Download - Lutilsky- Accounting lecture/predavanja BDIB
Introduction to Accounting
Ivana Dražić Lutilsky
Room 35, 2.floor, North
Tutorials: Wednesday 10 -12
18-19
The act of gathering and reporting about the
financial information of a company
Accounting is a continual process of:
Capturing financial data
Organizing it
Producing financial reports
Accountancy (profession) or accounting
(methodology) is the measurement,
statement, or provision of assurance about
financial information primarily used by
managers, investors, tax authorities and
other decision makers to make resource
allocation decisions within companies,
organizations, and public agencies.
Accounting is a service activity.
Its function is to provide quantitative
information primarily financial in nature,
about economic entities, that is intended to
be useful in making economic decisions, and
in making reasoned choices among
alternative courses of action.
It is also the discipline of measuring,
communicating and interpreting financial
activity.
Accounting is also widely referred to as the
"language of business".
Accounting/accountancy attempts to create
accurate financial reports that are useful to
managers, regulators, and other stakeholders
such as shareholders, creditors or owners.
The day-to-day record-keeping involved in
this process that is known as bookkeping.
Internal Users - managers use it to plan,
organize and run a business.
External Users
Investors (Current and Potential)
Creditors
Others
Taxing authorities
Regulatory agencies
Customers
Labor unions
Economic planners
An organization’s financial statements provides
managers with information to determine present
and future decisions. Such actions include:
Granting credit
Making investments
Borrowing money
Adhering to regulations
Determining executive compensation
Evaluating competition
Evaluating potential litigation
Accounting planning
Bookkeeping
Accounting control
Accounting analysis
Providing information
Financial accounting
Cost accounting
Managerial accounting
At the heart of modern financial accounting is the double-entry bookkeping system.
This system involves making at least two entries for every transaction: a debit in one account, and a corresponding credit in another account.
The sum of all debits should always equal the sum of all credits, providing a simple way to check for errors.
This system was first used in medieval Europe, although claims have been made that the system dates back to Ancient Rome or Greece.
Operates in an
environment
that makes
decisions and
takes actions
to make it
economically
better or worse
Economic
Concepts
Accounting
Conventions
Institutional
Context
Organization
(Entity) “Filter”
Financial
Reports
Balance
Sheet
Income
Statement
Cash Flow
Statement
Sole Proprietorship - owned by one person
Partnership - owned by more than one person
Corporation - organized as a separate legal entity
and owned by stockholders
Sole Proprietorship Simple to establish Owner controlled Tax advantages
Partnership Same as sole proprietorship except now with additional individual(s) the organization has a broader skill base (i.e., finance and marketing)
Corporation Easier to transfer ownership or raise money No personal liability
Economic Concepts – The economic principles
guiding the construction of accounting reports.
Accounting Conventions – The accounting rules
that apply the economic concepts to practical
situations.
Institutional Context – The environment that
shapes the consequences of adopting specific
accounting conventions.
The “filters” can be viewed as the financial
process the organization goes through in
producing the annual report, specifically the
financial statements.
Financial Values Attach to individual assets, liabilities, revenues and expense items by the accounting process
Wealth Measured by equity at a
point in time
Economic Income Change in wealth measured
by net income
Financial Statements Economic Concepts
Balance Sheet Assets Liabilities Equity
Income Statement Revenue
Expenses
Net Income
Cash Flow Statement Operating cash flow
Investing cash flow
Financing cash flow
Financial Statements
Balance Sheet
Income Statement
Statement of Cash Flows
Statement of Retained Earnings
Notes to the financial statements
The financial statements are part of a
comprehensive financial report referred to as
the annual report.
Asset
Liabilities
Equity
Revenues
Expenses
Financial results
Shows relationship between assets, liabilities and
equities--on a particular date (i.e., point in time).
Assets and liabilities and stockholders' equity must balance.
A= L + SE
Assets – A probable future economic benefit
obtained by entering into a transaction. The
resources owned by the business.
Liabilities – The probable future sacrifice of
economic benefits arising from an entity’s
obligation to transfer assets or provide services
for a past transaction. Creditors claims on total
assets (obligations or debts of the business).
Stockholders' Equity – The difference between an
entity’s assets and liabilities. The owners’ claim on
total assets.
Reports success or failure of the company's
operations during the period.
Summarizes all revenue and expenses for period--
month, quarter, or year. If revenues exceed
expenses, the result is a net income. If expenses
exceed revenue, the result is a (net loss).
Revenues – increases in net assets resulting from an
entity’s operation over a period of time.
Expenses – decreases in net assets resulting from an
entity’s operation over a period of time.
Net Income - the excess of revenues over expenses.
The Cash Flow Statement - describes the flow of cash into and out of an organization during an accounting period. These flows are classified in three categories:
Operating activities – The change in cash
resulting from actions intended to generate net income.
Investing activities – The change in cash
resulting from actions taken to acquire or dispose of productive company assets.
Financing activities – The change in cash resulting
from payments to or receipts from suppliers of
money to the firm (e.g., common shareholders or
debt holders).
Indicates amount invested by owners, amount paid
out in dividends, and amount of net income or net
loss for period.
Shows changes in retained earnings balance during
period covered by statement.
Financial value – The amount of money an
item would bring if sold.
Accurate financial valuation depends on how well a
market functions. In a well-functioning market,
goods and services will be properly valued.
Competitive – The market should reflect the true
financial value. No chance for a seller to make
abnormal profits.
Low transaction costs – The price paid to buy/sell
the good requires few operational resources to
complete the transaction.
Organized and regulated – The market in which
the good is traded has standard definitions for
making transactions and is open to new,
efficient methods for improvement.
Wealth – The sum of the financial values of
all things an organization owns.
Defined by the balance sheet (i.e., accounting
identity) description:
Assets = Liabilities + Equity
Economic income – The change in an organization’s
wealth, excluding capital transactions with its owners.
This measure describes an organization’s success using its economic resources in a period.
Reflected in the income statement (revenues minus expenses) for a period.
Owner investments (issuing new shares of stock) are excluded because the increase in wealth attributable to them is NOT generated by use of the organization’s resources!
Generally Accepted Accounting Principles known as
GAAP are the commonly understood and accepted
conventions for gathering, organizing, and reporting
the financial history of an organization.
Generally GAAP applies to one or more of
the following three broad areas:
Accounting Valuation
Recognition
Disclosure
Accounting Valuation - GAAP helps to specify
the value of the items reported. It provides
guidance and restrictions on the accounting values
used in the financial statements.
Example: describes how Union Plaza
values plant and equipment…. “Plant and
equipment are carried at cost less accumulated
depreciation and amortization.”
Recognition – How should an item be treated in the accounting records? Should an item be treated as an asset or an expense? For instance, does an advertising campaign have future benefits?
Example: shows how Novell utilizes
GAAP to guide their recognition…. An advertising
campaign is deemed to have no future value and
the cost of advertising is expensed as incurred.
Disclosure – The act of providing information about the organization and construction of its accounting reports. GAAP requires the disclosure of measurement methods, assumptions, etc., that add to the information content of the annual report.
Example: shows that Kmart values its inventory
using LIFO and discloses the value of the inventory. It also discloses what the inventory would be valued if Kmart used an alternative method (FIFO).
Market richness – Where the market for a good is a
well-functioning one (i.e., it is competitive and
experiences low transaction costs), GAAP will use
market valuations to drive the accounting.
Complexity of the transactions – When transactions
are simple (e.g., exchange of cash for a Big MacTM ,
GAAP is simple. When transactions are complex
(e.g., CEO compensation including a salary, bonus,
pension plan and stock options), GAAP will be
complex.
Form of the organization – GAAP differs depending
upon the type of business entity (e.g., sole
proprietor, partnership, corporation, not-for-profit,
governmental).
Croatian Association of Accountants and Financial Experts has approx. 30.000 members.
In order to be an accountant, the Law does not
define formal education requirements or diplomas, while auditors need to obtain the license from the Chamber of auditors (formed in 2006).
An accountant does not need to have an university diploma or any form of certificate to prove his adequacy; he/she needs to follow the regulations set by the Law of accounting and by the profession itself.
Accountants have not yet obtained qualifications compliant with International federation of accountants’ education requirements it is an important notion for legislative authorities!
The basic division between types of companies according to the accounting regulations:
A) Small companies:
Total asset is not larger than 32.5 mil. Kn
Max. revenue of 65 mil. Kn
Have at most 50 employees
B) Medium companies:
Total asset is not larger than 130 mil. Kn
Max. revenue not larger than 260 mil. Kn
Have no more than 250 employees
C) Large companies:
These have larger asset, revenues and more employees than the medium companies.
Regardless to their asset, revenue and number of employees, large companies are also all banks, all other saving institutions, insurance companies, investment funds, leasing companies, and pension plans.
Defines the institutional accounting framework in Croatia.
The newest one has been issued in 2007.
It defines: subjects that are obliged to use the law,
bookkeeping documents,
business books,
list of assets and liabilities,
financial reports,
standards of their presentation,
penalties,
It foresees the usage of International financial reporting standards, and
the act determines the Financial reporting council.
The Act functions in compliance with the Company act (largely influenced by the German legal system).
The Act must be used by all private and legal entities who are working in the interest of obtaining profit and thus have an obligation to pay income tax, except:
Government agencies
Central and local state funds
Health institutions,
Religious institutions
Political parties,
Sindycates,
Other non- profit institutions.
Besides defining the bookkeeping documents, business books and financial reports the act also states that:
most documents are to be kept within the company for 7 years,
financial reports are to be kept in original form for at least 11 years.
The international financial reporting standards are to be used in all EU Countries, and thus in those who want to join the EU, like Croatia.
In Croatia, only large companies, financial institutions and those listed on
the Zagreb stock exchange are obligatory to use the IFRS. In other words, only entities of public interest are obligatory to use IFRS.
Smaller companies must use the standards defined by the croatian
Financial reporting council that is controlled by the Ministry of finance. - Croatian Financial Reporting Standards
Both sets of accounting standards are to be published in the “Narodne novine” (National newspapers) before they are put into use.
.
FINA (financial agency) Receives all financial statements and reports
from every profit & non-profit institution in Croatia,
Publishes standardized summary financial
statements of all companies (it includes only the key financial figures without the audit report).
***NOTE: Ensuring public availability of full
financial statements is not common practice in Croatia.
HNB (Croatian national bank), HANFA (Croatian financial services supervisory agency) and the MoF (Department for financial systems of the Ministry of finance) are responsible for financial reporting of the financial sector:
HNB responsible for the development and implementation of financial reporting requirements applicable to the banking sector,
HANFA responsible for the rest of the financial sector
Management Discussion and Analysis
Notes to Financial Statements
Auditor's Report
Covers three aspects of a company:
liquidity - ability to pay near-term
obligations
capital resources - ability to fund
operations and expansions
results of operation - profitability and
efficiency
Provide additional information not included in
body of statements
Does not have to be numeric
Examples:
Description of accounting policies or explanation of
uncertainties and contingencies (e.g. Exhibits 1.4 and
1.5)
Company statistics (e.g., market share, percentage of
international sales, etc.)
Auditor, a professional accountant who conducts an independent examination of the financial accounting data presented by a company.
Auditor gives an unqualified opinion if the financial statements present the financial position, results of operations, and cash flows in accordance with GAAP.
Ivana Dražić Lutilsky
Different countries have developed their own accounting principles over time, making international comparisons of companies difficult.
To ensure uniformity and comparability between financial statements prepared by different companies, a set of guidelines and rules are used.
Commonly referred to as Generally Accepted Accounting Principles (GAAP), these set of guidelines provide the basis in the preparation of financial statements.
Recently there has been a push towards standardizing accounting rules made by the International Accounting Standards Board ("IASB").
IASB develops International Financial Reporting Standards that have been adopted by Australia, Canada and the European Union (for publicly quoted companies only), are under consideration in South Africa and other countries.
The United States Federal Accounting Standards Board has made a commitment to converge the U.S. GAAP and IFRS over time.
generally accepted accounting concepts
generally accepted principles
generally accepted standards
Concepts (or conventions,
assumptions) are theoretical basis and
their appliance is taking into
consideration formulation of
accounting principles.
Concepts by the IFRS are:
- accrual basis of accounting concept,
- going concern concept.
Concepts by the GAAP are:
- monetary unit,
- going concern concept,
- economic entity and
- time period.
Monetary Unit – Money is the unit used to
measure economic activity.
Economic Entity – This concept provides a
context or “point of view” for the economic
events (i.e., transactions) captured by the
financial statements. In short, it answers the
questions, “Whose asset is it?”; “Whose liability
is it?”
Time Period – A business can be divided into
artificial time periods. The most commonly used
time periods for public corporations is quarterly
and annually.
Going Concern - A company is expected to carry
out its operations into the foreseeable future.
Principles are based on concepts and they
are further determining accounting and it’s
basic characteristics for accounting policies.
Principles by the GAAP are:
- Cost principle (troškovno načelo)
- Objecivity principle (načelo objektivnosti)
- Realization principle (načelo realizacije)
- Matching principle (načelo sučeljavanja
prihoda i rashoda)
- Materiality principle -substance over form
principle (suština važnija od forme)
- Full-disclosure principle (načelo potpunosti)
- Consistency principle (načelo
konzistentnosti)
- Conservatism principle (načelo opreznosti)
Principles by the IFRS are: understand ability principle
relevance principle
materiality principle
reliability principle truly presentation principle
substance over form principle
neutrality principle
prudence principle
full disclosure principle
comparability principle.
Relevance - information makes a difference in
decisions.
Reliability - information must be free of error and
bias.
Comparability - ability to compare information of
different companies.
Consistency - companies must use the same
accounting principles and methods from year to year.
Cost Principle – Assets acquired are recorded
at cost.
Full Disclosure Principle – Information that
would effect an investor or creditors view of
the company should be disclosed.
Permits companies to modify GAAP without hurting the
usefulness of information
Materiality - if item doesn’t make a difference, GAAP
doesn’t have to be followed
Conservatism - in “gray” areas choose guide which
does not overstate assets or income
They are further concretization of
accounting principles in a view of methods in
recording accounting data, providing
accounting information and presentations of
financial statements and it’s elements.
IFRS – International financial reporting
standards – precondition for globalization
NS – national standards – made for national
levels and their specifics in accounting
They are part of company business policies
With accounting policies company can
deliberate influence the elements in
financial statements
Freedom of choices is given through
accounting standards
Companies have obligation of presenting
their accounting policies through notes
Accounting policies could influence financial
statements, like:
- amortization,
- Inventories,
- Revenues….
Generally contains the following standard
classifications:
Current Assets
Long-Term Investments
Property, Plant, and Equipment
Other Assets
Current Liabilities
Long-Term Liabilities
Stockholders' Equity
ASSETS
NON CURRENT CURRENT
NON CURRENT ASSETS
INTANGIBLE TANGIBLE FINANCIAL RECEIVABLES
- license - patents - concession - other rights - goodwill - advance payments for intangible assets
- land - buildings - plants - equipments - motor cars - advance payments for tangible assets
- bought securities - given deposits - given loans - other long term investments
- account receivables
is expected to be realized within more than 1 year after the balance sheet date
CURRENT
INVENTORIES RECEIVABLES FINANCIAL CASH
- raw materials - production inventories - work in progress - merchandise inventories - advance payments for inventories
- account receivables - employee
receivables - state receivables - other receivables
- bought securities
- given deposits
- given loans
- other short term
investments
- cash at bank - cash in hand
• is expected to be realized within 1 year after the balance sheet date
The probable future economic benefit an entity obtains by entering into a transaction
Assets that are expected to be converted to cash or used in the business within a short period of time, usually one year. Current assets are listed in order of liquidity.
Examples: Cash
Short-term investments
Receivables
Inventories
Prepaid expenses
Cash - Money in the form of cash or bank deposits (e.g., checking and/or money market account).
Short-term investments - An entity’s investment in another entity’s stock or debt (i.e., bonds). Sometimes referred to as “Marketable Securities”.
These assets yield a higher return (dividends, appreciation or interest) than is available through checking and money market accounts.
Inventories - The goods an entity has on hand is referred to as a finished good. The material that it needs to make the goods is referred to as raw materials. The raw material in process of being completed (i.e., finished) is referred to as work in process.
Prepaid expenses – The amounts an entity has already paid for services/goods to be delivered in the future (e.g., car insurance).
Accounts Receivable - The amounts due from customers for goods they purchased on credit. Because all customers do not pay their bills, the balance is reduced by an “allowance” (an estimate of what will not be collected).
Example - OshKosh December 29, 2001:
Total Accounts receivable $ 32,542 Less: Allowance ( 7,075)
Net accounts receivable $ 25,467
Assets that are expected to benefit the business over a long period of time. Non-current assets are usually listed in order of importance to the entity.
Examples: Property plant and equipment
Long-term investments
Other assets
Property, Plant, and Equipment - The land,
buildings, equipment, furniture and fixtures that
are used in operating the business.
SOURCES OF ASSETS
EQUITY NON CURRENT
LIABILITIES CURRENT LIABILITIES
SOURCES OF ASSETS
EQUITY NON CURRENT LIABILITIES CURRENT LIABILITIES
- owner’s equity - legal reserves - statutory reserves - revalorization reserves - other reserves - retention (retained
earnings) - net income - loss
- received long term loans - issued long term securities - accounts payables (long term)
- accounts payables - salaries payables - received short term loans - issued short term securities - issued checque - income tax liabilities - VAT liabilities - dividend payables - received advanced payments
Liabilities – The probable future sacrifice of economic benefits arising from an entity’s obligations to transfer assets or provide services as a result of a past transaction or event.
Liabilities that are expected to be paid by the business within a short period of time, usually one year. Current liabilities are listed in order of liquidity.
Examples: accounts payable
accrued liabilities
short-term borrowings
dividend payable
unearned revenue
Accounts payable – The amount an entity owes to
suppliers for goods previously delivered.
Sometimes referred to as “trade payables” or
“trade accounts payable”.
Accrued liabilities - The amounts an entity owes
for taxes, rent, wages, etc. More detail is offered
in the Notes to the Financial Statements.
Example: OshKosh -
A summary of 12/29/01 accrued liabilities follows:
Compensation $ 7,181
Workers’ compensation 8,900
Income taxes 5,182
Other 17,140
Total $38,403
Short-term borrowings – Monetary amounts due within
one year for repayment of bank loans, notes payable
and other commercial paper.
Dividends payable – The amount owed by a
corporation to its shareholders when dividends
declared by the board of directors have not yet been
paid.
Unearned revenues – The monetary amounts received by an entity that accepts up-front payments of cash in exchange for future delivery of its products.
Example: Your advance cash payment for a three-year subscription to Fortune Magazine requires their sacrifice of future economic benefits (they are liable) to provide the magazine. It is termed “unearned” as it represents a service (i.e., the subscription) that has NOT yet been completed (i.e., delivered to your door). It will be “earned” as delivery takes place.
Debts expected to be paid after one year.
Examples:
warranties employee benefit plan liabilities leases
bonds payable
long-term obligations
Warranties – The entity’s obligation to replace defective merchandise within a specified time period.
Employee benefit plan liabilities – The “sacrifice” of cash that an entity must make for pensions, retirement health care and other retirement benefits.
Lease – The “sacrifice” of cash that an entity must make to secure equipment or for the use of property to conduct operations
Bonds payable – The amount due to bond purchasers
under terms of the bond issue.
Long-term borrowings – Monetary amounts for bank
loans, notes payable and other commercial paper that
does not have to be repaid within one year.
Stockholders' Equity – The difference between total
assets and total liabilities. Stockholders’ equity
arises from the contributions of owners.
Risk capital, liable capital, proprietorship, net worth
After all liabilities are paid, ownership equity is the
remaining interest in assets
Equity = Assets - Liabilities
At the start of a business, owners put some funding into
the business to finance assets (equity capital)
Bankruptcy → creditors have the first claim on the
proceeds, ownership equity is paid at the end
Shareholder’s equity → when the owners are shareholders
Owner’s equity
Paid in capital – comes from the
shareholders through the purchase of the company’s stock
Earned capital – comes from
profitable operations (retained earnings)
Net worth of a company is reflected in its balance sheet as owner’s (shareholders') equity
Net worth is an important determinant of the value of a company, considering it is composed primarily of all the money that has been invested since its inception, as well as the retained earnings for the duration of its operation
Net worth can be used to determine creditworthiness because it gives a snapshot of the company's investment history
Market price per share ≠ equity per share
Common Stock – Shareholders’ investment in the entity through acquisition of stock.
Ownership of a share entitles the holder to a vote on major corporate decisions and a residual claim to the entity’s assets in the event of liquidation.
The amount recorded in this account represents the legal capital per share that must be retained in the business.
Additional paid-in-capital – The amount paid by the
investor for a share of stock in excess of its par value.
Preferred Stock – Another vehicle available to
corporations for raising owner contributions.
A preferred owner typically is not allowed to vote on
major corporate issues.
In the event of liquidation, these shareholders receive
the stated value of their shares.
Retained Earnings - equity (net income) generated
from operations less what has been returned to the
shareholders in dividends.
The adjective “retained” reveals that these earnings
have not been distributed to shareholders in the form
of dividends.
Constructing the Balance Sheet
Analyze the effect of business transactions on
the basic accounting identity:
Assets = Liabilities + Stockholders’ Equity
Remember: The Accounting Identity must
always balance.
Transaction Analysis
Transaction Analysis determines if and how
the transaction impacts the financial
statements.
Transactions can be divided into two types:
F External events
F Internal events
Only external transactions must be recorded in
the financial statements.
External events occur between the company and some outside party. It involves an exchange of assets, liabilities, or stockholders' equity between a company and an outside party
Internal events are economic events that occur entirely within one company. For example the act of hiring of an employee.
1. Analyze each transaction
2. Journalize each transaction
3. Post each transaction to a T account. An account
would be cash, accounts payable etc.
Analyze - determine how the transaction
affects the balance sheet (i.e., increase or
decrease assets, liabilities etc.).
Journal - accounting record where the
transactions are recorded in chronological
order.
Posting - transferring of information from the
journals to the general ledger accounts (i.e., T
- Accounts)
An individual accounting record of increases
and decreases in a specific Asset, Liability, or
Stockholders’ Equity item.
Three parts :
1) the Title of the account
2) a left or Debit side
3) a right or Credit side
Account
TITLE
DEBIT CREDIT
T - Account
Total the Entries to Each Side
If the greater sum is on the left,
the account has a Debit Balance
Total Debits Total Credits
TITLE
Debit Credit
Total the Entries to Each Side
If the greater sum is on the right,
the account has a Credit Balance
Total Debits Total Credits
TITLE
Debit Credit
DEBITS
Increase – Assets
Decrease – Liability and Equity Accounts
CREDITS
Decrease – Assets
Increase – Liability and Equity Accounts
The term normal balance for an account is the
side (i.e., debit or credit) that is increased.
Normal Debit Balance: Assets
Normal Credit Balance: Liabilities
Stockholders’ Equity
Let’s Practice
Transaction Analysis
The basic steps in the recording process are:
Analyze each transaction in terms of its
effect on the accounts.
Record the debit and credit effects on
specific accounts for each transaction.
On January 1, $40,000 is invested in
Rhody Corporation in exchange for
common stock.
How does this affect the accounting
equation?
A = L + SE + + Assets increase
Stockholders’ equity increases
What asset account and stockholders’ equity
account is affected?
Cash (debit) $40,000
Common Stock (credit) $40,000
Note: Debits are always written first
and you always indent the credit.
Also on January 1 Rhody purchases
$20,000 of equipment for cash.
How does this affect the accounting
equation?
A = L + SE + = - Assets increase
Assets decrease
What asset accounts are affected?
Equipment (debit) $20,000
Cash (credit) $20,000
Note: Debits are always written first
and you always indent the credit.
On January 5 Rhody purchases inventory
of $14,000 on account.
How does this affect the accounting
equation?
A = L + SE + + Assets increase
Liabilities increase
What asset account and liability account is
affected?
Inventory (debit) $14,000
Accounts Payable (credit) $14,000
Note: Debits are always written first
and you always indent the credit.
On March 6 Rhody buys $4,000 of
supplies for cash.
How does this affect the accounting
equation?
A = L + SE + = - Assets increase
Assets decrease
What asset accounts are affected?
Supplies (debit) $4,000
Cash (credit) $4,000
Note: Debits are always written first
and you always indent the credit.
On April 1 Rhody pays $12,000 to
insure its cars for the next year.
How does this affect the accounting
equation?
A = L + SE + + Assets increases
Assets decrease
What asset accounts are affected?
Prepaid Insurance (debit) $12,000
Cash (credit) $12,000
Note: Debits are always written first and you
always indent the credit.
On September 1, Rhody receives $18,000
in advance for services to be performed in
the future.
How does this affect the accounting
equation?
A = L + SE + + Assets increase
Liabilities increase
What asset account and liability
account is affected?
Cash (debit) $18,000
Unearned Revenue (credit)
$18,000
Note: Debits are always written first and you
always indent the credit.
October 1, 2004, Rhody lends the
Minutemen Corporation $10,000 in the
form of a note receivable. The note is due
on September 30, 2005, and carries an
interest rate of 9%.
How does this affect the accounting
equation?
A = L + SE + - Assets increase
Assets decrease
What asset accounts are affected?
Note Receivable (debit) $10,000
Cash (credit) $10,000
Note: Debits are always written first and you
always indent the credit.
Remember every journal entry will be posted to the
appropriate account.
For example, based on the entries made, the T-Account
for cash would have an ending debit balance of
$12,000 (see next slide).
CASH 1/1 40,000 1/1 20,000 3/6 4,000 4/1 12,000 9/1 18,000 10/1 10,000 58,000 46,000
Balance 12,000 (Debit)
•A list of all the accounts and their balances at
a given time.
•It serves to prove the mathematical equality of debits and credits after posting (shouldn’t be critical, assuming credible software is used).
•It aids in the preparation of financial
statements.
Rhody Corporation
Trial Balance
December 31, 2004 Debit Credit
Cash $12,000
Note Receivable 10,000
Supplies 4,000
Inventory 14,000
Prepaid Insurance 12,000
Office Equipment 20,000
Accounts Payable 14,000
Unearned Service Revenue 18,000
Common Stock 40,000
$ 72,000 $72,000
Income Statement Concepts: Income, Revenues, and Expenses
1
Income statement
• Income statement reports about the revenues and expenses for a specific period of the time.
• Dinamic statement
As a minimum, the face of the income statement shall include
line items that present the following amounts for the period:
(a) revenues;
(b) expenses (costs);
(f) profit or loss.
• Revenue is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.
• Expenses (cost) are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrence's of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.
Revenue Recognition Principle
• Dictates that revenue be recognized in the
accounting period in which it is earned.
• Revenue is earned when the service has been
provided or when the goods are delivered (i.e.,
an exchange has taken place.
• You are reasonably certain to collect the
revenue.
6
Income Concepts
Net Income (Loss) – The increase (decrease) in net
assets; resulting from operations; over a period of time. Net Assets – The excess of an entity’s economic
resources (assets) over its obligations (liabilities).
NET ASSETS (EQUITIES) = ASSETS – LIABILITIES Equities – Another name for net assets.
7
Changes in Net Assets
Generally, the cause of an increase (decrease) in
NET ASSETS from one period of time is INCOME
(LOSS).
However, since INCOME only results from
operations, exchanging shares of the entity’s
common stock for cash increases net assets; it
does not result from INCOME, but rather from an
additional equity investment by owners.
8
Changes in Net Assets
Also, the payment of dividends reduces net
assets as it does not result from LOSS, but rather
from the withdrawal of assets from the entity for
use by the stockholders (i.e., owners).
9
Effect of Net Income From Operations on Net Assets
10
Beginning
Balance Sheet
1/01/10
Ending
Balance Sheet
12/31/10
Income for the Period
1/1/10 –12/31/10
Revenue
Revenues – increase in net assets resulting from an entity’s operation over a period of time.
Alternative Names for Revenue: Sales – Used by merchandising entities and
manufacturing concerns. Sales of Services or Total Billings –Used by
service firms.
11
Revenue (continued)
Interest Revenue – Used by financial institutions that earn revenues by lending money and charging interest.
Commissions, Asset Management and Portfolio
Service Fees– Used by brokerage firms (e.g., Merrill Lynch) for fees charged for the different financial services performed for customers.
Premium Revenue – Used by insurance companies.
12
Gains and Losses
The difference between what is received by an entity and the book value of what is given up by the entity is reported as a gain or loss.
An example is the sale of equipment. Since the selling of assets is not the primary purpose of the business, the gain (loss) is reported separately on the income statement and not as part of income from continuing operations.
13
Income Statement
• Reports success or failure of the company's operations during the period.
• Summarizes all revenue and expenses for period of time --month, quarter, or year. If revenues exceed expenses, the result is a net income. If expenses exceed revenue, the result is a (net loss).
14
Retained Earnings
Retained earnings is net income minus dividends paid since the formation of the business. It is net income that is retained in the business not paid to shareholders.
The balance in retained earnings is part of the stockholders' claim on the total assets of the corporation.
15
Retained Earnings
Example: A balance of $100,000 in retained earnings does not mean that there should be $100,000 in cash.
The income resulting from the excess of revenues over expenses may have been used to purchase other assets--buildings, equipment, etc.
16
Articulation of The Financial Statements
Assets = Liabilities + Stockholders’ Equity
A = L + Common + Retained Stock Earnings
Revenue (R) - Expenses (E) = NI One should view the retained earnings statement
as the “bridge” that connects the income statement with the balance sheet.
17
Matching Principle
Requires that expenses be recorded in the
same period in which the revenues they
helped produce are recorded.
18
Accounting Conventions - Expenses
Accounting conventions relating to expenses are more involved than revenue’s “substantial completion of the earnings process”.
Some expenses “follow” the earning of revenue (e.g., salaries of administrative staff).
Others follow a “systematic” process (e.g., depreciation of plant and equipment is often straight-line or simply a fixed amount per year).
19
Expense Concepts
Expenses – The resources consumed in the process of earning revenues. This consumption results in a decrease in net assets over a period of time.
Examples of expenses:
Cost of sales – The expense associated with the cost of merchandise sold to customers by a merchandiser.
Rent expense – The cost of renting offices or warehouses.
Depreciation – The cost of using long-term assets such as “Property, Plant and Equipment.”
20
Depreciation
Depreciation - is the rational and systematic process of allocating the cost of a plant asset over its useful (service) life.
By expensing an asset’s cost over its useful life results in a better match of the expense to the periods the asset is expected to generate revenue.
21
Effect of Debits/Credits on Accounts
22
DEBITS
Increase – Expenses and Dividends
Decrease – Revenues
CREDITS
Decrease – Expenses and Dividends
Increase – Revenues
Normal Balance
23
The term normal balance for an account is the
side (i.e., debit or credit) that is increased.
Normal Debit Balance:Expenses, Dividends
Normal Credit Balance: Revenues
Let’s Continue With
Transaction Analysis
24
Transaction Analysis
Recall the basic steps in the recording process are:
–Analyze each transaction in terms of its effect on the accounts.
–Record the debit and credit effects on specific
accounts for each transaction.
25
Recording A Transaction
• On October 17 Rhody receives $40,000 in cash for services performed.
• How does this affect the accounting equation?
26
Recording A Transaction
A = L + SE + + • Assets increase
• Stockholders’ equity increases via retained earnings (i.e., revenue)
What asset account and “indirectly” what
Stockholders’ equity account is affected?
27
Recording A Transaction
Cash (debit) $40,000
Service Revenue (credit) $40,000
Note: The income statement account revenue is directly affected. However, this indirectly affects stockholders’ equity Recall: Debits are always written first and you always indent the credit.
28
Recording A Transaction
• On November 5 Rhody pays its employees $5,000 for work performed.
• How does this affect the accounting equation?
29
Recording A Transaction
A = L + SE - - • Assets decrease
• Stockholders’ equity decreases via retained earnings (i.e., wage expense)
What asset account and “indirectly” what
Stockholders’ equity account is affected?
30
Recording A Transaction
Salary Expense (debit) $5,000
Cash (credit) $5,000
Note: The income statement account expense is directly affected. However, this indirectly affects stockholders’ equity Recall: Debits are always written first and you always indent the credit.
31
Recording A Transaction
• On November 22 Rhody performs services and bills the client $15,000 for the services
• How does this affect the accounting equation?
32
Recording A Transaction
A = L + SE + + • Assets increases
• Stockholders’ equity increases via retained earnings (i.e.,revenue)
What asset account and “indirectly” what
Stockholders’ equity account is affected?
33
Recording A Transaction
Accounts Receivable (debit) $15,000
Revenue (credit) $15,000
Note: The income statement account revenue is directly affected. However, this indirectly affects stockholders’ equity Recall: Debits are always written first and you always indent the credit.
34
Recording A Transaction
• On December 12 Rhody pays a dividend to its stockholders.
• How does this effect the accounting equation?
35
Recording A Transaction
A = L + SE - - • Assets decrease
• Stockholders’ equity decreases via retained earnings (i.e., dividends)
What asset account and “indirectly” what
Stockholders’ equity account is affected?
36
Recording A Transaction
Dividends (debit) $500
Cash (credit) $500
Note: The retained earnings statement is directly affected. However, this indirectly affects stockholders’ equity Recall: Debits are always written first and you always indent the credit.
37
T-Account
Remember every journal entry will be posted to the appropriate account. For example, based on the entries made, the T-Account for revenue would have an ending credit balance of $55,000 (see next slide).
38
T - Account
REVENUE
10/17 40,000
11/22 15,000
55,000
Balance 55,000 (Credit)
39
Rhody Corporation
Trial Balance (From lecture 2)
December 31, 2004 Debit Credit
Cash $12,000
Note Receivable 10,000
Supplies 4,000
Inventory 14,000
Prepaid Insurance 12,000
Office Equipment 20,000
Accounts Payable 14,000
Unearned Service Revenue 18,000
Common Stock 40,000
$ 72,000 $72,000
40
Rhody Corporation
Updated Trial Balance
December 31, 2004 Debit Credit
Cash $46,500
Supplies 4,000
Accounts Receivable 15,000
Note Receivable 10,000
Inventory 14,000
Prepaid Insurance 12,000
Office Equipment 20,000
Accounts Payable 14,000
Unearned Service Revenue 18,000
Common Stock 40,000
Dividends 500
Service Revenue 55,000
Salaries Expense 5,000
$127,000 $127,000 41
Accrual Basis Accounting
42
Thus, revenue is recorded only when
earned not when cash is received
and
Expense is recorded only when incurred
not when cash paid
The Need for Adjusting Entries
• Companies are on a calendar or fiscal year
and business transactions can cut across two
years.
• Therefore, adjusting entries are needed to
ensure that the revenue recognition and
matching principles are followed.
43
The Need for Adjusting Entries
Jan. 1 Sept.1 Dec. 31 Mar.1
44
Transaction Period
Calendar year
Rule For Adjusting Entries
Every adjusting entry will affect an income
statement account and a balance sheet
account. The balance sheet account NEVER
will be CASH.
45
Major Types Of Adjusting Entries
Adjusting entries can be classified as either
Prepayments or
Accruals
Each of these classes has two subcategories.
46
Adjusting Entries For Prepayments
Prepayments fall into two categories--
–Prepaid expenses
and
–Unearned revenues.
47
Prepayments
Cash has been spent but the item
acquired has not been used or consumed
or
Cash has been collected before revenue
is earned
48
Prepaid Expenses
Prepaid expenses - expenses have been paid in cash and are recorded as assets until they are used or consumed.
Prepaid expenses expire with the passage of time (i. e., rent or insurance) or they are consumed (i. e., supplies or depreciation).
49
Prepaid Expenses
Recall on April 1, Rhody paid $12,000 for a one-year insurance policy.
Original Entry:
Prepaid Insurance (debit) $12,000
Cash (credit) $12,000
50
Prepaid Expenses
Adjusting Entry:
Insurance Expense (debit) $9,000
Prepaid Insurance (credit) $9,000 Calculation:
$12,000 x 9 = $9,000
12
51
Prepaid Expenses
Recall on January 1, Rhody paid $20,000
for equipment. The equipment has a
useful life of 5 years.
Original Entry:
Equipment (debit) $20,000
Cash (credit) $20,000
52
Prepaid Expenses
Adjusting Entry:
Depreciation Expense (debit) $4,000
Accumulated Depreciation (credit) 4,000
Calculation:
$20,000 / 5 = $4,000
53
Unearned Revenues
• Revenues received in cash and recorded as
liabilities before they are earned.
54
Unearned Revenues
Recall On September 1, Rhody received
$18,000 for rent from one of its tenants.
The lease is for 1 year.
Original Entry:
Cash (debit) $18,000
Unearned rent revenue (credit) 18,000
55
Unearned Revenues
Adjusting Entry:
Unearned rent revenue (debit) $6,000
Rent revenue (credit) $6,000
Calculation: $18,000 x 4 = $6,000 12
56
Adjusting Entries For Accruals
Accruals fall into two categories
–Accrued revenue
and
–Accrued expenses
57
Accrued Revenue
Accrued revenues are revenues that have
been earned but not yet received in cash.
58
Accrued Revenues
Recall on October 1, 2004, Rhody lent the
Minutemen Corporation $10,000 in the form
of a note receivable. The note is due on
September 30, 2005, and carries an interest
rate of 9%.
Original Entry:
Note Receivable (debit) $10,000
Cash (credit) $10,000
59
Accrued Revenues
Interest receivable is the amount of income a company receives for the use of its money. Information needed to compute interest income:
• Face value of note
• Interest rate (expressed as annual rate)
• The length of time note is outstanding
60
Accrued Revenues
Adjusting Entry:
Interest Receivable (debit) $225
Interest income (credit) $225 Calculation:
$10,000 x 9% = $900 x 3 = $225
12
61
Accrued Expenses
Accrued expenses are expenses that have
been incurred but not yet paid in cash and
there is no original entry.
62
Accrued Expenses
Rhody pays its workers every 2 weeks on Friday. The total payroll is $80,000 every two weeks. The employees work only Monday - Friday. Assume that the last payday in December is the 26th and that the next payday is January 9. What adjusting entry must be made at the end of December?
Original Entry:
NO ENTRY
63
Accrued Expenses
64
S M T W TH F S
21 22 23 24 25 26 27
28 29 30 31 1 2 3
4 5 6 7 8 9 10
Green days in 2004 - (3)
Red days in 2005 – (7)
The 26th and 9th are paydays
December/January
Accrued Expenses
Adjusting Entry:
Salary expense (debit) $24,000
Salary payable (credit) $24,000 Calculation: $80,000 x 3 days = $24,000 10 days
65
The Accounting Cycle
• Analyze business transactions.
• Journalize the transactions.
• Put in proper T – accounts (done by computer).
• Prepare a trial balance.
• Journalize and post adjusting entries--prepayments
and accruals.
• Prepare an adjusting trial balance.
66
The Accounting Cycle
• Prepare financial statements. Note the financial statements must be prepared in this order since the income flows into the retained earnings statement which flows into the balance sheet:
– Income statement
– Retained earnings statement
– Balance sheet
• Close out all temporary accounts
67
The Nature And Purpose of an Adjusted Trial Balance
• The adjusted trial balance is prepared after all adjusting entries have been journalized and posted.
• The adjusted trial balance shows the
balances of all accounts.
• Financial statements are prepared from the adjusted trial balance.
68
Rhody Corporation
Adjusted Trial Balance
December 31, 2004
Debit Credit Cash $46,500 46,500 Supplies 4,000 4,000 Note Receivable 10,000 10,000 Interest Receivable 225 225 Accounts Receivable 15,000 15,000 Inventory 14,000 14,000 Prepaid Insurance 12,000 9,000 3,000 Office Equipment 20,000 20,000 Accum. Depreciation 4,000 4,000 Accounts Payable 14,000 14,000 Salary Payable 24,000 24,000 Unearned Service Revenue 18,000 6,000 12,000 Common Stock 40,000 40,000 Dividends 500 500 Service Revenue 55,000 55,000 Salaries Expense 5,000 24,000 29,000 Insurance Expense 9,000 9,000 Depreciation Expense 4,000 4,000 Interest Income 225 225
Rent Revenue 6,000 6,000
Totals $127,000 $127,000 $43,225 $43,225 $155,225 $155,225
Debit Credit Debit Credit
69
Rhody Corporation Income Statement
January 1, 2004 - December 31, 2004
Revenue: Service Revenue $55,000 Rent Revenue 6,000 Interest Income 225 Total Revenue $61,225 Expenses: Salaries Expense $29,000 Insurance Expense 9,000 Depreciation Expense 4,000 Total Expenses 42,000 Net Income $19,225
70
Rhody Corporation Retained Earnings Statement
December 31, 2004
Retained Earnings on 1/1/04 $ 0 + Net Income (From Income Statement) 19,225 - Dividends 500 Retained Earnings on 12/31/04 $18,725
71
Rhody Corporation Balance Sheet
January 1, 2004 - December 31, 2004 ASSETS Cash $ 46,500 Accounts Receivable 15,000 Note Receivable 10,000 Interest Receivable 225 Supplies 4,000 Inventory 14,000 Prepaid Insurance 3,000 Total Current Assets $92,725 Office Equipment $20,000 Accum. Depreciation (4,000) 16,000 TOTAL ASSETS $108,725 LIABILITIES Accounts Payable $14,000 Salary Payable 24,000 Unearned Service Revenue 12,000 Total Current Liabilities $50,000 STOCKHOLDERS’ EQUITY Common Stock 40,000 Retained Earnings (FROM Retained Earnings Statement) 18,725 TOTAL LIABILITIES & STOCKHOLDERS’ EQUITY $108,725
72
Temporary/Permanent Accounts
• The computer will zero out all temporary accounts (i.e., income statement accounts revenue and expenses) and the dividend account. The income statement accounts are zeroed out because an income statement is limited to a period of time (i.e., one year).
• The permanent balance sheet accounts are never zeroed out since they continue forever (i.e., going concern concept).
73
Common-Sized Financials
A common-sized statement recast, either the balance sheet or the income statement as a percentage of a selected number. For the balance sheet, that number is assets, and for the income statement, that number is sales. Thus, all assets should be stated as a percentage of total assets and all expenses should be stated as a percentage of sales.
74
Rhody Corporation Common-Sized Income Statement
January 1, 2004 - December 31, 2004
Revenue: Service Revenue $55,000 Rent Revenue 6,000 Interest Income 225 Total Revenue $61,225 100.00% Expenses: Salaries Expense $29,000 47.36% Insurance Expense 9,000 14.70% Depreciation Expense 4,000 6.53% Total Expenses $42,000 68.59% Net Income $19,225 31.41%
75
Rhody Corporation Common-Sized -Balance Sheet
January 1, 2004 - December 31, 2004 ASSETS Cash $ 46,500 42.77% Accounts Receivable 15,000 13.80% Note Receivable 10,000 9.20% Interest Receivable 225 .02% Supplies 4,000 3.68% Inventory 14,000 12.88% Prepaid Insurance 3,000 2.76% Total Current Assets $92,725 85.28% Office Equipment 20,000 18.39% Accum. Depreciation (4,000) (3.68)% TOTAL ASSETS $108,725 100.00% LIABILITIES Accounts Payable $ 14,000 12.88% Salary Payable 24,000 22.07% Unearned Service Revenue 12,000 11.04% Total Current Liabilities 50,000 45.99% STOCKHOLDERS EQUITY Common Stock 40,000 36.79% Retained Earnings 18,725 17.22% TOTAL LIABILITIES & STOCKHOLDERS EQUITY $108,725 100.00%
76
Statement of Cash Flows—Operating, Investing, and
Financing Activities
Purpose of Cash Flow Statement
The purpose of a cash flow statement is to convert the income statement from an accrual basis to a cash basis. This conversion may be done using either of two methods:
– Indirect Method
–Direct method
We will focus only on the Indirect Method.
Why Focus on Cash?
Because investors, creditors, and other
interested parties want to now what is
happening to a company’s most liquid asset,
CASH.
Statement of Cash Flows
The Statement of Cash Flow helps to
evaluate: 1. The entity's ability to generate future cash flows. 2. The entity's ability to pay dividends and meet
obligations 3. The reasons for the difference between net income
and net cash provided (used) by operating activities 4. The investing and financing transactions during the
period.
Statement of Cash Flows
The Statement of Cash Flow can help answer the following questions:
• How did cash increase when there was a net loss for the period?
• Is cash flow greater or less than net income? • How was the expansion in the plant and equipment
financed? • How was the the debt retired? • How much money was borrowed during the year? • What amount was paid in dividends?
The Statement of Cash Flows
The cash flow statement provides
information about the company’s
– cash receipts and cash payments
– the net change in cash resulting from:
• operating,
• investing, and
• financing activities of a company during a period.
Sources of Information for the Statement of Cash Flows
Recall (see next slide) that the cash flow statement is a created statement that relies on information from the income statement and balance sheet. Notice wealth, financial value, and economic income don’t affect the cash flow statement. Therefore, to prepare the cash flow statement, you need:
– Current income statement (only current year)
– Comparative balance sheet (2 years)
– Additional information
Framework for Understanding Accounting Information
Financial Values Attach to individual assets, liabilities, revenues and expense items by the accounting process Wealth Measured by equity at a point in time
Economic Income Change in wealth measured by net income
Financial Statements Economic Concepts
Balance Sheet Assets Liabilities Equity Income Statement Revenue Expenses Net Income Cash Flow Statement Operating cash flow Investing cash flow Financing cash flow Significant non-cash
Format of the Statement of Cash Flows
Cash Flow Statement has Four Sections:
– operating
– investing
– financing
– significant non-cash investing and financing activities
Operating Activities
Operating activities – captures the effects operating transactions (i.e., normal revenues and expenses transactions) have on the company’s cash flow.
Operating Activities
Income Statement Information Needed: – Net income –Depreciation and amortization (non-cash
expenditures) –Gain(loss) on sale of assets or investments
Balance Sheet Information Needed:
–Change in Current Assets –Change in Current Liabilities
Examples of Cash Flows - Operating Activities
Cash inflows: – From sale of goods or services – From interest received and dividends
received Cash outflows:
– To suppliers for inventory – To employees for services – To government for taxes – To lenders for interest – To others for expenses
Investing Activities
Investing activities - captures a company’s purchase and sale of assets and its use of cash to acquire a long-term investment position in another company and the sale of these investments.
Investing Activities
Income Statement Information Needed : – Gain(Loss) of Assets
Balance Sheet Information Needed :
–Change in Long-Term Assets • Property Plant and Equipment • Long-Term Investments
Examples of Transactions That Affect Investing Activities
Cash inflows: – From sale of property, plant, and equipment – From sale of debt or equity securities of other
entities – From collection of principal on loans to other
entities Cash outflows:
– To purchase property, plant, and equipment – To purchase debt or equity securities of other
entities – To make loans to other entities
Financing Activities
Financing activities - captures a company borrowing and repaying long-term loans and selling or buying back shares of its own stock. In addition, it reflects any dividends paid by the company.
Financing Activities
Income Statement Information Needed: – None
Balance Sheet Information Needed:
–Change in Long-Term Liabilities –Change in Stockholders’ Equity
Retained Earnings Stmt Information: – Dividends Paid
Examples of Transactions That Affect Financing Activities
Cash inflows: – From issuance of equity securities
(company's own stock) – From issuance of debt (bonds and notes)
Cash outflows: – To stockholders as dividends – To redeem long-term debt or reacquire
company’s stock
Significant Non-Cash Activities
Transactions that do not affect cash are NOT reported in the body of the statement of cash flows. However, these items are reported:
– In a separate schedule at the bottom of the statement of cash flows or
– In a separate note or supplementary schedule to the financial statements.
Examples of Significant Non-Cash Activities
1. Issuance of common stock to purchase assets. 2. Conversion of bonds into common stock. 3. Issuance of debt to purchase assets. 4. Exchanges of plant assets.
Converting Net Income to Cash Flow From Operations
Revenue Earned
Net Income
Accrual Method Cash Method
Noncash expenses (e.g, depreciation)
Cash Flow From
Operations
Increases in Current Assets
Decreases in Current Liabilities
Decreases in Current Assets
Increases in Current Liabilities
- Expenses Incurred
+
+
-
Steps in Preparing Cash Flow Statement
1. Determine the net Increase (decrease) in cash. Note: This will serve as the check figure.
2. Determine the cash provided (used) by operations.
3. Determine the cash provided (used) by investing. 4. Determine the cash provided (used) by
financing. 5. Determine any significant noncash transactions
that should be disclosed.
Determine Net Cash Provided (Used) By Operating Activities
1. Get net income from the income statement. 2. Add to net income for items that did not affect
cash (i.e. depreciation and amortization). 3. Add (subtract) the changes in the current asset
and current liability accounts. An increase (decrease) in current assets is a decrease (increase) in cash flow. Whereas, an increase (decrease) in current liabilities is an increase (decrease) in cash flow.
Cash Flow Statement
Let’s Do An Example
Assume that Rhody has a beginning cash balance of $20,000 and an ending cash balance of $244,000. In addition, for the year Rhody has net income of $200,000 and depreciation and amortization of $15,000. What impact does this information have on the cash flow statement?
Cash Flow Example
The $224,000 increase between the beginning cash balance of $20,000 and an ending cash balance of $244,000 indicates that Rhody’s total cash flow for the year will increase by $224,000. The cash flow statement will show how this $224,000 increase was achieved. In essence, this will serve as a “check figure” to make sure the sum of cash flow from operations, investing, and financing reflects an increase of $224,000.
Change in Cash Account
The $15,000 of depreciation is a non-cash expense, so that amount must be added to net income. Remember, the goal is to go from net income (accrual basis) to “net income” on the cash basis. Therefore, we need to increase net income by $15,000, since we have “overstated” our cash expenses by the amount of depreciation.
Depreciation and Amortization
Cash flows from operating activities Net income $200,000
Depreciation & amortization 15,000
Net cash flow from operations $215,000
Rhody Company Statement of Cash Flows--Indirect Method
For the Year Ended December 31, 2004
Assume that Rhody had sales of $385,000 and all of its sales are on credit. The beginning balance in accounts receivable was $42,000 and the ending balance is $55,000. What impact does this have on the cash flow statement?
Remember, the goal is to go from net income
(accrual basis) to “net income” on the cash basis.
Impact of Change in Accounts Receivable (Current Asset)
Analysis Via T–Account
ACCOUNTS RECEIVABLE
1/1 42,000
Sales 385,000
Cash Collections 372,000
12/31 55,000 Notice that the income statement reports $385,000
as sales. However, we only collected $372,000 of it in cash. Thus, we need to reduce net income by the increase in the accounts receivable.
Cash flows from operating activities Net income $200,000
Depreciation & amortization 15,000
Increase in accounts receivable (13,000)
Net cash flow from operations $202,000
Rhody Company Statement of Cash Flows--Indirect Method
For the Year Ended December 31, 2004
Assume that Rhody’s operating expenses reported in the income statement were $185,000, of which $170,000 were expenditures requiring the future outlay of cash (i.e., other than depreciation). The beginning balance in accounts payable was $25,000 and the ending balance is $35,000. What impact does this have on the cash flow statement?
Remember, the goal is to go from net income (accrual
basis) to “net income” on the cash basis.
Impact of Change in Accounts Payable (Current Liability)
Analysis Via T–Account
ACCOUNTS PAYABLE
1/1 25,000
Expenses Incurred 170,000
Cash Payments 160,000
12/31 35,000
See explanation on next slide!
The income statement reports $185,000 of expenses. However, $15,000 of these expenses are for depreciation, which is a non-cash expense and would not be recorded as a payable (i.e., recall the credit is to accumulated depreciation). This leaves $170,000 of potential expenses to be paid for with cash. Since the payable account increased by $10,000, only $160,000 of these expenses were actually paid in cash. Thus, we need to increase net income by the increase in the accounts payable.
Impact of Change in Accounts Payable (Current Liability)
Cash flows from operating activities Net income $200,000
Depreciation & amortization 15,000
Increase in Accounts receivable (13,000)
Increase in Accounts payable 10,000
Net cash flow from operations $212,000
Rhody Company Statement of Cash Flows--Indirect Method
For the Year Ended December 31, 2004
Determine Net Cash Provided (Used) By Investing Activities
Add (subtract) the changes in the non-current asset accounts (i.e., property, plant, and equipment) . An increase (decrease) in property, plant, and equipment is a decrease (increase) in cash flow.
Assume that Rhody acquired $40,000 of equipment and sold equipment with a book value (original cost minus accumulated depreciation) of $20,000 for $25,000. What impact does this have on the cash flow statement?
Remember, the goal is to go from net income
(accrual basis) to “net income” on the cash basis.
Impact of Change in PP&E (Non Current Asset)
Analysis of Impact
The purchase of equipment is a cash outflow and the sale of the equipment is a cash inflow. However, the sale of equipment also affects the accrual basis income statement, since the $5,000 gain ($25,000 sales price - $20,000 book value) on the sale is included in net income. Since we are creating a cash flow statement, the gain must be removed from net income (see operating activities section) and the cash flow from this transaction (e.g., $20,000) is reported in the investing activities section.
Cash flows from operating activities: Net income $200,000
Depreciation & amortization 15,000
Increase in Accounts receivable (13,000)
Increase in Accounts payable 10,000
Gain on sale of equipment (5,000)
Net cash flow from operations $207,000
Cash flows from investing activities: Sale of equipment $ 25,000
Purchase of equipment (40,000)
Net cash flow from investing (15,000)
Rhody Company Statement of Cash Flows--Indirect Method
For the Year Ended December 31, 2004
Determine Net Cash Provided (Used) By Financing Activities
Add (subtract) the changes in the non-current liabilities accounts (i.e.,long-term debt) and add (subtract) the changes the stockholders’ equity accounts. An increase (decrease) in long-term debt is an increase (decrease) in cash flow.
Assume that Rhody borrowed $40,000 from Explorer bank and paid $8,000 in dividends to its shareholders. What impact does this have on the cash flow statement?
Remember, the goal is to go from net income
(accrual basis) to “net income” on the cash basis.
Impact of Change in Long-Term Debt (Non-Current Liability)
Analysis of Impact
The borrowing of money from the bank is a financing transaction that increases the amount of cash Rhody has available. Thus, this is a $40,000 increase in Rhody’s cash flow from financing. The payment of $8,000 in dividends is a financing transaction that reduces Rhody’s cash flow.
Net cash flow from operations $207,000
Net cash flow from investing (15,000)
Cash flows from financing activities:
Cash from long-term borrowings 40,000
Payment of dividends (8,000)
Net cash flow from financing 32,000
Net Increase (Decrease) in Cash $224,000 Cash at beginning of period 20,000 Cash at end of period $244,000
Rhody Company Statement of Cash Flows--Indirect Method
For the Year Ended December 31, 2004
Let’s Do Another
Cash Flow Example--
Comparative Basis
Assets
2004
2003
Change Increase/Decrease
Cash $56,000 $34,000 $22,000 increase
Accounts Receivable 20,000 30,000 10,000 decrease
Prepaid Expenses 4,000 0 4,000 increase
Land 130,000 0 130000 increase
Building 160,000 0 160,000 increase
Accumulated depreciation-building
(11,000)
0
11,000 increase
Equipment 27,000 10,000 17,000 increase
Accumulated depreciation-equipment
(3,000)
0
3,000 increase
Total $383,000 $74,000
Rhody Company Comparative Balance Sheet With Change in Accounts December 31, 2004
Liabilities and Stockholders’ Equity
2004
2003
Change
Accounts payable $59,000 $4,000 $55,000 increase
Bonds payable 130,000 0 130,000 increase
Common stock 50,000 50,000 No Change
Retained earnings 144,000 20,000 124,000 increase
Total $383,000 $74,000
Rhody Company Comparative Balance Sheet With Change in Accounts December 31, 2004
Revenues $507,000
Operating expenses 261,000
Depreciation expenses 15,000
Loss on sale of equipment 3,000 279,000
Income from operations 228,000
Income tax expense 89,000
Net income $139,000
Rhody Company Income Statement For the Year 1/1/04 through 12/31/04
• In 2004, the company declared and paid a $15,000 cash dividend.
• The company obtained land through the issuance of $130,000 of long-term bonds.
• An office building costing $160,000 was purchased for cash; equipment costing $25,000 was also purchased for cash.
• During 2004, the company sold equipment with a book value of $7,000 (original cost $8,000 less accumulated depreciation $1,000) for $4,000 cash.
Additional Information
Determine Net Cash Provided (Used) By Operating Activities
1. Get net income from the income statement. 2. Add to net income for items that did not affect
cash (i.e. depreciation and amortization). 3. Add (subtract) any loss (gain) on sale of assets
or investments. 4. Add (subtract) the changes in the current asset
and current liability accounts. An increase (decrease) in current assets is a decrease (increase) in cash flow. Whereas, an increase (decrease) in current liabilities is an increase (decrease) in cash flow.
Cash flows from operating activities Net income $139,000
Depreciation & amortization 15,000
Loss on sale of equipment 3,000
Decrease in Accounts receivable 10,000
Increase in Prepaid expenses (4,000)
Increase in Accounts payable 55,000 79,000
Net cash flow from operations $218,000
Rhody Company Statement of Cash Flows--Indirect Method
For the Year Ended December 31, 2004
Analysis of Impact of Equipment Sale
The sale of the equipment is a cash inflow (shown later in the investing section). However, the $3,000 loss ($4,000 sales price - $7,000 book value) on the sale of equipment is shown in net income. Since we are creating a cash flow statement, the loss must be added back to net income.
Study the balance sheet to determine changes in non-current assets.
Changes in each non-current account are
analyzed using selected transaction data to determine the effect, if any, the changes had on cash.
Determine Net Cash Provided (Used) By Investing Activities
The land of $130,000 was purchased through the issuance of long-term bonds.
Although the exchange of bonds payable for land has no effect on cash, it is a significant noncash investing and financing activity that
must be disclosed.
Determine Net Cash Provided (Used) By Investing Activities
The increase in the building of $160,000 is a use of cash. The equipment account increased by $17,000. The additional information provided reveals that this net increase resulted from two transactions:
– sale of equipment costing $8,000 for $4,000. – a purchase of equipment for $25,000
The purchase of equipment should be shown as a $25,000 outflow of cash and the sale of equipment should be shown as a cash inflow of $4,000.
Determine Net Cash Provided (Used) By Investing Activities
Analysis Via T–Account
EQUIPMENT 1/1 10,000 Sale $8,000 Purchase 25,000 12/31 27,000
Cash flows from operating activities: Net income $139,000
Depreciation & amortization 15,000
Loss on sale of equipment 3,000
Decrease in Accounts receivable 10,000
Increase in Prepaid expenses (4,000)
Increase in Accounts payable 55,000 79,000
Net cash flow from operations $218,000
Cash flows from investing activities: Purchase of building (160,000)
Purchase of equipment (25,000)
Sale of equipment 4,000
Net cash flow from investing (181,000)
Rhody Company Statement of Cash Flows--Indirect Method
For the Year Ended December 31, 2004
Study the balance sheet to determine changes in non-current liabilities and stockholders’ equity.
Changes in each non-current liability and
stockholders’ equity are analyzed using selected transaction data to determine the effect, if any, the changes had on cash.
Determine Net Cash Provided (Used) By Financing Activities
The net increase in Retained Earnings of $124,000 is a result of net income of $139,000 and the $15,000 payment of dividends that decreased Retained Earnings.
• Net income is the starting point of the cash flow
statement and is presented in net cash provided by operations.
• Payment of the dividend is a cash outflow that is
reported as a financing activity.
Determine Net Cash Provided (Used) By Financing Activities
Net cash flow from operations $218,000
Net cash flow from investing (181,000)
Cash flows from Financing investing activities: Payment of dividends $15,000
Net cash flow from financing (15,000)
Net Increase (Decrease) in Cash $22,000 Cash at beginning of period 34,000 Cash at end of period $56,000 Noncash investing and financing activities:
Issuance of bonds payable to buy land $130,000
Rhody Company Statement of Cash Flows--Indirect Method
For the Year Ended December 31, 2004
A Company Life Cycle
A series of phases all companies experience. The phases are often referred to as the:
– introductory phase – growth phase –maturity phase –decline phase.
The phase a company is in affects its cash flows.
Cash Flow
All companies go through business phases. The whole business might not go through each phase, but a segment of the business or a product line of the business will experience these phases.The phases are often referred to as the:
– introductory phase – growth phase – maturity phase – decline phase.
The phase a company is in will affect its cash flows.
Introductory Phase
To support asset purchases, the company needs to issue stock or debt. Since the operations are just starting,
Expect:
– cash from operations to be negative
– cash from investing to be negative.
– cash from financing to be positive.
Growth Phase
The company is striving to expand its production and sales.
Expect:
– cash from operations to generate a small amount of cash
– cash from investing to be negative.
– cash from financing to be positive.
Growth Phase The company’s sales and production begin to level
off. Thus, investing will consist of replacing some long-term assets and selling others.
Expect:
– cash from operations to be moderately positive.
– cash from investing to be neutral.
– cash from financing to be negative (paying back loans).
Decline Phase
The company’s sales and production begin to decline. Note: This phase is not true of all companies, but will certainly affect a segment of a company.
Expect:
– cash from operations to be minimally positive.
– cash from investing to be neutral or negative.
– cash from financing to be negative (paying back loans).
Accrual-based measures allow too much management discretion.
One disadvantage to the cash-based measures is that no published industry averages are readily available for comparison.
Cash-Based Ratio Measures
Recall that liquidity is the ability of a business to meet its immediate obligations and that one measure of liquidity is the current ratio.
A disadvantage of the current ratio is that it uses year-end balances of current assets and current liabilities (may not be representative of a company's position during most of the year.)
Liquidity
Current Cash Debt Coverage Ratio
A ratio that partially corrects this is the current cash debt coverage ratio.
Cash provided by operations
Average current liabilities
Since cash from operations involves the entire year rather than a balance at one point in time, it is often considered a better representation of liquidity on the average day.
Solvency
Recall that solvency is the ability of a firm to
survive over the long term. One measure of
solvency is the debt to total assets ratio.
Solvency
A measure of solvency that uses cash figures Is the cash debt coverage ratio.
Cash Provided By Operations Average Total Liabilities
This ratio measures a company's ability to repay its liabilities from cash generated from operations.
Statement of changes in equity
• Shows the changes in owner’s equity for a specific period of time. • It shows: (a) profit or loss for the period; (b) each item of income and expense for the period that, is
recognised directly in equity, and the total of these items; (c) for each component of equity, the effects of changes in
accounting policies and corrections of errors recognised in accordance with IAS 8.
(d) the amounts of transactions with equity holders acting in their capacity as equity holders, showing separately distributions to equity holders;
(e) the balance of retained earnings (ie accumulated profit or loss) at the beginning of the period and at the balance sheet date, and the changes during the period; and
Notes
The notes shall: • (a) present information about the basis of
preparation of the financial statements and the specific accounting policies;
• (b) disclose the information required by IFRSs that is not presented on the face of the balance sheet, income statement, statement of changes in equity or cash flow statement; and
• (c) provide additional information that is not presented on the face of the balance sheet, income statement, statement of changes in equity or cash flow statement, but is relevant to an understanding of any of them.
Disclosure of accounting policies
An entity shall disclose in the summary of significant accounting policies:
• (a) the measurement basis (or bases) used in preparing the financial statements; and
• (b) the other accounting policies used that are relevant to an understanding of the financial statements.
RECEIVABLES
INVENTORIES
FINANCIAL ASSETS
CASH
(CURRENT ASSETS)
are assets which fulfil following conditions:
It is expected that it will be realized or it is held for sale or for consumption in regular business performance;
Primarily is held for trading;
It is expected that it will be realized in the 12 month period from the balance-sheet date;
Cash or cash equivalent, except if it has limited possibility of exchange or liabilities settlement for period of at least 12 month from the balance-sheet date.
14.11.2012 2 Short – term assets
Types of short-term assets:
Inventories
Receivables
Financial assets
Cash
14.11.2012 3 Short – term assets
14.11.2012 4 Short – term assets
S0 x
consumption
of inventories
procuration
of inventories Si x
occur in several
forms:
Inventories of merchandise;
Inventories of raw materials and materials;
Production inventories (work in progress);
Inventories of finished goods;
Inventories of spare parts;
Inventories of small inventory;
Advances for inventories.
14.11.2012 5 Short – term assets
Are held for sale in regular business
performance by subjects that are performing
commercial services ( wholesale and retail
sale).
Evaluation:
INITIAL EVALUATION – per purchasing cost
AFTERWARDS EVALUATION– per purchasing cost or
per net market value, depending on what is lower (IAS
2 Inventories, art. 9.)
14.11.2012 6 Short – term assets
Procuration and stocking of
merchandise in
1) Per purchasing cost
2) Per selling price
(purchasing cost + difference in price)
14.11.2012 7 Short – term assets
1) Recording of merchandise
procuration per purchasing cost
Purchasing price
Depending costs
discounts Purchasing
cost
14.11.2012 8 Short – term assets
1) Recording of merchandise on inventories per
purchasing cost
Accounts payables Purchasing price Calculation of supply Merchandise inventories
Transportation costs
Customs
Irreversible taxes
(1a) (2)
Purchasing cost
VAT receivables
(3)
(1b)
(1c)
(1d)
(1a)
(3)
(3)
(3)
(1b)
14.11.2012 9 Short – term assets
2) Recording of merchandise on
inventories per selling prices
Purchasing price
Depending costs
Purchasing cost
Difference in price
(margin)
Selling price
Without VAT
14.11.2012 10 Short – term assets
Recording of merchandise on inventories per
selling price
Accounts payables Purchasing price Calculation of supply Merchandise inventories
Transportation cost
Customs
Irreversible taxes
(1a) (2) (2)
Selling Purch. cost price
VAT receivables
(3)
(1b)
(1c)
(1d)
(1a)
(3)
(3)
(3)
(1b)
Difference in price
(2) DIP
14.11.2012 11 Short – term assets
Merchandise wholesale and decrease of inventories
( for merchandise inventories held per
14.11.2012 Short – term assets 12
ACCOUNT
RECEIVABLES VAT PAYABLES
REVENUES
FROM SOLD
MERCHANDISE
MERCHANDISE
INVENTORIES
EXPENSES FROM SOLD
MERCHANDISE (COSTS OF
PURCHASED MERCHANDISE)
(1) SP+VAT VAT(1) SP (1)
S X PC (2) (2) PC
Expenditures methods:
•FIFO method
•Weighted average price
method
13
There are some methods for
determening those costs.
They are: FIFO, LIFO, HIFO and
AVERAGE COST.
By Croatian Law: FIFO method and
average cost.
14
FIFO method: first in, first out.
LIFO method: last in, first out.
HIFO method: highest in, first out.
Average costs: total value in HRK
dividing with total quantity of raw
material.
Merchandise wholesale and decrease of inventories
(for merchandise inventories held per
14.11.2012 Short – term assets 15
ACCOUNTS
RECEIVABLES VAT PAYABLES
REVENUES
FROM SOLD
MERCHANDISE
MERCHANDISE
INVENTORIES
RASHODI OD
PRODAJE (TROŠKOVI
NABAVE ROBE)
(1) SP+VAT VAT (1) SP (1)
S X SP without VAT
(2) (2) SP
without VAT
DIFFERENCE IN
PRICE (2a) DIP of sold
merchandise S X
(2a)
Procuration and stocking of
merchandise in
1) Transfer of merchandise from wholesale
in retail sale
2) Direct procuration in shop (recording of
merchandise per selling price with
calculated VAT)
14.11.2012 16 Short – term assets
14.11.2012 INVENTORIES IAS 2 17
Calculation of retail price
Calculation of retail price include
According to regulation this calculation must be in shops.
Calculation per selling price can be managed as Calculation in margin system,
Calculation with known selling price or as
Calculation in discount system.
Transfer of merchandise from wholesale to
retail shop
14.11.2012 Short – term assets 18
WHOLESALE
MERCHANDISE
DIFFERENCE IN THE
PRICE OF MERCHANDISE
CALCULATED VAT
MERCHANDISE IN
SHOP
RETAIL MARGIN
CALCULATED VAT
(recording of
merchandise per selling price with calculated
VAT)
14.11.2012 Short – term assets 19
ACCOUNTS
PAYABLES
DIFFERENCE IN THE
PRICE OF MERCHANDISE
CALCULATED VAT
MERCHANDISE IN
RETAIL SHOP
RETAIL MARGIN
CALCULATED VAT
PURCHASING
COSTS
Merchandise retail selling and decrease of inventories
14.11.2012 Short – term assets 20
ACCOUNTS
RECEIVABLES VAT PAYABLES
REVENUES FROM
SOLD
MERCHANDISE
CALCULATED VAT
EXPENSES FROM SOLD
MERCHANDISE (COSTS OF
PURCHASED MERCHANDISE)
(1) SP+VAT VAT (1) SP (1)
S X SP + VAT (2) (2) SP+ VAT
DIFFERENCE IN PRICE (2a) DIP of sold
merchandise S X
MERCHANDISE IN
SHOP
S X (2b) calculated
VAT of sold
merchandise
(2a)
(2b)
14.11.2012 Short – term assets 21
costs
costs
costs
Transfer of costs on
revenues burden
TRADE COSTS
(EXPENSES OF THE
PERIOD)
x
x
x
Σ x
OTHER TYPES OF INVENTORIES:
Inventories of raw and material;
Production inventories;
Finished goods inventories;
Inventories of spare parts;
Inventories of small inventory.
14.11.2012 Short – term assets 22
Initially are
recorded at
,
and afterwards at
, depending
on what is lower.
Note: Inventories of raw and material, production inventories and finished goods
inventories will be explained in detail within PRODUCTION.
Inventories of spare parts and inventories of small inventory, package and cartyres –
PLEASE READ IN YOUR BOOKS.
14.11.2012 Short – term assets 23
S0 x decrease of receivables
increase of receivables Si x
Include receivables with maturity under one year.
Most often that are receivables from:
related companies;
customers (accounts receivables);
participation interests;
employees;
government;
and other short –term receivables.
14.11.2012 Short – term assets 24
Occur as a consequence of goods and
services delivery.
That asset is REAL in its appearance and is
treated as transient form of asset from
material form to cash.
There are:
ACCOUNTS RECEIVABLES (DOMESTIC)
ACCOUNTS RECEIVABLES IN ABROAD.
14.11.2012 Short – term assets 25
Occur on the basis of:
Extrapayed salaries to employees;
Given short – term loans;
Shortages and other damages (responsibility of
employees);
Payed advances for official trips.
14.11.2012 Short – term assets 26
The most common that are VAT
RECEIVABLES by ingoing invoices.
Except that receivables from government can
also occur also for:
overpaid personal income tax on salaries;
overpaid contributions from and on salaries;
overpaid income tax;
overpaid custom duties;
and similar….
14.11.2012 Short – term assets 27
14.11.2012 Short – term assets 28
S0 x decrease of assets
increase of assets Si x
Occurs as a consequnce of invested money of
certain business subject on the period up to one
year.
Money is invested in form of:
Given short – term loans to other business subjects,
Investemnts in short – term securities (investment in
commercial bills, investemnt in treasury bills,
investment in short – term bonds),
Investemnt in shares and stakes in related companies,
Given deposits on the period within one year,
Other short – term investments.
14.11.2012 Short – term assets 29
14.11.2012 Short – term assets 30
S0 x decrease of cash
increase of cash Si x
Payments between business subjects are made CASHLESS above cash at bank account.
Cash is divided on cash in bank and cash in register.
Cash in bank and cash in register consist of: Cash at bank account,
Currency account,
Letter of credit,
Other cash assets.
14.11.2012 Short – term assets 31
14.11.2012 Short – term assets 32
CASH AT BANK
So X X (2)
CASH
REGISTER
So X
(1) X
X (1) (2) Received
bank statement
(1) Cash withdrawal from
cash at bank account and
payment on cash register
14.11.2012 Short – term assets 33
CASH AT BANK
So X
(2) X
CASH
REGISTER
So X x (1)
(1) X X (2) (2) Received bank
statement for that
payment (1) Cash withdrawal from
cash register and payment
on cash at bank
LETTER OF CREDIT – an instrument of payment
insurance
A letter of credit is a document that a financial institution or
similar party issues to a seller of goods or services which
provides that the issuer will pay the seller for goods or
services the seller delivers to a third-party buyer
14.11.2012 34
14.11.2012 Short – term assets 35
CASH AT BANK
So X X (1)
ACCOUNTS
PAYABLES
(2) X So X
(1) X X (2) (1) Letter of credit
opening (2) Payment to a supplier
from open letter of credit
Thank You for
Your attention!!!
14.11.2012 kratkotrajna imovina 36
PhD. Ivana Dražić Lutilsky
Is not aimed for sale and has characteristic
of permanency
It is expected that it will be realized into
money in period longer than one business
year
Transfers its value gradually on new effects
21.11.2012
LONG-TERM ASSETS
INTANGIBLE TANGIBLE FINANCIAL RECEIVABLES
• expenditures for development • patents • licence • software • concession • franchise • trademarks • goodwill •Advance payment for intangible assets
• land and forest • buildings • machines and equipment • tools • plant and office inventory • furniture • transport vehicles • long-term biological assets • advanced payment for tangible assets • tangible assets in preparation • other tangible assets
• stakes (shares) by related companies • given loans to related companies • participate intersts • investments in securities • given deposits • other long-term financial assets
• receivables from related companies • receivables from slaes on credit • other receivables
21.11.2012
softwer
Trade mark
franchise
21.11.2012
Intangible assets that is not in physical format
Assets acquired because of its usage in business performance
Heavily predictible life cycle
Heavily measurement of future economic benefits from its usage
Heavily transferabillity of those assets
Sometimes does not exsist the possibility of individual sale because that asset is specific for certain company
Tax regulation: value> 3.500 kn, n > 1 god.
21.11.2012
INTERNAL DEVELOPMENT
EXTERNAL ACQUIRING (PURCHASE OR OTHER RELATIONS WITH OTHERS)
Examples of external acquiring: Separete acquiring of long-term intangible assets (for instance,
licence purchase),
Acquiring of long-term intangible assets as a part of business acquisitions (for instance, value of goodwill of acquired company),
Acqisition of long-term intangible assets by using government injections (for instance, government injection in form of import allowance),
Acquiring of long-term intangible assets by asset exchange (exchange of patents between two companies)
21.11.2012
INTERNAL DEVELOPMENT
For internaly developed positions of long-term intangible assets purchasing cost is detemined on the basisi of all investments (costs) that have occured during creating, production or preparation of that position for its usage.
In internally developed intangible assets which is not recognized as balance sheet position following positions are included: internally developed trademarks, signs, publication names, lists of buyers and other similar positions.
ACQUIRED ASSETS IS CAPITALIZED IF FOLLOWING
REQUIREMENTS ARE FULFILLED:
IF IT IS SEPARABLE,
IF IT HAS LIMITED TIME OF USAGE.
21.11.2012
MRS 38 INTANGIBLE ASSETS
Link on standard: IAS 38 Intangible assets
CFRS 5 Long-term intangible assets
Determines issues of recognition, measurement
and recording of long-term intangible assets as
well as IAS 38, but in shorter form
21.11.2012
Expenditures for research and development
Patents
Licence
Software
Concession
Franchise
Trademarks
Other rights
Goodwill (externally acquired)
Advances for intangible assets
21.11.2012
1. EXPENDITURES FOR RESEARCH which are
recognized as expense in period in which
they ocurr;
The exsistance of long-term intangible assets which
should give certain future economic benefits can not be
proved in research phase
Examples of those activities are activities which goal is
acquiring new knowledge
In the moment of research work and acquiring of new
knowledges when it is not sure in which activity new
knowledge will be applied
21.11.2012
2. EXPENDITURES FOR DEVELOPMENT – are recognized as intangible assets if following requirements are fulfilled: Technical feasibility of intangible assets
which is finished in order to be available for usage or sale;
Intention for finishing of intangible assets and its usage or sale;
Possibility of usage or sale of intangible assets;
Way in which intangible assets will give promising economic benefits. Business subject needs to prove market exsistance for the production of intangible assets or for intangible assets itself, or for usefulness of intangible assets in case that it is used internally; 21.11.2012
Subject needs to prove market existance for
intangible assets production or for intangible assets
itself, or for usefulness of intangible assets in case
that is is used internally;
Avalilability of appropriate technical, financial and
other sources for finishing of development and usage
or sale of intangible assets;
Possibility of reliable cost detrmining which can be
credited to intangible assets development
IF ABOVE MENTIONED REQUIREMENTS ARE NOT SATISFIED,
DEVELOPMENT COSTS ARE PERIOD EXPENSES!
21.11.2012
Costs which ocurr related with research activity, and which could be capitalized are: Material and service costs which are used or
spent in creating of intangible assets
Salaries, wages and other costs of employees that are directly included in creating of that asset,
Fees for legal rights registering,
Depreciation of patents and licences which are used for creating of tangible assets
21.11.2012
Concession is “an agreement by which concession provider (government or other unit) is obliged to divide certain economic rights to concessionaire for ceratin fee
Concessions are usually divided on public interests (building of roads, bridges) and on concessions which are related to natural resources exploatation (water, oil, gass, etc.)
Concession payment according to contract is recorded as intangible long-term assets and through depreciation calculation is divided on periods of concession
21.11.2012
Patent is exclusive right of uage of own inovation after patent registration by competent governement institution.
By patent registering, inovation is protected from incompetent usage, the owner of the patent retain exclusive right of usage, offer or selling that patented inovation
Patent can be ycquired externally (purchase from others) or developed internally
21.11.2012
If patent is developed internally it a result of research and development activities and in that case is recognized through positions of development
Patent can be separate position of long-term intangible assets if it is acquired externally
In that case patent is recorded per purchasing cost which consists of purchasing price enlarged for depending purchasing costs (fees for legal services, administartive fees and similar)
21.11.2012
Licence is redeemed right of usage of foreign patented inovation. Licence purchase means, for instance, purchase of production rights of certain product on certain period of time.
Franchise is exclusive right in case when one company pays to other company fee for certain business for certain period of time, purpose and field. For example, franchise in fast-food industry
For recording of patents, licences and franchise it is important to know if the fee is payed in advance for several periods (business years) or it is payable in rates.
In first case patent, licence or franchise are recorded as long-term intangible assets.
21.11.2012
Trademark represents symbol of certain company by which this company is different from other companies and similar products.
Trademark has promotion goals and is needed to be patented in order to protect it from fraud
Trademark can be:
developed internally – it is not recognized as intangible assets,
Item of purchase – it is recognized as intangible assets.
21.11.2012
Goodwill is company reputation which can be a result of company’s reputation or monopolistic position or competitive strenght.
Goodwill can’t be seperatly identified and valued .
Goodwill is esential part of the whole company and it’s value and couldn’t be measured as seperate item.
Internally acquired goodwill isn’t capitalized.
21.11.2012
Eksternally acquired goodwill can be capitalized.
Goodwill is recorded only when there is a transaction
that involves the purchase of an entire business.
Goodwill is the excess of cost over the fair market value
of the net assets (assets less liabilities) acquired.
Goodwill is not amortized but it must be written down if
its value is determined to have declined (been
permanently impaired).
21.11.2012
Acquisition Usage Alienation
21.11.2012
Acquisition at market,
Acquisition under business combinations,
Acquisition under governement support,
Acquisition by exchange for some other type of asset,
Internally acquired.
21.11.2012
At beginning:
under cost principle (acquisition cost)
After valuation( after the begininng valuation):
Cost model– acquisition cost minus amortization
and minus losses for write – offs of value (value
adjustments); or
Revalorization model– under fair value
21.11.2012
Acquisition cost are:
Purchasing price after all deductions of
discounts,
Dependable costs of acquisition,
customs,
Excise duties.
21.11.2012
Account payables LTIA in preparation LTIA in usage
Vat receivables
Purchasing price
+ Dependable
cost
Acquisition cost
(1) (1)
(1)
(2) (2)
(2)
(1) + (2)
21.11.2012
acquisition Usage Alienation
21.11.2012
Amortization Is the allocation of the cost of an asset expense over its
useful life in a rational and systematic manner.
Depreciation is a process of cost allocation, not a process of asset
valuation.
Why depreciable asset? Because the usefulness to the company and
revenue – producing ability of each asset will decline over the asset
useful life.
Asset which amortize must satisfiy following terms:
a) It is expected that this asset will be used in business activity for a
longer period
b) That asset must have usefull life
c) That asset is held by the company for production, selling goods or
providing services, or for renting or for administrative purposes.
Amortization will started after that asset has started to be used
(next month).
21.11.2012
Basis for amortization is acquisition cost;
Period of amortization – period of usage (usefull life)
AMORTIZATION METHODS
1) TIMELINE METHODS
a) Proportional or straightline method
b) progressiv
c) degressiv
21.11.2012
Accumulated deprecistion
of LTIA Amortization cost
X X
21.11.2012
acquisition usage alienation
21.11.2012
Some forms of LTIA are not transferable or
reneweable or there isn’t a possibility of
independent valuation (goodwill, trade mark and
similar).
Some forms are acquired under special terms
and because of that it sales is limited
(concession).
LTTA stops being recognized in business books.
21.11.2012
Write down (value adjustment) is necessary if in
afterwards valuation estimates that recovarable
amount is lower than book-keeping value.
Recovarable amount is– higher amount between fair value
and value in usage.
Book-keeping amount is– acquisition cost minus accumulated
depreciation.
21.11.2012
Value correction LTIA
Expenses of write downs off
LTTA
X X
21.11.2012
Long term tangible asset
28.11.2012
Long term asset
Intangible Tangible Financial Receivables
•land and forest • buildings • machines and equipment • tools • plant and office inventory • furniture • transport vehicles • long-term biological assets • advanced payment for tangible assets • tangible assets in preparation • other tangible assets
28.11.2012
Disclosure framework
• IAS 16 –Property, plant and equipment
• IAS 36 – Imapairment of asset
• IAS 40 –Investment property
• IFRS 5 'Non-current Assets Held for Sale and Discontinued Operations'
• CFRS 6 – Long term asset
• CFRS 7 – Investment property
• CFRS 8 –Non-current Assets Held for Sale and Discontinued Operations
28.11.2012
• Asset in material form (touchable, tangible) is those which:
– Is used in production, delivering goods or for providing services, for renting or in administrative purposes;
– It will remain in the same form for a period longer then 1 year and it will not be spent in one production cycle.
• Transfers its value gradually on new effects
Tax regulation: value> 3.500 kn, n > 1 year.
28.11.2012
Accounting process
Acquisition Usage Alienation
28.11.2012
Acquisition of LTTA
28.11.2012
• Acquisition on market;
• Internally deployed;
• Exchange;
• Business combinations;
• Government support;
• Financial leases;
• Surpluses;
• Donations.
• Acquisition cost of LTTA should be recognized as asset if:
– It is probable that it will bring future economic benefits, and
– If acquisition cost could be realiable measured.
28.11.2012
Initial recognition of LTTA
• ACQUISITION COST of LTTA when purchased comprehend:
• Purchasing price including custom and excise duties after all discounts,
• Cost includes all costs necessary to bring the asset to working condition for its intended use.
• This would include not only its original purchase price but also costs of site preparation, delivery and handling, installation, related professional fees for architects and engineers, and the estimated cost of dismantling and removing the asset and restoring the site.
28.11.2012
Accounting recording
Account payables LTTA in preparation LTTA in usage
VAT receivables
Purchasing price
+ Other costs
Acquisition costs
(1) (1)
(1)
(2) (2)
(2)
(1) + (2)
28.11.2012
• Cost includes all costs necessary to bring the building to working condition for its intended use : – Preparation of building site; – Projects and other documentation based on
which building was build (architect, geodesist etc.)
– Necessary licenses for water, heating, telephone, etc.
– Costs for arrangement of surfaces ment for usage (acess roads, enviroment etc).
28.11.2012
• Temporary settlement situation
– has a character of invoices
– Used when is a longterm period of building
– Method for gradation of finishing buiding • After every ethap there is a settlement by temporary
situation,
• Total settlement situation - has a total amount of all
temporary situations.
– Method of completed contract (finished building)
28.11.2012
Afterwards recognition:
• Cost method
– After initial recognition as asset, property, plat and equipment should be shown under cost reduced for accumulated depreciation and accumulated losses from value adjustments,
• Revaluation method or revalorization (under fair value)
– Property, plant and equipment whose fair value could be reliable measured should be recognized under revaluated amount – fair value on the date of revaluation reduced for latter accumulated depreciation and latter accumulated losses from value adjustments.
28.11.2012
Advance paymemt
Given advances for LTTA
Taken advances
Given advances for LTTA Money
S0 X
Payables for takn advances Money
28.11.2012
S0 X
Inventory process and inventory differences
INVENTORY PROCESS is a list of asset and liabilities of a company and it is done with a purpose of adjustments bookkepping balance with an actual balance.
If actual balance is higher then the bookkepping balance
INVENTORY SURPLUS
VALUE CORRECTION ASSET
SURPLUS
(1)
(1)
(1)
28.11.2012
2) If actual balanve is lower then bookkepping balance INVENTORY DEFICIT
ASSET
(1) (1)
(1)
VALUE CORRECTION
DEFICIT
S0 X S0 X
28.11.2012
Accounting process
Acquisition Usage Alienation
28.11.2012
Amortization of LTTA
• Amortization Is the allocation of the cost of an asset expense over its useful life in a rational and systematic manner.
• Depreciation is a process of cost allocation, not a process of asset valuation.
Why depreciable asset? Because the usefulness to the company and revenue – producing ability of each asset will decline over the asset useful life.
Asset which amortize must satisfiy following terms:
a) It is expected that this asset will be used in business activity for a longer period
b) That asset must have usefull life
c) That asset is held by the company for production, selling goods or providing services, or for renting or for administrative purposes.
Amortization will started after that asset has started to be used (next month).
28.11.2012
Basis for amortization is acquisition cost;
Period of amortization – period of usage (usefull life)
AMORTIZATION METHODS
1) TIMELINE METHODS a) Proportional or straightline method
b) progressiv
c) Degressiv
2) Functional method or units of activity
28.11.2012
Depreciation is not used for:
• Land,
• Forrest,
• Art,
• Archives,
• Asset in preparation,
• Advances for LTTA.
28.11.2012
Depreciation recording
Accumulated depreciation of LTTA Depreciation cost
X X
28.11.2012
Timeline methods
o PROPORTIONAL – amount of depreciation is the same in useful life
o DEGRESSIV MEHOD – amount of depreciation declines in useful life
o PROGRESSIV METHOD – amount of depreciation inclines in useful life.
Depreciation is an accounting policy which is influencing financial result
Proportional method
Annual depreciation rate = 100/useful life (years)
Annual depreciation amount = (acquisition cost * annual depreciation rate)/100
Quaterly amount ofdepreciation = annual amount/4
Functional method or units of activity
• Is based on estimations of possible effects
n = estimated number of effects in total useful life
n1 = actual number of effects in one period
Annual depreciation amount= (acquisition cost/ n) * n1
Accounting process
Acquisition Usage Alienation
28.11.2012
Alienation processes:
• Sale
• Disposal
• Donations
• Inventory surplases
28.11.2012
Extraordinary revenue / expenses
SALES
LTTA in usage Accumulated depreciation
Expenses of sold LTTA – carrying amount .
Account receivables Revenues from sold LTTA VAT payables
S0 S0
Carrying amunt(CA) = AC-DEP +all other costs related to sale
28.11.2012 26
AC DEP CA
SP and VAT VAT SP
donation
LTTA in usage Accumuated depreciation
Carrying amount
S0 S0
28.11.2012 27
AC DEP CA
Impairing test of LTTA (Value adjustments)
• Bookkepping value>recovarable amount
– Recognized as loss of value adjustment
– Value adjustment – alue correction and expenses
• External and internal sources of information
• Determening of recovarable amount
– net sales value or value in usage depending in which is higher
28.11.2012
Value adjustment recording
Value correction of LTTA Expenses of value adjustments
X X
28.11.2012
Long term financial asset
28.11.2012
LONG TERM ASSET
INTANGIBLE TANGIBLE FINANCIAL RECEIVABLES
• stakes (shares) by related companies • given loans to related companies • participate intersts • investments in securities • given deposits • other long-term financial assets
28.11.2012
TERM definitions
• Financial asset is considered to be all financial instrumemt which could be measured and recognized.
• LTFA are all financial investments for a period longer than 1 year.
• By investments and holding financial asset they could gain certain benefits which depends about the type of investments like interest rate, dividends , etc.
28.11.2012
Disclosure framework
• IAS 32 FINANCIAL INSTRUMENTS
• IAS 39 FINANCIAL INSTRUMENTS
• IFRS 7 FINANCIAL INSTRUMENTS: disclosure
• CFRS 9 FINANCIAL ASSET
28.11.2012
LT RECEIVABLES
28.11.2012
LT RECEIVABLES
• Comprehend receivables with the maturity date longer then 1 year.
• FORMS: – Receivables from related companies, – receivables from sales on credit, – other receivables
28.11.2012
Equities
Transparency 13-2
Corporation
Is a legal entity that is formed through a
corporate charter and can operate in various
states (must have a license from each state
in which it does business), but is
incorporated in only one state.
Classified by purpose and ownership
Purpose - profit or nonprofit
Ownership - publicly or privately held
Transparency 13-3
Corporation
Corporate charter – The legal document
establishing a corporation under the laws of
its appropriate jurisdiction.
It specifies the types of equities and their
terms, number of shares that can be issued
(authorized), and the par value of these
issues.
Transparency 13-4
Ownership
Publicly Held Corporation
May have thousands of stockholders
and its stock is regularly traded on
national securities markets.
Privately Held Corporation
May have few stockholders and does
not offer its stock for sale to general
public.
Transparency 13-5
Separate legal existence
Limited liability of stockholders
Transferable ownership rights
Ability to acquire capital
Continuous life
Corporation management
Government regulations
Additional taxes
Characteristics of a Corporation
Transparency 13-6
Separate Legal Existence
Acts under its own name and may buy,
own, sell property; borrow money; enter
into legally binding contracts; may sue or
be sued; pays its own taxes.
Stockholders cannot bind corporation
unless the stockholder is acting as an
agent of the corporation.
Transparency 13-7
Limited Liability of Stockholders
Creditors have recourse only against
corporate assets to satisfy claims.
Liability of stockholders limited to
investment in corporation.
Thus, creditors have no legal claim on
personal assets of owners unless fraud
has occurred.
Transparency 13-8
Transferable Ownership Rights
Transfer of ownership among stockholders
has no effect on corporation’s operating
activities or assets, liabilities and total
stockholders' equity.
Remember that a corporation does not
receive any payments on the transfer (i.e.,
sale) of shares after the original issuance of
the stock.
Transparency 13-9
Continuous Life
Corporation is separate legal entity; thus,
a corporation is continuous and is not
affected by withdrawal, death, or
incapacity of any stockholder.
Transparency 13-10
Corporation Management
The corporation establishes by-laws upon incorporation.
Stockholders manage corporation indirectly through board of directors.
Board of directors formulates operating policies selects officers to execute policy and to
perform daily management functions.
Transparency 13-11
Stockholder Rights
Vote on the election of Board of Directors
Can share in corporate profits through dividends – assuming declared
Entitled to keep the same percentage of ownership if new shares are offered for sale.
Entitled to pro rata share (based on ownership percentage) of the assets in liquidation
Transparency 13-12
Difference Between Equity and Debt
First, debt agreements specify payments due to
their holders. In other words, debt determines the
maximum payment a debt holder can receive. This
is not the case with equity (i.e., dividends can be
unlimited).
Second, debt holders are entitled to receive
payments specified in the debt agreement and
possess legal recourse if promised payments are
not made (i.e., there is no requirement to pay
dividends).
Transparency 13-13
Difference Between Equity and Debt
Third, if a corporation defaults, debt holders
have the right to be paid before equity
holders (i.e., a senior position).
Fourth, equity holders possess decision
rights in the entity (as discussed in previous
slides), as long as a default has not
occurred.
Transparency 13-14
Questions in Issuing Stock
How many shares should be issued?
At what price should the shares be issued?
Transparency 13-15
Factors Involved in Setting Price of Stock
Company's anticipated future earnings
Its expected dividend rate per share
Its current financial position
Current state of the economy
Current state of the securities market
Transparency 13-16
Stock Terms
Authorized Stock Maximum amount of stock a corporation is allowed to sell as authorized by corporate charter. Amount must be disclosed on balance sheet.
Issued Stock Number of shares originally sold to stockholders. Outstanding Stock Number of shares held by stockholders (i.e.,shares issued minus shares reacquired – treasury stock).
Transparency 13-17
Par Value
Par value is the legal capital per share that
must be retained in the business.
NOTE: Par value has NO relationship to the
market value of the stock.
Transparency 13-18
Stockholders’ Equity Section of The Balance Sheet
Stockholders’ equity consists of two categories
(contributed capital and earned capital):
Contributed capital (paid capital)
Par Value
Additional paid-in capital
Earned capital
Retained earnings
Transparency 13-19
Accounting for Common Stock Issues
The issuance of common stock affects only
the contributed capital accounts.
When the issuance of common stock for
cash is recorded, the par value of the shares
is credited to Common Stock.
The portion of the proceeds above par value
is recorded in a separate paid-in account
referred to as either additional paid-in capital
or paid-in capital in excess of par.
Transparency 13-20
Issuing Stock at Par
Rhody issues 100,000 shares of the $1 par value
common stock for cash at $1 per share. The entry
is:
Cash 100,000
Common Stock 100,000
NOTE: Since the stock is issued at par, there is no
additional paid-in capital
Transparency 13-21
Assume Rhody issues another 100,000
shares of the $1 par value common stock for
cash at $5 per share. The entry is:
Cash 500,000
Common Stock 100,000
Additional Paid-in Capital 400,000
Issuing Stock Above Par
Stockholders' Equity Paid-in capital Common stock $200,000 Paid-in capital in excess of par 400,000 Total paid-in capital $600,000 Retained earnings 200,000* Total stockholders' equity $800,000 * For illustrative purposes, we assume
beginning retained earnings is $200,000.
Rhody’s Balance Sheet
Transparency 13-23
Treasury Stock
Treasury stock is a corporation's issued
and outstanding stock that has been
reacquired by the corporation and held in
“treasury” for future use.
Transparency 13-24
Why Does A Corporation Reacquire Its Own Stock?
Reissue shares to officers and employees under bonus and stock compensation plans.
Increase trading of company's stock in securities market in hopes of enhancing market value.
Have additional shares available for use in acquisition of other companies.
Transparency 13-25
Why Does A Corporation Reacquire Its Own Stock
Reduce number of shares outstanding,
thereby increasing earnings per share.
Prevent a hostile takeover.
Transparency 13-26
Purchase of Treasury Stock
On February 1, 2004, Rhody acquires
4,000 shares of its stock at $8 per share.
Treasury Stock 32,000
Cash 32,000
Transparency 13-27
Treasury Stock
The Treasury Stock account is debited for the cost
($32,000) of the shares (i.e., contra equity
account).
The original amount of Common Stock is not
affected because the number of issued shares
does not change.
Treasury stock is considered a contra equity
account (i.e., it has a debit balance when the
normal balance is a credit) and thus reduces the
stockholders' equity section of the balance sheet.
Stockholders' equity Paid-in capital Common stock,$5 par value, 200,000 shares issued and 196,000 outstanding $ 200,000 Additional Paid-in Capital 400,000 Retained Earnings 200,000 Total stockholders’ equity 800,000 Less: Treasury Stock 32,000 Total stockholders’ equity $768,000
Rhody’s Balance Sheet After Treasury Stock
Transparency 13-29
Preferred Stock
A type of stock that has contractual
preferences over common stock. Preferred
stockholders do not have voting rights.
Preferences
Dividends
Assets in the event of liquidation
Transparency 13-30
Preferred Stock
Assume Rhody issues 1,000 shares of $100
par value preferred stock for $12 cash per
share.
Cash 120,000
Preferred Stock 100,000
Additional Paid-in Capital - PS 20,000
Stockholders' equity Common stock,$5 par value, 200,000 shares issued and 196,000 outstanding $ 200,000 Additional Paid-in Capital 400,000 Preferred stock, $100 par value
1,000 shares issued and 1,000 outstanding 100,000
Additional Paid-in Capital – PS 20,000 Retained Earnings 200,000 Total stockholders’ equity 920,000 Less: Treasury Stock 32,000 Total stockholders’ equity $888,000
Rhody’s Balance Sheet After Preferred Stock
Transparency 13-32
Dividend Preferences
Preferred stockholders have the right to the distribution of corporate income before common stockholders.
Therefore, common shareholders will not receive any dividends until preferred stockholders have received their dividends.
Generally, the per share dividend amount is stated as either a percentage of the par value or as a specified amount.
Transparency 13-33
Cumulative Preferred Stock
As we have discussed, owning common or preferred stock does not guarantee the payment of a dividend.
Therefore, to protect preferred stockholders, most preferred stock is cumulative. While being “cumulative” does not guarantee that a company will pay preferred stockholders a dividend in a specific year, it does require that before the company can pay a dividend to common stockholders, it must pay preferred stockholders a dividend for all prior years that they did not receive a dividend (including a dividend for the current year).
Transparency 13-34
Dividends in Arrears
Unpaid prior-year dividends are referred to
as dividends in arrears and are not
considered a liability.
No liability exists until the dividend is
declared by the board of directors.
However, the amount must be disclosed in
the notes to the financial statements.
Thus, this is an example of an unrecorded
economic liability.
Transparency 13-35
Dividends in Arrears Example
Rhody has 1,000 shares of 7%, $100 par value
cumulative preferred stock outstanding. The
annual dividend is $7,000 (1,000 x $7 per share).
Dividends are 2 years in arrears. What amount
must Rhody pay preferred stockholders before
common stockholders can receive a dividend?
Dividends in arrears ($7,000 x 2) $ 14,000
Current-year dividends 7,000
Total preferred dividends $ 21,000
Transparency 13-36
Dividend
A dividend is a distribution by a corporation to its stockholders on a pro rata basis.
Pro rata means that if you own 10% of the
common shares, you will receive 10% of the dividend. However, dividends are reported on a per share amount.
Dividends come in two forms: cash stock.
Transparency 13-37
Cash Dividend
A cash dividend Is a pro rata distribution
of cash to stockholders.
Generally, a corporation must have 2
things to pay cash dividends
Retained earnings
Adequate cash
Transparency 13-38
Entries for Cash Dividends
Three dates are important in connection
with dividends: the declaration date
the record date
the payment date
Transparency 13-39
The Declaration Date
The declaration date is the date that the board of directors declares the cash dividend and commits the corporation to a binding legal obligation that cannot be rescinded.
Transparency 13-40
Accounting on the Declaration Date
On December 1, 2004, the directors of Rhody declare a $. 25 per share cash dividend on 196,000 shares (200,000 issued – 4,000 treasury) of $1 par value common stock. The dividend is $49,000 (196,000 x $.25).
Retained Earnings 49,000
Dividends Payable 49,000
NOTE: We don’t pay dividends on treasury stock, since that, in essence, would be paying dividends to ourselves.
Transparency 13-41
Accounting on the Date of Record
Represents the date ownership of the
outstanding shares is determined for
dividend purposes. Since this is an internal
not external transaction:
NO ENTRY IS NECESSARY
Stockholders' equity Common stock,$5 par value, 200,000 shares issued and 196,000 outstanding $ 200,000 Additional Paid-in Capital 400,000 Preferred stock, $100 par value
1,000 shares issued and 1,000 outstanding 100,000
Additional Paid-in Capital – PS 20,000 Retained Earnings 151,000 Total stockholders’ equity 921,000 Less: Treasury Stock 32,000 Total stockholders’ equity $839,000
Rhody’s Balance Sheet After Declaration of Dividend
Transparency 13-43
Accounting on the Date of Payment
When the dividend is paid on January 20,
2005, the entry is
Dividends Payable 49,000
Cash 49,000
Transparency 13-44
A Stock Dividend
A stock dividend Is a pro rata distribution of the corporation's own stock to stockholders.
Results in a decrease in retained earnings and an increase in paid-in capital.Thus, it does not decrease total stockholders' equity or total assets.
Is often issued by companies that do not have adequate cash to issue a cash dividend.
Transparency 13-45
Stock Dividends
Assume you own 2% of Rhody (3,920 of its
196,000 shares of outstanding common
stock) and it declares a 10% stock dividend.
Rhody would issue an additional 19,600
shares (196,000 x 10%) and you would
receive 392 (2% x 19,600) shares. After the
stock dividend your ownership interest would
remain at 2% (4,312 /215,600). Note: You
now own more shares of stock, but your
ownership interest has not changed.
Transparency 13-46
Reasons for a Stock Dividend
To satisfy stockholders' dividend expectations without spending cash.
To increase marketability of its stock by increasing number of shares outstanding and decreasing market price per share.
To emphasize that a portion of stockholders' equity has been permanently reinvested in business and is unavailable for cash dividends.
Transparency 13-47
Accounting for Stock Dividends
Generally, most stock dividends are
considered “small stock” dividends. That is,
the number of new shares created does not
increase the total number of shares
outstanding by more than 25%. A small
stock dividend reduces retained earnings by
the number of new shares issued multiplied
by the fair market value of the stock.
Transparency 13-48
Stock Dividend Example
Rhody’s declares a 2% stock dividend on its shares of $1 par value common stock. The current fair market value of the stock is $7 per share. Recall that its balance in retained earnings is $151,000. How many shares will be issued? What is the journal entry to record the stock dividend?
Transparency 13-49
Accounting on the Declaration Date
The number of shares to be issued is 9,800
(200,000 - 4,000) x 2%). The number of new
shares is then multiplied by the fair market
value ($7) of the stock and Retained Earnings
is decreased by $68,600 (9,800 x $7).
Journal Entry: Retained Earnings 68,600 Common Stock to be distributed 9,800 Additional Paid-in Capital 58,800
Transparency 13-50
Accounting on the Issuance Date
Journal Entry:
Common Stock to be distributed 9,800
Common Stock 9,800 Note: Although total stockholders' equity remains the same, a stock dividend rearranges the composition of stockholders' equity.
Transparency 13-51
Rhody’s Balance Sheet After Declaration of Dividend
Before After
Dividend Dividend Stockholders' equity Common stock $200,000 $209,800
Additional paid-in capital - CS 400,000 458,800 Preferred stock 100,000 100,000
Additional paid-in capital - PS 20,000 20,000
Total paid-in capital 720,000 788,600
Retained earnings 151,000 82,400
Less: Treasury stock ( 32,000) (32,000)
Total stockholders' equity $839,000 $839,000
Outstanding shares 196,000 205,800
Transparency 13-52
Stock Split
Is the issuance of additional shares of stock
to stockholders accompanied by:
A reduction in the par or stated value.
An increase in number of shares.
A stock split does not have any effect on
total paid-in capital, retained earnings, and
total stockholders' equity
Transparency 13-53
Stock Split
Assume that instead of issuing a 2% stock dividend, Rhody issues a 2-for-1 stock split on its 196,000 shares of common stock.
EFFECTS OF STOCK SPLIT
No journal entry is necessary.
Par Value per Share decreases and
number of shares outstanding increases
Transparency 13-54
Rhody’s Balance Sheet After Stock Split
Before After
Split Split Stockholders' equity Common stock $200,000 $200,000
Additional paid-in capital - CS 400,000 400,000 Preferred stock 100,000 100,000
Additional paid-in capital - PS 20,000 20,000
Total paid-in capital 720,000 720,000
Retained earnings 151,000 151,000
Less: Treasury stock ( 32,000) (32,000)
Total stockholders' equity $839,000 $839,000
Outstanding shares 196,000 392,000
Transparency 13-55
Comparison of Stock Dividend and Stock Split
Stock
Item Stock Split Dividend
Total paid-in capital No change Increase
Total retained earnings No change Decrease
Total par value No change Increase
Par value per share Decrease No change
Transparency 13-56
Retained Earnings
Retained earnings represents the net income that is retained in the business. Retained earnings is net income minus dividends paid since the formation of the business.
The balance in retained earnings is part of the stockholders' claim on the total assets of the corporation.
Retained earnings does not represent a claim on any specific asset.
Transparency 13-57
Retained Earnings
For example, a $100,000 balance in
retained earnings does not mean that
there should be $100,000 in cash.
Transparency 13-58
Retained Earnings Restrictions
Are legal, contractual or voluntary
circumstances that make a portion of
retained earnings currently unavailable
for dividends. This can be due to debt
covenants as discussed in lecture 8.
Transparency 13-59
Stock Options
Generally, compensation expense is not
recorded upon issue of the stock options.
This is permitted as long as the stock price
equaled or was lower than the exercise price
at the time the options were issued.
However, the entity must disclose in the pro
forma the effect the stock options would have
had on net income and diluted EPS if it was
recognized as an expense.
Transparency 13-60
Stock Options
On December 1, 2004, Rhody issues
5,000 stock options to the company
president. At the time, the fair market
value of the stock ($15) is equal to
the exercise price ($15). What
would Rhody record as compensation
expense at the date of issuance?
Transparency 13-61
Stock Options
Rhody would not make a journal entry
to record compensation expense.
When the stock options are exercised, it
would record the entry for the issuance
of the stock. However, it must make a
footnote disclosure in the financial
statements to reflect the effect this
would have had on net income and
EPS.
Transparency 13-62
Stock Options
On March 1, 2006, the president of
Rhody exercises his option to buy the
5,000 shares of stock when the fair
market value of the stock is $30.
Recall that the exercise price was
$15 and the par value of Rhody stock
is $1. How does Rhody record the
effect of the issuance of stock?
Transparency 13-63
Stock Options
Rhody would make the following journal
entry:
Cash $75,000*
Common Stock 5,000
Additional paid-in capital 70,000
* ($15 exercise price x 5,000 shares)
Transparency 13-64
Measuring Corporate Performance
One way that companies reward stock
investors for their investment is to pay
them dividends.
The payout ratio and dividend yield measure a corporation’s dividend performance.
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The Payout Ratio
Measures the percentage of earnings
distributed in the form of cash dividends to
common stockholders
Total Cash Dividends on Common Stock
Net Income
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The Dividend Yield
The rate of return an investor earns from dividends.
Dividends Per Share of Common Stock
Stock Price at Year-End
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Earnings Per Share
Measures the net income earned on each
share of common stock.
Net Income - Preferred Stock Dividends
Average Number of Shares of
Common Stock Outstanding
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Price-Earnings Ratio/Market Cap
The price-earnings ratio reflects the investors‘ assessment of a company's future earnings.
Market Price Per Share
Earnings Per Share
Alternatively as discussed in Chapter 7:
Market Capitalization
Book Value
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Return on Common Stockholders’ Equity Ratio
Measures the profitability from the stockholders’ point of view.
Net Income – Preferred Stock Dividends
Average Common Stockholders’ Equity