Accounting 100
Recovery of an Uncollectible Account
If a company collects from a customer after the account has been written off as uncollectible, the company makes 2 entries: 1. It reverses the entry made in writing off account (debit AR, credit Allowance DA) 2. journalizes the collection in the usual manner (debit Cash, credit AR)
Cash Disbursement Controls
Internal control over cash disbursements are more effective when companies pay with check or EFT 1. Voucher System--network of approvals by authorized individuals, acting independently, to ensure that all disbursements by check are proper. 2, Petty Cash Fund--used to pay relatively small amounts
External Users
Investors (stockholders): use accounting info to make decisions to buy, hold or sell stock. Creditors (suppliers or bankers): use accounting info to evaluate the risks of selling on credit or lending money.
Why are users interested in the Retained Earnings statement?
Investors--may prefer high or low dividend payouts Creditors--care because dividends reduce the ability to pay debts.
Expense Recognition Principle
"Let the expenses follow the revenues" match expenses with revenues in the period when the company makes efforts to generate those revenues (efforts be matched with results)
When the allowance account has a debit balance..
It occurs because the debits to the account from write-offs during the year exceeded the beginning balance in the account, which was based on estimates. -in such a case, the company adds the debit balance to the required balance when it makes the adjusting entry
Debit (Dr.)
LEFT side of an account. Increases in assets Decreases in liabilities: common stock, retained earnings Increases in dividends Increase expenses Decrease revenues
Tax Effects
LIFO--results in the lowest income taxes and thus, has the highest quality of earnings ratio
Cost of Goods Sold equation
(Beg inventory + Purchases) - Ending Inventory *the sum of cost of goods sold plus the cost of the ending inventory must equal the cost of goods available for sale
Valuing Accounts Receivable
-Some AR become uncollectible due to either economic downturn, or customer is laid off, etc. -Sellers record these losses that result from extending credit as *bad debt expense* -These losses are a normal and necessary risk of doing business on a credit bases
Human Resource Controls
1. Bonding--obtaining insurance protection against theft by employees 2. Rotate employees' duties and require employees to take vacations 3. Conduct thorough background checks
3 features of the Allowance Method
1. Companies estimate uncollectible accounts receivable and match them against revenues in the same accounting period in which the revenues are recorded 2. Debit: Bad Debt Expense, Credit: Allowance for Doubtful Accounts 3. Companies debit: actual uncollectibles to Allowance for Doubtful Accounts and credit them to AR
3 steps in effective-interst method
1. Compute the bond interest expense--multiply carrying value by the effective-interest rate. 2. Compute the bond interest paid--multiply FV by contractual interest rate 3. Compute amortization amount--the difference between steps 1 and 2
Steps for Reconciliation
1. Deposit in transit--add these to balance per bank 2. Outstanding Checks--deduct from balance per bank 3. Errors--note any errors 4. Bank Memorands--trace bank memoranda to the depositor's records
Segregation of Duties
1. Different individuals should be responsible for related activities 2. The responsibility for record-keeping for an asset should be separate from the physical custody of that asset
3 business activities
1. Financing= borrow money (debt finance) or issue shares of stock in exchange for cash (equity finance) 2. Investing=involves the purchase of the resources a company needs in order to operate. ex: purchasing a truck, computer, building, etc. 3. Operating= begin operations to generate revenue.
Basic principles of Cash Management
1. Increase the speed of receivables collection 2. Keep inventory levels low 3. Monitor payment of liabilities 4. Plan the timing of major expenditures 5. Invest idle cash--ensure that a company invests any excess cash
Other elements of an annual report:
1. Management Discussion and Analysis (MD&A) 2. Notes to the financial statements 3. Auditor's Report
SOX Act
1. all publicly traded US corporations are required to maintain an adequate system of internal control. 2. Corporate executives and boards of directors must ensure that these controls are reliable and effective. 3. independent outside auditors must attest to the adequacy of the internal control system. 4. PCAOB--establishes the auditing standards and regulates auditor activity
Comparisons of Methods
1. depreciation expense varies with each method, but total depreciation expense is the same 2. IRS allows corporate taxpayers to deduct depreciation expense when computing taxable income
Adjusting Entries
1. ensure that the revenue recognition and expense recognition principles are followed. 2. are necessary because the trial balance may not contain up-to-date and complete data. 3. required every time a company prepares financial statements. 4. every adjusting entry includes one income account and one balance sheet account
Other Expenses and Losses
1. interest expense 2. casualty loss 3. loss
Other Revenues and Gains
1. interest revenue 2. dividend revenue 3. rent revenue 4. gain
Long-term Investments
1. investments in stocks/bonds of other corporations that are held for more than a year 2. long-term assets you aren't currently using 3. long-term notes receivable
Depreciation applies to...
1. land improvements 2. buildings 3. equipment *does NOT apply to Land!!!!*
Fraud triangle
1. opportunity--workplace environment provides opportunities that an employee can exploit (lack sufficient control to deter and detect fraud) Ex: not monitoring employee actions, thus they believe they won't get caught. 2. financial pressure--personal financial problems caused by too much debt or they want to live a lifestyle that they can't afford on their current salary. 3. rationalization--to justify their fraud, employees rationalize their dishonest actions. Ex: they believe they are underpaid while the employer is making more money.
Cash Receipt Controls
1. over-the-counter receipts: cash sales are visible to customers so this prevents the cashier from entering a lower amount and pocketing the difference 2. mail receipts: all mail receipts should be opened in the presence of at least 2 mail clerks so that each clerk knows he or she is being observed by other clerks
Internal Control Limitations
1. reasonable assurance--the costs of establishing control procedures should not exceed their benefit 2. Human element--employee fatigue, carelessness, or indifference. 3. collusion--two or more individuals working together to get around prescribed controls 4. size of the business--small companies find it difficult to segregate duties or provide independent internal verification
2 accounting issues:
1. recognizing accounts receivable 2. valuing accounts receivable
Advantages of leasing
1. reduced risk of obsolescence (no longer useful) 2. little or no down payment 3. shared tax advantages 4. assets and liabilities are not reported.
Bank Statement
1. shows a company's bank transactions and balances 2. they are prepared from the bank's perspective--a deposit the bank receives is a bank's liability 3. lists in numerical sequence all paid checks along with the date the check was paid and its amount
Depreciation methods
1. straight-line method- most widely used 2. declining balance 3. units of activity *all acceptable under GAAP*
Current Market Price
1. the dollar amounts to be received 2. the length of time until amounts are received 3. market interest rate
An account consists of:
1. the title of the account 2. a left or debit side 3. a right or credit side
Revising Periodic Depreciation
1. when changes in estimates are required, revise the current and future years depreciation, but NOT prior. 2. Companies must disclose changes as they could be used to simply achieve financial statement goals.
Annual Rate
100%/useful life
Average collection period
365 / AR turnover -measures the average amount of time that a receivable is outstanding. *use it to asses the effectiveness of a company's credit and collection policies
Bonds may be redeemed (retired) before maturity by the issuing corporation. Explain why a company would decide to retire bonds before maturity and the necessary steps to record the redemption.
A company may decide to retire bonds before maturity to reduce interest cost and remove debt from its balance sheet. A company will retire debt early only if it has sufficient cash resources. When bonds are retired before maturity, it is necessary to eliminate the carrying value of the bonds at the redemption date and recognize a gain or loss on redemption. The gain or loss is the difference between the cash paid and the carrying value of the bonds.
GAAP
A set of accounting standards that guide accounting professionals. 1. rules based 2. developed by FASB 3. sox applies to large public companies
Prior to adjustments...
Assets are overstated and Expenses are understated
Balance Sheet
Assets: cash, accounts receivable, supplies, prepaid, equipment, short-term investments. Liabilities: payables Stockholders equity: common stock and retained earnings -used to present a picture in time of what your business owns and what it owes (assets vs liabilities)
Basic Accounting Equation
Assets= Liabilities + Stockholder's Equity
Why are users interested in net income?
Because it provides useful information for predicting future net income. Investors will then decide whether to buy or sell stock according to the net income and creditors will decide to give a loan if they think they will be repaid
Why do companies not report sales taxes as an expense?
Because that money was never really the company's in the first place. It's owned by the government and they just happen to be holding it for them for the time being. Thus, the company simply forwards it to the government the amount paid by the customer.
Cost Flows Assumptions
Beginning Inventory + Purchases - Ending Inventory = COGS
Flow of Costs
Beginning Inventory + Cost of goods purchased (including freight) = cost of goods available for sale. As goods are sold-->becomes cost of goods sold. The goods that are not sold at the end of the period are the ending inventory.
Retained Earnings Statement
Beginning retained earnings add: net income less: dividends = end retained earnings -Shows dividends distributed and how much was retained in the business to allow for future growth.
Statement of Cash Flows
Cash flows from: 1. operating activities 2. investing activities 3. financing activities [used to see where the companies cash came from and what they are doing with it]
Land
Cost includes: 1. cash purchase price 2. closing costs (title and attorney fees) 3. real estate brokers' commissions 4. any liens or accrued property taxes 5. any costs associated to getting land ready for use (clearing, draining, removing)
Unearned Revenues
Current Liability! The company receives an advance but hasn't performed the service yet.
Classified Balance Sheet
Current assets: cash, short-term investments, accounts receivable, notes receivable, inventory, supplies, prepaid. Long term investments: stock investments, investments in real estate Property, Land, and Equipment: land, equipment. less accumulated depreciation Intangible assets: patents, goodwill, Current liabilities Long-term liabilities: mortgage payable Stockholders equity: common stock and retained earnings
Journal Entry distinction
Debit: Equipment License Expense Prepaid Insurance Credit: Cash vs. Debit: Equipment Credit: Cash
Retirement of Plant Assets
Debit: Accumulated Depreciation Loss on disposal of plant assets Credit: Equipment
Record amortization
Debit: Amortization Expense Credit: Patent
Redeeming Bonds at Maturity
Debit: Bonds Payable Credit: Cash
Redeeming Bonds Journal Entry
Debit: Bonds Payable, Premium on BP, Loss on Redemption Credit: Cash
Gain on Sale
Debit: Cash Accumulated Depreciation Credit: Gain on Disposal of Plant Assets Equipment
Loss on Sale
Debit: Cash Accumulated Depreciation Loss on Disposal of Plant Assets Credit: Equipment
Issuing Bonds at a Premium
Debit: Cash Credit: Bonds Payable and Premium
Issuing Bonds at a Discount
Debit: Cash and Discount Credit: Bonds Payable
Depreciable Expense
Depreciable Cost/ Useful life
Sale of Plant Assets
Depreciation Expense (debited) Accumulated Depreciation (credited) Proceeds > Book Value= Gain Proceeds < Book Value= Loss
Documentation Procedures
Documents provide evidence that transactions and events occur. By requiring signatures on the documents, the company can identify the person responsible for the transaction or event. -Pre-numbered documents--preventing a transaction from being recorded twice or not being recorded at all -Require employees to promptly forward source documents for accounting entries to the accounting department to ensure timely recording.
Balance Sheet Effects
FIFO--the costs allocated to ending inventory will approximate their current cost
Income from Operations
Gross Profit - Operating Expenses
Gross Profit Rate
Gross Profit / Net Sales -measures the margin by which selling price exceeds cost of goods sold. -"The selling price exceeds COGS by ___%"
Discount on Bonds Payable
NOT an asset account; does have a normal debit balance--a contra account to bonds payable
Quality of Earnings Ratio
Net Cash Provided by Operating Activities / Net Income *<1 means using aggressive techniques to improve their income. >1 means using conservative techniques.
AR turnover
Net Credit Sales / average net AR during the year *measures the number of times a company collects receivables during a period. *liquidity ratio *the faster the turnover, the greater reliability of the current ratio for assessing liquidity
Return on Assets
Net Income / Average Total Assets -overall measure of profitability -indicates the amount of net income generated by each dollar of assets. *higher=better!
Earnings per Share
Net Income-Preffered Dividends / average number of common shares. -measures earnings available to common stock holders. *measures the net income earned on each share of common stock. *values shouldn't be compared across companies
Gross Profit
Net Sales - Costs of goods sold Represents merchandising profit, not TOTAL profit
Asset Turnover
Net Sales / Average Total Assets -indicates how efficiently a company uses its assets to generate sales -how many dollars of sales a company generates for each dollar invested in assets. *the higher, the more efficient*
Free Cash Flow
Net cash provided by operating activities - Capital Expenditures - Cash dividends
Segregation of record-keeping from physical custody
One employee should maintain the record of the asset and another employee should have physical custody to the asset -the accountant shouldn't physical custody or access to it. Likewise, the custodian of the asset should not maintain or have access to the accounting records.
Discount vs Premium
Premium is considered to be a reduction in the cost of borrowing while discount is an increase in cost.
Relation
Profit Margin (net income/ net sales) x Asset Turnover (net sales/average total assets) = Return on Assets
Credit (Cr.)
RIGHT side of an account Increases in liabilities Decreases in assets Decreases in dividends Increase revenues Decrease expenses
What's the primary objective of financial reporting?
Report financial information that is USEFUL to creditors and investors for making decisions on providing capital
Income Statement
Revenues - Expenses = Net Income -shows how successfully your business performed in a period
Contra Revenue Account
Sales Returns and Allowances and Sales Discount--it is offset against a revenue account on the income statement
Purpose for Classified Balance Sheet?
So that readers can determine whether the company has assets to pay liabilities as they come due and evaluate claims of short and long term creditors on the company's assets.
To determine the amount of sales in cases where sales taxes aren't entered separately..
Take the total amount and divide by 1 + % Ex: 10,600 at 6% 10,600/1.06
Accrual of Interest Receivable
To reflect interest earned but not yet received: Debit: Interest Receivable Credit: Interest Revenue
Debt to Assets Ratio
Total liabilities / Total Assets *lower value suggests favorable solvency--high number means more riskier company *measures the % of total financing provided by creditor rather than investors. -"every dollar of asset was financed by __% of debt"
Explain how establishing an allowance account satisfies the expense recognition principle.
When an allowance account is used, an adjusting journal entry is made at the end of each accounting period. This entry satisfies the expense recognition principle by recording the bad debts expense in the period in which the sales occur.
Gross Profit Rate vs Profit Margin
While the gross profit rate measures the margin by which selling price exceeds cost of goods sold, the profit margin measures the extent by which selling price covers all expenses
Payroll Taxes
With every payroll, the employer incurs liabilities to pay these levied upon the employer. These include the employer's share of Social Security (FICA) and state and federal unemployment taxes.
Corporation
a business organized as a separate legal entity owned by stockholders. -investors receive shares of stock to indicate their ownership claim. -easy to transfer ownership, easier to raise funds, no personal liability. ex: coca cola
Partnership
a business owned by 2 or more persons associated as partners. -often formed bc one person doesn't have enough economic resources to initiate alone. -simple to set up, tax advantages, group controlled. -personally liable for all debts and legal obligations ex: retail and service-type businesses
Sole Proprietorship
a business owned by one person. -simple to set up -you control the business -tax advantages -personally liable for all debts and legal obligations ex: small owner-operated barber shop
Purchase Discount
a cash discount claimed by a buyer for prompt payment of a balance due
NSF Check
a check that is not paid by a bank because of insufficient funds in a bank account
Double-declining method
a common declining-balance rate where you double the straight line rate: 100%/useful life x 2
Control features: Use of a Bank
a company can safeguard its cash by using a bank as a depository and clearinghouse for checks received and checks written
Franchises
a contractual arrangement under with the franchisor grants the franchisee the right to sell certain products, to perform specific services, or to use certain trademarks or trade names. -a license is a type of franchise -costs associated with acquisition should be capitalized
Current Liability
a debt that a company reasonably expects to pay from existing current assets or through the creation of other current liabilities, and within one year.
Fraud
a dishonest act by an employee that results in personal benefit to the employee at a cost to the employer
Factor
a finance company or bank that buys receivables from businesses for a fee and then collects the payments directly from the customers.
Bonds
a form of interest-bearing note payable issued by corporations, universities, and governmental agencies. ~sold in small denominations ~attract many investors
Unearned Revenues (Liability)
a liability account where companies record cash received before services are performed -opposite of prepaid expenses -prior to adjustment, liabilities are overstated and revenues are understated.
Post-closing Trial Balance
a list of all permanent accounts and their balances after closing entries are journalized and posted
Honor of Notes Receivable
a note is honored when its maker pays in full at its maturity date - the amount due at maturity is the face value of the note plus interest
Impairment
a permanent decline in the fair value of the asset below the book value. -the company writes the asset down to its new fair value during the year in which the decline in value occurs. -accounting standards require immediate loss recognition on impairments as earnings management was occurring -write-downs=problem because its depreciation expense will be lower in all subsequent periods
Sales Discount
a reduction given by a seller for prompt payment of a credit sale
Dividends
a reduction of stockholder's equity but not an expense. -not included in the calculation of net income
Trademarks
a word, phrase, jingle, or symbol that distinguishes or identifies a particular enterprise or product -cost=purchase price or any costs to secure the trademark (attorney's fees, registration fees, design costs, etc) *no amortization*
Notes Receivable
a written promise for amounts to be received--normally requires the collection of interest and extends for time periods of 60-90 days.
Net Income (multi-step Income Statement)
add or subtract the results of activities not related to operations
Permanent Accounts
all asset, liability, and stockholder's equity accounts.
Cost
all expenditures necessary to acquire the asset and make it ready for intended use
Temporary Accounts
all revenue, expense, and dividends accounts.
Average-Cost
allocates that the cost of goods available for sale on the basis of the weighted-average unit cost: cost of goods available for sale / total units available for sale = weighted-average unit cost.
Amortization
allocating expense of intangibles over life of the intangible *indefinite lives should NOT be amortized.*
Operating lease
allows the lessee to account for the transaction as a rental, with neither an asset nor a liability recorded
Face Value
amount of principal due at the maturity date.
Receivables
amounts due from individuals and companies that are expected to be collected in cash. *one of a company's most liquid and large asset*
Depreciation is NOT
an asset valuation process--the book value may differ from the fair value significantly
Account
an individual accounting record of increases and decreases in a specific asset, liability, stockholder's equity, revenue, or expense item
Off-balance-sheet financing
an intentional effort by a company to structure its financing arrangements so as to avoid showing liabilities on its balance sheet
Capital Expenditures
are costs included in the plant asset account and not immediately expensed.
Unsecured Bonds
are issued against the general credit of the borrower.
Fair Value Principle
assets and liabilities should be reported at fair value
Current Asset
assets that a company expects to convert to cash or use up within a year. *they are listed in order of liquidity: cash, short-term investments, accounts receivable, notes receivable, inventory, supplies, prepaid insurance. *they are important in assessing the company's short-term debt-paying ability*
Intangible Assets
assets that do not have physical substance but are very valuable (goodwill, patents, copyrights, trademarks)
Property, Plant, and Equipment (PPE)
assets with relatively long useful lives that are currently in use. (land, buildings, equipment) *must consider depreciation: Land, Equipment, Less: Accumulated Depreciation
Establishment of Responsibility
assigning responsibility to specific employees. *control is most effective when only one person is responsible for a given task* -limiting access only to authorized people and then identifying those people.
FIFO
assumes that the earliest goods purchased are the first to be sold *often parallels the actual physical flow of merchandise because usually you sell the oldest units first
LIFO
assumes that the latest goods purchased are the first to be sold--the costs of the latest goods purchased are the first to be recognized in determining cost of goods sold.
Industry-average comparisons
based on average ratios for the respective industries
Intercompany comparisons
based on comparisons with a competitor in the same industry
Cost Flow Assumptions
because specific identification is often impractical, most companies use 3 assumptions to determine costs: 1. First-in, First-out 2. Last-in, First-out 3. Average-cost *periodic thing
Convertible Bonds
bonds that can be converted into common stock at the bondholder's option ~gives bondholders the opportunity to benefit if the market price of the common stock increases and until conversion, bondholders receive interest on the bond. ~For the issuer, the bonds sell at a higher price and pay a lower rate of interest than comparable debt securities.
Callable Bonds
bonds that the issuing company can redeem (buy back) at a stated dollar amount prior to maturity
Inventory Turnover
calculated as cost of goods sold divided by average inventory. *indicates liquidity of inventory by measuring the number of times the average inventory "turns over"
Cost is measured by:
cash or cash equivalent price--equal to the fair value of the asset given up or the fair value of the asset received.
Restricted cash
cash that is not available for general use but rather is restricted for a special purpose *should be reported separately on a balance sheet as restricted cash*
Notes to financial statements
clarify financial statements and provide more detail.
Cash sales
classification of sales that a retailer considers from sales resulting the use of Visa and Mastercard. -another form of selling--factoring--the receivable by the retailer. -record these credit card charges the same way as checks deposited from a cash sale. *Debit Cash and Service Charge Expense* *Credit Sales Revenue*
Aging the Accounts Receivable
classifies customer balances by the length of time they have been unpaid *the longer a receivable is past due, the less likely it is going to be collected*
Information and Communication
communicate all pertinent information both down and up the organization
To follow the expense recognition principle,
companies allocate bond discount to expense in each period in which the bonds are outstanding--amortizing the discount.
Income Summary
companies close the revenue and expense accounts to income summary and the balance in income summary is the net income or loss for the year. Income summary is then closed, which transfers the net income or net loss from this account to Retained Earnings.
Straight-line method
companies expense an equal amount of depreciation each year of the asset's useful life
Managing Receivables: accelerating cash receipts
companies frequently sell their receivables to another company for cash. 1. they are owned by the company selling the product. 2. they may be the only reasonable source of cash 3. billing and collection are often time-consuming and costly.
Just-in-Time Inventory
companies manufacture or purchase goods just in time for use
Risk Assessment
companies must identify and analyze the various factors that create risk for the business and must determine how to manage these risks
Cash-Basis Accounting
companies record revenue when they receive cash and record an expense when they pay out cash. *NOT in accordance with GAAP
Valuing Notes Receivable
companies report short-term notes receivable at their cash realizable value
Managing Receivables: monitoring collections
companies should prepare an AR aging schedule monthly. -helps managers estimate time of future cash inflows -provides information about overall collection experience of the company and identifies problem accounts
Merchandising Companies
companies that buy and sell merchandise rather than provide services as their primary source of revenue
LIFO reserve
companies using LIFO are required to report the difference between inventory reported using LIFO and FIFO --enables analysts to make adjustments to compare companies that use different methods
Plant Asset Disposals
company can sell to another party, scrap the equipment, or trade asset for another asset *must determine the book value at time of disposal in order to determine gain or loss
Internal Auditors
company employees who continuously evaluate the effectiveness of the company's internal control systems
Declining-balance method
computes depreciation expense using a constant rate applied to a declining book value--ignores salvage value *results in higher depreciation in the early years of an asset's life than does the straight-line approach but produces a declining annual depreciation overtime*
Managing Receivables: establishing a payment period
consistent with competitors
Cash
consists of coins, currency (paper money), checks, money orders, and money on hand or on deposit in a bank or similar depository *checks that are dated later than the current date are not included in cash*
Manufacturing Inventory
contains 3 categories: 1. finished goods--items that are completed and ready for sale 2. work in progress--portion of manufacturing inventory that has begun production process but not finished. 3. raw materials--basic goods that are used in production but not yet placed...steel, glass, tires, etc.
Perpetual Inventory System
continuously show the inventory that should be on hand for every item.
When constructed:
contract price + architect fees building permits excavation costs + interest costs (limited to what is incurred during the construction period) -debit interest expense
Lease
contractual agreement where the owner of an asset (lessor) allows another party (lessee) to use the asset for a period of time at an agreed price.
Revenue Expenditures
costs NOT included in plant asset account and are expensed immediately
Freight Costs
costs for transporting the goods to the buyer's place of business
Additions and Improvements
costs incurred to increase the operating efficiency, productive capacity, or expected useful life of the plant asset--material and infrequent. *typically increase the company's investment and Debited to the plant asset affected*
Deferrals
costs or revenues that are recognized at a date later than the point when cash was originally exchanged
Intracompany comparisons
covering two years for the same company
The normal balance of a contra asset account is a ....
credit
Liabilities
creditors' claims on total assets / existing debts and obligations
Working Capital
current assets - current liabilities *higher number=better*
Current Ratio
current assets divided by current liabilities *higher ratio suggests favorable liquidity *Ex) 1.18:1 means for every dollar of current liabilities, we own $1.18 worth of assets.
For each transaction...
debits must equal credits
Expenses _______ Stockholder's Equity
decreases
Amortizing the premium
decreases the amount of interest expense reported each period (the amount of interest expense is less than the contractual amount)
Deposit in transit
deposits recorded by the depositor that have not yet been recorded by the bank
Control Activities
design policies and procedures to address the specific risks.
Periodic Inventory System
determine the cost of goods sold ONLY at the END of the accounting period.
Historical Cost Principle
dictates that companies record assets at their cost.
EFTs
disbursement systems that use wire, telephone, or computers to transfer cash from one location to the another *normally result in better internal control since no cash or checks are handled by company employees
Income Statement Effects
each dollar of difference in ending inventory results in a corresponding dollar difference in income before taxes *when prices are rising, FIFO is used cause it results in higher net income*
Accounting Transactions
economic events that require recording in the financial statements *occurs when assets, liabilities, or stockholder's equity (common stock, revenues, expenses, dividends) items change as a result of some economic event
Revenue
either an increase in assets or decrease in liabilities.
Under LIFO, since it is assumed that the first goods sold were those that were most recently purchased,
ending inventory is based on the prices of the oldest units purchased
Salvage value
estimate of the asset's value at the end of its useful life
Useful Life
estimate of the expected life based on need for repair, service life, and vulnerability to obsolescence--can be expressed in terms of time, units of activity, or units of output
Allowance Method
estimating uncollectible accounts at the end of each period. 1. provides better matching of expenses with revenues on the income statement 2. ensures that receivables are stated at their cash realizable value on balance sheet
Contingencies
events with uncertain outcomes that may represent potential liabilities. ~accounting rules require all contingencies to be disclosed in the notes. ~In some cases, they must accrue them as liabilities.
Patents
exclusive right issued by the US patent office that enables the recipient to manufacture, sell, or otherwise control an invention for a period of 20 years. -is amortized. -debit Patents and credit Cash
Research and Development Costs
expenditures that may lead to other intangibles. -debit R&D Expense, credit Cash
Ordinary Repairs
expenditures to maintain the operating efficiency and expected productive life of the unit--fairly small and occur frequently. *are Debited to Maintenance and Repairs Expense*
Accrued Expenses
expenses incurred but not yet paid or recorded at the statement date. -ex: interest, taxes, utilities, and salaries -adjusting entry=increase to an expense account and increase to a liability account
Prepaid expenses
expenses paid in cash before they are used or consumed. -ex: insurance, supplies, advertising, rent Debit Insurance Expense Credit Prepaid Insurance
Copyrights
gives owner the exclusive right to reproduce and sell an artistic or published work. -lasts for the creator's life plus 70 years -costs=cost of acquiring + defending it
Goods in transit should be included in the inventory of the company that....
has legal title to the goods-- 1. FOB shipping point: ownership passes to the buyer when they accept the goods from the seller 2. FOB destination: ownership remains with the seller until goods reach the buyer
Secured Bonds
have specific assets of the issuer pledged as collateral for the bonds.
Plant assets are recorded at...
historical cost--all costs necessary to acquire and make an asset ready for its intended use.
Consigned Goods
holding the goods of other parties and try to sell the goods for them for a fee--NO ownership is transferred
Accounting
how companies communicate financial information.
Current Replacement Cost
how market is defined -for a merchandising company, it is the cost of purchasing the same goods at the present time from the usual suppliers in the usual quantities
Other Receivables
include nontrade receivables such as interest receivable, loans to company officers, advances to employees, and income tax refundable
Equipment
includes all assets used in operations--store checkout counters, office furniture, delivery trucks. costs include: 1. purchase price 2. sales taxes 3. freight charges 4. insurance during transit 5. any testing, assembling, installation. *licenses and insurances NOT included!*
Cash receipts section
includes expected receipts from the company's principle source of cash such as cash sales and collections from customer's credit sales.
Cash Over and Short
income statement account; reported as a miscellaneous expense (cash shortfall) or miscellaneous revenue (overage) *difference between the actual cash and amount reported*
Revenue ______ Stockholder's Equity.
increases
Amortizing the Discount
increases the amount of interest expense reported each period.
High Inventory Turnover
indicates the company has minimal funds tied up in inventory--more efficient in inventory management
Time value of Money
indicates the relationship between time and money--that a dollar received today is worth more than a dollar promised in the future
Purchase Invoice
indicates the total purchase price and other relevant information
Faithful Representation
information actually depicts what really happened: 1. ensuring that nothing important has been omitted. 2. making sure the information isn't biased towards one position or another 3. free from error
Lower-of-Cost-or-Market
inventory is stated at the lower of either its cost or market value as determined by current replacement cost *it's conservative--least likely to overstate assets and net incomes*
Physical Inventory
involves actually counting, weighing, or measuring each kind of inventory on hand *usually done when the business is closed
Independent Internal Verification
involves the review of data prepared by employees 1. companies should verify records periodically 2. an employee who is independent of the personnel responsible for the info should make the verification 3. discrepancies and exceptions should be reported to a management level *useful in comparing recorded transactions with existing assets.
Allowance for Doubtful Accounts
is a contra account to Accounts Receivable on the balance sheet: Current Assets Cash Accounts Receivable Less: Allowance for Doubtful Accounts
Premium on Bonds Payable
is added to the bonds payable amount on the balance sheet.
Outstanding Checks
issued checks recorded by the company that have not yet been paid by the bank
Bond Certificate
issued to the investor to provide evidence of the investor's claim against the company
If a company wants to increase its return on assets...
it can: 1. increase the margin it generates from each dollar of goods sold that it sells (profit margin) 2. increase the volume of goods that it sells (asset turnover)
When a corporation issues bonds,
it is borrowing money! The person who buys the bonds is investing in bonds.
Relevance
it makes a difference in a business decision by: 1. having predictive value--helping provide accurate expectations about the future. 2. having confirmatory value--confirming and correcting prior expectations
Present Value
its equivalent today--you would want to determine the value today of the amount to be received in the future after taking into account current interest rates.
A company that has more current liabilities than current assets often,
lacks liquidity, or short-term debt-paying ability.
The sale of bonds above FV causes the total cost of borrowing to be..
less than the bond interest paid because the borrower is not required to pay the bond premium at the maturity of the bonds.
Capital lease
lessees show both the asset and the liability on the balance sheet *the leased item=asset, obligation owed to lessor=liability, and lessee depreciates leased asset*
Trial Balance
lists accounts and their balances at a given time -proves the mathematical equality of debits and credits -does NOT prove that all transactions have been recorded or that the ledger is correct 1. Assets 2. Liabilities 3. Common Stock 4. Dividends 5. Revenue 6. Expenses
Debts that do not meet both criteria are
long-term liabilities
Control Environment
make it clear that the organization values integrity and that unethical activity will not be tolerated
Segregation of related activities
making one individual responsible for related activities increases the potential for errors and irregularities. *assign related purchasing activities to different individuals and related sales activities to different people*
Percentage-of-Receivable basis
management establishes a percentage relationship between the amount of receivables and expected losses from uncollectible accounts Debit: Bad Debt Expense Credit: Allowance for Doubtful Accounts
Internal Users
managers who plan, organize, and run a business. --need reports on a timely basis ex: marketing managers, production supervisors, finance directors, company officers.
Managing Receivables: extending credit
many companies increase their sales by being generous with their credit policy but sometimes extend credit to risky customers -might require risky customers to provide letters if credit or bank guarantees so that if they don't pay, the bank will on their behalf
Unqualified opinion
means it's all good.
FOB Shipping Point
means that the buyer pays for the freight costs
"on account"
means that the company receives goods or services that it will pay for at a later date
FOB Destination
means that the seller pays for the freight costs
Accrual-Basis Accounting
means that transactions that change a company's financial statements are recorded in the periods in which the events occur, even if cash was not exchanged.
Liquidity Ratios
measure a company's ability to pay obligations within the next year; tells user short-term obligation fulfillment
Solvency Ratios
measure the ability for a company to survive; tells user long term obligation fulfillment
Profitability Ratios
measure the income or operating success of a company; tells user how much profit was made
Profit Margin
measures the percentage of each dollar of sales that results in net income. Net Income / Net Sales
Retailers
merchandising companies that purchase and sell directly to customers
Wholesalers
merchandising companies that sell to retailers.
Internal Control
methods and measures adopted within an organization to safeguard assets, enhance the reliability of accounting records, increase efficiency of operations, and ensure compliance with laws and regulations
Monitoring
monitor internal control system periodically for their adequacy
Companies frequently accept notes receivable from customers who
need to extend the payment of an outstanding Accounts Receivable
Revenue Accounts
normally show credit balances
Liabilities Accounts
normally show credit balances (credit>debit)
Expense Accounts
normally show debit balances
Asset Accounts
normally show debit balances (debit>credit)
Dishonor of NR
note that is not paid in full at maturity--no longer negotiable.
Trade Receivables
notes and accounts receivable that result from sales transactions
Disposing of Notes Receivable
notes may be held to their maturity date, at which time the face value plus the accrued interest is due
Notes Payable
obligations in the form of written notes *often used b/c notes payable provide written documentation of the obligation in case legal remedies are needed to collect the debt. *usually require the borrower to pay interest.
Long-term Liabilities
obligations that a company expects to pay more than one year in the future.
Current Liabilities
obligations that the company is to pay within the next year. (accounts payable, notes payable, salaries payable)
Contra Asset Account
offset against an asset account on the balance sheet -the Accumulated Depreciation--Equipment account offsets the asset Equipment
SEC: The Securities and Exchange Commission
oversees US financial markets and the FASB
Prepaid Expenses
payments of expenses that will benefit more than one accounting period. (an asset)
Payee
person who payment is to be made
Stakeholders
persons or groups who may be harmed or benefited.
MD&A
presents management views on the company's ability to pay near-term obligations, its ability to fund operations and expansion, and its results of operations.
Obsolescence
process by which an asset becomes out of date before it physically wears out
Reconciling the bank account
process of making the balance per books and balance per bank agree with the true amount. Why? because: 1. time lags that prevent one of the parties from recording the transaction in the same period 2. errors by either party in recording transactions
Times interest Earned
provides an indication of a company's ability to meet interest payments as they come due. Income + interest expense + tax expense / interest expense
Sales Invoice
provides support for each sale
When purchased:
purchasing price closing costs broker's commissions remodeling, replacing, repairing plumbing
Recognizing Notes Receivable
record notes receivable at its face value -no interest revenue is reported because of the revenue recognition principle
Goods in Transit
refers to goods on board a truck, train, ship, or plane--either purchased goods that haven't been received or sold goods that haven't been delivered
Physical Controls
relate to the safeguarding of assets and enhance the accuracy and reliability of the accounting records--safe vaults, locked warehouses, pass codes, alarms, time clocks, etc.
Accounts Receivable
represent the right to receive payment at a later date.
Depreciable cost
represents the total amount subject to depreciation. Cost-Salvage Value=Depreciable Cost
Full Disclosure Principle
requires that companies disclose all circumstances and events that would make a difference to financial statement users.
Revenue Recognition Principle
requires that companies recognize revenue in the accounting period in which the performance obligation is satisfied (when the service is actually performed)
Monetary Unit Assumption
requires that only those things that can be expressed in money are included in the accounting records.
Specific Identification (inventory costs)
requires the companies to keep records of the original cost of each individual inventory item--not practical
Assets
resources owned by the business. ex: property, plant, equipment, cash
Plant Assets
resources that have: 1. physical substance 2. used in operations 3. not intended for sale to customers 4. depreciate in service potential over their useful lives. -they are expected to provide service to the company for a number of years. *refers to property, plant, and equipment*
Accrued Revenues
revenues for services performed but not yet recorded at the statement date. -adjusting entry increases both assets and revenues because they're understated prior
Intangible Assets
rights, privileges, and competitive advantages that result from ownership of long-lived assets that do not possess physical substance. ~include government grants (patents, copyrights, trademarks), acquisition of another business (goodwill), private monopolistic arrangements (franchises and leases)
Sales Revenue
sale of merchandise; primary source of revenue
IFRS
set of accounting standards (international) 1. principles based 2. developed by IASB 3. does NOT comply with SOX
IASB: International Accounting Standards Board
sets accounting standards for countries outside of the US founded in the IFRS
The Public Company Accounting Oversight Board (PCAOB)
sets auditing standards created by SOX
FASB: Financial Accounting Standards Board
sets the accounting standards found in the GAAP
Cash equivalents
short-term highly liquid investments that are both: readily convertible and their market value is insensitive to changes in interest rates ex: treasury bills, commercial paper, money market funds
Cash Budget
shows anticipated cash flows, usually over one to two year period
Financing section
shows expected borrowings and repayments of borrowed funds plus interest.
Cash disbursements section
shows expected payments for investors labor, overhead, and selling and administrative expenses, projected payments from income taxes, dividends, investments, and plant assets
Adjusted Trial Balance
shows the balances of all accounts, including those adjusted, at the end of an accounting period -purpose is to prove the equality of the total debit balances and the total credit balances in the ledger after all adjustments
Journal
shows the debit and credit effects on specific accounts for each transaction
Retirement
some productive assets used in manufacturing may have very specific uses, and they consequently have no ready market when the company no longer needs them--it is retired.
Economic Entity Assumption
states that every economic entity can be separately identified and accounted for. (don't blur company transactions and personal transactions)
Periodicity Assumption
states that life of a business can be divided into artificial time periods.
Going Concern Assumption
states that the business will remain in operation for the foreseeable future.
Auditor's Report
states the auditor's (certified public accountant who conducts an examination of a company's financial statements) opinion as to the fairness of the financial presentation.
Buildings
stores, offices, factories, warehouses, airplane hangars. ~charges all necessary expenditures relating to purchase or construction of a building
Land Improvements
structural additions made to land--driveways, parking lots, fences, landscaping, sprinklers, etc. -Cost includes all expenditures to make ready for intended use.
Accounting Information System
system of collecting and processing transaction data and communicating financial information to decision makers. -the nature of the company's business, the types of transactions, the size of the company, etc. shape an AIS
Under FIFO, companies determine the cost of the ending inventory by...
taking the unit cost of the most recent purchase and working backward until all units of inventory have been costed.
Carrying Value
the FV of the bonds - discount + premium
Computing Interest
the Interest rate on the note is an annual rate of interest. -when it is stated in days, you take the number of days and divide by *360* -when counting days, omit the date the note is issued but include the due date
Inventory Account
the added asset account for a merchandising company
Effective-Interest method
the amortization of bond discount or bond premium results in periodic interest expense equal to a constant percentage of the carrying value of the bonds
To determine the new annual depreciation expense
the company must 1. compute the asset's depreciable cost at the time of the revision. 2. then allocates the revised depreciable cost to the remaining useful life. (Take the BV - New Salvage Value / remaining useful life)
Maturity date
the date that final payment is due to the investor
Liabilities
the debts and obligations of the business. [payables]
Book Value
the difference between the cost of any depreciable asset and its related accumulated depreciation
Ledger
the entire group of accounts maintained by a company
Determining the maturity date
the maturity date of a promissory note may be stated: 1. on demand 2. on a stated date 3. at the end of a stated period of time -when the life of a note is expressed in terms of months, you find the date when it matures by counting the months from the date of issue
Cash (net) realizable value
the net amount a company expects to receive in cash from receivables. Ending Balance in AR - Ending Balance in AFDA
Retained Earnings
the net income retained in the corporation
Cash
the one asset that is readily convertible into any other type of asset and is also the most susceptible to fraudulent activities
Maker
the party making the promise to pay
Depreciation
the process of allocating to expense the cost of a plant asset over its useful (service) life in a rational and systematic manner -match expenses with revenues-
Bank reconciliation
the process of comparing the bank's balance with the company's balance
Discounting the future amounts
the process of finding the present value
Posting
the process of transferring journal entry amounts to ledger accounts ( T accounts)
Market Interest Rate
the rate investors demand for loaning funds.
Contractual Interest Rate
the rate used to determine the amount of cash interest the borrower pays and the investor receives. *usually stated as an annual rate
Segregation of Record-Keeping from physical custody example
the supervisor has access to the cash register tape, but NOT to the cash. The clerk and the cashier have access to the cash but NOT the register tape.
Cost of goods sold
the total cost of merchandise sold during the period; it is directly related to the revenue recognized from the sale of goods.
Goodwill
the value of all favorable attributes that relate to a company 1. usually the largest intangible 2. only be identified with the business as a whole 3. recorded when there is an exchange transaction that involves the purchase of an entire business 4. equals cost of purchase less fair value of net assets acquired 5. indefinite life--not amortized
Concentration of credit risk
threat of nonpayment from a single large customer or class of customers that could adversely affect the financial health of the company
Sarabanes-Oxley Act
top management must now certify the accuracy of financial information to reduce unethical corporate behavior.
Common Stock
total amount paid in by stockholders for the shares they purchase.
Sales Return and Allowance
transactions where the seller either accepts goods back from a purchaser (a return) or grants a reduction in the purchase price (an allowance) so that the buyer will keep the goods.
Closing Entries
transfer net income and dividends to Retained Earnings so the balance in Retained Earnings agrees with the Retained Earnings statement. -produce a zero balance in each temporary account
Units of Activity Method
useful life is expressed in terms of the total units of production or the use expected from the asset *the amount of depreciation is proportional to the activity that took place during that period*
Direct Write-Off Method
when a company determines receivables from a particular company to be uncollectible, it charges the loss to Bad Debt Expense. *Debit: Bad Debt Expense, Credit: Accounts Receivable* ~under this method, bad debt expense will show only actual losses from uncollectibles and reports AR at its gross amount w/o any adjustment for estimated losses for bad debts. ~this can reduce the usefulness of both the income statement and balance sheet.
Consistency
when a company uses the same accounting principles and methods from year to year
Comparability
when different companies use the same accounting principles allowing investors to compare them
Timeliness
when financial information is available to it's users before it looses its capacity to influence their decisions
Understandability
when financial information is presented in a clear and concise fashion so that reasonably informed users can interpret and comprehend.
Verifiability
when financial information users are able to prove that the information is free from error
Effective-Interest rate
when the bonds are issued and remains constant in each interest period
Purchase Allowance
when the purchaser chooses to keep the merchandise if the seller is willing to grant a reduction of the purchase price.
Purchase Return
when the purchaser returns the goods to the seller for credit/cash
Promissory Note
written promise to pay a specified amount of money on demand or at a definite time -used when individuals and companies lend or borrow $, when the amount of the transaction and the credit period exceed normal limits, and in settlement of accounts receivable.
Recognizing Accounts Receivable
~A service organization recognizes accounts receivable when it performs service on account and a merchandiser recognizes AR when it sells merchandise on account. ~includes sales returns and allowances and sales discounts. ~Also, *interest revenue*
Premium on Bonds
~If the market interest rate is lower than the contractual interest rate, investors will have to pay more than FV for the bonds. ~Occurs when a bond is sold for more than its FV ~Premium=difference between FV and selling price
Discount on Bonds
~Occurs when a bond is sold for less than its face value ~Discount=difference between FV and selling price ~The actual interest rate incurred by the company increases to the level of the current market interest rate
Issuing bonds at face value
~Occurs when the contractual interest rate and the market interest rate are the same--very rare ~Interest is computed in the same manner as interest on notes payable.
Sales Tax Payable
~Sales taxes are expressed as a percentage of the sales price. ~The selling company collects the tax from the customer when the sale occurs and periodically remits the collections to the state's department of revenue.
Redeeming Bonds before Maturity
~may decide to do this in order to reduce interest cost and remove debt from its balance sheet. 1. eliminate the carrying value of the bonds at redemption date 2. record the cash paid 3. recognize gain or loss on redemption
