LECTURE OUTLINE

PACKET
for
Intro to
Financial Accounting

Fall 2024
 Chapter 1 Video Lecture Outline
Accounting Information and Decision Making

PART A: Accounting as a Measurement/Communication Process

Who uses Accounting Information?

Purpose of Accounting: measure the activities of a company and communicate it to others.

BUSINESS ACTIVITIES TO MEASURE

Financing
-creditors
-owners

Investing
-Long term Assets

Operating
Primary operations of the company
-Revenue
-Expenses

Forms of Business Organizations

-Sole proprietorship
-Partnerships
-Corporations

COMMUNICATING THROUGH FINANCIAL STATEMENTS

The Financial Statements

1. Income statement (IS)

2. Statement of Stockholders’ Equity (SSE)

3. Balance sheet (BS)

4. Statement of Cash Flows (SCF)

Financial statements summarize business activities.

Chapter 1 Page 1-1

Financial Statement Heading
NAME OF ENTITY
NAME of FINANCIAL STATEMENT
DATE OF FINANCIAL STATEMENT AND PERIOD IT COVERS
UNIT OF MEASURE

The Income Statement (IS)

Example of a heading for an income statement

A, Inc.
Income Statement
For the Year Ended June 30, 20XB
(in thousands of dollars)
“Period Ending”

ELEMENTS OF THE INCOME STATEMENT

Revenues (R)
Sales
Service revenue

Expenses (E)
Salaries expense
Rent expense

Net Income (NI)

The income statement equation is: (Revenue – Expenses = Net Income or Net Loss) R – E = NI

Practice
Rent expense $4,500
Wage expense 2,650
Painting supplies expense 1,950
Painting revenue 12,000
Supplies used 200
Insurance expense 700

Determine Net income: $

Chapter 1 Page 1-2

The Statement of Stockholders’ Equity (SSE)
The SSE shows increases and decreases to stockholders’ equity accounts over a period of time.

Stockholders’ Equity (SE) results from two basic categories:

Common Stock: (CS) are amounts invested by the owners.
Retained Earnings: (RE) are accumulated earnings minus distributions to owners

SE = CS + RE

STOCKHOLDERS’ EQUITY

Common Stock + Retained Earnings

Beginning Common Stock Beginning Retained Earnings
+ Issuance of common stock + Net Income or – (Net Loss)
- Dividends Declared
= Ending Common Stock = Ending Retained Earnings

Practice

At the beginning of the year (January 1), Bennett Drilling has $10,000 of common stock
outstanding and retained earnings of $7,200. During the year, Bennett reports net income of
$7,500 and pays dividends of $2,200. In addition, Bennett issues additional common stock for
$7,000. (What is ending Common Stock, ending Retained Earnings and ending Stockholders’
Equity?)

Bennett Drilling
Statement of Stockholders’ Equity
For the year ended December 31, 20XC
Common Stock Retained Earnings Total Stockholders’ Equity

Beginning balance $ $ $

+issuance of common stock

+ net income (net loss)

- dividends

Ending Balance $ $ $

Chapter 1 Page 1-3

The Balance Sheet (BS) (aka, The statement of Financial Position)
Example of a heading for a balance sheet
A, Inc.
Balance Sheet
At June 30, 20XB
(in thousands of dollars)
“AT”

ELEMENTS OF THE BALANCE SHEET

Assets (A)
-Owned by the company as a result of past transactions.
- Economic resources expected to provide future benefits to the company
-Examples: Cash, Equipment, Buildings

Liabilities (L)
-Owed by the company as a result of past transactions.
-Future claims on economic resources (either assets or services) of the company.
-Examples: Notes payable, Salaries payable

Stockholders’ Equity (SE)

Stockholders’ Equity results from two basic categories:
Common Stock (CS)
Retained Earnings (RE)

THE ACCOUNTING EQUATION (Balance Sheet Equation)

A = L + SE
CS + RE
Assets = Liabilities + Stockholders’ Equity
Economic resources = Sources of financing
What you have = Where it came from
or
A - L = SE
Net assets = Owners’ equity or Owners’ claim to resources

Chapter 1 Page 1-4

 Practice:
Smith Construction has the following account balances at the end of the year:

Equipment $21,000
Accounts payable 2,100
Common stock 10,000
Land 13,000
Supplies 100
Long-term debt 15,000
Cash 5,000
Retained earnings ?

Determine Retained earnings, Total assets, Total Liabilities and Total Stockholders’ Equity by
preparing the balance sheet at the end of the year.

Smith Construction
Balance Sheet
At December 31, 20XC
Assets Liabilities
$ $

Total liabilities $
Stockholders' Equity
$

Total stockholders’ equity

Total assets $ Total liabilities and stockholders' equity $

The Statement of Cash Flows

Categories:

OPERATING ACTIVITIES

INVESTING ACTIVITIES

FINANCING ACTIVITIES

Combining the three categories of net cash inflows and outflows indicates the change in CASH
during the period.

Chapter 1 Page 1-5

Practice:
Lincoln Trade has the following cash transactions for the period.

Identify as (O, I, F)
Cash received from sale of products to customers $35,000
Cash received from the bank for long-term loan 40,000
Cash paid to purchase factory equipment (45,000)
Cash paid to merchandise suppliers (11,000)
Cash received from the sale of an idle warehouse 12,000
Cash paid to workers (23,000)
Cash paid for advertisement (3,000)
Cash received for providing services to customers 25,000
Cash paid for dividends to stockholders (5,000)

Beginning cash balance was $4,000. Prepare the Statement of Cash Flows for Lincoln Trade.

Lincoln Trade
Statement of Cash Flows
For the year ending December 31, 20XC
Cash Flows from Operating Activities
Cash inflows:
$

Cash outflows:

Net cash flows from operating activities $

Cash Flows from Investing Activities

Net cash flows from investing activities

Cash Flows from Financing Activities

Net cash flows from financing activities

Net increase in cash
Cash at the beginning of the year
Cash at the end of the year $

Chapter 1 Page 1-6

 THE LINKS AMONG FINANCIAL STATEMENTS

Income Statement of Balance Sheet

Statement Stockholders’ Equity

R BCS BRE A = L + SE
-E +issuance +NI CS+RE
NI -DIV
ECS ERE

Statement of Cash Flows

Cash flows from operating activities
Cash flows from investing activities
Cash flows from financing activities
Change in cash
Beginning cash balance
Ending cash balance

Practice:
A company receives cash for services performed. How does this transaction affect the financial
statements?

What happens to the Income Statement?

What happens to the Statement of Stockholders’ Equity?

What happens to the Balance Sheet?

What happens to the Statement of Cash Flows?

Chapter 1 Page 1-7

Practice: Solve for the missing amounts:
Income Statement Statement of Stockholders’ Equity
Revenues $34,000 Common Retained Stockholders’
stock earnings Equity
Expenses: Beginning $9,000 $6,000 $15,000
Salaries (a) Issuance 1,000 1,000
Administrative 5,000 Net income (d) (d)
Utilities 3,000 Dividends ______ (2,000) (2,000)
Total expenses (b) Ending $10,000 $9,000 $19,000
Net income (c)
Balance Sheet
Assets Liabilities
Cash $3,000 Accounts payable (e)
A/R 5,500 Note payable 41,000
Office supplies 500 Total Liabilities (f)
Prepaid rent 8,000 Stockholders’ Equity
Equipment 45,000 Common stock (g)
Retained earnings (h)
Total Stockholders’ Equity (i)
Total assets $62,000 Total Liabilities and SE (j)

Chapter 1 Page 1-8

Other Information Reported to Outsiders

Management & Discussion Analysis (MD&A)

Management is responsible for the financial statements

The Notes
There are three basic types of notes.
1. Descriptions of accounting rules applied in the financial statements.
2. Details about line items in the statements.
3. Disclosures about items not listed in the statements.

PART B: FINANCIAL ACCOUNTING INFORMATION

Importance of Financial Accounting Information

Rules of Financial AccountingGenerally Accepted Accounting Principles (GAAP)

Rule enforcers (and authority to make the rules)Securities and Exchange Commission (SEC)

Rule makers (delegated by the SEC)Financial Accounting Standards Board (FASB)

International Accounting Standards Board (IASB)

Financial Statement Responsibility

Management is responsible for the financial statements

Role of the Auditorprovide a seal of approval

Public Company Accounting Oversight Board (PCAOB)Audits the auditors

OBJECTIVES OF FINANCIAL ACCOUNTING

1. Is useful to present and potential investors and creditors and other users in making
rational investment, credit and similar decisions.
2. Helps decision makers predict amounts, timing, and uncertainty of future cash flows.
3. Provides info about economic resources, claims to those resources, and effects of
transactions which causes changes in those resources and claims to them.

Primary objective: provide useful information to investors and creditors in making decisions.

Part C: Careers in Accounting

Chapter 1 Page 1-9

APPENDIX
THE CONCEPTUAL FRAMEWORK: Foundation for Developing Accounting Standards.

Qualitative Characteristics

Decision Usefulness

Relevance
-predictive value
-confirmatory (feedback) value
-materiality (significance)

Faithful Representation (aka Reliability)

- completeness
-neutral
-freedom of error

ENHANCING QUALITATIVE CHARACTERISTICS

Comparable and Consistent
Verifiable
Timely
Understandable

Cost Constraint
-Cost-benefit

Industry practice

UNDERLYING ASSUMPTIONS
Economic Entity assumption (“Separate Entity”)
Monetary Unit assumption—currently we don’t take inflation into consideration
Periodicity assumption
Going Concern assumption

Chapter 1 Page 1-10

 Chapter 2 Video Lecture Outline
The Accounting Cycle—During the Period

PART A: Measuring Business Activities

Business Transactions—Economic Events

Internal transactions
External transactions

Accounting Transactions:
Examples:

Some “events” are related to the business but have not yet given rise to a transaction and are
not subject to recording. These situations involve future promises but neither assets nor
liabilities have been established in their regard. Therefore, they are not recorded in the
business’ financial records.

Source Documents

Accounts
An account is a standardized format used to accumulate the dollar effects of transactions on a
specific financial statement item. (Examples, cash, accounts receivable (A/R), salaries payable,
retained earnings).

A Chart of Accounts (COA) is a listing of the accounts a company uses to record the transactions
of its business operations. (See Table of Contents for information on the Chart of Accounts the
textbook uses)

EFFECTS OF EXTERNAL TRANSACTIONS

1. Duality of Effects—at least two accounts are affected
2. A = L + SE must always remain in balance

Measuring External Transactions

Step 1. Use source documents to identify accounts affected by external transactions
Step 2. Accounts and effects
a. Identify the accounts (at least 2) affected and determine if they are A, L, SE, R or E
b. Determine the direction of the effect (increase or decrease) for each account
c. Make sure the accounting equation remains balanced (A = L + SE)
Chapter 2 Page 2-1
Practice: Using “transaction analysis” complete the following
a. Purchased a storage building by obtaining a loan of $5,000.
Asset Liabilities Stockholders’ Equity
a
.

b. Paid a cash dividend of $1,600 to stockholders.

Asset Liabilities Stockholders’ Equity
b.

c. The company issues $1,000 of common stock.

Asset Liabilities Stockholders’ Equity
c.

Revenues increase net income, and net income increases retained earnings causing
stockholders’ equity to increase. (R+  SE+). Keep in mind; REVENUES are income statement
accounts NOT Stockholders’ Equity accounts.

Expenses decrease net income, which cause retained earnings and stockholders’ equity to
decrease. (E+  SE-). EXPENSES are income statement accounts, NOT stockholders’ equity
accounts.

d. Provided services on account to customers, $1,800.

Asset Liabilities Stockholders’ Equity Revenues Expenses Net income

Common Stock Retained Earnings
d
.

e. Paid $1,200 cash for advertising for the month.

Asset Liabilities Stockholders’ Equity Revenues Expenses Net income

Common Stock Retained Earnings
e
.

Chapter 2 Page 2-2

 PART B: DEBITS AND CREDITS
Assets = Liabilities + Stockholders’ Equity
+ - - + - +
Increase Decrease Decrease Increase Decreas Increase
Debit Credit Debit Credit e Credit
Beg. Bal Beg. Bal Debit Beg. Bal
End. Bal End. Bal End. Bal

DEALOR Common Stock + Retained Earnings

D-E-A (debit) L-O-R (credit) - + - +

Decreas Increase Decrease Increase
Dividends Liabilities e Credit Debit Credit
Expenses Owners’ Equity Debit Beg. Bal Beg. Bal
Assets Revenue End. Bal End. Bal

The following accounts flow through Retained Earnings in the Expanded Accounting Equation:

Expenses Dividends Revenue

+ - + - - +
Increase Decrease Increase Decrease Decrease Increase
Debit Credit Debit Credit Debit Credit

Debit means the left side of an account. Credit means the right side of an account.
T- account equation:
Beginning balance + additions = ending balance + subtractions
OR Beginning balance + additions – subtractions = ending balance
OR Beginning balance + additions = total – subtractions = ending balance
OR Ending balance + subtractions = total – additions = beginning balance

RECORDING TRANSACTIONS
The Journal Entry In a journal entry, debited accounts and amounts should be listed first
followed by credits. Credited accounts and amounts are indented below the debit portion(s) of
the journal entry. The following are the journal entries from transaction a and b from page 2-2.

(a) Building (A+) 5,000

Note Payable (L+) 5,000

(b) Dividend (D+SE-) 1,600

Cash (A-) 1,600

Chapter 2 Page 2-3

POSTING

All amounts recorded in the journal entry are then posted to the ledger account. The T-account
is a representation of an account in the ledger.

Practice: The following activities occurred during The Company’s first month.
a. Received $60,000 cash from investors for 5,000 shares of common stock.
b. Purchased equipment for use in the business at a cost of $12,000; $3,000 was paid in cash
and the company signed a note for the balance (due in six months).
c. Received a $350 phone bill for usage for the month, it will be paid next month.
d. Provided $6,000 of services to customer Z, customer Z will pay within 30 days.
e. Bought $200 of office supplies on credit.
f. Customer Z paid the amount owed from transaction d.
g. Rent ($1,000) and wages ($2,300) were incurred and paid to Joe at the end of the month.
h. Collected $1,000 from Customer X for services to be rendered later.
Asset Liabilities SE (CS+RE) Revenue Expense NI

a
.

Asset Liabilities SE (CS+RE) Revenue Expense NI

b.

Asset Liabilities SE (CS+RE) Revenue Expense NI

c.

Asset Liabilities SE (CS+RE) Revenue Expense NI

d.

Asset Liabilities SE (CS+RE) Revenue Expense NI

e.

Asset Liabilities SE (CS+RE) Revenue Expense NI

f.

Asset Liabilities SE (CS+RE) Revenue Expense NI

g
.

Asset Liabilities SE (CS+RE) Revenue Expense NI

h.

Chapter 2 Page 2-4

Chapter 2 Page 2-5
Record the transaction: Journal Entries
(a)

(b)

(c)

(d)

(e)

(f)

(g)

(h)

Assets
Cash A/R Supplies Equipment

Liabilities
A/P N/P Deferred Revenue

Stockholders’ Equity
Common Stock Retained Earnings

Revenue Expenses
Service Revenue Phone Rent Wages

Chapter 2 Page 2-6

 Determine the following at the end of the month.

The Company
Income Statement
For the month ended

The Company
Statement of Stockholders’ Equity
For the month ended
Common Stock Retained Earnings Total Stockholders’ Equity

Beginning balance $ $ $

+issuance of common stock

+ net income (net loss)

- dividends

Ending Balance $ $ $

The Company
Balance Sheet
At the end of the month
Assets Liabilities
$ $

Total liabilities $
Stockholders' Equity
$

Total stockholders’ equity

Total assets $ Total liabilities and stockholders' equity $
TRIAL BALANCE

Chapter 2 Page 2-7

-Listing of all accounts…Normally listed by financial statement category: assets, liabilities,
stockholders’ equity (including dividends), revenue and expense accounts.
-IMPORTANT: The sum of all debits has to equal the sum of all credits.

SENECA COMPANY
Trial Balance
December 31, 20XX
Debit Credit
Cash 1,800
Accounts receivable 9,000
Supplies 540
Prepaid insurance 5,000
Machinery 190,000
Accumulated depreciation 18,000
Accounts payable 1,500
Note payable 100,000
Common stock 22,900
Retained earnings 40,040
Dividends 500
Revenues 89,000
Cost of sales 35,000
Utilities expense 3,500
Wage expense 19,900
Income tax expense 6,200
Totals 271,440 271,440

The retained earnings amount shown above is special, it is the ONLY account that is showing the
BEGINNING balance in the account. The ending balance is calculated by preparing the Statement
of Stockholders’ Equity. The other account balances shown are the ending balances of the
account before adjustment.

Chapter 2 Page 2-8

 Chapter 3 Outline
The Accounting Cycle—End of Period

PART A: Accrual Basis of Accounting

Revenue Recognition Principle:

The recognition of revenue involves consideration of two factors (simplistic view):
1. Provide a good or service
2. Collection is probable (being realized or realizable)
For this class we will assume “providing the good or service” to be the most important
consideration with “being realized or realizable” being the second most important.

Determining when to Record Revenue

-record in the period in which a good or service was provided
-a cash inflow is not necessarily “revenue”
-revenue recognition is NOT driven by cash receipt…being earned is most important
-deferred revenue is a LIABILITY it is NOT REVENUE

Practice—Revenue Recognition:
A. Target sells a $1,000 TV to a customer on September 15th. Customer writes a check to
purchase the TV. How much revenue should Target recognize in September? $

Complete the transaction analysis for case A.

Balance Sheet Income Statement

Assets Liabilities Stockholders’ Revenues Expenses Net Income
Equity
9/15

Record the transaction:

9/15

Post the transaction

Chapter 3 Page 3-1

Complete the following for the month of September.

B. A magazine company receives a total of $12,000 on September 16th from subscribers for a
one year subscription. The subscriptions begin in October. How much revenue should the
magazine recognize in September? $

Complete the transaction analysis for case B.

Balance Sheet Income Statement

Assets Liabilities Stockholders’ Revenues Expenses Net Income
Equity
9/16

Record the transaction:

9/16

Post the transaction

Accrual Basis Compared with Cash Basis Accounting

Accrual Basis Accounting revenue recognition “principle” is based on when revenues are
EARNED not based on when cash is received.

Cash Basis Accounting revenue recognition focuses on when CASH is RECEIVED from an
operating activity regardless of when the revenue is earned.

Practice: Indicate in which month we record revenue:

1. In May the company provides $3,000 of consulting services to a local business. Payment
will be received in June.
Accrual accounting: Cash basis accounting:

2. Received $2,000 in May from customers who were billed for services provided in April.
Accrual accounting: Cash basis accounting:

Chapter 3 Page 3-2

Expense Recognition (Matching Principle):
Record an expense when an asset is used up to earn revenue or a liability is incurred to earn
revenue. (Match the cost with the revenue the cost helped earn in the period it was earned).

Determining when to Record an Expense

-recording expenses
-used an asset or
-incurred a liability to generate revenue
-a cash outflow is not necessarily an “expense.”
-expense recognition is NOT driven by cash payment…INCURRED TO EARN REVENUE is most
important
-deferred expense, “prepaid expense” (is NOT an expense) it’s an ASSET

*Direct costs incurred to earn revenue are expensed when the revenue is earned.
*PERIOD costs are indirect costs incurred to earn revenue. Matching period costs directly to
revenue is difficult so they are matched to the period in which they occur instead of directly to
revenue.

Practice—Expense Recognition:
A. Rand Co. pays $3,000 rent for the month of January by the end of the
month. How much rent expense should Rand recognize for the month of $
JANUARY?

Balance Sheet Income Statement

Assets Liabilities Stockholders’ Revenues Expenses Net Income
Equity
1/31

Record the transaction:

1/31

Post the transaction

Chapter 3 Page 3-3

B. TEA Corp received a $1,500 electric bill for January on January 31 st and paid it on February
5th. For this transaction, how much should TEA Corp recognize as electric expense for
January? $

Balance Sheet Income Statement

Assets Liabilities Stockholders’ Revenues Expenses Net Income
Equity

Record the expense:

Post the transaction

Accrual Basis Compared with Cash Basis Accounting

Accrual Basis Accounting recognizes expenses using the matching principle which is based on
when expenses are INCURRED not when paid.

Cash Basis Accounting recognizes expenses based on when CASH is PAID for an operating item.
Practice:
Indicate in which month we record expense:

1. Purchased/Paid for supplies in May but did not use the supplies until June.

Accrual accounting: Cash basis accounting:

2. Paid employees in December for work performed in November.

Accrual accounting: Cash basis accounting:

Chapter 3 Page 3-4

The Measurement Process

The Accounting Cycle

Phase 1 (during the accounting period)

Transaction analysis
Recording journal entries in the general journal; and
Post amounts to ledger accounts (T accounts).
Prepare a trial balance

Phase 2 (at the VERY end of the accounting period)

Analyze adjustments
Record and post adjusting entries
Prepare and distribute financial statements
Record and post closing entries

Adjusting Entries
-record events that have occurred but have not been recorded yet
-adjusts the balance of a balance sheet account
-records an income statement account
-purpose is to make sure all accounting events have been recognized in the accounting records
-an adjusting entry will NEVER affect the CASH account

ADJUSTING ENTRIES FOR PREPAYMENTS or “Deferrals”

Cash received or paid/obligation to pay before a revenue or expense has been recognized

Prepaid expense or Deferred expenses: ASSET

Deferred revenue: LIABILITY

Practice--Prepaid Expense: On January 1st Clark Company purchased three years of flood
insurance paying $45,000 ($15,000 per year).

Original Entry on January 1st

Prepaid Insurance (A+) 45,000

1/1
Cash (A-) 45,000
How much insurance expense should be reported on the income statement for the year 20XA?
$
Balance Sheet Income Statement

Chapter 3 Page 3-5

 Assets Liabilities Stockholders’ Revenues Expenses Net Income
Equity
12/31

(1) Record the adjustment for insurance expense (1 income statement account, 1 balance
sheet account) for the first year:

12/31/20
A

Prepaid Insurance
45,000

If Clark company failed to record the adjustment, how would that failure affect their financial
statements?

Deferred Revenue—cash is received before the good or service has been provided; it is a
liability until provided.
Practice: A popular ski magazine company receives a total of $12,000 in September from
subscribers for a one year subscription. The subscriptions begin in October. (See Original entry
on page 3-2 of notes—Case B).

(2) Record the adjustment necessary at December 31st to recognize revenue earned.
Balance Sheet Income Statement
Assets Liabilities Stockholders’ Revenues Expenses Net Income
12/31
Equity

12/31

Deferred Revenue
12,000

If the magazine company failed to record the adjustment, how would that failure affect their
financial statements?
The matching principle says if the company uses an asset to help earn revenue an expense
needs to be recorded. DEPRECIATION EXPENSE is the name of the expense recognized when
the company uses a long-term asset.

Chapter 3 Page 3-6

 DEPRECIATION IS A COST ALLOCATION METHOD (we use straight-line depreciation in chapter 3,
other cost allocation methods will be discussed in Chapter 7).
-cost allocation--spreading the cost of the asset over the periods used to earn revenue

Contra Accounts—(X)—goes against and has an opposite balance of the primary account

-ACCUMULATED DEPRECIATION is a contra assetgoes against long-term assets

-it adds up (accumulates) the total depreciation taken on a long-term asset
-it has a “credit” balance (opposite of the long-term asset)

Book Value = Cost – Accumulated depreciation

Depreciation will be recognized as an adjusting entry, depreciation expense (income statement

account) and accumulated depreciation (balance sheet).

Practice: ABC purchased a truck on January 1, 20XA for $50,000. They expect to use the truck
for six years and each year they use the truck they will prepare an adjustment that allocates
$7,500 of the truck’s cost to depreciation expense; satisfying the matching principle.

(3) Record the adjustment for depreciation at the end of 20XC (end of third year).
Balance Sheet Income Statement
Assets Liabilities Stockholders’ Revenues Expenses Net Income
Equity

12/31/20C

Accumulated Depreciation
$15,000

What is the truck’s book value on December 31, 20XC?

Truck (A) Historical Cost (purchased on 1/1/XA)

Accumulated Depreciation-Truck (XA) Depreciation for 3 years @ _____/year
Truck, net of accumulated depreciation (A) Book Value as of 12/31/20XC
ADJUSTING ENTRIES FOR ACCRUALS
Cash not paid or received yet:

Chapter 3 Page 3-7

Accrued expenses: expense INCURRED before cash is paidcreates a liability.
Accrued revenue: provided a good or service before cash is received creates an asset.

Wage Expense
Utilities Expense

Interest Revenue or Expense

Interest Calculation
PxRxT
where:
P = Principal (FACE Value) is the amount borrowed
R = Annual interest rate (for this class INTEREST IS ALWAYS STATED IN ANNUAL TERMS)
T = length of time the money was used in the accounting period (based on a year because the
interest rate is an annual rate).

Practice—Accrued expense: R Company borrowed $100,000 at 9% interest for six months on

December 1, 20XA.

How much interest expense should be reported on the income statement for the year-ending
12/31/20XA? $

(4) Record the adjusting entry for interest expense

12/31

Chapter 3 Page 3-8

Practice—Accrued revenue: TR Company provided $300 of services to customers on December
31st but have not billed the customers as of the end of the month. These customers will be
billed January 3rd and are expected to pay the full amount on January 6th.

(5) Record the adjusting entry for service revenue

12/31

If TR Company failed to record the adjustment, how would that failure affect their financial
statements?

Not all accounts need to be adjusted.

ADJUSTED TRIAL BALANCE

Practice—Adjustments (see next page for trial balance)

Seneca Company has provided the following information to you and has asked that you prepare
the adjusting entries prior to preparing the financial statements.

Items that need to be adjusted are:

a. Forty percent of $5,000 of prepaid insurance was used up during the year.

a.

Prepaid insurance
+ - + -
5000

Using the adjustments from a above and b, c, complete the trial balance:

Chapter 3 Page 3-9

 SENECA COMPANY
Trial Balance
December 31, 20XE
Unadjusted Adjustments Adjusted Balance
Debit Credit Debit Credit Debit Credit
Cash 1,800
Accounts receivable 9,000
Supplies 540
Prepaid insurance 5,000
Machinery 190,000
Accumulated depreciation 18,000
Accounts payable 1,500
Note payable 100,000
Common stock 22,900
Retained earnings 40,040
Dividends 500
Revenues 89,000
Cost of sales 35,000
Depreciation expense
Insurance expense
Supplies expense
Utilities expense 3,500
Wage expense 19,900
Other expense 6,200
Totals 271,440 271,440

b. Beginning supplies were $120. During the year the company purchased $420 worth of
supplies. A year end count of supplies showed the company had $75 on hand.

b.

Supplies
+ - + -
120
420

Chapter 3 Page 3-10

c. Depreciation expense on the machinery was calculated at $6,000. Accumulated
depreciation before the adjustment was $18,000.

c.

Accumulated depreciation
- + + -
18,000

PART B: The Reporting Process

Retained Earnings shown on the Trial Balance represents the beginning retained earnings
amount. Ending Retained Earnings is computed on the Statement of Stockholders’ Equity. All
other amounts in the Adjusted Trial Balance are used to prepare the financial statements.

Income Statement
 Adjusted balances in the Revenue account(s) are added together to determine total
revenues.
 Adjusted balances in the Expense accounts are added together to determine total expenses.
 Total Revenue – Total expenses = net income.
Financial Statements for Seneca Company
Seneca Company
Income Statement
For the Year ended December 31, 20XE
Total revenues $89,000
EXPENSES
Cost of Sales $35,000
Depreciation expense 6,000
Insurance expense 2,000
Supplied expense 465
Utilities expense 3,500
Wage expense 19,900
Other expenses 6,200
TOTAL EXPENSES 73,065
Net income $15,935

Statement of Stockholders’ Equity

After finding net income on the Income Statement, the Statement of Stockholders’ Equity is
prepared.

Chapter 3 Page 3-11

 Seneca Company
Statement of Stockholders’ Equity
For the year ended December 31, 20XE
Common Stock Retained Earnings Total Stockholders’ Equity
Beginning Balance $22,900 $40,040 $62,940
Issuance of Common stock 0 0
Net income 15,935 15,935
Dividends declared (500) (500)
Ending Balance $22,900 55,475 78,375

Seneca Company
Balance Sheet
At December 31, 20XE
Assets: Liabilities:
Current Assets: Current Liabilities
Cash $1,800 Accounts Payable $1,500
Account Receivables 9,000 Total current liabilities 1,500
Supplies 75
Prepaid insurance 3,000 Note payable 100,000
Total current assets 13,875 Total liabilities 101,500

Machinery, net 166,000 Stockholders' equity:

Common Stock 22,900
Retained earnings 55,475
Total stockholders’ equity 78,375

Total assets $179,875 Total liabilities and stockholders' equity $179,875

Classified Balance Sheet

Operating Cycle: cash to cash cycle of the entity

Current Assets--

Long-term Assets--

Current Liabilities--

Long-term Liabilities--

Chapter 3 Page 3-12

PART C: The closing Process
Permanent Accounts—Balance sheet accounts (NOT CLOSED)

Temporary Accounts—Income statement accounts and Dividends Declared (CLOSED)

PURPOSE OF CLOSING ACCOUNTS:

1. During the accounting period revenue, expenses, and dividends (components of Retained
Earnings) are directly recorded to the specific account; they were not recorded into
Retained Earnings. The closing process accomplishes the transfer of the balances of these
temporary accounts into Retained Earnings.

2. To zero out the balances in the temporary accounts to get them ready for the next
accounting period (like clearing the scoreboard at the end of the game before the next
game starts).
Example:
Insurance Expense Revenue
+ - - +
2,000 89,000

Retained Earnings
- +

Record the closing entry for Seneca Company

Revenues
Retained Earnings
(close revenue to Retained Earnings)

Retained earnings
Cost of sales 35,000
Depreciation expense 6,000
Insurance expense 2,000
Supplies expense 465
Utilities expense 3,500
Wage expense 19,900
Other expense 6,200
(close expenses to Retained Earnings)

Chapter 3 Page 3-13

 Retained Earnings
Dividends
(close dividends to Retained Earnings)

Post the closing entry to Retained Earnings

Retained Earnings
- +
40,040

Prepare the Post Closing Trial Balance for Seneca

SENECA COMPANY
Post-Closing Trial Balance
December 31, 20XE

Debit Credit
Cash $1,800
Accounts receivable 9,000
Supplies 75
Prepaid insurance 3,000
Machinery 190,000
Accumulated depreciation $24,000
Accounts payable 1,500
Note payable 100,000
Common stock 22,900
Retained earnings 55,475
Totals $203,875 $203,875

Why are there no revenue, expense or dividend accounts shown?

Chapter 3 Page 3-14

 Chapter 4 Video Lecture Outline
Includes parts of Chapter 11
Cash and Internal Controls

PART A: Internal Controls

Sarbanes-Oxley Act of 2002 (SOX)

Management (Corporate Executives) are responsible for the financial statements and
effectiveness of its internal control structure and procedures.

Auditor must assess the company’s internal control and report as to its effectiveness. Auditor
must be independent—cannot provide non-audit services. Auditors must retain work papers for
seven years. Lead audit partners are required to rotate off the audit client every five years.

Audit committee is a subset of the Board of Directors—they act as a direct contact between the
stockholders and the auditors. The audit committee hires the auditor.

CEO and CFO must certify the financial statements fairly represent the financial position and the
results of operations and a statement that the company’s internal controls are adequate.

Purpose of Internal Control—Financial Accounting perspective:

1. Improve the accuracy and reliability of accounting information.

2. Safeguard the company’s assets.

COSO (Committee on Sponsoring Organizations) FRAMEWORK

Control Environment
-The success of an internal control system depends on the operating style of management and the
competency of the people responsible for the system—ethical tone of top management

-Personnel policies and practices are important components of the internal control system

Risk Assessment
Continually assessing the risks associated with forces preventing the company from reaching its
goals

Control Activity
Separation of duties: should separate “custody - authorization – reporting”

Information and Communication

The purpose of accounting is to provide relevant and reliable information to decision makers.
Providing accurate information is an important aspect of internal controls.

Chapter 4 Page 4-1

Monitor
Monitor the internal control system to make sure it is adequate

Limitations of Internal Control

Collusion

PART B: Cash

Cash and Cash Equivalents

Cash equivalent—SHORT TERM INVESTMENT WITH ORIGINAL MATURITY OF THREE MONTHS OR LESS (91
DAYS OR LESS). It must meet the definition at time of purchase to be a cash equivalent. If it does not meet
the definition at purchase, it will never be classified as a cash equivalent.

Examples
Items classified as Cash Items classified as Cash Equivalent
Coins and currency Company Money market account
Checks (with original maturity 3 months or less)
Customer’s payment using credit card US Treasury bills (T-bills)
Customer’s payment using debit card Commercial paper
Company balances in banking accounts Certificates of Deposits (CD)

Practice: Is the following Cash, Cash Equivalent or Neither. If neither, identify the account.

A cashier’s check
Customer checks to be deposited
Six-month commercial paper
Sixty-day US Treasury bills
Savings account at the Ft. Myers Savings & Loan
An employee borrows from the company (an IOU)
Three-month commercial paper

Control over Cash Receipts

1. Record all cash receipts and deposit them as soon as possible.

2. Separate the person who deposits the cash/checks from the person who receives the
cash/checks.
3. A different person should record the receipts in the accounting records. Verify the deposit with
the deposit slip.
4. Accept credit cards/debit cards to reduce the amount of cash employees’ handle.

Chapter 4 Page 4-2

Control over Cash Disbursements
1. All cash disbursements should be made by check/debit card/credit card.
2. Expenditures should be authorized before purchase and accuracy of purchase should be
verified. The person who authorizes should not prepare the check.
3. Use serial numbered checks. Only authorized person(s) should sign the check.
4. Debit/Credit card statements should be checked against purchase receipts. The person
verifying the statements should not be the person who made the purchases.
5. Set limits on purchases for credit/debit cards.
6. Separate the duties of the person responsible for making cash disbursements from the person
in charge of cash receipts.

Company Cash Receipts

Recording revenue: the company always recognizes revenue at the agreed upon price. The
amount of revenue recognized is not impacted by the way the customer pays for the good or
service. Example: Tim purchases $100 of groceries from Publix. Below are two examples, one
where Tim pays with either currency or a check; and the other example is if Tim pays with plastic
(credit card or debit card).

“CASH” Sales
Cash & Checks

Cash (A+) 100

Sale (R+  SE+) 100

Credit Cards & Debit Cards

Service fee—an expense

Cash (A+) 97
Service fee (E+  SE-) 3
Sale (R+  SE+) 100

Company Cash Disbursements

Cash/Checks/Debit card—act like cash

Credit Cards
When the company uses a Credit Card to pay for goods or service it creates a liability to the
company.

Office supplies (A+) 500

Credit card payable (L+) 500

Chapter 4 Page 4-3

 Bank Reconciliation
Timing differences and/or Errors

BANK’S RECORD COMPANY COMPANY’S RECORD

BANK
The bank statement represents the ACCOUNT The company’s cash account in the
bank’s record of the company’s general ledger is the company’s
account at the bank. Both records record of the company’s bank
are keeping account.
track of this
The bank statement shows the account. They The cash account shows the
ending balance of the account before should be the ending balance before it is
the bank account is reconciled. It is same. reconciled. It is the balance before
the balance before reconciliation. reconciliation.

The goal is to get both documents to be the same, by including everything, and fixing errors where they
exist.
Bank Reconciliation

Bank Statement Company’s Cash Ledger

Balance Before reconciliation Balance Before reconciliation
+ outstanding deposits +Notes received/collected by bank
- outstanding checks +Interest received
+/- bank errors -NSF checks
-unrecorded debit cards and EFTs
-Bank service fees
+/- company errors
Balance After reconciliation Balance After reconciliation

Bank Account (Statement) v. Company Cash Account (Ledger)

+/- items that are recorded in the Company +/- items that are recorded on the Bank
Cash account (ledger) but HAVE NOT been Statement but HAVE NOT been recorded in the
recorded on the Bank statement. Examples: Company Cash account (ledger). For example:
- outstanding checks +Notes received/collected by bank
+ outstanding deposits (deposits in transit) +Interest received
-NSF checks
-unrecorded debit cards and EFTs
-Bank service fees
Fix errors where they exist Fix errors where they exist
The goal is to get both to be the same (by including everything); they both represent the
Company’s bank account.
After the bank reconciliation is completed, make sure to record the changes made to the cash
account.
Practice
Chapter 4 Page 4-4
Madison Company's cash ledger reports the following for the month ending March 31, 20XX.

Deposits Date Amount Check No. Date Amount

3/4 $1,200 541 3/2 $5,100
3/11 1,200 542 3/8 800
3/18 3,700 543 3/12 2,200
3/25 3,400 544 3/19 1,100
Cash receipts 3/26 – 3/31 2,100 545 3/27 200
$11,600 546 3/28 600
547 3/30 1,300
Balance on March 1 $5,400 11,300
Receipts 11,600
Disbursements (11,300)
Balance on March 31 $5,700

Information from March's bank statement and company records reveals the following additional
information:

a. The ending cash balance recorded in the bank statement is $6,790.

b. Cash receipts of $2,100 from 3/26–3/31 are outstanding.
c. Checks 545 and 547 are outstanding.
d. The deposit on 3/11 includes a customer's check for $400 that did not clear the bank (NSF
check).
e. Check 543 was written for $2,800 for office supplies in March. The bank properly recorded the
check for this amount.
f. An automatic withdrawal for March rent was made on March 4 for $1,500.
g. Madison's checking account earns interest based on the average daily balance. The amount of
interest earned for March is $1.
h. Last year, one of Madison's top executives borrowed $4,000 from Madison. On March 24, the
executive paid $4,217 ($4,000 borrowed amount plus $217 interest) directly to the bank in
payment for the borrowing.
i. The bank charged the following service fees: $25 for NSF check, $1 for automatic withdrawal
for rent payment, and $2 for collection of the loan amount from the executive.

Prepare the bank reconciliation for March 31, 20XX; record the necessary cash adjustments.

Chapter 4 Page 4-5

 Madison Company
Bank Reconciliation
March 31, 20XX
Bank Statement Balance Company’s Cash Account Balance

Before reconciliation $ Before reconciliation $

Deposits outstanding NSF check
Checks outstanding Company error
EFT for rent
Interest on account
Note w/interest collected
Service charge
After reconciliation After reconciliation
A/R (A+)
Supplies (A+)
Rent (E+SE-)
Bank Service fees (E+SE-)
Cash (A-)

Cash (A+)
Note Receivable (A-)
Interest Revenue (R+SE+)

CASH
5,700

Chapter 4 Page 4-6

Petty cash fund: money kept on hand for making minor cash purchases. The account is
replenished when necessary. Receipts are kept with the petty cash fund so expenses can be
recognized periodically.

Petty Cash Imprest system is often used to account for petty cash (this is different from what the
book shows). With an imprest system, petty cash is only debited once for the original fund amount
and never credited; instead the cash account is credited for the replenishment.

PART C: Statement of Cash Flows and Chapter 11 Part A:Formatting the Statement of Cash Flows

Direct method

Indirect method—starts with net income and makes adjustments to cash flows from operating
activities.

Operating activities relate to items on the income statement in which cash has been
received or paid (including interest). Also relate to changes in current
assets and current liabilities based on payment or receipt of cash.

Investing activities cash paid or received from the purchase or sale of long term assets.

Financing activities cash received (paid) to raise money for the company or finance the
business. Does NOT include interest paid. Includes any cash flows
to/from owners (stockholders).

Of the three activities above, which activity would you expect a company to show “positive cash
flows” consistently over time?

The final amount shown on the statement of cash flows should reconcile with the cash shown on
the balance sheet.

Practice
Name the Cash Flow activity Operating, Investing, Financing for each item; use ( ) for cash outflow.
If no cash flow put NONE. Complete the statement of cash flows.
TR Company had the following transactions this year. Their Cash Flow Activity
beginning cash balance was $75,000. Use ( ) if outflow
Sell common stock to investors for $50,000
Receive cash from customers for $100,000
Pay for rent for $25,000
Borrowed $200,000 from the bank
Purchase a $250,000 building with cash
Sold truck used in the business for $10,000
Paid $5,000 dividend to stockholders

Chapter 4 Page 4-7

 Provided $30,000 of services to customers on account
Bought $200 of supplies on credit
Pay $3,000 interest on loan
Paid $55,000 to employee for salary

TR Company
Statement of Cash Flows
For the year ending December 31, this year
Cash Flows from Operating Activities
Cash inflows:

Cash outflows:

Net cash flows from operating activities

Cash Flows from Investing Activities

Net cash flows from investing activities

Cash Flows from Financing Activities

Net cash flows from financing activities

Net change in cash
Cash at the beginning of the year
Cash at the end of the year

Practice

During the year, a company issues common stock for $60,000 and repays previously borrowed
amounts of $100,000. In addition, the company pays dividends of $8,000 to stockholders, pays the
manager a salary of $52,000, pays landlord rent of $14,000 and pays interest of $500 to creditors,
sells old equipment for $15,000 and land for $40,000. Determine the amount of financing cash
flows the company would report in the current year.

Chapter 4 Page 4-8

 Chapter 5 Video Lecture Outline
Receivables and Sales

PART A: Recognizing Accounts Receivable

Revenue Recognition Review from chapter 3

3. Provide a good or service
4. Collection is probable (being realized or realizable)
The company will recognize the revenue at the agreed upon price, review from chapter 4.

Accounts Receivables (A/R) (also called trade receivables)—arise from Credit Sales (providing a
good or service and allowing the customer to pay later) also known as “sales on account.”

Recording a credit sale (review from chapter 2 and 3)

Mow & Grow provides $500 of monthly lawn maintenance services for Customer A. Customer
A does not pay at the time services are rendered.

Accounts Receivable (A+) 500

Lawn Maintenance Revenue (R+SE+) 500

Other Receivables—Nontrade receivables (less common)

-tax refunds receivable
-interest receivable
-loans extended to others
-Notes receivable (formal credit arrangement)

Trade Discount—represents a reduction in price for products/services. The purpose of a trade

discount is to increase sales (bulk purchases, etc.) or attract new customers. A trade discount is
not an account (will not show on a financial statement).

Sales discounts (Contra Revenue)—reduces the amount the customer owes the company if
paid within a specific time period. The purpose of a sales discount is to encourage credit
customers to pay early. Sales discounts only apply to credit sales.

2/10, n30

Practice:
Mow & Grow offers a 20% discount on their $500 monthly lawn maintenance service to new
customers for the first month of service. All customers are provided services on account and
are offered a sales discount of 2/10, n30. Customer B takes advantage of the discount and gets
her lawn maintained for January. Mow & Grow records the revenue at the reduced amount

Chapter 5 Page 5-1

($500 x (1-.20) = $400). Mow & Grow invoices Customer B on January 31 st and she pays on
February 7th.
Mow & Grow records the revenue on January 31st
Accounts Receivable (A+) 400
Lawn Maintenance Revenue (R+SE+) 400

Mow & Grow records the collection on February 7th

Cash (A+) 392

Sales discount (XR+SE-) 8
Accounts Receivable (A-) 400
Customer B has paid her account in full. By paying her invoice within 10 days she takes advantage of
the sales discount, she saves $8, 2% of the invoice amount. ($400 x .02 = $8)

Net Revenue or Net Sales

Effect of the lawn maintenance and cash payment on the income statement:

Lawn Maintenance Revenue $400

Sales discount (contra revenue) 8
Net Lawn Maintenance Revenue $392

Sales Returns and Sales Allowances (Contra Revenue)

Revenue (sometimes called “Gross sales” or “Sales”) Revenue

- Sales Returns and Sales Allowances - contra revenues
- Sales discounts Net Revenue
Net Sales
If no contra revenue accounts are present “Sales” and “Net Sales” would be the same amount.
(I.e., Sales – 0 = Net Sales.)
Practice
T-Mart reported the following amounts at the end of the year: Total sales = $650,000; sales
discounts = $15,000; accounts receivable = $50,000; sales returns = $40,000; sales allowances =
$20,000; accumulated depreciation = $9,000. Determine net sales for T-Mart:

Chapter 5 Page 5-2

End of Period Adjustment for Contra Revenues
Record an adjusting entry for estimated contra revenues for sales made during the period.
PART B: Estimating Uncollectible Accounts (valuing Accounts Receivable “A/R”)

Valuing accounts receivable is important because sometimes credit sales are not collectible.

Uncollectible accounts—(bad debts) customer accounts (accounts receivable) that the

company no longer expects to collect.

Accounting for Bad Debts

Matching principletells us to record the expense (bad debt expense)
-match cost (bad debt expense) with the revenue (credit sale) earned this period

Direct Write-Off Method -This method is not GAAP

-Does not do a good job of “matching”
-Used for income tax purposes—IRS
-Not used for this class

Allowance Method is used to estimate the dollar amount of accounts receivables deemed to be
uncollectible. The allowance method uses the account “Allowance for uncollectible accounts,”
a contra asset, to value accounts receivable.

Allowance for uncollectible accounts (“AUA”)—(Contra Asset “XA”) contra to accounts

receivable. The allowance for uncollectible accounts is management’s estimate of the dollar
amount of accounts receivable the company does not expect to collect.

Net Realizable Value—the amount of cash the company expects to collect from their accounts
receivable. Also known as Net Accounts Receivable (Net A/R). It is computed by taking total
accounts receivable and subtracting the allowance for uncollectible accounts. Net A/R = A/R -
AUA
Reporting Accounts on the Financial Statements

ASSET CONTRA ASSET EXPENSE

Account receivable Allowance for uncollectible accounts Bad debt expense
+ - - + +
20,000 2,000 1,900

Accounts Receivable, net is shown on the balance sheet and is shown at its net realizable value
of $18,000. (A/R – AUA = Net A/R)
Accounts Receivable (A) $20,000
- Allowance for Uncollectible Accounts (XA) (2,000)
Accounts Receivable, net of allowance for uncollectible accounts
$18,000
(“net book value” or “net realizable value” or “Net A/R”)

Chapter 5 Page 5-3

 Bad Debt Expense shown on the Income Statement with expenses at $1,900.
Estimating Uncollectible Accounts

An estimate of bad debts is made at the end of the accounting period to match the cost of
credit sales (bad debt expense) with the revenue credit sales allowed the company to record
during the period. The estimate is incorporated in the company’s books through an ADJUSTING
ENTRY and the entry increases the allowance for uncollectible accounts and bad debt expense.

Percent of Receivables Method (an allowance method)

- management estimates a percent of ending accounts receivable they expect to be uncollectible
- the ending balance of the Allowance for Uncollectible Accounts (AUA) is determined based on
the estimate (% of uncollectible accounts x ending balance of A/R, “% of A/R”). Example:
Management estimates 5% of their $50,000 of remaining accounts receivables (ending balance)
to be uncollectible. Therefore, the ending balance in the AUA needs to be $2,500 (5% x
$50,000).
- record the adjusting entry to get the ending balance in the Allowance for uncollectible accounts
(AUA) to be equal to the amount computed (% of A/R). Example: The ending balance in the
AUA needs to be $2,500. Before the adjusting entry the balance is $200 credit. To get the
balance to be $2,500, an adjusting entry for $2,300 is needed.

Practice At the end of the year, D Company’s balance in the allowance for uncollectible
accounts (AUA) was $500 (credit) before adjusting entries. The balance in Accounts Receivable
is $30,000. The company estimates that 15% of the accounts will not be collectible. Prepare
the adjusting entry for uncollectible accounts using the precent of receivables method.

A/R Allowance for uncollectible accounts

30,000 500

12/3
1

Bad Debt Expense Allowance for uncollectible accounts

500

What should D report as bad debt expense on their 12/31 Income Statement? $
D would report net accounts receivable on their 12/31 Balance Sheet at: $

Chapter 5 Page 5-4

 A/R Allowance for uncollectible accounts
30,000

Chapter 5 Page 5-5

 More Practice Same facts as above except assume that at year end D Company’s balance in the
uncollectible account was a $1,000 (debit)--instead of $500 (credit)--before adjusting entries.
Prepare the adjusting entry for uncollectible accounts using the precent of receivables method.

A/R Allowance for uncollectible accounts

30,000 1,000

12/3
1

Bad Debt Expense Allowance for uncollectible accounts

1,000

What should D report as bad debt expense on their 12/31 Income Statement? $
D would report net accounts receivable on their 12/31 Balance Sheet at: $

A/R Allowance for uncollectible accounts

30,000

An Allowance Method--Aging of Accounts Receivable

- focus is on the Accounts Receivable account on the balance sheet
- older Accounts Receivable have an increased chance of being uncollectible
- determine the ending balance in the Allowance for Uncollectible Accounts based on the aging
of Accounts Receivable
- record the adjusting entry to get the ending balance in the Allowance for Uncollectible
Accounts to the appropriate amount.

Example:
By the end of the year the D Company’s Account Receivable shows an ending balance of
$30,000 aged as follows:

Age Amount in A/R Estimated % Estimated allowance

(days past due) uncollectible
0 – 60 $22,000 5% $1,100
61 – 120 5,000 30% 1,500
121 – 180 2,000 40% 800
More than 180 1,000 90% 900
Total 30,000 $4,300

Chapter 5 Page 5-6

The ending balance in the Allowance for Uncollectible Accounts shows $1,000 debit; however,
based on the aging of Accounts Receivable it should be $4,300.
A/R Allowance for uncollectible accounts
30,000 1,000
5,300 adj.
4,300

The adjusting entry to record Bad Debt expense and update the Allowance for Uncollectible
Accounts would need to be 5,300 to get the ending balance in the Allowance account to $4,300.

Bad debt expense (E+SE-) 5,300

Allowance for uncollectible accounts (XA+A-) 5,300

What should D report as bad debt expense on their 12/31 Income Statement? $
D would report net accounts receivable on their 12/31 Balance Sheet at: $

WRITING OFF AN ACCOUNT RECEIVABLE

-Only Balance sheet accounts (Asset accounts) are affected
Accounts receivable (A) decreases (the A/R is removed)
Allowance for uncollectible accounts (XA) decreases

-Write off the account as soon as it goes “bad” (management determines it is uncollectible)
-Net A/R does not change, it is the same as it was before the write-off.

Example:
On January 1st D Company discovers that customer E will not be able to pay the $400 it owes
them from service provided last year. The company writes off E’s account on January 1st.

1/1 Allowance for uncollectible accounts (XA-A+) 400

Accounts Receivable (A-) 400
To write off Customer E’s A/R due to bankruptcy proceedings

A/R Allowance for uncollectible accounts

+ - - +
30,000 4,500
400 (1/1) 400 (1/1)
29,600 4,100
Notice that before and after the write-off, the company still expects to collect the $25,500 of
credit sales made last year.

Chapter 5 Page 5-7

 Asset Liabilities Stockholders’ Equity Revenues Expenses Net income
A/R -400 NE Common Retained NE NE NE
1/
AUA -400 Stock Earnings
2
A+400 NE NE

Before Write off After

Accounts Receivable $30,000 -400 29,600
Allowance for uncollectible accounts $4,500 -400 4,100
Net accounts receivable $25,500 $25,500

Practice
CHP finds out on May 10th that Customer W’s account receivable for $1,000 from services
provided last year is uncollectible. Prior to writing-off Customer W’s A/R the allowance for
uncollectible accounts had a credit (normal) balance of $8,300 and their A/R balance was
$285,000. Record the effects of the write-off on May 10th.

5/10

A/R Allowance for uncollectible accounts

285,000 8,300

What was CHP’s net A/R before the write-off and after the write off?
Before Write off After
Accounts Receivable $285,000
Allowance for uncollectible accounts $8,300
Net accounts receivable $276,700

Collection of Amounts Previously Written Off

Later in the year Customer W is able to pay $300 of his previous $1,000 he owed the company.
He pays the company $300.

Re-establish the Accounts Receivable for the amount paid by partially reversing the write-off on
May 10th as follows:
Accounts Receivable (A+) 300
Allowance for uncollectible accounts (XA+A-) 300
To re-establish a portion of Customer W’s A/R previously written off

Chapter 5 Page 5-8

 Then record customer W’s payment:
Cash (A+) 300
Accounts Receivable (A-) 300

PART C: NOTES RECEIVABLE

Formal arrangement
- Indicates amount (Face value or Principal)
- Due date
- Interest rate
- An asset to the lender (Note Receivable)

Interest Calculation--revisited
PxRxT
where:
P = Principal (FACE Value) is the amount borrowed
R = Annual interest rate
T = length of time the money was used this accounting period (fraction of year).

Example:
The Company extends credit to Customer P for six months to offset the A/R Customer P owes
the Company. The terms of the note are $10,000 due in six months at 12% interest. The date
of the note is February 1, 20XD. The due date is August 1, 20XD.

Record the note

2/1/XD Note Receivable (A+) 10,000
Accounts Receivable (A-) 10,000
Acceptance of a six month note at 12% interest to satisfy customer P’s account

The amount of interest to accrue over the six months = $10,000 x 12% x 6/12 = $600

Record the receipt of payment for the note

8/1/XD Cash (A+) 10,600
Note Receivable (A-) 10,000
Interest revenue (R+SE+) 600
Collection of note receivable plus interest (10,000 x .12 x 6/12)
If the note’s term was for 12 months instead of six, we would have to record an adjusting entry
for interest at the end of the year (December 31) prior to the note’s due date on January 31.

Chapter 5 Page 5-9

 12/31/ Interest Receivable (A+) 1,100
XD
Interest Revenue (R+SE+) 1,100
Accrual of interest on note (10,000 x .12 x 11/12)

Then when the note is paid in January the company would record:
1/31/XE Cash (A+) 11,200
Note Receivable (A-) 10,000
Interest Receivable (A-) 1,100
Interest Revenue (R+SE+) 100
Collection of note receivable, interest receivable and interest revenue (10,000 x .12 x 1/12)

Interest Revenue earned in 20XE is $100 (10,000 x .12 x 1/12).

Practice
The company lent $5,000 on July 1, 20XA at 10% interest for 9 months.

Determine interest revenue for 20XA. $

Determine interest revenue for 20XB $

The company lent $9,000 on December 1, 20XA at 7% for 18 months.

Determine interest revenue for 20XA. $

Determine interest revenue for 20XB $

Determine interest revenue for 20XC $

The company invested $300,000 on September 30, 20XA at 4% for 4
months.

Determine interest revenue for 20XB. $

Chapter 5 Page 5-10

Receivables Analysis

Receivable Turnover Ratio

The receivables turnover ratio is a measure of the effectiveness of a company’s Credit Granting
and Collection Activities.
Net credit sales
Receivables Turnover =
Average net trade accounts receivable

If you cannot determine net credit sales, use net sales as the numerator in the above equation.
“Average” is calculated as follows: (last year’s ending balance + this year’s ending balance)/2

Average collection period= 365 days/Receivable turnover

Average length of time it takes to collect A/R

Chapter 5 Page 5-11

 Chapter 6 Video Lecture Outline (skip part B);
And chapter 12 (vertical analysis)
Inventory and Cost of Goods Sold

PART A: Understanding Inventory and Cost of Goods Sold

Inventory: Inventory is tangible goods HELD FOR SALE IN THE NORMAL COURSE OF BUSINESS or
that will be used in producing goods (manufacturer) for sale.

Merchandisers
-Buy inventory for resale
-Wholesalers sell to other stores (retailers)
-Retailers sell to consumers (end users)

Merchandise Inventory (Inventory)

-cost to acquire including shipping & handling

Manufacturers
-create inventory from raw materials to sell to others
Manufacturing
-three inventory accounts: inventory is covered in
-raw material detail in Intro to
-work in process Managerial Accounting
-finished goods
-sell unit only after they are finished (finished goods)

Cost of Goods Sold (COGS)

BI
+ Purchases
-Matching principle in action GAFS
- EI
-COGS is an Expense COGS
-COGS is the cost to the seller of INVENTORY sold to the customer
-Goods available for sale (GAFS) are made up of Beginning inventory plus Purchases
-The Goods available for sale (GAFS) will either be sold (cost of goods sold) or will remain at the end
of the period (ending inventory)

Gross Profit
Sales
-contra revenues
-profit from the sale of inventory Net sales
-Cost of goods sold
-a subtotal that shows the amount net sales exceed the cost of inventory Gross profit
sold

Chapter 6 Page 6-1

MULTIPLE STEP INCOME STATEMENT

Sales Revenue (sometimes called “Gross sales” or “Sales”)

- Sales Returns and Sales Allowances
- Sales discounts BI
Net Sales + Purchases
GAFS
- Cost of goods sold - EI
Gross profit COGS

- operating expenses (S,G&A expense)

Operating Income or Income from operations
+/- other revenue/expense or gains, losses
Income before income taxes*
- income tax expense**
Net income

Operating expenses—selling, general, and administrative expenses

Shows Multiple Levels of Profit

Gross profit—profit from the sale of inventory

Operating Income —a subtotal used when other income, other expenses, gains or losses are
present on the multiple step income statement. It is also known as Income from operations.
Operating income is the profit from the company’s normal business operations.

Non-operating revenues and expenses

Other revenue: non-operating revenue: example, interest revenue

Other expense: non-operating expense: example, interest expense

Gains—peripheral

Losses—peripheral

* Income before income taxes

also known as:
 IBT
 Pre-tax income

** income tax expense (also known as “Provision for Income Taxes”)

 effective income tax rate x pretax income = income tax expense

Chapter 6 Page 6-2

Practice
At the beginning of 20C, Bay Inc. reports inventory of $6,000. During 20C, the company purchases
additional inventory for $29,000. At the end of 20C, the cost of inventory remaining is $8,000. The
company’s sales revenue for the year was $45,000 and they had $500 of sales discounts.

Calculate Net sales:

Calculate Goods available for sale:

Calculate cost of goods sold:

Calculate gross profit:

Gross Profit Ratio (AKA Gross Profit Margin):

Gross Profit
Gross Profit Ratio = x 100 = GP%
Net Sales
Vertical Analysis (Chapter 12)
Common sized Income Statement (Net sales is the common denominator)

Practice
Mills Corp. is a merchandising company that uses the periodic inventory system. Selected account
balances are listed below:
Sales $1,035,000
Sales returns 20,000
Sales discounts 15,000
Purchases 470,000
Inventory (beginning) 25,000
Inventory (ending) 30,000
Operating Expenses 248,000
Interest revenue 1,000
Effective Income Tax Rate 30%
Based on the above determine COGS:

Goods available for sale

Chapter 6 Page 6-3

Find the missing amounts
Sales (Total Sales) $1,035,000

Net Sales 100%

%
Gross Profit %
24.8%
Operating income 28.7%
0.1%
Income before tax 28.8%
8.64%
Net income %

INVENTORY COST METHODS

Units Cost per unit Total Amount
Beginning Inventory 2 $100 $200
Purchase 1 6 $101 606
Purchase 2 2 $103 206
Total 10 $1,012

Specific Identification Inventory Costing Method—directly identifies the units sold

First-In, First-Out (FIFO) Most closely represents the actual flow of inventory COKE MACHINE
Purchases occur

P2 units x cost

P1 units x cost

BI units x cost Costs assigned to units sold

Last-In, First-Out (LIFO) COOKIE JAR

Purchases occur Costs assigned to units sold

P2 units x cost

P1 units x cost

BI units x cost

Chapter 6 Page 6-4

Weighted Average Cost CUP OF COFFEE
Weighted Average cost per unit = Goods Available for Sale
Total Units Available for Sale

Purchases occur Cost assigned to units sold (WA cost per unit x units sold)

10 units @
Weighted Ave cost

Note: Inventory costing method used DOES NOT CHANGE the real
economic value of inventories…in all cases, the same units were sold;
however, depending on the inventory valuation method COGS and EI would be different.
Practice
AA Company uses a periodic inventory system. At the end of the annual accounting period the
accounting records provided the following information for product 1:

Units Cost per unit Total Amount

Beginning Inventory 100 $7 $700
Purchase, January 20 300 $8 2,400
Purchase, October 6 600 $9 5,400
Available for sale: 1,000 $8,500

AA Sold 950 units for $15 each for total sales revenue of $14,250 (950 x $15 = $14,250).

Determine the cost remaining in ending inventory and the cost of goods sold using FIFO, LIFO and
weighted average:

First in first out (FIFO)

Last in First out (LIFO)

Weighted Average cost

Chapter 6 Page 6-5

Prepare the income statement for the company for each inventory valuation method assuming
operating expenses are $5,000, income taxes are 30% and there were no contra revenues.

FIFO LIFO WA
Net Sales $14,250 $14,250 $14,250
COGS
Gross profit
Operating expenses 5,000 5,000 5,000
Operating income (pretax)
Income tax expense
Net income

-LIFO generally creates the lowest income tax expense amount...creating cash flow.
-Firms that use LIFO will report a “LIFO Reserve” so their inventory can be converted to FIFO
inventory for company comparison.

LIFO Conformity Rule

Impact on Valuation Methods with changes in the price level (inflation/deflation)

FIFO assigns the old inventory costs to COGS (New costs are assigned to Ending Inventory; Balance
Sheet approach)

LIFO assigns the old inventory costs to Ending Inventory (New cost are assigned to COGS; Income
Statement approach)

LIFO not allowed by IFRS (International Financial Reporting Standards)

Chapter 6 Page 6-6

Appendix A: (Periodic) Recording Inventory Transactions
Purchases: is a temporary account used in the periodic inventory system to keep track of purchases
of inventory. It is NOT an asset account; it is part of the calculation of COGS. (BI + Cost of Purchases
= GAFS – EI = COGS).
Practice
GJM, Inc., begins the year with inventory of $25,000 and ends the year with inventory of $12,000.
During the year the company purchased inventory with a cost of $185,000 and had net sales of
$300,000.

Calculate GAFS:
Calculate COGS:
Calculate gross profit:
Calculate gross profit ratio:

More Practice
Beginning inventory $7,470
Ending inventory 3,150
Contra revenue 1,900
Net sales 88,100
Purchases 51,100

Calculate gross sales:

Calculate COGS:
Calculate gross profit:
Calculate gross profit ratio:

PART C: Other Inventory Reporting Issues

Lower-of-Cost-and Net Realizable Value

-conservatism
-costs versus net realizable value (sales price less cost to sell)
-write-down goes to cost of goods sold
ANALYSIS: Inventory Turnover Ratio
The inventory turnover ratio is a measure of the effectiveness in managing inventory.

Inventory Turnover = Cost of Goods Sold

Average Inventory

Chapter 6 Page 6-7

“Average” is calculated as follows: (last year’s ending balance + this year’s ending balance)/2
Average days in Inventory = 365 days/Inventory turnover
Average length of time (in days) it takes to sell inventory

APPENDIX B

Inventory Errors
-Last period’s EI equals the current period’s BI. BI
+ Purchases
-EI is obtained by physical count (periodic system) or by referring to the GAFS
inventory account balance (perpetual system). - EI
COGS

Understatement of Ending Inventory

Year 1 Year 2
Year Year Year Year
BRE Assets = L + SE
1 2 1 2
+NI
Year 1
BI Net Sales
-DIV
Year 2
+P - COGS
ERE
GAFS Gross Profit The error will impact the Income
- EI - Operating Exp. statement, Statement of Stockholders’
COGS Op. Inc (NOI) Equity and Balance Sheet

Overstatement of Ending Inventory

Year 1 Year 2
Year Year Year Year
BRE = ↑
1 2 1 2 Assets =
+NI ↑ ↓L + SE
BI = ↑ Net Sales = = Year 1
-DIV =↑ = = ↑
+P = = - COGS ↓ ↑
EREYear 2 ↑ = = = =
GAFS = ↑ Gross Profit ↑ ↓
- EI ↑ = - Operating Exp. = =
COGS ↓ ↑ Op. Inc (NOI) ↑ ↓

Chapter 6 Page 6-8

Chapter 6 Page 6-9
 Chapter 7 Video Lecture Outline
Long Term Assets

CLASSIFICATION OF OPERATING ASSETS

-non-current assets
-being used in the business

PART A: Acquisitions

Capitalize – an expenditure that is classified as an asset

TANGIBLE ASSETS

PROPERTY, PLANT, AND EQUIPMENT (PPE)

-Property (Land) the company is using in operations
-Plant (Buildings)-offices, stores, storage, manufacturing plants, etc.
-Equipment--machinery, computers, copiers, vehicles, furniture, fixtures, etc.

Land Improvements
-includes: parking lots, sidewalks, fences, landscaping, etc., and should be kept separate from
the land account

Basket Purchase (purchasing land, building and/or equipment in a single purchase)

Acquisition Costs
-Costs to buy—cash equivalent price, including taxes and other fees
-Setup costs (transportation costs, installation costs)
-Costs to place the asset in service (to make usable)
-reduce acquisition cost by any salvage value received from items sold from the asset prior to
getting the asset ready to use.
-Does NOT include interest

Self Constructed Assets

-only time interest is included in the acquisition cost (it is called Capitalized Interest)
-once asset is completed, interest is no longer capitalized
-Capitalized interest satisfies the Matching Principle

Chapter 7 Page 7-1

Practice
JAX Inc., incurred the following costs associated with the purchase of a piece of land that it will
use to re-build an office building:

Purchase price for the land $300,000

Sale of salvage parts already on land 12,000
Demolition of the old building 16,000
Groundbreaking ceremony (food & supplies) 2,000
Title insurance 4,000
Real estate agent commissions 3,000
Back taxes on property 2,000
Property taxes due later in the year 3,000
Architect fees for blueprints for new building 15,000
Interest incurred for the first year 9,000

What amount should be recorded to the Land account? $

Practice
KEV, Inc., purchased a piece of equipment by paying $52,000 cash with a fair value of $54,000.
KEV also incurred shipping costs of $600 to get the equipment back to its factory, $300 to get
the equipment calibrated and installed, and $1,200 for a one-year maintenance contract.

For what amount should KEV record the equipment? $

Natural Resources
-Oil, natural gas, timber, etc.

INTANGIBLE ASSETS (Patents, Copyrights, Trademarks, Franchises, Goodwill)

Acquisition cost—purchase price plus all costs (legal and filing fees) to get the asset ready for
use. Additional legal fees add to cost.

Internally developed—most costs are expensed as incurred (R&D, advertising) and not included
in the asset account. Legal fees related to the intangible asset add to the cost of the asset.

Goodwill
-Recognized (recorded) when a company purchases another business for more than the fair
value of the net assets (assets – liabilities) acquired.
-Indefinite life

Chapter 7 Page 7-2

EXPENDITURES AFTER ACQUISTION

EXPENDITURES to EXPENSE
Repairs and Maintenance:
-benefits current accounting period only;
-expenditures that simply maintain a given level of service from the asset;
-amounts are normally small(er);
-normal maintenance;
-expense these costs as they are incurred.

EXPENDITURES to CAPITALIZE
-the cost is treated as an asset (added to the original acquisition cost of the asset)
-costs incurred to achieve greater future benefits
-increases asset’s life, makes the asset more efficient, or increases asset’s capacity

Improvements/Major Repairs

Additions
Legal Defense of Intangible Assets
-if successful, add to the legal costs of the intangible asset
-if unsuccessful, expense the legal costs

Materiality
-if amount is small it will be expensed (i.e., a stapler)

Practice
KL Manufacturing Company incurs the following expenditures during the year:

Remodel the manufacturing plant to improve production $45,000

Replaced oil and filters on all company trucks for the year $1,800
Security system installed in warehouse $22,000

Determine the amount that should be recorded as an expense this $

year:

Determine the amount that should be capitalized as an asset: $

If all of the costs are expensed in the year of expenditure, how would that affect:
Expenses in the year of expenditure
Net income in the year of expenditure

Chapter 7 Page 7-3

 Assets in the year of expenditure

Expenses (depreciation expense) in future years

Net income in future years
Assets in future years

PART B: COST ALLOCATION

ALL Long-term Assets USED in Operations are considered operational assets. Only operational
assets will be COST ALLOCATED (depreciated, depleted or amortized).
-systematic and rational cost allocation
-matching principal

PROPERTY, PLANT & EQUIPMENT (DEPRECIATION)

 depreciation expense (E+SE-) and accumulated depreciation (XA+  A-)

NATURAL RESOURCES (DEPLETION)

-typically uses activity-based method to determine the amount to deplete

INTANGIBLE ASSETS (AMORTIZATION)

-typically uses straight line method to determine the amount to amortize
-If an intangible asset has an indefinite life, amortization should not be recognized (i.e.,
Goodwill and most trademarks)

Book Value (net book value or carrying value) = Cost – Accumulated depreciation

1. Acquisition cost (discussed above)

2. Residual value (salvage value or scrap value)

-estimate

3. Estimated useful life (Service Life)

-estimate

Depreciable cost is the amount of the asset’s cost that is expected to be used up to generate
revenue over its life. Depreciable cost = Cost – Residual value

Chapter 7 Page 7-4

Alternative Depreciation Methods

Straight-line (SL)
Cost – Residual value
Depreciation expense =
Life in years

Declining-balance (DB) or Accelerated method. (200% maximum Declining rate, if the

declining rate is 200% it is called Double Declining Balance)

Declining rate
DB Depreciation Rate =
Life in years

Depreciation expense = DB Depreciation Rate x Beginning of the year Book Value

Depreciation expense = DB Depreciation Rate x (Cost – Accumulated depreciation)

Activity-Based (Units of Production)

Cost – Residual value
Depreciation rate per unit =
Life in units of production

Depreciation expense = Depreciation rate per unit x Units of production for the year

Practice
A new stamping machine was purchased at a cost of $125,000. The estimated residual value is
$20,000, and the estimated useful life is 3 years. The estimated productive life of the machine
is 150,000 units.

Determine the following for Straight line Depreciation

Cost
RV
Depreciable cost
Life
Year 1
Depreciation expense
Accumulated depreciation
Book value
Year 2
Depreciation expense
Accumulated depreciation
Book value

Chapter 7 Page 7-5

Year 3
Depreciation expense
Accumulated depreciation
Book value

Determine the following table for 150% Declining Balance Depreciation

Cost
RV
Depreciable cost
Life
Year 1
Depreciation expense
Accumulated depreciation
Book value
Year 2
Depreciation expense
Accumulated depreciation
Book value
Year 3
Depreciation expense
Accumulated depreciation
Book value

Determine the following for Activity-Based (Units of Production) Depreciation

Cost
RV
Depreciable cost
Life

Year Units made

1 52,000 units
2 50,000 units
3 48,000 units

Year 1
Depreciation expense
Accumulated depreciation
Book value

Chapter 7 Page 7-6

Year 2
Depreciation expense
Accumulated depreciation
Book value

Year 3
Depreciation expense
Accumulated depreciation
Book value

Partial Year Depreciation

Assume the stamping machine was purchased on October 1st, using straight-line
depreciation, depreciation expense for year 1 would be: $

Change in Estimate
Determine book value before the change in estimate
Determine the remaining useful life based on the change in estimate
Determine the new residual value based on the change in estimate

Recalculate depreciation expense using the book value prior to the change in estimate as the
“new cost” and use the new residual value and remaining useful life.

Depreciation expense after change in estimate = BV prior to change – Residual value

Remaining Life in years
PART C: ASSET DISPOSITION
- Record depreciation for time used in the year of disposal
- Remove asset from books (Asset and Accumulated Depreciation (XA))
- Record gain/loss from removal of asset, if any.

Practice: Landscape Company sells a mower it used in its business. Acquisition (historical) cost
was $8,000, 4 year useful life, no residual value; mower is sold after 1.5 years of use.

Calculate annual depreciation (straight line): $

Calculate depreciation for the year of sale. $

Record depreciation in the year of sale:
Depreciation expense (E+SE-)
Accumulated depreciation (XA+)

Chapter 7 Page 7-7

 Mower Accumulated Depreciation
8,000 2,000

Total accumulated depreciation at time of sale: $

Book value of the asset at the time of sale is: $

Record the sale of the mower for $5,000:

Cash (A+)
Accumulated depreciation (XA- A+)
Mower (A-)
Record the sale of mower

Record the sale of the mower for $6,000:

Cash (A+)
Accumulated depreciation (XA- A+)
Mower (A-)

Record the sale of mower

Record the sale of the mower for $4,000:

Cash (A+)
Accumulated depreciation (XA- A+)

Mower (A-)
Record the sale of mower

ANALYSIS
Profit Margin (net profit margin):
Question: For each dollar of sales, how much profit is the company making?

Net income
Profit margin = x 100 = NPM%
Net sales

Practice: Quality Resort Toys had sales of $1,900,000; net sales were $1,880,000 with cost of
goods sold of $1,000,000 resulting in net income of $235,000.
Determine the Net Profit margin %

Chapter 7 Page 7-8

 Chapter 8 Video Lecture Outline
Current Liabilities
PART A: CURRENT LIABILITIES

Liabilities
1) Probable future sacrifices of economic benefits
2) Arising from present obligations to other entities
3) As a result of past transactions or events

Current liabilities are short-term obligations that will be paid within the current operating
cycle or one year, whichever is longer (normally one year). Current liabilities are recorded at
face value because the time to maturity is short.

Non-current liabilities include all other liabilities that are not current liabilities. Non-current
liabilities are recorded at their cash equivalent amount (present value).

Cash equivalent- (the cash amount that the creditor would accept to settle the liability today)
-Does not include interest until interest has accrued

Order of Liabilities on Balance Sheet

-Current Liabilities go first, then
-Long term (non-current) Liabilities

CURRENT LIABILITIES

Notes Payable (could be current or non-current)

-Evidenced by a contract
-Includes interest

Interest Calculation (Revisited…again)

PxRxT
P = Principal (FACE Value) is the amount borrowed
R = Annual interest rate
T = length of time the money was used this accounting period (fraction of year).

Chapter 8 Page 8-1

Accrued interest—(interest incurred/earned—but not paid/received yet)
-current liability (if payments are made periodically and interest is due within the year)
-non-current liability (if interest is added to the liability and the liability is non-current)

Practice
On December 1, Casino Cruise Lines borrows $1,000,000 from Bank of America signing a 6
month, 5% note. Principal and interest is payable at maturity.
Record the entry for Casino Cruise Lines on December 1:

Record the adjusting entry for Casino Cruise Lines at year-end December 31:

How would Casino Cruise Lines treat the note on their Balance Sheet?

What affect does the note have on Casino Cruise Line’s Income Statement?

Record the entry for Casino Cruise Lines on May 31 when the note matures:

Line of Credit—an arrangement with a lending institution that allows the company to
continuously borrow up to prearranged limit.

Commercial Paper—is when a company borrows from another company; it usually matures
from 30 – 270 days. It’s a current liability for the issuer.

Accounts Payable (A/P) trade accounts payable—arise through the normal course of business
(purchase inventory, goods or services on credit)

PAYROLL LIABILITIES—examples include: salaries and wages, taxes, and fringe benefits.

Federal Income taxes—amount withheld depends on income and exemptions

Chapter 8 Page 8-2

FICA Taxes
--Social security: 6.2% up to a maximum amount (amount increases each year)
--Medicare: 1.45%
Employee portion—7.65%
Employer matching portion—7.65%  Self-employed—15.3%

FUTA/SUTA (Federal/State Unemployment taxes—only employer pays)

-6.2%
-assessed on the first $7,000 of earnings per employee per year

Fringe Benefits
-Health/Dental/Vision insurance premiums
-Life insurance premiums
-Retirement/savings programs
Practice
Greg works at D Ski Resorts working 40 hours per week earning $20 per hour. Greg gets paid
every two weeks. The company pays $250 per pay for health insurance and Greg pays $50.
15% of Greg’s income is withheld for federal income taxes and 1% for state taxes.

Calculate the amount Greg expects to get direct deposited into his account for his first
paycheck:
Wages $
Less: Withholdings
Federal Income Taxes $
State Income Taxes
FICA Taxes
Health insurance
Total Withholdings
Actual Direct Deposit $
Calculate the total cost to D Ski Resort for Greg’s paycheck being deposited

Wages $
Plus taxes
FICA Taxes $
Unemployment taxes (FUTA)
Total taxes
Health Insurance
Actual Payroll costs

Chapter 8 Page 8-3

Deferred Revenue—cash received before a good or service is provided

Sales taxes payable

Current Portion of Long-Term Debt

-the principal amount of the debt coming due within a year of the balance sheet date

Practice
United Supply has a $25 million liability at December 31, 20XC, of which $5 million of the
principal and the accrued interest is payable in each of the next five years. How should the
liability be shown on the balance sheet at December 31, 20XC?

Current:

Long-term:

What about interest on the loan?

PART B: CONTINGENCIES

Loss Contingency-an existing uncertain situation that might result in a loss

A contingent liability is a “potential” liability/loss that could arise in the future.

-contingent liabilities are reported on the financial statements and disclosed if they are
probable and the liability can be reasonably estimated.
-contingent liabilities are only disclosed in the notes if they are probable and cannot be
estimated; OR if they are reasonably possible (regardless if they can be estimated or not).

-if the possibility of liability is remote it normally is not reported or disclosed.

Estimable Within a Range

-use the more likely amount
-no “more likely amount” use lower loss amount and disclose the potential additional loss.

Lawsuits

Product Warranties and Guarantees (estimated liability)

Warranty liabilityWarranty expense (based on estimated amounts)—matching principle
-current liability if warranty period is for a year or less
-noncurrent liability if warranty period is more than a year.

Chapter 8 Page 8-4

GAIN CONTINGENCIES
-not recorded until gain is certain
- Conservatism

ANALYSIS

Liquidity is being able to pay current debts

Working Capital = CA - CL

Current Ratio = CA/CL

Acid-test Ratio aka Quick Ratio = (Cash + Current investments +A/R)/CL

--does not include inventory or prepaid-assets
--uses assets that can be easily converted to cash

Practice
UA, Inc., shows the following balance sheet accounts; IDENTIFY the CURRENT assets &
liabilities:
Assets Liabilities
Cash $50,000 Note payable due in six months $25,000
Accounts receivable 30,000 Accounts payable 20,000
Land 200,000 Bond Payable 1,000,000
Short term investments 70,000 Payroll taxes payable 15,000
PPE, net 1,250,000 Note payable due in 18 months 75,000
Inventory 55,000 Current portion of Long Term Debt 10,000
Intangible assets 45,000 Deferred revenue 5,000
Other current 5,000 Long Term Debt 50,000

Determine total Determine Total

CURRENT Assets: $ CURRENT Liabilities: $

Calculate working capital:

Calculate the current ratio:
Calculate the quick ratio:

Assume UA paid off its A/P with cash; re-calculate:

Working capital:
Current ratio:
Quick ratio

Chapter 8 Page 8-5

 Appendix C at end of text
Time Value of Money
“A dollar today is worth more than a dollar in the future.”

Assumptions:
1. The dollar is invested today
2. The dollar is earning a positive return

Simple interest: P x R x T
Compound interest
-Compounding (Future Value “FV”)
-Discounting (Present Value “PV”). In Accounting we record long term assets and long-term
liabilities at their present value (cash equivalent amount); therefore, we mostly use PRESENT
VALUE concepts.

Two types of CASH FLOWS

ANNUITY—very specific—it is the same dollar amount that occurs the same time each period.

SINGLE SUM— A single sum can occur at any time at any amount. It is possible to have multiple
single sum cash flows in an investment; an amount that does not occur at the same time each
period.
A cash flow is either an annuity OR a single sum, it cannot be both.
Ordinary Annuity (Payment = $50)
$50 $50 $50 $50 $50 $50 $50 $50 $50 $50

1 2 3 4 5 6 7 8 9 10
Single sum (example of 2 single sums, $500 and $1,000)
$500 $1000

1 2 3 4 5 6 7 8 9 10

An investment with two types of cash flows (annuity ($50 payment) and a $1,000 single sum)
$1000
$50 $50 $50 $50 $50 $50 $50 $50 $50 $50

TVM Page TVM-1

 1 2 3 4 5 6 7 8 9 10
PV and FV Tables (available in Canvas) or use the BAII Plus Financial Calculator)
Future Value of a Single Amount (FV$1) Factor = (1 + i)n
Where i is the interest rate and n is the number of compounding periods.
Present Value of a Single Amount (PV$1) Factor = 1/(1 + i)n the PV$1 is the reciprocal of the FV$1
Future Value of an Ordinary Annuity (FVA) Factor = (FV$1 –1)/i
Present Value of an Ordinary Annuity (PVA) Factor = (1-PV$1)/i

Interest rates are stated in annual terms (one year, 12 months, 365 days…sometimes 360 days)
If compounding occurs more than once a year, the interest rate i needs to be divided (RxT) to
reflect the number of compounding periods in a year. And “n” needs to reflect the total number
of compounding periods over the life of the investment. For example:
An investment pays 12% interest annually for 5 years: (12%, 5n)
An investment pays 12% interest semiannually for 5 years: (6%, 10n) interest is cut in half,
compounding periods are doubled.
An investment pays 12% interest quarterly for 5 years: (3%, 20n) interest is cut in fourth,
compounding periods are quadrupled.
An investment pays 12% interest monthly for 5 years: (1%, 60n) interest is cut in 12ths,
compounding periods multiplied by 12.

IDENTIFY (4 of the 5 variables, solve for the 5th):

N number of compounding periods over the life of the investment/borrowing
I/Y interest rate (affected by compounding periods) earned on investment
PV a single sum (the amount today)
PMT an annuity (equal cash flows that occur at the same time each period)
FV a single sum (the amount in the future)

Using the factor tables the equation to use is:

Cash flow x factor = VALUE
Where:
Cash flow is either a single sum (PV or FV) or the payment (PMT)
Factor is based on the %, n, single sum or annuity, PV or FV
Value is dependent on the factor (PV or FV) used
If a present value FACTOR is used, the VALUE will be the present value. If a future value
FACTOR is used, the VALUE will be the Future value.

For BAII Plus Financial Calculator:

Set P/Y to 1 by pressing the 2ND key and then the (I/Y) key. Type in 1 and press enter. Then
press the 2ND key and then the CPT key.
Following are the keys to use for Time Value of Money on the BAII Plus Financial Calculator
N = number of compounding periods PMT = annuity cash flow (payment)
I/Y = interest rate FV = Future Value
PV = present value CPT = compute key

TVM Page TVM-2

To quit/clear, press 2ND then CPT and then 2ND then FV. (Note: turning off the calculator will
not clear the TVM items).

TVM Page TVM-3

PRACTICE:

1. You invest $5,000 today, how much will your investment be worth at the end of five years if a
12% market rate of return could be earned?
$ $

0 1 2 3 4 5

x =
CASH FLOW X FACTOR ( %, n)

or
N I/Y PV PMT FV

2. You are looking at buying an investment where you will receive $10,000 at the end of 10
years at a market rate of interest of 6%. What will the investment cost?

$ $

0 1 2 3 4 5 6 7 8 9 10

x =
CASH FLOW X FACTOR ( %, n)

or
N I/Y PV PMT FV

3. You invest $1,000 every year for the next 10 years, how much will your investment be worth
at the end of 10 years if you can earn an 8% market rate each year?

$ $

0 1 2 3 4 5 6 7 8 9 10

x =
CASH FLOW X FACTOR ( %, n)
or
N I/Y PV PMT FV

TVM Page TVM-4

4. How much could you borrow today if you make semi-annual payments of $1,000 for 5 years
at an 8% market interest rate?

$ $

0 1 2 3 4 5 6 7 8 9 10

x =
CASH FLOW X FACTOR ( %, n)
or

N I/Y PV PMT FV

5. How much would you pay for an investment that provides $100 semiannually for five years
and at the end of five years it would also provide $5,000? At the time of your decision, the
market rate of interest is 3.5%.

$5000
$ $100 $100 $100 $100 $100 $100 $100 $100 $100 $100

0 1 2 3 4 5 6 7 8 9 10

x =
CASH FLOW FACTOR ( %, n) =$
x =
CASH FLOW FACTOR ( %, n)
or

N I/Y PV PMT FV

Assets and Liabilities are recorded at PRESENT VALUE (cash equivalent)

6. On January 1st, BB Company acquired a truck that had a purchase price of $38,000. The seller
agreed to allow BB to pay for the truck over a five-year period (12 payments per year, 60
payments in total) at 3% interest. Determine the amount of each payment:

x =
CASH FLOW FACTOR ( %, n) Present Value
or

N 1/Y PV PMT FV

TVM Page TVM-5

 For the Financial Calculator

If the analysis is a single sum,

then the PMT = 0

If the analysis is an annuity,

then either PV or FV will be = 0.
If the Value is FV, PV = 0
If the Value is PV, FV =0

Equation for the Factor Tables

Cash flow x Factor = Value
Cash flow x PV factor = Present value
Cash flow x FV factor = Future Value

1. Cash flow: single sum (PV or FV) or annuity (PMT); if PMT is

involved, it will ALWAYS be the CASH FLOW!
2. Value: Present value or Future Value
3. I/Y (divide annual interest by compounding periods per year)
4. N: number of compounding periods over the life (years x
compounding periods per year)

TVM Page TVM-6

 Chapter 9 Video Lecture Outline
Long-Term Liabilities
Part A: Long Term Debt

Financing Alternatives
Debt versus Equity
Interest versus dividends
Capital structure
Financial leverage

Types of Long Term Debt

1. Notes Payable or Installment Notes

2. Leases
3. Bonds

Installment Notes

Recurring payments (installments)

Once all payments are made the debt is extinguished

Installment payments (includes both principal (decrease in carrying value) and interest)

Practice: Loan Amortization schedule:

You purchased a car for $22,999.79 (tax, tag, title) and agreed to make monthly payments of
$370.41 for 6 years (72 months). Annual interest rate 5% (monthly 0.41667%)

Time Cash Payment Interest expense @ Decrease in Carrying Value

.0041667 Carrying Value
Today $22,999.79
1st payment $370.41 $95.83 $274.58 22,725.21
2nd payment 370.41 94.69 275.72 22,449.49
3rd payment 370.41 93.54 276.87 22,172.62
4th payment 370.41 92.39 278.02 21,894.60
5th payment 370.41
6 – 71 ** ** ** **
payments ** ** ** 368.87
72nd payment 370.41 1.54 368.87 0

You are getting ready to make your 5th car payment. Determine your interest expense, decrease in
carrying value and new debt balance after the payment has been made.

Interest expense:
Decrease in Carry value:
New Carrying value:

Chapter 9 Page 9-1

Leases
A lease provides the lessee (user) the right to use an asset for a specified period of time.

BONDS
What are Bonds and why do corporations issue them?

TERMS (pay close attention to terminology):

Face value (aka bond payable, bond principal, or maturity value) is the contract amount and is a
future cash flow the company will pay at maturity.
Bond Liability (aka bond carrying amount) the liability on the balance sheet related to the bond
and is made up of bond payable + bond premium or bond payable – bond discount.
Stated rate (aka contract rate) the rate promised by the issuer. It is the rate used to calculate the
interest payment. (Bond payable x stated rate = annual interest payment, a cash flow)

ABC Corporation

$1,000
10% interest Interest payable
June 30 and December 31
Matures December 31, 20XE
5 year bond
Following are the cash flows provided by the above bond ($1,000 face, 10% semi-annual interest)
$1000
$50 $50 $50 $50 $50 $50 $50 $50 $50 $50

1 2 3 4 5 6 7 8 9 10

Market rate (aka, effective interest rate) the true interest rate yielded by the bond
1. The market rate is used to calculate the bond issue price; and
2. it is used to calculate bond interest expense (bond liability x market rate = annual interest
expense).

Parts B & C: BOND PRICING and RECORDING

We will use the present value concepts to determine the issue price of the bonds (Present value
factor tables found in Canvas; or use your TI BAII Plus Financial Calculator).

Chapter 9 Page 9-2

 Bonds can be issued (sold) for more or less than their face value.
Sells at Face Amount (100%):
Bond Premium (>100%):
Bond Discount (<100%):

Determining the Issue Price of a Bond

1. Identify the two cash flows provided by the bond (Face value—a single sum AND interest
payments [face x stated rate or if semiannual then face x ½ stated rate]—an annuity).
2. Compare the market rate with the stated rate to determine if bond will sell at face, premium or
discount. If at face then no more calculations are needed.
3. Eliminate the stated rate, you don’t need it anymore as you already know the cash flows from
the bond.
4. Use the market rate and compounding periods to determine the correct factor to present value
the cash flows.

Practice
ABC Corporation wants to issue five-year $1,000 bonds 10% stated rate paying semi-annual
interest. Market rate of interest is 8%; (therefore, semiannual would be 5% stated rate and 4%
market rate respectively). What is the bond issue price on January 1, 20XA?

Calculate the issue price of the bond:

CASH FLOW X PV FACTOR (use market rate) = Present Value
Present Value of Principal (Face)
Present Value of Interest Payment
(Face x stated)
Issue price (sales price)

OR with the TI BAII Plus Calculator

N PMT CPT PV
I/Y FV The issue price: $

Calculate the difference:

Bond issue price
Bond face amount
Difference

Record the bond issuance on January 1, 20XA

Chapter 9 Page 9-3

 Effective Interest Amortization (Note: this differs from the book)

The purpose of the effective interest amortization is to get rid of the difference
between the bond payable and the bond liability.

Affects Income statement Affects Cash Flow Affects Liabilities on BS

Bond Interest Expense - Bond Interest Paid = Amortization Amount
Carrying value at Market rate Face value Stated
Beginning of x at issuance - of bond x Interest = Amortization Amount
Period (Effective
Interest Rate)

Use the amortization schedule below to record the first interest payment on June 30, 20XA

Note: this differs from the book

Determining the bond carrying value at the end of the period:
Interest expense – interest payment = amount amortized + Bond carrying value at the beginning of
the period = Bond carrying value at the end of the interest payment period.

Date Interest expense @ Interest payment @ Amortization Carrying Value at end

.04 (1/2 market) .05 (1/2 stated)
1/1/XA $1,081.11
6/30/XA
12/31/XA
6/30/XB

Bond Liability (Carrying Value)

Premium $1,081
(8%) xxx
xxx
B L xxx
O I xxx
N A xxx
D B xxx
I xxx
L xxx
I xxx
T xxx
Y $1,000
0 1 2 3 4 5 6 7 8 9 10 @Maturity

Interest payment periods, every 6 months

Chapter 9 Page 9-4

 Practice
XYZ Corporation wants to issue ten-year $1,000 bonds 6% stated rate paying interest annually.
Market rate of interest is 6%. What is the bond issue price on January 1, 20XA?

Cash flows provided by the bond ($1,000 face, 6% annual interest)

$1000
$60 $60 $60 $60 $60 $60 $60 $60 $60 $60

1 2 3 4 5 6 7 8 9 10

Calculate the issue price of the bond

CASH FLOW X PV FACTOR (use market rate) = Present Value
Present Value of Principal (Face)
Present Value of Interest Payment
(Face x stated)
Issue price (sales price)

OR with BAII Plus Calculator

N PMT CPT PV
I/Y FV The issue price: $

Record the bond issuance on January 1, 20XA:

Date Interest expense @ Interest payment @ Amortization Carrying Value at end

.06 .06
1/1/XA $1,000.00
12/31/XA

Record the interest payment on December 31, 20XA:

Bond Liability (Carrying Value)

Face (6%) $1,000 xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx $1000
0 1 2 3 4 5 6 7 8 9 10 @Maturity

Interest payment periods, once per year

Interest expense for the FIFTH interest payment: $

Bond liability after the FIFTH interest payment: $

Practice

Chapter 9 Page 9-5

 BC Corporation wants to issue five-year $1,000 bonds 11% stated rate paying semi-annual interest.
Market rate of interest is 12%; (therefore, semiannual would be 5.5% stated rate and 6% market
rate respectively). What is the bond issue price on January 1, 20XA?

Cash flows provided by the bond ($1,000 face, 11% semi-annual interest)

$1000
$55 $55 $55 $55 $55 $55 $55 $55 $55 $55

1 2 3 4 5 6 7 8 9 10

Calculate the issue price of the bond:

CASH FLOW X PV FACTOR (use market rate) = Present Value
Present Value of Principal (Face)
Present Value of Interest Payment
(Face x stated)
Issue price (sales price)
OR with BAII Plus Calculator

N PMT CPT PV
I/Y FV The issue price: $

Calculate the difference:

Bond issue price

Bond face amount
Difference

Record the bond issuance on January 1, 20XA

Record the interest payment on June 30, 20XA

Chapter 9 Page 9-6

 Bond Liability (Carrying Value)
xxx $1,000
B L 995.28 Maturity
O I xxx
N A xxx
D B xxx
I xxx
L xxx
I xxx
T xxx
Y xxx
Discount $963
(12%) 0 1 2 3 4 5 6 7 8 9 10

Interest payment periods, every 6 months

Note: this differs from the book

Date Interest expense Interest payment @ Amortization Carrying Value at end
@ .06 .055
1/1/XA $963.20
6/30/XA
12/31/XA
6/30/XB
...

12/31/XE $59.72 $1,000

At what price did the company issue the bonds? $

Interest expense for the second interest payment: $

Bond liability after the 2nd interest payment: $

Bond Retirement at Maturity

Record the retirement of the bond on December 31, 20XE (after all interest payments have been
made):

Chapter 9 Page 9-7

Bond Retirement Before Maturity

Early extinguishment of debt may create a gain or loss

Example
The bonds BC Corporation issued on January 1, 20XA at 12% two years ago are now trading on the
market at 10% on July 1, 20XB. BC estimates that market prices will continue to fall over the next
few years. BC decides to retire as many of the bonds as it can by buying them back in the market
today; they will pay $1,028.93 per bond (PV of $1,000 face for 7n, 5% and $55 for 7n, 5%). As
shown above in the amortization schedule, the carry value for each bond on July 1, 20XB is $972.09
and the bond discount balance is $27.91 per bond ($1,000 – $972.09 = $27.91). Record the early
extinguishment of one of the bonds:

Bonds Payable 1,000.00

Loss on early retirement 56.84
Bond discount 27.91
Cash 1,028.93

DEBT ANALYSIS

Total Liabilities
Debt to Equity Ratio =
Total Stockholder’s Equity

Leverage (positive financial leverage)

Risk—higher ratio, more risk

Net Income + Interest expense + tax expense

Times Interest Earned =
Interest expense

Shows the ability to pay interest

Higher is better

See next page for a recap of bond terms, interest, bond issuance, and bond amortization.

Chapter 9 Page 9-8

RECAP
Terms
Bond payable (B/P) Bond liability = B/P + premium or B/P - discount
Bond principal
Face value or amount Bond carrying value or amount
Maturity value or amount
It is the FUTURE VALUE CASH FLOW

Stated rate (does not change) printed Market rate

Use: to calculate the interest PAYMENT Use: to calculate the issue price
It is the ANNUITY CASH FLOW And to calculate the interest EXPENSE

Interest for EACH interest payment period is ALWAYS calculated by P x R x T

Face value x stated rate = interest payment Bond liability x market rate = interest expense
Face value x ½ stated rate = semi-annual Bond liability x ½ market rate = semi-annual
interest payment interest expense

1. FIRST THING, determine the future cash flows from a bond (Face value and interest payments)

2. Then determine if the bond will sell for A PREMIUM, AT FACE, OR A DISCOUNT (compare stated
rate with market rate). If stated is higher, bond will sell at a premium. If stated rate is lower, bond
will sell at a discount.

3. Then, GET RID OF THE STATED RATE (you don’t need it anymore, you already have the interest
payment from #1)

4. USE THE MARKET RATE to determine the present value of the future
cash flows (FROM #1)

n % PV$1 PVA
Use market rate here

Date Interest Interest Payment Amortization Bond Liability

expense (already (the amount of the a.k.a.
Use market computed in #1 difference being decreased) Bond carrying
rate (M%) above) premium or discount value or amount
a b c BCV
Jan 1st Issue price=BCV 0
June 30 BCV0 x M% = a b a–b=c BCV0 + c = BCV1
Dec 31 BCV1 x M% = a b a–b=c BCV1 + c = BCV2

Chapter 9 Page 9-9

 Chapter 10 Video Lecture Outline
and Appendix D
Stockholders’ Equity

Corporations
Stockholders are the owners of the corporation Board of Directors work in the best interest of
the owners.
Initial Public Offering (IPO)

STOCKHOLDER RIGHTS: to vote, receive dividends, and share in the distribution of assets

ADVANTAGES of a CORPORATION
-limited liability
-ability to raise capital and transfer ownership

DISADVANTAGES of a CORPORATION
-double taxation
-SEC regulation requirements

STOCK (Common stock)

Number of Shares
Authorized Shares:

Issued Shares:

Outstanding Shares:

Unissued Shares:

Treasury Stock:

Stockholders’ Equity—three sections

Invested Capital (Source of Financing)
Earned Capital
Treasury stock (contra equity)

Invested Capital (Paid-in Capital)

Invested capital is the resources contributed to a company by its owners (the stockholders) and is
shown in the Paid in Capital accounts.
Preferred stock account = Par value x shares issued
+Common stock account = Par value x shares issued
+Additional Paid in Capital account = amount received above par value
Total Paid in Capital (total amount company received from stocked issued)

Chapter 10 Page 10-1

Par value or Stated value
-legal capital
-not market value
Par value is an outdated concept but still exists, so we have to account for it.
Par value goes into the stock account (Common Stock or Preferred Stock)…anything above par
value goes into Additional Paid in Capital (APIC).

No-par Stock
Paid in capital all goes into common stock

PREFERRED STOCK
-Not normally voting
-Preference in dividends
-Fixed dividend rate (% of par or specified amount)
-Cumulative (dividends in arrears)
-Convertible
-Redeemable
-Mandatory Redeemable preferred stock is treated as debt on the balance sheet

Practice
A firm issues 50,000 shares of $0.10 par value common stock for $10 per share, record the
issuance.

A firm issues 50,000 shares of $100 par value preferred stock for $110 per share, record the
issuance.

A firm issues 50,000 shares of no-par common stock for $10 per share, record the issuance.

TREASURY STOCK
-Contra Equity (reduces SE does NOT reduce common stock)
-Issued but NOT outstanding
-Recorded at COST
-No voting rights
Chapter 10 Page 10-2
-No dividend or distribution rights

Economic Gain on sale of Treasury Stock (Resold for more than cost)
-not shown as a GAIN
-increase Additional paid in capital

Economic Loss on sale of Treasury Stock (Resold for less than cost)
-not shown as a LOSS
-decrease Additional paid in capital if available, or, if not available
-decrease Retained Earnings

Practice
(a) A firm purchases 1,000 shares of their $0.10 par common stock for $12 per share, record the
purchase.

Balance Sheet Income Statement

Assets Liabilities Stockholders’ Equity Revenues Expenses Net Income
Cash -12,000 Treasury stock + 12,000
SE -12,000

Cash Treasury Stock APIC-TS

Beg 15,000

(b) A firm resells 100 shares of the treasury stock purchased above for $14 per share, record the
sale.

(c) A firm resells 100 shares of the treasury stock purchased above for $11 per share, record the
sale.

Chapter 10 Page 10-3

 Statement of Stockholders’ Equity

Changes in Paid-in Capital

Changes in retained earnings
Changes in Treasury stock

REMEMBER—Paid in Capital equals

Preferred stock account = Par value x shares issued
+Common stock account = Par value x shares issued
+Additional Paid in Capital account = amount above par value
Total Paid in Capital (total amount company received from stocked issued)

Practice
TR Corp shows the beginning balances in its Statement of Stockholders’ Equity at January 1, 20XX.
Additional Total
Preferred Common Paid-in Retained Treasury Stockholders’
Stock Stock Capital Earnings Stock Equity
Beginning balance $10,000 $35,000 $955,000 $1,900,000 ($200,000) $2,700,000
Issuance of stock
Net income for the year
Dividends
Purchase of Treasury shares
Sale of Treasury shares
Ending balance

During the year the company resold all 8,000 shares of treasury stock for $30 per share (cost was
$25, $1 par value). The company had net income of $250,000 and paid dividends of $100,000.
During the year the company issued 1,000 additional shares of common stock at $31 per share.
Complete the Statement of Stockholders’ Equity.

Sale of Treasury

Issue additional common stock

What is total paid in capital at the end of the period?

How many total shares of common stock were issued by the end of the year?

Chapter 10 Page 10-4

 Practice
JCorp Stockholders’ Equity section from their 12/31 Balance Sheet is given:
JCorp
Balance Sheet (Stockholders’ Equity Section)
At December 31, 20XX

Preferred stock, $100 par value $1,000

Common stock, $0.01 par value; 100,000,000 authorized 1,500
Additional Paid in capital 471,010
Total paid in capital 473,510
Retained earnings 450,000
Treasury stock (2,000 common shares) (30,000)
Total stockholders' equity ?
Complete the following statements and show your computations:
1
. The number of shares of common stock issued was Shares
2
. The number of shares of common stock outstanding was Shares
3
. Ten shares of preferred stock were issued at $101 per share; what was the
average sales price of the common stock when issued? $ per share
4
. What is the cost per share for the treasury stock? $ per share
5
. Total Stockholders’ Equity is $

6. Assume 500 shares of the treasury stock are resold at $20 per share. Record the sale of treasury
stock:

7. How much did “additional paid in capital” change when the 500 shares of
treasury stock were resold? $
8
. What is the remaining balance in the Treasury Stock account? $

9. What does the Stockholders’ Equity Section look like after the 500 shares of treasury stock is sold?
Preferred stock, $100 par value $1,000
Common stock $0.01 par value; authorized 100,000,000 shares, (issued
_____ shares and ________outstanding ) 1,500

Chapter 10 Page 10-5

 Additional paid in capital
Retained earnings 450,000
Treasury stock (_______ shares)
Total Stockholders’ Equity $__________

Chapter 10 Page 10-6

Earned Capital

Retained Earnings (BRE + NI – DIV = ERE)

Accumulated Deficit

DIVIDENDS ON COMMON STOCK

There are two requirements to be met for the Board of Directors to declare a CASH dividend.
1. Sufficient cash to pay the dividend
2. Sufficient retained earnings

Dividend Dates

Date of declaration
Date of record
Date of payment

G, Inc., declares a $0.50 per share dividend on the 10,000 outstanding shares on October 31 st to be
paid on December 15th

Date of Declaration (October 31st)

Date of Payment (December 15th)

STOCK DIVIDENDS AND STOCK SPLITS

Stock Dividends
-Pro rata basis
-Does not create a liability
-Does not reduce assets
-Capitalizes earnings

Small stock dividend

- < 25%
- At market price

Large stock dividend

- 25% or more
- par value

Chapter 10 Page 10-7

A stock dividend of 10,000 shares was distributed (100% of outstanding shares); par value $0.10

Balance Sheet Income Statement

Assets Liabilities Stockholders’ Equity Revenues Expenses Net Income
Common stock + 1,000
Retained earnings -1,000

Stock Splits

-NOT a dividend
-No journal entry required
-Old shares changed for new shares
-Only things that change are shares issued and par value

-Shares issued increased (by the stock split, 2/1)

-Par value reduced (by the reciprocal of the stock split, 1/2)
-Shares authorized do not change
-Retained earnings unaffected

Practice

On July 1, 20XX, T Corp. had the following capital structure:

Common stock (par $0.10, 100,000,000 authorized shares) $20,000

Additional paid in capital 880,000
Retained earnings 720,000
Treasury stock 0

Complete the following comparative tabulation based on two independent cases:

Case 1: The board of directors declared and issued a 50% stock dividend when the stock was
selling at $10 per share.

Record the distribution

Chapter 10 Page 10-8

 Item Before Stock Dividend Affect on Item After Stock Dividend
Common stock account $20,000 $
Par per share $0.10 $
Shares issued & outstanding 200,000
Additional paid in capital $880,000 $
Retained earnings $720,000 $
Total stockholders’ equity $1,620,000 $

Case 2: The board of directors voted a 3-for-2 stock split (i.e., a 50% increase in the number of
shares). The market price prior to the split was $10 per share.

Does this require a journal entry?

Item Before Stock Split Affect on Item After Stock Split

Common stock account $20,000 $
Par per share $0.10 $
Shares issued & outstanding 200,000
Additional paid in capital $880,000 $
Retained earnings $720,000 $
Total stockholders’ equity $1,620,000 $

EQUITY ANALYSIS

Return on Equity (ROE):

Net Income
Return on Equity =
Average stockholders’ equity
or
Profit margin x asset turnover x equity multiplier
Return on Equity =
(NI/Net Sales) x (Net Sales/Ave TA) x (Ave TA/Ave SE)

Dividend Yield:
Dividends per share
Dividend yield =
Stock price

Earnings Per Share (EPS):

Net Income – Preferred Dividends
Earnings per Share =
Weighted average # of Common Shares Outstanding

Chapter 10 Page 10-9

Price-Earnings Ratio (P/E):

Stock price
Price-Earnings Ratio =
EPS

APPENDIX D (End of text pages D1 – D7 & D14 only)

EQUITY INVESTMENTS
-Will create Gains/Losses
-“Dividend Revenue”

Degree of Influence
1. Insignificant influence (owns between 0% - 20% of voting shares)
2. Significant influence (owns between 20% - 50% of voting shares)
3. Controlling influence (owns more than 50% of voting shares)

Accounting for Equity Investments—Insignificant Influence

-Fair value method is used—valued at the amount one could expect to receive if sold today.
*Trading Securities (current asset)
-Unrealized Gains/Losses—Net income

Comprehensive income (changes in Stockholders’ Equity other than those caused by transactions
with shareholders).

Chapter 10 Page 10-10