Transcript Document

Accounting Process & Concepts
Receivables, Assets & Liabilities
By:
Associate Professor Dr. GholamReza Zandi
[email protected]
How Much Cash Should a Business Have?
The Valuation of Financial Assets
Basis for Valuation in
Type of Financial Assets
the Balance Sheet
Cash (and cash equivalents) Face amount
Short-term investments
Fair market value
(marketable securities)
Receivables
Net realizable value
Estimated collectible amount
Cash
Coins and
paper
money
Bank credit
card sales
Cash is
defined as
any deposit
banks will
accept.
Travelers’ checks
Checks
Money orders
Reporting Cash in the Balance Sheet
Cash
Equivalents
Restricted
Cash
Lines of
Credit
Cash Management
• Accurately account for cash.
• Prevent theft and fraud.
• Assure the availability of adequate amounts of
cash.
• Prevent unnecessarily large amounts of idle
cash.
Internal Control Over Cash
• Segregate authorization, custody and recording
of cash.
• Prepare a cash budget (or forecast).
• Prepare a control listing of cash receipts.
• Require daily deposits.
• Make all payments by check.
• Require that every expenditure be verified
before payment.
• Promptly reconcile bank statements.
Cash Over and Short
Assume that on May 5, total cash sales
were $4,500. However, cash receipts in the
register drawer were counted
and total only $4,485.
GENERAL JOURNAL
Date
Account Titles and Explanation
Debit
May 5 Cash Over and Short
Credit
15
Cash
To record a shortage in cash receipts for the day.
Cash Over and Short is debited for
shortages and credited for overages.
15
Reconciling the Bank Statement
Explains the difference between cash
reported on bank statement and cash
balance in depositor’s accounting
records.
Provides information for
reconciling journal entries.
Reconciling the Bank Statement
Balance per Bank
Balance per Depositor
+ Deposits in Transit
+ Deposits by Bank
(credit memos)
- Outstanding Checks
- Service Charge
- NSF Checks
± Bank Adjustments
± Book Adjustments
= Adjusted Balance
= Adjusted Balance
Reconciling the Bank Statement
• The July 31 bank statement for Parkview Company indicated
•
•
•
•
•
•
•
a cash balance of $5,000.17.
The cash ledger account on that date shows a balance of
$4,262.83.
Four outstanding checks totaled $717.75.
A $410.90 deposit made after banking hours on July 31 does
not appear in the bank statement.
On July 30, the bank returned J.B. Ball’s NSF check for
$50.25, received as payment of an account receivable.
The bank statement showed $24.74 interest earned on the
bank balance for the month of July. The bank collected a
non-interest bearing note on July 22 for $500 and charged a
$5 collection fee.
Check 893 for telephone expenses cleared the bank for $85
but was erroneously recorded in our books as $58.
The bank charged a July service charge of $12.00.
Reconciling the Bank Statement
Reconciling the Bank Statement
Short-Term Investments
Capital
Stock
Investments
Bond
Investments
Readily
Marketable
Marketable
Securities
are . . .
Almost As
Liquid As
Cash
Current Assets
Marketable Securities Classifications
Trading
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Held-toMaturity
Availablefor-Sale
15
Trading Securities
• Equity or debt securities
• Actively managed for profit
• Valued at current market value
• Current asset on balance sheet
• Increase or decrease in value during the period
shown as unrealized gain or loss on income
statement
• Earned interest or dividends reported as income
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Held-to-Maturity Securities
• Debt securities
• Intended to be held to maturity date
• Valued at cost
• Maturity date determines whether current or
long-term asset on balance sheet
• Earned interest reported as income
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Available-for-Sale Securities
• Equity or debt securities not classified as Trading
or Held-to-Maturity securities
• Valued at current market value
• Maturity date determines whether current or
long-term asset on balance sheet
• Increase or decrease in value during the period
shown as change to stockholders’ equity
• Earned interest or dividends reported as income
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Purchase of Marketable Securities
Foster Corporation purchases as a short-term
investment 4,000 shares of The Coca-Cola
Company on December 1. Foster paid $48.98
per share, plus a brokerage commission of $80.
GENERAL JOURNAL
Date
Dec
Account Titles and Explanation
1 Marketable Securities
Cash
Debit
Credit
196,000
196,000
Total Cost: (4,000 × $48.98) + $80 = $196,000
Cost per Share: $196,000 ÷ 4,000 = $49.00
Recognition of Investment Revenue
On December 15, Foster Corporation
receives a $0.30 per share dividend on its
4,000 shares of Coca-Cola.
GENERAL JOURNAL
Date
Dec
Account Titles and Explanation
15 Cash
Debit
Credit
1,200
Dividend Revenue
4,000 × $0.30 = $1,200
1,200
Sales of Investments at a Gain
On December 18, Foster Corporation sells 500
shares of its Coca-Cola stock for $50.04 per
share, less a $20 brokerage commission.
GENERAL JOURNAL
Date
Dec
Account Titles and Explanation
18 Cash
Debit
Credit
25,000
Marketable Securities
Gain on Sale of Investment
Sales Proceeds: (500 × $50.04) - $20 = $25,000
Cost Basis: 500 × $49 = $24,500
Gain on Sale: $25,000 - $24,500 = $500
24,500
500
Sales of Investments at a Loss
On December 27, Foster Corporation sells an
additional 2,500 shares of its Coca-Cola stock
for $48.01 per share, less a $25 brokerage fees.
Date
Dec
Account Titles and Explanation
27 Cash
Loss on Sale of Investment
Marketable Securities
Debit
Credit
120,000
2,500
122,500
Sales Proceeds: (2,500 × $48.01) - $25 = $120,000
Cost Basis: 2,500 × $49 = $122,500
Loss on Sale: $120,000 - $122,500 = $2,500
Adjusting Marketable Securities to Market Value
On December 31, Foster Corporation’s remaining shares of
Coca-Cola capital stock have a current market value of
$47,000. Prior to any adjustment, the company’s
Marketable Securities account has a balance of $49,000
(1,000 × $49 per share).
GENERAL JOURNAL
Date
Dec
Account Titles and Explanation
31 Unrealized Holding Loss on Investments
Debit
Credit
2,000
Marketable Securities
Unrealized Loss: $47,000 - $49,000 = ($2,000)
2,000
Presentation of Marketable
Securities in the Balance Sheet
Matching Uncollectible Accounts Expense
to the Period in which the Credit Sale is Made
Reflecting Uncollectible Accounts in the Financial
Statements
At the end of each period, record an
estimate of the uncollectible accounts.
GENERAL JOURNAL
Date
Account Titles and Explanation
Jan 31 Uncollectible Accounts Expense
Credit
10,000
Allowance for Doubtful Accounts
Selling expense
Debit
10,000
Contra-asset account
The Allowance for Doubtful Accounts
The net realizable value is the amount of
accounts receivable that the business
expects to collect.
Accounts receivable
Less: Allowance for doubtful accounts
Net realizable value of accounts receivable
Writing Off an Uncollectible Account Receivable
When an account is determined to be
uncollectible, it no longer qualifies as
an asset and should be written off.
GENERAL JOURNAL
Date
Account Titles and Explanation
Jan. 5 Allowance for Doubtful Accounts
Accounts Receivable (Discount Stores)
Debit
Credit
4,000
4,000
Writing Off an Uncollectible
Account Receivable
Accounts receivable
Less: Allow. for doubtful accts.
Net realizable value
Before
Write-Off
$ 250,000
10,000
$ 240,000
After WriteOff
$ 246,000
6,000
$ 240,000
Notice that the $4,000 write-off did not
change the net realizable value nor did it
affect any income statement accounts.
Monthly Estimates of Credit Losses
At the end of each month,
management should
estimate the probable
amount of uncollectible
accounts and adjust the
Allowance for Doubtful
Accounts to this new
estimate.
Two Approaches to Estimating Credit Losses
1. Balance Sheet Approach
2. Income Statement Approach
Estimating Credit
Losses — The Balance Sheet Approach
 Year-end Accounts Receivable is
broken down into age classifications.
 Each age grouping has a different
likelihood of being uncollectible.
 Compute a separate allowance for
each age grouping.
Estimating Credit
Losses — The Balance Sheet Approach
At December 31, the receivables for Valley
Ranch Supply were categorized as follows:



Estimating Credit
Losses — The Balance Sheet Approach
Valley Ranch’s unadjusted
balance in the allowance
account is $4,000.
Per the previous
computation, the desired
balance is $5,680.
Allowance for
Doubtful Accounts
4,000
1,680
5,680
GENERAL JOURNAL
Date
Account Titles and Explanation
Dec. 31 Uncollectible Accounts Expense
Allowance for Doubtful Accounts
Debit
Credit
1,680
1,680
Estimating Credit Losses — The Income
Statement Approach
Uncollectible accounts’ percentage is based
on actual uncollectible accounts from prior
years’ credit sales.
Net Credit Sales
 % Estimated Uncollectible
Amount of Journal Entry
Estimating Credit Losses — The Income Statement
Approach
In September, Valley Ranch Supply had credit
sales of $150,000. Historically, 2% of Valley’s
credit sales has been uncollectible. For the
September, the estimate of uncollectible
accounts expense is $600.
($150,000 × .02 = $3,000)
GENERAL JOURNAL
Date
Account Titles and Explanation
Sep 30 Uncollectible Accounts Expense
Allowance for Doubtful Accounts
Debit
Credit
3,000
3,000
Recovery of an Account Receivable Previously
Written Off
Subsequent collections require that the
original write-off entry be reversed before the
cash collection is recorded.
GENERAL JOURNAL
Date
Account Titles and Explanation
Feb 27 Accounts Receivable (Brad Wilson)
Debit
500
Allowance for Doubtful Accounts
27 Cash
Accounts Receivable (Brad Wilson)
Credit
500
500
500
Direct Write-Off Method
This method makes no attempt to
match revenues with the expense of
uncollectible accounts.
GENERAL JOURNAL
Date
Account Titles and Explanation
Feb 16 Uncollectible Accounts Expense
Accounts Receivable (Bell Products)
Debit
Credit
250
250
Management of
Accounts Receivable
Extending credit encourages customers to
buy from us but it ties up resources in
accounts receivable.
Factoring
Accounts
Receivable
Credit Card
Sales
Notes Receivable and Interest Revenue
A promissory note is an unconditional
promise in writing to pay on demand or at
a future date a definite sum of money.
Maker—the person who
signs the note and
thereby promises to pay.
Payee—the person to
whom payment is to be
made.
Notes Receivable
and Interest Revenue
The interest formula includes three
variables:
Interest = Principal × Interest Rate × Time
When computing interest for one year, “Time”
equals 1. When the computation period is less
than one year, then “Time” is a fraction.
For example, if we needed to compute interest for
3 months, “Time” would be 3/12.
Notes Receivable
and Interest Revenue
On December 1, a three-month, 6 percent note
receivable is acquired from a customer, Marvin White, in
settlement of an existing account
receivable of $60,000. What adjusting entry needs to be
made on Dec. 31 to accrue the interest earned to date on
notes receivable?
Date
Description
Dec. 31 Interest Receivable
Interest Revenue
Debit
Credit
300
$60,0006% 1/12 = $300
300
Notes Receivable
and Interest Revenue
What entry would Valley Ranch Supply
make on March 1, the maturity date?
$60,0006% 2/12 = $600
Date
Description
Mar. 1 Cash
Interest Receivable
Interest Revenue
Notes Receivable
Debit
Credit
60,900
300
600
60,000
Financial Analysis
and Decision Making
Accounts Receivable Turnover Rate
This ratio provides useful information for
evaluating how efficient management has
been in granting credit to produce
revenue.
Net Sales
Average Accounts Receivable
Financial Analysis
and Decision Making
Avg. Number of Days to Collect A/R
This ratio helps judge the liquidity of a
company’s accounts receivable.
Days in Year
Accounts Receivable Turnover Ratio
Plant Assets as
a “Stream of Future Services”
Plant assets represent a bundle of future
services, and can be thought of as long-term
prepaid expenses.
D a te
The cost of plant assets is the
advance purchase of services.
D e scrip tio n
D e b it
C re d it
As years pass, and the
services are used, the cost is
transferred to depreciation
expense.
Major Categories of Plant Assets
T a n g ib le P la n t
In ta n g ib le
N a tu ra l
Asse ts
Asse ts
R e so u rc e s
L on g -term
assets h avin g
p h ysical su b stan ce.
N on cu rren t assets
with n o p h ysical
su b stan ce.
S ites acq u ired for
extractin g valu ab le
resou rces.
L an d , b u ild in g s,
eq u ip m en t,
fu rn itu re, fixtu res.
P aten ts, cop yrig h ts,
trad em arks,
fran ch ises, g ood will.
O il reserves,
tim b er, oth er
m in erals.
Accountable Events in the
Lives of Plant Assets
1. Acquisition.
2. Allocation of the acquisition
cost to expense over the
asset’s useful life
(depreciation).
3. Sale or disposal.
Acquisition of Plant Assets
Cost
=
Asset price
+
Reasonable and
necessary costs . . .
. . . for getting
the asset to the
desired location.
. . . for getting
the asset ready
for use.
Special Considerations
Land
Land
Improvements
Cost includes real estate
commissions, escrow fees,
legal fees, clearing and
grading the property.
Improvements to land such as
driveways, fences, and
landscaping are recorded
separately.
Special Considerations
Buildings
Costs incurred for remodeling
prior to the building being put
in use are considered part of
the building’s cost.
Equipment
Related interest, insurance,
and property taxes are
treated as expenses of the
current period.
Special Considerations
Allocation of a Lump-Sum Purchase
The total cost
must be
allocated to
separate
accounts for
each asset.
The allocation is
based on the
relative Fair
Market Value of
each asset
purchased.
Capital Expenditures and Revenue
Expenditures
Capital
Expenditure
Revenue
Expenditure
Any material expenditure
that will benefit several
accounting periods.
Expenditure for
ordinary repairs
and maintenance.
To capitalize an expenditure
means to charge it to an
asset account.
To expense an expenditure
means to charge it to an
expense account.
Depreciation
The allocation of the cost of a plant asset to
expense in the periods in which services are
received from the asset.
Balance Sheet
Purchase
cost as
assets
purchased
Assets:
Plant and
equipment
Income Statement
Revenues:
Expenses:
Depreciation
as the services are
received
Depreciation
Book Value
Cost – Accumulated Depreciation
Depreciation
 Contra-asset
 Represents the portion of an asset’s cost
that has already been allocated to expense.
Causes of Depreciation
 Physical deterioration
 Obsolescence
Straight-Line Depreciation
Depreciation
=
Expense per Year
Cost - Residual Value
Years of Useful Life
Straight-Line Depreciation
On January 2, S&G Wholesale Grocery buys a new
delivery truck. The truck cost $17,000, has an
estimated residual value of $2,000, and an estimated
useful life of 5 years.
Compute annual depreciation using the straight-line
method.
Cost – Residual Value
Years of Useful Life
$ 17,000 – $ 2,000
=
5
= $
3,000 per year
Straight-Line Depreciation
S&G will record $3,000 depreciation each year for five
years. Total depreciation over the estimated useful life of
the equipment is:
Year
First
Second
Third
Fourth
Fifth
Depreciation
Expense
(debit)
$
$
3,000
3,000
3,000
3,000
3,000
15,000
Accumulated
Depreciation
(credit)
$
$
3,000
3,000
3,000
3,000
3,000
15,000
Accumulated
Depreciation
Balance
$
3,000
6,000
9,000
12,000
15,000
Salvage Value
Undepreciated
Balance
(book value)
$
17,000
14,000
11,000
8,000
5,000
2,000
Depreciation for Fractional Periods
When an asset is acquired during the year,
depreciation in the year of acquisition must be
prorated.
Half-Year Convention
In the year of acquisition,
record six months of
depreciation.
½
Half-Year Convention
• Using the half-year convention, assume that an
insurance company purchases hundreds of
desktop computers throughout the current year
at a total cost of $600,000. The company
depreciates these computers by the straight-line
method, assuming a five-year life and no residual
value.
Depreciation = ($600,000 - $0) ÷ 5
= $120,000 for a full year
Depreciation =
$120,000 × 1/2 = $60,000
Declining-Balance Method
Depreciation in the early years of an asset’s estimated
useful life is higher than in later years.
Accelerated
Depreciation
Remaining
=
× Depreciation
Expense
Book Value
Rate
The double-declining balance depreciation rate is
200% of the straight-line depreciation rate of
(1÷Useful Life).
Declining-Balance Method
On January 2nd , S&G buys a new delivery truck
paying $17,000 cash. The truck has an estimated
residual value of $2,000 and an estimated useful
life of 5 years.
Compute depreciation for the first year using the
double-declining balance method.
First Year
Expense
=
Remaining
Book Value
= $
= $
= $
×
17,000 ×
17,000 ×
6,800
Accelerated
Depreciation Rate
2 × 1/5
40%
Declining-Balance Method
Total depreciation over the estimated useful
life of an asset is the same using either the
straight-line method or the decliningbalance method.
Year
Computation
First
$ 17,000 × 40%
Second
10,200 × 40%
Third
6,120 × 40%
Fourth
3,672 × 40%
Fifth
Plug year # 5
Total Depreciation
Depr.
Expense
$ 6,800
4,080
2,448
1,469
203
$ 15,000
Accumulated
Depreciation
$
6,800
10,880
13,328
14,797
15,000
Book
Value
$ 10,200
6,120
3,672
2,203
2,000
Financial Statement Disclosures
Estimates of Useful Life and Residual Value
• May differ from company to company.
• The reasonableness of management’s
estimates is evaluated by external
auditors.
Principle of Consistency
• Companies should avoid switching
depreciation methods from period to
period.
Revising Depreciation Rates
Predicted
salvage value
Predicted
useful life
So depreciation
is an estimate.
Over the life of an asset, new information
may come to light that indicates the
original estimates need to be revised.
Revising Depreciation Rates
• Assume that a company acquires a $10,000
asset estimated to have a five-year useful life
and no residual value. At the beginning of the
fourth year, management decides that the asset
will last for five more years. The revised
estimate of useful life is, therefore, a total of
eight years. Calculate depreciation expense
for the fourth year and for each of the
remaining years.
Revising Depreciation Rates
When our estimates change,
depreciation is:
Book value at
date of change
–
Salvage value at
date of change
Remaining useful life at date of change
Asset cost
Accumulated depreciation
($2,000 per year × 3 years)
Remaining book value
Divide by remaining life
Revised annual depreciation
$ 10,000
$
$
6,000
4,000
÷5
800
Impairment of Plant Assets
If the cost of an asset
cannot be recovered
through future use or
sale, the asset should
be written down to its
net realizable value.
Disposal of Plant and Equipment
Update depreciation
to the date of disposal.
Journalize disposal by:
Recording cash
received (debit).
Removing accumulated
depreciation (debit).
Recording a
gain (credit)
or loss (debit).
Removing the
asset cost (credit).
Disposal of Plant and Equipment
If Cash > BV, record a gain (credit).
If Cash < BV, record a loss (debit).
If Cash = BV, no gain or loss.
Recording cash
received (debit).
Removing accumulated
depreciation (debit).
Recording a
gain (credit)
or loss (debit).
Removing the
asset cost (credit).
Disposal of Plant and Equipment
Assume that a machine costing $10,000, had
accumulated depreciation of $8,000 and book
value of $2,000 (10,000 - $8,000) at the time it
was sold for $3,000 cash.
Determine the gain or loss on sale of this
machine.
Cost of machine
Accumulated depreciation
Book value at time of sale
Cash received
Gain on sale of machine
$ 10,000
(8,000)
2,000
3,000
$ 1,000
Disposal of Plant and Equipment
Assume that a machine costing $10,000, had
accumulated depreciation of $8,000 and book
value of $2,000 (10,000 - $8,000) at the time it
was sold for $3,000 cash.
Determine the gain or loss on sale of this
machine.
Description
Cash
Accumulated Depreciation: Machinery
Machinery
Gain on Disposal of Plant Asset
Debit
Credit
3,000
8,000
10,000
1,000
Trading in Used Assets
for New Ones
Assume that Rancho Landscape exchanges an
old truck for a new truck costing $25,000. They
received $3,500
trade-in allowance on the old truck, which
had a book value of $2,000. Rancho pays the
remaining $21,500 cost of the new truck in
cash.
Trading in Used Assets
for New Ones
Cost of old truck
Accumulated derpreciation: Vehicles
Book value of old truck
Fair market value of old truck
Gain on disposal of old truck
Description
Vehicles (New truck)
Accumulated depreciation: Vehicles (old truck)
Vehicles (Old truck)
Cash
Gain on Disposal of Asset
$ 10,000
8,000
$ 2,000
3,500
$ 1,500
Debit
Credit
25,000
8,000
10,000
21,500
1,500
International Financial Reporting Standards
Under international accounting standards,
companies have an option to follow a revaluation
process rather than continuing to use historical
cost throughout the asset’s useful life.
This revaluation alternative requires that an
asset’s fair value can be reliably measured and it
must be applied to an entire class of plant assets.
If an asset’s carrying amount is increased as a
result of a revaluation, the increase is recorded in
other comprehensive income and accumulated
equity.
Intangible Assets
Noncurrent assets
without physical
substance.
Often provide
exclusive rights
or privileges.
Characteristics
Useful life is
often difficult
to determine.
Usually acquired
for operational
use.
Intangible Assets
Record at
current cash
equivalent cost,
including
purchase price,
legal fees, and
filing fees.
•
•
•
•
Patents
Copyrights
Leaseholds
Leasehold
Improvements
• Goodwill
• Trademarks and
Trade Names
Amortization
• Amortization is the systematic write-off to
expense of the cost of intangible assets over
their useful life or legal life, whichever is
shorter.
• Use the straight-line method to amortize
most intangible assets.
Date
Description
Amortization Expense
Intangible Asset
Debit
Credit
$$$$$
$$$$$
Goodwill
Occurs when one
company buys
another company.
Only purchased
goodwill is an
intangible asset.
The amount by which the
purchase price exceeds the fair
market value of net assets acquired.
Goodwill is NOT amortized. It is tested
annually to determine if there has been an
impairment loss.
Patents
Exclusive right granted
by federal government to sell or
manufacture an invention.
Cost is purchase
price plus legal
cost to defend.
Amortize cost
over the shorter of
useful life or 20 years.
Trademarks and Trade Names
A symbol, design, or logo
associated with a business.
Internally
developed
trademarks
have no
recorded
asset cost.
Purchased
trademarks
are recorded
at cost, and
amortized over
shorter of legal
or economic life.
Franchises
Legally protected right to sell products or
provide services purchased by franchisee
from franchisor.
Purchase price is intangible asset which is
amortized over the shorter of the
protected right or useful life.
Copyrights
Exclusive right granted by the federal
government to protect artistic or
intellectual properties.
Legal life is
life of creator
plus 70 years.
Amortize cost
over period
benefited.
Research and Development Costs
All expenditures classified as research and
development should be charged to expense
when incurred.
All of these R&D costs
will really reduce our net
income this year!
Natural Resources
Total cost,
including
exploration and
development,
is charged to
depletion expense
over periods
benefited.
Extracted from
the natural
environment
and reported
at cost less
accumulated
depletion.
Examples: oil, coal, gold
Depletion of Natural Resources
Depletion is calculated using the
units-of-production method.
Unit depletion rate is calculated as follows:
Cost – Residual Value
Total Units of Natural
Resource
Plant Transactions and the
Statement of Cash Flows
Cash payments for plant assets represent a cash
outflow for investing activities on the statement of
cash flows. A disposal of a plant asset for cash
results in a cash inflow to the company.
Depreciation is a noncash charge to income
and has no effect on
cash flows.
How much should be invested in assets?
• Too few assets may result in lost sales and
profits
– Too few factories or insufficient equipment to
meet demand
• Too many assets are expensive to maintain &
finance
– Upkeep and repairs on buildings and equipment
– Interest on borrowings used to acquire assets
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Asset Ratios
• Return on Assets (ROA)
– How much profit is generated by long-term
assets
• Fixed Asset Turnover
– How productive are long-term assets in
generating sales
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88
Return on Assets (ROA)
• Usually computed
for an annual period
• Average total assets
is
Beginning Balance + Ending Balance
2
• Result described as
“percent”
7/21/2015
Net Income
Average Total
Assets
Return on Assets
89
Fixed Asset Turnover
• Usually computed for
an annual period
Sales
• Average fixed assets is
Beginning Balance + Ending Balance
2
• Result described as
number of “times per
year”
7/21/2015
Average Fixed
Assets
Fixed Asset
Turnover
90
The Nature of Liabilities
Defined as debts or obligations arising from
past transactions or events.
Maturity = 1 year or less
Maturity > 1 year
Current
Liabilities
Noncurrent
Liabilities
Distinction Between Debt and Equity
The acquisition of assets is financed
from two sources:
DEBT
Funds from creditors, with
a definite due date, and
sometimes bearing
interest.
EQUITY
Funds from
owners.
Estimated Liabilities
Estimated liabilities have two basic
characteristics:
1. The liability is known to exist,
2. The precise dollar amount cannot be
determined until a later date.
Example: An automobile
warranty obligation.
Current Liabilities: Accounts Payable
Short-term obligations to suppliers for
purchases of merchandise and to others for
goods and services.
Merchandise
inventory
invoices
Office
supplies
invoices
Examples
Shipping
charges
Utility and
phone bills
Current Liabilities: Notes Payable
When a company borrows money, a note payable is
created.
Current Portion of Notes Payable
The portion of a note payable that is due within one
year, or one operating cycle, whichever is longer.
Current Notes Payable
Total Notes
Payable
Noncurrent Notes Payable
Current Liabilities: Notes Payable
Accrued Liabilities
Accrued liabilities arise from the recognition of
expenses for which payment will be made in the
future. Accrued liabilities are often referred to as
accrued expenses.
Examples include:
1. Interest payable,
2. Income taxes payable, and
3. Accrued payroll liabilities.
Payroll Liabilities
Gross Pay
Net Pay
Less Deductions:
Social
Security and
Medicare
Workman’s
Compensation
Federal
Income Tax
State and Local
Income Taxes
Voluntary
Deductions
Unearned Revenue
Cash is sometimes collected from the customer
before the revenue is actually earned.
As the earnings
process is
completed
Cash is
received in
advance.
Deferred
revenue is
recorded.
a liability account.
Earned
revenue is
recorded.
Long-Term Liabilities
Relatively small debt needs can
be filled from single sources.
Banks
or
Insurance Companies
or
Pension Plans
Long-Term Liabilities
Large debt needs are often filled by
issuing bonds.
Maturing Obligations Intended to be
Refinanced
One special type of long-term liability is an
obligation that will mature in the current period
but that is expected to be refinanced on a longterm basis.
If management has both the intend and ability
to refinance soon-to-mature obligations on a
long-term basis, these obligations are
classified as long-term liabilities.
Installment Notes Payable
Long-term notes that call for a series of
installment payments.
Each payment covers
interest for the period
AND a portion of the
principal.
With each payment, the
interest portion gets smaller
and the principal portion gets
larger.
Allocating Installment Payments Between
Interest and Principal
1. Identify the unpaid principal balance.
2. Interest expense = Unpaid Principal × Interest
rate.
3. Reduction in unpaid principal balance =
Installment payment – Interest expense.
4. Compute new unpaid principal balance.
On October 15, Year 1, King’s Inn purchases furnishings
at a cost of $16,398. The loan was an 18-month loan
and had an interest rate of 12%. The monthly payment
is $1,000,beginning November 15th.
Let’s prepare an amortization table for King’s Inn.
Preparing an Amortization Table
Using the Amortization Table
The information needed for the journal entry can be
found on the amortization table. The cash payment
amount, the interest expense, and the principal
reduction amount are all in the table.
Date
Description
Nov. 15 Interest Expense
Installment Note Payable
Cash
Debit
164
836
Credit
1,000
Using the Amortization Table
If December 31, Year 1, is the end of the King’s Inn’s
financial reporting period, the company must make an
adjusting entry to record one-half month’s accrued
interest on this liability. The amount of this adjusting entry
is based on the unpaid balance shown in the amortization
table as of the last payment (December 15).
Date
Description
Dec. 31 Interest Expense
Interest Payable
($14,718 x 1% x ½ = $74
Debit
Credit
74
74
Bonds Payable
• Bonds usually involve the
borrowing of a large sum of
money, called principal.
• The principal is usually paid
back as a lump sum at the end
of the bond period.
• Individual bonds are often
denominated with a par value,
or face value, of $1,000.
Bonds Payable
• Bonds usually carry a stated rate of interest,
also called a contract rate.
• Interest is normally paid semiannually.
• Interest is computed as:
Principal × Stated Rate × Time = Interest
Bonds Payable
• Bonds are issued through an intermediary
called an underwriter.
• Bonds can be sold on organized securities
exchanges.
• Bond prices are usually quoted as a
percentage of the face amount.
For example, a $1,000 bond priced
at 102 would sell for $1,020.
Types of Bonds
Mortgage
Bonds
Debenture
Bonds
Convertible
Bonds
Junk
Bonds
Accounting for Bonds Payable
On March 1, 2015, Wells Corporation issues
$1,000,000 of 6%, 20-year bonds payable, dated
March 1. Interest is payable semiannually, each
March 1 and September 1.
Assume the bonds are issued at face value.
Record the issuance of the bonds.
Date
Description
Mar. 1 Cash
Bonds Payable
Debit
Credit
1,000,000
1,000,000
Accounting for Bonds Payable
Record the interest payment on September 1, 2015.
Date
Description
Sep. 1 Bond Interest Expense
Cash
$1,000,000 × 6% × ½ = $30,000
Debit
Credit
30,000
30,000
Bond Interest Adjusting Entry at Year-End
Record the interest payment on December 31, 2015.
Date
Description
Sep. 1 Bond Interest Expense
Bond Interest Payable
$1,000,000 × 6% × 4/12 = $20,000
Debit
Credit
20,000
20,000
Interest Payment after
Year-End Adjustment
Record the interest payment on March 1, 2016.
Date
Description
Mar. 1 Bond Interest Expense
Bond Interest Payable
Cash
$1,000,000 × 6% × 2/12 = $10,000
Debit
Credit
10,000
20,000
30,000
Bonds Issued Between Interest Dates
•
•
Bonds are often sold between interest dates.
The selling price of the bond is computed as:
Present value of the bond
+ Accrued interest since the
last interest payment
= Selling price of the bond
Example: Bonds Issued Between Interest Dates
Assume Wells Corporation issues $1 million of 6 percent
bonds at par value on May 1 —two months after the
March interest date printed on the bonds. The amount
received from the bond purchasers now will include two
months’ accrued interest
Date
Description
May 1 Cash
Bonds Payable
Bond Interest Payable
Debit
Credit
1,010,000
$1,000,000 × 6% × 2/12 = $10,000
1,000,000
10,000
Example: Bonds Issued Between Interest Dates
Four months later on the regular September 1 semiannual
interest payment date, a full six months’ interest ($60 per
$1,000 bond) will be paid to all bondholders, regardless of
when they purchased their bonds. Here is the entry for
the semiannual interest payment:
Date
Description
May 1 Bond Interest Payable
Bond Interest Expense
Cash
Debit
Credit
10,000
20,000
30,000
Bonds Issued at a Discount or a Premium
The selling price of the bond is
determined by the market based
on the time value of money.
Stated interest rate is
Above market rate
Equal to market rate
The bonds sells:
At a premium
(Cash received is greater than face
amount)
At face amount
(Cash received is equal to face
amount)
At a discount
Below market rate
(Cash received is less than face
amount)
Bonds Issued at a Discount
Wells, Corp. issues bonds on March 1, 2015.
Principal = $1,000,000
Issue price = $970,000
Stated Interest Rate = 6%
Interest Dates = 9/1 and 3/1
Maturity Date = Mar. 1, 2035 (20 years)
Principal
$1,000,000
Cash
Proceeds
- $ 970,000
Discount
= $ 30,000
Bonds Issued at a Discount
To record the bond issue, Well, Inc. would
make the following entry on March 1, 2015:
Date
Description
Jan. 1 Cash
Discount on Bonds Payable
Bonds Payable
Debit
Credit
970,000
30,000
1,000,000
Bonds Issued at a Discount
Partial Balance Sheet as of March 1, 2015
Long-term Liabilities:
Bonds Payable
Less: Discount on Bonds Payable
$ 1,000,000
30,000
$ 970,000
Maturity Value
Carrying Value
Bonds Issued at a Discount
Amortizing the discount over the term of the
bond increases Interest Expense each
interest payment period.
Using the straight-line method, the
discount amortization will be $750
every six months.
$30,000 ÷ 40 periods = $750
Amortization of the Discount
Interest paid every six months is calculated as follows:
$1,000,000 × 6% × ½ = $30,000
We prepare the following journal entry to record
the first interest payment.
Date
Description
Sep. 1 Bond Interest Expense
Discount on Bonds Payable
Cash
Debit
Credit
30,750
750
30,000
Bonds Issued at a Discount
Wells Corporation will repay the principal amount
on March 1, 2035 with the following entry:
Date
Description
Mar. 1 Bonds Payable
Cash
Debit
Credit
1,000,000
1,000,000
The Concept of Present Value
How much is a future amount
worth today?
Present
Value
Today
Interest compounding periods
Future
Value
Bonds Issued at a Premium
When bonds are issued at a premium, the borrower
repays less than the amount originally received at the
date of issuance. The premium represents a
reduction in the overall cost of borrowing. Unlike
bonds issued at a discount, the interest expense
associated with bonds issued at a premium will be
less than the semiannual cash payment made to
bondholders.
Principal
$ 1,000,000
Cash
Proceeds
- $
1,030,000 =
Premium
$ (30,000)
The Concept of Present Value
Two types of cash flows are involved
with bonds:
 Periodic interest payments called annuities.
Today
Maturity
 Principal payment
at maturity is a lump
sum payment.
Early Retirement of Debt
Gains or losses incurred as a result of
retiring bonds should be reported as other
income or other expense on the income
statement.
Loss Contingencies
An existing uncertain situation involving
potential loss depending on whether some
future event occurs.
Two factors affect whether a loss contingency
must be accrued and reported as a liability:
1. The likelihood that the confirming event
resulting in the loss will occur.
2. Whether the loss amount can be
reasonably estimated.
Evaluating the Safety of Creditors’ Claims
Interest
Coverage
Ratio
=
Operating Income
Interest Expense
This ratio indicates a margin of
protection for creditors. From the
creditor’s point of view, the higher this
ratio, the better.
How Much Debt should a Business Have?
• The answer hinges on the effective use of
leverage. Using borrowed money to
finance business operations is called
applying leverage .The more leverage a
company applies, the greater the effects
on net income and the return on equity.
Summarizing the effects of leverage:
Ethics, Fraud & Governance Related to Debt
 The most infamous financial fraud in U.S. history
occurred at Enron and was revealed in the fall of
2001.
 A major part of the Enron fraud involved the
understatement of debt.
 Enron understated its debt by at least $550
million each year from 1997 to 2000.
WHY?
 Enron’s management was motivated to
understate debt in order to maintain a high credit
rating from Moody’s and Standard & Poor’s.
Special Types of Liabilities
Special types of liabilities common to most
large organizations:
1. Leases - contracts where the lessor (owner of the property) gives
the lessee (the renter) the right to use an asset for a specified period
of time in exchange for periodic rental payments.
2. Postretirement Benefits – an obligation of the employer for
benefits that employees earn the right to receive while they are
working for that employer.
3. Deferred Taxes – The portion of income taxes expense that is
deferred to future tax returns as a result of timing differences
between accounting principles and tax rules.
The End
Further Discussion & Exercises:
Types of Sales
Cash
7/21/2015
Credit
card
Debit
card
On
account
137
Cash Sales
• Most desirable as cash is received
immediately
• No need to keep records of individual
customers
• May limit sales potential by not providing
option to pay later
7/21/2015
138
Credit Card Sales
• Can be issued by:
– A bank (VISA and MasterCard)
– A credit card company (Discover and American Express)
• Benefits:
– Allows customer to buy now and pay later
– Guarantees collection for retailers
– Facilitates online and phone sales
• Drawback:
– Retailers pay service fee
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139
Debit Card Sales
• From retailer’s perspective:
– Nearly identical to credit card benefits and
drawbacks
• From customer’s perspective:
– Nearly identical to cash payment
– Payment is made directly from checking
account
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140
Credit / Debit Card Processing
• Third party processor charges a fee to
retailer
• Fee payment can be:
– Deducted from proceeds at time of sale
– Deducted from retailer’s bank account
monthly
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141
Sales on Account
• Sales increase
– Risk of not collecting amount due increases
• Business must manage customer
relationships to avoid bad debts
7/21/2015
142
Internal Controls over Cash Receipts
• Cash is easy to steal
• All transactions ultimately affect cash
• Cash receipts should be deposited quickly
• Companies can receive cash:
– Over the counter
– Through the mail
7/21/2015
143
Cash Receipts over the Counter
• Cash registers provide control over cash
receipts
• Customer receives receipt as proof of
purchase
• Sales per terminal reconciled to cash in
drawer
– Combined with other cash and deposited
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144
Cash Receipts by Mail
Checks
Remittance
Advices
Treasurer
Accounting Dept.
Prepare
Bank
Deposit
Journal
Debit to
Cash
Bank
7/21/2015
Mailroom
Controller
145
Internal Control Over Check Payments
• Payment by check is an internal control
– Provides record of the payment
– Evidence to support payment should be
reviewed
– Must be signed by an authorized official
7/21/2015
146
Internal Controls Over Check Payments
Purchasing Agent
Prepare
Purchase
Order
Company A
Receiving
Report
Purchase
Order
Shipping Dock
7/21/2015
Supplier X
Prepare
Receiving
Report
Invoice
Treasurer
Approve
Payment
Goods
Check
147
The Bank Reconciliation
• Important internal control
• Explains difference between:
– Cash balance according to the bank
statement
and
– Cash balance according to the company’s
records
7/21/2015
148
Bank Reconciliation Format
BANK
BOOKS
Balance per bank statement
Ending balance in ledger
Add:
Add:
Deposits in transit
Bank collections
Bank errors
Electronic fund transfers
Interest revenue and Book errors
Less:
Less:
Outstanding checks
Electronic fund transfers
Bank errors
NSF checks
Service charges and Book errors
= Adjusted bank balance
7/21/2015
= Adjusted book balance
149
Bank Reconciliation Entries
(1 of 2)
GENERAL JOURNAL
DATE
ACCOUNTS
POST REF.
DEBIT
CREDIT
Cash
Notes Receivable
Interest Revenue
Record note and interest collected by bank
Cash
Accounts Receivable
Record EFT of customer payment
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150
Bank Reconciliation Entries
(2 of 2)
GENERAL JOURNAL
DATE
ACCOUNTS
POST REF.
DEBIT
CREDIT
Miscellaneous Expense
Cash
Record bank service charges
Accounts Receivable
Cash
Record NSF check returned by bank
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151
Bank Reconciliation Format
BANK
BOOKS
Balance, January 31
$1,030 Balance, January 31
Add:
Add:
Deposits in transit
660
Bank collection
505
Interest revenue
25
(a) 1,690
(a)
Less:
Outstanding checks
Adjusted cash
bankbalance
balance
7/21/2015
(c) $ 830
(c)
(d) 1,360
(d)
Less:
(b)
400
(b)
Service charges
$1,290 Adjusted cash
bookbalance
balance
70
$1,290
152
Cash and Cash Equivalents
• Cash includes:
–
–
–
–
–
–
–
Coins
Currency
Checks on hand
Petty Cash
Checking accounts
Money orders
Traveler’s checks
• Cash equivalents are liquid short-term investments that
include:
–
–
–
–
7/21/2015
Time deposits
Money market accounts
Certificates of deposit (CDs)
U.S. Treasury bills and notes
153
Types of Receivables
Accounts
Receivable
7/21/2015
Notes
Receivable
Loans to
Employees
Interest
Receivable
154
Internal Control over
Accounts Receivable
• Balance of extending credit
– Avoid uncollectible receivables
– Grant credit to generate sales
• Separation of duties
– Granting credit
– Receiving cash
– Recording accounts receivable transactions
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155
Accounting for
Uncollectible Receivables
7/21/2015
156
Uncollectible Receivables Methods
Direct
Write-off
7/21/2015
Allowance
157
Direct Write-Off Method
• Customer account written off as expense
GENERAL
JOURNAL
when determined
uncollectible
DATE
ACCOUNTS
Mar. 5
Bad Debt Expense
Accounts Receivable – Bill Johnson
POST REF.
DEBIT
CREDIT
400
400
Wrote off Bill Johnson’s account
7/21/2015
158
Direct Write-Off Method vs. GAAP
• Not allowed by GAAP
– Violates matching principle
• Used by:
– Small non-public companies not required to
follow GAAP
or
– Companies that have low amounts of bad debt
expense
- as determined by applying the materiality
principle
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159
Direct Write-Off Method:
Recovery of Accounts Written Off
GENERAL JOURNAL
DATE
ACCOUNTS
Aug.10 Accounts Receivable – Bill Johnson
POST REF.
DEBIT
CREDIT
250
Bad Debt Expense
250
Reinstate Bill Johnson’s account
Aug.10 Cash
Accounts Receivable – Bill Johnson
250
250
Collected cash on account
7/21/2015
160
Allowance Method
• Records a debit for an estimated bad
debt expense in same period as revenue
– Matching principle
– Required by GAAP
• Records a credit to a contra-account called
Allowance for Uncollectible Accounts
– Contra-account tied to Accounts Receivable
– Reduces net realizable value of Accounts
Receivable
7/21/2015
161
Estimating Uncollectible Accounts
• Considerations:
– Past bad debt experience
– State of the economy
– Industry
• Two methods:
– Percent of sales
– Aging
7/21/2015
162
Percent of Sales Method
• Income Statement
approach
• Bad Debt Expense
estimated by this
calculation is the
adjusting entry
amount
7/21/2015
Net Credit Sales
Historical % of
Uncollected Credit
Sales
Bad Debt Expense
163
Aging Method
• Balance Sheet approach
• Aging of Accounts Receivable Schedule considers:
– List of individual customer balances and how long balance
has been outstanding
– Estimated uncollectible accounts based on age category
• Allowance for Uncollectible Accounts
– Ending balance after adjusting entry recorded should
equal total estimated uncollectible accounts on aging
schedule
– Adjusting entry is amount needed to reach that ending
balance
7/21/2015
164
Aging Method Illustrated
Accounts Receivable Aging Schedule
AGE
CATEGORY
BALANCE
ESTIMATE
PERCENT
UNCOLLECTIBLE
Current
ESTIMATED
UNCOLLECTIBLE
AMOUNT
$26,850
2%
$537
2,800
5%
140
31-60
475
20%
95
61-90
325
40%
130
1,250
50%
625
>180
300
80%
240
Total
$32,000
1-30
91-180
7/21/2015
Allowance for
Uncollectible Accounts
Begin. Balance
450
Adjusting Entry
1,317
?
End. Balance
1,767
$1,767
165
Writing Off Uncollectible Accounts under
the Allowance Method
• Customer account written off to contraaccount when determined uncollectible
GENERAL JOURNAL
DATE
ACCOUNTS
Mar. 5
Allowance for Uncollectible Accounts
Accounts Receivable – Bill Johnson
POST REF.
DEBIT
CREDIT
400
400
Wrote off Bill Johnson’s account
7/21/2015
166
Allowance Method: Recovery of Accounts
Written Off
GENERAL JOURNAL
DATE
ACCOUNTS
Aug.10 Accounts Receivable – Bill Johnson
POST REF.
DEBIT
CREDIT
250
Allowance for Uncollectible Accounts
250
Reinstate Bill Johnson’s account
Aug.10 Cash
Accounts Receivable – Bill Johnson
250
250
Collected cash on account
7/21/2015
167
Age of Accounts
1-30 Days
Accounts Receivable
31-60 Days 61-90 Days
Over 90
Days
$120,000
$75,000
$65,000
$10,000
Est. Percentage Uncollectible
0.4%
2.0%
10.0%
45.0%
Est. Uncollectible Amount
$480
$1,500
$6,500
$4,500
$12,980
7/21/2015
168
Allowance for
Uncollectible Accounts
Begin.Balance
Balance
Initial
4,100
Adjusting Entry
?
8,880
End. Balance
Ending
Balance
12,980
Total estimate from Aging Schedule
GENERAL JOURNAL
DATE
ACCOUNTS
Jan.31
Bad Debt Expense
Allowance for Uncollectible Accounts
POST REF.
DEBIT
CREDIT
8,880
8,880
To record estimated bad debts
7/21/2015
169
Allowance for
Uncollectible Accounts
Initial Balance
900
Adjusting Entry
13,880
?
Ending Balance
12,980
GENERAL JOURNAL
DATE
ACCOUNTS
Jan.31
Bad Debt Expense
Allowance for Uncollectible Accounts
POST REF.
DEBIT
CREDIT
13,880
13,880
To record estimated bad debts
7/21/2015
170
Net Realizable Value
Allied Enterprises
Balance Sheet (partial)
Month Ended December 31, 2012
Accounts Receivable
$32,000
Less: Allowance for Uncollectible Accounts
Accounts Receivable, Net
1,767
$30,233
Allied Enterprises
Balance Sheet (partial)
Month Ended December 31, 2012
Accounts Receivable, Net of Allowance for Uncollectible Accounts of $1,767
7/21/2015
$30,233
171
Notes Receivable
Principal
Date Interest Starts
PROMISSORY NOTE
$1,000.00
Amount
March 31, 2012
Date
For value received, I promise to pay to the order of
Payee (Creditor)
Allied Enterprises
Omaha, Nebraska
One thousand and no/100s-----------------------------------On March 31, 2013
plus interest at the annual rate of 10 percent
Dollars
Maturity Date
Bill Anderson
Interest Rate
Maker (Debtor)
7/21/2015
172
Origination of Notes Receivable
Lending
Money
7/21/2015
Providing
Goods
or
Services
Payment
on
accounts
receivable
173
Computing Interest
Amount
of
Interest
7/21/2015
Principal
Interest
Rate
Time
174
Accruing Interest Revenue
GENERAL JOURNAL
DATE
ACCOUNTS
POST REF.
Dec.31 Interest Receivable
DEBIT
CREDIT
75
Interest Revenue
75
To accrue interest revenue
DATE
ACCOUNTS
Mar.31 Cash (Maturity Value)
Note Receivable – Bill Anderson
POST REF.
DEBIT
CREDIT
1,100
1,000
Interest Receivable
75
Interest Revenue
25
Record repayment of note at maturity
7/21/2015
175
Liquidity Management
• How a business manages its cash so it can
pay its bills
• Two ratios
– Current ratio
– Quick ratio
7/21/2015
176
Current Ratio
• Ratio of current assets to current liabilities
– Assets convertible into cash within the next year
– Bills due to be paid within the next year
Current Assets
(cash, short-term investments, accounts receivable, inventory)
Current Liabilities
(accounts payable, accrued liabilities, other debts due within a year)
7/21/2015
177
Quick Ratio
• Ratio of quick assets to current liabilities
– Assets easily convertible into cash in the near
future
– Bills due to be paid within the next year
Quick Assets
(cash, short-term investments, accounts receivable)
Current Liabilities
(accounts payable, accrued liabilities, other debts due within a year)
7/21/2015
178
Receivables Management
• Accounts receivable turnover
– The ability to collect cash from credit
customers
• Receivable collection period
– How many days it takes to convert accounts
receivable
into cash
7/21/2015
179
Accounts Receivable Turnover
Sales
7/21/2015
180
Receivable Collection Period
7/21/2015
181
Petty Cash
• Small amount of cash used to pay for
minor expenditures
• Controls needed:
–
–
–
–
7/21/2015
Designate a custodian responsible for fund
Establish fixed amount of fund
Keep in safe locked location
Support payments with documentation
182
Setting Up the Petty Cash Fund
• Write check for designated amount
GENERAL JOURNAL
DATE
ACCOUNTS
Jun. 1
Petty Cash
Cash
POST REF.
DEBIT
CREDIT
200
200
Establish the petty cash fund
7/21/2015
183
Petty Cash Documentation
• Use standardized
form, such as petty
cash ticket
– Describes use of
funds
Cash in fund
Total of
payment forms
• Signed by:
– The recipient of the
cash
– The custodian of the
fund
7/21/2015
Fund balance
184
Reconciling the Petty Cash Fund
Petty Cash Reconciliation
Cash on Hand
Petty Cash Tickets
Subtotal
Cash Shortage
Fund Balance
7/21/2015
$108
90
198
2
$200
185
Replenishing the Petty Cash Fund
GENERAL JOURNAL
DATE
ACCOUNTS
Jun.30
Office Supplies Expense
53
Delivery Expense
37
Cash Short
Cash
POST REF.
DEBIT
CREDIT
2
92
Replenish the petty cash fund
7/21/2015
186
Long-Term Assets
Type of Asset
Plant Assets
Depreciation
Intangible
Assets
Amortizatio
n
Natural
Resources
Depletion
Cost Allocation Terminology
7/21/2015
187
Cost Principle
Acquisition costs
Preparation costs
Cost of
Plant Asset
7/21/2015
188
Land & Land Improvements
•
•
•
•
•
•
7/21/2015
LAND
Purchase price
Commissions
Survey & legal fees
Unpaid property
taxes
Title costs
Costs of clearing land
& removing
unwanted buildings
•
•
•
•
•
LAND IMPROVEMENTS
Fencing
Paving
Sprinkler systems
Lighting
Signs
189
Buildings
•
•
•
•
•
•
7/21/2015
PURCHASED
Purchase price
Commissions
Survey & legal fees
Unpaid property
taxes
Title costs
Costs of repairing &
renovating building
for its intended use
•
•
•
•
CONSTRUCTED
Architectural fees
Building permit fees
Contractor charges
Payments for
material, labor, and
overhead
190
Machinery & Equipment
•
•
•
•
•
•
•
7/21/2015
Purchase price less discounts
Transportation
Insurance while in transit
Sales and other taxes
Purchase commissions
Installation
Testing before use
191
Furniture & Fixtures
• Includes:
–
–
–
–
–
Desks
Chairs
File cabinets
Display racks
Shelving
• All costs needed to get ready for use
– Similar to machinery & equipment
7/21/2015
192
Lump Sum Purchases
Total
Purchase
Price
Land
Allocation
based on
market values
Equipment
Building
7/21/2015
193
Depreciation
• Process of allocating a plant asset’s cost to
expense over its useful life
• Matches expense of using asset to revenue
• Assets are “used up” over time
– Use
– Physical factors
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194
Depreciation is NOT
• Process of valuation
• Cash set aside to replace an asset
7/21/2015
195
Factors in Computing Depreciation
• Cost
Cost
• Estimated useful life
– Expressed in time or in
units of output
Residual value
• Estimated residual value
– Also called salvage value
– Expected cash value at
end of useful life
7/21/2015
Depreciable cost
196
Depreciation Methods
Straightline
7/21/2015
Units-ofproduction
Decliningbalance
197
Straight-Line (SL) Method
• Allocates an
equal amount of
depreciation
to each period
Depreciable
cost
Depreciable
cost
(cost - residual value)
Estimated life
(in years)
Depreciation Expense
(per year)
7/21/2015
198
Book Value
• Accumulated
Depreciation
increases as an
asset is used up
• Book value
decreases
accordingly
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Cost
Accumulated
Depreciation
Book value
(never below residual value)
199
Units-of-Production (UOP) Method
Activity
Depreciable
cost
Depreciable
cost
(cost – residual value)
(during period)
Estimated life
Depreciation
(in units)
(per unit)
Depreciation
Depreciation
Expense
(per unit)
(for period)
which is then used to calculate…
7/21/2015
200
Double-Declining Balance (DDB) Method
• Accelerated method
– Writes off more depreciation near the start of
an asset’s life
• Residual value is not in formula
– Impacts depreciation amount during last year
of asset’s life
• Generally used for income tax purposes
7/21/2015
201
Double-Declining Balance Formula
• Since book value
declines each
year, the
depreciation
expense
diminishes each
year as well
• Book value is not
allowed to fall
below the asset’s
residual value at
the end of its life
7/21/2015
Book Value
Value
Book
(Cost – Accumulated Depreciation)
.
2
.
Estimated life
Depreciation Expense
(for period)
202
Comparing Depreciation Methods
Straight-line (SL)
• For assets that
generate
revenue evenly
over time
7/21/2015
Units-of –
production (UOP)
• For assets that
depreciate due
to usage
Double-decliningbalance (DDB)
• For assets that
produce more
revenue in their
early years
203
Partial Year Depreciation
• Half-month
convention
assigns a “full
month” for
proration
purposes if asset
is in use for at
least half its first
month
7/21/2015
Full Year’s Depreciation
Months in use
12 months
Depreciation Expense
(prorated for partial year)
204
Changing Useful Life
Remaining book value – New residual value
New estimated life – Periods already depreciated
Revised depreciation expense
7/21/2015
205
Fully Depreciated Assets
• Asset has reached the end of its estimated life
• Record no more depreciation
• If still useful, company continues to use it
• Book value reported on balance sheet
– Original cost less accumulated depreciation
• Asset never reported below residual value
7/21/2015
206
Types of Repairs
Ordinary
repairs
7/21/2015
Extraordinary
repairs
Betterments
207
Ordinary Repairs
• Maintain asset in proper working order
• Do not extend life or increase productivity
• Recorded as an expense
7/21/2015
208
Capital Expenditures
• Recorded as a debit to the asset
– Not expensed
• Two types
– Extraordinary repairs
• Extends useful life of asset
– Betterments
• Increases capacity or productivity
7/21/2015
209
Disposal of Plant Assets
• Ensure depreciation is up-to-date before
disposal
Discarded
7/21/2015
Sold
Exchanged
210
Recording Disposal of a Plant Asset
• Record “what you got”
– Cash and/or another plant asset
• Record “what you gave up”
– Remove cost of disposed asset
– Remove Accumulated Depreciation of disposed
asset
– Cash may be paid or a Note Payable signed
• Record gain or loss
7/21/2015
211
Intangible Assets
• Convey special rights to owners
– Have no physical form
• Allocating the cost of an intangible asset to
expense is called amortization
– Straight-line method
– Expense offset directly credited to asset account
(no Accumulated Amortization account)
7/21/2015
212
Specific Intangibles
(1 of 2)
Patents
Copyrights
• Exclusive 20-year
right to produce
& sell an
invention
• Exclusive right to
sell intellectual
property such as
software, books,
art, films, or musical
works
7/21/2015
213
Specific Intangibles
Trademarks and
Brand Names
• Represent
distinctive
products or
services
7/21/2015
(2 of 2)
Franchises &
Licenses
• Allows purchaser
to sell goods or
services under
specific conditions
214
Goodwill
• Only recorded when
a company
purchases another
business
Goodwill
• Excess of the cost to
• Not amortized
purchase another
– Current value
company over the
measured each year
market value of its
• If value increases, no
net assets
entry
• If value decreases, a loss
is recorded
7/21/2015
215
Research & Development (R&D) Costs
• Important to many industries,
such as pharmaceutical companies
• Not an intangible asset
– Expensed as incurred
7/21/2015
216
Natural Resources
• Assets that come from the earth
– Minerals and precious metals
– Oil, coal & natural gas
– Timber
• Allocating the cost of a natural resource to
expense is called depletion
– Similar to Units-of-Production method
– Accumulated Depletion is a contra-asset
account to the natural resource
7/21/2015
217
Depletion
Cost –
residual value
Units Removed
Estimated resource
Depletion
(in units)
(per unit)
Depletion
Depletion
Expense
(per unit)
(during period)
(for period)
which is then used to calculate…
7/21/2015
218
Other Assets
• Real estate held for resale
• Investments in marketable securities
– Equity securities (stock)
– Debt securities (bonds)
– Classified as current
or long-term assets
7/21/2015
219
Categories of Liabilities
Known
liabilities
7/21/2015
Estimated
liabilities
Contingent
liabilities
220
Classification of Liabilities
221
CURRENT
LONG-TERM
• Obligation settled
within one year
• Settlement more
than one year from
balance sheet date
7/21/2015
Current Liabilities: Known Amount
Accounts
Payable
Accrued
Expenses
(Accrued
Liabilities)
7/21/2015
Short-Term
Notes Payable
Sales Tax
Payable
Unearned
Revenues
Current
Portion of
Long-Term
Debt
222
Current Liabilities: Known Amount
ACCOUNTS PAYABLE
• Amounts owed for
products or services
purchased on
account
223
SHORT-TERM NOTES
PAYABLE
• Due within one year
• Used to borrow cash
or purchase asset
• Accrue interest
7/21/2015
Accounting for Notes Payable
GENERAL JOURNAL
DATE
ACCOUNTS
Dec. 1
Inventory
POST REF.
DEBIT
CREDIT
30,000
Notes Payable
30,000
Signed a 3-month, 9% note payable
Dec.31 Interest Expense
Interest Payable
225
225
Accrue interest on note payable
(30,000 x 9% x 1/12)
7/21/2015
224
Accounting for Notes Payable
GENERAL JOURNAL
DATE
ACCOUNTS
Feb.28
Notes Payable
POST REF.
DEBIT
30,000
Interest Payable
225
Interest Expense
450
Cash
CREDIT
30,675
To record repayment of note payable
7/21/2015
225
Current Liabilities: Known Amount
226
SALES TAX PAYABLE
ACCRUED LIABILITIES
• Levied on retail sales
• Collected from
customers but not
yet remitted to tax
authority (state,
county, city)
• Expenses incurred
but not yet paid
• Common expenses:
– Salaries Payable
– Interest Payable
– Income Taxes Payable
7/21/2015
Sales Tax Payable
GENERAL JOURNAL
DATE
ACCOUNTS
Cash
Sales
Sales Tax Payable
POST REF.
DEBIT
CREDIT
10,500
10,000
500
Record cash sales and tax collected
7/21/2015
227
Current Liabilities: Known Amount
UNEARNED REVENUES
• Business receives
payment in advance of
providing goods or
services
• Results in obligation to
provide goods or
services in the future
228
CURRENT PORTION OF
LONG-TERM DEBT
• Long-term debt often
paid in installments
• Amount of principal
payable within one
year
• Amounts reclassified
from long-term to
current
7/21/2015
GENERAL JOURNAL
DATE
ACCOUNTS
2012
Accounts Receivable
POST REF.
DEBIT
311,000
Sales
2012
Warranty Expense
311,000
27,990
Estimated Warranty Payable
2012
Estimated Warranty Payable
Cash
7/21/2015
CREDIT
27,990
13,000
13,000
229
Contingent Liabilities
• Arise from a past event
• Dependent on outcome of future event
• Examples:
– Pending litigation
– Potential fines from regulatory agency
– Loan guarantees
7/21/2015
230
Accounting for Contingent Liabilities
LIKELIHOOD OF
OBLIGATION OCCURRING
ACCOUNTING TREATMENT
Remote
No action
Possible
Disclose in footnotes
Probable
Record on financial statements if the
amount can be estimated
Disclose in footnotes if amount
cannot be estimated
7/21/2015
231
Types of Long-Term Debt
Notes
payable
7/21/2015
Bonds
payable
Leases
payable
232
Notes Payable
• Debt supported by a promissory note
• Long-term if due date is more than one year from
balance sheet date
• Mortgages: Notes payable secured by collateral
– Lender had right to take assets if borrower is unable
to repay loan
– Paid in installments that include both principal and
interest
7/21/2015
233
Accounting for Notes Payable
GENERAL JOURNAL
DATE
ACCOUNTS
Jan. 1
Buildings
POST
REF.
DEBIT
CREDIT
155,000
Mortgage Payable
155,000
Issued mortgage to purchase building
Jun.30
Interest Expense
6,200
Mortgage Payable
1,631
Cash
7,831
Record semiannual loan payment
7/21/2015
234
Bonds Payable
• Long-term interest-bearing notes
• Issued to multiple lenders (bondholders)
• Generally sold in $1,000 increments
7/21/2015
235
Bond Terminology
TERM
DEFINITION
Term bonds
Mature at same time
Serial bonds
Mature at different times
Secured bonds
Backed by collateral
Unsecured bonds
Not backed by collateral
Convertible bonds
Can be exchanged for common stock
Callable bonds
Company can buy back at specified price
7/21/2015
236
Bond Terminology
TERM
DEFINITION
Principal amount
Amount that must be paid back at maturity date
Maturity date
Date when principal must be repaid to bondholders
Stated interest rate
Determines cash interest payment
Printed on bond
Remains constant
Market interest rate
Rate investors are willing to pay
Often differs from stated rate
7/21/2015
237
Bond Prices
INTEREST RATES
BONDS SOLD AT
Stated rate =
market rate
Par
Stated rate <
market rate
Discount
Stated rate >
market rate
Premium
7/21/2015
WHY?
Bond offers same interest rate as
similar bonds with equal risk
Bondholders will receive a lower
return from this bond than from
similar bonds with equal risk
Bondholders will receive a higher
return from this bond than from
similar bonds with equal risk
238
Bond Prices
• Quoted as a percentage of maturity value
• Issue price determines amount of cash
company receives
• Company pays maturity value at maturity date
Bond sold at par
A $1,000 bond quoted at 100
would sell for $1,000
Bond sold at discount
A $1,000 bond quoted at 96.4
would sell for $964
Bond sold at premium
A $1,000 bond quoted at 102.8
would sell for $1,028
7/21/2015
239
Accounting for Bonds
Issued at Par Value
GENERAL JOURNAL
DATE
ACCOUNTS
Apr. 1
Cash
POST
REF.
DEBIT
CREDIT
500,000
Bonds Payable
500,000
Issued 8% interest bonds at par value
Sep.30 Interest Expense
20,000
Cash
20,000
Paid semiannual bond interest
$500,000 x 8% x ½ yr.
7/21/2015
240
Accounting for Bonds at Maturity
GENERAL JOURNAL
DATE
ACCOUNTS
POST
REF.
DEBIT
CREDIT
2022
Mar.31
Bonds Payable
Cash
500,000
500,000
Repaid bonds at maturity
7/21/2015
241
Accounting for Bonds Issued at a Discount
GENERAL JOURNAL
DATE
ACCOUNTS
Apr. 1
Cash
Discount on Bonds Payable
Bonds Payable
POST
REF.
DEBIT
CREDIT
478,000
22,000
500,000
Issued 8% interest bonds at discount
Contra account to
Bonds Payable
7/21/2015
242
Carrying Value of Bonds Payable Issued at a
Discount
Bonds Payable
$500,000
Less: Discount on Bonds Payable
22,000
Carrying Value of Bonds Payable
$478,000
7/21/2015
243
Accounting for Interest on Bonds Issued at a
Discount
GENERAL JOURNAL
DATE
ACCOUNTS
POST
REF.
Sep.30 Interest Expense
DEBIT
CREDIT
21,100
Discount on Bonds Payable
Cash
1,100
20,000
Paid semiannual bond interest
$22,000 / 20
Straight-line amortization
7/21/2015
244
Accounting for Bonds Issued at a Premium
GENERAL JOURNAL
DATE
ACCOUNTS
Apr. 1
Cash
Premium on Bonds Payable
Bonds Payable
POST
REF.
DEBIT
CREDIT
515,000
15,000
500,000
Issued 8% interest bonds at premium
Adjunct account to
Bonds Payable
7/21/2015
245
Carrying Value of Bonds Payable Issued at a
Premium
Bonds Payable
$500,000
Plus: Premium on Bonds Payable
15,000
Carrying Value of Bonds Payable
$515,000
7/21/2015
246
Accounting for Interest on Bonds
Issued at a Premium
GENERAL JOURNAL
DATE
ACCOUNTS
POST
REF.
Sep.30 Interest Expense
DEBIT
CREDIT
19,250
Premium on Bonds Payable
Cash
750
20,000
Paid semiannual bond interest
$15,000 / 20
Straight-line amortization
7/21/2015
247
Adjusting Entry for Bonds Issued at a
Discount (accrue interest at year end)
• Interest payments seldom occur at year
end
DATE
– Interest must be accrued
GENERALor
JOURNAL
– Bond Discount
Premium must be
ACCOUNTS
P
DEBIT
amortized
R .
OST
CREDIT
EF
Dec.31 Interest Expense
Discount on Bonds Payable
Interest Payable
10,550
550
10,000
Accrue three months of bond interest
7/21/2015
248
Adjusting Entry for Bonds Issued at a
Discount (payment after year end accrual)
• Next interest payment takes accrual into
account
– Interest payable previously accrued is debited
– Remaining Bond Discount or Premium for
current period is amortized
GENERAL JOURNAL
DATE
ACCOUNTS
DEBIT
Mar.31 Interest Payable
10,000
Interest Expense
10,550
Discount on Bonds Payable
Cash
7/21/2015
POST
REF.
Paid semiannual bond interest
CREDIT
550
20,000
249
Lease Liabilities
• Agreement in which one party (lessee)
agrees to pay another party (lessor) for
the use of an asset
• Two categories
Operating
leases
7/21/2015
Capital
leases
250
Operating Leases
• Rental agreement
• Lessee uses the asset in exchange for
regular payments
• Lessee returns asset at end of lease
– Lessor retains title of asset
• Lease payments
– Expense for lessee
– Revenue for lessor
7/21/2015
251
Capital Lease Criteria
• If any of the following applies:
7/21/2015
Transfer of title at
end of lease
Bargain purchase
option
Lease term > 75%
of useful life
Present value of
lease payments >
90% of fair value of
asset
252
Capital Lease Accounting
• Asset is debited; Lease Payable is credited
• Each payment allocated between interest
and principal
• Depreciation recorded on leased asset
7/21/2015
253
Balance Sheet Presentation
Current Liabilities
Accounts Payable
$2,200
Unearned Revenue
1,400
Income Tax Payable
6,200
Other Accrued Liabilities
15,445
Current Portion of Long-Term Debt
11,700
Total Current Liabilities
$36.945
Long-Term Debt:
Mortgage Payable
Bonds Payable, Net of $20,350 Discount
Lease Payable
Total Long-Term Debt
Total Liabilities
7/21/2015
85,000
479,650
36,650
601,300
638,245
254
Financing Ratios
• Debt Ratio
– The percentage of assets financed with
liabilities
• Interest Coverage Ratio
– The ability of a business to pay the interest
on its debt
7/21/2015
255
Debt Ratio
• Result described as a percentage
Total Liabilities
7/21/2015
Total Assets
256
Interest Coverage Ratio
• Result described as number of “times”
• Interpreted as “x$ of operating profit” for
every $1 of interest expense”
Earnings before
Interest & Taxes
7/21/2015
Interest Expense
257