FINANCIAL ACCOUNTING
Revision of double-entry
Revision of double-entry
Today we want to:
Revise double-entryUnderstand the cash flow
statementPractice with examples
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Revision of double-entry
Example: Marvin Company
Assets € Liabilities + Equity €Cash and cash equivalents 25,000 Capital 55,000Inventory 50,000
Total current assets 75,000 20,000PPE 0Total assets 75,000 Total Liabili.+Equity 75,000
Short-term borrowing
Marvin Company balance sheet at the 1st of January was as follows
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Revision of double-entry
Transaction 1a
Goods were sold for 12,000€. The client pays cash. Analysis
– The asset Cash increases– The revenue Sales Revenue increases
Journal entryCash……………………….12,000
Sales revenue…………………..12,000
Posting
0 25,000 12,000 (1a)(1a) 12,000
Cash and cash equivalents Sales revenue
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Revision of double-entry
Transaction 1b
The inventory value of the goods sold is 7,000€. Analysis– The asset Inventory decreases– The expense Cost of Sales increases
Journal entry
Cost of sales……………………….7,000
Inventory……..…………………..7,000 Posting
(0) 50,000 7,000 (1b) (1b) 7,000
Inventory Cost of Sales
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Revision of double-entry
Transaction 2 Marvin places an order to Star Company merchandise for
7,000€ and receives the goods. Analysis
– The asset Inventory increases– The liability Trade payables increases
Journal entryInventory……………………….7,000
Trade payables…………………..7,000
Posting
(0) 50,000 7,000 (1b) 7,000 (2)(2) 7,000
Inventory Trade payables
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Revision of double-entry
Transaction 3a Goods sold for 2,500€ and paid in cash Analysis
– The asset Cash increases– The revenue Sales revenue increases
Journal entryCash……………………….2,500
Sales revenue…………………..2,500
Posting
0 25,000 12,000 (1a)(1a) 12,000 2,500 (3a)(3a) 2,500
Cash and cash equivalents Sales revenue
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Revision of double-entry
Transaction 3b The inventory value of the goods sold is 1,500€.
Analysis– The expense Cost of Sales increases– The asset Inventory decreases
Journal entry
Cost of sales……………………….1,500
Inventory……..…………………..1,500 Posting
(0) 50,000 7,000 (1b) (1b) 7,000(2) 7,000 1,500 (3b) (3b) 1,500
Inventory Cost of Sales
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Revision of double-entry
Transaction 4a Goods sold for 3,400€ on credit Analysis
– The asset Trade receivables increases– The revenue Sales revenue increases
Journal entry
Trade receivables……………….3,400
Sales revenue…………………..3,400 Posting
(4a) 3,400 12,000 (1a)2,500 (3a)3,400 (4a)
Trade receivables Sales revenue
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Revision of double-entry
Transaction 4b The inventory value of the goods sold is 2,000€.
Analysis– The expense Cost of Sales increases– The asset Inventory decreases
Journal entry
Cost of sales……………………….2,000
Inventory……..…………………..2,000 Posting
(0) 50,000 7,000 (1b) (1b) 7,000(2) 7,000 1,500 (3b) (3b) 1,500
2,000 (4b) (4b) 2,000
Inventory Cost of Sales
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Revision of double-entry
Transaction 5 Marvin pays the employees for January 4,200€ in cash Analysis
– The expense Wages increases– The asset Cash decreases
Journal entry
Wages………………………….4,200
Cash………..…………………..4,200 Posting
(0) 25,000 4,200 (5) (5) 4,200(1a) 12,000(3a) 2,500
Cash and cash equivalents Wages
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Revision of double-entry
Transaction 6 Marvin purchases land for 20,000€ and pays in cash Analysis
– The asset PPE increases– The asset Cash decreases
Journal entry
PPE(Land)…………………….20,000
Cash………..…………………..20,000 Posting
(0) 25,000 4,200 (5) (6) 20,000(1a) 12,000 20,000 (6)(3a) 2,500
Cash and cash equivalents PPE
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Revision of double-entry
Transaction 7 Marvin purchases a two year insurance policy for 2,800€ and pays in cash Analysis
– The asset Prepaid expenses increases– The expense Insurance increases– The asset Cash decreases
Journal entry
Prepaid expenses…………….2,683
Insurance…………………………117
Cash………..…………………..2,800 Posting
(0) 25,000 4,200 (5) (7) 2,683(1a) 12,000 20,000 (6)(3a) 2,500 2,800 (7)
(7) 117
Cash and cash equivalents Prepaid expenses
Insurance
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Revision of double-entry
General journal for Marvin
DateEntry no. Accounts and explanations Debit Credit
1 Jan 1a Cash 12000 Sales Revenue 12000
1b Cost of Sales 7000 Inventory 7000Sale for cash
2 Jan 2 Inventory 7000 Trade payables 7000Purchased inventory on credit
3 Jan 3a Cash 2500 Sales revenue 2500
3b Cost of sales 1500 Inventory 1500Sale for cash
4 Jan 4a Trade receivables 3400 Sales revenue 3400
4b Cost of sales 2000 Inventory 2000Sale on credit
5 Jan 5 Wages 4200 Cash 4200Paid wages to emplyees
8 Jan 6 PPE (Land) 20000 Cash 20000Purchased land for cash
9 Jan 7 Prepaid expense 2683Insurance 117 Cash 2800Paid insurance policy for two years14
Revision of double-entry
Assets = Liabilities + Equity
Short-term borrowing(6) 20,000 20,000 20,000 20,000 (0) 55,000 55,000 (0)
20,000 20,000 20,000 55,00020,000
(0) 50,000 7,000 (1b) 7,000 7,000 (2) 3,083 3,083 (2)(2) 7,000 1,500 (3b) 7,000 3,083
2,000 (4b)46,500
57,000 57,00046,500
(4) 3,400 3,400 (1b) 7,000 12,000 (1a)3,400 (3b) 1,500 2,500 (3a)
(4b) 2,000 10,500 17,900 3,400 (4a)10,500 10,500 17,900 17,900
(7) 2,683 2,683 10,500 17,9002,683 2,6832,683
(7) 117 117
(0) 25,000 4,200 (5) 117(1a) 12,000 20,000 (6)
(3a) 2,500 2,800 (7)
12,500 (5) 4,200 4,20039,500 39,500 4,20012,500
Retained earnings
Cost of sales Sales revenue
Wages
Owner's capital
Prepaid expenses
InsuranceCash and cash equivalents
PPE
Trade payablesInventory
Trade receivables
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Revision of double-entry
Trial balance for Marvin at the 9 of January
Debit CreditCash and cash equivalents 12,500Trade receivables 3,400Inventory 46,500Prepaid expenses 2,683PPE 20,000Trade payables 7,000Short-term borrowing 20,000Owner's capital 55,000Retained earnings (initial balance) 0Sales revenues 17,900Cost of sales 10,500Wages 4,200Insurance 117Total 99,900 99,900
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Revision of double-entry
Trial balance, income statement and balance sheet
Debit CreditCash and cash equivalents 12,500Trade receivables 3,400Inventory 46,500Prepaid expenses 2,683PPE 20,000Trade payables 7,000Short-term borrowing 20,000Owner's capital 55,000Retained earnings (initial balance) 0Sales revenues 17,900Cost of sales 10,500Wages 4,200Insurance 117Total 99,900 99,900
Assets € Liabilities + Equity €PPE 20,000 Capital 55,000Total fixed assets 20,000 Profit 3,083Inventory 46,500 Owners' equity 58,083Trade receivables 3400 20,000Prepaid expenses 2683Cash and cash equivalents 12,500 7000
Total current assets 65,083Total assets 85,083 Total Liabili.+Equity 85,083
Short-term borrowing
Trade payables
€Sales 17,900Deduct: cost of sales -10,500Gross profit 7,400Deduct: operating expensesWages 4200Insurance 117
-4,317Operating profit 3,083Deduct: Interest expense 0Profit 3,083Deduct: income taxes 0Net profit 3,083
Balance sheet for Marvin co. asat the 9 of January - €
Income statement for Marvin co. for the period ending 9 of January - €
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Revision of double-entry18
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?
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Sources of Information for theStatement of Cash FlowsThe cash flow statement is a created
statement that relies on information from the income statement and balance sheet. Therefore, to prepare the cash flow statement, you need:
Current income statement (only current year) Comparative balance sheet (2 years) Additional information
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Format of the Statement of Cash FlowsCash Flow Statement has four sections: operating investing financing significant non-cash investing and financing
activities
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Operating Activities
Income Statement Information Needed:– Net income– Depreciation and amortization (noncash
expenditures)– Gain(loss) on sale of assets or investments
Balance Sheet Information Needed:– Change in Current Assets– Change in Current Liabilities
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Investing Activities
Income Statement Information Needed :– Gain(Loss) on Assets
Balance Sheet Information Needed :– Change in Long-Term Assets– Property Plant and Equipment– Long-Term Investments
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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
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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.
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Examples of Significant Non-Cash Activities Issuance of common stock to purchase
assets. Conversion of bonds into common stock. Issuance of debt to purchase assets. Exchanges of plant assets.
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Converting Net Income to Cash Flow From Operations
Accrual Method
Revenue earned
- Expense incurred
NET INCOME
Cash Method
Non cash expenses(e.g. depreciation)
Decreases in current assets Increases in current liabilities
Increases in current assets Decreases in current liabilities
CASH FLOW FROM OPERATIONS
+
+
-
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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.
Cash Flow statement (1)
Revision of double-entry
Marvin co. - Comparative balance sheetsAssets € Liabilities + Equity €
1st Jan 9th Jan 1st Jan 9th JanPPE 0 20,000 Capital 55000 55,000Total fixed assets 0 20,000 Profit 0 3,083Inventory 50,000 46,500 Owners' equity 55,000 58,083
Trade receivables 0 3400 20,000 20,000Prepaid expenses 0 2683Cash 25000 12,500 0 7000
Total current assets 75,000 65,083
Total assets 75,000 85,083 Total Liabili.+Equity 75,000 85,083
Short-term borrowing
Trade payables
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Cash Flow statement (2)
Revision of double-entry
Cash Flow statement - Marvin Co.Period ending on the 9th of January
Operating activities €Net Profit 3,083Increase in (non-cash) current assets -2,583Increase in trade payables 7,000Cash flow from operating activities 7,500Investing activitiesAcquisition of fixed assets -20,000Cash flow from investing activities -20,000Financing activitiesIssue of capital 0New short-term borrowing 0Cash flow from financing activities 0
Net cash flow for the period -12,500Beginning cash balance 25,000Ending cash balance 12,500
Indirect method
Cash Flow statement - Marvin Co.Period ending on the 9th of January
Operating activities €Collections from customers 14,500Labor -4,200Insurance -117Pre-paid insurance -2,683Cash flow from operating activities 7,500Investing activitiesAcquisition of fixed assets -20,000Cash flow from investing activities -20,000Financing activitiesIssue of capital 0New short-term borrowing 0Cash flow from financing activities 0
Net cash flow for the period -12,500Beginning cash balance 25,000Ending cash balance 12,500
Direct method
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Using The Accounting Framework:
America Online Inc.
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Revision of double-entry
Accounting Tools That Will Be Used
The accounting equation Relationships (Articulation) among the
financial statements Information disclosed in footnotes to the
financial statements Debits, credits and T-accounts
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Revision of double-entry
Total Assets 1996 $ 959 million
Total Assets 1997 $ 847 million
Change in Total Assets $(112 million)
WHY?32
Revision of double-entry
The accounting equation
= + +
Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. + - - + - + - +
Assets Liabilities Capital Retained earnings
Equity
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Revision of double-entry
Total Liabilities 1996 $446 million
Total Liabilities 1997 $719 million
Change in Liabilities $273 million
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Revision of double-entry
Total Equity 1996 $ 513 million
Total Equity 1997 $ 128 million
Change in Equity $(385 million)
HERE IS THE KEY!35
Revision of double-entry
Explanation for Changes In Shareholders’ Equity Retained earnings: decreased by $499
million Common stock and additional-paid-in capital:
increased by $98 million AOL issued additional shares of stock
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Revision of double-entry
The role of the income statement
= + +
Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. + - - + - + - +
Assets Liabilities Capital Retained earnings
Dr. Cr. Dr. Cr. + - - +
Total expenses Total Revenues
Dr. Cr. Dr. Cr. + - - +
Expense account Revenue account
Income Statement
Equity
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Revision of double-entry38
Revision of double-entry
Analysis of the expenses
Cost of revenues $1,041 million
Marketing $ 409 million
General & administrative $ 194 million
Write-off of deferredsubscriber acquisition cost $ 385 million
What is the last entry?
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Revision of double-entry
Subscriber Acquisition Costs - Footnote #2
Costs attributable to marketing programs that result in subscriber registrations
These expenditures are recorded as an asset– What?
Amortized (as opposed to depreciated) monthly over a period less than 24 months
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Revision of double-entry
Subscriber Acquisition Costs - Footnote #3 Due to change in business model, AOL
changed to a flat-rate pricing and reduced reliance on online subscriber revenues.
This change in the future stream of revenue created uncertainty as to whether these expenditures created an asset (i.e., produced a future benefit)
After 10/1/96 these costs were expensed as incurred - no longer recorded as assets. Thus, the asset must be written off.
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Revision of double-entry
How Does A Company Write Off An Asset ?
• AOL must remove the asset from its books and debit the expense, deferred subscriber acquisition expense and credit the asset, deferred subscriber acquisition cost. Footnote 3 indicates that AOL wrote off $385 million for the year.
Deferred subscriber acquisition expense 385,221,000Deferred subscriber acquisition cost 385,221,000
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Revision of double-entry
How Does A Company Write Off An Asset ? Remove (credit) the asset from the books Add (Debit) the corresponding expense Footnote 3 indicates that AOL wrote off $385
million for the year. Journal entryDeferred subscriber acquisition expense 385,221,000
Deferred subscriber acquisition cost 385,221,000
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T-accounts (1)
Accumulated Deficit(Retained Earnings)
7,767Balance 6/30/96From balance sheet
499,3471997 loss fromincome statement
507,114Balance 6/30/97From balance sheet
Revision of double-entry
T-accounts (2)
Deferred Subscriber Acquisition Costs(Asset account)
314,181Balance 6/30/96
The Statement of Cash Flows indicates that an additional$130,229 cash was spent on these costs between 7/1/96and 9/30/96.
130,229
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Revision of double-entry
T-accounts (3)
314,181
130,229
The Statement of Cash Flows indicates that amortization of these costs between 7/1/96 and 9/30/96 was $56,189. AOL estimated that $56,189 of the asset expired over this time period.
56,189
Deferred Subscriber Acquisition Costs(Asset account)
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Revision of double-entry
Writing-off the asset (1)
314,181
130,229
385,221
56,189
Balance 9/30/96
It was this 385,221 that was “written off” as an expense on 10/1/96
Deferred Subscriber Acquisition Costs(Asset account)
385,221 Write-offon 10/1/96
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Revision of double-entry
Writing-off the asset (2)
Deferred Subscriber Acquisition Costs(Expense account)
385,221
This expense will enter the income statement and will affectThe Balance sheet through the profit and/or loss for the year
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Income statement and cash flow
Revision of double-entry
Information from the Cash Flow StatementAOL’s cash flow statement shows that:
– Cash flow from operations was a positive $123 million.
– Cash flow from financing activities provided cash of $79 million. Note this is consistent with our earlier analysis of stockholders’ equity.
– Investing activities used cash of $197 million. This is to be expected from a growing company.
– Overall increase in cash, $6 million.
How could AOL’s income statement show such a large loss, yet have a positive cash flow?
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Revision of double-entry
Information from the Cash Flow Statement Operating cash flows, positive $123 million Investing activities used cash of $197 million -
this is to be expected from a growing company Financing activities provided cash of $79 million
- from issuance of new stock Overall increase in cash, $6 million.How could a large loss have caused no cashflow problem?
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Revision of double-entry
Explanation of Increase in Cash Flow
The write-off (expense) of the $385 million in deferred subscriber acquisition costs, current subscriber acquisition costs of $59 million, $22 noncash restructuring charges, and $64 million of depreciation and amortization are all non- cash expenses that are added back to net income. It is a noncash expense. Therefore, the income statement reported $530 million dollars in expenses that did not require the outlay of cash!
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Revision of double-entry
Summing up
Accounting is far from being an exact picture of the situation of the company
Crucial importance of the balance sheet equation
The relationship between the income statement at the balance sheet equation
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