonds and notes) Outflows of cash: -payment of dividends -redemption of debt -reacquisition of capital stock e.g., obtaining cash from creditors and repaying the amounts borrowed, obtaining capital from owners and providing them with a return on their investment, proceeds from issuing equity instruments, retirement of bonds

Operating Activities-Statement of Cash Flows

Activities that involve the cash effects of transactions that enter into the determination of net income (revenues, expenses, gains, and losses; current assets and current liabilities; depreciation, amortization). They include the cash effects of transactions that are used to determine net income. Inflows of cash: when revenues exceed expenses Outflows of cash: when expenses exceed revenues e.g., cash receipts from sales of goods and services, cash payments to suppliers, cash payments to employees and expenses, interest payments paid on loans

What is the correct total of current liabilities?

Adjusted Trial Balance: D-Cash- 875,000 D-Accounts Receivable (net)- 2,695,000 D- Inventory- 2,085,000 D- PP&E- 8,269,000 C- Accounts payable and accrued liabilities-1,761,000 C-Income taxes payable-654,000 C-Deferred income tax liability- 85,000 C-Common stock- 2,350,000 C-Additional paid-in capital- 3,680,000 C-Retained earnings- 3,490,000 C-Net Sales and other revenues- 13,560,000 D- Costs and expenses- 11,180,000 D-Income tax expense- 476,000 Accounts payable and accrued liabilities plus Income taxes payable. ($1,761,000 + $654,000 = $2,415,000)

Intangible assets (noncurrent asset)

Assets that do not have physical substance and are not financial instruments, such as patents, copyrights, franchises, goodwill, trademarks, trade names, and customer lists -A company writes off (amortizes) limited-life intangible assets over their useful lives.

As a term of a loan covenant, Bullzai, Inc. is required to evaluate its financial liquidity. To calculate its current cash debt coverage, Bullzai must divide its net cash provided by operating activities by which type of liability?

Average current liabilities; Cash debt coverage indicates a company's ability to repay its current liabilities from net cash provided by current operating activities. Net cash from operating activities/average current liabilities = current cash debt coverage.

A corporation would like to evaluate its financial flexibility. In order to calculate its overall cash debt coverage, the corporation must divide its net cash provided by operating activities by which type of liability?

Average total liabilities; The cash debt coverage indicates a company's ability to repay its liabilities from net cash provided by operating activities, without having to liquidate the assets employed in its operations. It is calculated by dividing net cash provided by operating activities by average total liabilities.

Usefulness of the Balance Sheet

By reporting information on assets, liabilities, and stockholders' equity, the balance sheet provides a basis for computing rates of return and evaluating the capital structure of the enterprise. Analysts also use information in the balance sheet to assess a company's risk and future cash flows. In this regard, analysts use the balance sheet to assess a company's liquidity, solvency, and financial flexibility. -The balance sheet is useful to investors because it can help calculate the solvency of the company.

Packard Corporation reports the following information: Net cash provided by operating activities $335,000 Average current liabilities 150,000 Average long-term liabilities 100,000 Dividends declared 60,000 Capital expenditures 110,000 Payments of debt 35,000 What is Packard's cash debt coverage?

Cash Debt Coverage = (Net Cash Provided by Operating Activities/ Average Total Liabilities) =335,000/ (150,000 + 100,000) = 1.34

How to prepare the current assets section of the balance sheet:

Current assets include cash and other assets that are expected to be converted into cash, sold, or consumed within one year or an operating cycle -typical current assets include cash and cash equivalents, short-term investments, receivables, inventories, and prepaid expenses -current assets are listed in the balance sheet in order of liquidity 1. Start with cash in the current assets section as it is considered the most liquid asset

What are current liabilities?

Current liabilities are the obligations that are reasonably expected to be liquidated either through the use of current assets or the creation of other current liabilities. Current liabilities include notes and accounts payable, advances received from customers referred to as unearned revenue, current maturities of long-term debt, taxes payable, and accrued liabilities. Obligations due to be paid during the next year may be excluded from the current liability section if the item is expected to be refinanced through long-term debt or the item will be paid out of noncurrent assets.

What is the balance sheet?

It's the measure of the entity's financial position at one point in time. e.g. on December 31, 2021 -it really represents the accounting equation Assets = Liabilities + Equity -there are various measurement attributes that we put on the balance sheet e.g., historical cost, net book value, fair value, net realizable value, present value -to report assets or liabilities at the appropriate measurement attribute, we use contra and adjunct accounts -components of the financial statements are classified as current or non-current

According to the accounting formula, total assets of a business are equal to what?

Liabilities plus total stockholder's equity; The accounting formula and the presentation of the balance sheet is Assets = Liabilities + Stockholders' Equity (A = L + E)

What is the current cash debt coverage often used to assess?

Liquidity; Liquidity refers to the "nearness to cash" of assets and liabilities - how quickly can they get and use their cash

Which error will cause an imbalance in the trial balance?

Listing the balance of an account with a debit balance in the credit column of the trial balance.

What are long-term investments?

Long-term investments are one of four types: • Investments in securities of other companies, such as common stock, bonds, or long-term notes. • Investments in tangible fixed assets not currently used in operations. • Investments set aside in special funds (sinking, pension, plant expansion) and the cash surrender value of life insurance. • Investments in nonconsolidated subsidiaries or affiliated companies. Long-term investments are shown in the balance sheet below current assets in a separate section called Investments.

What is the proper classification of Treasury stock on the balance sheet?

Reduction of stockholders' equity; Treasury Stock is the cost of shares repurchased by the company. It is reported in the Stockholders' Equity section of the balance sheet as a reduction in stockholders' equity.

Property, Plant, and Equipment (PP&E)-noncurrent asset

Tangible long-lived assets used in the regular operations of the business, such as land, buildings, machinery, furniture, tools, and wasting resources (timberland, minerals) -With the exception of land, a company either depreciates (e.g., buildings) or depletes (e.g., timberlands or oil reserves) these assets

indirect method of for preparing operating section of statement of cash flows:

begin with net income and either adjust net income up or down to arrive at cash flows from operations -begins with net income on an accrual basis and reconciles to a cash basis, i.e. the difference between beginning and ending cash A comparative accrual Balance Sheet is needed to prepare the indirect method. The indirect method is the preferred method and is widely used

Owners' Equity (Stockholder's Equity)

Residual interest in the assets of an entity that remains after deducting its liabilities. In a business enterprise, the equity is the ownership interest -one of the most difficult sections to prepare and understand Companies usually divide the section into six parts: 1. Capital Stock (preferred, common) 2. Additional Paid-In Capital 3. Retained Earnings 4. Accumulated Other Comprehensive Income 5. Treasury Stock 6. Noncontrolling Interest (Minority Interest) "Cats are really able to nap"

Receipt of interest from a Note Receivable for trade activity would be reported as a cash inflow in which section?

operating activities; operating activities involve the cash effects of transactions that enter into the determination of net income, including interest earned on trade activities remember current assets and current liabilities are reported in the operating section and interest receivable is a current asset

issuance

sale

The company liquidated its available-for-sale investment portfolio at a loss of $5,000

sale of investments is an investing activity (add) loss on sale of investments is an operating activity (add)

financial flexibility (usefulness of the balance sheet)

the ability of an enterprise to take effective actions to alter the amounts and timing of cash flows so it can respond to unexpected needs and opportunities e.g., a company with a high degree of financial flexibility is better able to survive bad times, to recover from unexpected setbacks, and to take advantage of profitable and unexpected investment opportunities

accumulated other comprehensive income

the aggregate amount of other comprehensive income items -includes such items as unrealized gains and losses on available-for-sale debt investments and unrealized gains and losses on certain derivative transactions

liquidity (usefulness of the balance sheet)

the amount of time that is expected to elapse until an asset is realized or otherwise converted into cash or until a liability has to be paid e.g., How quickly will my assets convert to cash?

Limitations of the Balance Sheet

Some of the major limitations of the balance sheet are: 1. Most assets and liabilities are reported at historical cost. As a result, the information provided in the balance sheet is often criticized for not reporting a more relevant fair value. 2. Companies use judgments and estimates to determine many of the items reported in the balance sheet. 3. The balance sheet necessarily omits many items that are of financial value but that a company cannot record objectively. e.g., the value of employees

the cash at the end of the year balance on the statement of cash flows should equal

the cash balance of the year we are preparing the statement of cash flows for

retained earnings

the corporation's undistributed earnings -the retained earnings amount may be divided between the unappropriated (the amount that is usually available for dividend distribution) and restricted (e.g., by bond indentures or other loan agreements) amounts

treasury stock

the cost of shares repurchased by the company -companies show any capital stock reacquired (treasury stock) as a reduction of stockholders' equity

trade accounts payable

the money a company owes its vendors for inventory-related goods, such as business supplies or materials that are part of the inventory; it is a current liability

capital stock

the par or stated value of the shares issued -companies must disclose the par value and the authorized, issued, and outstanding share amounts. e.g., common stock, preferred stock

redemption (retirement)

the repayment of a fixed-income security

Peterson Enterprises reports the following information: Net income $5,000,000 Depreciation expense 680,000 Loss on the sale of investments 154,000 Increase in accounts receivable 320,000 What should Peterson report for cash provided by operating activities?

5,000,000 + 680,000 + 154,000 - 320,000 = 5,514,000

Trial balance

A list of all open accounts in the ledger and their balances at a given time -it is usually prepared at the end of an accounting period -lists the accounts in the order in which they appear in the ledger, with debit balances listed in the left column and credit balances in the right column -proves the mathematical equality of debits and credits after posting -uncovers errors in journalizing and posting -it is useful in the preparation of financial statements -it does NOT prove that a company recorded all transactions or that the ledger is correct-as long as a company posts equal debits and credits, even to the wrong account or in the wrong amount, the total debits will equal the total credits

Which balance sheet format lists the assets on the left side of the page and the liabilities and stockholders' equity on the right side?

Account form

classified balance sheet

Because the accounts from the adjusted trial balance contain all data needed for financial statements, the adjusted trial balance is the primary basis for the preparation of financial statements, including the classified balance sheet.

Examples of Operating Activities:

Current assets, current liabilities, gains, losses, depreciation, amortization ADD: · Depreciation of machinery · Amortization of patent · Loss on the sale of equipment · Depreciation of fixed asset · Amortization of intangible asset · Loss on sale of fixed asset and/or investments · Decrease in current assets during the year · Increase in current liabilities during the year -Increase in accounts payable -Decrease in inventory DEDUCT: · Increase in accounts receivable during the year · Decrease in accounts payable during the year · Gain on sale of fixed asset and/or investments · Increase in current assets during the year · Decrease in current liabilities during the year

What is an appropriate major asset classification?

Current assets; Current Assets, Noncurrent Assets, and Other Assets are the major asset classification on a balance sheet.

What is an intangible asset?

Customer lists; Customer lists lack physical substance and are not financial instruments.

What are included in long term liabilities?

Deferred income taxes and most lease obligations; Deferred income taxes is categorized as an "other asset" on the balance sheet and is considered a long-term liability.

$12,000 in depreciation expense

Depreciation expense is an operating activity (add)

What is working capital?

Excess of total current assets over total current liabilities; Total current assets less total current liabilities measures working capital - the ability for a company to meet the financial demands of the operating cycle.

In which section of a statement of cash flows should you report proceeds from issuing equity instruments?

Financing activities; Financing activities involve liability and owners' equity items

Payment of dividends would come under which activity on the statement of cash flows?

Financing; Financing activities involve owners' equity items including obtaining resources from owners and providing them with a return on their investment (dividends).

Numerous errors may exist even though the trial balance columns agree.

For example, the trial balance may balance even when a company (1) fails to journalize a transaction (2) omits posting a correct journal entry (3) posts a journal entry twice (4) uses incorrect accounts in journalizing or posting, (5) makes offsetting errors in recording the amount of a transaction

The balance sheet is one of the three financial statements required by __________________________________________________________.

Generally Accepted Accounting Principles (GAAP)

What is the Statement of Cash Flows?

It is a financial statement that provides information about the cash inflows and cash outflows of an enterprise during a period. -it reports cash receipts and cash payments from operating, investing, and financing activities -it reports the net change in cash resulting from these activities -helps in evaluating a company's liquidity, solvency, and financial flexibility

Examples of financing activities:

Long-term liabilities + equity ADD: · Issuance (sale) of common stock · Issuance of bonds -Issuance of long-term notes payable -proceeds from issuing equity instruments -issuance of equity securities -issuance of notes -issuance of debt (bonds and notes) -issuance of capital stock DEDUCT: · Redemption (retirement) of bonds · Payment of cash dividends · Purchase of treasury stock · Redemption (retirement) of long-term notes payable -reacquisition of capital stock (treasury stock)

What are long-term liabilities?

Long-term liabilities are obligations whose settlement dates extend beyond the normal operating cycle or one year, whichever is longer. Examples include bonds payable, notes payable, lease obligations, and pension obligations. Long-term liabilities that mature within the current operating cycle are classified as current liabilities if their liquidation requires the use of current assets.

noncurrent assets

Noncurrent assets are those not meeting the definition of current assets. e.g., PPE, long-term investments, intangibles

long-term liabilities

Obligations that are not reasonably expected to be liquidated within a year or the normal operating cycle, whichever is longer, but instead, are payable at some date beyond that time -Companies classify long-term liabilities that mature within the current operating cycle as current liabilities if payment of the obligation requires the use of current assets. e.g., bonds payable, notes payable, deferred income tax liabilities, lease obligations, and pension obligations, premium on bonds payable, notes payable due within two years, discount on bonds payable due in four years, mortgage payable, bonds payable due in ten years, notes payable due in 14 months

Interest payments to lenders and other creditors should be classified in which section on the statement of cash outflows?

Operating activities; Operating activities involve the cash effects of transactions that enter into the determination of net income. Interest payment is from an interest expense-remember net income involves revenues, expenses, gains, and losses

Preparing the Statement of Cash Flows

Preparing the statement of cash flows from these sources involves four steps: 1. Determine the net cash provided by (or used in) operating activities. 2. Determine the net cash provided by (or used in) investing and financing activities. 3. Determine the change (increase or decrease) in cash during the period. 4. Reconcile the change in cash with the beginning and the ending cash balances.

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 -Similar to assets, companies classify liabilities as current or long-term.

What are acceptable balance sheet formats?

Report form and account form

What is a trait of usefulness of the balance sheet?

Solvency is measured; The balance sheet is useful to investors because it can help calculate the solvency of the company. Solvency refers to the ability of the company to pay its debts.

Which financial statement summarizes operating, investing, and financing activities of an entity for a period of time?

Statement of cash flows

Which financial statement summarizes the operating, investing, and financing activities of an entity for a period of time?

Statement of cash flows

One of the benefits of the statement of cash flows is that it helps users evaluate financial flexibility. How can you best describe financial flexibility?

The firm's ability to respond and adapt to financial adversity and unexpected needs and opportunities

Which statement accurately describes financial flexibility?

The firm's ability to respond and adapt to financial adversity and unexpected needs and opportunities;

How to prepare the Statement of Cash Flows (videos):

The statement of cash flows is a financial statement that shows a company's cash receipts and cash payments from operating, investing, and financing activities during a period. It is prepared using: -comparative balance sheet -the current income statement -selected transaction data Four steps in preparing the statement of cash flows: 1. Determine the cash provided by (or used in) operating activities 2. Determine the cash provided by (or used in) investing and financing activities 3. From the comparative balance sheets, determine the change (increase or decrease) in cash during the period 4. Reconcile the change in cash with the beginning and the ending cash balances *Cash from operating activities represent the difference in cash receipts and cash payments for operating activities. It is determined by converting net income on an accrual basis to a cash basis. This is done by adding or deducting those items from net income that do not affect cash.

The FASB and IASB are working to improve the presentation of financial information on the balance sheet, as well as other financial statements.

The statement of financial position is divided into five major parts, with many assets and liabilities netted against one another, which is a bit different than the traditional balance sheet.

An important element of the objective of financial reporting is "assessing the amounts, timing, and uncertainty of cash flows."

Three financial statements—the income statement, the statement of stockholders' equity, and the balance sheet—each present some information about the cash flows of an enterprise during a period. But they do so to a limited extent.

Net cash provided by operating activities is the excess of cash receipts over cash payments from operating activities. Companies determine this amount by converting net income on an accrual basis to a cash basis.

To do so, they adjust net income for items that do not affect cash. This procedure requires that a company analyze not only the current year's income statement but also the comparative balance sheets and selected transaction data. e.g., accounts receivable reflects a noncash increase in revenues, accounts payable reflects a noncash increase in expenses

Net assets:

Total assets - Total Liabilities = Net assets

adjunct accounts

added to the balance sheet account

trading securities

bought and held primarily for sale in the near term to generate income on short term price differences

noncurrent liabilities

e.g., notes payable, bonds payable, pension liabilities

working capital (net working capital)

excess of total current assets over total current liabilities -represents the net amount of a company's relatively liquid resources -it is the liquidity buffer available to meet the financial demands of the operating cycle

assets

probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events

A tract of land was purchased for $38,000

purchase of land is an investing activity (deduct)

contra accounts

subtracted from the balance sheet account

solvency (usefulness of the balance sheet)

the ability of a company to pay its debts as they mature

additional paid-in capital

the excess of amounts paid in over the par or stated value

Adjusted Trial Balance

-after journalizing and posting all adjusting entries, another trial balance (adjusted trial balance) is prepared from the ledger accounts -the purpose of an adjusted trial balance is to prove the equality of the total debit balances and the total credit balances in the ledger after all adjustments

Not reported as a cash flow

-exchange of furniture for office equipment

Tips on construction a balance sheet (video):

1. From the trial balance, determine what's on the balance sheet and what's on the income statement 2. list the assets, liabilities, and then equity

The procedures for preparing a trial balance consist of:

1. Listing the account titles and their balances. 2. Totaling the debit and credit columns. 3. Proving the equality of the two columns.

What are current assets?

Current assets are presented in the balance sheet in the order of their liquidity and normally include cash and cash equivalents, short-term investments, receivables, inventories, and prepaid expenses.

The major classifications of activities reported in the statement of cash flows are operating, investing, and financing. Classify each transaction listed as: Operating activity- add to net income Operating activity- deduct from net income Investing activity Financing activity Reported as significant noncash activity

(a) Issuance of capital stock- financing activity -It effect's the stocholders' equity accounts (b) Purchase of land and building- investing activity -land and building are long-term assets (c) Redemption of bonds - financing activity -indicates that the company has repurchased its bonds before maturity resulting in a decrease in liability (d) Sale of equipment- investing activity -it is a sale of a long-term asset (e) Depreciation of machinery - operating activity: add to net income -it is an expense and reduced from revenue to determine net income (f) Payment of cash dividends - financing activity -it reduces retained earnings, which reduces stockholders' equity (g) gain on sale of equipment - operating activity: deduct from net income -it is added to compute net income (h) repayment of advances made to other parties - investing activity (i) exchanging furniture for office equipment - reported as a significant noncash activity (j) acquiring debt instruments of another entity - investing activity

Preparation of the Balance Sheet

*Account Form* It lists assets, by sections, on the left side, and liabilities and stockholders' equity, by sections, on the right side. The main disadvantage is the need for a sufficiently wide space in which to present the items side by side. Often, the account form requires two facing pages. *Report Form* The report form lists the sections one above the other, on the same page Infrequently, companies use other balance sheet formats. For example, companies sometimes deduct current liabilities from current assets to arrive at working capital. Or, they deduct all liabilities from all assets.

Example of Classified Balance Sheet Layout:

*Current Assets* Cash Investments (available-for-sale) Accounts Receivable Less: Allowance for Doubtful Accounts Notes Receivable Inventories Supplies on hand Prepaid Expenses Total Current Assets *Long-term investments* Equity investments *Property, Plant, and Equipment* Land Buildings Less: Accumulated Depreciation Total Property Plant and Equipment *Intangible Assets* Goodwill Total Assets *Liabilities and Stockholders' Equity* *Current Liabilities* Notes payable to bank Accounts Payable Accrued interest on notes payable Income taxes payable Accrued salaries, wages, and other liabilities Deposits received from customers Total Current Liabilities *Long-term debt* Total Liabilities *Stockholders' Equity* Capital Stock (preferred, common) Additional paid-in capital Retained earnings Accumulated other comprehensive income Less: Treasury Stock Total Stockholders' Equity Total Liabilities and Stockholders' Equity

Classification in the Balance Sheet

-Balance sheet accounts are classified: balance sheets group together similar items to arrive at significant subtotals and the material is arranged so that important relationships are shown To classify items in financial statements, companies group those items with similar characteristics and separate items with different characteristics. For example, companies should report separately: 1. Assets that differ in their type or expected function in the company's central operations or other activities. 1. Assets and liabilities with different implications for the company's financial flexibility. 2. Assets and liabilities with different general liquidity characteristics. For example, Boeing Company reports cash separately from inventories. -The three general classes of items included in the balance sheet are assets, liabilities, and equity. -Companies then further divide these items into several subclassifications: current assets, long-term investments, PP&E, intangible assets, current liabilities, long-term debt, owner's equity -Assets are classified as current or noncurrent, with the noncurrent divided among long-term investments; property, plant, and equipment; and intangible assets. -Liabilities are also classified as current or noncurrent. -Equity includes capital stock, additional paid-in capital, and retained earnings.

Equity accounts

-includes contributed capital: the amount contributed by owners e.g., common stock, preferred stock, and additional paid-in capital -includes retained earnings: the cumulative amount of earnings retained by the entity less any dividends ever since the inception of the entity e.g., treasury stock, common stock, preferred stock, additional paid-in capital,

Adjusted Journal Entries

-the use of adjusting entries makes it possible to report on the balance sheet the appropriate assets, liabilities, and stockholders' equity at the statement date -the trial balance—the first pulling together of the transaction data—may not contain up-to-date and complete data -there are adjusting entries for deferrals (prepaid expenses, unearned revenues) and accruals (accrued revenues, accrued expenses) Depreciation D-Depreciation Expense C-Accumulated Depreciation-Equipment Allowance for Doubtful Accounts (uncollectible receivables) D-Bad Debt Expense C-Allowance for Doubtful Accounts Inventory (after a physical count of inventory on hand) D-Cost of Goods Sold C-Inventory Prepaid Expenses D-Insurance Expense C-Prepaid Insurance Accruals D-Unearned Revenue C-Revenue Notes Payable-Accrued Interest D-Interest Expense C-Interest Payable e.g., 41,000 x 0.12 x (3/12) Salaries and Wages Expense D-Salaries and Wages Expenses C-Salaries and Wages Payable

The steps for preparing the Statement of Cash Flows are:

1. Determine Net Income 2. Determine the noncash expenses to add back to net income such as depreciation, amortization, and depletion. 3. Remove the effect of any gain and/or loss on net income. Losses are added to net income and gains are deducted from net income. 4. Calculate the change (increase or decrease) in the Balance Sheet accounts other than the cash account. 5. Classify each change as an operating, investing, or financing activity 6. Calculate net cash provided by or used for each activity section. 7. Verify that the sum of net change in cash equates to the change in beginning and ending cash

How to prepare the balance sheet (video):

1. List the assets -current assets are listed in the order of their liquidity: cash, short-term investments, accounts receivable (less allowance for doubtful accounts), inventory -PP&E include tangible long-lived assets used in the regular operations of the business such as land, equipment (less accumulated depreciation), 2. List the liabilities and stockholders' equity accounts -current liabilities such as accounts payable -long-term liabilities such as bonds payable and notes payable -stockholders' equity accounts include common stock and retained earnings -retained earnings can be calculated by adding net income and deducting dividends from the beginning retained earnings balance

Addison, Inc. reports: Cash provided by operating activities $2,300,000 Cash used by investing activities 640,000 Cash used by financing activities 220,000 Beginning cash balance 340,000 What is Addison's ending cash balance?

2,300,000 - 640,000 - 220,000 = 1,440,000 1,440,000 + 340,000 = 1,780,000

Prepare a trial balance, adjusting journal entries, and a resulting adjusted trial balance.

A *trial balance* is a list of accounts and their balances at a given time. The use of *adjusting entries* makes it possible to report on the balance sheet the appropriate assets, liabilities, and stockholders' equity at the statement date. These may include depreciation expense, allowance for doubtful accounts, inventory, prepaid items, expiration of prepaid assets, and basic accruals adjusting entries. However, the trial balance—the first pulling together of the transaction data—may not contain up-to-date and complete data. After journalizing and posting all adjusting entries, an *adjusted trial balance* can be prepared, which is the primary basis for the preparation of financial statements, including the classified balance sheet.

prepaid expenses (current assets)

A company includes prepaid expenses in current assets if it will receive benefits (usually services) within one year or the operating cycle, whichever is longer. As we discussed earlier, these items are current assets because if they had not already been paid, they would require the use of cash during the next year or the operating cycle. A company reports prepaid expenses at the amount of the unexpired or unconsumed cost. e.g. prepayment for insurance policy, prepaid rent, advertising, taxes, and office or operating supplies

receivables (current asset)

A company should clearly identify any expected loss due to uncollectibles, the amount and nature of any nontrade receivables, and any receivables used as collateral. Major categories of receivables should be shown in the balance sheet or the related notes. For receivables arising from unusual transactions (such as sale of property, or a loan to affiliates or employees), companies should separately classify these as long-term, unless collection is expected within one year.

short-term investments (current asset)

A company should report trading securities as current assets. It classifies individual equity investments and held-to-maturity and available-for-sale debt securities as current or noncurrent depending on the circumstances (based on management's intent) e.g., corporate notes, municipal bonds, u.s. gov't securities

balance sheet (statement of financial position)

A financial statement that summarizes a company's assets, liabilities, and stockholders' equity at a specific point in time. -reports the assets, liabilities, and stockholders' equity of a business enterprise at a specific date -provides information about the nature and amounts of investments in enterprise resources, obligations to creditors, and the owners' equity in net resources -helps in predicting the amounts, timing, and uncertainty of future cash flows

Basic format of the Statement of Cash Flows

Cash Flows from Operating Activities Cash Flows from Investing Activities Cash Flows from Financing Activities Net increase (decrease) in cash Cash at beginning of year Cash at end of year

Current Assets

Cash and other assets a company expects to convert into cash, sell, or consume either in one year or in the operating cycle, whichever is longer; Assets expected to be realized in cash or consumed within one operating cycle or year -Current assets are presented in the balance sheet in order of liquidity The five major items found in the current assets section, and their bases of valuation, are: -cash and cash equivalents (fair value) -short-term investments (fair value) e.g., trading securities -receivables (lower-of-cost-or-net-realizable value/market) -inventory -prepaid expenses (cost) Generally, if a company expects to convert an asset into cash or to use it to pay a current liability within a year or the operating cycle, whichever is longer, it classifies the asset as current. e.g., debt investments (trading), petty cash, equity investments (trading), allowance for doubtful accounts, accounts receivable, supplies, inventory, prepaid insurance, investments (available for sale), trading securities (short-term investments, marketable securities), notes receivable

Statement of Cash Flows layout example:

Cash flows from Operating Activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation Expense (Add) Increase in accounts receivable (Deduct) Decrease in accounts payable (Deduct) Net cash provided by operating activities Cash flows from Investing Activities Purchase of Equipment (Deduct) Net cash used in investing activities Cash flows from Financing Activities Issuance of common stock (add) Payment of cash dividends (deduct) Net cash provided by financing activities Net increase (or decrease) in cash Cash at beginning of year Cash at end of year

Cash (current asset)

Cash is generally considered to consist of currency and demand deposits (monies available on demand at a financial institution). Cash equivalents are short-term highly liquid investments that will mature within three months or less. Most companies use the caption "Cash and cash equivalents," and they indicate that this amount approximates fair value. -A company must disclose any restrictions or commitments related to the availability of cash. e.g., restricted cash and investments

What is the correct order to present current assets?

Cash, accounts receivable, inventories, prepaid items; The order of liquidity is the proper presentation of current assets. Liquidity is the measure of how quickly an asset can be converted to cash. Accounts receivable will be collected and inventories sold before a company can receive a refund for prepaid items. The five major items found in the current assets section of the balance sheet include (in the order of liquidity) are Cash, Short-Term Investments, Accounts Receivable, Inventory, and Prepaid Expenses.

Content of the Statement of Cash Flows

Companies classify cash receipts and cash payments during a period into three different activities in the statement of cash flows—operating, investing, and financing activities, defined as follows. 1. *Operating activities* involve the cash effects of transactions that enter into the determination of net income. 2. *Investing activities* include making and collecting loans and acquiring and disposing of investments (both debt and equity) and property, plant, and equipment. 3. *Financing activities* involve liability and owners' equity items. They include (a) obtaining resources from owners and providing them with a return on their investment, and (b) borrowing money from creditors and repaying the amounts borrowed. The statement's value is that it helps users evaluate liquidity, solvency, and financial flexibility. As stated earlier, liquidity refers to the "nearness to cash" of assets and liabilities. Solvency is the firm's ability to pay its debts as they mature. Financial flexibility is a company's ability to respond and adapt to financial adversity and unexpected needs and opportunities.

Sources of information for the preparation of the Statement of Cash Flows

Companies obtain the information to prepare the statement of cash flows from several sources: (1) comparative balance sheets (2) the current income statement (3) selected transaction data

The relationship between the Balance Sheet and the Statement of Cash Flows:

Current assets and current liabilities --> Operating Section Noncurrent assets --> Investing Section long-term liabilities + EQUITY --> Financing

Reed Co. wishes to enter receipts and payments in such a manner that adjustments at the end of the period will not require reversing entries at the beginning of the next period. Reed received $15,000 for six months for a portion of the building on November 1, 2020. The original entry was: Debit Cash $15,000, Credit Unearned Rent Revenue $15,000. What is the correct adjusting entries on December 31, 2020?

D- Unearned Rent Revenue (liability)- $5,000 C-Rent Revenue- $5,000 The original entry was made when the cash was received for the rent, but it was not posted to Rent Revenue. For 2020, Reed must post two months (November & December) into 2020 revenue. The rent receipt was for 6 months of rent or $2,500 per month. $15,000/6= $2,500/ month $2,500 x 2 months = $5,000

Pappy Corporation received cash of $36,000 on September 1, 2020, for one year's rent in advance and recorded the transaction with credit to Unearned Rent Revenue. What is the correct representation of the December 31, 2020 adjusting entry made by Pappy?

D- Unearned Rent Revenue 12,000 C- Rent Revenue 12,000 36,000/12= 3,000/month 3,000 x 4 months =12,000 Explanation: The rent was originally posted as a debit to Cash, an asset and a credit to Unearned Rent Revenue, a liability. In order to record the current year's income, Pappy's must journalize 4 months (September, October, November, and December) of rental income in the current year. $36,000 x 4/12 = $12,000. The correct journal entry is Debit Unearned Rent Revenue $12,000, Credit Rent Revenue $12,000.

Usefulness of the Statement of Cash Flows

For small and newly developing companies, cash flow is the single most important element for survival. Even medium and large companies must control cash flow. Creditors examine the cash flow statement carefully because they are concerned about being paid. They begin their examination by finding net cash provided by operating activities. A high amount indicates that a company is able to generate sufficient cash from operations to pay its bills without further borrowing. Conversely, a low or negative amount of net cash provided by operating activities indicates that a company may have to borrow or issue equity securities to acquire sufficient cash to pay its bills. -companies can fail even though they report net income -substantial increases in receivables and/or inventory can explain the difference between positive net income and negative net cash provided by operating activities *Financial Liquidity* Readers of financial statements often assess liquidity by using the current cash debt coverage. It indicates whether the company can pay off its current liabilities from its operations in a given year. *(Net Cash Provided by Operating Activities/Average Current Liabilities)= current cash debt coverage* The higher the current cash debt coverage, the less likely a company will have liquidity problems. For example, a ratio near 1:1 is good. It indicates that the company can meet all of its current obligations from internally generated cash flow. *Financial Flexibility* It indicates a company's ability to repay its liabilities from net cash provided by operating activities, without having to liquidate the assets employed in its operations. Notice its similarity to the current cash debt coverage. However, because it uses average total liabilities in place of average current liabilities, it takes a somewhat longer-range view. *(Net Cash Provided by Operating Activities/Average Total Liabilities) = cash debt coverage* The higher this ratio, the less likely the company will experience difficulty in meeting its obligations as they come due. It signals whether the company can pay its debts and survive if external sources of funds become limited or too expensive.

Identify the content of the statement of cash flows.

In the statement of cash flows, companies classify the period's cash receipts and cash payments into three different activities. (1) Operating activities: Involve the cash effects of transactions that enter into the determination of net income. (2) Investing activities: Include making and collecting loans, and acquiring and disposing of investments (both debt and equity) and of property, plant, and equipment. (3) Financing activities: Involve liability and owners' equity items. Financing activities include (a) obtaining capital from owners and providing them with a return on their investment, and (b) borrowing money from creditors and repaying the amounts borrowed. Creditors examine the statement of cash flows carefully because they are concerned about being paid. The net cash flow provided by operating activities in relation to the company's liabilities is helpful in making this assessment. Two ratios used in this regard are the current cash debt ratio and the cash debt ratio. In addition, the amount of free cash flow provides creditors and stockholders with a picture of the company's financial flexibility.

What are intangible assets?

Intangible assets lack physical substance. Their benefit lies in the rights they convey to the holder. Examples include patents, copyrights, franchises, goodwill, trademarks, and trade names. customer lists

What should be included in the current assets section of the balance sheet?

Inventory; Inventory is expected to be converted to cash during a company's operating cycle. It is reported in the Current Assets section of the balance sheet.

In which section of the statement of cash flows would you report making and collecting loans and disposing of property, plant, and equipment?

Investing activities

How are activities that involve the cash effects of making and collecting loans and acquiring and disposing of property, plant, and equipment classified?

Investing activities; Investing activities include making and collecting loans and acquiring and disposing of investments (both debt and equity) and property, plant, and equipment.

Receipts from sales of property, plant, and equipment and other productive assets should generally be classified in which section on the statement of cash inflows?

Investing activities; Investing activities include making and collecting loans and acquiring and disposing of investments (both debt and equity) and property, plant, and equipment.

An additional $30,000 in common stock was issued at par

Issuance of common stock is a financing activity (add)

long-term investments/investments (noncurrent assets)

Long-term investments, often referred to simply as investments, normally consist of one of four types: 1. Investments in securities, such as bonds, common stock, or long-term notes. 2. Investments in tangible fixed assets not currently used in operations, such as land held for speculation. 3. Investments set aside in special funds, such as a sinking fund, pension fund, or plant expansion fund. This includes the cash surrender value of life insurance. 4. Investments in nonconsolidated subsidiaries or affiliated companies. Companies usually present long-term investments on the balance sheet just below "Current assets," in a separate section called "Investments." Realize that many securities classified as long-term investments are, in fact, readily marketable. But a company does not include them as current assets unless it intends to convert them to cash in the short-term—that is, within a year or in the operating cycle, whichever is longer e.g., equity investments (long-term), bond sinking fund,, land held for future use, cash surrender value of life insurance, debt investments (held-to-maturity)

What is included in an owners' equity section reported in the balance sheet?

Noncontrolling interest; Capital Stock, Additional Paid-in Capital, Retained Earnings, Accumulated Other Comprehensive Income, Treasury Stock, and Noncontrolling interests are reported in the Stockholders' Equity section of the balance sheet.

Examples of investing activities:

Noncurrent assets ADD: · Sale of equipment -Sale of fixed assets and/or investments -Sale of land -Sale of PP&E -Sale of equipment at book value DEDUCT: · Purchase of land and building -Purchase of fixed assets and/or intangible assets -Purchase of equipment -purchase of PP&E

Current Liabilities

Obligations that are reasonably expected to be liquidated either through the use of current assets or the creation of other current liabilities within the longer of 1 year or the operating cycle; Obligations expected to be extinguished with current assets or another liability within one operating cycle or year This concept includes: 1. Payables resulting from the acquisition of goods and services: accounts payable, wages payable, taxes payable, and so on. 2. Collections received in advance for the delivery of goods or performance of services, such as unearned rent revenue or unearned subscriptions revenue. 3. Other liabilities whose liquidation will take place within the operating cycle, such as the portion of long-term bonds to be paid in the current period or short-term obligations arising from the purchase of equipment. -Companies do not report current liabilities in any consistent order. In general, though, companies most commonly list notes payable, accounts payable, or short-term debt as the first item. Income taxes payable, current maturities of long-term debt, or other current liabilities are commonly listed last. e.g., dividends payable, interest payable, income taxes payable, unearned revenue, salaries & wages payable, accounts payable, bonds payable (current maturity portion), notes payable due next year, rent payable, accrued liabilities, deposits from customers, trade accounts payable

Dividends totaling $10,000 were declared and paid to stockholders.

Payment of dividends is a financing activity (deduct)

What is PPE?

Property, plant and equipment are tangible in nature that are used in the regular operations of the company. Examples include land, land improvements, buildings, machinery, furniture, tools, and natural resources. With the exception of land, these assets are either depreciable or depletable

Explain the uses, limitations, and content of the balance sheet.

The *balance sheet is useful* because it provides information about the nature and amounts of investments in a company's resources, obligations to creditors, and owners' equity. The balance sheet contributes to financial reporting by providing a basis for (1) computing rates of return, (2) evaluating the capital structure of the enterprise, and (3) assessing the liquidity, solvency, and financial flexibility of the enterprise Three *limitations of a balance sheet* are as follows: (1) The balance sheet does not reflect fair value because accountants use a historical cost basis in valuing and reporting most assets and liabilities. (2) Companies must use judgments and estimates to determine certain amounts, such as the collectibility of receivables and the useful life of long-term tangible and intangible assets. (3) The balance sheet omits many items that are of financial value to the business but cannot be recorded objectively, such as human resources, customer base, and reputation. The *general elements of the balance sheet* are assets, liabilities, and equity. The major classifications of assets are current assets; long-term investments; property, plant, and equipment (PPE); intangible assets; and other assets. The major classifications of liabilities are current and long-term liabilities. The balance sheet of a corporation generally classifies owners' equity as capital stock, additional paid-in capital, and retained earnings.

Prepare a statement of cash flows.

The information to prepare the statement of cash flows usually comes from comparative balance sheets, the current income statement, and selected transaction data. Companies follow four steps to prepare the statement of cash flows from these sources. (1) Determine the net cash provided by (or used in) operating activities. (2) Determine the net cash provided by (or used in) investing and financing activities. (3) Determine the change (increase or decrease) in cash during the period. (4) Reconcile the change in cash with the beginning and ending cash balances.

other assets (noncurrent assets)

The items included in the section "Other assets" vary widely in practice. Some include items such as long-term prepaid expenses, prepaid pension cost, and noncurrent receivables. Other items that might be included are assets in special funds, deferred income taxes, property held for sale, and restricted cash or securities. A company should limit this section to include only unusual items sufficiently different from assets included in specific categories.

operating cycle

The operating cycle is the average time between when a company acquires materials and supplies and when it receives cash for sales of the product (for which it acquired the materials and supplies). The cycle operates from cash through inventory, production, receivables, and back to cash. When several operating cycles occur within one year (which is generally the case for service companies), a company uses the one-year period. If the operating cycle is more than one year, a company uses the longer period.

Purpose of the Statement of Cash Flows

The primary purpose of a statement of cash flows is to *provide relevant information about the cash receipts and cash payments of an enterprise during a period*. The statement of cash flows meets the objective of financial reporting—to help assess the amounts, timing, and uncertainty of future cash flows. To achieve this purpose, the statement of cash flows reports the following: (1) the cash effects of *operations* during a period (2) *investing* transactions (3) *financing* transactions (4) the *net increase or decrease in cash* during the period Reporting the sources, uses, and net increase or decrease in cash helps investors, creditors, and others know what is happening to a company's most liquid resource (cash). Because most individuals maintain a checkbook and prepare a tax return on a cash basis, they can comprehend the information reported in the statement of cash flows. The statement of cash flows provides answers to the following simple but important questions: -Where did the cash come from during the period? -What was the cash used for during the period? -What was the change in the cash balance during the period?

Explain the purpose and usefulness of the statement of cash flows.

The primary purpose of a statement of cash flows is to provide relevant information about a company's cash receipts and cash payments during a period. Reporting the sources, uses, and net change in cash enables financial statement readers to know what is happening to a company's most liquid resource.

What is equity?

The stockholders' equity section of the balance sheet includes capital stock, additional paid-in capital, and retained earnings.

Morganstern, Inc has the following inventory information: -The supplies inventory on January 1, 2020 was $5,000. -Supplies costing $16,000 were purchased during 2020 and debited to the asset account. -A count on December 31, 2020 revealed supplies on hand of $3,000. Which adjusted journal entry is made by Morganstern prior to preparing the December 31 financial statement?

The supplies purchased were posted to the inventory account. Therefore an adjusting entry for both the purchases and the difference in inventory must be made. $5,000 (beginning inventory) plus $16,000 (purchases) minus $3,000 (ending inventory) = $18,000; The correct adjusting journal entry: Debit Supplies Expense $18,000; Credit Supply Inventory $18,000 D-Supplies Expense- $18,000 C-Supply Inventory- $18,000

inventories (current asset)

To present inventories properly, a company discloses the basis of valuation (e.g., lower-of-cost-or-net realizable value or lower-of-cost-or-market) and the cost flow assumption used (e.g., FIFO or LIFO)

Which investments should always be reported as current assets?

Trading securities; Current assets are those assets that the company expects to convert to cash within the operating cycle or one year, whichever is longer. Trading securities are bought and held primarily for sale in the near term to generate income on short term price differences.

noncontrolling interest (minority interest)

a portion of the equity of subsidiaries not wholly owned by the reporting company