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AFM 101 Midterm 1
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AFM 101 Midterm
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Outline
• Chapter 1: Financial Statements • Chapter 2: The Balance Sheet • Chapter 3: The Income Statement • Chapter 4: Adjustments• Chapter 5: Statement of Cash Flows• Chapter 6: Interpreting and
Communicating Accounting Information
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Chapter 1
4 Major Financial Statements: 1) Balance Sheet2) Income Statement3) Statement of Retained Earnings 4) Statement of Cash Flows
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Chapter 1Balance Sheet• The company’s financial position at a point in time
ABC Co. Balance Sheet December 31, 2009
Assets (list all assets) $XXTotal Assets XX
Liabilities (list all liabilities) $XXOwner’s Equity/Shareholder’s Equity
(list owner’s equity components) XXTotal Liabilities and Owner’s Equity XX
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Chapter 1Income Statement• Measures the performance or operations of a company over a period of time
ABC Co.Income StatementFor the Year Ended December 31, 2009
Revenue (list all sources of revenue) $XXTotal Revenue XX
Expenses (list all Expenses) $XXTotal Expenses XXNet Income XX
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Chapter 1Statement of Retained Earnings• Retained Earnings is an account on the Balance Sheet• It represents the accumulation of income from Year 1 of the business
ABC Co.Statement of Retained EarningsFor the Period Ended December 31, 2009
Beginning Retained Earnings $XX Add Net Income for period XX
Subtract Dividends paid to shareholders XXEnding Retained Earnings XX
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Chapter 1Statement of Cash Flow• Used to show the activity of cash by the company during the year• Used to calculate the cash balance on the balance sheet
ABC Co.Statement of Cash FlowFor the Period Ended December 31, 2009
Cash flows from Operating Activities (list details) $XXCash flows from Investing Activities (list details) $XXCash flows from Financing Activities (list details) $XXNet Increase/Decrease in Cash XXCash balance (Jan 1, 2009) XXCash Balance (Dec 31, 2009) XX
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Chapter 1
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Chapter 1Generally Accepted Accounting Principles (GAAP)• Principles and guidelines used by management to
account and record their company’s operations• Auditor’s job is to see if financial statements are
created in accordance to GAAP• Now, Canada is moving towards a transition to IFRS• IFRS will be an international set of standards that will
allow greater comparability and consistency for companies across many different countries
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Chapter 2
The Balance Sheet
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Chapter 2
Remember the fundamental accounting equation
A = L + SE
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Chapter 2Assets• Current Assets– Cash– Short Term Investments– Accounts Receivable– Inventory– Prepaid Expenses
• Non Current Assets– Long term investments– Capital Assets /PPE (property, plant, equipment)– Intangible assets (patents, trademarks, licenses, etc.)
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Chapter 2
Liabilities • Current Liabilities– Accounts Payable – Notes Payable– Accrued Liabilities (Income Tax, Salaries, Interest, etc.)– Current Portion of Long Term Debt
• Long Term Liabilities– Long term debt– Mortgage Payable– Bond Payable
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Chapter 2
Shareholder’s Equity• Share Capital / Common Shares– Proceeds received when shareholders purchased
their shares• Retained Earnings– The accumulation of net income from year 1– The balance comes from the statement of retained
earnings – If dividends are paid to shareholders, it comes out of
retained earnings
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Chapter 2
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Business Transactions • How do we know ending balances on the B/S?• Business transactions that occurred during the
year must be recorded in the general journal• Each journal entry gets posted to the specific
accounts involved (General Ledger or T-account)• Sum up the amounts in each T-account to
determine the amount to report on the B/S at the end of the year
Chapter 2
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Double Entry Accounting DR = CR
Debits are always on the leftCredits are always on the right
Chapter 2
AssetsDebit Credit
+ -
LiabilitiesDebit Credit
- +
Shareholder’s EquityDebit Credit
- +
Share CapitalDebit Credit
- +
Retained EarningsDebit Credit
- +
= +
Dividends Net Income = Revenue - Expenses
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Chapter 2
GENERAL JOURNAL Page 1
Date DescriptionPost. Ref. Debit Credit
On Dec 31, ABC Co. purchased an equipment for $10,000. They paid $400 cash up front and the rest on account.
Cash A/P Equipment
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Chapter 2
GENERAL JOURNAL Page 1
Date DescriptionPost. Ref. Debit Credit
On June 30, ABC Co. declared a $15,000 dividend to its shareholders. It was paid on Aug 1.
Cash Dividends
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Assume a company's January 1, 2007, financial position was: Assets, $40,000 and Liabilities, $15,000.
During January 2007, the company completed the following transactions: (a) paid the $8,000 in principle on a long term debt(b) collected accounts receivable, $4,000;(c) issued commons shares for cash, $2,000; (d) purchased a truck, paying $1,000 cash and $8,000 notes payable.
The company's January 31, 2007, financial position is:
Chapter 2
Assets Liabilities Shareholder’s Equity
40,000 15,000 25,000
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Chapter 3
The Income Statement
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Chapter 3
Remember the “other” fundamental accounting equation
Revenue – Expenses = Net Income
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Chapter 3Results of Continuing OperationsRevenue/Sales $XXLess: Cost of Goods Sold (COGS) XXGross Profit XXOperating Expenses- Selling expenses $XX- Depreciation XX- Administrative expenses XX
Total Operating Expenses XXOperating Income XXOther Revenue and Expenses XXEarnings before Income Tax XXIncome Tax Expenses XXNet Income from Continuing Operations XX
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Chapter 3
Rest of the Income StatementNet Income from Continuing Operations XXDiscontinued Operations XXIncome Before Extraordinary Events XXExtraordinary Events (+/-) XXNet Income XXEarnings Per Share XX
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Chapter 3
The Accrual Basis of Accounting• Determines when we can record revenue and
expenses on our books
• Revenue Recognition Principle• Matching Principle
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Chapter 3
Revenue Recognition Principle• Determines when revenue is considered
earned• 3 criteria– Earnings process is complete– Exchange takes place– Collection of money is reasonably assured
• When 3 criterion are met, we can recognize the revenue on the income statement
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Chapter 3
Matching Principle• Determines when expenses are incurred • Idea is that expenses should be incurred and
recorded in the same period as the revenue it helped earn
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Chapter 3
Cash Basis of Accounting• Revenue is recognized when cash is received• Expenses are incurred when the payment is made
Cash 500Revenue 500
Expense 300Cash 300
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Chapter 3
On September 30th ABC Co just made a $3,000 cash payment for the next 6 months of rent
Cash Basis Accrual Basis
**Cash is paid before the expense is incurred
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Chapter 3
On Nov 25th TIX Co, a ticketing service agency received $5,000 worth of payments from customers for a Broadway show later in the year
Cash Basis Accrual Basis
**Cash is received before the revenue is earned
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Chapter 3The company received a $500 hydro bill on
December 31st, they didn’t make the payment until the next fiscal period
Cash Basis Accrual Basis
**Expense is incurred before cash is paid
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Chapter 3You own a lawn-mowing business and you’ve
mowed $200 worth of lawns, yet your clients have promised to pay within the next week
Cash Basis Accrual Basis
**Revenue is earned before payment is received
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Chapter 3
Dangers of the Cash Basis• With cash basis of accounting, we are
recognizing revenue before it’s earned and expenses before they are incurred OR we’re not recording an entry to reflect the business transaction at all!
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Chapter 4
Adjusting Entries
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Chapter 4
During the Fiscal Period:• Record Business Transactions – occurring
throughout the fiscal year• Record Adjusting Entries – recognize revenue
when earned and expenses when incurred
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Chapter 4
At the end of the fiscal period:• Prepare Trial Balance – list all the accounts with
their balances• Prepare Year End Adjusting Entries – not
triggered by a specific event, does not affect Cash• Prepare Closing Entries – transfers net income to
retained earnings • Prepare Financial Statements
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Chapter 4Pre-Closing Trial Balance (before closing entries)
ABC Co.Trial Balance
December 31, 2009Debit CreditCash XXAccounts Receivable XXInventory XX……Accounts Payable XXAccrued Liabilities XX……Share Capital XXRetained Earnings XXRevenue XXOther Revenue XXSalaries Expense XXRent Expense XX….….Total XX XX
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Deferred Revenues (Unearned Revenue) – cash was received before revenue was earned– During the fiscal period, when cash was received
– Adjustment (revenue is earned)
Chapter 4
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On Jan 1st, ABC Co signed a contract stating they will provide 2 months of services. They received $1,200 payment up front.
Jan 1st
Jan 31st
Feb 28th
Chapter 4
Cash
Revenue
Unearned Revenue
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Deferred Expense (Prepaid Expenses) – payment was made before expense was incurred– During the fiscal period, when cash was paid
out:
– Adjustment (when expenses are incurred): Adjust to reflect amount of expense incurred, and the asset used up:
Chapter 4
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On Jan 1st, the Supplies account had an opening balance of $1,000. On April 30th, ABC Co purchased $500 worth of supplies. At December 31st, a count revealed only $700 worth of supplies were left
April 30th
December 31st
Chapter 4
Supplies
Supplies Expense
$1,000
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Accrued Revenue (Receivables)– cash is received after revenue is earned– During the fiscal period, when service /good is
provided (set up a receivable)
– Adjustment when cash is received:
Chapter 4
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On Mar 1st, ABC Co provided services worth $500, the customer subsequently paid on Apr 24th
Mar 1st
Apr 24th
Chapter 4
Service Revenue
A/R
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Accrued Expense (Payable) - cash is paid out after an expense is incurred– During the fiscal period, when expense is
incurred (set up a payable):
– Adjustment when payment is made:
Chapter 4
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The company pays their employees on a bi-weekly basis. Total salaries expense for each period is $20,000. The next payday is Jan 2nd. The company has a Dec 31st year end.
Dec 31st
Jan 2nd
Chapter 4
Salaries Expense
A/P
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Amortization- Matching Principle match expense with revenue- Capital Assets used to generate revenue- Therefore, portions of the cost of capital assets are
allocated as amortization expense each period- Cost Principle assets are listed on the balance sheet at
their historical cost (i.e. purchase price)- Amortization is accumulated in a contra-asset account
accumulated amortization
Chapter 4
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Capital Assets are listed at their net book value on the Balance Sheet
Non-Current AssetsEquipment 10,000Less: Accumulated Amortization – Equipment 2,000 8,000
Chapter 4
Equipment Accumulated Amortization: Equipment
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How much to amortize each period?– Lots of different methods, right now we’ll look at
the straight line method
Amortization expense each period (usually 1 year) =
[cost – residual value] / useful life
Chapter 4
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On April 1st, ABC Co purchased equipment for 80,000 on account. It was assumed this equipment would have a salvage value of 8,000 and a useful life of 9 years. Record the journal entry on purchase date and the requirement adjusting entry at year end.
April 1st
December 31st
Chapter 4
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Chapter 4Equipment Accumulated Amortization: Equipment
80,000 6,000
Year 1 on B/S:EquipmentAccumulated Amortization Equipment
Year 2 on B/S:EquipmentAccumulated Amortization Equipment
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Interest Expense • Companies borrow money by issuing Bond Payable or
Note Payable • Companies need to pay interest on the Bond or Note• The interest paid is a percentage of the principle,
stated in the contract beforehand• Since interest payment days usually do not correspond
with year end, adjusting entries must be made to recognize the interest expenses
Chapter 4
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On April 1st, ABC Co issued a $10,000 bond paying 6% interest semi annually, interest is paid every September 30th and March 31st
April 1st December 31st
September 30th March 31st
Chapter 4
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Closing Entries- Remember the relationship between B/S and I/S- At the end of the operating cycle, the company transfers the net income on
the I/S to retained earnings through closing entries
Temporary (Nominal) Accounts - Revenue, Expense accounts- Close out to retained earnings at end of fiscal period- Start with $0 balance at beginning of fiscal period
Permanent (Real) Accounts- accounts on the BS that have a balance at beginning of fiscal period- no need to close
Chapter 4
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Closing Entries
Close Revenue AccountsSales Revenue XXRent Revenue XX Income Summary XX
- Income Summary is another temporary account used specifically during the closing entry process
Chapter 4
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Closing Entries
Close Expense AccountsIncome Summary XX
Rent Expense XXSalaries Expense XXUtilities Expense XXInterest Expense XXIncome Tax Expense XX
Chapter 4
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Closing Entries
Close Income Summary AccountIf overall Net Income:Income Summary XX
Retained Earnings XX
If overall Net Loss:Retained Earnings XX
Income Summary XX
Chapter 4
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Chapter 4Account Name Debit CreditCash 5,000Accounts Receivable 4,000Supplies Inventory 2,000Small Tools Inventory 6,000EquipmentAccumulated Amortization – EquipmentOther Assets 9,000Accounts Payable 7,000Notes PayableWages PayableInterest PayableIncome Taxes PayableDeferred RevenueShare Capital (15,000 shares outstanding) 15,000Retained Earnings 4,000Service RevenueAmortization ExpenseIncome Tax ExpenseInterest ExpenseOther ExpensesTotal 26,000 26,000
Trial Balance at beginning of year
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Chapter 4Cash A/R
5,000 4,000
Supplies Inventory
2,000
Small Tools Inventory
6,000
Other Assets
9,000
Accounts Payable
7,000
Share Capital
15,000
Retained Earnings
4,000
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Chapter 4
• Required:– Record journal entries for transactions occurring in 2007,
post to general ledger or t-accounts– Record adjusting entries for 2007, post to general ledger or
t-accounts– Prepare the income statement– Prepare closing entries and post to general ledger– Prepare the balance sheet
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Chapter 4a) Borrowed $25,000 cash on an 8% note payable, dated July 1, 2007b) Purchased equipment for $18,000 cash on Jan 1, 2007c) Issued 5,000 additional shares for $1 cash per share
Cash5,000
Share Capital
15,000
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Chapter 4d) Earned revenue for 2007 of $74,000 including $15,000 on credite) Recognized other expenses for 2007 $35,000 including $9,000 on creditf) Purchased additional small tools inventory, $3,000 cashg) Collected A/R, $8,000
Cash5,000 18,00025,0005,000
Small Tools Inventory
6,000
A/R
4,000
Accounts Payable
7,000
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Chapter 4h) Paid A/P, $11,000i) Purchased supplies on account, $10,000j) Received a $3,000 deposit on work to start Jan 15, 2008k) Declared and paid cash dividend, $12,000
Cash
5,000 18,00025,000 26,0005,000 3,00059,0008,000
A/R
4,000 8,00015,000
Accounts Payable
7,0009,000
Supplies Inventory
2,000
Retained Earnings
4,000
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Chapter 4Adjusting Entriesl) Service supplies inventory of $4,000 and small tools inventory of $9,000
were on hand at year end
Supplies Inventory2,00010,000
Small Tools Inventory
6,0003,000
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Chapter 4Adjusting Entriesm) The equipment’s useful life is 4 years and salvage value is $2,000
Equipment
18,000
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Chapter 4Adjusting Entriesn) Accrued interest on the notes payable has yet to be computed8% note payable purchased on July 1, 2007
Note Payable
25,000
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Chapter 4Adjusting Entrieso) Wages earned since December 24 pay date but not yet paid $4,000p) Income tax expense payable in 2008, $4,000
Wages Expense Wages Payable
Income Tax Expense Income Tax Payable
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Chapter 4Income Statement Accounts
Service Revenue
74,000
Wages Expense
4,000
Income Tax Expense
4,000
Amortization Expense
4,000
Interest Expense
1,000
Supplies Expense
8,000
Other Expense
35,000
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Chapter 4ABC Co.
Income StatementFor the Period Ended December 31, 2007
Service Revenue 74,000 Expenses
Amortization Expense 4,000Interest Expense1,000Supplies Expense 8,000Wages Expense 4,000Other Expenses 35,000Income Tax Expense 4,000 56,000Net Income 18,000
Earnings Per Share (18,000 / 20,000) $0.9
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Chapter 4
Closing Entries
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Chapter 4
Income Summary
74,000
0
56,00018,000
Service Revenue
74,000
0
74,000
Amortization Expense
4,000 4,000
0
Interest Expense
4,000 4,000
0
Supplies Expense
8,000 8,000
0
Wages Expense
4,000 4,000
0
Other Expense
35,000 35,000
0
Retained Earnings
4,00012,000 18,000
10,000
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Chapter 4ABC Co; Balance Sheet; December 31, 2007
AssetsCash 35,000Accounts Receivable 11,000Supplies Inventory 4,000Small Tools Inventory 9,000Equipment 18,000Accumulated Amortization – Equipment 4,000 14,000Other Assets 9,000Total Assets 82,000 Liabilities and Shareholder’s EquityLiabilitiesAccounts Payable 15,000Notes Payable 25,000Interest Payable 1,000Income Tax Payable 4,000Wages Payable 4,000Deferred Revenue 3,000Total Liabilities 52,000 Shareholder’s EquityShare Capital 20,000Retained Earnings 10,000Total Shareholder’s Equity 30,000Total Liabilities and Shareholder’s Equity 82,000
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Chapter 5
Cash Flow Statement
76
Chapter 5
• Because of accrual basis– revenues don’t always = cash collected– expenses don’t always = cash paid out
• Cash flows are important! – a company can be making a profit, but can go
bankrupt if it has no cash inflows
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Chapter 5
• The cash flow statement looks at the activities within the company affecting cash
• The cash flow statement classifies activities involving cash in the company as operating, investing, and financing activities
• It gives us an increase or decrease of cash for the period
Cash (Beginning Balance)+/- Increase or Decrease of Cash
= Cash (Ending balance)
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Chapter 5
Cash Flows from Operating Activities:• Cash inflows/outflows related to the day-to-
day operations of business– Cash received from sales– Cash received as dividends and interest– Cash paid for operating expenses (i.e. salary,
utilities, rent)– Cash paid for taxes
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Chapter 5
Cash Flows from Investing Activities:• Cash inflows/outflows related to acquisitions
and disposals of assets and investments in other companies– Cash paid for buying new property or equipment– Cash received from sale of property or equipment– Cash paid for buying investments– Cash received from sale of investments
• Interest received on the investments is cash inflow from operating activities
80
Chapter 5
Cash Flows from Financing Activities:• Cash inflows/outflows related to the financing of the company
from creditors or owners– Cash received from debt borrowing (Bond Payable, Notes
Payable, Mortgage Payable)– Cash paid for repayment of the Bond Payable, Notes
Payable, Mortgage Payable • Interest paid on the debt is cash outflow from operating activities
– Cash received from issuing new shares– Cash paid for repurchasing shares from existing owners– Cash paid as dividends to shareholders of the company
• Dividend received from investing in another company’s shares is cash inflow from operating activities
81
Chapter 5
Non-cash Financing and Investing Activities• Using shares or a debt instrument to buy an
asset• This transaction does NOT involve cashDR Equipment
CR Debt/Common Shares • However, it should be disclosed as this is a
significant transaction
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Chapter 5• Accounts and Types of Activities (General Guideline)
A =Current Assets• operating
Non Current Assets• investing
L +Current Liabilities• operating
Long Term Liabilities• financing
SE• financing
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Chapter 5Operating, investing or financing activity? A) Paying dividends to shareholders B) Sale of a piece of land and related building C) Investing in common stock of another company D) Repayment of a note payable
E) Purchasing a supply of inventory
F) Issuing Common Shares to new shareholders
G) Receiving dividends on the shares purchased of other companies
H) Borrowed money by issuing a bond
84
Chapter 5• Cash Flows from Operations section– Direct method – record all the actual cash
inflows and outflows that occurred in the period
– Indirect method – start with net income and adjust for any non-cash items
• Both methods give the same cash flow from operating activities number
85
Chapter 5
Direct Method+ Cash Inflows• Cash received from customers• Cash received as interest and dividends
- Cash Outflows• Cash paid to suppliers• Cash paid to employees• Cash paid as interest
= Cash Flow from Operations
86
Chapter 5
Indirect MethodNet Income+/- Changes in current assets+/- Changes in current liabilities+ Non cash expenses, losses- Non cash revenues, gains= Cash Flow from Operations
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Chapter 5
Indirect Method
Revenue Cash Received- Expenses - Cash Paid= Net Income = Net Cash Flows
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Chapter 5Changes in Current Assets (A/R, Inventory, Prepaid)
• Subtract increases in current assets• Add decreases in current assets
Why?A/R
Beginning
Revenue Cash Collected
Ending
Beginning A/R + Revenue – Cash Collected = Ending A/R
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Chapter 5
Beginning A/R + Revenue – Cash Collected = Ending A/R
IF Beginning A/R < Ending A/R Increase in A/RThen
Revenue – Cash Collected > 0Revenue > Cash Collected
SUBTRACT the difference from net income
IF Beginning A/R > Ending A/R Decrease in A/RThen
Revenue – Cash Collected < 0Revenue < Cash Collected
ADD the difference to net income
90
Chapter 5
Indirect Method
Revenue Cash Received- Expenses - Cash Paid= Net Income = Net Cash Flows
91
Chapter 5
Changes in Current Liabilities (A/P, Interest Payable, Unearned Revenue, etc.)
• Add increases in current liabilities• Subtract decreases in current liabilities
Why? A/P
Beginning
Cash Paid Expenses
Ending
Beginning A/P + Expenses – Cash Paid = Ending A/P
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Chapter 5Beginning A/P + Expenses – Cash Paid = Ending A/P
IF Beginning A/P < Ending A/P Increase in A/PThen
Expenses – Cash Paid > 0Expenses > Cash Paid
Since expenses are subtracted to arrive at net income and our actual cash outflows are less than actual expenses ADD the difference to net income
IF Beginning A/P > Ending A/P Decrease in A/PThen
Expenses – Cash Paid < 0Expenses < Cash Paid
Since expenses are subtracted to arrive at net income and our actual cash outflows are greater than actual expenses SUBTRACT the difference from net income
93
Chapter 5
Indirect Method
Revenue Cash Received- Expenses - Cash Paid= Net Income = Net Cash Flows
94
Chapter 5
Non cash expenses and losses• Add expense amounts on the income
statement that do not affect cash– Depreciation expense, future income tax expense
• Add losses on sale of assets or investments – Accounted for in the investing section
• Add losses on repayment of long term debt– Accounted for in the financing section
95
Chapter 5
Indirect Method
Revenue Cash Received- Expenses - Cash Paid= Net Income = Net Cash Flows
96
Chapter 5
Non cash revenues and gains• Subtract revenue amounts on the income
statement that do not affect cash
• Subtract gains on sale of assets or investments – Accounted for in the investing section
• Subtract gains on repayment of long term debt– Accounted for in the financing section
97
Chapter 5
Indirect Method
Revenue Cash Received- Expenses - Cash Paid= Net Income = Net Cash Flows
98
Chapter 5 Required: Prepare the statement of cash flows for SOS Limited for 2009
using the indirect method.
2008 2009 Cash $10,000 $20,200 Accounts receivable 17,000 21,000 Inventories 14,000 18,400 Prepaid expenses 3,500 1,000 Equipment 50,000 65,000 Accumulated amortization, equipment 19,000 27,000 Amortization expense, equipment 11,000 14,000 Land 80,000 120,000 Accounts payable 13,000 19,000 Interest payable 550 1,150 Notes payable 31,000 44,000 Bonds payable 50,000 30,000 Mortgage payable 40,000 40,000 Capital stock 210,000 217,000
99
Chapter 5
The following information relates to activities for SOS Limited for 2009.
a) Net income for the year ended December 31, 2009, was $22,500. b) The company borrowed $20,000 on a long-term note from the bank. Interest is
payable annually and the interest expense of $3,000 is included in net income.c) An additional piece of land was purchased on November 30, 2009. The seller of the
land accepted a mortgage as full payment.d) During the year, a piece of equipment was sold for $15,000, paid in cash. Any gain or
loss on the sale was included in net income. A new piece of equipment costing $28,000 was purchased in June. The purchase price was paid in cash.
e) Dividends of $6,000 were paid in cash. f) Capital stock was issued in exchange for the retirement of $7,000 of long-term notes
payable.g) A portion of the bonds matured during 2009 and the company paid cash to redeem
these bonds.
100
Chapter 5
Net income for the year ended December 31, 2009, was $22,500
Cash flows from operating activities
Net Income 22,500Adjustments:Increase in A/RIncrease in InventoryDecrease in PrepaidIncrease in A/PIncrease in Interest Payable??
2008 2009 Cash $10,000 $20,200 Accounts receivable 17,000 21,000 4,000 Inventories 14,000 18,400 4,400 Prepaid expenses 3,500 1,000 (2,500)Equipment 50,000 65,000 Accumulated amortization, equipment 19,000 27,000 Amortization expense, equipment 11,000 14,000 Land 80,000 120,000 Accounts payable 13,000 19,000 6,000 Interest payable 550 1,150 600 Notes payable 31,000 44,000 Bonds payable 50,000 30,000 Mortgage payable 40,000 40,000 Capital stock 210,000 217,000
101
Chapter 5c) An additional piece of land was purchased on November 30, 2009. The seller of the land accepted a
mortgage as full payment.d) During the year, a piece of equipment was sold for $15,000, paid in cash. Any gain or loss on the sale
was included in net income. A new piece of equipment costing $28,000 was purchased in June. The purchase price was paid in cash.
Cash flows from Investment activities:
102
Chapter 5d) During the year, a piece of equipment was sold for $15,000, paid in cash. Any gain or loss on the sale
was included in net income. A new piece of equipment costing $28,000 was purchased in June. The purchase price was paid in cash.
2008 2009 Cash $10,000 $20,200 Accounts receivable 17,000 21,000 4,000 Inventories 14,000 18,400 4,400 Prepaid expenses 3,500 1,000 (2,500)Equipment 50,000 65,000 Accumulated amortization, equipment 19,000 27,000 Amortization expense, equipment 11,000 14,000 Land 80,000 120,000 Accounts payable 13,000 19,000 6,000 Interest payable 550 1,150 600 Notes payable 31,000 44,000 Bonds payable 50,000 30,000 Mortgage payable 40,000 40,000 Capital stock 210,000 217,000
Equipment
Accumulated Amortization: Equipment
103
Chapter 5d) During the year, a piece of equipment was sold for $15,000, paid in cash. Any gain or loss on the sale
was included in net income. A new piece of equipment costing $28,000 was purchased in June. The purchase price was paid in cash.
2008 2009 Cash $10,000 $20,200 Accounts receivable 17,000 21,000 4,000 Inventories 14,000 18,400 4,400 Prepaid expenses 3,500 1,000 (2,500)Equipment 50,000 65,000 Accumulated amortization, equipment 19,000 27,000 Amortization expense, equipment 11,000 14,000 Land 80,000 120,000 Accounts payable 13,000 19,000 6,000 Interest payable 550 1,150 600 Notes payable 31,000 44,000 Bonds payable 50,000 30,000 Mortgage payable 40,000 40,000 Capital stock 210,000 217,000
Gain on sale of equipment= Sale Price – Net Book Value of equipment
Net Book Value = Cost – Accumulated Amortization
104
Chapter 5Cash flows from operating activitiesNet Income 22,500Adjustments:Increase in A/R (4,000)Increase in Inventory (4,400)Decrease in Prepaid 2,500Increase in A/P 6,000Increase in Interest Payable 600Amortization Expense 14,000Gain on Sale of Equipment (8,000)Net Cash Flows from Operating Activities 29,200
Cash flows from investing activitiesCash paid for purchase of new equipment (28,000)Cash received for sale of equipment 15,000Net Cash Flows from Investing Activities (13,000)
105
Chapter 5 b) The company borrowed $20,000 on a long-term note from the bank. Interest is payable annually
and the interest expense of $3,000 is included in net income.e) Dividends of $6,000 were paid in cash. f) Capital stock was issued in exchange for the retirement of $7,000 of long-term notes payable.g) A portion of the bonds matured during 2009 and the company paid cash to redeem these bonds.
2008 2009 Cash $10,000 $20,200 Accounts receivable 17,000 21,000 4,000 Inventories 14,000 18,400 4,400 Prepaid expenses 3,500 1,000 (2,500)Equipment 50,000 65,000 Accumulated amortization, equipment 19,000 27,000 Amortization expense, equipment 11,000 14,000 Land 80,000 120,000 Accounts payable 13,000 19,000 6,000 Interest payable 550 1,150 600 Notes payable 31,000 44,000 Bonds payable 50,000 30,000 Mortgage payable 40,000 40,000 Capital stock 210,000 217,000
Cash flows from financing:
Borrowed N/PDividends PaidB/P matured
Note Payable
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Chapter 5Cash flows from operating activitiesNet Income 22,500Adjustments:Increase in A/R (4,000)Increase in Inventory (4,400)Decrease in Prepaid 2,500Increase in A/P 6,000Increase in Interest Payable 600Amortization Expense 14,000Gain on Sale of Equipment (8,000)Net Cash Flows from Operating Activities 29,200
Cash flows from investing activitiesCash paid for purchase of new equipment (28,000)Cash received for sale of equipment 15,000Net Cash Flows from Investing Activities (13,000)
Cash flows from financing activitiesCash received from issuance of N/P 20,000Cash paid for dividends (6,000)Cash paid for redemption of bonds (20,000)Net Cash Flows from Financing Activities (6,000)Net Increase in Cash 10,200Cash (Begin) 10,000Cash (End) 20,200
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Chapter 5
2008 2009 Cash $10,000 $20,200 Accounts receivable 17,000 21,000 4,000 Inventories 14,000 18,400 4,400 Prepaid expenses 3,500 1,000 (2,500)Equipment 50,000 65,000 Accumulated amortization, equipment 19,000 27,000 Amortization expense, equipment 11,000 14,000 Land 80,000 120,000 Accounts payable 13,000 19,000 6,000 Interest payable 550 1,150 600 Notes payable 31,000 44,000 Bonds payable 50,000 30,000 Mortgage payable 40,000 40,000 Capital stock 210,000 217,000
2008 2009 Cash $10,000 $20,200 Accounts receivable 17,000 21,000 4,000 Inventories 14,000 18,400 4,400 Prepaid expenses 3,500 1,000 (2,500)Equipment 50,000 65,000 Accumulated amortization, equipment 19,000 27,000 Amortization expense, equipment 11,000 14,000 Land 80,000 120,000 Accounts payable 13,000 19,000 6,000 Interest payable 550 1,150 600 Notes payable 31,000 44,000 Bonds payable 50,000 30,000 Mortgage payable 40,000 40,000 Capital stock 210,000 217,000
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Chapter 6
Participants in Accounting Process• Company want to produce financial
statements for external users • Different parties will be involved in this
process
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Chapter 6
Participants in Accounting Process• Regulators– Sets the standards of how to report financial
information– The “rules” that the company must follow
• Management – CEO, CFO, other executives– Decide on which accounting methods to use
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Chapter 6
Participants in Accounting Process• Board of Directors– The voice for shareholders– Ensures the integrity of the company
• Auditors– Independent third parties– Issues an opinion on whether FS are in compliance
with standards– Issues the Auditor’s Report
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Chapter 6
Participants in Accounting Process• Auditors do NOT have an opinion on the
financial wealth of the company• Financial Analysts– Takes public information and analyzes the financial
position of the company– Makes recommendations on whether buy, hold, or
sell the stock
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Chapter 6Characteristics of Useful Information• Relevant – predictive, timely
• Reliable – verifiable, accurate, neutral
• Comparable – can be compared across different companies or against itself
• Consistent – use same accounting principles over time, or makes a
disclosure if accounting methods are changed
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Chapter 6
How much information is TOO MUCH?• Materiality– Some accounts are not significant, will not affect
the user’s decisions• Cost-benefit constraint– Management should think about the costs of
obtaining more information• Conservatism– It’s better to understate assets and overstate
liabilities
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Ratios
• Make sure you understand what each ratio means
• Ratios need to be compared against a benchmark– companies in the same industry– against prior years financial figures
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Chapter 1
Price Earnings Ratio = Market Price Net Income
• Investors will multiply the P/E ratio with expected or actual net income to generate a “price” one would pay for the company
• The higher the ratio, the greater confidence investors have in the company’s ability to generate income
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Chapter 2
Debt to Equity Ratio = Total Liabilities Total Owners’ Equity
• Measures how much debt has been used to finance the company – versus financing through the owners/shareholders of the company
• A ratio larger than 1 means the company uses more debt than equity to finance
• A high debt-to-equity ratio means there is a higher risk that a company may not be able to meet its financial obligations
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Chapter 3
Asset Turnover = ____Total Sales____ Average Total Assets
• Average total assets = [beginning assets + ending assets] / 2
• Measures how much revenue is generated by every $1 of assets
• Measures company’s effectiveness at utilizing assets to generate revenue
• A higher ratio is more favourable
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Chapter 3
Return on Assets = ____Net Income____ Average Total Assets
• Average total assets = [beginning assets + ending assets] / 2
• Measures how much income is generated by every $1 of assets
• Measures company’s effectiveness at utilizing assets to generate income
• A higher ratio is more favourable
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Chapter 4
Net Profit Margin = Net Income Net Sales
• Measures how much income is generated for each dollar of sales
• For every $1 of sales, how much does the company get to retain?
• A higher net profit margin is more favourable
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Chapter 4
Return on Equity (ROE) =________Net Income_____Average Shareholders’ Equity
• Measures how much income is generated for each dollar of shareholder’s equity
• Measures ability the earn income for owners/ shareholders
• A higher ratio is more favourable
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Chapter 5
Quality of Income Ratio =__Cash Flow from Operating Activities__
Net Income
• Measures portion of income generated in cash• A higher ratio indicates greater ability to
finance operating activities from cash inflows
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Chapter 5
Capital Acquisition Ratio = ____Cash Flow from Operating Activities____
Cash Paid for Property, Plant, and Equipment
• Measures the ability of company to pay for PPE purchases using available cash, without relying on debt or equity financing
• High ratio indicates less need for outside financing to acquire new capital assets
