Accoun&ng Exam Notes:
What is the purpose of accoun&ng?
-­‐ To provide useful informa&on for decision making
-­‐ Qualita&ve characteris&cs of accoun&ng informa&on (understandability, relevance, reliability, comparability)
-­‐ Recogni&on and Measurement Criteria (determine when items should be included and recognized, outline how to measure or assign amount to items)
CICA: Canadian Ins&tute of Chartered Accountants
IASB: Interna&onal Accoun&ng Standards Board
IFRS: Interna&onal Financial Repor&ng Standards
GAAP’s
Going Concern: a company will con&nue to operate in the future. You con&nue to prepare your financial statements following the cost principle un&l liquida&on has been confirmed and set. Monetary Unit: only record data that has a real value in terms of money. Ex. You cannot record employees as an asset.
Economic En3ty: the owner and the business should be considered separately. So the owner cannot record any personal drawings and a company’s expense
Time Period: economic life should be divided into &me periods, like fiscal periods.
Cost Benefit: if the value of informa&on exceeds the cost of providing it. This is applicable mainly for small businesses
Materiality: an item’s impact on a firm’s overall financial condi&on and opera&ons. You cannot amor&ze a stapler, for example. Matching: expenses should be recorded in the same period as the revenue it helped earn.
Full Disclosure: disclosure of circumstances and events that affect financial statement users should be noted. Cost: assets should be recorded at COST, unless you get it appraised.
Revenue Recogni3on: revenue should be recognized in the same period it was earned
-­‐ Point of sale: should be recognized in the same period it was earned
-­‐ During produc3on: revenue recogni&on is possible before produc&on is completed
o costs incurred/total es3mated costs= percent complete x total revenue= revenue recognized
-­‐ Comple3on of produc3on: if you are not sure about the costs, wait &ll comple&on to recognize revenue
-­‐ Instalment Method: payment received periodically, gross profit recognized in the period in which cash is collected
o Cash Collec3on x Gross Profit Margin= Gross Profit Recognized
§ Gross Profit Margin: Gross Profit/Total Sales
Adjus3ng Entries
Prepaid Expenses: examples of prepaid expenses are suppliers, adver&sing, insurance and rent. Dec 31
_____________ Expense
Xxx
(Prepaid)_____________
Xxx
Record ______ expense for the year
Unearned Revenue: cash received before the service has been preformed are unearned revenues. Ex. Rent, magazine subscrip&on, customer deposits. Unearned revenue is a liability. Once it has been earned, it must adjusted. Dec 31
Unearned Revenue
Xxx
Earned Revenue
Xxx
Record revenue for services provided
Accrued Revenues: revenues earned for services but no payment has been received. Dec 31
Accounts Receivable
Xxx
Earned Revenue
Xxx
Record revenue that has not been billed or collected
Accrued Expenses: expenses incurred but not yet paid or recorded. Examples are: interest, rent, property taxes and salaries. Needed to record the obliga&ons that exist at the balance sheet date and to recognize the expenses that apply to the current accoun&ng period.
Dec 31
__________ expense
Xxx
______________ payable
Xxx
Record accrued expenses.
Long Term Adjus3ng Entries: Amor&za&on, alloca&on of the cost of capital assets to expense over their useful lives**more on amor&za&on in later chapter**
Dec 31
Amor&za&on Expense
Accumulated Amor&za&on
Xxx
Xxx
Record amor&za&on expense for the year
Inventory:
Merchandising Company: has cost of goods sold and opera&ng expenses. For the opera&ng cycle, it takes longer to go from cash to cash producing revenues.
Perpetual Inventory
-­‐ Con&nuously shows the inventory that should be on hand and the cost of goods sold, at any &me. Used mainly for high unit cost, low volume turnover goods
-­‐
-­‐
Cost of goods purchased should be documented by a purchase order or a purchase invoice
When Inventory is bought, it is added to merchandise inventory (asset account). When merchandise is bought, it is deducted from merchandise inventory
-­‐ Purchase Return and Allowances (contra expense): a purchaser may be dissa&sfied with the merchandise and return it for a refund or credit
-­‐ Sales revenues is recognized when earned, COGS is recognized by debi&ng COGS and credi&ng Merchandise Inventory
-­‐ When a customer returns goods to the seller for credit/return. It is recorded by decreasing COGS and increasing Merchandise Inventory. When the merchandise is unsellable, or they choose to keep the inventory, it is recorded under sales returns and allowances (contra revenue).
-­‐ Freight Costs incurred by the seller on outgoing merchandise are debited to Freight Out or Delivery Expense.
-­‐ Freight in is absorbed into the cost of the merchandise inventory
FOB Shipping Point: buyer pays the freight cost
FOB Des3na3on Point: seller must pay the freight cost
Purchases under the Perpetual Inventory
Merchandise Inventory
X
AP
X
Purchased merchandise on account
Merchandise Inventory
X
Cash
X
Paid for freight on goods purchased
AP
x
Merchandise Inventory
x
Returned unsa&sfactory goods
AP
X
Merchandise Inventory
X
Received an allowance for damaged goods
AP
X
Cash
X
Purchase discounts
X
Made payment within discount period
COGS
Merchandise Inventory
X
X
Record difference between inventory records and physical units on hand
Sales under Perpetual AR
X
Sales Revenue
X
Sold goods on account
COGS
X
Merchandise Inventory
X
Value of goods sold
Sales Returns and Allowances
X
AR
X
Customer returned damaged goods
Merchandise Inventory
X
COGS
X
Value of goods returned
Cash
X
Sales Discounts
X
AR
X
Customer paid within discount period. Selling expenses: delivery and shipping expenses that help complete the sale. Ex. Salaries, adver&sing, amor&za&on, freight out.
Administra3ve Expenses: relate to general expenses management, accoun&ng. Ex. Salaries, rent, u&li&es, insurance. Non Opera3ng Ac3vi3es
-­‐ Other revenue gains o Interest revenue
o Dividend revenue from investments
o Rent revenue
-­‐ Other expenses and losses
o Interest revenue on notes and loans payable
o Casualty losses from recurring causes such as accidents and vandalism
o Loss from the sale of capital assets
o Loss from strikes
Periodic Inventory
-­‐ Inventory is only updated periodically
-­‐ Ownership of goods must be determined before they are included in the inventory
Goods in transit (FOB shipping points belong to the buyer, FOB des&na&on belong to the seller)
o Goods on approval belong to vendor
o Goods on consignment belong to the consigner and are not included in the holder’s inventory.
-­‐ Freight in is recorded separately as well as purchase returns and allowances.
Purchases under the Periodic System
s
o
Purchases
X
AP
X
Purchased merchandise on account
Freight In
X
Cash
X
Paid for freight on goods purchased
AP
X
Purchase returns and allowances
X
Returned unsa&sfactory goods
AP
X
Purchase Returns and Allowances
X
Received an allowance for damaged goods
AP
X
Cash
X
Purchase discounts
X
Made payment within discount period
Sales under the periodic inventory AR
X
Sales Revenue
X
Sold goods on account
Sales Return and Allowances
X
AR
X
Customer returned damaged goods
Cash
X
Sales discounts
X
AR
X
Customer paid within discount period
Beginning Inventory + Purchases – Purchase Returns and Allowances= Net Purchases + Freight In = Cost of goods Available for Sale – Ending Inventory= COST OF GOODS SOOOOLLLD!!! Two more closing entries in periodic inventory system: beginning inventory is removed and ending inventory is inserted
Capital
X
Merchandise Inventory
X
To close beginning inventory
Merchandise Inventory
X
Capital
X
To close ending inventory
First in, first out: the first items purchased in the year are the first to be dols. This method closely resembles how most companies sell their inventory. This method is beber for the balance sheet because it has beber inventory representa&on
Last In, Last Out: this method is no longer acceptable in Canada. Considers the most recently purchased inventory is to be sold first. Beber for income statement because it matches current expenses with current revenue. Average Cost: average unit cost of all goods available for sale during the period should be used to cost inventory. Specific iden3fica3on: matches each item sold with its specific cost. Mainly used for companies who sell expensive products. Effect of Cost Flow Assump3ons on the Financial Statements
Prices
COGS
GP and NI
Merchandise inventory
LIFO
FIFO
LIFO
FIFO
LIFO
FIFO
Rising
Highest
Lowest
Lowest
Highest
Lowest
Highest
Falling
Lowest
Highest
Highest
Lowest.
Highest
Lowest
Inventory errors
Item
Error
Goods Available for COGS
Sale
Gross Profit and Net Income
Beginning Inventory Understated
OR Cost of goods purchased
Overstated
Under
Under
Over
Over
Over
Under
Ending Inventory
Over
Over
Under
Under over
Understated
Overstated
Lower of cost and market (LCM)
When the market value of the inventory falls below its cost, it is wriben down to market value. Market value=net realizable value. Loss is reported in the Other Expenses sec&on of the Income Statement. Loss due to decline in Net Realizable Value of inventory
X
Merchandise inventory
X
Mul3-­‐Step Income Statement now includes:
-­‐ Net sales: sales revenue-­‐sales discounts-­‐ sales returns and allowances
-­‐ Gross profit: net sales-­‐COGS
-­‐ Opera&ng Income: gross profit-­‐ opera&ng expenses
Internal Control: op&mizes resources, prevent and detect errors, safeguard assets, maintain reliable control systems
1) Authoriza&on of transac&ons and ac&vi&es 2) Segrega&on of du&es 3) Documenta&on procedures
4) Safeguarding assets and records (physical, mechanical and electronic controls)
5) Independent verifica&on (by both internal and external auditors) 6) Other Controls: bonding employees who handle cash, rota&ng du&es and requiring employees to take vaca&ons (easy way to catch any cons going on)
Limita3ons
-­‐ Reasonable assurance rests on the premise that the costs must not exceed its benefit.
-­‐ Human element (fa&gue, carelessness and indifference)
-­‐ Size of business
PeOy Cash: used to pay small expenses
-­‐ To establish fund, DR Peby Cash and CR Cash
-­‐ Replenishing: DR all the necessary expenses and CR what cash is needed
Bank Reconcilia3on P8-­‐4A Bank
Books
+ deposits in transit
+ collec&ons by bank on our behlf
-­‐ outstanding cheques
+ Interest earned
+/-­‐ errors
-­‐ interest and other bank charges
-­‐ NSF cheques
+/-­‐ errors
Cash
X
Bank Charges
X
Notes Receivable
X
Interest Revenue
X
Record collec&on of note receivable by bank Cash
X
AP
X
Correct error in recording cheque AR
X
Cash
X
To record NSF Bank Service Charge
X
Cash
X
Record bank charges/cheque prin&ng charges
Receivables:
-­‐ Accounts receivable (owned by customers on account)
-­‐ Notes receivables: basically you lent out money. It would be due in 30-­‐90 days
-­‐ Other receivables: GST recoverable, interest receivable, loans to company officers, advances to employees, and recoverable income taxes. Valuing Accounts Receivables: some&mes customers do not pay back their loans on &me. Credit losses are debited to bad debts expenses. When bad debts are too low, their credit policy is too strict and they may be losing business. 1) Direct Write off method: when the account is determined to be uncollec&ble, the loss is charged to bad debts expense. If they pay in the future, they can reverse the entry. Bad Debts Expense
AR
X
X
To write off an uncollec&ble account
2) Allowance Method: uncollec&ble accounts receivables are es&mated. It is treated as an expense and is matched against sales. Es&mated uncollec&bles are debited to bad debts expense and credited to Allowance for DoubRul Accounts (contra asset) through and adjus&ng entry at the end of each period. Bad Debts Expense (opera&ng expense)
X
Allowance for Doubmul Accounts
X
Record es&mate of uncollec&ble accounts
Allowance for Doubmul Accounts
X
AR
X
To write off account
AR
X
Allowance for Doubmul Accounts
X
To reverse the write off
Cash
X
AR
X
To record collec&on of account
a) Percentage of Sales: management indicated what percentage of sales will be uncollec&ble. (Mul&ply percent by the total sales). That is ADDED to the total amount in the accounts receivables. b) Percentage of Receivables: increasing percents for each credit term period for which the receivable has not been wriben off. The amount of bad debt adjus&ng entry is the difference between the required balance and the exis&ng balance in the allowance account
Credit Card Sales: major advantages are that the issuer does the credit inves&ga&on, maintains customer accounts, they undertake any losses and the retailer receives cash quicker. Cash
X
Credit Card Expenses (credit card service fee)
X
Sales
X
To record credit card sales
AR-­‐ American Express
X
Credit Card Expense
X
Sales
X
Record American Express (non-­‐bank) credit card sales
Cash
AR-­‐ American Express
Record redemp&on of credit card billing
X
X
Note Receivable: credit may also be granted in exchange for a promissory note. It is used when individuals and companies lend or borrow money.
Note Receivable
X
AR
X
Record acceptance of Company A note
Cash
X
Notes Receivable
X
Interest Revenue
X
Record collec&on of note
AR
X
Notes Receivable
X
Interest Revenue (other revenue and gains)
X
Record the dishonouring of the note
-­‐
Note may be sold to a third party prior to maturity in order to immediately receive cash on the note. Capital Assets
-­‐ Subdivided into property, plant and equipment (land improvements, buildings, equipment, land) and natural resources
Determining the costs of capital assets: -­‐ Land= purchase price + closing losts (ex. Legal fees, accrued property tax, and other liens) + costs that come from preparing the land for use.
-­‐ Building= purchase price + closing costs + costs of making the building ready for its intended use, costs related to construc&on of a building= contract price + architect’s fees, building permits, excava&on costs, interests cost
-­‐ Equipment= purchase piece + freight charges + insurance + assembling/installing/tes&ng costs
-­‐ When capital assets are purchased assets are purchased for a single price, it is called a basket price. To figure out how much you record in the accounts, you look at the fair market value and give the same percentage to how much you paid for it. Amor3za3on Methods
1) Straight Line, matches expenses with revenues: Cost – Residual Value = Amor3zable Cost/ Useful Life = Annual Amor3za3on Expense
a. Amor3za3on expense/Amor3zable Cost = Straight Line Rate of Amor3za3on
2) Declining Balance produces a decreasing annual amor&za&on expense over the asset’s useful life. The amor&za&on rate remains constant from year to year, but the net book value to which the rate is applied declines each year. Residual value does limit the total amor&za&on that can be taken respects matching principle (higher amor&za&on expense in earlier years when the higher benefits are received)
a. Net book Value at Beginning of the Year x (2 x Straight Line Rate) = Annual Amor3za3on. 3) Units of Ac&vity: useful life is expressed as the total units of ac&vity or produc&on expected from the asset. Best used to assets like machinery, delivery equipment, planes.
a. Cost – Residual Value = Amor3zable Cost / Total Units of Ac3vity = Amor3zable Cost per Unit x Units of Ac3vity during the year = Annual Amor3za3on Expense
Revising Periodic Amor3za3on: some&mes es&mates are off and the residual value or useful life could change. Then you would have to revise the amor&za&on schedule
-­‐ Current Net Book Value – Revised Residual Value = Revised amor3zable cost/remaining useful life = revised annual amor3za3on
Expenditures over useful life: ordinary repairs are small but frequent expenses that are debited to expense account. Addi&ons and improvements improve efficiency and/or increase useful life of the asset (called capital expenditures) are debited to capital asset account
Disposals:
-­‐ Disposal of an asset that if fully amor&zed gives you no gain or loss. If the asset is s&ll useful even aner full amor&za&on, you must leave it at its residual value and not amor&ze anymore. The accumulate amor&za&on of an asset must never exceed its cost.
-­‐ If you re&re an asset before it is fully amor&zed, there will be a loss on disposal (other expenses).
-­‐ Gain on disposal (other revenue) occurs when you sell the asset for more than the net book value. -­‐ Loss on disposal occurs when you sell an asset for less than the net book value
Accum. Amor&za&on
X
Prin&ng Equipment
X
Record re&rement of a fully amor&zed prin&ng equipment
Accum. Amor&zaion-­‐ Prin&ng Equipment
X
Loss on Disposal
X
Delivery Equipment
X
Record re&rement of prin&ng equipment at a loss
Cash
X
Accum. Amor&za&on
X
Delivery equipment X
Gain on Disposal
X
Record sale of delivery equipment at a gain
Cash
X
Accum. Amor&za&on
X
Loss on Disposal
X
Delivery Equipment
X
Record Sale of delivery equipment at a loss
Intangible Assets: amor&zed typically on a straight line basis. Amor&zed over the useful or legal life of asset. -­‐ Patents: ini&al cost is the cash paid to acquire it; legal costs to successfully defend the patent are added to the patent account. The cost of the patent should be amor&zed over its 20-­‐year legal life or its useful life, whichever one is shorter. -­‐ Copyrights: cost of copyright consists of the cost of acquiring and defending it. Copyright legal life is the life of the creator plus 50 years
-­‐ Trademark/Trade names: indefinite life, therefore no amor&za&on. If it is purchased, its cost is the purchase price. If it was designed internally, the cost of securing it is the cost.
-­‐ Franchises and Licences: you could or could not amor&ze it depending on if the franchises/
licence is granted for an indefinite amount of &me, or not. -­‐ Goodwill: largest intangible asset. Includes: excep&onal management, desirable loca&on, good customer rela&ons, etc. good will is the excess of cost over the fair market value of the net assets acquired. It is also not amor&zed
-­‐ Research and Development: not intangible assets. All research costs should be expense, certain development costs with reasonable assured benefits can be capitalized (added to capital account)
Corpora3ons
-­‐ Separate legal existence
-­‐ Limited liability of shareholders
-­‐ Transferable ownership rights
-­‐ Ability to acquire capital
-­‐ Con&nuous life
-­‐ Corpora&on management (board of directors)
-­‐ Government regula&on
-­‐ Income tax
o Corpora&ons must pay taxes as a separate legal en&ty, but there are deduc&ons that can reduce the substan&al tax rate. Shareholders do not pay tax on corporate earnings un&l they are distributed in dividends. -­‐ To form a corpora&on, you have to file an applica&on with provincial/federal authori&es. They file ar&cles of incorpora&on to incorporate a company. The costs incurred are called organiza&on costs and are expensed in the year they occur. -­‐ Shares are divided up into different classes (common, preferred, class A and class B). o Common shares allow you to: a vote, dividends, purchase more shares, residual claim on assets in the event of liquida&on, pre-­‐emp&ve right (keep the same percentage of ownership even when more shares are issued)
o Preferred shares: higher priority, do not have vo&ng rights but have higher priority over dividends and assets in event of liquida&on. You can convert your shares into common shares at a specific ra&o that would not result in a gain or loss to the corpora&on. Callable preferred shares means the company can buy the shares back from you, retractable preferred shares means you can sell it back to the corpora&on. Share Issue Considera3ons:
-­‐ Authorized Share Capital: amount of shares a corpora&on is authorized to issue is indicated in its ar&cles of incorpora&on. No journal is needed un3l they issue the shares
-­‐ Issuance of shares: first issue is known as the IPO, then they trade on the secondary market. They buy and sell from each other on the stock exchange
-­‐ Market Value of Shares: established by the interac&on between buyers and sellers. Follows earnings trend generally.
Corporate Capital:
-­‐ Contributed Capital: total amount of cash/assets paid to the corpora&on by shareholders in exchange for shjares
-­‐ Retained Earnings: cumula&ve net income/loss that has been retained (not given out in dividends). Net income is closed out to retained earnings
-­‐ Owner’s equity is now Shareholder’s equity
Types of Shares:
-­‐ Par value: assigned a specific value in the corporate charter and will not change, represents the legal capital per share that must be kept in the business for the protec&on of the share holders. Not really used anymore
-­‐ No par value: not been assigned a calue in the corporate charter, en&re proceeds received become legal capital
-­‐ Stated Value: does not indicate market value, board of director’s assigns it and can change it. -­‐ You can issue shares in exchange for services or non cash assets. Cash
1000
Common Shares
1000
To record issue of 1000 no apr value shares (@ $1 per share) *same for preferred shares, except “preferred shares” is credited instead.
Cash
5000
Common Shares (1000 x 1)
1000
Contributed Capital in Excess of Stated Value (1000x4)
4000
Record issue of 1000 common shares ($1/per share stated value, but sold for $5/per share)**similar of par value**
Land
Common Shares
Record 10000 no par value shares for land
X
X
Financial Ra3os:
Current Ra&o
Current Assets/Current Liabili&es
Quick Ra&o
(Cash+temp investments+receivables)/ Current Liabili&es
Receivables Turnover
Net Credit Sales/Average Net Receivables
Inventory Turnover
COGS/Average Inventory
Day Sales in Inventory 365/Inventory Turnover
Collec&on Period
365/Receivables turnover
Return on Assets
(Net Income/ Total Average Assets) x100
Asset Turnover
(Net sales/Average Total Assets) x100
Profit Margin
Net income/Net Sales
Gross Profit Margin
Gross Profit/Net Sales
Cash Return on Sales
Net Cash/Net Sales
Measures short term debt paying ability, best is 2:1. Anything over 1:1 is fine.
Measures immediate short-­‐term liquidity. Again, 1:1 and over is fine
Measures liquidity of receivables. Again, a high number is good
Measures liquidity of inventory. How many &mes the inventory is sold during the fiscal period. Measures days’ stock is on hand. Varies for each industry. Gorcery stores should be low, but car dealerships may be higher
Measures number of days receivables are outstanding. Lower the number the beber
Efficiency ra&o, overall profitability of assets, higher the number the beber
Measures how efficiently assets are being used to generate sales, higher the beber
Measures net income generated by each dollar of sales. Higher the beber
Measures gross profit generated by each dollar of sales, see above
Measures the net cash flow generated by each dollar of sales