Accounting 1 (Quick Study Business) [Lam Rfc Cr ed.] 1423221508, 9781423221500

Citation preview

BarCharts, Inc.®

WORLD’S #1 QUICK REFERENCE GUIDE

Accounting Basics Accounting Standards

1. Accounting principles have been in existence since the late 1400s when devised by Luca Pacioli, an Italian mathematician, and have evolved over time 2. Modern-day accounting principles in the United States are called generally accepted accounting principles (GAAP); these principles guide the work of accountants and auditors 3. The U.S. Securities and Exchange Commission (SEC) has regulatory authority over accounting principles used by public corporations A. The SEC is a federal agency responsible for enforcing the federal securities laws and regulating the securities industry B. It delegates the responsibility for the development of GAAP to the accounting profession via the Financial Accounting Standards Board (FASB) 4. The FASB develops new standards via due process activities that allow input from accountants and executives in business and industry 5. The International Accounting Standards Board (IASB) develops global accounting standards A. Multinational companies follow IASB standards B. The IASB works with other key global accounting standards bodies to create a single source of accounting standards 6. The Government Accounting Standards Board (GASB) sets state and local government standards for accounting A. The GASB is a private, nongovernmental organization subject to oversight and funding by the Financial Accounting Foundation (FAF) B. The federal government follows standards set by the FASB when performing accounting for its units

Concepts & Principles

1. Entity concept A. An organization stands apart from other organizations as a separate economic unit B. Assets and obligations must be accounted for separately from the personal resources and obligations of its owners 2. Going concern concept (a.k.a. continuity assumption): The entity will continue to operate long enough to meet its contractual obligations and carry out plans 3. Time period concept A. Businesses should report information at regular intervals B. Annual reports show income for the last 12 months and end on the last day of the fiscal year; therefore, annual reports show the financial position as of the last day of the fiscal year C. Public companies report based on quarterly (3-month) time intervals 4. Reliability principle A. Accounting records must be based on the most reliable data available B. Reliable information is accurate, objective (unbiased), and verifiable 5. Relevance principle A. Accounting information must be timely B. Accounting information is predictive, provides feedback, and helps decision makers 6. Cost principle: Assets and services acquired are recorded at actual, historical cost rather than current value 7. Conservatism A. Care must be exercised to avoid overstating assets and revenues and understating expenses and liabilities B. Accounting estimates should be based on conservative assumptions 8. Revenue principle A. Revenue should only be recorded when earned B. Revenue is earned when the business has completed rendering services to the customer C. The amount to record is equal to the cash value of services or goods D. The collection of cash must be reasonably assured on credit sales 9. Matching principle A. Expenses must be matched against revenues in the same accounting period B. Costs incurred to generate revenues in a period are recognized as expenses 10. The accounting period A. The accounting period is the period covered by the income statement B. It is usually 1 year ending on Dec. 31 (when the fiscal year is the calendar year) C. The fiscal year can end on any other date of the year chosen by management 11. Cash-basis accounting A. The impact of events is not recognized until cash is paid or received B. Revenue is recorded when cash is received; expenses are recorded when cash is paid C. This method is adequate for small companies that don’t report to external parties, but it is not acceptable under GAAP 12. Accrual-basis accounting A. The impact of events is recognized as they occur B. Revenue is recorded when earned; expenses are recorded when incurred C. Transactions are recorded even when cash has not been received or paid D. This method is required by GAAP

1. Assets A. Assets are economic resources expected to benefit the company in the future; they result from past transactions

i. Cash: Money, certificates of deposit, and checks ii. Accounts receivable: Oral or implied promises; usually arise from sales made to customers where no promissory note exists iii. Notes receivable: Promissory notes; a signed note usually with payment stipulations such as time period and interest rate iv. Inventory: Merchandise the entity holds or manufactures to sell v. Supplies: Assets used in the everyday running of the business; examples include office and cleaning supplies vi. Prepaid expenses: Expenditures for goods and services to be received in the future vii. Land: Property the business owns and uses in operations viii. Building: Cost of an office, warehouse, garage, etc. ix. Equipment, furniture, and fixtures: Cost of office and store equipment

B. Assets are listed on the balance sheet in order of liquidity C. Assets are listed according to current versus long-term status 2. Liabilities: Economic obligations or debts; probable sacrifices of assets resulting from past transactions A. Accounts payable: Oral or implied promises to pay debts that arise from credit purchases B. Notes payable: Amounts the company must pay as a result of signing a promissory note for goods or services C. Taxes payable: Wages and salaries payable D. Unearned revenues: Money received for services not yet fulfilled or products not yet delivered; examples include cash received for airline tickets (flights not yet flown), subscriptions (magazines not yet delivered), or season tickets (games not yet played) 3. Owners’ equity: Claims held by owners; the difference between assets and liabilities; divided into two main categories: A. Contributed or paid-in capital: Amounts invested in the corporation by its owners i. Par value stock: The value printed on a share certificate; generally a small, arbitrary value ii. Paid-in capital in excess of par: The total amount of capital raised in a sale of stock less the par value of that stock (a) EX: 1,000 shares of $2 par value stock sold for $10 per share; paid-in capital in excess of par would be $8,000 (total capital of $10,000 less $2,000 of par value)

B. Retained earnings: Income earned from operations

i. Expenses: Decreases in retained earnings resulting from operations ii. Revenues: Increases in retained earnings resulting from operations iii. Dividends: Distributions of assets to shareholders; decreases in retained earnings iv. Change in retained earnings: Beginning Retained Earnings + Net Income (or – Net Loss) – Dividends

Financial Statements: Formal Reports of an Entity Balance Sheet (Statement of Financial Position)

1. Assets are balanced with the sum of liabilities and owners’ equity as of a specific date 2. Prepared after the income statement and the statement of retained earnings 3. Current assets A. Cash and other resources expected to be cash, sold, or used up during the normal operating cycle of the business (usually 1 year) B. Typical current assets: Cash, receivables, inventories, investments, supplies, and prepaid expenses 4. Noncurrent assets A. Assets that are not current assets B. Typical noncurrent assets: Buildings, equipment, furniture, fixtures, land, natural resources, and intangible assets (patents and goodwill) 5. Current liabilities A. Obligations that will be paid within the operating cycle (usually 1 year) B. Typical current liabilities: Accounts payable, wages and salaries payable, taxes payable, unearned revenues, and short-term notes payable 6. Noncurrent liabilities A. Liabilities that are not current liabilities B. Typical noncurrent liabilities: The noncurrent portion of any payable liabilities, capital leases, pension benefit obligations, and long-term obligations under product or service warranties 7. Equity A. The difference between assets and liabilities B. Typical equity: Capital contributed by owners and retained earnings Company Balance Sheet for Year Ended Dec. 31, 20XX ASSETS CURRENT ASSETS: Cash Accounts receivable Allowance for doubtful accounts Notes receivable Merchandise inventory Prepaid insurance Total current assets

The Accounting Equation

Assets = Liabilities + Owners’ Equity 1

$58,280 50,300 3,100

47,200 8,000 58,000 6,000 $177,480

Financial Statements (continued ) LONG-TERM ASSETS (PLANT AND EQUIPMENT): Land $60,000 Building 110,000 Accum. depr. 65,000 45,000 Delivery truck #1 13,000 Accum. depr. 4,200 8,800 Total long-term assets Total assets

DEBIT retained earnings for the amount of the total of the ending balances of expenses and CREDIT each expense account for ending balances

B. In effect, net income or net loss is closed (transferred) to retained earnings through closing entries i. Net income increases retained earnings ii. Net loss decreases retained earnings

Company Income Statement for Year Ended Dec. 31, 20XX 113,800 $291,280

LIABILITIES CURRENT LIABILITIES: Accounts payable Notes payable Salaries payable Unearned rent Total current liabilities LONG-TERM LIABILITIES: Notes payable Total liabilities

$30,000 4,000 2,000 900 36,900 30,000 $66,900

STOCKHOLDERS’ EQUITY PAID-IN CAPITAL: Common stock, $10 par (10,000 authorized and issued) Paid-in excess of par Total paid-in capital Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

$100,000 62,080 162,080 62,300 $224,380 $291,280

Classified Balance Sheet

1. Typical classifications used by most companies: A. Assets

i. Current assets: Cash, marketable securities, accounts receivable and notes receivable, inventories, prepaid expenses ii. Noncurrent assets: Property, plant, and equipment; intangible assets; other noncurrent assets

B. Liabilities

i. Current liabilities: Accounts payable, current notes payable, current maturities of long-term debt ii. Noncurrent liabilities: Noncurrent notes payable, bonds payable

C. Equity

i. Capital contributed by owners ii. Retained earnings

Retained Earnings Statement

1. Contains a summary of changes in retained earnings during a specific period 2. Begins with the retained earnings balance at the beginning of the period A. Add net income or subtract net loss B. Deduct dividends C. End with new retained earnings balance

Income Statement (Statement of Earnings or Operations)

1. Contains a summary of revenues and expenses of an entity for a period in time (e.g., for the year ended 12/31/XX or for the quarter ended 3/31/XX) 2. Reports results of operations 3. Reports net income or net loss of the period 4. Formula: Revenues – Expenses + Gains – Losses = Net Income (or Net Loss) A. Revenues include sales (of products) and fees (charges for services); these are inflows or other increases in assets from the delivery of goods or the production of services that are part of the ongoing or critical operations of the business B. Expenses are outflows, or the using up of assets or the incurrence of liabilities from delivery of goods and providing services as part of the ongoing or critical operations of the business; this includes selling and administrative expenses

i. Selling expenses are incurred in selling or marketing of goods and services and include sales force salaries and commissions, traveling expenses, rent and depreciation for marketing facilities and related assets, ecommerce costs, and distribution (shipping) costs ii. Administrative expenses are incurred to manage the company as a whole and include rent, utilities, insurance, and managerial salaries

C. Gains and other revenue come from other-than-primary business activities and gains that are either unusual or infrequent; examples include gains from the sale of securities, gains from the disposal of fixed assets, and rent revenue earned on excess facilities D. Losses are expenses not related to primary business operations; examples include foreign exchange losses, losses from the disposal of fixed assets, and losses from lawsuits as a result of a transaction that is outside of a business’s primary activities 5. Prepared before the statement of retained earnings and the balance sheet 6. Income statement accounts are temporary accounts A. Accounts are periodically closed (at the end of the period), which means the balances are set back to zero i. Revenues for the period are closed to the retained earnings account; DEBIT each revenue for the amount of ending balances and CREDIT retained earnings for the same amount ii. Expenses for the period are closed to the retained earnings account;

Sales Less: Sales returns and allowances Sales discounts Net sales COST OF GOODS SOLD: Beginning inventory, Jan. 1, 20XX Purchases Less: Purchase returns and allowances Purchase discounts Net purchases: Add: Transportation in Cost of merchandise purchased Merchandise available for sale Less: Ending inventory, Dec. 31, 20XX Cost of merchandise sold Gross profit on sales OPERATING EXPENSES: Selling expenses: Sales salaries expense Advertising expense Bad debt expense Depreciation expense—delivery truck Miscellaneous expenses Total selling expenses Administrative expenses: Office salaries expense Rent expense Depreciation expense—building Insurance expense Office supplies expense Miscellaneous expenses Total admin. expenses Total operating expenses Income from operations OTHER INCOME: Interest income Rental income OTHER EXPENSES: Interest expense NET INCOME: Average number of shares outstanding Earnings per share

$600,000 9,500 4,500

14,000 $586,000 $55,000

490,000 8,800 4,900

13,700 476,300 8,300 484,600 539,600 58,000 $481,600 $104,400

$39,100 1,200 1,000 800 200 $42,300 $13,000 10,000 900 1,900 340 180 26,320 $68,620 $35,780 $800 10,000

10,800 $600

10,200 $45,980

10,000 $4.60

Retained Earnings Statement

1. Shows changes in retained earnings for the period A. Retained earnings are reported in the shareholders’ equity section of the balance sheet B. Companies with net accumulated losses will show a deficit (negative) balance in retained earnings 2. Covers the same time period as the income statement 3. Prepared after the income statement but before the balance sheet and the statement of cash flows; retained earnings must be known (from the income statement) before the balance sheet can be completed Company Retained Earnings Statement for Year Ended Dec. 31, 20XX Retained earnings, Jan. 1, 20XX Net income for year Less dividends Increase in retained earnings Retained earnings, Dec. 31, 20XX

$16,320 45,980 0 45,980 $62,300

Statement of Cash Flows

1. Reports cash receipts and cash payments during a period; helpful in understanding operations, liquidity and solvency, and potential for positive cash flow 2. “Cash” means cash and cash equivalents 3. Three sections A. Operating activities: Revenues and expenses from the firm’s major line of business i. Collections from customers, including: (a) Sales revenue (plus decrease in accounts receivable or minus increase in accounts receivable) (b) Receipt of interest and dividends ii. Payments to suppliers, including: (a) COGS (plus increase in inventory or minus decrease in inventory) and (b) (plus decrease in accounts payable or minus increase in accounts payable) iii. Payments of operating expenses, including: 2

(a) Operating expenses other than salaries, wages, and depreciation (plus increase in prepaid expenses or minus decrease in prepaid expenses) and (b) (plus decrease in accrued liabilities or minus increase in accrued liabilities) iv. Payments to employees, including: (a) Salary and wage expense (plus decrease in salary and wages payable or minus increase in salary and wages payable) v. Payments of interest and taxes

B. Investing activities

i. Increases and decreases in cash due to dispositions or purchases of firm’s assets ii. Sale of plant assets iii. Sale of investments iv. Cash received on loans receivable v. Acquisition of plant assets vi. Acquisition of investments vii. Loans made

C. Financing activities

i. Increases and decreases in cash from investors and creditors ii. Stock issuance iii. Sale and purchase of treasury stock iv. Borrowing money v. Payments of dividends vi. Payments of principle on debts

Company Statement of Cash Flows for Year Ended Dec. 31, 20XX CASH FLOWS FROM OPERATING ACTIVITIES: Net income per income statement Add: Depreciation Allowance for doubtful accounts Deduct: Increase in inventory Increase in prepaid expenses Decrease in accounts payable Net cash flow from operating activities

$45,980 1,700 1,000 3,000 1,000 2,500

2,700

48,680

6,500 $42,180

CASH FLOWS FROM INVESTING ACTIVITIES: Cash received from investments sold Less: Cash paid for store equipment Net cash flow from investing activities

$10,000 3,000 $7,000

The Accounting Cycle 1. Accounting information system A. Technology and procedures that capture, store, and process accounting data B. Common elements include chart of accounts, general journal, special journals, subsidiary ledgers, and general ledger

E. Develop trial balance on a worksheet F. Journalize and post adjusting entries

i. Match revenues and expenses to period earned and incurred ii. Correct measurement of period’s income iii. Bring related asset and liability accounts up to date

i. Chart of accounts: Listing of account names G. Prepare financial statements and account numbers of all accounts in the H. Journalize and post closing entries general ledger I. Prepare post-closing trial balance ii. General journal: Where double-entry bookkeeping entries are recorded by debiting one 3. Five categories of adjusting entries or more accounts and crediting another one A. Prepaid expenses: Expire or are used up in or more accounts; a general journal entry inthe next period cludes the date of the transaction, titles of the B. Accrued expenses: Expenses incurred but not accounts debited and credited (the credited acyet paid count is indented several spaces), the amount C. Depreciation: Systematically spreads the cost of each debit and credit, and if necessary, an of assets over periods explanation of the transaction D. Accrued revenue: Revenue earned but cash iii. Special journals: Designed to facilitate the not yet received process of journalizing and posting transacE. Unearned revenue: Revenue not earned by tions; used for the most frequently occurring business but cash already received transactions; examples include sales, purchases, cash receipts, cash disbursements, and 4. The adjusting process (a.k.a. accrual method) A. Used to measure income correctly payroll journals B. Each entry affects one income statement iv. Subsidiary ledgers: Subset of the general account (revenue or expense) ledger; shows details of the related general C. Each entry also affects one balance sheet ledger (control) account (a) The total of the balances in any particular account (asset or liability) subsidiary ledger should equal the related 5. The closing process general ledger account A. Transfers temporary account balances (in(b) Examples include accounts receivable, come statement accounts) to retained earnings inventory, fixed assets, accounts payable, B. Resets temporary account balances back to and employee subsidiary ledgers zero to start the next period

2. Procedures: A series of steps (accounting cycle) that produces financial statements A. Open ledger accounts B. Journalize transactions C. Post to the ledger D. Calculate unadjusted balances

i. Temporary accounts with debit balances are credited for their balance (bringing the accounts to zero balances) ii. Temporary accounts with credit balances are debited (bringing the accounts to zero balances)

CASH FLOWS FROM FINANCING ACTIVITIES: Cash paid for dividends Increase in cash Cash at the beginning of the year Cash at the end of the year

0 $49,180 9,100 $58,280

Transactions 1. Transaction: Any event that affects financial position and is recorded; a transaction affects both sides of the accounting equation; examples: A. X invests $10,000 in company Y B. Company Y buys land worth $5,000 for future office C. Company Y buys $2,000 worth of office supplies on account D. Company Y receives $3,000 due from its customers E. Company Y pays $2,000 of its accounts payable ASSETS = LIABILITIES + STOCKHOLDERS’ EQUITY (SE) ASSETS LIABILITIES 1. +10,000 cash 2. –5,000 cash +5,000 land 3. +2,000 office supplies +2,000 accounts payable 4. +3,000 cash –3,000 accounts receivable 5. –2,000 cash –2,000 accounts payable

SE +10,000 SE

2. “T accounts”: Accounts in which transactions are recorded A. Assets accounts i. Increases are recorded on the left side (DEBIT side) ii. Decreases are recorded on the right side (CREDIT side)

B. Liability accounts

i. Increases are recorded on the right side (CREDIT side) ii. Decreases are recorded on the left side (DEBIT side)

C. Owners’ equity accounts

i. Increases are recorded on the right side (CREDIT side) ii. Decreases are recorded on the left side (DEBIT side)

3. Transaction analysis model: A way to remember the rules of debits and credits and a visual way of understanding the math of doubleentry accounting ASSETS LIABILITIES + Debits – Credits – Debits + Credits STOCKHOLDERS’ EQUITY Contributed Capital Retained Earnings – Debits + Credits + Debits – Credits Revenues & Gains Expenses & Losses – Debits + Credits + Debits – Credits

Recording Transactions 1. Transactions are first recorded in journals A. Record date B. Record the account title C. Record the posting references D. Record the debits and the credits in separate columns 2. After the amounts are journalized, they are then posted to the ledger A. Record date B. Enter any special notations C. Enter a journal reference D. Record the debits and credits; a trial balance can now be taken, which lists all accounts and their up-to-date balance 3. If special journals and subsidiary ledgers are used, the process is as follows: A. Record transaction in appropriate special journal i. Credit sales recorded in a sales journal (a.k.a. sales register)

ii. Transactions involving inflows of cash are recorded in a cash receipts journal iii. Transactions involving outflows of cash are recorded in a cash disbursements journal iv. Purchases of inventory and supplies on credit are recorded in a purchases journal v. Payment of employees are recorded in a payroll journal (a.k.a. payroll register)

B. Post transactions from special journals to the related subsidiary ledger C. Summary totals are periodically posted from special journals to general ledger accounts D. Transactions that cannot be recorded in a special journal are recorded in a general journal, and processing is the same as listed in items A and B; examples include adjusting entries and employer payroll-related costs such as FICA and Medicare employer amounts

Operating Cycle of a Merchandise Business 1. Purchase merchandise inventory A. Items are bought for resale to customers B. When the invoice is received:

ii. FOB destination (a) Title passes when inventory is received by the buyer (b) Seller pays shipping cost

i. DEBIT purchases B. Journal entry: DEBIT freight-in and CREDIT (a) Record net of any quantity discounts (b) Purchase discounts, computed on net purcash or accounts payable chases, is a contra account to purchases 5. Sale of inventory (CREDIT balance) and is recorded when A. Journal entry: DEBIT cash or accounts receivcash is paid early able and CREDIT sales revenue ii. CREDIT accounts payable

B. Sales discounts and sales returns and allow2. Purchase returns and allowances ances are contra accounts to sales revenue; A. Contra account to purchases (CREDIT balance) when a company receives a returned good, B. When merchandise is returned or received DEBIT sales returns and allowances and damaged, DEBIT accounts payable and CREDIT accounts receivable CREDIT purchase returns and allowances C. Net Sales = Sales Revenue – Sales Discounts 3. Net purchases: Purchases minus discounts – Sales Returns and Allowances minus returns and allowances 6. Cost of goods sold (COGS) 4. Transportation cost A. For a merchandising company, COGS = BeA. Free on board (FOB) governs legal title to ginning Inventory + Freight-in + Purchases = goods shipped Goods Available for Sale – Ending Inventory i. FOB shipping B. For a manufacturer, COGS = Beginning (a) Title passes when inventory is placed on Work-in-Process + Periodic Manufacturing the carrier Costs – Ending Work-in-Process (b) Buyer pays shipping cost 3

Types of Business Organizations 1. Proprietorship A. Usually small retail businesses or individual professional businesses (e.g., attorneys and accountants) B. Single owner with personal unlimited liability for business debts C. Single equity account 2. Partnership A. More than one owner B. Each owner is a partner with personal unlimited liability for partnership debts 3. Corporations A. Owned by stockholders with limited liability B. Dominant form of business in the United States

Accounting in Business 1. Users of accounting information A. Primary users: Current or prospective investors or creditors and government regulators i. Need information to make decisions ii. Evaluate such characteristics as liquidity, solvency, profitability, and other indicators or metrics of performance

B. Individuals: To evaluate job prospects or make investments and decisions C. Businesses: To set goals, evaluate company progress, or decide which building or equipment to purchase D. Investors and creditors: To decide whether to start a new venture, evaluate what income they expect on their investment, or analyze a company’s financial statements E. Governing, oversight, and regulatory bodies i. To tax or assess fees; examples include bank insurance regulators ii. To monitor compliance with laws and regulations, such as with banks; examples include the FDIC, Comptroller of the Currency, and Federal Reserve

2. The accounting profession A. Public accountants

i. Serve the general public ii. Work includes auditing, income tax planning and preparation, and management consulting iii. 10% of all accountants iv. Certified Public Accountants (CPAs) are licensed by state boards of accountancy

B. Private accountants

i. Work for a single business ii. Examples of businesses that private accountants serve are restaurants, charitable organizations, educational institutions, and government agencies

3. Accounting organizations and designations A. American Institute of Certified Public Accountants (AICPA)

i. The national professional organization of CPAs ii. Prepares and grades the CPA exam iii. Publishes the Journal of Accountancy, a monthly journal iv. Each state has its own AICPA chapter and boards of accountancy that award CPA licenses

B. Financial Accounting Standards Board (FASB) formulates GAAP, which establish accounting guidelines

C. Institute (IMA)

of

Management

Accountants

i. Formerly known as the National Association of Accountants (NAA) ii. Focuses on the practice of management accounting iii. Publishes Strategic Finance, a monthly journal

D. Certifications: All must meet certain work experience and education requirements and adhere to strict ethical standards

i. Certified Public Accountant (CPA): Must pass 4-part exam; content is developed by AICPA ii. Certified Management Accountant (CMA): Must pass 2-part exam; content is developed by IMA iii. Certified Internal Auditor (CIA): Must pass 4-part exam; content is developed by the Institute of Internal Auditors iv. Certified Fraud Examiner (CFE): Must pass 1-part exam; awarded by the Association of Certified Fraud Examiners

Inventory Systems 1. Periodic A. Inventory entries are made only at the end of the period B. Companies that sell products must calculate COGS and disclose inventory costs i. On the balance sheet, show ending inventory ii. On the income statement, show calculation of COGS

C. Detailed inventory accounts are not kept up to date D. Journal entries:

i. To record purchases, DEBIT purchases and CREDIT accounts payable ii. To record sales, DEBIT accounts receivable and CREDIT sales revenue iii. To close the books at the end of the period: (a) DEBIT income summary for beginning inventory balance and CREDIT inventory (beginning balance)

(b) DEBIT inventory (ending balance) and CREDIT income summary (ending balance)

2. Perpetual A. A continuous record of inventory on hand is maintained B. Inventory on hand is computed daily C. A physical count is done only to check on perpetual records D. On the balance sheet, show inventory E. On the income statement, Sales Revenue – COGS = Gross Margin F. Journal entries:

i. To record purchases, DEBIT inventory and CREDIT accounts payable ii. To record sales: (a) DEBIT accounts receivable and CREDIT sales revenue (b) DEBIT COGS and CREDIT inventory

Corporate Characteristics 1. Separate legal entity A. Formed under state law and granted a charter from the state B. Similar to an artificial person C. Ownership interests are divided into shares of stock 2. Continuity of life: Corporations live regardless of changes in ownership of stock 3. No mutual agency: Stockholder cannot commit

the corporation to a contract unless he/she does so in his/her capacity as an officer 4. Limited liability: The most a stockholder can lose is the amount of money he/she invested 5. Separation of ownership and management: The stockholders own the business and elect a board of directors (BOD) who appoint corporate officers who manage the company

Assets (a) Calculate maturity value (Principal + Interest)

Cash

(b) Calculate the bank discount period (Total Pe1. First item on the balance sheet riod of the Note – Days the Note Is Held Prior 2. Cash short and over to Discounting) A. Difference between actual cash receipts and record(c) Calculate bank discount (Maturity Value × ed total Discount Rate × Discount Period) B. If sales revenue exceeds cash receipts, DEBIT (d) Calculate the proceeds (Maturity Value cash short and over (miscellaneous expense) – Discount) C. If cash receipts exceed sales revenue, CREDIT ii. Prepare the journal entry cash short and over (other revenue) (a) DEBIT cash and CREDIT notes receivable 3. Petty cash (b) CREDIT interest revenue or DEBIT interest A. Small amount of cash on hand to pay for minor expense (if proceeds are less than principal expenses amount) B. Designate custodian Long-Lived Assets & Related Expenses C. Keep specific amount in fund (a.k.a. imprest fund) 1. Assets are future economic benefits D. All fund disbursements are supported by petty A. Plant assets: Tangibles, land, buildings, and cash ticket; replenish fund through normal cash equipment disbursement procedures B. Intangible assets: Rights, patents, copyrights, Accounts Receivable & Notes Receivable trademarks, and goodwill 1. Receivables C. Costs of assets i. Purchase price A. Claims against businesses and individuals ii. Brokerage commissions B. Accounts receivable (a.k.a. trade receivables) i. Amounts that customers owe ii. Current asset

C. Notes receivable

i. Promise in writing by debtor ii. If due in 1 year, then current asset iii. If due in more than 1 year, then long-term asset

2. Uncollectible accounts (bad debts) A. Allowance method (based on accounts receivable)

i. Allowance for accounts: Contra asset account related to accounts receivable ii. The equation for Net Realizable Value = Accounts Receivable – Allowance for Uncollectible Accounts iii. Writing off accounts: Entry has no effect on net income; no expense is incurred (a) DEBIT allowance for uncollectible accounts (b) CREDIT accounts receivable iv. Recovery of an account previously written off (a) Reinstate account; DEBIT accounts receivable (b) CREDIT allowance for uncollectible accounts (c) Record cash collected; DEBIT cash (d) CREDIT accounts receivable

B. Direct write-off method: Written off when determined uncollectible i. DEBIT uncollectible account expense ii. CREDIT accounts receivable

3. Notes receivable A. More formal than accounts receivable B. Promissory note (written promise to pay)

i. DEBIT notes receivable ii. CREDIT cash or account receivable iii. When collected, DEBIT cash and CREDIT notes receivable and interest revenue

C. Discounting a note (selling a note before maturity) i. Compute the discount 4

iii. Survey fees iv. Legal fees v. Back property taxes vi. Sales and other taxes vii. Transportation charges and insurance while in transit viii. Installation cost

2. Group or basket purchase: Costs are allocated among assets based on relative fair market value

Cost Allocation Methods

1. Natural resources expensed through depletion A. The depletion expense is the portion of a natural resource’s cost that is used up during the period B. The method to calculate depletion expense is the same as the units-of-production method of depreciation C. Record depletion expense and accumulated depletion 2. Intangible assets expensed through amortization A. Straight-line amortization must not exceed a period of 40 years B. Amortization is written off directly against the asset

Inventory

1. Costing methods A. Specific unit

i. Used when inventory can be individually identified (e.g., autos, jewels, real estate) ii. Cost of inventory is the specific cost of a particular unit

B. Weighted-average flow of cost over periods

i. Based on weighted-average cost of inventory during the period

Assets (continued )

2. Straight-line depreciation method A. An equal amount of depreciation is deducted each year B. Cost – Residual Value ÷ Useful Life in Years C. Entry to record depreciation expense Example i. DEBIT depreciation The cost of a depreciable asset is $6,000 expense The estimated salvage value is $500 ii. CREDIT accumulated The estimated life is 5 years and 10,000 hours depreciation

ii. Average Cost = Cost of Goods Available for Sale ÷ Number of Units Available iii. Ending Inventory and COGS = Number of Units × Weighted Average Cost per Unit

Example

Jan. 1 Beginning inventory 100 units at $10 = $1,000 Feb. 6 Purchases 400 units at 12 = 4,800 May 9 Purchases 200 units at 13 = 2,600 July 3 Purchases 300 units at 13 = 3,900 Sept. 11 Purchases 500 units at 14 = 7,000 Oct. 18 Purchases 100 units at 15 = 1,500 Nov. 7 Purchases 200 units at 16 = 3,200 Merchandise available for sale: 1,800 units Ending inventory on Dec. 31: 250 units $24,000

Weighted-average cost method: Ending inventory is made up of the weightedaverage unit costs $24,000 ÷ 1,800 = $13.33 per unit 250 units × $13.33 = $3,333

3. Units-of-production method $6,000 − $500 = $0.55 hourly depreciation A. The amount of depreciation depends on the units of 10,000 hours output B. (Cost – Salvage Value) ÷ Estimated Hours C. First in, first out (FIFO) i. The first costs (oldest costs) in inventory are the first costs that flow out of inventory 4. Double-declining balance (DDB) method A. Accelerated form of depreciation that is larger in earlier years and smaller in ii. Ending inventory is based on the most recent cost (most recent purchases) later years when compared to straightline depreciation iii. Unit COGS may be different than unit cost for ending inventory iv. If inventory cost is increasing, FIFO ending inventory is high (most recent cost) B. Only method that ignores residual value Example C. DDB Rate per Year = (1 ÷ Useful Life in Years) × 2 = % Nov. 7 costs 200 units at $16 = $3,200 Example Oct. 18 costs applied 50 units at 15 = Ending inventory 250 units at $3,950 ÷ 250 = $15.80 per unit

750 $3,950

Year Cost of Accumulated Book Value at Rate Depreciation Book Value Depreciation at Beginning for This Year at End Beginning of Year of Year of Year 1 $6,000 — $6,000 40% $2,400 $3,600 2 6,000 $2,400 3,600 40% 1,440 2,160 3 6,000 3,840 2,160 40% 864 1,296 4 6,000 4,704 1,296 40% 518 778 5 6,000 5,222 778 40% 311 467

D. Last in, first out (LIFO)

i. The last costs (recent costs) in inventory are the first costs that flow out of inventory ii. Ending inventory is made up of the earliest costs iii. If inventory cost is increasing, LIFO ending inventory is low (oldest cost) iv. An income tax advantage of LIFO is that it yields lower net income when prices are rising

5. Sum-of-years’-digits (SYD) method: Accelerated form of depreciation that is larger in earlier years and smaller in later years when compared to straight-line method Step 1 Sum of years’ digits = n(n + 1)/2, where n = useful life in years Step 2 Numerator = last year of life, counting backward each year Step 3 Denominator = sum of years’ digits Step 4 Cost – Residual Value × (Step 2/Step 3) 2. Lower-of-cost-or-market (LCM) rule A. Associated with accounting conservatism because it reports an asset at the Example: 5 + 4 + 3 + 2 + 1 = 15 lower end of its historical cost or its market value Year Cost Less Rate Depreciation Accumulated Book Value at B. Market value means replacement cost Salvage Value for This Year Depreciation End of Year

Example

Jan. 1 costs 100 units at $10 = Feb. 6 costs applied 150 units at 12 = Ending inventory 250 units at $2,800 ÷ 250 = $11.20 per unit

$1,000 1,800 $2,800

Depreciation

at End of Year 1 $5,500 5/15 $1,833 $1,833 $4,167 2 5,500 4/15 1,467 3,300 2,700 3 5,500 3/15 1,100 4,400 1,600 4 5,500 2/15 733 5,133 867 5 5,500 1/15 367 5,500 500

1. Definitions A. Depreciation is the process of allocating an asset’s cost over the period the asset is used B. Depreciation expense for the period is the amount of the asset’s cost that is used up C. Accumulated depreciation is the total amount of cost that has been used up over the life of the asset

Obligations B. Recorded if probable or estimable 3. Long-term liabilities A. Any obligation other than current liabilities B. Bonds

Payroll

1. Payroll is employee compensation 2. Payroll deductions A. Employee income tax B. Federal Insurance Contributions Act (FICA): 6.2% Social Security tax on the first $113,700 of wages (2013 limit) and 1.45% of total wages for the Medicare tax 3. Entries A. To record salary expense:

i. Issued at a premium means at a price above par ii. Issued at a discount means at a price below par iii. Interest rates (a) Contract or stated interest rate is the rate on the bond (b) Market or effective interest rate is the rate investors demand in exchange for loaning their money iv. When bonds are issued between interest dates, accrued interest must be calculated (a) Investor pays interest from last interest date on bond up to date of purchase (b) When interest payment is made, investor receives full amount of interest accrued on bond for period v. Bonds issued at a discount when the stated rate on bonds is less than market rate (a) Journal entry: DEBIT cash (proceeds), DEBIT discount on bonds payable (difference between the proceeds and the maturity value), and CREDIT bonds payable (maturity value) (b) Amortization of the discount (straight-line): DEBIT interest expense, CREDIT cash (Maturity Value × Stated Rate × Period), and CREDIT discount on bonds (Discount ÷ Number of Periods) vi. Bonds issued at a premium when the stated rate on bonds exceeds the market rate (a) Journal entry: DEBIT cash (proceeds), CREDIT bonds payable (maturity value), and CREDIT premium on bonds payable (b) Amortization of the premium (straight-line): DEBIT interest expense. DEBIT premium on bonds payable (Premium ÷ Number of Periods), and CREDIT cash (Maturity Value × Stated Rate × Period) vii. GAAP requires the use of the effective interest method viii. Retirement of bonds payable (a) Recognize gain or loss on retirement (extraordinary) (b) Journal entry: DEBIT bonds payable (maturity value), CREDIT discount on bonds payable or DEBIT premium on bonds payable (for unamortized portion), CREDIT cash, and CREDIT extraordinary gain on retirement or DEBIT extraordinary loss on retirement (c) Convertible bonds are usually convertible into common stock

i. DEBIT salary expense (gross) ii. CREDIT employee income tax payable (amounts withheld) iii. CREDIT FICA tax payable iv. CREDIT employee union dues payable v. CREDIT salary payable to employees (net)

B. To record employer’s payroll taxes:

i. DEBIT payroll tax expense ii. CREDIT FICA tax payable iii. CREDIT state unemployment tax payable iv. CREDIT federal unemployment tax payable

C. To record fringe benefits:

i. DEBIT health insurance expense ii. DEBIT life insurance expense iii. DEBIT pension expense iv. CREDIT employee benefits payable

4. Payroll bank account: Special account that contains the exact amount of net pay to employees for the period

Liabilities

1. Current liabilities due in 1 year or less A. Trade accounts payable: Represents amounts owed to suppliers for products or services B. Short-term notes payable: Notes payable due within 1 year C. Discounted notes payable i. Borrower receives the face value of the notes less the interest ii. DEBIT cash (Maturity Value – Interest) iii. DEBIT discount on notes payable (interest) iv. CREDIT notes payable, short term

C. Lease liabilities

i. Operating leases: Short term; DEBIT rent expense and CREDIT cash ii. Capital leases: Long term; accounted for like purchase of asset (a) Journal entry: DEBIT asset account, CREDIT cash, and CREDIT lease liability (present value of future lease payments) (b) Record depreciation expense (over life of the lease) (c) Record interest expense

D. Current portion of long-term debt E. Unearned revenue: Revenue collected in advance F. Warranty expenses payable 2. Contingent liability A. Potential liability that depends on future events that arise from past transactions 5

Obligations (continued )

Discount on Bonds Payable: Amortization by the Interest Method C1 Year

C2 Interest Paid

1 2 3 4 5

Example $10,000 bond at 6% interest paid due in 5 years The bond was sold on Jan. 1, 2013, for $9,792

6% × 10,000

C3 Interest Expense 6.5% × C6

C4 Discount Amortization C3 – C2

$600 600 600 600 600

$637 639 641 644 647

$37 39 41 44 47

C5 Unamortized Discount C5 – C4 $208 171 132 91 47 0

C6 Bond Carrying Amount C6 + C4 $9,792 9,829 9,868 9,909 9,953 10,000

Premium on Bonds Payable: Amortization by the Interest Method C1 Year Expense

1 2 3 4 5

C2 Interest Paid Premium Amortization 6% × 10,000 $600 600 600 600 600

C3 C4 Interest Unamortized Bond Carrying Premium Amount 5.5% × C6 C3 – C2 $562 560 557 555 552

38 40 43 45 48

C5

C6

C5 – C4 $214 176 136 93 48 0

C6 + C4 $10,214 10,176 10,136 10,093 10,048 10,000

Example $10,000 bond at 6% interest paid due in 5 years; the bond was sold on Jan. 1, 2013, for $10,214

Owners’ Equity Stock

Common Stock Subscriptions

1. Capital stock is the basis unit issued in shares A. Outstanding stock is stock issued to shareholders B. Shareholders’ rights

i. To vote ii. To receive dividends, if declared iii. To receive assets in a liquidation after liabilities are paid iv. To maintain proportionate ownership percentage (preemptive right)

DATE JOURNAL ENTRY

DEBIT

6/21

Cash (50% down payment $105 × 5,000 × 0.5)

$262,500

Common stock subscriptions receivable (50% owed $105 × 5,000 × 0.5)

$262,500

2. Stockholders’ equity contains two types of accounts A. Contributed capital

i. Capital stock is paid in capital ii. Preferred stock (a) Priority in dividends (b) Priority in distribution of assets when liquidation occurs (c) May have different classes; each class is recorded separately

CREDIT

Common stock subscribed (100% stock $100 × 5,000)

$500,000

Additional paid-in capital ($5 × 5,000)

25,000

Aug. 14, the corporation received 25% of the subscription price from all the subscribers 8/14

Cash (25% down payment $105 × 5,000 × 0.25) $131,250 Common stock subscriptions receivable

B. Earned capital

$131,250

Oct. 5, the corporation received the final 25% of the subscription price from all the subscribers

i. Retained earnings: Increases in equity through profitable operations ii. Entry to transfer income to the equity section (a) DEBIT income summary and CREDIT retained earnings (b) If net loss occurs, DEBIT retained earnings and CREDIT income summary

10/5

Cash (25% down payment $105 × 5,000 × 0.25) $131,250

10/5

Common stock subscribed ($100 × 5,000)

Common stock subscriptions receivable

3. Issuing stock A. Common stock at par: DEBIT cash and CREDIT common stock B. Common stock at premium: DEBIT cash, CREDIT common stock (par value), and

131,250 500,000

Common stock ($100 × 5,000)

CREDIT paid-in capital in excess of par (premium) C. Issuing common stock for other assets: DEBIT asset (fair market value), CREDIT 2. Cumulative preferred stock common stock (par), and CREDIT paid-in capital in excess of par (Fair Market Value – Par) A. All dividends must be paid before corporation pays any

500,000

Example Brown Corporation received subscriptions at $105 per share for 5,000 shares of $100 par common stock on June 21; the subscribers made a 50% down payment on the common stock

D. Preferred stock: Accounted for in the same fashion, using a preferred stock account dividends to common shareholders and paid-in capital in excess of par-preferred stock account B. Any dividends not paid are considered to be in arrears E. Donated capital 3. Participating preferred stock: May receive dividends i. Asset received as gift or donation beyond stated amount or percentage ii. DEBIT asset (fair market value) and CREDIT donated capital 4. Convertible preferred stock: Can be exchanged for an4. Treasury stock other class of stock A. Stock issued and later reacquired by company 5. Values of stock B. Reasons this may occur A. Market value: Price a share is bought and sold for i. To provide company with stock for distributions to officers and employees under bonus B. Redemption value: Price a corporation agrees to pay plans for stock after it’s been issued ii. To help support market price C. Liquidation value: Amount a corporation would pay if liquidated (assets sold, iii. To increase net assets (buy low and sell high) liabilities paid, and residual amount distributed to stockholders) iv. To avoid takeover by outside party D. Book value: Amount of owners’ equity on the books for each class of stock C. Purchase of treasury stock 6. Stock dividend i. DEBIT treasury stock and CREDIT cash A. Proportional distribution of corporation’s own stock ii. Does not decrease the number of shares issued, only the number of shares outstanding B. Reasons for stock dividend 5. Retirement of stock i. To continue dividends but conserve cash A. Once retired, the stock cannot be reissued ii. To reduce market price of share of stock B. No gain or loss arises C. Small stock dividend (less than 25% of stock issued) C. Record increase in paid-in capital from retirement of common stock or decrease rei. Recorded at fair market value at date of declaration, DEBIT retained earnings (fair martained earnings ket value), CREDIT common stock dividend distributable (par value), and CREDIT

Appropriations on Retained Earnings

paid-in capital in excess of par ii. On the distribution date, DEBIT common stock dividend distributable (par) and CREDIT common stock (par)

1. Restriction on retained earnings 2. Recorded by formal journal entries: DEBIT retained earnings and CREDIT retained earnings appropriated for a particular purpose

D. Large stock dividend (more than 25% of stock issued)

i. Recorded at par value, DEBIT retained earnings (par value of stock) and CREDIT common stock dividend distributable (par value) ii. On the distribution date, DEBIT common stock distributable and CREDIT common stock

Dividends

1. Dividend dates A. Declaration date

i. BOD announces dividend and legal liability created ii. DEBIT retained earnings and CREDIT dividends payable

7. Stock splits A. Events that increase the number of shares authorized, issued, and outstanding B. Stock splits affect no accounts C. No formal journal entry is required D. They reduce the par value per share

B. Date of record: All those who own stock on this date will receive dividend C. Payment date i. Date dividend is paid ii. DEBIT dividends payable and CREDIT cash

U.S. $6.95 AUTHOR: Michael P. Griffin Customer Hotline #1.800.230.9522

free downloads &

hundreds of titles at

Find us on

Facebook

quickstudy.com

NOTE TO STUDENT: This guide is intended for informational purposes only. Due to its condensed format, this guide cannot cover every aspect of the subject; rather, it is intended for use in All rights reserved. No part of this publication may be reproduced or transmitted in any form, or by any means, conjunction with course work and assigned texts. BarCharts, Inc., its writers, editors, and design electronic or mechanical, including photocopying, recording, or any information storage and retrieval system, staff are not responsible or liable for the use or misuse of the information contained in this guide. without written permission from the publisher. MADE IN THE USA © 2013 BarCharts, Inc. 0315 6