Topic 4 - 10 Accounting

Sales Allowance

Occurs when a customer agrees to keep the merchandise they wish to return, and the company refunds a portion of the original sales price.

Sales Return

Occurs when a customer returns previously purchased merchandise.

For a sole proprietorship, the balance sheet lists the total ending owner's equity in....

A single capital account, affected by owner's investments, withdrawals and net income.

Petty Cash Fund

A special cash fund controlled by one employee, used for making small cash payments for the business, included in the balance of cash.

Reporting

Applications of standards and proper disclosure

Return on Total Assets Ratio Calculation (evaluates profitability) x%

((Net Income + Interest Expense)/Average Total Assets) x 100

Calculation for Average Amount for Return on Assets and Return on Equity

(Beginning Balance + Ending Balance)/2

Return on Equity (ROE) Calculation x% (evaluates profitability)

(Net Income/Average Owners' Equity) x 100

Equity Ratio [financial flexibility] Calculation x%

(Total Equity/Total Assets) x 100

Debt Ratio [financial flexibility] Calculation x%

(Total Liabilities/Total Assets) x 100

Debt To Equity Ratio [financial flexibility] x%

(Total Liabilities/Total Equity) x 100

Horizontal Analysis Calculation

(amount in current period - amount in previous period/amount in previous period) x 100

Accumulated Depreciation Formula

(cost of asset - salvage value)/useful life

Annual depreciation expense =

(cost of asset -expected residual value) / asset's expected useful life

Examples of Liabilities

- Accounts payable - Notes payable - Wages payable - Interest payable

Ratio Analysis

- Calculation and interpretation of a financial ratio - By expressing $ amount of one item by $ amount of another - Comparing ratio with bench - Interpreting difference from previous years, other entities or industry averages

Examples of Assets

- Cash - Accounts receivable - Supplies - Inventory - Buildings

Working Capital Items

- Cash - Accounts receivable - Inventory - Accounts payable.

Examples of Quick Assets

- Cash - Marketable Securities - Accounts/Notes Receivable

Vertical Analysis

- Compares items in financial statement to anchor item of same statement - Revenue and expense items expressed as % of sales or revenue - Assets, Liabilitiy & Asset items expressed as % of total assets

Inventory Internal Controls

- Control of ordering and acceptance of inventory deliveries - Physical controls over inventory while being held for sale - Period physical counts to ensure accurate inventory records

Examples of improved image/reputation from sustainability:

- Customer loyalty/preference to business - Less risk of government intervention/legal issues - Preferred place to work

Examples of Revenues

- Fees earned - Commissions Revenue - Rent Revenue

GST-Free Supplies

- Fresh food - Educational supplies - Medical products & services - Wages & salaries - Capital contributions and withdrawals - Exported goods.

Corporate Social Responsibility

- Incorporates public interest into business planning and decision making - Questions the role of business in facilitating sustainable environmental and social change

Investing activities include...

- Lending money - Collecting on loans - Investing in other companies - Buying and selling property and equipment

Examples of reduced costs of sustainability:

- Less waste - Less risk of social conflict - More productive employees - Operation efficiency

Allowance For Doubtful Debts

- Negative asset account on the balance sheet - Records balance of doubtful debts unlikely to be collected in future but not yet written off

Cash Return on Total Assets

- Net cash flow provided by operating activities & interest paid/average total assets - Shows how well the business is using its resources to generate cash from operating activities

Cash Return on Owner's Equity

- Net cash flow provided by operating activities/average owner's equity - Shows how much net cash from operating activities the business generated with each dollars of owner's capital

Cash definitions

- Notes and coins held - Deposit call accounts at financial institutions - Cash equivalents

Financing activities include...

- Obtaining capital from the owner - Providing owner with return on investment - Obtaining capital from creditors - Repaying amounts borrowed

Cash Flow Statement Sections

- Operating activities - Investing activities - Financing activities

Sustainability reporting can be:

- Part of a business annual report - A stand-alone sustainability report - An environmental or social impact report

Operating activities include:

- Payments to suppliers - Payment of rent - Payment of salaries - Receipts from customers

Trend Analysis

- Predictions of future direction of various items on basis of past direction of items - Needs 3 years of data minimum to calculation - Expresses items in subsequent years relative to base year - Given value of 100.

Examples of Non-Current Assets

- Property and Equipment - Long-Term Investments - Intangible Assets

Investing activities include:

- Purchase of investment in stock - Payment for machinery

Financing activities include:

- Receipts from owner's additional investment - Receipts from bank loan - Retirement of bond

Benefits of sustainability:

- Reduced costs - Improved image/reputation - Sustainable future operation

Role of accountant

- Reporting - Accounting information system design - Audit and assurance on reports issued - Cost analysis

2 main parts in the GRI reporting framework:

- Reporting principles and standard disclosures - Implementation manual

Analysis of cash flow statement helps external users....

- See how the entity obtained and used its cash - Evaluate the entity's need for additional cash to pay for or expand existing operations - Evaluate entity's ability to make interest payments and pay of debt as it becomes due

Cash Equivalents

- Short-term, highly liquid investments easily converted to cash, relatively insensitive to interest rate changes - Investments with maturity less than 3 months

Examples of Expenses

- Wages Expense - Rent Expense - Miscellaneous Expense

Characteristics of sustainable business:

- Well-written business plan to measure performance against regularly - Clear understanding of key drivers of business operations - Strong corporate governance and ethical framework for conduct - Long-term investment in human capital and knowledge - Establishing partnerships and networks

Balance sheet information shows

- economic resources for investing choices [assets] - economic obligations for financing decisions [liabilities] - solvency - financial flexibility - liquidity

The Global Reporting Initiative (GRI):

-Generally accepted framework for reporting an organisation's economic, environmental and social performance - Continually updated - Works with a global multi-stakeholder network from over 60 countries - Stakeholders include business, society, academia, labour and other professional institutions

Return on Total Assets Ratio Shows...

Whether a business uses it's assets/economic resources efficiently to generate income, evaluates profitability.

Business Cash Includes

1. Money on hand 2. Deposits in cheque and saving accounts 3. Cheques and credit card invoices received from customers but not yet deposited 4. Anything a bank will accept as a deposit

Limitations of the Balance Sheet

1. Most assets and liabilities are reported at historical cost. 2. Use of judgments and estimates. 3. Many items of financial value are omitted. 4. Does not provide much information about entity's cash management because it is based on accrual accounting.

Revenues

Inflows from ordinary activities, money earned by selling goods/services to customers that result in an increase in assets or a decrease in liabilities.

Control procedures for cash sales

1. Proper use of cash register 2. Confirming identity of cheque-paying customers 3. Matching total amounts collected against total of cash register tape at each employee's shift end

Decision making process

1. Recognise the need for a decision 2. Identify alternative solutions 3. Evaluate alternate solutions 4. Make the decision - Consider the financial/profit impact of each alternative, and non-financial factors such as impact on employees, communities, and the environment

Basic Rules for Internal Control Over Cash Payments

1. All payments must be authorised before being made. 2. Business should only pay for approved purchased that are supported by proper documents.

What 3 factors determine the depreciation expense for a fixed asset?

1. Asset's initial cost. 2. Asset's expected useful life. 3. Asset's estimated residual value.

Accounting Period

A period of time covered by an accounting report, conventionally reports are made yearly for external users.

Weighted Average Method

An inventory costing method based on the weighted-average cost per unit of inventory that is calculated after each purchase. Weighted-average cost per unit is determined by dividing the cost of goods available for sale by the number of units available.

Internal Controls over Accounts Receivable

1. Determining that a customer is likely to pay. 2. Monitoring accounts receivable balances of customers. 3. Monitoring total business accounts receivable.

Process of identifying relevant costs

1. Eliminate past costs 2. Estimate costs not necessary to carry out decision alternatives 3. Eliminate costs that would not differ from one alternative to another - By the process of elimination of steps 1 to 3, costs relevant to the decision will become apparent

Accounts Payable Internal Control

1. Establishing control over who can obligate the business 2. Establishing controls over payments 3. Monitoring total amount of accounts payable

Cost Flows Assumptions

1. First in first out [FIFO] 2. Weighted average (first 2 methods permitted under IFRS) 3. Last in first out [not permitted under IFRS]

Purpose of financial analysis

1. Highlights strengths and weaknesses of firms. 2. Better understanding of future financial health. 3. Compares figures with previous years and other statements.

Analytical Methods

1. Horizontal analysis 2. Trend analysis 3. Vertical analysis 4. Ratio analysis 5. Benchmarks

Financial statements:

1. Income statement and statement of comprehensive income 2. Balance sheet 3. Statement of changes in equity 4. Statement of cash flows

The balance sheet is important because...

1. Shows an entity's financial position on a specific date 2. Helps users evaluate business' ability to earn a profit, maintain liquidity and financial flexibility, and remain solvent

Cash Flow Statement is importance because...

1. Shows changes in cash during an accounting period 2. Lists cash inflows and outflows from investing, operating and financing activities during the period 3. Provides information about business' ability to remain solvent and grow

What are the 3 depreciation methods?

1. Straight-line 2. Units of output 3. Double-declining balance

Sustainability can be integrated into budgeting by:

1. Understanding what sustainability really means 2. Defining sustainability for your organisation and determining what factors to include or exclude 3. Determining your time horizon for profitability 4. Build sustainability into corporate strategy and objectives 5. Integrate sustainability into performance management

Straight line rate =

1/useful life in years

Days Account Receivable Calculation x times [efficiency measure]

365/Accounts Receivable Turnover

Days Inventory Turnover Calculation [measures efficiency] x times

365/Inventory Turnover

Cost of Goods Sold Calculation

beginning inventory + purchases - ending inventory

Periodic Inventory System

An inventory system in which a company does not maintain detailed records of goods on hand throughout the period and determines the cost of goods sold only at the end of an accounting period.

Goods and Services Tax (GST)

A broad-based tax of 10 per cent on the supply of most goods and services consumed in Australia.

Credit Memo

A business document listing the information for sales return or allowance.

Entity Concept

A business is considered to be separate from it's owners and any other business.

Historical Cost Concept

A business records its transactions based on the amount exchanged at the time the transaction first occurred.

Financial Flexibility

A business' ability to manage cash flows in such a manner that the company can respond appropriately to unexpected change in opportunities & needs.

Liquidity

A business' ability to meet its short-term financial commitments, measured by how quickly it can convert assets into cash to pay its bills.

Perpetual Inventory System

A continuous record of the cost of inventory on hand and cost of inventory sold.

Incremental loss indicates...

A decision is expected to decrease income

Incremental income indicates...

A decision is expected to increase income

Statement of Comprehensive Income

A financial document showing a company's income and expenditure over a particular time period, usually one year, required by the AASB.

Income Statement

A financial statement showing the revenue and expenses for a fiscal period.

Balance Sheet

A financial statement that reports assets, liabilities, and owner's equity on a specific date.

GST Collected

A liabilitiy obtained through tax collected by a business from its customers on goods and services provided.

Book Value

AKA Carrying Amount. The difference between the cost of a depreciable asset and its related accumulated depreciation.

Net Realisable Value

AKA carrying amount on a balance sheet. The amount expected to be ultimately collected from customers.

Non-Current Assets

AKA fixed or operating assets. Items that a business owns and which it expects to retain for one year or longer.

Drawing Account

Account representing the amount of withdrawals made by the owner.

Sales Revenue Account

Account retail businesses record customer purchases of goods on cash or credit, source documents may include sales invoice, cash register tape or credit card receipt.

Current Liabilities Example Accounts on Balance Sheet

Accounts Payable Salaries Payable Unearned Revenues Short-term Notes/Interest Payable

Accounts Payable

Amounts a business owes its suppliers for credit purchases of inventory and supplies.

Accounts Receivable

Amounts owed to a business by customers from previous credit sales. Reported on the balance sheet as 'net realisable value (carrying amount)'.

GST Paid

An asset obtained through tax paid by a business on goods and services purchased.

Business Activity Statement

An entity must complete a statement reporting their tax obligations to the ATO at regular intervals (monthly, quarterly or annually) to accompany their tax payments/claims.

Assets

An entity's economic resources, controlled by the entity, that will provide future benefits to the business.

Incremental Analysis

Analyses incremental/differential revenues and costs to determine incremental/differential impact on income of two alternative courses of action

Cost analysis

Assessing pros and cons on projects involving environmental and social aspects

The Accounting Equation

Assets = Liabilities + Owner's Equity

Current Assets

Assets the business expects to convert into cash, sell or use up within one year. Grouped in order of liquidity.

Balance Sheet Accounts

Assets, Liabilities, Owner's Equity

Specific Identifcation Method

Assigns to each unit sold and each unit in ending inventory the cost to the business of purchasing that particular unit. Amount of ending inventory usually verified by a physical count.

Closing Temporary accounts of an Income Statement

At the end of the period all income and expense accounts are cleared/reduced to 0 balance, and the difference between the revenues and expense accounts is transferred to Equity so you can start each period with no balance in income and expense accounts.

Net Sales

Initial sales revenue - sales returns and allowances, and sales (cash) discounts taken. Reported on business' income statement.

Horizontal Analaysis

Compares reported numbers in different reporting periods to highlight magnitude and significance of changes

Balance of Inventory account is included at the end of an accounting period on the __________ ___________.

Balance Sheet.

Where does accumulated depreciation go?

Balance sheet.

Too Little Working Capital

Business risks not having enough liquidity.

Too Much Working Capital

Business risks not putting resources to their best use.

Triple Bottom Line

Business strategy where firms measure not only financial performance but their social & environmental impact. Can be broken down into "three Ps": profit, people, and the planet.

Operating Capability

Business' ability to sustain a given level of operations in the future.

Sales Policies

Business' policies related to sales of their goods or services, such as discount policies, sales return policies, & sales allowance policies.

Accept or Reject a Special Order Analysis

Businesses may be offered opportunities to sell products at discounted prices for specials, events, or export. Incremental analysis depends on whether the business is operating at full or less than capacity. If at less, the additional order does not increase fixed costs, but administrative costs may change because of this added business.

Gains

Increases in equity (net assets) from peripheral or incidental transactions of an entity and from all other transactions and other events and circumstances affecting the entity during a period except those that result from revenues or investments by owners.

Current Liabilities

Obligations the business expects to pay within one year.

Cash Flows are....

Increases to the beginning cash balance (+): 1. Decreases in assets other than cash 2. Increases in liabilities 3. Increases in owner's equity

Reducing-balance method

Calculates depreciation by subtracting a fixed percentage from the previous year's net book value

Non-Current Assets are presented at...

Carrying Amount or Book Value.

Order of liquidity of Assets on the Balance Sheet

Cash Accounts Receivable Inventory Supplies Prepaid Rent GST

Examples of income transactions

Cash and credit sales.

Net Resources

Cash flow revenue from all sources. Includes wage/salary income, interest, dividends, royalties, self-employment income, etc.

Other Comprehensive Income (OCI)

Certain gains and losses that are excluded from the calculation of net income, but included in the calculation of comprehensive income

Evaluating Long-Term Financial Flexibility

Common Indicators show use of debt relative to equity to finance investments in assets, AKA Capital Structure Ratios: 1. Debt Ratio 2. Equity Ratio 3. Debt to Equity Ratio

Make-or-Buy Analysis

Incremental analysis can help when manufacturing business need to decide whether make part of a product or purchase it from a supplier [outsourcing]

Operating expenses can be divided in to ______ and ________ on income statements

Selling expenses; General and administrative expenses

Selling Expenses Examples

Consulting expense, advertising expense, sales salaries expense, sales telephone expense, sales utilities expense, rent expense, depreciation expense.

General and Administration Expenses Examples

Consulting expense, office salaries expense, office telephone expense, office utilities expense, office supplies expense, rent expense.

Times Inventory Turnover Calculation (measures efficiency) x times

Cost of Goods Sold/Average Inventory

Cost Base

Cost of an asset when first purchased, includes costs of acquiring, holding and disposing of the asset.

Cost of Goods Sold

Cost of the inventory that was sold during the period

Operating Expenses

Costs [other than cost of goods sold] a business incurs in daily operations, including having sales staff, occupying building space and running adverts in the newspaper.

Sunk Costs

Costs already incurred that will not be changed or avoided by any future decision, not relevant costs.

Liquidity Current Ratio (x times)

Current Assets/Current Liabilities

On a classified balance sheet, liabilities are grouped into...

Current Liabilities and Non-Current Liabilities

Quick Assets

Current assets that may be easily converted into cash.

Net Amount of Accounts Receivable Calculation on Balance Sheet

Gross Accounts Receivable - Allowance for Doubtful Debts

Gross Profit Margin %

Gross profit/sales revenue x 100

Unit of production depreciation

Depreciates the assets based on the actual usage of the asset

Sustainable Development

Development that meets the needs of the present without compromising the ability of future generations to meet their own needs.

Cash Flow Statement

Difference of cash balance in the balance sheet between period beginning and ending

Marketing performance analysis is conducted by calculating...

Earnings per share.

Ending Cash Balance is shown in...

End of month Balance Sheet.

Cash in Flows - Cash Outflows is shown in....

End of month Cash Flow Statement.

Solvency

Entity's ability to meet its long-term financial commitments.

Cash inflows and outflows combined

Equal the ending cash balance

Efficiency Ratios

Evaluate business efficiency in using its economic resources in generating revenues through calculating: 1. Inventory Turnover 2. Accounts Receivable Turnover

Profitability Ratios

Evaluate how well a busienss has met profit objectives in relation to resources invested.

Source Documents

Evidence of transactions that have occurred.

Income

Increases in economic benefits during the accounting period in the form of inflows or enhancements of assets, or decreases in liabilities, that result in increases in equity.

Transaction

Exchanges with another entity/individual that affect the assets, liaibilities and equity items in an entity.

Depreciation

Expense created by the systematic allocation of the cost of tangible assets (like plant and equipment) to periods in which they are used; represents the expense of using the asset.

Relevant costs

Future costs that will change as a result of a decision, will differ between alternatives

Return on Equity shows....

How much return the owner/s can get as a result of business operation in a period.

Intergenerational Equity

Idea that development to meet the needs of the present should not compromise the ability of future generations to meet their needs

Balance of the Cost of Goods Sold account is included on the ____________ ____________.

Income Statement.

Difference between Income Statement & Cash Flow Statement...

Income statement reports on activities using accrual accounting, cash flow statement reports only on cash activities.

Accounting information system design

Incorporating social and environmental information into the accounting system

When a business purchases inventory it _____________ Inventory by the invoice cost of the merchandise (plus freight charges).

Increases

Inventory at End of Period Calculation

Inventory at beginning of period + Purchases - Cost of Goods Sold

Cost of Goods Sold Calculation

Inventory at period beginning + Purchases - Inventory at period end

Why is land not depreciated?

It has an infinite (unlimited) useful life.

Income statement is important because...?

It shows the net profit, which largely defines the financial health of a business.

Ratio Analysis Formula

Item 1 $ Amount/Item 2 $ Amount

Non-Current Liabilities Example Accounts on Balance Sheet

Long-Term Notes Payable Mortgages Payable Bonds Payable

Net Income

Makes up part of the owner's equity.

Sell a product or process it further

Management is deciding whether to process a product further and then sell it, or sell it at an intermediate stage of production, the costs of producing the intermediate product do not change, whether the intermediate product is sold or processed further.

Decision to drop a product analysis

Management may consider discontinuing or dropping a product if it is generating losses.

Matching Principle

Matching income earned with expenses incurred in earning the revenues in a reporting period.

Inventory

Merchandise held for resale

Non-Current Liabilities

Money owed by the business for more than one year.

Net Income/Profit/Earnings

Money remaining after operating expenses are subtracted from gross profit.

Accounts Receivable Turnover Calculation [efficiency measure] x times

Net Credit Sales/Average Accounts Receivable

Profit Margin %

Net Income/Net Sales x 100

Operating cash flow margin

Net cash flow provided by operating activities/net sales.

Investing activities are...

Non-current asset category transactions

Details of gross value and allowance are disclosed in....

Notes to the financial statements

Sustainable Business

One that ensures all processes, products and activities maintain a profit while addressing current environmental and social concerns

Current Liabilities are usually listed in....

Order of liquidity.

Book Value Calculation

Original Cost - Accumulated Depreciation

Land is listed on the balance sheet initially at its....

Original cost.

Order of liquidity of Non-Current Assets section on the Balance Sheet

Other Financial Assets Plant and Equipment Deferred Tax Assets Intangible Assets

Owner's equity account is affected by....

Owner's additional investments or withdrawals and by net income.

Cash Outflows are....

Payments decreasing beginning cash balance (-): 1. Increases in assets other than cash 2. Decreases in liabilities 3. Decreases in owner's equity

Sales Discount

Percentage reduction of the invoice price if the customer pays the invoice within a specified period, expressed as 5/N30 for a 5% discount if paid within 30 days.

Two Main Systems in Recording Inventories

Perpetual inventory system and periodic inventory system.

Earnings Per Share Calculation (x cents/share) (market performance analysis)

Profit Available to Ordinary Shareholders/Weighted No. of Ordinary Shares on Issue

Opportunity Costs

Profits a business forgoes by following a particular course of action

Liquidity Quick Ratio Calculation (x times)

Quick Assets/Current Liabilities

When the business sells merchandise it ____________ Inventory and _______________ Cost of Goods Sold by the cost of the inventory it sold.

Reduces; Increases.

Quantity Discount

Reduction in the sales price of a good or service because of the number of items purchased or because of a sales promotion. This discount is not recorded in the accounting system.

Statement of changes in equity

Reports the transactions that affected the owner's equity during the accounting period, linking the income statement and the amount of owner's capital reported on the balance sheet.

Income Calculation =

Revenue + Gains

Accrual Accounting

Revenue and expenses are recognized at the time they are earned or incurred, whether or not cash changes hands, financial statements must be prepared on this basis by accounting standards.

Income Statement Accounts

Revenue, Expenses

Net Income Calculation

Revenues - Expenses

Revenue Recognition Concept

Revenues are recorded when they are realized and can be measured, where there is an exchange of goods or services and assets received can be measured.

Days Inventory Turnover

Shows average number of days it takes to sell inventory in the business operating cycle.

Accounts Receivable Turnover

Shows how efficiently a business collects its receivables.

Classified Balance Sheet

Shows subtotals for Current Assets and Current Liabilities in related groupings.

Inventory Turnover

Shows the average number of times the inventory sold [turned over] during a period.

Financing activities impact...

Size and composition of contribution equity and long-term borrowing

What depreciation method is simplest?

Straight line

Financial Flexibility

The ability of a company to alter and adapt cash flows in order to take advantage of unexpected investment opportunities and needs

Incremental Cost

The amount of increase in cost expected from a course of action as compared to an alternative

Incremental revenue

The amount of increase in revenue expected from a course of action as compared to an alternative

What happens if a fixed asset has no residual value?

The assets entire cost should be allocated to depreciation.

Going Concern Assumption

The assumption an entity will continue viably for the forseeable future.

Expenses

The cost of providing goods/services to customers, resulting in a decrease in assets or an increase in liabilities.

Monetary Unit Concept

The currency used where the business operates.

Incremental income [loss]

The difference between the incremental revenue and incremental costs

Net Loss

The difference between total revenue and total expenses when total expenses are greater.

Liabilities

The economic obligations (debts) of a business to creditors.

Working Capital

The excess of a business' current assets over its current liabilities.

When is the expected useful life and residual value of a fixed asset estimated?

When the asset is placed into service.

Owner's Equity

The owner's rights to, and current investment in the entity's assets after all liabilities have been paid.

Internal Control

The processes used by a business to safeguard assets, process information accurately and ensure legal and regulatory compliance.

Beginning Cash Balance is shown in....

The start of month Balance Sheet.

Accumulated Depreciation

The sum of all the depreciation expense recorded to date for a depreciable asset.

Risk

The uncertainty about the future earnings potential of a business.

Uses of the income statement for evaluation

To evaluate risk, operating capability and financial flexibility of a business.

Investors use of the income statement

To help judge their return on investment

Creditors use of the income statement

To help make loan decision

Solvency Calculation (x %)

Total Liabilities/Total Equity x 100

End-of-Period Adjustments

Updating and adjusting account transactions that do not have a source document to reflect changes over time at the end of an accounting period.

Avoidable Costs

costs a business must incur to perform an activity at a given level, but can be avoided if the business reduces or discontinues the activity

Relevant revenues

future revenues that will change as a result of a decision, will differ between alternatives

Carrying value

the value of a non-current asset that is yet to be consumed/allocated as an expense, plus any residual value