Tabular analysis of the effects of various

Midterm Review Accounting Balance Sheet Equation: Assets = Liabilities + Owner’s Equity z z z Assets =probable future economic benefits owned by the firm Liabilities = probable future economic sacrifices Owners’ Equity = Assets – Liabilities owners’ claim = “own” – “owe” z z (Owners’ Equity is sometimes also called shareholders’ equity, net book value, or the “residual claim”) Assets = Liabilities + Owners equity Changes in Shareholders’ Equity Beginning of year: S. E. Beginning Beginning Paid in Capital Retained Earnings + Net Income + new paid in capital - Dividends Ending Retained Earnings Ending Paid in Capital End of year: S. E. Balance Sheet Equation z z z Assets = Liabilities + Owner’s Equity Key: Every economic event that leads to an accounting entry has two sides Given an event and an accounting entry, you should be able to identify the two sides Contra-Asset Accounts z z z z z z Contra asset accounts act like liability accounts – increases are recorded as credits Their existence is tied to specific asset accounts For example z Allowance for Doubtful Accounts (existence tied to Accounts Receivables, a current asset) z Accumulated Depreciation (existence tied to depreciable longterm assets like PP&E) On the balance sheet, Accounts Receivables is reported net of ADA and PP&E is reported net of Accumulated Depreciation Thus, contra-asset balances are not reported on the liabilities side, but as negative numbers on the asset side Assets – Contra-Assets (if any) = Liabilities + Stockholders’ Equity Debits and Credits z z z z z z Assets = Liabilities + Owner’s Equity Increases in assets are debits Increases in liabilities are credits Increases in Owner’s Equity (Capital Stock, RE) are credits Revenues increase Retained Earnings – Credits Expenses reduce Retained Earnings - Debits Accounting Entries z Every accounting entry has two sides – a debit and a credit. This is the same point as two slides before Accounting Entries z Two kinds: z z z z Transactions based Adjusting entries Transactions-based entries record the effects of specific transactions Adjusting entries are entries that arise out of the basic principles of accrual accounting z z z Depreciation expense Salaries expense even when employees have not actually been paid Bad debt expense Basic Principles of Accrual Accounting z Determine what net income has been earned during a period, not just what cash has been generated during the period from operations z z z Why? To capture the economic events that have occurred during the period Determine revenues applying the revenuerecognition principles Report as expenses those costs that have been or will be incurred to generate those revenues Accruals and Cash flows: Four Cases 1) Cash precedes expense Pay Cash Recognize Expense (a) (b) Time Balance Sheet Date Examples: Rent paid in advance, Prepaid Insurance, PP&E, Inventory Associated entries: (A) Cash Prepaid Rent (a) –$ +$ (b) –$ = (SE) Ret. Earn. –$ (rent expense) Example: Prepaid Rent z z z z Assume on Jan 1, you pay rent for the next year for @ $1,000 per month Dr Prepaid Rent (CA) 12,000 Cr Cash (CA) 12,000 Say you make adjusting entries at the end of every month. At the end of the first month, on Jan 30th, you would record the following expense: Dr Rent Expense (RE) 1,000 Cr Prepaid Rent (CA) 1,000 The first entry increase a current asset (Prepaid Rent) and decreased Cash The second entry decreased Retained Earnings and also decreased a current asset (Prepaid Rent) Accruals and Cash flows: Four Cases 2) Cash follows expense Recognize Expense Pay Cash (a) (b) Balance Sheet Date Time Examples: Taxes paid after yearend, Salaries paid on the 15th of the month, bad debt expense, warranty expenses Associated entries: (A) = (L) (SE) Cash Salaries Payable* Ret. Earn. (a) +$ –$ (salary expense) (b) –$ –$ * sometimes also called “accrued salaries” Accruals and Cash flows: Four Cases 3) Cash precedes revenue Receive Cash Recognize Revenue (a) (b) Time Balance Sheet Date Examples: Airplane tickets sold in advance Newspaper subscriptions sold in advance Associated entries: (L) Cash Unearned Revenue* (a) +$ +$ –$ (b) *sometimes also called “deferred revenue” (SE) Ret. Earn. $ (revenue) Accruals and Cash flows: Four Cases 4) Cash follows revenue Recognize Revenue Receive Cash (a) (b) Time Balance Sheet Date Examples: Accounts Receivable Goods shipped but cash not yet received Services provided but cash not yet received Associated entries: (A) (A) Cash Accounts Receivable (a) +$ (b) $ –$ (SE) Ret. Earn. +$ (revenue) Revenue Recognition z z Revenue recognition principles: Service has been provided by the company, customer has been billed and there is reasonable certainty of cash collection Issues in revenue recognition z z z Credit sales Warranties and returns Bill & hold sales, SAB 101 Accounts Receivable z z z Not all accounts receivables will be collected in cash The balance in Allowance for Doubtful Accounts at the end of the year reflects estimated defaults. Bad debt expense is recorded at the end of every period to adjust the balance in ADA to the desired amount Income Statement and Balance Sheet Relations Accounts Receivable (A) Beg Balance Amount of Credit Sales Cash collected Write-offs Ending balance Allowance for doubtful accounts (XA) Beg Balance Amount of Bad Debt Expense Write-offs Ending balance AR and ADA Account Balances Accounts Receivable (A) – Allowance For Doubtful Accounts (XA) Beginning Balance + Credit Sales – Cash Collected – Net Amounts Written Off Beginning Balance + Amounts Recorded as Bad Debt Expense – Net Amounts Written Off = Ending Balance = Ending Balance Inventories - The Key Equation Inventory Beg. Inventory Cost of goods sold Purchases/ Production End. Inventory Beg. inventory + purchases/production - COGS = End. inventory Accounting for Inventory A Comparison of LIFO and FIFO Income Statement Balance Sheet LIFO New costs* Old costs FIFO Old costs New costs *if LIFO liquidation old and new costs Using the “LIFO Reserve”: Income Statement EInvFIFO = BInvFIFO + Purchases – COGSFIFO EInvLIFO = BInvLIFO + Purchases – COGSLIFO Subtracting these two equations yields: EInvFIFO – EInvLIFO = BInvFIFO–BInvLIFO – (COGSFIFO–COGSLIFO) EInvFIFO – EInvLIFO – (BInvFIFO–BInvLIFO) = COGSLIFO–COGSFIFO End LIFO Reserve – Beg. LIFO Reserve = COGSLIFO–COGSFIFO ÎChange in LIFO Reserve = LIFO-FIFO difference in COGS LIFO versus FIFO COGS z In inflationary economies, in general LIFO COGS will be higher than FIFO. z There are tax benefits to using LIFO z Of course, for companies that face declining costs FIFO COGS will be higher: Intel was an example z If input prices do not change, LIFO COGS = FIFO COGS z (LIFO COGS excluding the effects of any LIFO liquidation – FIFO COGS) is a measure of difference in COGS under the two methods that is driven solely by changes in input prices LIFO Liquidation z z z z z z z Relevant for firms that report LIFO Occurs when production < sales You are selling out of beginning inventory Under LIFO, beginning inventory is at older costs Firms disclose LIFO liquidation profits in the footnotes Watch out for: whether LIFO liquidation profits are disclosed post-tax or pretax LIFO COGS without LIFO liquidation – LIFO costs reported after LIFO liquidation = Pre-tax LIFO liquidation profits = (Post-tax LIFO liquidation profits)/(1-tax rate) Cash Flow Statements z z z z Change in net cash = Operating cash flows + Investing cash flows + Financing cash flows Given two, you should be able to work out the third Two methods: Indirect and Direct For the exam: worry about Indirect The Indirect Method z Operating z z z Investing z z z Start with Net Income Make adjustments to arrive at CFO (cash flow from operations or operating cash flows) Purchase of PPE and/or other long-term assets (outflows) Proceeds from sale of PPE and/or other long-term assets (inflows) Financing z z z Dividends paid (outflows) Issuance of securities (inflows) Retirement of securities (outflows) Operating Cash Flows (CFO) z z z z z Net Income includes non-cash revenues and non-cash expenses These non-cash revenues/expenses usually are captured in changes in operating current assets and operating current liabilities (recall the twosidedness of all entries) Step 1: Identify operating non-cash current assets and operating current liabilities Step 2: Identify non-cash revenues or expenses that do not affect operating current assets or operating current liabilities (example: Depreciation Expense) Step 3: z z z z z Start with net income Add /(subtract) to it any non-cash expense /(revenue) that does not affect operating current assets or operating current liabilities ** Subtract /(add) any increase /(decrease) in non-cash operating current assets Add /(subtract) any increase /(decrease) in operating current liabilities Arrive at CFO ** Sometimes transactions that have cash consequences are similarly adjusted out of the operating section because they are not considered a result of operating activities – do not worry about this yet. Summary z z Understand how events are translated into accounting reports via the BSE. Understand the differences between accrual accounting numbers and cash flows z z z Revenue vs. cash collected COGS vs. purchases vs. cash paid for purchases Reconciliation net income and cash flow from operations