Financial Accounting

CH1
Operating Activities day-to-day operations of the firm
Investing Activities buy or sell long-term assets
Financing Activities receipt/payment of money to investors/creditors
Balance Sheet Financial position of the firm, stock report
Income Statement company performance to sell goods and make profit
Statement of Shareholder Equity annual contribution or payment to
investors, reinvestment in the firm
Statement of Cash Flows ability to generate cash and how it is used
CH 2: Framework
FASB sets the financial standards
Separate Entity Assumption business activities are separate from
activities of owners
Going Concern Assumption assume business is stable and operational
Stable Monetary Unit reports in national monetary units, no changes for
purchasing power (inflation)
CH 3: Income Statement
- There is almost always a disconnect between providing services and
when cash changes hands
Revenue Increase in assets or settlement of liabilities (A+, L-, RE+, SE+)
Revenue Realization Principle:
1. Delivery has occurred of service rendered
2. Persuasive evidence of an arrangement for customer payment
3. Price is fixed or determinable
4. Collection is reasonably assured
Expenses Outflows or using up of assets OR increase in liabilities from
ongoing operations to generate revenue (A-, L+, RE-, SE-)
- Already paid cash for resources used to generate revenue
- Use assets at same time that you pay cash for them
- Still need to pay cash for resources to generate revenue
Operating Expenses associated with the central focus of the business
- COGS, SG+A, Depreciation Expense
Other Items Items affecting income statement that are not directly
related to ongoing operations
- Investment income, Interest Expense, Gains/Losses on Sale of Assets
Bottom of Income Statement:
- Income Tax Incurred
- Earnings Per Share
Accrual Basis records revenue when earned and expenses when incurred

CH 4: Adjustments, Financial Statements, and Quality of Earnings

Adjusting Entries disconnect across financial periods
(1) Cash
Unearned Revenue
Deferred Revenue: Received cash, yet to deliver goods
(2) Unearned Revenue (L-)
Revenue (R, SE+)
Accrued Revenue: Started to deliver goods, not yet paid
(2) Accounts Receivable (A+)
Revenue (R, SE+)
Prepaid
_________ Expense (E, SE-)
Prepaid ________ (A-)
Unbilled but Incurred Cost
_________ Expense (E, SE-)
_______ Payable (L+)
Depreciation Allocation of an assets historic cost over its estimated
useful life to the organization
- Contra-Account offset to or reduction of primary account
o PPE does not decline directly due to depreciation
o Accumulated Depreciation: contra to PPE
- Net Book Value = Acquisition Cost Accumulated Depreciation
o Depreciation Expense (E, SE-)
Accumulated Depreciation (CA+, A-)
CH 5: Communicating and Interpreting Account Information
Stockholders residual claimants of the firm
Board of Directors represent shareholders
Top Managers day-to-day operations; responsible for firm financial
statement
Regulators SEC, FASB, and PCAOB
Auditors independent public accounting firm by PCAOB standards
(Deloitte)
Info Intermediaries Info services; Bloomberg; Financial Analysts
Users Institutional Investors; consumer power
Annual Report All statements, notes, audits, etc. Not necessarily public
10-K public firms; disclosure of annual report and additional information
10-Q Quarterly filing, less detailed
8-K Disclose any material not previously reported; reported immediately
Accounting Errors Overstate revenue = expense unchanged = Net
Income overstated = Assets overstated = Liabilities unaffected = SE
overstated

CH 6: Reporting and Interpreting Revenue, Receivables, and Cash

Delivery Terms:
- Free On Board (FOB): revenue recognized when title changes hands
(buyer pays for shipping
- FOB Destination: title changes hands when good is delivered (seller
pays for shipping)
Credit Card Sales Corporation pays a fee to Credit Card Company
A: Sales Revenue, total paid
B: LESS Credit card discount, %*total amount
C: Net Sales, difference
Cash (A+)
C
Credit Card Discount (XR, SE) B
Revenue (R, SE+)
A
Sales Discount to Businesses 2/10, n/30; discount if early/early,
net/on-time
(1) Account Receivable (A+)
Revenue (R, SE+)
(Early) Cash
C
Sales Discount B
Account Receivable A
(On time) Cash
Account Receivable
Sales, Returns, and Allowances
S, R, + Allowances (XR, SE-)
Account Receivable (A-)
To calculate net sales, must remove CC Discounts, Sales Discounts,
and Sales Returns from total revenue
Bad Debt Expense expense associated with estimated amount of
uncollected receivables
Allowance for Uncollectible Accounts contra-asset to account
receivable containing estimated amount for allowance for doubtful
accounts
1. End of fiscal period, record BDE
Bad Debt Expense (E, SE-) WW
Allowance for UA (XA, A-) WW
2. Write off specific accounts when determines to be uncollectible
Allowance for UA (XA, A-) YY
Accounts Receivable (A+) YY
Estimate Bad Debt:
- BDE= BD Loss Rate * periods credit sales
- BD Loss Rate= Total BD Losses/Total Credit Sales
Allowance for Uncollectible Accounts, end = YY = AUA, beg + BDE
Write off
Account Receivable, gross end = Acct Rec, beg + credit sales Cash
collect Write off

Acct Rec, gross end = Acct Rec, gross end AUA, end
CH 7: Inventory
COGS Cost of inventory used to generate revenue; net sales COGS =
gross margin; (Inventory, beg + Purchases) - inventory
Inventory Tangible product held for sale or used to produce good/services
to sell; RECORDED AT COST
Inventory Costing Methods
1. Specific Identification
a. Cost of each item sold is individually identified and recorded
b. Unique, high priced firms
2. FIFO
a. Goods purchased earlier are sold first
b. Goods purchased most recently are left in inventory
3. LIFO
a. Goods purchased most recently sold first
4. Average Cost
a. Weighed average COG available for sale for both ending
inventory and COGS
b. COG Available/# units available
As unit costs rise, FIFO has lower COGS, higher net income, income
tax, and inventory.
- Minimize tax by LIFO
LIFO LIQUIDATION Company doesnt purchase as much as it sells, makes
it seem like COGS is down while revenue remains same
Convert LIFO to FIFO
LIFO Reserve: FIFO Inventory LIFO Inventory
o Contra asset
Difference in COGS under FIFO vs. LIFO: Beg LIFO reserve End
LIFO reserve
Sales Discount and Inventory: Affecting buyer
Purchased
Inventory (A+)
Account Payable (L+)
Pay Early
Account Payable (L-)
X
Inventory (A-)
discount
Cash (A-)
X discount
Pay on time
Account Payable
Cash
Lower of Cost or Market (LCM) Inventory valuation tool
- Must recognize loss if purchase price is less

COGS +, Inventory -

CH 8: Reporting & Interpreting Long Lived Assets

Cost Principle all reasonable and necessary expenditures made in
acquiring/prepping an asset for use should be recorded as COST OF ASSET
Increase Asset Value Sales tax, legal fees, transportation cost,
installation cost
- Sales discounts are subtracted from assets value
Capitalization expenditure that are normally expenses instead increase
COST OF ASSETS
Record Purchase
Cash
Equipment (A+)
Cash (A-)
Debt
Equipment (A+)
Cash (A-)
Note Payable (L+)
Equity
Equipment (A+)
Common Stock (SE+)
APIC (SE+)
Tangible Physical substance: Land, PPE, Natural resources
Intangible No physical substance but confers specific rights to owner:
trademark, copyright, licenses, patents, and franchises
Repairs & Maintenance maintaining productivity capacity of an asset
during the current accounting period; EXPENSE
Repair Expense (SE-)
Cash (A-)
Improvements increase the productive life, operating efficiency, or
capacity of asset; INCREASE IN ASSET VALUE
Flight Equipment (A+)
Cash (A-)
Leasing:
- Operating: short term, not on balance sheet
- Capital (Financing): long term; acquisition of asset; report on balance
sheet
DEPRECIATION
Straight Line equal portion of asset over time
- Depreciation cost = (Cost- Est. Residual Value)/Useful Life
Units of Production portion of assets depreciable cost is expensed over
its life
- (Cost Est. Residual Value) * (Actual Production/Est. Total Production)

Declining Balance Method higher at first, reflecting more useful and

productive
- (Cost-Accumulated Depreciation) * (2/Useful Life)
MACRS Modified Accelerated Cost Recovery System
- Used by government for taxes; allows companies to report expenses
sooner
Asset Impairment occurs when events or changed circumstances cause
est. future cash flow from an asset to fall below NBV
- Impairment Loss = NBV- Fair Value; LOSS
o Fair Value estimated future cash flow
o FV = Market Value
- If cost is less than MV, record as loss on sale
Asset Impairment Loss (SE-)
Asset (A-)
Asset impairment is only bad if returns go down
Disposal of PP&E
- Voluntary: sell of get rid of because no longer wanted
- Involuntary: storm, fire, accident, expropriation
Must consider
1. What is on the books related to the asset that must be removed
Asset + Accumulated Depreciation
2. What is received for giving up the asset needs to be recorded cash,
sometimes nothing
3. What id debits credits Gain/Loss on sale of asset
Sell for more than net value
Cash (A+)
A
Accumulated Depreciation (XA-)
B
Gain on Sale of Asset (SE+)
(a + b - c)
Asset (XA-)
C
Sell for less than net value
Cash (A+)
A
Accumulated Depreciation (XA-)
Loss on Sale of Asset (SE-)
Asset (A-)

B
(C-B+A)
C

Intangible Assets recorded at historic cost ONLY when purchased

Amortized systematic and rational allocation of acquisition cost of an
Intangible Asset over its useful life
Definite Life amortized on straight-line bases
Indefinite Life not amortized but reviewed
Goodwill excess of purchase price of a business over fair value of its
assets and liabilities; recorded only when purchase another business;
assumed indefinite life

Research and Development always expensed, unless buying

someones R+D
Natural Resource Assets that occur in nature
Depletion systematic and rational allocation of cost of NR over the period
of its exploitation
CH 9:
Accounts Payable better to pay later
Accrued Liabilities Payables; income tax payable, wages payable
Employee Related Tax Payable Payroll taxes
- Withholding: employer collects employee income taxes; liability to the
firm
- FICA: social security and Medicare
- Employer Unemployment Tax: FUTA, SUTA; tax on first $7000 of wages
Taxes Paid by Employees
Compensation Expense
Liability for Income Tax Withheld
FICA Payable
Cash
Taxes Paid by Employer
Compensation Expense
FUTA Payable
FICA Payable
Note Payable Company borrows; signed agreement
Borrow
End Of Year
Cash
Interest Expense
Note Payable
Interest Payable
Current Portion of Long Term Debt liability
- If you can refinance current debt, you dont have to put it on your
balance sheet
LEASES
Operating Does not meet any of 4 criteria for capital leases; not recorded
as A or L
Capital Recorded as Asset + Liability
1. Lease term is 75% or more of assets expected economic life
2. Ownership of Asset is transferred to lessee
3. Contract permits lessee to purchase asset @ lower than fair MV
4. Present value of lease payments is 90% or more of fair MV of asset
when signed
LT Note Payable written promise to pay sum (Private)
LT Bonds publically traded debt (public)
Present Value current value of an amount to be received in the future
PV of a Single Account worth to you today of receiving that amount
some time in the future

PV 1/(1+i)n * Amount in the future

PV of Annuity series of periodic cash receipts or payments that are equal
in amount each interest period
PVA [1-(1+i)-n/i] * Amount in the future
CH 10: Debt VS Equity
Debt
- Pros: current stockholders maintain control; interest is tax deductible
- Cons: Higher risk of bankruptcy; no obligation to repay stockholder
Bonds publically traded debt
- Principle face amount
- Coupon Rate rate that determines cash interest payments per
period
- Unsecured no assets are pledged as a guarantee of repayment at
maturity
- Security specific asset are pledged as guarantee of repayment;
creditors seize
- Callable may be repaid early by issuer (must pay premium)
- Convertible converted into common stock of issuer
- Zero Coupon no interest payments made overtime (rolled into
repayment)
Credit Rating if below investment grade = JUNK BOND; affects whether
certain institutional investors can buy or hold a companys debt

PREMIUM Coupon Rate > Market Rate; buyer pays MORE than face value
PAR Coupon Rate = Market Rate; equal
DISCOUNT Coupon Rate < Market Rate; buyer pays LESS than face value
PV Principle = Face Value * PV Market Rate
PV Interest Payable = (Face Value * Coupon Rate) * PV Annuity Market
Rate
Willing to Pay = PV Principle +PV Interest Payment

AMORTIZATION SCHEDULE DISCOUNT

Date
Interest Payment Interest Expense Amortization
(Coupon Rate* Principle)

(MR*NBV)

(Int. Exp. Int. Pay)

NBV

(FV-Discount)

AMORTIZATION SCHEDULE PREMIUM

Date
Interest Payment Interest Expense Amortization
(Coupon Rate* Principle)
(FV+ Premium)

(MR*Principle)

NBV

(Int. Exp. Int. Pay)

Early Retirement of Debt Borrower retires bond before maturity date;

pay premium: Loss on Bond Callable
CH 11: Owners Equity
Investors Perspective on Equity
- Pros: voice in managements; dividends; residual claim
- Costs: Dividends not guaranteed; tax implications; residual claim
Company Perspective
- Reduce likelihood of bankruptcy
- Tax Implications: no tax benefits
Number of Shares
- Shares outstanding total # of shares held by stockholder on a
given date
- Shares Issued total # of shares sold to public
- Authorized # of Shares max # of shares that can be issued
Treasury Stock Issued but reacquired by firm; creates difference in
shares outstanding and shares issued
- Indirect method for returning profit to shareholders; creates capital
gain for SH
- May signal management is confident that company in undervalued

Sale of Stock Initial Public Offering (IPO) or Seasoned Equity Offering

(SEO)
Cash (A+)
Z
Common Stock (SE+) Y
Y= # shares * par value
APIC (SE+)
(Z-Y)
Common Stock Transaction stock issued for employee compensation;
align employee/stockholder interest
Repurchase of Stock: x = # shares purchased * market price when
acquired
Treasury Stock (XSE+, SE-)
x
Cash (A-)
x
Later Sale of Repurchased Stock
If sold for more
If sold for less
Cash (A+)
B
Cash (A+)
B
Treasury Stock (XSE-, SE+)
X
APIC (SE-)
(X-B)
APIC (SE+)
(B-X)
Treasury Stock
X
X= # shares * per share price when placed in TS, B= # shares * price sold to
market today
Dividends direct payment to shareholders; some have regular stream of
payments
- Not tax deductible; counts as ordinary income rather than capital
gain no lower tax rate
- More common among mature companies who do not need to reinvest
in operations
- Provided when sufficient retained earnings
1. Declaration Date Board approves dividend amount based on shares
outstanding
Retained Earnings (SE-)
Dividends Payable (L+)
2. Date of Record Date that company prepares list of current
stockholders to be paid
3. Date of Payment date cash is provided to shareholders
Dividends Payable (L-)
Cash (A-)
Large Dividends >20%+
Retained Earnings (SE-)
Common Stock (SE+)

Small Dividends <20% +

Retained Earnings (SE-)
Common Stock (SE+)
APIC (SE+)
Initial value * %* # shares
MV* Shares *%
Stock Splits Increase total number of authorized shares by ratio
- Changes in shares outstanding + Par Value
- Not affecting Retained Earnings

- No Journal entry
Preferred Stock specific rights over CS
PRO: priority in terms of dividend payments and distribution of assets
CONS: no voting rights
CH12: Cash Flows
1. Change in each account from beginning balance to end balance (BBEB)
2. Categorize balance sheet accounts into Operating, Financial, and
Investing; Convert new income to cash flow #
a. Cash Collections= Revenue - Account Receivable
b. Cash Paid = COGS + inventory - Account Payable
c. Other Cash Payment = Expenses + Prepaid - Accrued
Expenses
3. Note effect of change
Cash Flows from Investing PPE, Intangibles, ST/LT Investments,
purchase outflow
Financing ST/LT Debt, CS +APIC, RE, issued debt inflow, repay
outflow
Some financing/investing activities have no cash flow effect disclose in
footnotes

RATIOS!!!
Current Ratio: current assets/current liabilities
- Measure of liquidity
- Slightly above 1 is good
Net Profit Margin Ratio: Net Income/Net Sales
- How much of every dollar generated during the period is profit?
- Luxury companies have higher margins and strategies
Asset Turnover Rate: Net Sales/Average Total Assets
- Shows how efficiently a firm uses assets
- Higher # is generally better
Return on Assets: Net Income/Average Total Assets
- How efficient is a company in deriving profits from resources
- Higher # is better
Dupont Analysis: ROA= Net Profit Margin * Asset Turnover
Inventory Turnover Ratio: COGS/Average Inventory
- How many time the average inventory was sold during year
- Higher is better
Average Days to Sell Inventory: 365/Inventory Ratio Turnover
Working Capital: Current Assets Current Liabilities
- Need decent ratio
Accounts Payable Turnover: COGS/Average Accounts Payable

- How quick a company pays its creditors

Interest Coverage Ratio: Net Income+ Interest Expense +Interest Tax
Expense/ Int. Exp.
Debt to Equity: Total Liabilities/Total Equity
- Higher # = Highly dependent on funds from creditors to shareholders