Accounting 2
Chapters 13 to 26
Class Handouts
For Instructor
Howard J. Levine
Note: This packet should be brought to class every week. If you forget or misplace it you can reprint the set by going to the Valley College
web site and navigating to Howard Levine’s instructor page:
http://www.lavc.edu/hlevine
Page 1 of 37
13-1
ORGANIZATION COSTS
Record the following entry for Hoover Corporation:
Hoover Corporation was organized early in 2014. Legal
costs and other fees associated with incorporation totaled $3,500.
Page 2 of 37
14-1
DISTRIBUTION OF
DIVIDENDS—COMMON AND
PREFERRED SHAREHOLDERS
Belson Corporation has 5,000 shares of $100 par value, 5% cumulative preferred stock. It also has 5,000 shares of $100 value common
stock. In the prior year it had horrible cash flow problems and did not
pay dividends; in the current year it declares a $65,000 dividend.
Compute who gets what.
Belson Corporation
Preferred stock is cumulative.
Dividend = $65,000
Preferred
Common
Total
Shareholders Shareholders Distributed
Page 3 of 37
14-2
DISTRIBUTION OF
DIVIDENDS—STOCK DIVIDENDS
Jones Corporation has $100,000 in Retained Earnings. It declares
a 5% stock dividend on its 10,000 shares of $10 par value common
stock. The market price of the stock on the date of declaration is
$15/share.
How many shares are issued?
What is the amount debited to Dividends?
The entry would be:
Page 4 of 37
14-3
Technograph Corporation discovered that some
hazardous material was buried on a parcel of land currently
owned by the corporation. A former owner of the property
buried the material. It will cost Technograph $1 million to remove the material and
dispose of it properly.
Would it be appropriate for Technograph's board of
directors to restrict $1 million for cleanup of the hazardous
material? If so, what would the restriction accomplish?
Page 5 of 37
14-4
RETURN ON EQUITY
Coca Cola (Appendix C)
2010:
Net income .................. $11,809
Average equity:
($24,799 + $31,003) / 2 = $27,901
Return on equity
($11,809 / $27,901) = 42.3%
2011:
Net income ................... $8,572
Average equity:
($31,635 + $31,003) / 2 = $31,319
Return on equity
($8,572 / $31,319) = 27.4%
Amazon-Com (Appendix D)
2010:
Net income .................... $631
Average equity:
($5,257 + 6,864) / 2 = $6,060.50
Return on equity
($631 / $6,060.50) = 10.4%
2011:
Net income ................... $1,152
Average equity:
($6,864 + $7,757) / 2 = $7,310.50
Return on equity
($1,152 / $7,310.50) = 15.75%
Page 6 of 37
15-1
Present Value
Assume that you have a rich uncle who dies.
In his will, he leaves you with the following option:
You can have $100,000 today or $200,000 in 10 years.
Interest rates are 10%. Which should you choose?
Answer:
From Appendix G (Page G4) we see that the present value of
$1 at 10% for 10 years is .38554. You multiply $200,000 x .38554 to
find that today’s value is $77,108, not the $100,000 that it seems. So
take the money over the next ten years!
To prove this:
Year 1 ............................... $100,000 * 10% = $10,000
Year 2 ............................... $110,000 * 10% = $11,000
Year 3 ............................... $121,000 * 10% = $12,100
Year 4 ............................... $133,100 * 10% = $13,310
Year 5 ............................... $146,410 * 10% = $14,641
Year 6 ............................... $161,051 * 10% = $16,105
Year 7 ............................... $177,156 * 10% = $17,716
Year 8 ............................... $194,872 * 10% = $19,487
Year 9 ............................... $214,359 * 10% = $21,440
Year 10............................... $235,800 * 10% = $23,580
By taking the money slowly you end up with $259,380 instead
of $200,000 as promised. This is called compound interest and is a
very important financial tool.
Page 7 of 37
15-2
DEBT TO ASSETS RATIO
Pepsi (Appendix B)
2010:
Debt ............................. $46,677
Assets .......................... $68,153
Ratio .................................. 68.4%
2011:
Debt ............................. $51,983
Assets .......................... $72,882
Ratio .................................. 71.3%
Coke (Appendix C)
2010:
Debt ............................. $41,604
Assets .......................... $72,921
Ratio .................................. 57.1%
2011:
Debt ............................. $48,053
Assets .......................... $79,974
Ratio .................................. 60.1%
Why are these ratios going up when the companies are making lots
of money?
Page 8 of 37
15-3
TIMES INTEREST EARNED
Pepsi (Appendix B)
2010:
IBTE* ...................................... $9,135
Interest Expense ..................... $903
Times interest earned .............. 10.1
2011:
IBTE* ...................................... $9,690
Interest Expense ..................... $856
Times interest earned ............. 11.3
Coke (Appendix C)
2010:
IBTE* ................................... $14,976
Interest Expense .................... $733
Times interest earned ............. 20.4
2011:
IBTE* ................................... $11,856
Interest Expense .................... $417
Times interest earned ............ 28.4
*Income before taxes and interest expense
Page 9 of 37
16-1
TRADING SECURITIES /
AVAILABLE-FOR-SALE
SECURITIES
Unrealized gain/loss
Unrealized gain/loss
Trading Securities
Available for Sale Securities
Stockholders’ Equity
Income
section of the
Statement
Valued at:
Changes in valuation are
reported as:
Reported on the
balance sheet as:
Classified on balance sheet as:
Balance Sheet
Trading
Securities
Fair Value
Available-for-Sale
Securities
Fair Value
Held-to-Maturity
Securities
Amortized Cost
Unrealized gain or
loss is reported on
income statement
as Other income
(loss).
Accumulated unrealized gain or loss
is reported in
stockholders’ equity on the balance
sheet.
Cost of investments plus or minus valuation allowance.
Either as a current
or noncurrent asset, depending on
management’s intent.
Premium or discount amortization
is reported as part
of interest revenue
on the income
statement.
Amortized cost of
investment.
Cost of investments plus or minus valuation allowance.
A current asset.
Page 10 of 37
Either as a current
or noncurrent asset, depending on
remaining term to
maturity.
16-2
TRADING SECURITIES
Portfolio of Trading Securities:
Market
Cost
Value
Security A
$10,000
$10,000
Security B
22,000
21,900
Security C
8,000
9,500
Total
$40,000
$41,400
Cost……………………….
$40,000
Unrealized
Gain/(Loss)………………
$1,400
Page 11 of 37
Unrealized
Gain/(Loss)
$
0
(100)
1,500
$1,400
17-1
STATEMENT OF CASH FLOWS
Three "Foolers"
The following transactions are reported in the Operating Activities section of the statement of cash flows:
1. Interest paid on debt
Justification: The decision to finance the business
through debt is a financing activity. Once that decision
has been made, the cash to pay for the interest on debt
must come from operating activities.
2. Interest received on investments
3. Dividends received on investments
Justification: The decision to use cash to purchase equity
or debt securities is an investment decision. Once that
decision has been made, the cash received from interest
or dividends is used to operate the business.
Page 12 of 37
17-2
CASH FLOWS FROM OPERATING
ACTIVITIES—INDIRECT METHOD
+
+/–
+/–
Net income (from income statement) ..........
Noncash expenses (depreciation,
amortization, and depletion) ....................
Losses or gains on investing or
financing activities ....................................
Changes in current asset and current
liability accounts related to operating
activities .....................................................
Net cash flows from operating activities ....
Page 13 of 37
$ XXX
XXX
XXX
XXX
$ XXX
17-3
STATEMENT OF CASH FLOWS
FROM OPERATING
ACTIVITIES—DIRECT METHOD
Cash received from customers:
Sales +/– Change in Accounts Receivable
Cash payments for purchases:
Cost of Merchandise Sold +/– Change in Inventories +/– Change in
Accounts Payable
Cash payments for operating expenses:
Operating Expenses +/– Change in Prepaid Expenses +/–
Change in Accrued Expenses
Cash payments for interest:
Interest Expense +/– Change in Interest Payable
Cash payment for income taxes:
Income Tax Expense +/– Change in Income Taxes
Payable
Page 14 of 37
17-4
FREE CASH FLOW
Pepsi (Appendix B)
2010:
8,448 - 3,253 – 2,978 = ........... 2,217
2011:
8,944 – 3,339 – 3,157 =........... 2,448
Coke (Appendix C)
2010:
9,532 – 2,215 – 4,068 =......... 3,249
2011:
9,474 – 2,920 – 4,300 =......... 2,254
Free cash flow: Net cash provided by operating activities less
capital expenditures less cash dividends.
Page 15 of 37
18-1
HORIZONTAL ANALYSIS
Pepsi (Appendix B)
Dollar Change
2010
2011
Net Sales
Gross Profit
Operating Expenses
Net Income
$14,606
57,838-43,232
$8,130
31,263-23,133
$7,788
22,814-15,026
$374
6,320-5,946
Percentage Change
2010
2011
$8,666
33.7%
66,504-57,838 14,606/43,232
$3,648
35.1%
34,911-31,263 8,130/23,133
$2,331
51.8%
25,145-22,814 7,788/15,026
$123
5.9%
6,443-6,320
374/6,320
15.0%
8,666/57,838
11.6%
3,648/31,263
10.2%
2,331-22,814
1.9%
123/6,320
Coke (Appendix V)
Dollar Change
2010
2011
Net Sales
Gross Profit
Operating Expenses
Net Income
$4,129
35,119-30,990
$1,613
12,693-11,088
$1,800
13,158-11,358
$4,956
11,859-6,906
$11,423
46,542-35,119
$5,523
18,216-12,693
$4,282
17,440-13,158
$-3,225
8,634-11,859
Page 16 of 37
Percentage Change
2010
2011
13.3%
4,129/30,990
14.5%
1,613/11,088
15.8%
1,800/11,358
71.8%
4,956/6,906
32.5%
11,423/35,119
43.5%
5,523/12,693
32.5%
4,282-13,158
-27.1%
-3,225/11,859
19-1
FINANCIAL ACCOUNTING VS.
MANAGERIAL ACCOUNTING
Financial Accounting
1. External Focus: Primarily reports results of
business operations to persons "outside" the
company
2. Reports historical data
3. Must follow generally accepted accounting
principles
Managerial Accounting
1. Internal Focus: Reports information used by
management in overseeing daily operations of
company
2. Reports historical data and budgets or estimates
for the future
3. Reports more detailed information
4. Not restricted by generally accepted accounting
principles
5. Usefulness to management is guiding principle
Page 17 of 37
19-2
QUESTION TO PONDER
Why is it permissible to violate generally accepted accounting principles when preparing reports used strictly by company management?
Page 18 of 37
19-3
MANUFACTURING COSTS
Direct Materials—materials and component parts that become an integral part of the final product. These materials can be traced directly
to a finished unit of product.
Direct Labor—cost of wages paid to employees who work directly on
the product.
Factory Overhead—all other costs incurred in making the product.
These costs include the following:
1. General manufacturing costs that cannot be traced directly to
the product:
Utilities (heating, lighting)
Depreciation on machines
Property taxes
Insurance
2. Indirect Labor—wages/salaries paid to workers who are necessary to keep the factory running, but do not work directly on the
product:
Maintenance workers
Janitorial staff
Factory personnel department
Plant manager and supervisors
3. Indirect Materials—materials used in the manufacturing process
that do not end up in the final product:
Materials used to test machines
Lubrication used on machines
NOTE: Direct materials and direct labor costs may be treated as factory overhead costs if they are insignificant.
Page 19 of 37
19-4
Statement of Cost of Goods Manufactured
Work in process inventory, beginning of period
$XXX
Direct Materials:
Materials Inventory, Beginning of period
$XXX
Purchases
XXX
Cost of materials available for use
$XXX
Less materials inventory, Ending
XX
Cost of Materials placed in production
$XXX
Direct Labor
XXX
Factory Overhead:
Indirect Labor
$XXX
Depreciation on factory equipment
XXX
Factory Utility Expenses
XXX
Total Factory overhead
XXX
Total manufacturing costs added
XXX
Total manufacturing cost
$XXX
Less ending work in process inventory
Cost of goods manufactured
XX
$XXX
Page 20 of 37
19-5
Income Statement For Manufacturing Company
Sales
$XXX
Cost of Goods Sold:
Beginning finished goods inventory
$XXX
Cost of goods manufactured
XXX
Cost of finished goods available for sale
XXX
Less ending finished goods inventory
XXX
Cost of goods sold
XXX
Gross profit
$XXX
Operating expenses:
Selling expenses
$XXX
Administrative expenses
XXX
Total Operating expenses
XXX
Net Income
$XXX
Page 21 of 37
20-1
JOB ORDER VS.
PROCESS COSTING
Job Order Costing
Used by manufacturers who make special
orders, customized products, or standard
products produced in batches.
Process Costing
Used by manufacturers who mass produce large quantities of identical units in
a continuous flow.
Page 22 of 37
20-2
JOURNAL ENTRIES IN A JOB ORDER
COST ACCOUNTING SYSTEM
Record the following entries for Jen Manufacturing.
1. Purchased materials costing $20,000 on account.
2. Materials costing $13,000 were requisitioned for
use in making specific customer jobs. An additional $1,000 in materials was requisitioned for
general factory use.
3. $7,800 was paid to direct laborers. An additional
$9,500 was paid to factory employees who do not
work directly on Jen's products.
4. Factory overhead expenses totaling $5,000 were
paid in cash.
5. $3,700 in depreciation was recorded on factory
machines.
6. Overhead was applied to production using a
predetermined rate of $24.50 per direct labor
hour. Jen used 780 direct labor hours during the
period.
7. Jobs costing $38,000 were completed.
8. Jobs costing $32,000 were sold to credit customers for $55,000.
Page 23 of 37
20-5
JOB ORDER COSTING IN A
SERVICE BUSINESS
John Meyer, CPA, does tax and audit work. He estimates his overhead costs for the current year will be:
Wages paid to receptionist ....................... $17,000
Supplies ......................................................
8,000
Depreciation on office equipment ............
2,000
Advertising .................................................
1,300
Rent and utilities ........................................
4,000
$32,300
John uses direct labor hours to allocate overhead
costs to jobs performed for clients. He estimates that
he will work 1,900 hours conducting audits and preparing tax returns this year. John uses $25 per hour
for his wage rate when computing the cost of any
work performed for a client.
John spent 12 hours preparing a tax return for Sharon
Ward. What was the cost to prepare Sharon's return?
Page 24 of 37
20-6
JOB ORDER COSTING IN A
SERVICE BUSINESS
Solution
$32,300
Predetermined overhead rate =
= $17 per hour
1,900 hours
Cost to prepare the tax return:
Direct Labor ($25/hour × 12 hours) ..........................
$300
Overhead ($17/hour × 12 hours) ..............................
204
Total......................................................................
$504
Page 25 of 37
21-1
SIMILARITIES IN JOB ORDER
AND PROCESS COSTING
Both systems determine a product cost by measuring the amount of direct materials and direct labor used and
allocating overhead costs. They also use the same accounts
(Raw Materials Inventory, Factory Labor and Manufacturing
Overhead).
Both systems allocate overhead using a predetermined overhead rate(s).
Both systems maintain perpetual inventory records
with subsidiary ledgers for materials, work in process, and
finished goods.
Page 26 of 37
21-2
DIFFERENCES IN JOB ORDER
AND PROCESS COSTING
Job Order:
Only one Work in Process Account is used.
Costs are accumulated by job.
Costs are totaled at the completion of a job.
Cost to Make One Unit
=
Cost of the Job
No. of Units in the Job
Process Costing:
Work in Process is used for each department.
Costs are accumulated by department for a time period (for example, one month).
Cost to Make One Unit
in One Department
=
Department’s Cost
for the Month
No. of Units Produced
during the Month
To find the total unit cost, add the unit costs incurred in each department.
Page 27 of 37
23-2
COST OF GOODS SOLD BUDGET—
BOWERMAN CORPORATION
Finished goods inventory, August 1...........................
$87,000
Work in process inventory, August 1 .........................
$ 35,000
Direct materials:
Direct materials inventory, August 1 ..................... $ 7,300
Direct materials purchases ....................................
26,500
Materials available for use .....................................
33,800
Less direct materials inventory, August 31 ..........
7,000
Materials placed in production ..............................
26,800
Direct labor ...................................................................
50,000
Factory overhead .........................................................
31,000
Total manufacturing costs ..........................................
107,800
Total work in process during August .........................
142,800
Less work in process, August 31 ...............................
30,000
Cost of goods manufactured ......................................
112,800
Finished goods available for sale ...............................
199,800
Less finished goods inventory, August 31 ................
90,000
Cost of goods sold .......................................................
$109,800
Page 28 of 37
23-3
CASH BUDGET
Estimated Cash Receipts
– Estimated Cash Payments
Cash Increase (or Decrease)
+ Cash Balance at the Beginning of Month
Cash Balance at the End of Month
– Minimum Cash Balance
Excess (or Deficiency)
Page 29 of 37
23-4
CASH BUDGET
ESTIMATING CASH RECEIPTS
The sales budget of Carson Industries projects the following
sales for January through May:
January ..................................................
February .................................................
March......................................................
April ........................................................
May .........................................................
$235,000
250,000
270,000
212,000
220,000
Carson sells 30% of its merchandise to cash customers. Of
the sales on credit, 75% are collected in the month after the sale, and
25% are collected in the second month after the sale.
Determine the amount of cash that Carson expects to collect
from cash sales and accounts receivable during the months of
March, April, and May.
March
Cash sales.........................
Collections on
accounts receivable:
(1) From last month's
credit sales ...............
(2) From credit sales
2 months ago ............
Total cash receipts ...........
Page 30 of 37
April
May
24-1
BUDGETING
Joes House of Child Care has just hired a new controller,
Diana Metcalf. During her first week on the job, Diana was asked to
establish a budget for operating expenses in 2014. Since Diana was
not yet familiar with the operations of Joes House of Child Care, she
decided to budget these expenses using the same procedures as the
prior controller. Therefore, in order to establish a budget for operating expenses, Diana started with actual operating expenses incurred
in 2013 and added 4.3%. Diana based this percentage on inflation as
measured by the consumer price index.
Comment on the effectiveness of Diana’s budgeting strategy.
Page 31 of 37
24-2
BUDGETING METHODS
TWO MAJOR TYPES OF BUDGETS
Static Budget
Description:
A budget that does not reflect potential
changes in volume or activity level
Strength:
Simple—all expenses are budgeted as
fixed costs
Weakness:
Does not reflect changes in revenues and
expenses that must occur as volumes
change, making it difficult to interpret
actual performance
Typical Usage: Service organizations or administrative
departments of retailers and manufacturers
Flexible Budgets
Description:
A budget that shows revenues and expenses
for a variety of volumes or activity levels
Strength:
Provides information needed to analyze the
impact of volume changes on actual
operating results
Weakness:
Requires greater research into costs—must
differentiate fixed and variable costs in the
budgeting process
Typical Usage: Operational departments of retailers and
manufacturers whose costs change with
sales and production
Page 32 of 37
24-3
Budgeting
Assume that you manage one store in a chain of
sporting goods retailers. Each month, your store is evaluated
by comparing actual operating results to budgeted results.
During December of the current year, your store's
sales were up 25% from sales projected on the budget. As a
result of this increase in sales, would you expect any other
items to come in over (or under) their budgeted amounts? If
so, describe why they would vary from the budget.
Page 33 of 37
24-4
Laboratory Services—
Eastgate Hospital
Flexible Budget
Budgeted total cost per test: $40
Number of tests anticipated at the beginning of the year: 13,000
Number of actual tests for the year: 14,800
Resource
Budget
Budget
Cost per (Based on
(Based on
Test 13,000 Tests) 14,800 Tests)
Actual
(End of
Year)
Salaries ...........
Benefits ...........
Supplies ..........
Training ...........
$30
5
3
2
$390,000
65,000
39,000
26,000
$444,000
74,000
44,400
29,600
$420,000
70,000
50,000
30,000
Total .............
$40
$520,000
$592,000
$570,000
Page 34 of 37
26-1
Summer Job Offers
You have been offered two different jobs for the upcoming summer.
Since both are full-time positions, you must choose to work only one of the
jobs.
The first job is in an office. The pay will be $320 per week. The office
is located 20 miles from your home, so you estimate that you will spend $25
per week on gas. You will also have to pay $25 per week for parking. Because
you are required to dress professionally, you will need to purchase some new
clothes. You estimate that you will spend $350 on new clothes for this job during the summer.
The second job is at an amusement park. The pay will be $220 per
week. The amusement park is also 20 miles from your home, but you can carpool with a friend. Your share of the gas will be $12.50 per week. There is no
charge for parking. The amusement park will furnish you with a uniform, so
you won't need to buy any special clothes.
Assuming that your summer break will allow you to work 12 weeks,
which job will provide you with more money?
Page 35 of 37
26-2
METHODS USED TO EVALUATE CAPITAL INVESTMENTS
Method
Annual Rate
of Return
Cash Payback
Net Present
Value
Advantages
Disadvantages
Easy to calculate
Ignores cash flows
Considers accounting
income (often used to
evaluate managers)
Ignores the time value
of money
Considers cash flows
Ignores profitability
(accounting income)
Shows when funds
are available for
reinvestment
Ignores cash flows after
the payback period
Considers cash flows
and the time value of
money
Ignores the time value
of money
Assumes that cash received from the project
can be reinvested at the
rate of return.
Necessary to evaluate
projects of unequal size
using a present value
index
Internal Rate
of Return
Considers cash flows
and the time value of
money
Ability to compare
projects of unequal
size
Page 36 of 37
Requires complex
calculations or trialand-error methods
Assumes that cash
received from the project
can be reinvested at the
internal rate of return
26-3
EXERCISE
What are some of the factors
that management would consider in
setting the minimum rate of return for investments?
Page 37 of 37