Accounting Exam 3
effect on balance sheet
decrease assets (by amount of cash paid to reacquire the stock) and decrease equity (since the account treasury stock is a contra-equity account)
effects of depreciation on balance sheet
decrease assets (by increasing contra asset - accumulated depreciation) and decrease retained earnings
effects of revenue expenditure on balance sheet
decrease cash decrease retained earnings
Over time, what happens to the book value of an asset?
decrease each year because the amount of accumulated depreciation gets larger each year
As the compounding frequency increases, what happens to the present value?
decreases
treasury stock effects on balance sheet
decreases total stockholders' equity
key point using straight line method
depreciation expense is the same amount each year of the asset's life using the straight line method
how does the entry to record the reacquisition of treasury stock affect net income, balance sheet, and cash flows?
doesn't affect net income. assets & equity on balance sheet are decreased. cash paid to reacquire stock is a financing cash outflow.
in the first year, which method will give an income tax advantage?
double declining balance - in the first year, double declining balance shows larger amount of expense. thus shows smaller amount of net income, thus pay less income tax
in the last year, which method will show the highest net income?
double-declining balance
compound interest
earns interest on both principal invested as well as all previously earned interest
Future Value of an Ordinary Annuity
payment * future value annuity factor(i,n) **the payment represents the amount of each individual, equal payment. do not add payments together **FV & PV not reciprocal
Present Value of an Ordinary Annuity formula
payments * present value annuity factor(i,n) **the payment represents the amount of each individual, equal payment. do not add payments together **FV & PV not reciprocal
is it easier to compare the different alternatives using present or future values?
present
to record annual amortization of the leased asset (if ownership reverts to lessee)
present value / economic value
cash flow impact
proceeds from issuance are a financing cash inflow
how does the acquisition of an asset impact the income statement?
none
to record the depreciation of the leased asset
debit amortization expense credit leased asset
effects of depreciation on statement of cash flow
none - depreciation is a non-cash expense
effects of revenue expenditure on statement of cash flow
operating cash outflow
dividends are paid on...
outstanding shares. no dividends are paid on treasury stock.
total preferred stock dividend
par value per share x % * # shares outstanding
preferred stock dividend
par value per share x % per share dividend
to record annual amortization of the leased asset
debit amortization expense credit leased asset calculate by: present value / lease term
recording depreciation expense
debit depreciation expense, credit accumulated depreciation
to record the inception of the lease
debit leased asset credit lease liability
to record first lease payment
debit: interest expense lease liability credit: cash
to record first mortgage payment
debit: interest expense mortgage payable credit: cash
present value of a lump sum
Present Value = Future Value * Present Value Factor(i,n)
At what amount should PPE be recorded when it is purchased?
-at cost -cost is the purchase price plus all costs incurred in getting the asset ready for use -costs incurred in getting the asset ready for use include sales tax, freight costs, installation costs, repair costs incurred prior to use, assembly costs, fees such as closing costs and recording fees
transactions involving our own stock effect on net income
never affect
treasury stock account balance
# of shares reacquired * reacquisition cost
units of production formula
((Cost - Residual Value) / (total estimated usage) = depreciable cost per unit ----> (depreciable cost) * (actual usage for current year) = depreciation expense
average total assets
(Beginning Total Assets + Ending Total Assets) / 2
times interest earned ratio formula
(Net Income + Interest Expense + Income Tax Expense) / Interest Expense
straight line depreciation
(cost-residual value)/useful life in years **residual value is also referred to as salvage value
Earnings Per Share (EPS)
(net income - preferred stock dividends) / # of common shares outstanding measures the amount of net income associated with each share of common stock
double declining balance depreciation key points
- book value at the beginning of the first year is the cost of the asset since the balance in accumulated depreciation at the beginning of the asset's useful life is zero - in subsequent years, book value is the difference between cost and accumulated depreciation at the beginning of the year - residual value is ignored in calculating the amount of depreciation expense
Accumulated Depreciation
- causes decrease in assets - contra asset account - normal balance is credit - found on the balance sheet directly under the asset being depreciated - represents the total amount of the of the building or equipment 'used up' since it was acquired by the company
depreciation expense
- classified as an expense account - found on the income statement - reduces net income - represents the amount of the building or equipment 'used up' in the current year
effect on income statement
none
characteristics of cash dividends
-dividends must be declared by the board of directors before they can be paid -the corporation is not legally required to declare (and subsequently pay) dividends -dividends are not classified as an expense and do not impact net income. rather, dividends are paid out of net income -classified as a contra-equity account because they reduce equity (specifically retained earnings) - cash dividends require sufficient cash and retained earnings to cover the dividend -normal balance is debt -once a dividend is declared, a liability is created
lessee accounting
-lessee records a leased asset and a lease liability on their balance sheet equal to the present value of the lease payments -the leased asset is depreciated -the lease liability is amortized (gradually reduced) over the lease term down to a zero balance
amortization of the lease liability
-reduces the liability each time a payment is made. at the end of the lease term, the liability balance must be zero -each payment is separated into two components - interest expense and principle reduction (i.e. reduction of the lease liability) -set up an amortization table
depreciation of the leased asset
-referred to as amortization -typically calculated using straight-line method -assume residual value = 0 -if the lease agreement calls for the asset to be returned to the lessor at the end of the lease, the lessee uses the lease term as the asset's life -if the lease agreement calls for the ownership of the asset to be transferred to the lessee at the end of the lease, the lessee uses the economic life of the asset as the asset's life
record during the asset's useful lifetime
-report depreciation expense on income statement and accumulated depreciation on the balance sheet -additional capital expenditures added to capitalized amount on the balance sheet and cash spent reported as an investing activity on the statement of cash flows -additional revenue expenditures are expensed on the income statement and cash spent reported as an operating activity on the statement of cash flows
when a change in estimate is made
1. No corrections or changes are made to amounts previously recorded as depreciation expense 2. The new estimates are incorporated into the current and future years depreciation calculations only
Four Accountable Events in the Life Cycle of PPE
1. account for the acquisition of PPE 2. account for any capital expenditures made during the life of the asset 3. account for the depreciation of buildings and equipment 4. account for the sale of disposal of PPE
expenditures during the life of the asset
1. capital expenditures 2. revenue expenditures
To record the sale of a plant asset, there are 4 items that must be accounted for:
1. cash received from sale 2. eliminate asset sold from balance sheet at its cost 3. eliminate accumulated depreciation related to the asset sold from the balance sheet
3 important dates relating to dividends
1. date of declaration 2. date of record 3. date of payment
4 time value of money cases
1. future value of a lump sum 2. present value of a lump sum 3. future value of an annuity 4. present value of an annuity
2 types of capital stock
1. preferred stock 2. common stock
3 common depreciation methods
1. straight line 2. double declining balance 3. units of production
effects of capital expenditure on income statement
none
Future Value of a Lump Sum
Future Value = Present Value * Future Value Factor (i,n)
Return on Equity (ROE)
Net Income / Average Equity measures the amount of profit earned for each dollar of stockholder investment
once an asset is in use, what costs are capitalized?
Once an asset is in use, only those costs that significantly improve the asset or substantially extend its life are capitalized
cumulative preferred stock
Preferred stockholders must be paid both current and prior years unpaid dividends before common stockholders receive any dividends
dividends in arrears
Prior years unpaid preferred stock dividends. Do not represent actual liabilities and thus are not recorded in the accounts, but must be disclosed in the notes to the financial statements
recording recurring, ongoing costs
Recurring, ongoing costs such as repairs after the asset is in use, maintenance and insurance are expensed as incurred (i.e., they are not capitalized).
to determine the new annual depreciation expense
The book value (cost - accumulated depreciation) of the asset at the date of the change less any salvage value is depreciated based on the number of years remaining in the useful life
lease
a contract that specifies the terms under which the owner of an asset agrees to transfer the right to use the asset to another party
annual depreciation is based on
a declining book value (cost - accumulated depreciation)
recording at disposal
a gain or loss, if any, is reported on the income statement. the asset is removed from the balance sheet at its cost. the accumulated depreciation related to the asset sold is also removed from the balance sheet. the cash received is reported as an investing cash inflow in the statement of cash flows
par value
a monetary amount assigned to each class of stock for accounting purposes only -when stock is sold to owners (stockholders), the stock account is only recorded at par value --- the excess of the selling price of the stock over the par value is recorded in the equity account called: --- > paid-in capital
annuity
a series of equal payments (either amounts to be received or paid) with each payment having the same time interval between them
capitalization
all of these costs incurred in getting the asset ready for use are recorded on the balance sheet as part of the cost of the asset
annuity due
an annuity with payments occurring at the beginning of each period
ordinary annuity
an annuity with payments that occur at the end of each period
making the lease balance equal to zero
because of rounding errors, for the last year, make the reduction of principal equal to the lease balance and force out the interest.
advantage
best adheres to matching concept problem is that the estimates involved can be very difficult to develop for most plant assets
to calculate double declining balance depreciation
book value at beginning of year * (2/asset's life)
in the last year, in the first year, which method will show the highest total assets on the year-end balance sheet?
both will be same
effect on cash flow
cash paid to reacquire stock is financing outflow
common stock
common stockholders have voting privileges -election of board of directors -vote on significant activities of management dividend rates are determined by the board of directors based on the corporation's profitability -receive dividends after preferred stockholders
treasury stock
considered issued stock but not outstanding stock does not have voting rights cannot receive dividends recorded at its reacquisition cost no gains or losses are ever recorded
treasury stock account
contra equity account normal balance is debit
book value formula
cost of asset - accumulated depreciation
recording acquisition
cost reported as an asset on the balance sheet and amount paid in cash reported as an investing cash outflow on the statement of cash flows
Factors in Calculating Depreciation
cost, useful life, residual value
capital expenditures
costs incurred to increase the: -operating efficiency of the asset -productive capacity of the asset -the expected useful life of the asset -usually substantial in amount and occur infrequently during the period of ownership -capitalized (the capital expenditure is added to the cost of the asset that has been improved or bettered
Revenue expenditure
expenditures made to keep an asset in good working order: -ordinary repairs to an asset usually small in amount and usually occur frequently throughout the life of the asset have no effect on the useful life of the asset not capitalized. rather they are expensed immediately (repair expense)
discounting
figuring out how much a future amount is worth today
preferred stock
has dividend preference - means if a dividend is paid the preferred stockholders must be paid in full before common stockholders can receive a dividend the preferred stock dividend is set at a fixed percentage preferred stockholders typically do not have voting rights
adjustment to i & n when interest is compounded in any way other than annual
i / # of compounds per year n * # of compounds per year
gain on sale
if the cash received exceed the book value -revenue account -recorded on income statement -increases net income (thus retained earnings)
loss on sale
if the cash received is less than the book value -expense account -recorded on income statement -decreases net income (thus retained earnings)
adjusting book value when it falls below residual
in the year that the book value falls below the residual, stop depreciating once the book value hits the residual value depreciation costs - depreciation expenses in the previous years - x = residual
how does the acquisition of an asset impact the balance sheet?
increase PPE decrease cash
effects of capital expenditure on balance sheet
increase PPE & decrease cash
balance sheet impact
increase assets (by amount of cash received) and increase equity (both common stock & paid-in capital)
effects of depreciation on income statement
increase depreciation expense and decrease net income
effects of revenue expenditure on income statement
increase repair expense decrease net income
As the compounding frequency increases, what happens to the present value?
increases
effects of capital expenditure on cash flow
investing cash outflow
how does the acquisition of an asset impact the statement of cash flows?
investing cash outflow
how does units of production differ from the other 2 methods?
it is not based on time. it is based on actual usage.
double declining balance depreciation
known as an accelerated depreciation method
land & depreciation
land does not depreciate since its usefulness and revenue producing ability generally remain intact (never gets used up)
Price Earnings Ratio
market price per share of stock / earnings per share measures investors' expectations regarding the growth potential and earnings stability of a company
asset turnover ratio
measures how efficiently a company uses its assets to generate sales net sales revenue / average total assets
return on assets (ROA)
measures the amount of profit earned for each dollar invested in assets net income / average total assets
Time Interest Earned Ratio
measures the companies' ability to meet its interest payments as they come due can be thought of as a 'margin of safety' provided to creditors the higher the ratio, the more income the company has to pay its interest and the less likely the company is to default on these payments
debt-to-equity ratio
measures the percentage of funds being provided by creditors vs stockholders measures how protected creditors are in the event the company is unable to pay its debts (insolvency) all things being equal, the higher the debt to equity ratio, the higher the risk to creditors the higher the ratio, the more debt we have than equity, the greater proportion of credit we have, and thus higher likelihood an individual creditor would not be paid in full if the company can't meet its obligations additionally, higher ratio typically results in a higher rate of interest charged by lenders to accommodate for the added risk
accelerated depreciation method records what
more depreciation in the early years of an asset's life and less depreciation in the later years. thus, these methods show a declining amount of depreciation each year
to find the future value of an annuity due table factor
multiply the ordinary annuity factor by (1+i)
to find the present value of an annuity due table factor
multiply the ordinary annuity factor by (1+i)
re-issuance of treasury stock: when the re-issue price > reacquisition cost
record the excess in the equity account Paid-in capital - treasury when treasury stock is re-issued, always remove the treasury stock from the balance sheet at its reacquisition cost
re-issuance of treasury stock: when the re-issue price < reacquisition cost
reduce paid-in capital -- treasury by debiting the account for the difference. however it cannot go past zero. if a deficit still exists after debiting the paid-in capital - treasure account, reduce retained earnings for the remaining deficit
once an asset is fully depreciated, its ending book value is equal to what amount?
residual (salvage) value
treasury stock
stock that has been reacquired
in the first year, which method will show the highest net income?
straight line -in the first year, records lower amount of depreciation than accelerated
in the last year, in the first year, which method will give an income tax advantage?
straight-line
in the first year, which method will show the highest total assets on the year-end balance sheet?
straight-line - lower depreciation in first year, therefore accumulated depreciation in first year is less. thus since accumulated depreciation is a contra asset, straight-line will show lower reduction of assets in first year and thus a higher amount of total assets
how to determine the cost assigned to each individual asset purchased
the cost is allocated to the individual assets purchased by determining the percentage of total market value made up by each asset and then allocating the cost to those assets based on that percentage
date of payment
the date on which a corporation pays dividends to its stockholders debit dividends payable credit cash income statement not affected cash flow is financing outflow balance sheet - assets decrease and liabilities decrease
date of record
the date on which a stockholder must own one or more shares of stock in order to receive the dividend no accounting entry required
date of declaration
the date the corporation's board of directors formally decides to pay a dividend to stockholders debit dividends credit dividends payable balance sheet effects - liabilities increased & equity decreased no effect on income statement or cash flow
difference between issued and outstanding shares
the difference represents shares of stock issued by the company and then reacquired by the company (i.e. the company buys back the stock)
compounding
the frequency with which interest is added to the principal
lessor
the owner of property that is leased to another party
lessee
the party that is granted the right to use property under the terms of a lease
depreciation
the systematic allocation of the cost of a plant asset to expense over its useful life
outstanding shares
the total number of shares actually in the hands of stockholders
issued shares
the total number of shares of stock that have been sold to the public
authorized shares
the total number of shares of stock that the company is allowed to sell to the public
debt-to-equity ratio formula
total liabilities/total stockholders equity
Present Value of an Ordinary Annuity
want to know the value today of a series of equal payments to be made or received in the future
lump sum (basket) purchase
when a company purchases more than one asset for one, lump-sum amount
When is a cost capitalized?
when it is recorded as part of an asset on the balance sheet rather than as an expense on the income statement