ACCOUNTING: TEXT AND CASES

ACCOUNTING: TEXT AND CASES
Anthony, Hawkins, and Merchant ACCOUNTING: TEXT AND CASES Tenth Edition These electronic slides are intended for the exclusive use by adopters of Irwin/McGraw-Hill accounting textbooks only. Any other use of these presentations without express written permission of Irwin/McGraw-Hill is strictly prohibited. The McGraw-Hill Companies, Inc., 1999

This electronic presentation prepared by Douglas Cloud, Professor of Accounting, Pepperdine University

Task Force Clip Art included in this electronic presentation is used with the permission of New Vision Technology of Nepean Ontario, Canada

1 The Nature and Purpose of Accounting Part One: Financial Accounting
The McGraw-Hill Companies, Inc., 1999

Planning Slide 1-1 Planning is the process of deciding what actions should be taken in the future. ….

Planning recognizing that a problem or an opportunity exists
Slide 1-2 Planning involves making decisions. Decisions are arrived at by-- recognizing that a problem or an opportunity exists specifying and ranking the criteria to be used to determine the best solution identifying alternative ways of addressing the problem or opportunity analyzing the consequences of each alternative comparing these consequences to each other and the criteria so as to decide which is best

The Nature and Purpose of Accounting
Slide 1-3 Information Nonquantitative information Quantitative information Accounting information Nonaccounting information Consists of Operating information Financial accounting Management accounting Tax accounting Consists of

Relationship of Management Functions
Slide 1-4 Planning

Slide 1-5 Planning Implementation

Slide 1-6 Planning Implementation Control

Slide 1-7 Planning Implementation Control Appropriate action Feedback Plan revision

The Balance Sheet HOLDEN COMPANY Assets Liabilities and Owners’ Equity
Slide 1-8 HOLDEN COMPANY Balance Sheet As of December 31, 1999 (000 omitted) Assets Liabilities and Owners’ Equity Current assets: Current liabilities: Cash $ 1,449 Accounts payable $ 5,602 Marketable securities 246 Bank loan payable 1,000 Accounts receivable, net 9,944 Accrued liabilities 876 Inventories 10,623 Estimated tax liability 1,541 Prepaid expenses Current portion of long- term debt Total current assets $22, Total current liabilities $ 9,519 Current Section

The Balance Sheet Assets Liabilities and Owners’ Equity
Slide 1-9 Assets Liabilities and Owners’ Equity Noncurrent assets: Noncurrent liabilities: Property, plant, equipment Long-term debt, less at cost $26, current portion $ 2,000 Less: Accumulated Deferred income taxes Depreciation 13, Total liabilities 12,343 Property, plant, equipment net 13,412 Owners’ equity: Investments 1,110 Common stock 1,000 Patents and trademarks 403 Additional paid-in capital 11,256 Goodwill Total paid-in capital 12,256 Retained earnings 13,640 Total owners’ equity 25,896 Total liabilities and owners’ Total assets $38,239 and owners’ equity $38,239 Noncurrent Section

The Accounting Equation
Slide 1-10 Assets = Liabilities + Owners’ Equity Assets are economic resources which are owned by a business and are expected to benefit future operations.

The Accounting Equation
Slide 1-11 Assets = Liabilities + Owners’ Equity Liabilities are obligations of the entity to outside parties who have furnished resources

Less operating expenses 10,785 Income before taxes 12,466
Income Statement Slide 1-12 HOLDEN COMPANY Income Statement For the Year 1999 (000 omitted) Sales revenue $75,478 Less cost of sales 52,227 Gross margin 23,251 Less operating expenses 10,785 Income before taxes 12,466 Provision for income taxes 6,344 Net income $ 6,122

Financial Statement Objectives
Slide 1-13 Financial reporting should provide information: Useful to present and potential investors and creditors in making rational investment and credit decisions Comprehensible to those who have a reasonable understanding of business and economic activities and are willing to study the information with reasonable diligence About the economic resources of an enterprise, the claims to those resources, and the effects of transactions and events that change resources and claims to those resources About an enterprise’s financial performance during a period

Condensed Balance Sheet
A “Package” of Accounting Reports Slide 1-14 Condensed Balance Sheet As of December 31, 1999 Assets Current assets $22,651 Building and equip. 13,412 Other assets 2,176 Total assets $38,239 Liabilities and Owners’ Equity Liabilities $12,343 Owners’ Equity Paid-in capital 12,256 Retained earnings 13,640 Total liabilities and owners’ equity $38,239

Condensed Balance Sheet
A “Package” of Accounting Reports Slide 1-15 Income Statement For the Year 1999 Condensed Balance Sheet As of December 31, 1999 Assets Current assets $22,651 Building and equip. 13,412 Other assets 2,176 Total assets $38,239 Liabilities and Owners’ Equity Liabilities $12,343 Owners’ Equity Paid-in capital 12,256 Retained earnings 13,640 Total liabilities and owners’ equity $38,239 Sales revenue $75,478 Less cost of sales 52,222 Gross margin 23,351 Less operating exp. 10,785 Income before taxes 12,466 Provision for taxes 6,344 Net income, 1999 $ 6,122

A “Package” of Accounting Reports
Slide 1-16 Income Statement For the Year 1999 Condensed Balance Sheet As of December 31, 1999 Assets Current assets $22,651 Building and equip. 13,412 Other assets 2,176 Total assets $38,239 Liabilities and Owners’ Equity Liabilities $12,343 Owners’ Equity Paid-in capital 12,256 Retained earnings 13,640 Total liabilities and owners’ equity $38,239 Sales revenue $75,478 Less cost of sales 52,222 Gross margin 23,351 Less operating exp. 10,785 Income before taxes 12,466 Provision for taxes 6,344 Net income, 1999 $ 6,122 Statement of Retained Earnings Retained earnings $13,640 Add net income 6,122 19,762 Less dividends 4,390 Retained earnings $15,372

Slide 1-17 Income Statement For the Year 1999 Condensed Balance Sheet As of December 31, 1999 Assets Current assets $22,651 Building and equip. 13,412 Other assets 2,176 Total assets $38,239 Liabilities and Owners’ Equity Liabilities $12,343 Owners’ Equity Paid-in capital 12,256 Retained earnings 13,640 Total liabilities and owners’ equity $38,239 Sales revenue $75,478 Less cost of sales 52,222 Gross margin 23,351 Less operating exp. 10,785 Income before taxes 12,466 Provision for taxes 6,344 Net income, 1999 $ 6,122 Statement of Retained Earnings Retained earnings $13,640 Add net income 6,122 19,762 Less dividends 4,390 Retained earnings $15,372

Slide 1-18 Current assets $24,062 Building and equip. 14,981 Other assets 3,207 Total assets $42,250 Liabilities and Owners’ Equity Liabilities $14,622 Owners’ Equity Paid-in capital 12,256 Retained earnings 15,372 Total liabilities and owners’ equity $42,250 Condensed Balance Sheet As of December 31, 2000 Assets Statement of Retained Earnings Retained earnings $13,640 Add net income 6,122 19,762 Less dividends 4,390 Retained earnings $15,372

Slide 1-19 Current assets $24,062 Building and equip. 14,981 Other assets 3,207 Total assets $42,250 Liabilities and Owners’ Equity Liabilities $14,622 Owners’ Equity Paid-in capital 12,256 Retained earnings 15,372 Total liabilities and owners’ equity $42,250 Condensed Balance Sheet As of December 31, 2000 Assets Statement of Retained Earnings Retained earnings $13,640 Add net income 6,122 19,762 Less dividends 4,390 Retained earnings $15,372

Summary An organization has four types of accounting information:
Slide 1-20 An organization has four types of accounting information: Operating information, which has to do with the details of operations Management accounting information, which is used internally for planning, implementation, and control Financial accounting information, which is used both by management and external parties Tax accounting information, which is used to file tax returns with taxing authorities

2 Basic Accounting Concepts: The Balance Sheet
Part One: Financial Accounting The McGraw-Hill Companies, Inc., 1999

Basic Concepts Accounting period Money measurement Conservatism
Slide 2-1 Accounting period Conservatism Realization Matching Consistency Materiality Money measurement Entity Going concern Cost Dual aspect

The Entity Concept Owner
Slide 2-2 The owner of a clothing store removes $100 from the store’s cash register for personal use. Should the store’s accounting records show that the owner took this cash? Owner

The Entity Concept Slide 2-3 Yes, because of the entity concept. This concept requires that the accounting records of the clothing store show that the business has less cash than it had previously.

The Going -Concern Concept
Slide 2-4 A thriving blue jeans manufacturing firm has jeans in various stages of production. If the firm had to cease operations and liquidate today, the jeans would have little, if any, value. If today is the last day of the accounting period, should the jeans be shown at liquidation value?

The Going -Concern Concept
Slide 2-5 Because of the going-concern concept, the firm would not value the jeans at what they are currently worth--the liquidation value.

The Cost Concept--Nonmonetary Assets
Slide 2-6 Land purchased last year for $250,000 has a current market value of $270,000. What amount should be shown in the accounting records to reflect ownership of this land?

The Cost Concept--Nonmonetary Assets
Slide 2-7 The land should be shown at the original purchase price of $250,000 because of the cost concept.

What amount should be shown on the balance sheet?
The Cost Concept--Monetary Assets Slide 2-8 A company invested surplus cash in 100,000 shares of the common stock of General Electric. The cost of per share was $60; therefore, the firm spent $6,000,000. By the end of the fiscal period, the stock had a fair market value of $65 per share. What amount should be shown on the balance sheet?

The Cost Concept--Monetary Assets
Slide 2-9 The fair value of the stocks is $6,500,000. This is the amount that should be shown for this monetary asset.

The Dual-Aspect Concept
Slide 2-10 Assets = Equities Assets = Liabilities + Owners’ equity + $40,000 + $40,000 = Ms. Jones opens a bank account for the business by depositing $40,000.

The Dual-Aspect Concept
Slide 2-11 Assets = Liabilities + Owners’ equity + $40,000 = $40,000 + 15,000 + 15,000 The business borrows $15,000 from the bank.

Assets = Liabilities + Owners’ equity
The Dual-Aspect Concept Slide 2-12 Assets = Liabilities + Owners’ equity + $40,000 = $40,000 + 15,000 + 15,000 $55, $15, $40,000 Assets = Equities

The Balance Sheet--The Heading
Slide 2-13 GARSDEN CORPORATION Balance Sheet As of December 31, 1998 Name of entity Name of statement Moment of time

The Balance Sheet--Assets
Slide 2-14 Current assets: Cash $ 3,448,891 Marketable securities 246,221 Accounts receivable 5,954,588 Inventories 12,623,412 Prepaid expenses ,960 Total current assets $22,651,072 Property, plant, and equipment: Land 642,367 Building and equipment, at cost 26,303,481 Less: accumulated depreciation 13,534,069 12,769,412 Other assets: Investments 110,000 Intangible assets , ,214 Total assets $36,236,065

The Balance Sheet--Liabilities and Shareholders’ Equity
Slide 2-15 Current liabilities: Accounts payable $ 6,301,442 Taxes payable 1,672,000 Accrued expenses 640,407 Deferred revenues 205,240 Current portion of long-term debt ,000 Total current liabilities $ 9,119,089 Long-term debt 3,000,000 Total liabilities 12,119,089 Shareholders’ equity: Paid-in capital 5,000,000 Retained earnings 19,116,976 Total shareholders’ equity 24,116,976 Total liabilities and shareholders’ equity $36,236,065

Account Categories--Current Assets
Slide 2-16 Cash Funds that are readily available for distribution Marketable securities Investments that are both readily marketable and expected to be converted into cash within one year Accounts receivable Amounts owed to the entity by its customers

Account Categories--Current Assets
Slide 2-17 Inventories Aggregate of items either held for sale in the ordinary course of the business, in process of production for such sale, or soon to be consumed in production Prepaid expenses Assets, usually of an intangible nature, whose usefulness will expire in the near future

Account Categories--Current Liabilities
Slide 2-18 Accounts payable Claims of suppliers arising from their furnishing goods or services to the entity for which they have not been paid Taxes payable Amount the entity owes governmental agencies

Account Categories--Current Liabilities
Slide 2-19 Accrued expenses Amounts earned by outside parties but have not been paid by the entity Deferred revenues Liabilities that arise because the entity receives advanced payments for services the entity has agreed to render in the future Current portion of long-term debt

Music Mart Slide 2-20 On January 1, John Smith starts an incorporated CD and tape store called Music Mart, Inc. He deposits $25,000 of his own funds in a bank account that he opened in the name of the entity. In return, he takes $25,000 of stock certificates.

Music Mart Slide 2-21 On January 1, John Smith starts an incorporated CD and tape store called Music Mart, Inc. He deposits $25,000 of his own funds in a bank account that he opened in the name of the entity. In return, he takes $25,000 of stock certificates. MUSIC MART Balance Sheet As of January 1 Assets Liabilities and Owners’ Equity Cash $25,000 Paid-in capital $25,000

Music Mart Slide 2-22 On January 2, Music Mart borrows $12,500 from a bank; the loan is evidence by a legal document called a note. MUSIC MART Balance Sheet As of January 1 Assets Liabilities and Owners’ Equity Cash $25,000 Paid-in capital $25,000

Music Mart Slide 2-23 On January 2, Music Mart borrows $12,500 from a bank; the loan is evidence by a legal document called a note. MUSIC MART Balance Sheet As of January 1 Assets Liabilities and Owners’ Equity Cash $37,500 Notes payable $12,500 Paid-in capital 25,000 Total $37,500 Total $37,500

Music Mart Slide 2-24 On January 3, the business buys inventory in the amount of $5,000, paying cash. MUSIC MART Balance Sheet As of January 1 Assets Liabilities and Owners’ Equity Cash $32,500 Notes payable $12,500 Inventory 5,000 Paid-in capital 25,000 Total $37,500 Total $37,500

Music Mart Slide 2-25 On January 4, the business sells merchandise that cost $500 for $750. Cash was received. MUSIC MART Balance Sheet As of January 1 Assets Liabilities and Owners’ Equity Cash $33,250 Notes payable $12,500 Inventory 4,500 Paid-in capital 25,000 Retained earnings 250 Total $37,750 Total $37,750

3 Basic Accounting Concepts: The Income Statement

Basic Business Financial Flows
Slide 3-1 Collection activities Cash Purchasing or production activities Accounts receivable Inventories Earnings activities

Basic Concepts Accounting period Money measurement Conservatism Entity

Basic Concepts Let’s take a look at Revenues $122,400 our summer camps
Slide 3-3 Let’s take a look at our summer camps income statement for a few summer months. Revenues $122,400 Less expenses: Food $42,756 Wages 46,935 Rental 12,000 Other costs 5,472 Total exp. 107,163 Net income $ 15,237 Accounting Period Concept

Basic Concepts The accounting period Revenues $122,400
Slide 3-4 The accounting period concept allows us to find out how we did for a specific period of time. Revenues $122,400 Less expenses: Food $42,756 Wages 46,935 Rental 12,000 Other costs 5,472 Total exp. 107,163 Net income $ 15,237 Accounting Period Concept

Aspects of the conservatism concept:
Basic Concepts Slide 3-6 Aspects of the conservatism concept: Recognize revenues (increases in retained earnings) only when they are reasonably certain. Recognize expenses (decreases in retained earnings) as soon as they are reasonably possible.

When should the revenue be recognized?
Basic Concepts Slide 3-7 In December, customers pay for a year’s subscription to a magazine that they will begin receiving in January. When should the revenue be recognized? Conservatism Concept

Basic Concepts Slide 3-8 In December, customers pay for a year’s subscription to a magazine that they will begin receiving in January. Revenue is recognized when the service is performed--thus in the year the magazine service is provided. Conservatism Concept

Basic Concepts Slide 3-10 Joe makes credit sales of merchandise amounting to $100,000. Realization Concept

Basic Concepts Slide 3-11 If experience indicates that 3 percent of credit sales will eventually become bad debts, then revenue for the period is $97,000. Sorry Joe, I can’t pay. Realization Concept

Basic Concepts Slide 3-13 Today is March On March 19, an item of inventory costing $1,000 is received. 19 Matching Concept

16 Basic Concepts On April 16, the vendor is paid in full.
Slide 3-14 Today is April On April 16, the vendor is paid in full. 16 Matching Concept

When should the merchandise be an expense to the firm?
Basic Concepts Slide 3-15 Today is May On May 9, the item of merchandise is sold for $1,500. 9 When should the merchandise be an expense to the firm? Matching Concept

9 Basic Concepts In May, when the merchandise is sold.
Slide 3-16 Today is May On May 9, the item of merchandise is sold for $1,500. 9 In May, when the merchandise is sold. Matching Concept

Expenditures that are also expenses
Basic Concepts Slide 3-17 Types of transactions that need to be considered in distinguishing between amounts that are properly considered as expenses of a given accounting period and the expenditures made in connection with the item. Expenditures that are also expenses Beginning assets that become expenses Expenditures that are not yet expenses Expenses not yet paid

Basic Concepts Slide 3-19 LIFO The consistency concept: Once an entity has decided on one accounting method, it should use the same method for all subsequent events of the same character (unless it has a sound reason to change methods).

Basic Concepts Slide 3-21 A dozen pencils were purchased for the office secretary. These pencils are assets to the firm and technically should be expensed each time one is used. Materiality allows the firm to expense the pencil either at the time of purchase or when an inventory is taken of office supplies at period-end. Materiality

Income Statement GARDEN CORPORATION Net sales $75,478,221
Slide 3-22 GARDEN CORPORATION Income Statement For the Year Ended December 31, 1998 Net sales $75,478,221 Cost of sales 52,227,004 Gross margin 23,251,217 Research and development expense 2,158,677 Selling, genera, and administrative expenses 8,726,696 Operating income 12,356,844 Other revenues (expenses): Interest expense (363,000 Interest and dividend revenues 43,533 Royalty revenues ,010 Income before income taxes 12,466,387 Provision for income taxes 4,986,555 Net income $ 7,479,832 )

Statement of Retained Earnings
Slide 3-23 Statement of Retained Earnings Retained earnings at the beginning of year $16,027,144 Add: Net income 7,479,832 Deduct: Dividends ($4 per common share) (4,390,000 Retained earnings at end of year $19,116,976

4 Accounting Records and Systems Part One: Financial Accounting

The Account (decrease) Cash (increase) 750 Beginning balance -0- 5,000
Slide 4-1 Cash (decrease) 750 7,200 4,800 3,000 15,750 (increase) Beginning balance -0- 5,000 4,000 200 12,000 21,200 New balance ,450

Debits and Credits Assets Liabilities Owners’ Equity
Slide 4-2 Assets Liabilities Owners’ Equity Debit Credit Debit Credit Debit Credit

The Accounting Process
Slide 4-3 1. Analyze transactions 2. Journalize original entries 3. Post journal entries to ledger 4. Identify, journalize, and post adjusting entries 5. Journalize and post closing entries 6. Prepare financial statements

Transaction Analysis Slide 4-4 On August 1, Snelson invested $5,000 in the business as owner. Cash Paid-in Capital 5,000 5,000

Transaction Analysis Slide 4-5 On August 1, the firm paid $750 rent for the month of August. Cash Prepaid Expenses 5,000 750 750

Transaction Analysis Slide 4-6 The firm borrowed $4,000 from a bank on a 9 percent note payable, with interest payable quarterly and the principal due in full at the end of two years. Cash Notes Payable 5,000 750 4,000 4,000

Transaction Analysis Slide 4-7 Equipment costing $7,200 was purchased for cash. The expected life of the equipment was 10 years. 4,000 Cash Equipment, at Cost 5,000 750 7,200 7,200 Refer to pages 94 through 96 for the remaining entries for the month of August.

Balancing an Account Cash Balance -0- 750 5,000 7,200 4,000 4,800
Slide 4-8 Balance 5,000 7,200 4,000 4,800 200 3,000 12, To Balance ,450 21,200 21,200 Cash Balance ,450

The Trial Balance CAMPUS PIZZERIA, INC. Slide 4-9 Trial Balance
As of August 31 Balance Debit Credit Cash……………………………………………………. $ 5,450 Accounts receivable……………………………………. -0- Inventory……………………………………………….. 550 Prepaid expenses……………………………………….. 750 Equipment, at cost……………………………………… 7,200 Accounts payable………………………………………. $ 2,200 Notes payable………………………………………….. 4,000 Paid-in capital………………………………………….. 5,000 Sales revenue………………………………………… ,200 Cost of sales……………………………………………. 6,000 Wage expense………………………………………….. 3,000 Utilities expense……………………………………… Totals……………………………………………….. $23,400 $23,400

Fuel oil was purchased for $1,000.
Adjusting Entries Slide 4-10 Fuel oil was purchased for $1,000. Fuel Oil Inventory Accounts Payable 1,000 1,000

Adjusting Entries Slide 4-11 By the end of the accounting period, $600 of the fuel had been consumed. Fuel Oil Inventory Fuel Expense 1,000 600 600

Paid an insurance premium on company car, $1,200.
Adjusting Entries Slide 4-12 Paid an insurance premium on company car, $1,200. Prepaid Insurance Cash 1,200 1,200

At year-end, $800 of this is an expense.
Adjusting Entries Slide 4-13 At year-end, $800 of this is an expense. Prepaid Insurance Insurance Expense 1,200 800 800

Adjusting Entries Slide 4-14 Employees earned $150 of wages during the period. These wages have not been paid. Wages Expense Accrued Wages 150 150

Annual depreciation on equipment totaled $2,000.
Adjusting Entries Slide 4-15 Annual depreciation on equipment totaled $2,000. Depreciation Accumulated Expense Depreciation 2,000 2,000 Additional adjusting entries are explained on pages 99 through 101 of the textbook.

Closing the Sales Revenues account
Closing Entries Slide 4-16 Closing the Sales Revenues account Sales Income Revenues Summary 12, ,400 12,200 200

Closing the Cost of Sales account
Closing Entries Slide 4-17 Closing the Cost of Sales account Cost of Income Sales Summary 6,000 6,000 6,000 12,400

Closing Entries Closing the Income Summary account Income Summary
Slide 4-18 Closing the Income Summary account Income Summary (B) 6,000 (C) 3,000 (D) 450 (E) 750 (F) 60 (G) 10,290 (A) ,400 Credit Income Tax Liability (17) (H) ,528

Financial Statements CAMPUS PIZZERIA, INC.
Slide 4-19 CAMPUS PIZZERIA, INC. Balance Sheet As of August 31 Assets Liabilities and Owners’ Equity Cash $ 5,450 Accounts payable $ 2,200 Accounts receivable 200 Notes payable 4,000 Inventory 550 Accrued expenses 30 Prepaid expenses Income tax liability Total current assets 6, Total liabilities 6,612 Equipment, at cost 7,200 Paid-in capital 5,000 Less: Accum. Depr Retained earnings 1,728 Equipment, net 7, Total owners’ equity 6,728 Total assets $13,340 Total liab. and own. eq. $13,340

Financial Statements CAMPUS PIZZERIA, INC. Sales revenues $12,400
Slide 4-20 CAMPUS PIZZERIA, INC. Income Statement For the Month of August Sales revenues $12,400 Cost of sales 6,000 Gross margin 6,400 Operating expenses: Wages $3,000 Rent 750 Utilities 450 Depreciation 60 Interest ,290 Income before income taxes 2,110 Income tax expense Net income $ 1,728

5 Revenue and Monetary Assets Part One: Financial Accounting

The Business Operating Cycle
Slide 5-1 Collect cash from the customer Customer acknowledges receipt of the item Purchase materials Ship the product and send the customer an invoice Convert materials into a finished product Receive an order for the product from a customer Inspect the product Store the product in a warehouse

Timing of Revenue Recognition
Slide 5-2 Typical Revenue Recognition Revenue Recognition Event at This Time Method 1. Sales order received no none 2. Deposit or advance no none payment received 3. Goods being produced For certain long- percentage of term contracts completion 4. Production completed; For precious metals production goods stored and certain agri- cultural products 5. Goods shipped or usually delivery 6. Customer pays account collection is installment receivable uncertain

Consignment Shipments
Slide 5-3 Goods costing $1,000 were shipped out on consignment. dr. Inventory on consignment 1,000 cr. Merchandise inventory 1,000

Consignment Shipments
Slide 5-4 These goods are sold by the consignee for $1,400. dr. Cost of goods sold 1,000 cr. Inventory on consignment 1,000 dr. Accounts receivable 1,400 cr. Sales revenue 1,400

Completed-Contract Method
Slide 5-5 Customer Project Year-End Payments Costs Percent Year Received Incurred Complete Revenues Expenses Income 1 $120,000 $160, $ $ $ 2 410, , 3 370, , , , ,000 Total $900,000 $800,000 $900,000 $800,000 $100,000 If the amount of income to be earned on the contract cannot be reliably estimated, then revenue is to be recognized only when the project has been completed.

Percentage-of-Completion Method
Slide 5-6 Customer Project Year-End Payments Costs Percent Year Received Incurred Complete Revenues Expenses Income 1 $120,000 $160, $180,000 $160,000 $ 20,000 2 410, , , ,000 50,000 3 370, , , , ,000 Total $900,000 $800,000 $900,000 $800,000 $100,000 GAAP assumes that the percentage-of-completion method will be used to account for long-term contracts.

schedule in Illustration 5-4.
Bad Debts Slide 5-7 The firm expects bad debts of $7,132 . Check out the aging schedule in Illustration 5-4.

The adjusting entry would be:
Bad Debts Slide 5-8 The adjusting entry would be: dr. Bad Debts Expense 7,132 cr. Allowance for Doubtful 7,132 The accounts receivable section of the December 31, 1997 balance sheet would appear as follows: Accounts receivable $262,250 less: allowance for doubtful accounts 7,132 accounts receivable, net $255,118

receivable is unchanged.
Bad Debts Slide 5-9 If sometime in 1998 the Essel Company decided that James Johnson was never going to pay his bill of $250, the following entry would be made: dr. Allowance for Doubtful Accounts 250 cr. Accounts Receivable 250 Note the the net amount of accounts receivable is unchanged. The accounts receivable section of the balance sheet immediately after the write-off entry would show-- Accounts receivable $262,000 less: allowance for doubtful accounts 6,882 accounts receivable, net $255,118

Sold $1,000 of merchandise on credit terms of 2/10, net/30.
Sales Discounts Slide 5-10 Sold $1,000 of merchandise on credit terms of 2/10, net/30.

Sold $1,000 of merchandise on credit terms of 2/10, net/30.
Sales Discounts Slide 5-10 Sold $1,000 of merchandise on credit terms of 2/10, net/30. dr. Accounts Receivable 980 cr. Sales Revenue 980 If payment is made within the discount period: dr. Cash 980 cr. Accounts Receivable 980

If payment is made after the discount period:
Sales Discounts Slide 5-11 If payment is made after the discount period: dr. Cash 1,000 cr. Discounts Not Taken 20 Accounts Receivable 980 The 2 percent discount really amounts to an annual rate of 32 percent.

Bank plan (MasterCard and Visa)
Credit Card Sales Slide 5-12 Bank plan (MasterCard and Visa) dr. Cash 970 Sales Discounts (Credit Cards) 30 cr. Sales Revenue 1,000 Other plans (American Express and Discover) dr. Accounts Receivable 970 Sales Discounts (Credit Cards) 30 cr. Sales Revenue 1,000

Interest Revenue Slide 5-13 On September 1, 1997, a bank loaned $10,000 for one year at 9 percent interest, the interest and principal to be paid on August 31, The bank’s entry on September 1, 1997 is: dr. Loan Receivable 10,000 cr. Cash 10,000 On December 31, 1997, an adjusting entry is made to record the fact that interest for one-third of a year, $300, was earned in 1997: dr. Loan Receivable 300 cr. Interest Revenue 300

Interest Revenue Slide 5-14 On September 1, 1997, a bank loaned $10,000 for one year at 9 percent discounted. dr. Loan Receivable 10,000 cr. Cash 9,100 Unearned Interest Revenue 900 On December 31, 1997, an adjusting entry is made to record the fact that $300 of interest was earned in 1997. dr. Unearned Interest Revenue 300 cr. Interest Revenue 300

On August 31, 1998, when the loan is repaid, the entry is:
Interest Revenue Slide 5-15 On August 31, 1998, when the loan is repaid, the entry is: dr. Cash 10,000 cr. Loans Receivable 10,000 After repayment by the borrower, an adjusting entry is also made by the bank to record the fact that $600 interest was earned in 1998. dr. Unearned Interest Revenue 600 cr. Interest Revenue 600

Current Ratio Current assets Current liabilities Current Ratio =
Slide 5-16 Current assets Current liabilities Current Ratio = $1,245.1 $1,214.6 Current Ratio = 1.03 Current Ratio =

Cash, temporary investments, and accounts receivable (net)
Acid-Test Ratio Slide 5-17 Cash, temporary investments, and accounts receivable (net) Monetary Current assets Current liabilities Acid-Test Ratio = $634.9 $1,214.6 Acid-Test Ratio = 0.52 Acid-Test Ratio =

Expenses (net of depreciation) 365 Cash Cost Per Day =
Slide 5-18 Expenses (net of depreciation) 365 Cash Cost Per Day = $5,348.0 365 Cash Cost Per Day = $14.65 per day Cash Cost Per Day =

Days’ Cash Cash Cash costs per day Days’ Cash = $98.1 $14.65
Slide 5-20 Cash Cash costs per day Days’ Cash = $98.1 $14.65 Days’ Cash = 7 days Days’ Cash =

6 Cost of Sales and Inventories Part One: Financial Accounting

Merchandise Inventory and Flows
Slide 6-1 Available for sale $11,400 Purchases $7,400 Ending inventory $? Cost of goods sold $? Beginning inventory $4,000 Inventory reservoir

Periodic Inventory Method
Slide 6-2 Beginning inventory $ 4,000 Plus: Purchases 7,400 Equals: Goods available for sale 11,400 Less: Ending inventory 2,000 Cost of goods sold $ 9,400 In the periodic inventory method a physical count is made of merchandise in the ending inventory.

Slide 6-3 Beginning inventory $ 4,000 Plus Purchases, gross $7,000 Freight-in 7,600 Less: Purchase returns Net purchases 7,400 Goods available for sale 11,400 Less: Ending inventory 2,000 Cost of goods sold $ 9,400

Slide 6-4 Entries First, close the beginning inventory amount: Cost of Goods Sold 4,000 Merchandise Inventory 4,000 Next, close Purchases, Purchases Returns, and Freight-In accounts. Cost of Goods Sold 7,400 Purchase Return 200 Purchases 7,000 Freight-In 600

Slide 6-5 Entries The new balance from the physical inventory is entered: Merchandise Inventory 2,000 Cost of Goods Sold 2,000 Finally, Cost of Goods Sold is closed: Income Summary 9,400 Cost of Goods Sold 9,400

Perpetual Inventory Method
Slide 6-6 Entries For purchases: Merchandise Inventory 7,000 Cost of Goods Sold 7,000 For shipment to customers: Cost of Goods Sold 8,800 Merchandise Inventory 8,800 For purchase returns: Accounts Payable 200 Merchandise Inventory 200

Item: Cassette Deck, Model S150 Unit: Each
Perpetual Inventory Method Slide 6-7 Item: Cassette Deck, Model S150 Unit: Each Date Receipts Shipments Balance Unit Unit Unit Units Cost Total Units Cost Total Units Cost Total Jan ,000 , , ,800 ,200 ,000

$11,000/$16,000 =69% Retail Method Beginning inventory $ 4,000 $ 6,000
Slide 6-8 At Cost At Retail Beginning inventory $ 4,000 $ 6,000 Purchases 7,000 10,000 Goods available for sale $11,000 $16,000 $11,000/$16,000 =69%

Cost of goods sold: $13,000 x .69 = $8,970
Retail Method Slide 6-9 At Cost At Retail Beginning inventory $ 4,000 $ 6,000 Purchases 7,000 10,000 Goods available for sale $11,000 $16,000 Sales 13,000 Ending inventory at retail $ 3,000 Ending inventory at cost $ 2,070 $3,000 x .69 Cost of goods sold: $13,000 x .69 = $8,970

Flow of Cost Through Inventories
Slide 6-10 Materials Inventory Balance, Jan 1 154 Purchases 273 Work in Process Inventory Balance, Jan 1 19 Finished Goods Inventory Balance, Jan 1 69

Slide 6-11 Materials Inventory Balance, Jan 1 154 Purchases 273 264 Work in Process Inventory Balance, Jan 1 19 Materials used 264 Conversion cost 330 Finished Goods Inventory Balance, Jan 1 69

Slide 6-12 Materials Inventory Balance, Jan 1 154 Purchases 273 264 Work in Process Inventory Balance, Jan 1 19 Materials used 264 570 Conversion cost 330 Finished Goods Inventory Balance, Jan 1 69 Cost of Goods Sold Goods manufactured 570

Inventory Costing Methods
Slide 6-13 Specific identification Average cost First-in, first-out (FIFO) Last-in, first-out (LIFO)

Slide 6-14 Basic Data Units Unit Cost Total Cost Inventory, January $8 $ 800 Purchased June Purchased October Goods available for sale 240 $2,140 Goods sold 150 Ending inventory 90

Specific Identification Method
Inventory Costing Methods Slide 6-15 Specific Identification Method Units Unit Cost Total Cost Inventory, January $8 $ 800 Purchased June Purchased October Goods available for sale 240 $2,140 Goods sold 150 Ending inventory 90 SOLD 100 SOLD 50

Slide 6-16 Specific Identification Method Units Unit Cost Total Cost Purchased June 1 10 $ 9 $ 90 Purchased October Ending inventory 90 $890 Cost of goods sold = (100 x $8) + (50 x $9) = $1,250

Slide 6-17 Average Cost Method Units Unit Cost Total Cost Inventory, January $8 $ 800 Purchased June Purchased October Goods available for sale 240 $8.917 $2,140 Ending inventory: 90 x $8.917 = $802 $2,140 240 Cost of goods sold: 150 x $8.917 = $1,338

Slide 6-18 FIFO Units Unit Cost Total Cost Inventory, January $8 $ 800 Purchased June Purchased October Goods available for sale 240 $2,140 Goods sold 150 Ending inventory 90 Sold 100 Sold 50

Cost of goods sold: (100 x $8) + (50 x $9) = $1,250
Inventory Costing Methods Slide 6-19 FIFO Units Unit Cost Total Cost Purchased June Purchased October Ending inventory 90 $890 Cost of goods sold: (100 x $8) + (50 x $9) = $1,250

Slide 6-20 LIFO Units Unit Cost Total Cost Inventory, January $8 $ 800 Purchased June Purchased October Goods available for sale 240 $2,140 Goods sold 150 Ending inventory 90 Sold 10 Sold 60 Sold 80

Slide 6-21 LIFO Units Unit Cost Total Cost Inventory, January 1 90 $8 $720 Ending inventory Cost of goods sold: (80 x $10) + (60 x $9) + (10 x $8) = $1,420

Comparison of Method FIFO $1,250 $890 $2,140
Slide 6-22 Cost of Ending Goods Sold Inventory Total FIFO $1,250 $890 $2,140 Average cost 1, ,140 LIFO 1, ,140

7 Long-Lived Nonmonetary Assets and Their Amortization

Types of Long-Lived Assets
Slide 7-1 Method of Converting to Expense Type of Asset Tangible assets: Land not amortized Plant and equipment depreciation Natural resources depletion Intangible assets: Goodwill amortization Patents, copyrights, etc. amortization Leasehold improvements amortization Deferred charges amortization Research and development costs not capitalized

Items Included in Cost Purchase price Sales tax Transportation costs
Slide 7-2 Purchase price Sales tax Transportation costs Installation cost

Straight-Line Method The expected amount to be recovered at the end
Slide 7-3 The expected amount to be recovered at the end of the service life. Original cost - Residual value Service life (years) Depreciation Expense = The number of accounting periods over which the asset will be useful to the entity.

Straight-Line Method Original cost - Residual value
Slide 7-4 Depreciation Expense = Original cost - Residual value Service life (years) Depreciation Expense = $10, $1,000 5 years Depreciation Expense = $1,800

Declining-Balance Method
Slide 7-5 Depreciation Expense Book Value $10,000 Year 1: $10,000 x .40 = $4, ,000 Year 2: $6,000 x .40 = 2,400 3,600 Year 3: $3,600 x. 40 = 1,440 2,160 Year 4: $2,160 x .40 = ,296 Year 5: $1,296 - $1,000 = ,000 Note that this amount reduces the book value to the salvage value.

Years’-Digits Method n + 1 5 + 1 n 2 5 2 15
Slide 7-6 First, determine the sum by using the following equation: n + 1 2 5 + 1 2 n = 5 15 = Next, build a table: Annual Depreciation Book Value $10,000 Year 1: 5/15 x ($10,000 - $1,000) $3,000 7,000 Year 2: 4/15 x ($10,000 - $1,000) 2,400 4,600 Year 3: 3/15 x ($10,000 - $1,000) 1,800 2,800 Year 4: 2/15 x ($10,000 - $1,000) 1,200 1,600 Year 5: 1/15 x ($10,000 - $1,000) 600 1,000

Units-of-Production Method
Slide 7-7 Depreciation Expense = Original cost - Residual value Service life (units) Depreciation Expense = $10, $1,000 90,000 miles Depreciation Expense = $.10 per mile

Accounting for Depreciation
Slide 7-8 Building, at net $1,000,000 Less: Accumulated depreciation ,000 Building, net $975,000 December 31, 1996 Building, at net $1,000,000 Less: Accumulated depreciation ,000 Building, net $950,000 December 31, 1997

Accounting for Depreciation
Slide 7-9 The annual journal entry to record depreciation is: Depreciation Expense 25,000 Accumulated Depreciation 25,000 A fully depreciated building still in use (assume no salvage value) would appear on the balance sheet as follows: Building, at net $1,000,000 Less: Accumulated depreciation 1,000,000 Building, net $0

Disposal of Plant and Equipment
Slide 7-10 A building is sold for its book value of $750,000: Cash 750,000 Accumulated Depreciation 250,000 Building 1,000,000 Assume instead that the building was sold for $650,000: Cash 650,000 Accumulated Depreciation 250,000 Loss on Sale of Building 100,000 Building 1,000,000

Exchanges and Trade-Ins
Slide 7-11 Assume a company trades in two automobiles, each of which originally cost $20,000 and each has a book value of $5,000. Each car has a market value of $7,000. $18,000 + $7,000 - “gain” of $2,000 The first car is traded for another car with a list price of $30,000, and $18,000 cash is given to the dealer in addition to the trade-in. Automobile (New) 23,000 Accumulated Depreciation (Automobile) 15,000 Cash 18,000 Automobile (Old) 20,000

Exchanges and Trade-Ins
Slide 7-12 Assume a company trades in two automobiles, each of which originally cost $20,000 and each has a book value of $5,000. Each car has a market value of $7,000. The second automobile is traded for a piece of equipment that also has a list price of $30,000 and $18,000 cash is given in addition to the trade-in. $18,000 + $7,000 Equipment (New) 25,000 Accumulated Depreciation (Automobile) 15,000 Cash 18,000 Automobile (Old) 20,000 Gain on Disposal of Automobile 2,000

Group Depreciation Slide 7-13 Group depreciation treats all similar assets (such as automobile or office chairs) as a “pool” or group rather than making the calculation for each one separately. A used microcomputer which originally cost $3,000 is disposed of for $400 cash. Cash 400 Accumulated Depreciation, Microcomputers 2,600 Microcomputers 3,000

A method provided by the tax code
MACRS Slide 7-14 A method provided by the tax code Designed as an incentive to invest in capital assets Shortened assets’ lives for tax purposes Most classes of property acquired or disposed of at any point during the year are assumed to have been acquired or disposed of at the midpoint of the year

MACRS Assume that a machine in the five-year class is
Slide 7-15 Assume that a machine in the five-year class is acquired at some point in 19x1 for $100,000. Cost Recovery Year Deduction Computation 19x1 $ 20,000 1/2 * 40% * $100,000 19x2 32,000 40% * ($100,000 - $20,000) 19x3 19,200 40% * ($80,000 - $32,000) 19x4 11,520 40% * ($48,000 - $19,200) 19x5 11,520 change to straight-line 19x ,760 1/2 * 19x5 amount Total $100,000

Investment Tax Credit Slide 7-16 In late December 19x1 a company purchased a $200,000 machine that qualified for a $20,000 investment tax credit. Income Tax Liability 20,000 Income Tax Expense 20,000 This is the flow-through method.

Investment Tax Credit Slide 7-17 An alternative approach is to record the investment tax credit as a deferred credit--which is analogous to unearned revenue. Income Tax Liability 20,000 Deferred Investment Tax Credits 20,000 This approach is called the deferred method.

Investment Tax Credit In 19x2 and the subsequent nine years, Income
Slide 7-18 In 19x2 and the subsequent nine years, Income Tax Expense would be decrease by $2,000. Deferred Investment Tax Credits 2,000 Income Tax Expense 2,000 This method has the effect of increasing net income each year the entry is made.

Depletion Expense An oil property cost $250 million and is
Slide 7-19 An oil property cost $250 million and is estimated to contain 50 million barrels of oil. Depletion Expense = Original cost - Residual value Total barrels of oil Depletion Expense = $250 million - $0 50 million Depletion Expense = $5 per barrel

Leasehold improvements Deferred charges Research and development costs
Intangible Assets Slide 7-20 Goodwill Patent Copyrights Franchise rights Leasehold improvements Deferred charges Research and development costs

8 Sources of Capital: Debt Part One: Financial Accounting

2. The amount of loss can be reasonable estimated.
Loss Contingency Slide 8-1 A loss contingency is recorded as a liability if both of the following conditions are met: 1. Information available prior to issuance of the financial statements indicates that it is probable that an asset has been impaired or a liability has incurred. 2. The amount of loss can be reasonable estimated.

a specified sum of money at a stated date, called the maturity date
Bonds Slide 8-2 A bond is a certificate promising to pay its holder-- a specified sum of money at a stated date, called the maturity date interest at a stated rate until the maturity date Bond

Types and Features of Bonds
Slide 8-3 A bond can have a combination of these features. Mortgage bond Secured bond Debenture bond Sinking fund bond Serial bonds Callable bonds Zero-coupon bonds Convertible bonds Subordinated bonds

Recording a Bond Issue Slide 8-4 Mason Corporation’s 10% bonds, for which investors paid $851 each, also had issue costs to Mason averaging $21 per bond, resulting in a net cash inflow to Mason of $830 per bond. Cash 83,000 Bond Discount 14,900 Deferred Charges 2,100 Bonds Payable 100,000

Recording a Bond Issue Slide 8-5 By contrast, if prevailing rates for similar bonds had been 9 percent, the bonds would have been issued at a premium of $91 per bond. Cash 107,000 Deferred Charges 2,100 Bond Premium 9,100 Bonds Payable 100,000

Balance Sheet Presentation
Slide 8-6 If a Discount: Bonds payable: Face value $100,000 Less: Unamortized discount 14,900 $ 85,100 If a Premium Bonds payable: Face value $100,000 Plus: Unamortized premium 9,100 $109,100

Bond Interest Expense Slide 8-7 The first year’s interest expense for the 10 percent Mason Corporation bonds (issued at a discount; effective rate is 12 percent). $85,100 x .12 Bond Interest Expense 10,212 Bond Discount 212 Cash 10,000 $100,000 x .10

Adjusting Entries Slide 8-8 The bonds were issued on October 1. The interest date is September 30, and the fiscal year ends on December 31. The adjusting entry at December 31 would be-- $85,100 x .12 x 3/12 Bond Interest Expense 2,553 Bond Discount 53 Accrued Interest Payable 2,500 $100,000 x .10 x 3/12

Interest Payment Entry
Slide 8-9 Payment of interest is made to bondholders on September 30. $85,100 x .12 x 9/12 Bond Interest Expense 7,659 Accrued Interest Payable 2,500 Bond Discount 159 Cash 10,000 $100,000 x .10

Refunding a Bond Issue Slide 8-10 One hundred Mason Corporation bonds are called at the end of five years at a price of $1,050 per bond. Miscellaneous refunding costs amount to $1,000. Reacquisition price ($105,000 + $1,000) $106,000 Net carrying amount: Face value $100,000 Less: Unamortized discount (13,553) Less: Unamortized issuance cost (1,575) 84,872 Loss on retirement of bond $ 21,128

Refunding a Bond Issue Slide 8-10 One hundred Mason Corporation bonds are called at the end of five years at a price of $1,050 per bond. Miscellaneous refunding costs amount to $1,000. Bonds Payable 100,000 Loss on Retirement of Bonds 21,128 Cash 106,000 Bond Discount 13,553 Deferred Charges (Issuance Costs) 1,575

Capital Leases Slide 8-11 The Financial Accounting Standards Board has ruled that a lease is a capital lease if one or more of the following criteria are met: Ownership is transferred to the the lessee at the end of the term of the lease The lessee has an option to purchase the asset at a “bargain” price The term of the lease is 75 percent or more of the economic life of the asset The present value of the lease payments is 90 percent or more of the fair value of the property

Capital Leases Slide 8-12 A company leases equipment whose useful life is 10 years. Lease payments are $1,558 per year payable at the end of each of the next 10 years. The fair value of the equipment is $10,000. What is the journal entry to record acquiring the equipment?. Equipment 10,000 Capital Lease Obligations 10,000

Capital Leases Slide 8-13 The first annual lease payment consists of $900 of interest expense and $658 to reduce the liability. Interest Expense 900 Capita Lease Obligations 658 Cash 1,558 Assuming straight-line depreciation, the following adjusting entry is made to record annual depreciation. Depreciation Expense 1,000 Accumulated Depreciation 1,000

Debt/Equity Ratio Total liabilities Shareholders’ equity
Slide 8-14 Total liabilities Shareholders’ equity Debt/Equity Ratio = $3,400 $3,600 Debt/Equity Ratio = Debt/Equity Ratio = 94 percent Excluding current liabilities, the ratio changes to 50 percent

Times Interest Earned Pre-tax income before interest Interest expense
Slide 8-15 Pre-tax income before interest Interest expense Times Interest Earned = $1,000 $200 Times Interest Earned = 5.0 times Times Interest Earned =

Future Value--Compound Interest
Slide 8-16 FV = p(1 + i) n where: p = Principal (initial investment) i = Interest rate n = Number of periods The future value of $1,000 invested at 5 percent for 10 years is given by: FV = $1,000( ) = $1,628.89 10

Present Value of a Future Amount
Slide 8-17 Amount to be received in future PV = p (1 + i) n What is the present value of $400 to be received 10 years hence, discounted at a rate of 8 percent? PV = p (1 + i) n From Table A, we find the 10 year/8% factor to be $ = $400 x 0.463

Present Value of a Series of Payments
Slide 8-18 What would be the present value of a series of equal payments of $1,750 for 10 years (assume 10 percent)? Year Payment (Table A) Value Present 1 $1, $1,591 2 1, ,446 3 1, ,314 4 1, ,195 Present value of series $5,546

Present Values and Liabilities
Slide 8-19 Kinnear Company borrowed $25,000, with interest at 10 percent to be paid annually and the principal to be repaid in one lump sum at the end of ten years. What balance sheet liability would be reported at the inception of the debt? Interest, $2,500*3.791 (Table B) $ 9,478 Principal, $25,000*0.621 (Table A) 15,575 Total present value $25,003* *Does not add exactly to $25,000 due to rounding

Present Values and Liabilities
Slide 8-20 Kinnear Company borrowed $25,000, with interest at 10 percent to be repaid in equal annual amounts at the end of each of the next five years. How much is each equal annual payment? PV of the annuity = Table B Value x Annual for 10 percent/5 payment year factor $25, = x ? $25, = x $6,595

9 Sources of Capital: Owners’ Equity Part One: Financial Accounting

Sole Proprietorship Forms of Business Organizations
Slide 9-1 Sole Proprietorship Owned by an individual No incorporation fees No special reports Profits taxed at proprietor’s personal tax rate Personally responsible for the entity’s debts Borrow money as an individual

Partnership Forms of Business Organizations
Slide 9-2 Partnership Owned by two or more persons Each partner is personally liable for all debts incurred by firm Each partner is responsible for business actions of other partners Taxed as individuals

Corporation Forms of Business Organizations
Slide 9-3 Corporation Legal entity with essentially perpetual existence Granted a charter to operate Taxed as an entity Limited liability to owners Ownership of an individual is easily added or liquidated

Disadvantages of the Corporation Form
Slide 9-4 There may be significant legal and other fees involved in formation. The corporation’s activities are limited to those specifically granted in its charter. It is subject to numerous regulations and requirements. It must secure permission from each state in which it wishes to operate. Its income is subject to double taxation.

Partnership Equity Salary $60,000 $20,000 $40,000
Slide 9-5 The partnership agreement of Jackson and Curtin provided that Jackson would receive a salary of $20,000 and Curtin a salary of $40,000; that each would receive 8 percent interest on their invested capital; and they they would share any remainder equally. The partnership’s net income for the year is $80,000. Total Jackson Curtin Salary $60,000 $20,000 $40,000 Interest on capital 8,000 2,400 5,600 Remainder 12, , ,000 Total $80,000 $28,400 $51,600

Partnership Equity Slide 9-6 If the partnership agreement is silent concerning the remainder, then it is divided equally. Total Jackson Curtin Salary $60,000 $20,000 $40,000 Interest on capital 8,000 2,400 5,600 Remainder 12, , ,000 Total $80,000 $28,400 $51,600

Recording a Common Stock Issue
Slide 9-7 Kuick Corporation is authorized to issue 200,000 shares of $1 par value common stock. Of these, 100,000 shares were issued at $7 per share. Cash 700,000 Common Stock at Par 100,000 Additional Paid-In Capital 600,000 100,000 x $1

Cash Dividend Slide 9-8 Kuick Corporation declares a $6,000 dividend on December 15 to be paid on January 15 to holders of record as of January 1. December 15 Retained Earnings 6,000 Dividends Payable 6,000 January 1 (no entry) January 15 Dividends Payable 6,000 Cash 6,000

Stock Dividend Slide 9-9 Kuick Corporation declares and issues a 5 percent stock dividend to the holders of its 100,000 outstanding shares (par value of $1) when the market price of a share is $10.50. 5,000 x $10.50 Retained Earnings 52,500 Common Stock at Par 5,000 Additional Paid-In Capital 47,500 5,000 x $1

Balance Sheet Presentation
Slide 9-10 PRESTON COMPANY AND SUBSIDIARIES Consolidated Balance Sheet At December 31 (millions) Common stock, $25 per share $ $ Capital in excess of par Retained earnings Treasury stock, at cost (1,653.1) (1,105.0) Total stockholders’ equity $1, $2,075.6

Basic Earnings Per Share
Slide 9-11 Basic earnings per share is a measurement of the corporation’s per share performance over a period of time. Assume Nugent Corporation had net income of $7 million and 1 million shares of common stock outstanding. Earnings per share = Net income Number of shares of common stock outstanding Earnings per share = $7,000,000 1,000,000 shares = $7

Basic Earnings Per Share
Slide 9-12 Now, assume that Nugent Corporation also has 100,000 shares of $8 convertible preferred stock. Earnings per share = Net income - Preferred dividends Number of shares of common stock outstanding Earnings per share = $7,000,000 - $800,000 1,000,000 shares = $6.20

Earnings Per Share Slide 9-13 For diluted earnings per share, we assume that the 100,000 convertible preferred shares are exchanged for 200,000 shares of common stock. Earnings per share = Net income - Preferred dividends Number of shares of common stock outstanding Earnings per share = $7,000,000 1,200,000 shares = $5.83

Earnings Per Share Slide 9-14 For diluted earnings per share, we assume that the 100,000 convertible preferred shares are exchanged for 200,000 shares of common stock. Note that all the preferred stock is assumed converted, so there would be no dividends. Earnings per share = Net income - Preferred dividends Number of shares of common stock outstanding 1,000,000 shares of common stock plus the 200,000 shares assumed from converting preferred stock Earnings per share = $7,000,000 1,200,000 shares = $5.83

Weighted-Average Number of Shares
Slide 9-15 Optel Corporation had 1 million shares of common stock outstanding on January 1. On July 1 it issued an additional 500,000 shares. How many weighted-average shares would be used for calculating earnings per share? 1,000,000 x 12/12 = 1,000,000 500,000 x 6/12 = ,000 Denominator amount 1,250,000

Zero-Coupon Bonds Slide 9-16 Bonds with a total par of $100,000 and carrying zero interest are issued when the current yield is 14 percent. How much should the investor pay for each $1,000 bond? $1,000 x .519 = $519 per $1,000 bond No cash is paid by the borrower until these bonds mature.

Debt With Warrants Slide 9-17 Some corporations issue warrants in conjunction with the issuance of bonds, putting an exercise price on the warrants of about 15 to 20 percent above the current market price of the common stock. If detachable, the warrants can be removed from the debt and used to purchase the issuer’s stock or sold to a third party.

Debt With Warrants Slide 9-18 Some corporations issue warrants in conjunction with the issuance of bonds, putting an exercise price on the warrants of about 15 to 20 percent above the current market price of the common stock. If nondetachable, the debt is accounted for as if it were a convertible debt security--no recognition is given to the equity character of the debt.

Redeemable Preferred Stock
Slide 9-19 Redeemable preferred stock not only pays dividends, it may also be redeemed by the investor on or after a certain date. The SEC requires that redeemable preferred stock be listed as a separate item on the balance sheet at it’s redemption price. This item must be listed between the liability and owners’ equity section and not included in the total of either liabilities or owner’s equity.

Redeemable Preferred Stock
Slide 9-20 Redeemable preferred stock $ 8,000,000 Stockholders’ equity: Common $1 par 20,000,000 Additional paid-in capital 75,000,000 Total paid-in capital 95,000,000 Retained earnings ,000,000 Total stockholders’ equity $155,000,000 The $8 million for redeemable preferred stock is not included.

10 Other Nonowner Items that Affect Owners’ Equity

Detailed Condensed Statement (Top)
Slide 10-1 BASEL CORPORATION Condensed Statement of Income and Retained Earnings Year Ended December 31, 1998 (in thousands) Net sales and other revenue $60,281 Expenses 46,157 Income from continuing operations before income taxes 14,124 Provision for income taxes 5,650 Income from continuing operations 8,474 Discontinued operations (Note A): Loss from operations of Division X (less applicable income taxes of $320) $480 Loss on disposal of Division X (less applicable income taxes of $ (1,440)

Detailed Condensed Statement (Bottom)
Slide 10-2 Extraordinary loss (less applicable income taxes of $400)(Note B) (600) Cumulative effect of changes in accounting principles (less applicable income taxes of $125)(Note C) (400) Net income $ 6,034 Retained earnings at beginning of year: As previously reported $41,400 Adjustments (Note D) (1,200) As restated 40,200 Add net income 6,034 Deduct dividends (2,000) Retained earnings at end of year $44,234

Extraordinary Items Slide 10-3 In order to qualify as an extraordinary item, an event must satisfy two criteria: The event must be unusual; it should be highly abnormal and unrelated to, or only incidentally related to, the ordinary activities of the entity. The event must occur infrequently; it should be of a type that would not reasonably be expected to recur in the foreseeable future.

Extraordinary Items Slide 10-4 The following gains and losses are specifically not extraordinary: Write-down or write-off of accounts receivable, inventory, or intangible assets Gains or losses from changes in the value of foreign currency Gains or losses on disposal of a segment of a business Gains or losses from the disposal of fixed assets Effects of a strike

Discontinued Operations
Slide 10-5 The transaction must involved a whole business Discontinuance may occur by abandoning the segment and selling off the assets Discontinuance may occur by selling the whole segment as a unit to some other company

Discontinued Operations
Slide 10-6 Two amounts are reported on the income statement after their income tax effect has been taken into account: 1. The net income or loss attributed to the operations of the segment until it is sold 2. The estimated net gain or loss on disposal after taking account of all aspects of the sale, including the amount received and the write-off of assets that are not sold

Change in Accounting Principles
Slide 10-7 Sometimes a change is required by a new FASB Statement. If a company has a sound reason for doing so, it may occasionally shift from one GAAP to another one. The consistency concept requires that a company use the same accounting principle from one year to the next. The cumulative effect of the change is reported as one of the nonrecurring items on the income statement in the year the changed is made.

Adjustments to Retained Earnings
Slide 10-8 Only correction of past periods errors is allowed as an adjustment to Retained Earnings.

Adjustments to Retained Earnings
Slide 10-8 So, what is an error? Mathematical mistakes Mistakes in the application of accounting principles An oversight or misuse of facts

Personnel Costs Deductions from an employee’s paychecks:
Slide 10-9 Deductions from an employee’s paychecks: An amount representing the employee’s FICA contribution and medicare coverage An amount withheld from gross earnings to apply toward the employee’s personal state and federal income taxes Deductions for charitable contributions, savings plans, union dues, and a variety of other items

Personnel Costs When wages are earned:
Slide 10-10 If an employee with three dependents earned $600 for work in a certain week in 1998, $45.90 for FICA and $63.00 for withholding tax would be deducted from this $600. The employer incurs a matching expense of $45.90 for FICA plus $54 for federal and state unemployment insurance taxes. When wages are earned: Wages Cost Wages Payable Employment Tax Cost 99.90 FICA Taxes Payable Unemployment Taxes Payable

Personnel Costs When wages are paid: When the government is paid:
Slide 10-11 When wages are paid: Wages Payable Cash FICA Taxes Payable Withholding Taxes Payable When the government is paid: FICA Taxes Payable 91.80 Unemployment Taxes Payable 54.00 Withholding Taxes Payable 63.00 Cash $ $45.90

Pensions A company’s pension cost is the sum of four elements.
Slide 10-12 A company’s pension cost is the sum of four elements. The year’s service cost element The year’s interest cost element The actual return on plan assets element The amortization of several other pension-related items

Pensions Slide 10-13 The net pension cost using a defined benefit plan are $500,000 Net Pension Cost 500,000 Unfunded Accrued Pension Cost 500,000 A liability A subsequent contribution of $450,000 is made to the plan by the employer. Unfunded Accrued Pension Cost 450,000 Cash 450,000

Income Taxes Slide 10-14 A company buys personal computers costing over $15,000 each. For tax purposes it elects to use an accelerated depreciation method. For financial reporting purposes it decides to use the straight-line method. If all other items are accounted for in the same way, the company’s taxable income for the year will be lower than its book pre-tax income. In the first year the depreciation charge for tax purposes will be higher than the depreciation for financial reporting purposes. At the end of the year the net carrying amount of the computers on the company’s tax books will be lower than their net carry amount on the company’s financial reporting books.

Deferred Income Taxes Slide 10-15 Because of temporary differences, in 1998 a corporation reported $1 million pre-tax income to its shareholders and $800,000 taxable income to the IRS (resulting in an income tax expense of $340,000 and a tax liability of only $272,000). Assets = Liabilities Owners’ Equity - $272, Retained Earnings - $340,000 Reflecting actual tax bill paid Reflecting tax expense used to measure book income

Deferred Income Taxes Slide 10-16 Because of temporary differences, in 1998 a corporation reported $1 million pre-tax income to its shareholders and $800,000 taxable income to the IRS (resulting in an income tax expense of $340,000 and a tax liability of only $272,000). Income Tax Expense--Current 272,000 Income Tax Expense--Deferred 68,000 Cash 272,000 Deferred Income Taxes Liability 68,000

Deferred Tax Measurement
Slide 10-17 Income before Depreciation Taxable Taxes Due Year Depreciation and Taxes Charge Income (at 40 percent rate) 1998 $1, $ $ $ 1999 1, 2000 1, 2001 1, 2002 1, $5,000.0 $1,000.0 $4,000.0 $1,600.0 Calculation of Taxes Due (thousands of dollars)

Slide 10-18 Original Annual Cumulative Year Depreciable Cost Tax Depreciation Tax Depreciation Tax Basis 1998 $1, $333.3 $333.3 $666.7 1999 1, 2000 1, 2001 1, 2002 1, , Tax Basis Calculation (thousands of dollars)

Slide 10-19 Original Annual Book Cumulative Book Net Book Year Book Cost Depreciation Depreciation Value 1998 $1, $200.0 $200.0 $800.0 1999 1, 2000 1, 2001 1, 2002 1, , Net Book Value Calculation (thousands of dollars)

Slide 10-20 When the taxes are paid: Income Tax Payable 266,700 Cash 266,700 Combining all three 1998 entries: Income Tax Expense 320,000 Cash 266,700 Deferred Income Taxes Liability 53,300

11 The Statement of Cash Flows Part One: Financial Accounting

Sale of property, plant, and equipment Sale of other noncurrent assets
Sources of Cash Slide 11-1 Operations New borrowings New stock issues Sale of property, plant, and equipment Sale of other noncurrent assets

Repayment of borrowings Repurchase of stock
Uses of Cash Slide 11-2 Cash dividends Repayment of borrowings Repurchase of stock Purchase of property, plant, and equipment Purchase of other noncurrent assets

Typical Questions Answered by the SCF
Slide 11-3 How much cash was provided by the normal, ongoing operations of the company? In what other ways were significant amounts of cash raised? Is the company investing enough in new plant and equipment to maintain or increase capacity and to replace old facilities with more efficient ones? Is the company reinvesting excess cash in productive assets, or is it using the cash to retire stock?

Major Categories on the SCF
Slide 11-4 Operating activities: Transactions associated with sales revenues and cash outflows associated with the operating expenses Investing activities: Transactions involving acquiring and disinvesting in long-lived assets Financing activities: Transactions involving borrowing of cash through noncurrent instruments and the issuance of equity securities

Investing Activities Section of SCF
Slide 11-5 Cash flows from investing activities: Acquisition of plant and equipment (500) Proceeds from disposals of plant and equipment 20 Purchase of investment securities (25) Proceeds from sales of investment securities 75 Net cash used by investing activities (430) Cash flows from investing activities: Acquisition of plant and equipment (500) Proceeds from disposals of plant and equipment 20 Purchase of investment securities (25) Proceeds from sales of investment securities 75 Net cash used by investing activities (430) Cash flows from investing activities: Acquisition of plant and equipment (500) Proceeds from disposals of plant and equipment 20 Purchase of investment securities (25) Proceeds from sales of investment securities 75 Net cash used by investing activities (430) The net result of these two transaction on the balance sheet is an increase in plant and equipment of $350,000. Equipment costing $500,000 was purchased for cash during the year. Equipment that originally cost $150,000 was sold for $20,000, resulting in an inflow of cash .

Investing Activities Section of SCF
Slide 11-6 Cash flows from investing activities: Acquisition of plant and equipment (500) Proceeds from disposals of plant and equipment 20 Purchase of investment securities (25) Proceeds from sales of investment securities 75 Net cash used by investing activities (430) Cash flows from investing activities: Acquisition of plant and equipment (500) Proceeds from disposals of plant and equipment 20 Purchase of investment securities (25) Proceeds from sales of investment securities 75 Net cash used by investing activities (430) Investment securities decreased $50,000 ($450,000 to $400,000) during the year. The firm purchased $25,000 of new securities (an inflow of cash) and and sold $75,000 of old securities (and outflow of cash)

Financing Activities Section of SCF
Slide 11-7 Cash flows from financing activities: Proceeds from short-term debt 15 Payments to settle short-term debt (36) Proceeds from long-term debt 375 Payments on long-term debt (40) Proceeds from issuing common stock 44 Dividends paid (160) Net cash provided by financing activities 326 Cash flows from financing activities: Proceeds from short-term debt 15 Payments to settle short-term debt (36) Proceeds from long-term debt 375 Payments on long-term debt (40) Proceeds from issuing common stock 44 Dividends paid (60) Net cash provided by financing activities 326 The firm borrowed $15,000 using short-term debt and paid $36,000 on old borrowings. Short-term borrowing decreased $21,000 (from $147,000 to $126,000).

Slide 11-8 Cash flows from financing activities: Proceeds from short-term debt 15 Payments to settle short-term debt (36) Proceeds from long-term debt 375 Payments on long-term debt (40) Proceeds from issuing common stock 44 Dividends paid (60) Net cash provided by financing activities 326 Cash flows from financing activities: Proceeds from short-term debt 15 Payments to settle short-term debt (36) Proceeds from long-term debt 375 Payments on long-term debt (40) Proceeds from issuing common stock 44 Dividends paid (160) Net cash provided by financing activities 326 The firm borrowed $375,000 using long-term debt and paid $40,000 on old long-term debt. Long-term debt increased $335,000 (from $500,000 in 1997 to $835,000 in 1998).

Slide 11-9 Cash flows from financing activities: Proceeds from short-term debt 15 Payments to settle short-term debt (36) Proceeds from long-term debt 375 Payments on long-term debt (40) Proceeds from issuing common stock 44 Dividends paid (60) Net cash provided by financing activities 326 Cash flows from financing activities: Proceeds from short-term debt 15 Payments to settle short-term debt (36) Proceeds from long-term debt 375 Payments on long-term debt (40) Proceeds from issuing common stock 44 Dividends paid (160) Net cash provided by financing activities 326 During 1998, Fairway issued 10,000 additional shares of $1 par value common stock resulting in cash proceeds of $44,000. On the balance sheet, common stock increased $10,000 and paid-in capital increased by $34,000 between 1997 and 1998.

Slide 11-10 Cash flows from financing activities: Proceeds from short-term debt 15 Payments to settle short-term debt (36) Proceeds from long-term debt 375 Payments on long-term debt (40) Proceeds from issuing common stock 44 Dividends paid (60) Net cash provided by financing activities 326 Cash flows from financing activities: Proceeds from short-term debt 15 Payments to settle short-term debt (36) Proceeds from long-term debt 375 Payments on long-term debt (40) Proceeds from issuing common stock 44 Dividends paid (160) Net cash provided by financing activities 326 During 1998, cash dividends amounted to $60,000.

Operating Activities Section of SCF
Slide 11-11 Net cash flow from operating activities: Cash received from customers $3,103 Dividends and interest received Cash provided by operating activities 3,122 Cash paid to suppliers and employers 2,729 Interest paid 67 Income taxes paid Cash disbursed for operating activities 2,894 Net cash flow from operating activities 228 FASB 95 encourages use of the direct method. Direct Method

Slide 11-12 Net cash flow from operating activities: Net income $200 Noncash expenses, revenues, and losses included in income: Depreciation 120 Deferred taxes 5 Increase in accounts receivable (87) Increase in inventories (47) Increase in accounts payable 56 Increase in taxes payable 1 Gain on sale of equipment (20) Cash flow from operating activities 228 Net cash flow from operating activities: Net income $200 Noncash expenses, revenues, and losses included in income: Depreciation 120 Deferred taxes 5 Increase in accounts receivable (87) Increase in inventories (47) Increase in accounts payable 56 Increase in taxes payable 1 Gain on sale of equipment (20) Cash flow from operating activities 228 Indirect Method

Slide 11-13 The actual adjusting entry made: Depreciation Expense 120,000 Accumulation Depreciation 120,000 Depreciation expense reduces net income, but has no effect on cash. Let’s restate the entry by replacing depreciation.

Slide 11-14 The restated entry: Cash provided by operations 120,000 Accumulation Depreciation 120,000 Examine Illustration 11-6 closely. Notice that entry (3) matches the restated entry above.

Slide 11-16 Inventories Beginning balance 610,000 Cost of sales 2,290,000 Purchases 2,337,000 Ending balance 657,000 Beginning balance in next period 657,000 Purchases = Cost of sales + (Ending Balance - Beginning Balance) Actual cash payments (assume all purchases were cash purchases) $2,337,000 Cost of sales (based on units sold) 2,290,000 Excess of cash spent over amount recorded as a cost on the income statement $ ,000

Slide 11-18 Freeway Corporation sold equipment that originally cost $150,000 for $20,000. The asset was fully depreciated at the time of sale. The journal entry made was: Cash 20,000 Accumulated Depreciation 150,000 Equipment, at Cost 150,000 Gain on Disposal of Equipment 20,000 This gain increased net income by $20,000.

Slide 11-19 The actual cash inflow should be treated as cash provided by investing activities and the gain on disposal subtracted from net income through reducing cash provided by operations (see entry 6 in Illustration 11-6). The restated entry is: Cash provided by investing activities 20,000 Accumulated Depreciation 150,000 Equipment, at Cost 150,000 Cash provided by operating activities 20,000

Slide 11-20 Suppose the equipment had a book value of $10,000 at the time of sale, and the cash proceeds totaled $15,000. The journal entry made was: Cash 15,000 Accumulated Depreciation 140,000 Equipment, at Cost 150,000 Gain on Disposal of Equipment 5,000

Slide 11-20 Suppose the equipment had a book value of $10,000 at the time of sale, and the cash proceeds totaled $15,000. The entry restated is: Cash provided by investing activities 15,000 Accumulated Depreciation 140,000 Equipment, at Cost 150,000 Cash provided by operating activities 5,000 Cash provided by investing activities increased $15,000 and cash provided by operating activities decreased $5,000.

12 Acquisitions and Consolidated Statements

Fair-Value Method Slide 12-1 If an investor company owns less than 20 percent of an investee company’s common stock, and the stock’s fair value is readily determinable, the investment is reported using the fair value method.

Fair-Value Method Slide 12-2 When a dividend is received, the entire amount is credited to Dividend Revenues. Cash 50,000 Dividend Revenues 50,000

Cost Method Slide 12-3 If an investor company owns less than 20 percent of an investee company’s common stock, and the stock’s fair value is not readily determinable, the investment is reported at its cost.

Equity Method Slide 12-4 If the investing company owns less than 50 percent of the voting stock, but can significantly influence the actions of the investee, the investment is accounted for by the equity method.

Equity Method Slide 12-5 Merkle Company acquired 25 percent of the common stock of Pentel Company on January 2, 1998, for $250,000. Assume that Merkle Company has significant influence Investments 250,000 Cash 250,000 Pentel’s net income for 1998 was $100,000. Investments 25,000 Investment Revenue 25,000 25% of $100,000

Equity Method Slide 12-6 During 1998, Merkle Company received $10,000 in dividends from Pentel Company. Cash 10,000 Investments 10,000 Note that the dividend reduces the Investments account.

Consolidated Basis Amount of Ownership Method of Reporting
Slide 12-7 Amount of Ownership Method of Reporting Over 50% consolidated statements 20-50% equity method Less than 20% fair-value method Corporation B

Pooling If all of the following are met, pooling is required:
Slide 12-8 Keep going! There are two more requirements. If all of the following are met, pooling is required: The acquiring corporation issues only common stock with rights identical to the majority of its outstanding voting common stock in exchange for substantially all of the voting common stock of the acquired company. Each combining company is autonomous and has not been a subsidiary or division of another corporation within the previous two years. The combination is effected in a single transaction or is completed according to a specific plan within on year.

Pooling If all of the following are met, pooling is required:
Slide 12-9 If all of the following are met, pooling is required: Following the combination the acquiring corporation does not reacquire its voting common stock for a six-month period other than for normal business purposes, such as the issuance of shares under stock option programs. The combined corporation does not intend to dispose of a significant part of the assets of the combining companies within two years after the combination.

Pro-Forma Consolidated Balance Sheet
Slide 12-10 Pooling Purchase Assets Cash and marketable securities $ 7,000 $ 7,000 Accounts receivable 6,400 6,400 Inventories 8, ,200 Total current assets 21,600 21,600 Goodwill ,500 Plant and equipment, net 13,400 14,500 Total assets $35,000 $37,600 Assets Section

Pro-Forma Consolidated Balance Sheet
Slide 12-11 Pooling Purchase Liabilities and Shareholders’ Equity Accounts payable $ 7,700 $ 7,700 Other current liabilities 1, ,800 Total current liabilities 9,500 9,500 Long-term debt 9, ,800 Total liabilities 19,300 19,300 Common stock (par plus paid-in capital) 3,200 8,500 Retained earnings 12, ,800 Total shareholders’ equity 15,700 18,300 Total liabilities and shareholders’ equity $35,000 $37,600 Liabilities and Shareholders’ Equity Section

Accounting as a Pooling
Slide 12-12 There is a “marriage” of the two entities. The two balance sheets simply are added together at book value to arrive at a consolidated balance sheet for the surviving entity.

Accounting as a Purchase
Slide 12-13 First, B’s identifiable net assets are revalued to their fair value. Plant and equipment had a book value of $2.8 million, but a fair value of $3.9 million. The consolidated plant and equipment account shows $14.5 million.

Accounting as a Purchase
Slide 12-14 Second, any excess of the purchase price over the total amount of the revalued identifiable net assets is shown on the consolidated balance sheet as an asset called goodwill. Purchase price $6,000,000 Less: Book value of net assets acquired 3,400,000 2,600,000 Less: Write-up of identifiable assets to fair value 1,100,000 Goodwill $1,500,000

Pro Forma Consolidated Income Statement
Slide 12-15 Corporation A Corporation B If independent corporation: Income before taxes $3,780 $945 Income tax expense (40%) 1, Net income $2,268 $567 Number of outstanding shares 1,000, ,000 Earnings per share $2.27 $5.67

Slide 12-16 Combined Corporations A-B Combined A-B, pooling treatment: Income before taxes $4,725 Income tax expense (40%) 1,890 Net income $2,835 Number of outstanding shares 1,200,000 Earnings per share $2.36

Slide 12-17 Combined Corporations A-B Combined A-B, purchase treatment: Income before taxes $4,725 Less: Additional depreciation expense 110 Less: Amortization of goodwill 100 Income before taxes 4,515 Income tax expense (40%) 1,806 Net income $2,709 Number of outstanding shares 1,200,000 Earnings per share $2.26

Consolidated Worksheet
Slide 12-18 Separate Intercompany Consolidated Statements Eliminations Balance Parent Subsidiary Dr Cr Sheet Assets Cash 45,000 12, ,000 Accounts receivable 40,000 11,000 (1) 5,000 46,000 Inventory 30,000 15,000 (4) 2,000 43,000 Fixed assets, net 245,000 45, ,000 Investment in subsidiary 55, (2) 55, 415,000 83, ,000 Liabilities and SH Equity Accounts payable 20,000 13,000 (1) 5, ,000 Other current liabilities 25,000 9, ,000 Long-term liabilities 100, ,000 Capital stock 100,000 40,000 (2) 40, ,000 Retained earnings 170,000 21,000 (2) 15,000 (4) 2, ,000

Asset Valuation Slide 12-19 Assume that the Parent purchased Subsidiary stock for $70,000 rather than $55,000. If Subsidiary’s assets were found to be recorded at their fair value, there would be goodwill of $15,000. The elimination entry would have been: Goodwill 15,000 Capital Stock (Subsidiary) 40,000 Retained Earnings (Subsidiary) 15,000 Investment in Subsidiary (Parent) 70,000

Minority Interest Slide 12-20 If Parent had purchased less than 100 percent of Subsidiary’s stock, then there would have been minority interest. The majority example shown in this chapter is $11,800. This is the net of four items: 20% of subsidiary capital stock $ 8,000 20% of subsidiary retained earnings at time of acquisition 3,000 20% of the $6,000 increase in subsidiary retained earnings since acquisition 1,200 Less 20% of the $2,000 intercompany profits (400) Total minority interest $11,800

13 Financial Statement Analysis Part One: Financial Accounting

Return on Assets (ROA) Return on assets =
Slide 13-1 Return on assets = Net income + Interest (1 - Tax rate) Total assets Return on assets = $ $33.3(.66) $4,237.1 Return on assets = 16.6 percent Return on assets (ROA) reflects how much the firm has earned on the investment of all the financial resources committed to the firm.

Return on Invested Capital
Slide 13-2 Return on invested capital = Net income + Interest (1 - Tax rate) Long-term liabilities + Shareholders’ equity Return on invested capital = $ $33.3(.66) $1, $1,713.4 Return on invested capital = 23.2 percent Return on invested capital focuses more on the use of permanent capital (noncurrent liabilities plus shareholders’ equity)

Return on Shareholders’ Equity
Slide 13-3 Return on shareholders’ equity = Net income Shareholders’ equity Return on shareholders’ equity = $680.7 $1,713.4 Return on shareholders’ equity = percent Return on shareholders’ equity (ROE) reflects how much the firm has earned on the funds invested by the shareholders.

Return on Investment profit margin or return on sales turnover
Slide 13-4 Net income Sales * Sales Investment profit margin or return on sales turnover

Price/Earnings Ratio (P/E)
Slide 13-5 Price/earnings ratio = Market price per share Net income per share Price/earnings ratio = $65.375 $2.94 Price/earnings ratio = times The price/earnings ratio (P/E) is the best indicator of how investors judge the firm’s future performance.

Gross Margin Percentage
Slide 13-6 Gross margin percentage = Gross margin Net sales revenues Gross margin percentage = $3,306.4 $6,295.4 Gross margin percentage = 52.5 percent

Profit Margin Profit margin = Net income Net sales revenues
Slide 13-7 Profit margin = Net income Net sales revenues Profit margin = $680.7 $6,295.4 Profit margin = 10.8 percent

Earnings Per Share Earnings per share = Net income
Slide 13-8 Earnings per share = Net income Number of shares of common stock outstanding Earnings per share = $680.7 231.5 Earnings per share = $2.94

Asset Turnover Asset turnover = Sales revenue Total assets $6,295.4
Slide 13-9 Asset turnover = Sales revenue Total assets $6,295.4 $4,237.1 Asset turnover = Asset turnover = 1.5 times

Investment Capital Turnover
Slide 13-10 Invested capital turnover = Sales revenue Invested capital $6,295.4 $4,237.1 Invested capital turnover = 1.5 times Invested capital turnover =

EquityTurnover Equity turnover = Sales revenue Shareholders’ equity
Slide 13-11 Equity turnover = Sales revenue Shareholders’ equity $6,295.4 $1,713.4 Equity turnover = Equity turnover = 3.7 times

Capital Intensity Sales revenue Property, plant, and equipment
Slide 13-12 Capital intensity = Sales revenue Property, plant, and equipment Capital intensity = $6,295.4 $2,768.4 Capital intensity = times The capital intensity ratio focuses only on the usage of property, plant, and equipment. Companies with a high ratio are particularly vulnerable to cyclical fluctuations.

Working Capital Turnover
Slide 13-13 Working capital turnover = Sales revenue Working capital Working capital turnover = $6,295.4 $30.5 Working capital turnover = times Working capital is current assets minus current liabilities

Days’ Payables Days’ payables Operating payables
Slide 13-14 Days’ payables Operating payables Pretax cash expenses/365 = $ $76.5 + $ $141.4 Days’ payables $760.5 $4,996.1/365 = Days’ payables = days Operating payables include accounts payable, accrued wages and payroll taxes, and other items that represent deferred payments for operating expenses.

Cash Conversion Cycle Days
Slide 13-15 Days Receivables conversion period (days’ receivables) 31 Plus: inventory conversion period (days’ inventory 49 Operating cycle 80 Less: payment deferral period (days’ payable) 56 Cash conversion cycle 24 The result of this calculation is a measure of liquidity; it also indicates the time interval for which additional short-term financing might be needed to support a spurt in sales.

Dividend Yield Dividend yield = Dividends per share
Slide 13-16 Dividend yield = Dividends per share Market price per share Dividend yield = $1.32 $65.375 Dividend yield = 2.0 percent

Dividend Payout Dividend payout = Dividends Net income
Slide 13-17 Dividend payout = Dividends Net income Dividend payout = $305.2 $680.7 Dividend payout = 45 percent

Other Key Ratios Days’ cash Cash Cash expenses/365 Days’ receivables
Slide 13-18 Days’ cash Cash Cash expenses/365 Days’ receivables Accounts receivable Sales/365 Days’ inventory Inventory Cost of sales/365

Other Key Ratios Inventory turnover Cost of Sales Inventory
Slide 13-19 Inventory turnover Cost of Sales Inventory Current ratio Current assets Current liabilities Acid-test (quick) ratio Monetary current assets Current liabilities

Other Key Ratios Financial leverage ratio Assets Stockholders’ equity
Slide 13-20 Financial leverage ratio Assets Stockholders’ equity Debt/equity ratio Long-term liabilities Shareholders’ equity Times interest earned Pretax operating profit + Interest Interest

14 Understanding Financial Statements Part One: Financial Accounting

Who are auditor? Independent, outside public accountants
Slide 14-1 Independent, outside public accountants Certified public accountants (CPAs) who meet prescribed professional standards Licensed to practice by the state in which they do business Their task is to examine financial statements (including notes) and to express an opinion

What is the auditors’ opinion?
Slide 14-2 It is a paragraph required by the AICPA expressing the results of the auditors’ examination of the financial statements Under certain circumstances, additional paragraphs are required In our opinion, such financial statements present fairly, in all material respects, the financial position of X Company as of December 31, 1998, and 1997, and the results of its operations for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. Standard Opinion Paragraph

Qualified Opinion Qualification may occur for any of three reasons:
Slide 14-3 Qualification may occur for any of three reasons: A lack of consistency Existence of a major uncertainty Doubt as to the entity’s ability to continue as a going concern

Qualified Opinion If not justified, it is a violation of consistency
Slide 14-4 If not justified, it is a violation of consistency Consistency A company changed an accounting method from the method used in the preceding year. Uncertainty Auditors are required to call attention to major uncertainties in an additional paragraph following the opinion paragraph, without making a prediction of the eventual outcome. Going-Concern Doubt Auditors determine if there is substantial doubt about the company’s ability to continue as a going concern over the next year.

Disclaimer Slide 14-5 I can’t issue an opinion... I’ll have to issue an disclaimer. A disclaimer may result because limitations were placed on the scope of the audit by management.

Adverse Opinion Slide 14-6 If the auditors conclude than the financial statements do not “present fairly” the situation, they write an adverse opinion.

Notes to Financial Statements
Slide 14-7 Typical notes to financial statements provide: Summaries of the accounting policies the company has followed in preparing the statement Details on long-term debt Description of stock option plans Description of postretirement benefits Details about the composition of inventories and depreciable assets Discussion of major contingencies Discussion of the company’s financial condition and results of operations

Segment Reporting For each operating segment, the company reports:
Slide 14-8 For each operating segment, the company reports: Revenues from external and intercompany customers Operating profit or loss Interest expense Identifiable assets, including depreciation expense on these assets

Basic Accounting Criteria
Slide 14-9 Accounting information should be relevant Accounting information should be objective The reporting of accounting information should be feasible

Basic Financial Accounting Concepts
Slide 14-10 Money Measurement Accounting records only those facts that can be expressed in monetary terms. Entity Accounts are kept for entities, as distinguished from the persons who are associated with those entities. Going Concern Accounting assumes that an entity will continue to operate indefinitely and that it is not about to be liquidated.

Slide 14-11 Cost An asset is ordinarily entered in the accounts at the amount paid to acquire it. Dual Aspect The total amount of assets equals the total amount of liabilities and owners’ equity. Accounting Period Accounting measures activities for a specified interval of time, usually one year.

Slide 14-12 Conservatism Revenues are recognized only when they are reasonably certain, whereas expenses are recognized as soon as they are reasonably possible. Realization The amount recognized as revenue is the amount that is reasonably certain to be realized, that is, paid by customers. Matching When a given event affects both revenues and expenses, the effect on each should be recognized in the same accounting period.

Slide 14-13 Consistency Once an entity has decided on a certain accounting method, it should use the same method for all subsequent events of the same character unless it has a sound reason to change methods. Materiality Insignificant events may be disregarded, but there must be full disclosure of all important information.

Accounting Alternatives
Slide 14-14 Differences in how certain transactions may be recorded result from: Requirements imposed by regulatory agencies in certain industries The latitude that exists within GAAP Judgments and estimates that must be made in applying a given principle

Accounting Alternatives
Slide 14-15 A business is a complex organism, so there has to been some diversity. The consistency concept prevents diversity from becoming chaos. Should all the diversity in accounting be permitted?

Inherent Limitations Accounting reports are necessarily monetary
Slide 14-16 Accounting has two inherent limitations that no foreseeable accounting practice can overcome. Accounting reports are necessarily monetary They are necessarily influenced by estimates of future events

Income Statement The income statement is the dominant financial
Slide 14-17 The income statement is the dominant financial statement. CLOUD, INC. Income Statement For the year ended December 31, 1998 Sales $250,000 Cost of goods sold 130,000 Gross margin 120,000 Operating expenses: Rent $20,000 Wages 35,000 Utilities 14,000 Advertising 6,000 Supplies 3,000 Depreciation 4,000 Total expenses 82,000 Income for taxes 38,000 Income taxes 15,000 Net income $23,000

Effect on Income of Alternative Practices
Slide 14-18 Income Statement Current year Next year Future years Expense (period cost) $1,000 Cost item $1,000 ?

Slide 14-19 Income Statement Current year Next year Future years Expense (period cost) $1,000 Cost item $1,000 Product cost ? $ $600

Slide 14-20 Income Statement Current year Next year Future years Expense (period cost) $1,000 Cost item $1,000 Product cost ? $ $600 Capital cost $ $ $ $100

Types of Balance Sheet Items
Slide 14-21 Monetary assets and liabilities Unexpired costs Inventories Investments Other liabilities and owners’ equity

ACCOUNTING: TEXT AND CASES

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