Financial Statements: Balance Sheets (1/29)

Assets
Overview
Definition: economic resources owned by the business and are expected to benefit
future operations
Must be measurable to be recorded
Examples: cash, IOUs (accounts receivable), prepaid expenses, buildings, inventory,
etc.
Classifications
Current Assets
Current: will be used or converted to cash within the next year
Listed by liquidity (1st three are the most liquid)
Cash
Accounts receivable: oral agreement to pay
Money that people owe you
Marketable securities: investments expected to sell within the upcoming
year
Inventory
Notes receivable: written promise to pay
Example: agreement to pay back loans
Prepaid expenses (aka prepaid assets)
Non-Current Assets
Property, Plant & Equipment (PP&E)
Land
Buildings
Machinery
Vehicles
Furniture & Fixtures
Long-term investments (longer than a year)
Investments in other companies (large investments in other companies may be
listed themselves)

Intangible Assets
Patents
Copyrights
Goodwill
Valuation
Historical cost (acquisition cost)
PP&E, intangibles, prepaid expenses
Net Realizable Value: amount you expect to get from your customers
Accounts receivable
Market to market (market value)
Marketable Securities (investments), cash
Lower-of-cost-or-market
Inventory (either the lower of what you paid for the inventory or the current price
you would pay for that inventory; choose the lower number)
Non-marketable securities (an investment that is not publicly traded and so the
value is not publicly available; show what you paid for that investment or what you
would pay or that investment today; choose the lower number)
(2/1) PPE Depreciation
PP&E helps generate revenueso what would the matching principle say?
Depreciation is the systematic and rational allocation of the cost of limited PP&E to
the period in which it is used to generate revenue
Depreciation Calculation: Straight-line method
(Cost-Salvage Value)/Useful Life = Annual Depreciation Expense
(Cost-salvage value) = depreciable basis: the total amount that will be recorded as
an expense over the life of the asset
Asset cost accumulated depreciation = book value
Accumulated Depreciation = Depreciation expense year 1 + deprecation
expense Yr 2 + .
Total amount tht has been depreciated to date of the PP&E asset
Accumulated Depreciation is a contra asset because it decreases the assets value
Partial Year Depreciation:

If you purchase an asset partway through the year you only want to record
depreciation for the part of the year for which you have had that asset

Liabilities
Overview:
Liabilities debts that require a future sacrifice (usually in the form of a cash
payment)
Types of liabilities:
Accounts payable (you buy something from someone and you still owe them an
amount for that)
Borrowed funds (notes/payable/bonds payable)
Accrued amounts (e.g., accrued wages, income tax payable, etc.)
Accrued wages/wages payable: someone worked for your company and you have
not paid it out yet
Unearned revenue/deposits
Ex: newspaper company receives money for a subscription and you owe that person
a product in the future
Contingent liabilities (talk about later)
CLASSIFICATIONS of LIABILITIES:
Current liabilities those liabilities that are scheduled to be paid within one year
A/P, current portion of long-term debt (ex: pay off part of a loan within the next
year), unearned revenue, notes payable (line-of-credit), accrued expenses, income
taxes, etc.
Long-Term Liabilities (Debt)
Mortgages, bonds, notes payable, etc.

EQUITY
Takes on different names depending on the type of business entity:
Corporation
Shareholders/stockholders/owners equity
Proprietorship
Owners equity or owners capita

Partnership
Stockholders equity:
The amount of assets that the owners have claim to
The capital they invested (contributed capital/common stock
The earnings that have been retained (retained earnings)
Treasury stock: the compny can buy back shares of stock from the public

Recording transactions:
The Accounting Equation: A = L + OE
OE is made up of Common Stock (CS) and Retained earning (RE)
Retained earnings (RE) are made up of beginning revenues + net income +
dividends
NI = Rev + Exp

**At least two accounts of the accounting equation will be affected by

every transaction
***The accounting equation should be in balance after every
transaction is recorded

Statement of cash flows

Information comes from the cash column
Categories
Operating cash flows
Anything related to revenues or expenses (cash collected from customers, cash
paid for expenses)
Investing cash flows
Buying/selling PP&E or investments

Financing cash flows

Cash transactions with owners
Borrowing/repaying loans

February 10, 2016

More About Liabilities and Equity
Interest Bearing Debt (Note Payable)
Principal also called face amount
Amount that is borrowed
Interest rate always expressed on an annual basis unless very specifically stated
otherwise

Calculating Interest Expense

Principle x interest x time outstanding = interest expense
Borrow $100,000 at 6% on January 1
Interest expense for the year is: 100,000 x 0.6 x (12/12) = $6000

Paid or Payable?
If you have paid/are paying in cash
Cash decreases ($500)
Interest expense increases (^ in the negative) $500
If you have not paid in cash at the end of the reporting period, you must accrue the
interest expense
Interest payable increases $500
Interest expense increases [ in negative] ($500)

PRACTICE
Borrowed 50,000 at 8% on July 1, interest and principal are not due until February
1st. What is the interest expense for the year (assume calendar year)?

$50,000*0.08* 6/12 = $2000

$2000 interest payable (recording)
Borrowed $75,000 at 7% on July 1, interest is payable on the last day of each
quarter. What is the entry for July 31?
Quarter Ends: March 31st, June 30th, Sept 30th, Dec 31st
75,000*0.07*1/12 = $437.50
Will not be paid until the end of September (end of the quarter)

Contingent Liabilities
A contingent liability is recognized (recorded in numbers in the financial
statements) when:
It is determined that it is probable that the company will have to pay
The amount of the liability can be reasonable estimated
Estimated Expense for the Law Suit $40,000 (^ in negative)
Estimated Damages Payable $40,000

Common Stock
What is par value?
A legal amount that you have to retain within the company
According to some state laws, it is the minimum mount of money a company must
leave in the business. Corporations typically set this at a very low value so as to
have the most flexibility
If a company has no par value for its stock, it is most likely incorporated in a state
that does not require a minimum

EXAMPLE
R Co currently has 100,000 authorized shares of common stock at $10 par value
R Co issues 50,000 shares for $40 each. What is the entry?
Increase cash by $40*50,000 shares = $2,000,000
Increase common stock $10*50,000 shares = $500,000
Increase in Additional Paid In Capitol (APIC) $1,500,000

Treasury Stock
R Co repurchases 2,000 shares at $30 each
Decrease cash by 60,000
Record -60,000 in treasury stock
Contra Equity
Treasury stock is now recorded in the Shareholders Equity part of the transaction
sheet as a contra asset

Dividends
Not an expense; not on the income statement, only seen on the statement of
retained earnings
Recorded as a reduction in the retained earnings column
Dividends are payable when declared by the board of directors. The entry is
Dividends (retained earnings)
Dividends Payable (own column in the Liability section)
Later when the dividends are actually paid
Cash (decrease)
Dividends Payable (decrease)

The Income Statement

This financial statement presents the results of operations for a defined
period of time
Revenues
Measures of the increases in net assets resulting from the sale of products and
services

Revenue recognition principle

Under accrual accounting:
Revenue is recognized (recorded) as soon as it is both

Earned (the seller has performed a service or conveyed a product to the buyer)
Reasonably assured and measurable (the value to be received for that service or
product is reasonably assured and can be measured with a high degree of reliability)
The revenue transaction may be for cash or on credit

Matching Principle
Under accrual accounting
Expenses are expired costs assets used up to produce revenues and ae recorded
in the same accounting period in which revenues are recognized. Expenses are
matched to revenues
Revenues Expenses = Net Income

Types of Expenses
Product Costs: all costs involved in acquiring or making a product
Costs attached directly to product being sold
Expenses when product is sold
Period Costs (ex: rent, salary)
Costs that are not product costs
Expensed in period they occur

Expense Matching Cost of Goods Sold (CGS)

CGS is the cost of making the product (manufacturer) or purchasing the product
(wholesale/retailer) and is expensed in the period in which the product is sold
Calculating cost of goods sold:
Beginning inventory + purchases ending inventory = cost of goods sold
Example: Fleet Feet had a beginning shoe inventory of $40,000 and purchased
$20,000 more during the year. A count of the shoe inventory at the end of the year
totaled $15,000 of shoes
40,000+20,000-15,000 = $45,000 (cost of goods sold) (recorded under expenses)
Selling, General & Administrative Expenses (SG&A)
These are operating expenses related to the production of revenue, but that are not
directly related to the product sold (aka Operating Expenses

Net operating income = gross profit (under revenues) SG&A Exapenses

These are period costs and are expensed in the period in which they are incurred.
(They cannot be matched directly with a product)

Income Statement Elements

Net operating income is often referred to as NOI
Net income (NI) is the BOTTOM line
Other income & expense (+ or -)
Ancillary income/expense of the company that is not derived from the mainstream
operations of the business.
Net income before taxes may be abbreviated NIBT
Unusual nonrecurring revenues and expenses
Discontinued operations (segment reporting)
Extraordinary gains and losses
Change in accounting principle
Finally, EPS is reported (if a formal presentation)
Earnings per share (EPS)
EPS = NI preferred dividends/average common shares outstanding

Accruals and Deferrals (2/17)

Adjusting entries
Transactions that the accountant must remember to make in order for the financial
statements to be correct

Accruals v. Deferrals
Accrual event:
Business action followed by cash exchange
Credit transaction
Deferral event

Cash exchange followed by business action

Prepaid rent
Unearned revenue: customers pay in advance (magazine subscription)

Accrual related adjustments

Are there expenses that have been incurred but not recorded?
Is there revenue/income that has been earned but not recorded?

Deferral related adjustments

A deferral is a delaying of revenues or expenses
Since cash already changed hands, the initial transaction should lready be recorded
Has an revenue previously recorded as unearned now been earned?
Have an expenses previously recorded as prepaid now been incurred
prepaid expense in assets
unearned revenue
Customer deposits

Other Deferral Related Adjustments

Also consider other assets that have been used in the process of producing
revenue for the current period
Inventory CoGS
Supplies inventory operating expense
PP&E depreciation expense

Valuation Related Adjustments

Report accounts receivable at the amount expected to be collected
The amount you are expected to collect is the Net Realizable Value (NRV); this is
what you should record
Need to estimate uncollectible accounts
Estimate bad debt expense

Need to abide by matching principle; record in the same time that we receive that
credit from the customers

Uncollectable Accounts
Method of estimating bad debt expense:
% of credit sales
%age*credit sales = bad debt expense
Best estimate of collectible ending balance

%age of Sals (income statement approach)

Jones co. had $500,000 in sales during the year, 60% of which were credit sales
Note: if you are not told the $ or % of credit sales, assume that all sales are on
credit)
Jones Co. estimates that 2% of credit sales will be uncollectable
The entry is?
$300,000*0.02 = $6000
$6000 is the bad debt expense
Put into expenses and into allowance for doubtful accounts as -6000 (contra
asset)

Allowance for bad debts and accumulated depreciation are similar

We will show accounts receivable, net on the balance sheet (do not
show the allowance account on a separate line)