© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irw1in Identifies Records Communicates Relevant Reliable Comparable Importance of Accounting Accounting

© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irw1in

IdentifiesIdentifies

RecordsRecords

CommunicatesCommunicatesRelevantRelevant

ReliableReliable

ComparableComparable

Importance of AccountingImportance of Accounting

AccountingAccountingis a

system that

information

that is

to help users make better decisions.

to help users make better decisions.


Financial accounting practice is governed by concepts and rules known as generally accepted

accounting principles (GAAP).

Financial accounting practice is governed by concepts and rules known as generally accepted

accounting principles (GAAP).

Generally Accepted Accounting PrinciplesGenerally Accepted Accounting Principles

Relevant Information

Relevant Information

Affects the decision of its users.

Affects the decision of its users.

Reliable InformationReliable Information Is trusted by users.

Is trusted by users.

Comparable Information

Comparable Information

Is helpful in contrasting organizations.

Is helpful in contrasting organizations.


Principles of Accounting— General PrinciplesPrinciples of Accounting— General Principles

Objectivity PrincipleAccounting information is supported by independent,

unbiased evidence. It is intended to make financial statements useful by ensuring they report reliable and

verifible information.

Source documents.


Principles of AccountingPrinciples of Accounting

Revenue Recognition Principle

Provides guidance on when a company must recognize revenue.

1.Recognize revenue when it is earned.2.Proceeds need not be in cash (Credit sales).3.Measure revenue by cash received plus cash

value of items received.


LiabilitiesLiabilities EquityEquityAssetsAssets = +

Expanded Accounting EquationExpanded Accounting Equation

RevenuesRevenues ExpensesExpensesOwner CapitalOwner Capital

Owner Withdrawals

Owner Withdrawals

_ + _



Double-Entry AccountingDouble-Entry Accounting

Debit Credit Debit Credit Debit Credit

ASSETS

+ - + -

LIABILITIES

- + - +

EQUITIES

- + - +Normal Balance

Normal Balance

Nomal Balance


RevenuesRevenues ExpensesExpensesOwner’s Capital

Owner’s Capital

Owner’s Withdrawals

Owner’s Withdrawals

__ ++ __

Debit Credit

Capital

- + - + Debit Credit

Withdrawals

+ - + - Debit Credit

Expenses

+ - + -Debit Credit

Revenues

- + - +


EquityEquity

Exh.3.8

Normal Balance

Normal Balance

Normal Balance

Normal Balance



When there is a debited account, there must be a credited account.

The total amount debited must be equal to the total amount credited for each transaction.

The left side is the normal balance side for assets, and the right side is the normal balance side for liabilities and equity.

有借必有貸，借貸必相等。


Analyzing and Recording ProcessAnalyzing and Recording Process

Step 1: Analyze transactions and source

documents.


Step 2: Apply double-entry accounting

(Left side) (Right side)Debit Credit

T- Account

ACCOUNT NAME: ACCOUNT No.

Date Description PR Debit Credit Balance

Step 4: Post entry to ledger Step 3: Record journal entry


After processing its remaining transactions for December, FastForward’s Trial Balance is prepared.

After processing its remaining transactions for December, FastForward’s Trial Balance is prepared.

Debits CreditsCash 4,400$ Accounts receivable - Supplies Prepaid Insurance 2,400 Equipment 26,000 Accounts payable 6,200$ Unearned consulting revenue 3,000 C. Taylor, Capital 30,000 C. Taylor, Withdrawals 600 Consulting revenue 5,800 Rental revenue 300 Salaries expense 1,400 Rent expense 1,000 Utilities expense 230 Total 45,300$ 45,300$

FastForwardTrial Balance

December 31, 2004

The trial balance lists all account balances in the general ledger.

If the books are in balance, the total

debits will equal the total credits.

The trial balance lists all account balances in the general ledger.

If the books are in balance, the total

debits will equal the total credits.

9,270


Recognizing Revenues and ExpensesRecognizing Revenues and Expenses

Revenue recognition principle requires that revenue be recorded when earned, not before or after.

Matching principle intends to record expenses in the same accounting period as the revenues that are earned as a result of these expenses.


AdjustmentsAdjustments

An adjusting entry is recorded to bring an asset or liability account balance to its proper amount.

Adjusting AccountsAdjusting Accounts

Paid (or received) cash before expense (or revenue) recognizedPaid (or received) cash before

expense (or revenue) recognizedPaid (or received) cash after

expense (or revenue) recognizedPaid (or received) cash after

expense (or revenue) recognized

Prepaid (Deferred) expenses*

Prepaid (Deferred) expenses*

Unearned (Deferred) revenues

Unearned (Deferred) revenues

AccruedexpenseAccruedexpense

AccruedrevenuesAccruedrevenues

Framework for Adjustments

*including depreciation


Prepare adjusted trial

balance.

Prepare adjusted trial

balance.

FastForwardWork Sheet

For Month Ended December 31, 2004


FastForwardWork Sheet

For Month Ended December 31, 2004

Sort adjusted trial balance amounts to financial statements.

Sort adjusted trial balance amounts to financial statements.


Financial StatementsFinancial Statements

Income Statement: revenues and expenses together with the how much profit the firm makes.

Statement of Owner’s Equity: reports information how equity changes over the reporting period.

Balance Sheet: a company’s financial position at a point of time.

Statement of cash flows: cash receipts and cash payments over a period of time.


Temporary Accounts

Revenues

Income Summary

Exp

ense

s

With

draw

als

Permanent Accounts

Assets

Lia

bili

ties

Ow

ner’s

Cap

ital

The closing process applies only to

temporary accounts.

The closing process applies only to

temporary accounts.

Temporary and Permanent AccountsTemporary and Permanent Accounts


Accounting cycleAccounting cycle

1. Analyze transactions

2. Journalize

3. Post

4. Prepare unadjusted Trial balance

5. Adjust 6. Prepare adjusted Trial balance

7. Prepare statements

8. Close

9. Prepare Post-closing Trial balance


Inventory SystemsInventory Systems

+

+

BeginninginventoryBeginninginventory

Net cost ofpurchasesNet cost ofpurchases

Merchandiseavailable for sale Merchandiseavailable for sale

Ending InventoryEnding InventoryCost of Goods

SoldCost of Goods

Sold

==


Itemized Cost of Merchandise PurchasedItemized Cost of Merchandise Purchased

Invoice cost of merchandise purchases 692,500$ Less: Purchase discounts (10,388) Purchase returns and allowances (4,275) Add: Cost of transportation-in 4,895 Total cost of merchandise purchases 682,732$

Matrix, Inc.Total Cost of Merchandise Purchases

For Year Ended May 31, 2005Invoice cost of merchandise purchases 692,500$ Less: Purchase discounts (10,388) Purchase returns and allowances (4,275) Add: Cost of transportation-in 4,895 Total cost of merchandise purchases 682,732$

Matrix, Inc.Total Cost of Merchandise Purchases

For Year Ended May 31, 2005


Accounting for Merchandise SalesAccounting for Merchandise Sales

Sales discounts and returns and allowances are Contra Revenue accounts.Sales discounts and returns and allowances are Contra Revenue accounts.


Inventory Cost Flow AssumptionsInventory Cost Flow Assumptions

First-In, First-Out(FIFO)

Assumes costs flow in the order incurred.

Last-In, First-Out(LIFO)

Assumes costs flow in the reverse order incurred.

Weighted Average

Assumes costs flow at an average of the costs available.


Sales of MerchandiseSales of MerchandiseOn March 18, Diamond Store sold $25,000 of merchandise on account. The merchandise was

carried in inventory at a cost of $18,000.

On March 18, Diamond Store sold $25,000 of merchandise on account. The merchandise was

carried in inventory at a cost of $18,000.

Mar. 18 Accounts Receivable 25,000 Sales 25,000

Sales of merchandise on credit

Cost of Goods Sold 18,000 Merchandise Inventory 18,000

To record cost of sales


Some customers may not pay their account. Uncollectible amounts are referred to as bad debts. There are two

methods of dealing with bad debts:

• Direct Write-Off Method• Allowance Method

Some customers may not pay their account. Uncollectible amounts are referred to as bad debts. There are two

methods of dealing with bad debts:

• Direct Write-Off Method• Allowance Method

Valuing Accounts ReceivableValuing Accounts Receivable


Two Methods 1. Percent of Sales Method

2. Accounts Receivable Methods Percent of Accounts Receivable Aging of Accounts Receivable

Method

Two Methods 1. Percent of Sales Method

2. Accounts Receivable Methods Percent of Accounts Receivable Aging of Accounts Receivable

Method

Estimating Bad Debts ExpenseEstimating Bad Debts Expense


Desired balance in Allowance for Doubtful Accounts.

Percent of Accounts ReceivablePercent of Accounts Receivable

Dec. 31 Bad Debts Expense 3,100 Allowance for Doubtful Accounts 3,100

To record estimated bad debts


Total interest due at May 30.

Computing Maturity and InterestComputing Maturity and Interest


The calculation of depreciation requires three amounts for each asset:

Cost.

Salvage Value.

Useful Life.

Factors in Computing DepreciationFactors in Computing Depreciation


Straight-line

Units-of-production

Declining balance

Depreciation MethodsDepreciation Methods


Recording cashreceived (debit)or paid (credit).

Recording cashreceived (debit)or paid (credit).

Removing accumulateddepreciation (debit).

Removing accumulateddepreciation (debit).

Update depreciation to the date of disposal.

Journalize disposal by: Journalize disposal by:

Removing the asset cost (credit).

Removing the asset cost (credit).

Recording again (credit)

or loss (debit).

Recording again (credit)

or loss (debit).

Disposals of Plant AssetsDisposals of Plant Assets


Selling Plant AssetsDetermine Gain or Loss on DisposalDetermine Gain or Loss on Disposal

Cost 100,000$ Accumulated depreciation 38,000

Book Value 62,000 Cash Received 60,000

Loss on disposal (2,000)$

If Cash > BV, record a gain (credit).

If Cash < BV, record a loss (debit).

If Cash = BV, no gain or loss.


Accounts PayableAccounts Payable

Sales Taxes PayableSales Taxes Payable

Unearned RevenuesUnearned Revenues

Short-Term Notes PayableShort-Term Notes Payable

Known (Determinable) LiabilitiesKnown (Determinable) Liabilities

Payroll LiabilitiesPayroll Liabilities

Multi-Period Known LiabilitiesMulti-Period Known Liabilities


An estimated liability is a known obligation of an uncertain amount, but one that can be reasonably estimated.

Estimated LiabilitiesEstimated Liabilities

Warranty: Seller’s obligation to replace or correct a product (or service) that fails to perform as expected within a specified period. To conform with the matching principle, the seller reports expected warranty expense in the period when revenue from the sale is reported.

Warranty: Seller’s obligation to replace or correct a product (or service) that fails to perform as expected within a specified period. To conform with the matching principle, the seller reports expected warranty expense in the period when revenue from the sale is reported.


CorporationCorporation

Issuing stocks: common / preferred stocks Distribute dividends: cash / stock dividends Stock splits Treasury Stock Earning Per Share


Bond Discount or PremiumBond Discount or Premium

Prepare the entry for Jan. 1, 2005 to record the following Prepare the entry for Jan. 1, 2005 to record the following bond issue by Rose Co. bond issue by Rose Co. Par Value = $1,000,000Par Value = $1,000,000Issue Price = 92.6405% of par valueIssue Price = 92.6405% of par valueStated Interest Rate = 10%Stated Interest Rate = 10%Market Interest Rate = 12%Market Interest Rate = 12%Interest Dates = 6/30 and 12/31Interest Dates = 6/30 and 12/31Bond Date = Jan. 1, 2005Bond Date = Jan. 1, 2005Maturity Date = Dec. 31, 2009 (5 years)Maturity Date = Dec. 31, 2009 (5 years)

Prepare the entry for Jan. 1, 2005 to record the following Prepare the entry for Jan. 1, 2005 to record the following bond issue by Rose Co. bond issue by Rose Co. Par Value = $1,000,000Par Value = $1,000,000Issue Price = 92.6405% of par valueIssue Price = 92.6405% of par valueStated Interest Rate = 10%Stated Interest Rate = 10%Market Interest Rate = 12%Market Interest Rate = 12%Interest Dates = 6/30 and 12/31Interest Dates = 6/30 and 12/31Bond Date = Jan. 1, 2005Bond Date = Jan. 1, 2005Maturity Date = Dec. 31, 2009 (5 years)Maturity Date = Dec. 31, 2009 (5 years)

Contract rate is: Bond sells:Above market rate At a premiumEqual to market rate At par valueBelow market rate At a discount

Contract rate is: Bond sells:Above market rate At a premiumEqual to market rate At par valueBelow market rate At a discount


Jan. 1 Cash 926,405 Discount on bonds payable 73,595

Bonds payable 1,000,000 Sold bonds at a discount on issue date

Contra-LiabilityContra-LiabilityAccountAccount

Contra-LiabilityContra-LiabilityAccountAccount

On Jan. 1, 2005 Rose Co. would record the On Jan. 1, 2005 Rose Co. would record the bond issue as follows. bond issue as follows.


Issuing Bonds at a DiscountIssuing Bonds at a Discount


June 30 Bond interest expense 57,360 Discount on bonds payable 7,360 Cash 50,000

Paid semi-annual interest and amortized discount

$73,595 ÷ 10 periods = $7,360 (rounded)

$1,000,000 × 10% × ½ = $50,000

$73,595 ÷ 10 periods = $7,360 (rounded)

$1,000,000 × 10% × ½ = $50,000

Make the following entry every six months to Make the following entry every six months to record the cash interest payment and the record the cash interest payment and the

amortization of the discount.amortization of the discount.

Make the following entry every six months to Make the following entry every six months to record the cash interest payment and the record the cash interest payment and the

amortization of the discount.amortization of the discount.

Issuing Bonds at a DiscountIssuing Bonds at a Discount


Jan. 1 Cash 1,081,145 Premium on bonds payable 81,145 Bonds payable 1,000,000

Issued bonds at a premium on issue date

Adjunct-LiabilityAdjunct-LiabilityAccountAccount

Adjunct-LiabilityAdjunct-LiabilityAccountAccount



Issuing Bonds at a PremiumIssuing Bonds at a Premium


June 30 Bond interest expense 41,885 Premium on bonds payable 8,115

Cash 50,000 Paid semi-annual interest and amortized premium

$81,145 ÷ 10 periods = $8,115 (rounded)

$1,000,000 × 10% × ½ = $50,000

$81,145 ÷ 10 periods = $8,115 (rounded)

$1,000,000 × 10% × ½ = $50,000

This entry is made every six months to This entry is made every six months to record the cash interest payment and the record the cash interest payment and the

amortization of the premium.amortization of the premium.

This entry is made every six months to This entry is made every six months to record the cash interest payment and the record the cash interest payment and the

amortization of the premium.amortization of the premium.

Issuing Bonds at a PremiumIssuing Bonds at a Premium


Classes of and Reporting for InvestmentsClasses of and Reporting for Investments

Held-To-MaturityHeld-To-Maturity

Available-For-Sale

Available-For-Sale

Significant Influence

Significant Influence

Controlling Influence

Controlling Influence

ConsolidateConsolidateEquityMethodEquity

MethodMarket Value

MethodMarket Value

Method

TradingTrading

AmortizedCost

AmortizedCost

Class of Investment

Reporting


The Statement of Cash Flows includes the following three sections:

Operating Activities Investing ActivitiesFinancing Activities

Classifying Cash FlowsClassifying Cash Flows


Analyzing the Cash AccountAnalyzing the Cash Account

Balance, Jan. 1, 2005 22,000 Payments for merchandise 150,000 Receipts from customers 466,000 Payments for wages 145,000 Receipts from sale of land 25,000 Payments for interest 10,000 Receipts from stock issuance 35,000 Payments for taxes 20,000

Payments for equipment 70,000 Payments for bond retirement 50,000 Payments for dividends 40,000

Balance, Dec. 31, 2005 63,000

Cash

Let’s use this Cash account to prepare B&G Company’s Statement of Cash

Flows under the Direct Method.


Net Income

Net Income

Cash Flows from Operating

Activities

Cash Flows from Operating

Activities

97.5% of all companies use the indirect method.97.5% of all companies use the indirect method.

Changes in current assets and current liabilities.

Changes in current assets and current liabilities.

+ Losses and - Gains

+ Losses and - Gains

+ Noncash expenses such as depreciation and

amortization.

+ Noncash expenses such as depreciation and

amortization.

Indirect Method of Reporting Operating Cash FlowsIndirect Method of Reporting Operating Cash Flows


Horizontal AnalysisHorizontal Analysis

Time

Comparing a company’s financial condition and performance across time

Tools of AnalysisTools of Analysis


Comparing a company’s financial condition and

performance to a base amount

Tools of AnalysisTools of Analysis Vertical

Analysis

Vertical

Analysis


Using key relations among financial statement items

Tools of AnalysisTools of Analysis


Liquidity and

EfficiencySolvency

Profitability MarketProspects

Ability to meet short-term

obligations and to efficiently

generate revenues

Ability to generate future revenues and

meet long-term obligations

Ability to generate positive market

expectations

Ability to provide financial rewards

sufficient to attract and retain

financing

Building Blocks of AnalysisBuilding Blocks of Analysis


Total Unit

Sales Revenue (2,000 units) 100,000$ 50$

Less: Variable costs 60,000 30

Contribution margin 40,000$ 20$

Less: Fixed costs 30,000

Net income 10,000$

How much contribution margin must this company have to cover its fixed costs (break even)?

Answer: $30,000

Computing Break-Even PointComputing Break-Even Point


Target net income is income after income tax.Target net income is income after income tax.

Dollar sales =

Fixed Target net Incomecosts income taxes

Contribution margin ratio

+ +

Computing Sales (Dollars) for aTarget Net IncomeComputing Sales (Dollars) for aTarget Net Income Exh.

22-14


The resulting break-even formulafor composite unit sales is:

Break-even pointin composite units

Fixed costsContribution marginper composite unit

=

Consider the following example:

Continue

Computing MultiproductBreak-Even PointComputing MultiproductBreak-Even Point Exh.

22-19


YearAnnual Net Cash Flows

Present Value of $1

Factor

Present Value of

Cash Flows1 4,100$ 0.8929 3,661$ 2 4,100 0.7972 3,269 3 4,100 0.7118 2,918 4 4,100 0.6355 2,606 5 4,100 0.5674 2,326 6 4,100 0.5066 2,077 7 4,100 0.4523 1,854 8 4,100 0.4039 1,656

Total 32,800$ 20,367$

Amount to be invested (16,000) Net present value of investment 4,367$

A positive net present value indicates that thisproject earns more than 12 percent on the investment.

Net Present Valuewith Even Cash FlowsNet Present Valuewith Even Cash Flows Exh.

26-7


Internal Rate of Return (IRR)Internal Rate of Return (IRR)

The interest rate that makes . . .

Presentvalue of

cash inflows

Presentvalue of

cash outflows=

The net present value equal zero.


Costs that are applicableto a particular decision.

Costs that should have a bearing on which alternative a manager selects.

Costs that are avoidable.Future costs that differ

between alternatives.

1

2

Relevant CostsRelevant Costs

Documents

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irw1in Identifies Records Communicates Relevant Reliable Comparable Importance of Accounting Accounting