Financial Accounting - Definitive Exam 3 Master Guide

Financial Accounting - Definitive Exam 3 Master Guide Chapters 9, 10, & 12 Financial Accounting - Master Exam 3 Prep Sheet Comprehensive Mechanics, Lecture Theory, and Exam Applications Chapter 9: Liabilities & Accruals 1. Classifying Debt (Current vs. Long-Term) Core Mechanic: Liabilities are classified as Current if they will be paid using current assets within 1 year. If a long-term note is paid in installments, the portion due in the next 12 months is reclassified as a Current Liability. Exam Application: Classifying Debt Scenario: Lakeside Co. borrows $36M on a 6-year note. Principal is repaid in equal annual installments of $6M. They just made the first payment. How is the remainder classified? • Total Remaining: $36M − $6M = $30M. • Current Liability: The next installment due in exactly 1 year = $6M. • Long-Term Liability: The rest of the balance = $30M − $6M = $24M. 2. Payroll Accounting Mechanics Core Mechanic: Employers must track both the employee’s withholdings (which reduce the employee’s gross pay) and the employer’s matching taxes (an additional expense to the company). • Net Pay = Gross Pay − Income Taxes − FICA − Medicare. • Employer Taxes = Matching FICA + Matching Medicare + FUTA/SUTA (Unemployment). Lecture Concept: Complete Payroll Journal Entries Assume Gross Payroll = $100,000. Income taxes withheld = $15,000. FICA/Medicare withheld = $7,650. Employer unemployment taxes = $620. 1. Recording Employee Compensation (Wage) Expense FICA Taxes Payable Withheld Income Taxes Payable Cash (Net Pay sent to employees) Pay & 100,000 Withholdings (Employer’s books): 7,650 15,000 77,350 2. Recording Employer’s Payroll Tax Expense (7,650 + 620) 8,270 FICA Taxes Payable (Employer Match) Unemployment Taxes Payable 1 Additional 7,650 620 Payroll Taxes: Financial Accounting - Definitive Exam 3 Master Guide Chapters 9, 10, & 12 3. Accruing Interest over Multiple Periods Core Mechanic: Interest accrues with time. Formula: Principal×Annual Rate×(Months Elapsed / 12). Exam Application: Multi-Year Interest Accrual Scenario: Pinecrest borrowed $750,000 on July 1, 2025, on a 3-year, 5% note. Interest is payable at maturity. No adjusting entries have been made since July 2025. Record the Dec 31, 2026 entry. • Months Elapsed: July 1, 2025 → Dec 31, 2026 = 18 months. 18 • Calculation: $750, 000 × 5% × 12 = $56, 250. Adjusting Journal Entry (12/31/2026): Interest Expense 56,250 Interest Payable 56,250 2 Financial Accounting - Definitive Exam 3 Master Guide Chapters 9, 10, & 12 4. Contingent Liabilities & Warranties (Matching Principle) Core Mechanic: If a future liability is Probable and Estimable, you must record the expense in the same period the related revenue is earned. Synthesized Example: Warranty Liabilities T-Accounts Scenario: Company sells $500,000 of goods in Year 1. They estimate 2% will require warranty repairs. In Year 2, a customer claims $1,200 in repairs, which the company fixes using parts inventory. 1. Year 1 (Point of Sale): Record the estimated expense. Warranty Expense ($500,000 × 2%) 10,000 Estimated Warranty Payable 10,000 2. Year 2: Perform the repair. (Do NOT hit expense again!) Estimated Warranty Payable 1,200 Inventory (Parts used) / Cash 1,200 Estimated Warranty Payable (Liability) Dr. Cr. 10,000 (Yr 1 Estimate) 1,200 (Yr 2 Repair) Bal: 8,800 Credit 5. Deferred Income Taxes Core Mechanic: Financial statements use GAAP (e.g., Straight-Line depreciation). Tax returns use IRS rules (e.g., MACRS accelerated depreciation). This creates a temporary timing difference. When Tax Expense (GAAP) > Taxes Payable (IRS), the difference is credited to a Deferred Tax Liability. Exam & Lecture Synthesis: Deferred Taxes Scenario: Pretax GAAP income is $400,000. Taxable income on the IRS return is $360,000 (due to taking more depreciation on the tax return). Tax rate is 21%. 1. Calculate the components: • Income Tax Expense (GAAP IS): $400, 000 × 21% = $84, 000. • Income Taxes Payable (IRS Return): $360, 000 × 21% = $75, 600. • Deferred Tax Liability: Difference = $8,400. Income Tax Expense 84,000 Income Taxes Payable 75,600 2. Journal Entry: Deferred Tax Liability 8,400 Deferred Tax Liability Dr. Cr. 8,400 (Yr 1 creation) Bal: 8,400 Credit (Owed in future years) 3 Financial Accounting - Definitive Exam 3 Master Guide Chapters 9, 10, & 12 Chapter 10: Bonds and Long-Term Liabilities 1. Bond Pricing & Effective-Interest Amortization Core Mechanics: • • • • • Issue Price = PV of Principal + PV of Interest Payments (Discounted using Market Rate). Cash Payment (Constant) = Face Value × Stated Rate × Time. Interest Expense (Changing) = Carrying Value × Market Rate × Time. Amortization = | Interest Expense − Cash Payment |. New Carrying Value = Old Carrying Value + Discount Amortization OR − Premium Amortization. Lecture Concept: Premium Bond Amortization Scenario: Face Value = $200,000. 2-year bond. Stated Rate = 10% (Annual). Market Rate = 8% (Annual). Payments are Semi-Annual. Semi-Annual Rates: Stated = 5%, Market = 4%. Issue Price = $207,259. Cash Premium on Bonds Payable Bonds Payable (Face) 2. First Interest Payment (6 Months): • Cash Paid = $200, 000 × 5% = $10, 000. • Interest Expense = $207, 259 × 4% = $8, 290. • Amortization = $10, 000 − $8, 290 = $1, 710. Interest Expense 8,290 Premium on Bonds Payable 1,710 Cash 10,000 207,259 1. Issuance Journal Entry: 7,259 200,000 Premium on Bonds Payable (Adjunct Liability) Dr. Cr. 7,259 (Issuance) 1,710 (Per 1 Amortization) Bal: 5,549 Credit New Carrying Value = $200,000 Face + $5,549 Premium = $205,549. 4 Financial Accounting - Definitive Exam 3 Master Guide Chapters 9, 10, & 12 Synthesized Example: Discount Bond Amortization Scenario: Face Value = $100,000. Issued at a discount for $95,000. The discount account is a Contra-Liability (Debit balance). First period Interest Expense is calculated at $4,500 based on the market rate, but Cash Paid is only $4,000 based on the stated rate. Cash 95,000 1. Issuance Journal Entry: Discount on Bonds Payable 5,000 Bonds Payable (Face) 100,000 2. First Interest Payment: (Amortization = 4, 500 − 4, 000 Interest Expense 4,500 Discount on Bonds Payable 500 Cash 4,000 = $500). Discount on Bonds Payable (Contra-Liability) Dr. 5,000 (Issuance) Cr. 500 (Per 1 Amortization) Bal: 4,500 Debit New Carrying Value = $100,000 Face − $4,500 Discount = $95,500. (CV goes UP toward face). 2. Early Retirement of Bonds Core Mechanic: Compare the Carrying Value on the date of retirement to the Cash Paid to Retire. • If CV > Cash Paid → Gain on Retirement (Credit). • If CV < Cash Paid → Loss on Retirement (Debit). Synthesized Example: Early Bond Retirement Scenario: A company retires a bond early. The Face Value is $100,000. The Unamortized Premium is $3,000. (Carrying Value = $103,000). The company buys back the bonds on the open market for $105,000 cash. • CV ($103,000) < Cash Paid ($105,000) → $2,000 Loss. Bonds Payable (Face) 100,000 Premium on Bonds Payable 3,000 Retirement Journal Entry: Loss on Bond Retirement 2,000 Cash 105,000 5 Financial Accounting - Definitive Exam 3 Master Guide Chapters 9, 10, & 12 Chapter 12: The Statement of Cash Flows 1. Classifying Cash Flows Core Mechanic: • Operating (O): Current Assets, Current Liabilities, Net Income items. (Includes Interest Paid/Received and Dividends Received under GAAP). • Investing (I): Long-Term Assets (Buying/selling PP&E, loans made to others). • Financing (F): Long-Term Liabilities & Equity (Issuing debt, issuing stock, Dividends Paid). Exam Application: Classifying & Netting Cash Flows Data: Customers ($210k in), Suppliers ($92k out), Employees ($48k out), Interest ($9k out), Taxes ($16k out). Common Stock ($80k in), Borrowing ($120k in), Repay Bank Loan ($45k out), Treasury Stock ($18k out), Dividends ($22k out), Sell Land ($28k in). 1. Operating Net Cash: $210k(Cust) − $92k(Supp) − $48k(Emp) − $9k(Int) − $16k(Tax) = $45, 000. 2. Investing Net Cash: $28k(Sell Land) = $28, 000. 3. Financing Net Cash: $80k(Stock) + $120k(Borrow) − $45k(Repay) − $18k(Treasury) − $22k(Div) = $115, 000. 2. Operating Section: The Indirect Method Core Mechanic: Reconcile from accrual Net Income to Cash flow by stripping out non-cash items and reversing working capital accruals. • + Non-Cash Expenses: Depreciation, Amortization. • + Losses / − Gains: Reverse gains/losses from investing activities. • Current Assets (Opposite): Subtract increases, Add decreases. (e.g., AR goes up → subtracted from NI because you didn’t collect cash yet). • Current Liabilities (Same): Add increases, Subtract decreases. (e.g., AP goes up → added to NI because you saved cash by not paying yet). 6 Financial Accounting - Definitive Exam 3 Master Guide Chapters 9, 10, & 12 Lecture & Exam Synthesis: Indirect Method Reconciliation Data: Net Income = $280,000. Depreciation = $85,000. Gain on Sale of Equip = $1,000. Inventory increased by $25,000. Accounts Receivable decreased by $7,000. Wages Payable increased by $12,000. Net income $280,000 Adjustments to reconcile net income to net cash: + Depreciation Expense $85,000 − Gain on Sale of Equipment (1,000) + Decrease in Accounts Receivable 7,000 − Increase in Inventory (25,000) + Increase in Wages Payable 12,000 78,000 Net Cash Provided by Operating Activities 7 $358,000 Financial Accounting - Definitive Exam 3 Master Guide Chapters 9, 10, & 12 3. Direct Method Conversions & T-Account Mastery Core Mechanic: The direct method requires finding the exact amount of cash that entered or left a specific T-account. You must map out the beginning balance, the income statement expense/revenue, and solve for the missing cash plug. Mastering T-Accounts: Cash Paid for Insurance Scenario: Insurance Expense = $96,000. Prepaid Insurance (Asset) increased by $14,000 during the year. Find Cash Paid. Equation Logic: Cash Paid = Expense + Increase in Prepaid Asset = $96k + $14k = $110, 000. Prepaid Insurance (Asset) Dr. Beg Bal Cash Paid (Plug) = 110k Cr. 96k (Expense recognized) End Bal (+14k higher) Bal: . . . Mastering T-Accounts: Cash Paid to Suppliers (2-Step) Scenario: Cost of Goods Sold (COGS) = $780,000. Inventory increased by $40,000. Accounts Payable decreased by $25,000. Find Cash Paid. Step 1: Find Purchases via Inventory T-Account. Equation: Purchases = COGS + Increase in Inventory = $780k + $40k = $820, 000. Inventory (Asset) Dr. Beg Bal Purchases (Plug) = 820k Cr. 780k (COGS) End Bal (+40k higher) Bal: . . . Step 2: Find Cash Paid via Accounts Payable T-Account. Equation: Cash Paid = Purchases + Decrease in AP = $820k + $25k = $845, 000. Accounts Payable (Liability) Dr. Cr. Beg Bal 820k (Purchases from Step 1) Cash Paid (Plug) = 845k End Bal (-25k lower) Bal: . . . 8 Financial Accounting - Definitive Exam 3 Master Guide Chapters 9, 10, & 12 Mastering T-Accounts: Solving for Depreciation Expense Scenario: Beginning Accumulated Depreciation (AD) = $72,000. Ending AD = $95,000. Equipment sold during the year had $18,000 of accumulated depreciation. Logic: Accumulated Depreciation is a contra-asset (credit normal balance). It increases with Depreciation Expense and decreases when equipment is sold and removed from the books. Accumulated Depreciation Dr. 18,000 (AD of Sold Equip) Cr. 72,000 (Beg Bal) Depr. Expense (Plug) = 41,000 95,000 (End Bal) Bal: . . . Equation Check: $72, 000 − $18, 000 + X = $95, 000 → X = $41, 000. Mastering T-Accounts: Cash Paid for Equipment (Investing) Scenario: Equipment account increased by $200,000. Accounts Payable specifically related to equipment increased by $30,000. Find Cash Paid. Logic: You acquired $200k worth of equipment. But you financed $30k of it by increasing AP. Therefore, the actual cash that left the building is $200, 000 − $30, 000 = $170, 000. 9