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 nonprofit 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


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.


equation?

A = L + SE + = - Assets increase

Assets decrease

What asset accounts are affected?

Equipment (debit) $20,000

Cash (credit) $20,000



On January 5 Rhody purchases inventory

of $14,000 on account.


equation?


Liabilities increase

What asset account and liability account is

affected?

Inventory (debit) $14,000

Accounts Payable (credit) $14,000



On March 6 Rhody buys $4,000 of

supplies for cash.


equation?

A = L + SE + = - Assets increase

Assets decrease


Supplies (debit) $4,000




On April 1 Rhody pays $12,000 to

insure its cars for the next year.


equation?

A = L + SE + + Assets increases

Assets decrease


Prepaid Insurance (debit) $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.


equation?


Liabilities increase

What asset account and liability

account is affected?


Unearned Revenue (credit)

$18,000



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%.


equation?

A = L + SE + - Assets increase

Assets decrease


Note Receivable (debit) $10,000




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


24


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


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



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


• On November 5 Rhody pays its employees $5,000 for work performed.


29


A = L + SE - - • Assets decrease

• Stockholders’ equity decreases via retained earnings (i.e., wage expense)



30


Salary Expense (debit) $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


• On November 22 Rhody performs services and bills the client $15,000 for the services


32


A = L + SE + + • Assets increases

• Stockholders’ equity increases via retained earnings (i.e.,revenue)



33


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


• On December 12 Rhody pays a dividend to its stockholders.

• How does this effect the accounting equation?

35


A = L + SE - - • Assets decrease

• Stockholders’ equity decreases via retained earnings (i.e., dividends)



36


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)


Cash $12,000


Supplies 4,000

Inventory 14,000





Common Stock 40,000

$ 72,000 $72,000

40

Rhody Corporation

Updated Trial Balance


Cash $46,500

Supplies 4,000

Accounts Receivable 15,000


Inventory 14,000





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


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


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:


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


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.


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.


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 - 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.


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.



Increase in accounts receivable (13,000)




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)


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)



Increase in Accounts receivable (13,000)

Increase in Accounts payable 10,000




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?



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


Increase in Accounts receivable (13,000)

Increase in Accounts payable 10,000

Gain on sale of equipment (5,000)


Cash flows from investing activities: Sale of equipment $ 25,000

Purchase of equipment (40,000)

Net cash flow from investing (15,000)



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?



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.



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



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.



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




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.


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.


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.



EQUIPMENT 1/1 10,000 Sale $8,000 Purchase 25,000 12/31 27,000

Cash flows from operating activities: Net income $139,000


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


Cash flows from investing activities: Purchase of building (160,000)

Purchase of equipment (25,000)

Sale of equipment 4,000




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.


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.




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



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



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.


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.)


Procuration and stocking of

merchandise in

1) Per purchasing cost

2) Per selling price

(purchasing cost + difference in price)


1) Recording of merchandise

procuration per purchasing cost

Purchasing price

Depending costs

discounts Purchasing

cost


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)


2) Recording of merchandise on

inventories per selling prices

Purchasing price

Depending costs

Purchasing cost

Difference in price

(margin)

Selling price

Without VAT


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


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


ACCOUNTS


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 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


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)


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


ACCOUNTS


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)


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.


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.


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.


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.


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.


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….



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.



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.



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


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


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

http://www.google.hr/imgres?imgurl=http://uoos.hr/wp-content/uploads/2007/Slike nove/evidencija.jpg&imgrefurl=http://uoos.hr/wp/?p=13&usg=__evUtz5I_7y8uUsdRZJA8KTBmBic=&h=400&w=400&sz=34&hl=hr&start=9&sig2=N88TKuboz4PP843tgv3GVA&zoom=1&tbnid=r_xd5nqpFpyfLM:&tbnh=124&tbnw=124&ei=r8oRT-35PJGwtAb7kr0x&prev=/search?q=evidencija&um=1&hl=hr&sa=X&gbv=2&tbm=isch&um=1&itbs=1

http://www.google.hr/imgres?imgurl=http://vijesti.gorila.hr/var/mojportal/storage/images/moj_portal/zabava_i_lifestyle/razno/numerologija_sretni_brojevi/952673-1-cro-HR/numerologija_sretni_brojevi_tabfull.jpg&imgrefurl=http://vijesti.gorila.hr/gorilopedija/razno/numerologija_sretni_brojevi&usg=__gwDeaZTU8zbeFg7KlWu4oH45r-E=&h=313&w=470&sz=33&hl=hr&start=4&sig2=q30uLVMQhSHgrs6VtFBMrg&zoom=1&tbnid=h4KEM4pyd2H_oM:&tbnh=86&tbnw=129&ei=KssRT7LqBMvEsgbj05ww&prev=/search?q=brojevi&um=1&hl=hr&sa=N&gbv=2&tbm=isch&um=1&itbs=1

http://www.google.hr/imgres?imgurl=http://www.relax-livno.com/zanimljivosti/Pictures/papiri.jpg&imgrefurl=http://www.relax-livno.com/zanimljivosti/Livanjska_katolicka_prezimena.htm&usg=__PC_87dHqi70GJv14u5K7kzxaOeo=&h=164&w=193&sz=8&hl=hr&start=2&sig2=V7RocoY3wCsDTGMXoS3Gxg&zoom=1&tbnid=urFWK4HHbswCkM:&tbnh=88&tbnw=103&ei=XcsRT5_HOISAtQaVouUm&prev=/search?q=papiri&um=1&hl=hr&sa=N&gbv=2&tbm=isch&um=1&itbs=1

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


• 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

http://srr-fbih.org/msfi_mrs/26_mrs_38.htm

http://srr-fbih.org/msfi_mrs/26_mrs_38.htm

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


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


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


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


• 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.

Transparency 13-65

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

Transparency 13-66

The Dividend Yield

The rate of return an investor earns from dividends.

Dividends Per Share of Common Stock

Stock Price at Year-End

Transparency 13-67

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

Transparency 13-68

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

Transparency 13-69

Return on Common Stockholders’ Equity Ratio

Measures the profitability from the stockholders’ point of view.

Net Income – Preferred Stock Dividends

Average Common Stockholders’ Equity

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