1. FINANCIAL ACCOUNTING A USER PERSPECTIVE Hoskin Fizzell Davidson Second Canadian Edition

2. Transaction Analysis and Accounting Entries Chapter Two

3. Basic Accounting Equation Assets = Liabilities + Shareholders’ Equity

4. Transaction Analysis Demo Retail Company, Inc. is formed as a company in December of 2000.

5. Transaction Analysis Transaction A: Common shares are issued for $7,500. Effects: –Assets (Cash) increase –Shareholders’ Equity (Common Shares) increase

6. Effects on the Balance Sheet Exhibit 2-1

7. Transaction Analysis Transaction B: Purchased equipment for $4,500. Effects: –Assets (Cash) decrease –Assets (Equipment) increase

8. Effects on the Balance Sheet Exhibit 2-1

9. Transaction Analysis Transaction C: Purchased $2,500 of inventory on account. Effects: –Assets (Inventory) increase –Liabilities (Accounts Payable) increase

10. Effects on the Balance Sheet Exhibit 2-1

11. Demo Retail Company, Ltd. Balance Sheet As at December 31, 2000 Assets Liabilities Cash$ 3,000 Accounts payable $ 2,500 Inventory 2,500 Equipment 4,500 Shareholders’ Equity Common shares 7,500 Retained earnings 0 Total liabilities and Total assets$10,000 shareholders’ equity $10,000

12. Transaction Analysis - Operating Period Transaction 1: Sold units of inventory on account for $2,500. Effects: –Assets (Accounts Receivable) increase –Shareholders’ Equity (Retained Earnings) increases

13. Revenue Recognition Criteria Accrual basis accounting: measures performance in the period in which the performance takes place, rather than when the cash is collected.

14. Transaction Analysis Transaction #1

15. Transaction Analysis - Operating Period Transaction 2: The cost of units removed from inventory: $1,800. Effects: –Assets (Inventory) decreases –Shareholders’ Equity (Retained Earnings) decreases

16. Matching Concept All costs associated with generating sales revenue must be matched with the revenue earned. –Cost of goods sold related to revenue should be recognized in the same period as the sales revenue.

17. Transaction Analysis Transaction #2

18. Transaction Analysis - Operating Period Transaction 3: Purchase of new inventory: cost of $2,100. Effects: –Assets (Inventory) increase –Liabilities (Accounts Payable) increase

19. Transaction Analysis Transaction #3

20. Transaction Analysis - Operating Period Transaction 4: Received $2,200 from customers as payments on their accounts. Effects: –Assets (Cash) increase –Assets (Accounts Receivable) decrease

21. Transaction Analysis Transaction #4

22. Transaction Analysis - Operating Period Transaction 5: Made payments on accounts payable: $2,700. Effects: –Assets (Cash) decrease –Liabilities (Accounts Payable) decrease

23. Transaction Analysis Transaction #5

24. Transaction Analysis - Operating Period Transaction 6a: Paid $360 for six- month insurance policy. Effects: –Assets (Prepaid Insurance) increase –Assets (Cash) decrease

25. Prepaid Expenses An amount paid in advance of the coverage period is recorded as an Asset (Prepaid Expense). When time passes, the coverage is “consumed,” and is then recognized as an expense.

26. Transaction Analysis Transaction #6a

27. Transaction Analysis - Operating Period Transaction 6b: One month’s insurance consumed: $60. Effects: –Assets (Prepaid Insurance) decrease –Shareholders’ Equity (Retained Earnings) decrease

28. Transaction Analysis Transaction #6b

29. Amortization of Assets When an asset is used up over time, some of the cost of the asset should be shown as an expense in each period in which it is used. The amount shown as an expense in any period is called the amortization of the asset.

30. Amortization of Assets Straight-line Amortization: Original — Estimated Residual Cost Value Estimated Useful Life

31. Transaction Analysis - Operating Period Transaction 7: Amortize equipment for January: $150. Effects: –Assets (Equipment) decrease –Shareholders’ Equity (Retained Earnings) decrease

32. Transaction Analysis Transaction #7

33. Transaction Analysis - Operating Period Transaction 8a: Issued new shares for $5,000. Effects: –Assets (Cash) increase –Shareholders’ Equity (Common Shares) increase

34. Transaction Analysis Transaction #8a

35. Transaction Analysis - Operating Period Transaction 8b: Borrowed from the bank: $10,000. Effects: –Assets (Cash) increase –Liabilities (Bank Loan) increase

36. Transaction Analysis Transaction #8b

37. Transaction Analysis - Operating Period Transaction 8c: Purchased land for $15,000. Effects: –Assets (Cash) decrease –Assets (Land) increase

38. Transaction Analysis Transaction #8c

39. Accrued Expense Expenses that are recognized on the income statement in the period in which they are incurred, which is prior to the period in which they are paid in cash.

40. Transaction Analysis - Operating Period Transaction 9: Recorded one month’s interest on the loan at 6%: $10,000 x 6% x 1/12 = $50. Effects: –Shareholders’ Equity (Retained Earnings) decrease –Liabilities (Interest Payable) increase

41. Transaction Analysis Transaction #9

42. Transaction 10: Dividends were declared and paid: $250. Effects: –Assets (Cash) decrease –Shareholders’ Equity (Retained Earnings) decrease Transaction Analysis - Operating Period

43. Transaction Analysis Transaction #10

44. Financial Statements Balance Sheet Income Statement Cash Flow Statement

45. Classified Balance Sheet Current assets and liabilities are distinguished from noncurrent assets and liabilities

46. Demo Retail Company, Ltd. Balance Sheet As at December 31, 2000 Current Assets Current Liabilities Cash $ 1,890 Accounts payable $ 1,900 Accts receivable 800 Interest payable 50 Inventory 2,800 Total current liabilities 1,950 Prepaid insurance 300 Bank loan 10,000 Total current assets 5,290 Total liabilities 11,950 Land 15,000 Common shares 12,500 Equipment 4,350 Retained earnings 190 Total liabilities and Total assets $24,640 shareholders’ equity $24,640

47. Income Statement Calculates profit (net income) by subtracting expenses from revenues for the period. Dividends: –are not expenses –are payments of earnings to shareholders.

48. Demo Retail Company, Ltd. Income Statement For the month ended January 31, 2001 Sales revenues $ 2,500 Less: Cost of goods sold (1,800) Gross profit 700 Amortization expense (150) Insurance expense ( 60) Interest expense ( 50) Net income $ 440

49. Profitability Ratios Profit Margin Ratio: Profit Revenues

50. Profitability Ratios Return on Assets: Profit Average total assets invested

51. Profitability Ratios Return on Equity: Profit Average total shareholders’ equity

52. Cash Flow Statement Explains the changes in cash flow during the period Details changes in: –Operating activities –Investing activities –Financing activities

53. Demo Retail Company, Ltd. Cash Flow Statement For the month ended January 31, 2001 Cash from operating activities: Cash receipts from customers $ 2,200 Cash disbursement to suppliers (2,700) Cash disbursement for insurance ( 360) Cash flow from operating activities $ (860)

54. Demo Retail Company, Ltd. Cash Flow Statement For the month ended January 31, 2001 Cash from investing activities: Purchase of land (15,000) Cash from financing activities: Proceeds from issuance of common shares 5,000 Proceeds from bank loan 10,000 Dividends paid ( 250) Cash flow from financing activities 14,750 Decrease in cash $ ( 1,110)