FINANCIAL ACCOUNTING (D.

YOUNG) 1 OCTOBER 2007

•
1. Basic Objectives 4.
Expenses as actual incurred expenses
Completed Contract Method (JE 78-79)
 20
(4) 35
|
|
 40
(5) 10
|
|
Operating Cycle
A/P turnover
To allow better allocations of Capital market Ressources ♦Useful • All expenses capitalised (work in progress, construction  55 |  50 | Cash Cycle
to those making invest and credit decisions ♦ Provide info: in progress)
(A) Buildings & (A) Contra Acc 1. Operations: ROIC = Profit Margin x Total Asset
economic resour, claims and changes • Cash inflows generate a liability (Advance from
Equi pment Depreciation Turnover (example of desegregation)
Fundamental Concepts customer)
 100 | | 30  ROA=PMRxICT
Relevant - Past, Present, Future Events ♦ Reliable - Dependable, • Income and Expense recognition when client takes over
Reasonably Free Of Error ♦ Verifiable ♦ Comparable to other (6a) 135 | 10 (1a) (1a) 7 | 17 (2a) • Measure Firm profitability in using assets to generate
5. Instalment Method earnings (regardless how they finance the assets)
entities ♦ Consistent over time  225 | | 40 
• Revenue is recognised as cash is received • Very relevant to lenders/creditors (Return on asset
Recognition And Measurement Concepts • Recognise corresponding expenses (L) A/P (Suppliers) (L) A/P (Other)
Economic entity ♦ Going concern ♦ Monetary unit ♦ Periodically should > cost of asset)
6. Cost-Recovery-First (revenues | 30  | 10  • Higher = more efficient (in late 90’ US – 8-12%, EU –
Basic Principles &expenses=cash receipts) | 20 (7) | 2 (8)
Historical cost ♦ Accrual basis (recognize when goods are sold or lower)
• Match revenue $ for $ working expenses | 50  | 12  • The goal – maximise product of PM and TAT! If ↑ PM then
service rendered) Revenue recognise when realised ♦ Matching • Profit is recognised only after costs recovery
principle ♦ Full disclosure (L) Salaries Payable (L) Bonds Payable TAT ↓
How to cook the account : Barter, Front end loading (software | 5  | 0  1a.Profit(NOPAT) Margin Ratio = (Operating Income(1-T)
Constraints-Cost/Benefit ♦ Materiality ♦ Industry practice ♦ recogn full rev even if promise for future upgrades), Channel
Conservatism | 1 (9) | 100 (10) +EquityIncome)/sales
Stuffing (coke), Grossing up (Priceline), Present Value Game | 6  | 100  • Measures the firm’s ability to control expenses level
Abbreviations (Xerox), Vendor Finance ,round trip,bill &hold
(SE) Retained
relative to sales
B.P.
C.S.
Bond Payable
Common Stock
APIC
PMR
Additional PIC
Profit Margin Ratio 5. Cash Flow Statement Earnings
•
•
High indicates a lower cost for given sales level
To understand : we analyse pricing & brand equity,
CSE Common SE PV Present Value ∆$ = ∆Liab + ∆SE – ∆N$A ♦ ∆$ = CFO + CFI + CFF ♦C$ begin + ∆$ | 15 
EOF End of Financing R.E. Retained Earnings
= C$ end outsourcing, SWOT
(Period) S.H. ShareHolder (3) 8 | 20 (1)
Note : CFO+CFI+CFF (long term should be on average =0) 1b. Total Asset(ic) Turnover Ratio = Sales / Average Total
FV Future Value S.E. ShareHolder Equity | 27 
IE Interest Expense SYD Sum of the Years’ Digits CFO (includes paid interest on debt and received Dividends or assets (IC)
I.S.
FS
Income Statement
Financial Statements
TA
ICT
Total Assets
Invested CapitalTurnover
Interests on Invest) 6. Interpretation of Cash Flows • Tells how good is mngmnt at converting company’s
Activities directly related to revenues and expenses Key Relationship 1: COMPARE Net Income to CFO (WC) asset base into sales
LCM Lower Cost & Market XA Uncollectable Accounts
CFO>NI if not check! • Gives an insight on Fixed asset turnover and Working
M.S. Marketable Securities ~A Contra-Asset (negative) ♦ Net Income + Depreciation + Other NonCash
N.I. Net Income $ CASH • CFO shows how efficiently companies manage their Capital efficiency
Expenses (Provisions) – NonCash Income (Equity
PIC Paid In Capital.
operating cycle (buy material-produce, sell, collect – loop) • The higher – the better! Lower in more capital intensive
Income) -/+ Gain/Loss from sales of assets - ∆WCR
2. Balance sheet • Assets: all current (non-cash) & Liabilities: all current • Working Capital is what you put into business to make industries.
Assets Liabilities fixed assets work 1bi. Fixed Asset(PP&E) Turnover = Sales / PP&E net
• except short-term borrowing or debt  CFF (book-accum.depr)
Current Assets Current Liabilities • Increase in WC may signal problems – tied-up in useless
•  Dividends paid  CFF • Measures success in converting LT productive assets
Cash Payable places, eg inventory
CFI (buying/selling Fixed Assets or Financial instr(shares/bonds) into sales
Marketable (Account, Note,Interest, Net Working Capital = Current Assets – Current Liabilities
•  Other non-current assets  CFI • Decrease may show expansion with delayed payback
Securities/Stocks Salaries, Income Tax) WCR = total invested into operating cycle (inventory, A/R,
CFF (borrowing,paying principal ; Issuing & Buyback Shares, on investment
Short Term Adv. from prepaid expenses ;) - total invested by others into our
Dividend) • Increase may show cut back in capital expend (because
Investment Customer (Deferr. Rev) operating cycle (A/P, accrued expenses (wages, taxes),
Short-term and long-term borrowing & issue of capital stock of poor sales forecasts) or asset sales
Rent Received In advances from clients). This is cash needed to operate business,
•  Retained earnings : only dividend portion • Relate to (a) expansion for future growth or prep for
Receivables(Acct, Advance provided investment in fixed capital is complete (WCR<0
Columnar worksheet (indirect method) sales decline and (b) reduced investing on CF statement,
note,interst) Non-Current Liabilities Dell,Carrefour but not always good)
(Incr) Decr in ∆ BS CFO CFI CFF reduced depreciation:sales.
Inventories Bonds Payable Key Relationship 2 . Free Cash Flow (FCF) = CFO + CFI +
Assets • “Sales normally lag capital expenditures for a growing
Advances To Supplier Mortgage Interest Expense
A/R (35’000) (35’00
Prepaid Payable FCF represents what’s left before distribution to stakeholders company so decline in FA t/o need not concern”
Merch inv. (10’000) 0)
Insurance, Rent Deferred Income Build & Equip (125’000) (10’00 (125’00 • FCF is used to pay interest, return principle (bankers); • Accelerated depr- > high ratio, straight-ine depr- >low
Taxes Accum Depr 10’000 0) 0) dividends, buy back shares (shareholders) ratio
Non Current Assets Other • Value of the company depends on these 4 (future  Working capital analysis – efficiency of the company’s
Investment In (Provisions) 10’000 expectations of FCF) operating cycle
Securities Shareholders' Equity Incr (Decr) in • If FCF>0 then CFI<0 (giving back)  Operating cycle = Inventory period + Receivables
Liab. • If FCF<0 then CFI>0 (borrowing, can’t finance all Period
Land, Common Stock AP 20’000 20’00 The shorter - less investment & cash that company ties up in
Buildings & Preferred Stock activities internally)
Salaries payable 1’000 0 op.cycle - the better!
Equip(PP&E) Additional Paid In Bonds payable 100’000 1’000 100’00
• Want CFO>0, If CFO<0, must get cash from financing
Accumulative Capital (GAAP) (below) 1bii. Inventory Turnover Ratio,Inventory period (30-150
Common stock 2’000 0
Depr (~A) Retained Earnings Retained 13’000 2’000 • If Net Income >0 but CFO is <0, company can be days)
Leasehold (Indirect) earnings 20’00 (7’000) growing but has cash flow problems. Buying assets • Spe ed of inventory sale. Relate to potential loss of
Patent (Only If Treasury Shares 0 indicates expansion, ↑ inventory, AR  Lag between customers if inventory too depleted.
Purchased) O.C.Income (clean Incr (Decr) in (24’000) 6’000 (125’0 95’00 Income and cash flow • Impr ove by reducing manufacturing cycles, speeding
Goodwill (Only surplus acc.) Cash 00) 0 • If CFO > Net Income, this is assurance that company sales, improving distribution
If Purchased) Statement of Cash Flow for Year n really made profits 1biii. Accounts Receivable Turnover, Receivables period
Recognition – recorded and reflected in the FS CFO • Issuing debt & retiring equity increases leverage • Measures cash collection (times per year)
Assets Recognition Net income 20’000 • State what you see : change in income, • Some payments made in cash so in fact time is
• Firm has acquired rights to use in the future as a result Additions (↓A, ↑L): • change in CFO and its interpretation – sign of overstated
of a transaction Depreciation expense not using cash (~A) 10’000 growth/maturity/decline, • Compare to credit terms with customers
• Future benefits are measurable or quantifiable Increased Accounts payable 20’000 • asset replacement Vs depreciation,  Cash cycle = Inventory Period + Receivables Period –
Assets Valuation Increased Salaries payable 1’000 • CFO sufficient/insufficient for investing in fixed assets Payables Period
• Monetary Assets at NPV Non-Cash Expenses • Signs of weaknesses : CFO<0, increase in inventory, The shorter – the better – more operating cash flow
• Non-Monetary Assets at Acquisition cost (part adjusted Depreciation expense addback. X either big↑or ↓ of receivables, pay of dividends by selling 1biv. A/P Turnover(COGS+end inventory-begin
for depreciation) Amortisation expense addback..X asset or when not enough cash, no new debt – inability to inventory=purches),Payables Period
• Write-off if the asset is permanently impaired Loss on sale of assets..............................X borrow due to weak CFO, treasury stock or other • Incre ase indicates firm pays obligation to suppliers
Revenue recognition Increase in payables ................................X securities investments without enough cash. quickly, requiring cash, but smaller portion of payables
• Firm has performed all or most of the service or has Loss on retirement of bond.....................X As company grow, CFO↑, growth/investing↓, cash-in ↑, WCR↓, due in near future
received $ or equivalent Bond amortization....................................X FCF>0, start giving back • Higher A/P turnover will reduce cash
Expense recognition Decrease in NET receivables ..................X Cash Flows from: A B C D • Look at all 3 elements in inventory equation: purchases
• If a particular revenue causes an asset expiration or an Increase in deferred revenue, taxes or provisions X Operations (3) 7 15 8 = COGS + ending inv – beginning inv.
asset exprires Advances from customers.......................X Investing (15) (12) (8) (2)  Cash conversion efficiency ratio = CFFO / Sales
Increase in liabilities................................X Financing 18 5 (7) (6) 2. Rate of Return on Common Shareholders’
Liquid Assets Decrease in inventory.............................X Net Cash Flow 0 0 0 0 Equity
Cash Increase in other current liabilities........X ROE = ROIC x Adjusted leverage = PMR x ICT x
A. New, rapidly growing. Not yet operating profitably. Build ups
Marketable Securities Decrease in other current assets...........X CEL x CSL
of A/R & Inventories. To sustain growth must invest in PPE.
• Investment of current cash excess,convertible to cash Subtractions (↑A, ↓L): • Denominator: average Common Shareholder equity
Needs to rely on external sources of cash to finance
and Firm intend to convert them within a year Increased Accounts receivable 35’000 during the period
operations and investing – mainly SE (banks do not give
Accounts receivable – JE 52-55 (net of provisions for Increased Merchandise inventories 10’000 • Explicitly considering financing
much). FCF<0. Future for early growth: expect CFO ↑, for high
unpayments ~A) Gain on sale of assets (X) • Primary interest to investors in firm's common stocks
growth WCR↓, CFO>NI
Fixed Assets(PP&E) Lack of coupon payment over int exp (bond) (X)
Decrease in payables ...........................(X)
B. More seasoned than A but still growing. Operates profitably • ROE > ROIC→Earning more on borrowed money than
Acquisition cost - Include all relevant charges but since growth is slowing it has CFO>0. CFO not enough to cost of it.
Self-construct - Capitalise interest during construction Increase in NET receivables .................(X) finance investing in PPE- >still requires financing. FCF<0. • If ROE = ROIC then Company entirely financed by equity
Gain on retirement of bond..................(X) C. Mature, stable firm. Healthy cash flow from operations, more (all profits belong to shareholders)
Depreciation - Allocates cost of assets to periods of use
Decrease in deferred revenue, taxes / provisions (X) than enough to cover PPE acquisitions. Uses excess cash flow 2b. Adj. Leverage = Com.Earn. Lever. (CEL) x Capit Struct.
Land - Do not depreciate. Can be adjusted to market value
Decrease in liabilities............................(X) to repay financing from earlier and dividends. CFO>NI, robust Lever. (CSL)
under IFRS
Buildings - Salvage = 0 Increased inventories ............................(X) profit, large FCF give back to market, invest • Tells what percent of profits belong to shareholders(all
Decrease in other current liabilities. . .(X) D. Stages of decline. CFO begun ↓ but still >0 due to reductions equity firms=1)
Changes in Depreciation
Increase in other current assets..........(X) in A/R and inventories. Cut back on capital expenditure 2bi. Common Earnings Leverage
• Spread remaining undepreciated balance less new
salvage value over new remaining life Cash Flow from Operations 6’000 because it is in a declining industry. Uses some cash to repay • Net income/ NOPAT=(operting Income(1-T)+equity
CFI outstanding financing. Remainder available for investing in Income,net tax)
Repair & Maintenance
• Expense Acquisition of building (125’000) new products or industries. • Tells what % of unlevered profits belong to
Sale of Marketable Securities (non-cash equ) X Checks shareholders: if all-equity=1
Improvement
Sale of Non-Current assets (e.g. PPE) ............X • Good if CFO > NI + Depreciation + Amortisation 2bii. Capital Structure Leverage or Financial Leverage or
• Capitalise & amortise.
(this records the net cash form sale or purchase of assets) (JE • Accounts Payable and Accounts Receivable movement Leverage Ratio
Retirement
• Bring depreciation up to sale date 3-5) • Change in Debt situation (may affect ratios esp. Debt / • Measures capital structure
Goodwill (Adq. Costs – Fair Value + Debt) Can be negative Record principle on loans to others...............X Equity) • Increasing leverage ratio→increasing proportion of
Issue Bond ........................................................X • What happens to bottom line if you remove some large debt.
• Capitalise if purchased. Write-off if sufficient evidence of
impairment Increase in Leased Liability account..............X items • Financing with debt (and preferred stock) can increase
Decrease in Leased Liability account.........(X) • In CFF, if Div & Share buy back ↑ or big = very good $ the return on shareholders’ equity. If firm earns a rate of
Liabilities Purchase of Marketable Securities..............(X) back to investors return on IC (ROIC) that exceeds the rate it paid for the
Definition Retirement Bond..........................................…….. (X) • In CFF , change in capital structure for wacc or tax shield use of debt, the rate of return on SE (ROE) will increase >
1. Obligation involve future transfer of cash/goods/services on Acquisition of Non-Current assets...............(X) or because r ↓ ROIC.
a definite date Make loans ..................................................... (X) Cool Phrases • ↑ the proportion of debt to the capital structure, ↑ the
2. Little/no discretion to avoid the transfer Cash Flow from Investing (125’000) • Company is using CFO to finance Investing risk to common shareholders. Firm cannot ↑ debt without
3. The transaction related to the obligation has occurred CFF • Short-term investment of temporarily excess cash ↑ the cost of debt. As it adds more debt to the capital
Contingencies Proceeds from bond issued 100’000 • Preferred stock offers more latitude than LT debt structure, the risk of default or insolvency becomes
• Potential obligation Proceeds from common stock issued 2’000 • CFO should finance payment of dividends, if not seach greater.
• Should be recognised only if the impair/incur is Dividends paid (7’000) other reason like WalMart family big stake  their source • Financial leverage can enhance owners’ rate of return
probable and the amount of loss can reasonably Float (Issue) (Common) Stock.........................X of revenue in good years, but owners run the risk that bad earnings
estimated (JE 60) Incur debt (issue bonds, loans, notes pay).. .X • Acquisitions to provide operating cap to sustain rapid years will be even worse than they would have been
Current Liabilities Stock (shares) bought back..........................(X) growth without the borrowing. Common stock S/H are last.
• Appear at amount payable Repayment (reduction) of debt and CS......(X) • Low dividends payoff suggests that it expects capital Earnings per Share = NI / SE
Deferred Performance Liability Cash Flow from Financing 95’000 expenditures • Income attributable to common stock per share. Not so
• Receive cash for future service (advance payments) (JE Net change in cash (24’000) • Investing activities are using cash useful since it takes into account only cost of debt and not
61-63) Cash January 1 30’000 • Loan priniciple- CFF, loan interest-CFO/dividend cost of equity.
Long-Term Liabilities Cash December 31 6’000 received-CFO,payed- CFF Analyse adjusted leverage by analysis of Short-term and long- term analysis
• Mortgages,Notes,Bonds RISK ANALYSIS (1-4 short term-liquidity; 5-7long term-capital struct)
• PV of future payments at historical rate
Preparation of Statement of Cash Flow:
1. Obtain Balance Sheet (beginning & end of period)
7. DuPont Analysis Factors to consider:
Mortgage 1. ROE = measure earnings available to SH as % of equity • Economy-wide (inflation, int rates, unemployment,
2. Enter beginning & end balances in each account given recsn)
• Pay back every period interest & principal (JE 64-66) capital (both financing choices and operatin profitability)
in Balance Sheet • Industry-wide (competition, raw mats, technology)
• Mortgage Payable: = Cash - Interest Expenses - Interest ROIC-no leverage
3. Enter beginning & end balances for Cash • Firm-specific (strikes, loss of facilities)
Payable • If PMR * ICT ≠ ROA then stated PMR must be pre- interest
4. Reconstruct entries explaining change in Master • Liquid resources give flexibility against risk.
Notes effects  recalulate using new PMR
between beginning and end in each non cash Account • Compare inv t/o, a/c pay t/o, a/c rec t/o to determine
• Postpone equip purchase pay + interest (JE 67-69) • R/E (Closing) = R/E (Opening) + Net Income - Dividend
5. Net Income = Increase in Retained Earnings + liquidity risk and whether will need Short-Term financing
paid
Income Statement Dividends • Net Income > Cash from operation  Alarm 1. Current Ratio – (0.9-1.5) higher-firm safer
Net Operating (Sales) Revenues Selling equipment effect on CF statement (JE 3-5) • Shows firm's ability to meet its ST obligations (useless if
• Check whether “Debt Equity” = Debt / Equity or Debt –
Cost of Goods Sold Bonds, treasury stock and dividends CFO high (coke))
Equity
Gross (Operating) Profit Bonds: Gain/Loss on retirement: CFO -gain, +loss (CFF will have • Prob lems:1.Unsure how liquid current assets are
State: what’s happening; why; whether of concern.
Selling Expenses, General Sales & Administrative Expenses, the sale proceeds) (?Included already:) Issued/Less than par: + 2. Static B/S measure (so use CFO/Current
Salaries Insurance Expenses Int. Exp-Cash outpayment, Issued/More than par: - (Cash DON’T FORGET TO AVERAGE Liabilities)
R&D Expenses (for GAAP) or Research Expenses (IFRS) outpayment -Int. Exp); Limitations of ratio analysis:
• If curr ent ratio is small, need mitigating factors (e.g.
Depreciation Expenses • Dividends calculated (NI – RE) must be subtracted form • Disa ggregate ratios so can see sources of profitability
large cash from operation)
Operating Income CFF • Recognise that circumstances change in
• ↓ current ratio – less working capital and lower capital
Interest Expense • Create T account for PIC & CS, to track changes firm/industry/economy
charges
• Must be compared with some standard either trend of
Other Income
Income before Income Taxes
T-Account Worksheet ratio, or w/ industry
• Can be manipulated
Asset Accounts |Liability Accounts & S.H. • Growth will bring about increased investments in A/R
Less Income Taxes • Should be used as a pointer for further investigation
Equity and inventories
Equity Income (if Equity >20%) Profitability: ROIC, ROE
Dr (+) Cr. (-) | Dr (-) Cr. (+) • How is firm financed (e.g. bank loan vs. stretching A/P)
Net Income Efficiency: Invested Capital t/o (ICT), A/R t/o, A/P t/o, Inventory
Start Balances | | |Start Balances 2. Quick Ratio – (0.5-1.5)
t/o, PP&E t/o
3. Accounting Process  Short-term liquidity (risk): Current R, Quick R, CFO to Current
• Stronger than current ratio to test ability to pay
liabilities
Accrual Basis JE 88-94 Inc. (+) | Dec. (-) | Dec. (-) | Inc. (+) liabilities R.
End Balances | End Balances  • Numerator: use only cash and A/R (highly liquid assets)
• Recognise cash when goods are sold (delivered. Ex: Car Risk (long-term liquidity): Common Earnings Leverage R,
Cash Days of receivabls and inventory: better measure of risk than
manufacturer) Capital Structure Leverage R, Long-term debt R, Debt-Equity R,
 30 | quick and current rat.
• Expenses at period when revenue it helped produce Interest coverage R
Operations Notes: Retailers have negative cash cycles because of high
are recognised
Net Income (1) 20 | 35 (4) Incr A/R inventory turnover.
Adjusting Entries JE 80-85
Depr. Exp.(2a) 17 | 10 (5) Incr. Inv. 3. A/R Turnover inventory Turnover
Closing Temporary Accounts JE 86-87
Incr. A/P (7) 20 | ROIC ROE The shorter the period , the closer the receivables are realized
4. Revenue Recognition Incr. A/P to Oth (8) 2 | | | as cash
Revenues can be recognized if: measurable, earned and Incr. Sal. Pay.(9) 1 | Profit IC Profit IC 4. CFO to Current Liabilities Ratio– >40% (30-70%)
realizable Investing Levr • Not Static
1. Accrual Basis JE 88-94 Sale of Equip. (1a) 3 | 135 (6a)Acqu. of Build. Margin % turnov. ratio Margin % turnov ratio • If the ratio ↑ the company can tolerate lower current
2.Cash Basis Financing ratio ratios
• Recognise revenue when receive cash L.T. Bond Issue (10) 100 | 8 (3)Dividends | | | 5. Long term Debt Ratio
• Expenses when cash is paid  5 PP&E t/o as for ROIC as for ROIC CEL 6. Debt(all forms of financing) / Equity (60% utility; 30%
3.% Completion Method (for long-term contracts) INV t/o CSL industrial)
(A) Accounts (A) Merchanise A/R t/o • % of total assets financed by debt
• Sales revenue as % of completion
Receivable Inventory
FINANCIAL ACCOUNTING (D. YOUNG) 2 OCTOBER 2007
• Likelihood meeting fixed interest & principal • EP =EVA 1.focus on earnings instead of cash flow Impairment (Permanent) 2. Dividends received : Dividend Revenue or Cash (to BS & IS)
payments in future 2.better measure of year-on-year performance • If "Fair Value" > NetBV  Nothing (GAAP), increase but recognise revenue only when dividend is declared (JE
• Debt cheap but risky with regard to equity • Value(firm) = Ve + Vd = PV (future FCFs + financial NetBV (IFRS) 46)
• Do not consider availability of liquid assets assets) = IC + PV (future EP) = Current_Operation_Value • If "Fair Value" < NetBV  Write-off (JE 107) 3. Capital gain/loss : Market Value increase/decrease and
• Evaluate debt level: short term borrowing vs. long term (COV) + Future_Growth_Value • Once FV is used , updates required every year for all Unrealized Gains/Losses on Trading Securities (IS) or
borrowing • RONIC =increase inNOPAT over last year/increase in IC assets-costly barely used Unrealized Gains/Losses on Securities Available for Sale
7. Interest Coverage=Time Interest Earned (>3, probably over last year Asset retirement/Sale (JE 3-4-5, 13) (BS-OCI) (JE 47-48)
5) • Curr OperatingVal = IC + PV (future • Calculate the NetBV of what is sold: PPE – AccumDepr 4. Sale of Invesment: debits Cash and adjusts Realised Loss on
• Abil ity to pay its interest EP=EVA)=IC+EV/WACC=Market Value (PPE = PPEb + PPEperiod – PPEe) Investment Sale & credits Investment and adjusts Unrealised
• A rule of thumb – at least 5 for cyclical companies, but • Relative Evaluation(P/E) (AccDepr = AccDepr b + Period Depr – AccDepr e) Loss on Investments (JE 49)

•
often lower – lower rating when it issues bonds
EBITDA interest coverage ratio (also relies on
What is value-based management?
Creation of Shareholder Value should be the main goal because
12. Leasing Significant Active (Equity Method): AFFILIATES,associates
• 20 - 50 %  Some Influence
accounting earnings) if you create value for SH it means that you took care of clients, Benefits: potential tax adv, off-BS-financing and management of • Less than 20% if existence of significant influence by
• Cash interest coverage ratio (covered with "real" cash) employees, products,… obsolescence risk investor is evidenced
8. Free Op. CF to Total Debt (not incude A/P)ratio It’s about the alignment of key management systems and Operating Lease Method (JE 25-26) purchase agreement • Investment  Equity Method (change of share price 
• Covers not only the interests, but also the principal processes with the value creation imperative: Strategic • Not owner, Rent machine or building, Return at end of no entries)
lease
How Liquid is the Company planning,Capital allocation,Performance measure
Incentive compensation, Communication, Value – capital market • CFO: no impact (expenses already in Net Income) no
1. Acquisition : record initial investment at acquisition cost (JE
94)
Current Ratio, Quick Ratio, $Flow from ops to current liable ratio, expectations of the future cash-flows, discounted at a cost of journal entry 2. Earnings : increase Investments account of Sub Earnings (JE
Payable Turnover capital. • Early years: lower expenses, higher NI, reverse later 95)
• Short-term risk, Indicates ability to pay off debts as they • Net income is a good measure of of corporate years 3. Dividends : decrease Invesments acc. of Dividends and
fall due performance but does not take into account WACC, so NI Note: if necessary you can capitalize the operating debit cash (JE 96)
• SEE DuPont for details can improve w/o improving SH value lease before calcul ratios. 4. Sale of Investment: sales proceeds (cash), eliminate
(= Current Assets / Current Liabilities) If non-cancelable lease, liability since start, discounting back to
How Efficient is the Company 10. Uncollectibles / Bad Debts the day it started.
investment at BV, recognize gain or loss from sale of
Investment (IS) (JE 99)
Direct Write Off Method (JE 53-54) Capital Lease Method (JE 27-28) Majority (Control): SUBSIDIARIES
Ability to generate sales from asset (an asset is only good if • Decide on specific customer shortcomings in sale • Buy the asset, with payment arrangement
generates sales Rev.) • > 50 %  Control
period • Alternative method to finance the acquisition of a long- • Consolidation (show minority x% interest if firm has
Inventory Turnover (useless for service companies) • No matching, can manipulate earnings, wrong term asset
• Affects operation cost 100-x%,BS SE &IS)
receivable in BS • Equal to the lower of fair value and the PV of the
•
•
When COGS not reported use sales in numerator
Increase indicates more efficient but risk of shortages
Allowance Method (GAAP & IFRS) (JE 55-57) minimum lease payment 16. Financial St. Manipulation
• When firm can estimate uncollectible with reasonable Capital lease if at least one of the following conditions hold: Why managers do it?
Receivable Turnover precision • Transfers ownership to lessee at end of the lease term Profit-based compensation ♦ST boost Share Price ♦ Avoid debt
• Decrease may indicate risk of not being able to collect • Estimate can be adjusted by checking Debt Expense / • Transfer seems likely due to “bargain purchase” option covenants violations ♦Minimize political costs ♦Maximize
receivables %Sales or %historic A/R • Lease covers at least 75 % of asset’s economic life proceeds from IPOs
• Compare to payment terms (Days receivable = # days • Firm make adjustment against the year sales at end of • PV of lease payments ≥90 % of fair market val at the Evidence
to collect sales) the year time sign contract Profit Stream less volatile than business ♦Small reported losses
OPERATING CYCLE = Inv. Period + A/R Period • Reduces opportunity to manage earnings but can Cash Flow Statement are rare ♦Small reported profits are common ♦Small declines in
Plant Assets Turnover create hidden resurved • CFO : Interest expense already in Net Income (provide profit are rare ♦Small increases in profit are common ♦Meet or
• Decrease may show expansion with delayed payback • Also used for Product Returns and Repairs & tax-shield) exceed forecast is common ♦Just missing consensus forecasts is
on investment Replacement under Warr. • CFO↑ if the lease is capitalized as part of the expense rare ♦Huge discrepancies between accrued profits and CFO
• Increase may show cut back in capital expend (because (Dr. Sales Return & Allowances, Cr. Account Receivables) goes to CFF How
of poor sales forecasts) or asset sales Write Off for Next Period (JE 56) no effect on earnings , • CFF : adjustments to Lease Liability Recognize fictitious revenues ♦Recog rev too soon ♦Over/under
Cash Cycle = Inventory Period + Receivable Period – IS is unaffected Converting operating leases in capital leases (JE 29-30) provisioning ♦Uses reserves (cookie jar) to hide losses or
Payables Period(if <0 company is financing its • Allowance for Uncollectible is moved from Gross • Record asset at leases market value expenses ♦Mislabeling one-off gains ♦Labeling losses
customers) Accounts Receivable to Net Accounts Receivable • Cash = operating leases obligations (interest "noncontinuing" or "extraordinary
• Allowance account cannot be in debit it is a contra %liabilities, plug diff) Red flags
How Risky is the Company account Capital Lease Example (Lessee) Changes in acc. policies ♦Finan. St. inconsistent with business
Debt = BS + PV(operating leases) + securitized Estimating Uncollectibles (JE 16-17, 55) • Purchase computer of $ 45,000 with interest 15 % p.a. ♦Inconsistencies between FS and MD&A ♦Unusual
receivables (if off-BS) • Percentage Of Sales Method (defined by firm (over 3 years) wording in audit reports ♦Delays in FS release
• + contingent liabilities (when payout is likely) experience) • Annual payment = 45,000 * 15% / (1-1/(1+15%)^3) = $ ♦Weak control environment ♦Small audit firm
• + unconsolidated debt from affiliates (how much?) • Aging of Accounts Receivable Method 19,709 ♦Competitive pressure intensifies ♦Suspect
Ratio Analisis More costly but more accurate Classify accts by age and estim Amortisation Table management team ♦High-growth firms entering
• Debt-Equity ratio: Interest Bearing debt / SE the% per class Year Lease Interest Payment Lease Lease lower growth phase ♦Frequent on-time charges
• Interest coverage: Op Income/Interest (>5 for cyclical Analyzing Receivables n Start Expense (+/-) End ♦Large deferred tax assets ♦Growth in days of
bus., >3 for stable) • firm aggressive in revenue recognition-check A/R 1 45,000 6,750 19,709 + 12,959 32,041 inventory ♦Downward trends in CFO/Sales ♦Sharp
• EBITDA coverage: EBITDA / Interest expense • Receivable/Sale ration increase:lanient in credit 2 32,041 4,806 19,709 + 14,903 17,138 increase in receivables ♦Unusual increases in
• Cash coverage: (CFFO + Interest paid + Taxes) / terms/credit to risky customer/collection 3 17,138 2,571 19,709 + 17,138 0 intangibles ♦Reduction of reserves ♦Declines in
Interest paid proble/Revenue recog to early in operating cycle Capital vs. Operating Raw/Inv ♦Growth in SG&A/Sales ♦Large changes in
provisions ♦Abnormal growth of A/P ♦Operating
• FOCF / Total debt
Risk of Bankruptcy. Shows if the firm relies on debt or equity to
Inventory Accounting Policies Using above example assume:
• Total Company Liabilities =L (e.g. 200) leases for core assets ♦Securitizations that bypass
Inventories • Total Company Equity =E (e.g. 100) the BS
finance assets Merchandise / Raw Materials / Supplies / Work in process / •
Capital Structure
• Long term risk
Finished goods
Asset Value at End of Period
Capital Operating
=V
Apperance
(e.g. 50)
Journal Entries Dr. Cr.
• Begin Inventories(BI) + Purchases (P) – End Debt/Equity L/E (L-V) / E reduces riskiness 1. Net Income
Long Term Debt Inventories(EI) = CoGS
• The debt holders’ portion of the firm's long-term capital. ROIC V / (L+E) ~V / (L+E-V) increases ROIC Cash (Operations - Net Income).............X
• CoGS Available forSale = BI + Net Purchases ROE V/E ~V / E little impact on ROE Retained Earning.....................................X
Debt-Equity • Inventory includes all NECESSARY costs incurred to
•
•
% of total assets financed by debt
Likelihood of meeting fixed interest & principal
acquire & prepare for sale (interests are expensed) 13. Provisions & Contingencies 2. Depreciation Expense
Depreciation Expense .............................X
• Show inventory @ lower-of-cost-or-market (LCM  Provision (JE 108-110) (i.e restructuring)
payments in future Accumulated Depreciation .....................X
replacement) (JE 18) • PRESENT obligation to transfer benefits from PAST
• Debt cheap but risky with regard to equity Increase  No Decrease  Yes at Net Realizable event (legal/constructive obligation)
3. Equipment Sold @ 3 (Original cost 10,
• Do not consider availability of liquid assets Value • Probable out-flow of economic benefits to settle
Accumulated Depreciation 7)
• Evaluate total debt level: short term borrowing vs. long • Life on inventory journals(purches, manufacturing, obligation
Cash (Inventory: Sale of Equipment).....3
term borrowing Accumulated Depreciation......................7
finished, sold) (JE 100-103) • Reliable Evaluation of the amount of obligation
• Debt / total assets: company financed by who? Specific Identification Recorded as an expense (IS) and liability (BS) @ present
Buildings & Equipment..........................10
CFO to Total Liabilities 4. Equipment Sold-Loss @ 2 (Original Cost 10,
• Specific cost attached to each individual unit (on sale , value
• Consider the availability of liquid assets to cover debts inventory->COGS) Best estimate for minimum expenditure.No tax deduction
Accumulated Depreciation 7)
• > 20% for a healthy firm • Practical in firms w/ small num of expensive units Reversals:rduction taken to the provisions account uring a
Cash (Inventory: Sale of Equipment).....2
CFO to Current Liabilities Loss on Asset retirement.........................1
(automobile) year
• > 40 % for a healthy firm • Manipulation:boost earnings 1) pay a portion of liabilities 2)correcting over
Accumulated Depreciation......................7
Times Interest Earned (Interest Coverage) PP&E(at cost)..........................................10
FIFO (First-In-First-Out, Last-In-Still-Here) (most common) estimation,check for hidden reserve
• The relative protection that operating profitability Compared to LIFO Contingent Liability: does not meet any of the 3 (i.e litigation)
5. Equipment Sold-Gain @ 4 (Original Cost 10,
provides bond holders, indicating probability firm can Accumulated Depreciation 7)
• If prices are rising, lower COGS, higher Net Income, (JE 111-114)
meet required interest payments Cash (Inventory: Sale of Equipment).....4
higher taxes • POSSIBLE obligation &/or not probable outflow &/or not
• Has to be at least equal to 1 • Balance Sheet is more exact, Income statement is less reliable estimate
Accumulated Depreciation......................7
• High implies low long term solvency risk exact No impact on financial statements (disclosed in notes)
Gain on Asset retirement........................1
PP&E (at cost).........................................10
LIFO (Last-In-First-Out, First-In-Still-Here) To provide tax Contingent Asset (i.e cash receipts from a favorable lowsuit
How Profitable is the Company benefits settelment) 6. Dividend Payment
Profit (NOPAT) Margin Ratio (PMR) = (NI + IE) / Rev • COGS represents current costs (better matching) • POSSIBLE asset from past events whose existence Retained Earning......................................X
• Measure the firm ability to control expenses level LIFO Layers (Inventory costs from past years) depends on an event not wholly in control of the firm Cash (Finance - Dividend).......................X
relative to sales • If inventory declines company uses old LIFO layers  No impact on financial statements (disclosed in notes) 7. Accounts Receivable Increase
Accounts Receivable ................................X
Defer red IncomeTaxes

• Expresses expenses as % of sales Net Income increase(high profit)  Low Current Ratio Differencebetween BookIncomeand TaxableIncome(on tax stm t):
•
•
Permanent differences: bookincludes item that are non-taxable
Temporary differences: revenues and expenses taxable in another period

Cash (Operations.)...................................X
Disclosure in Notes (JE 41)

• Indicates the firm’s effectiveness to control level of (Current Assets are too small)and large tax bill Balance sheet appr oach
1.
2.
Identify at each balance sheet date the differencesbetween bookand tax income
Elim inate permanent differences

• 8. Merchandising Inventory Increase

3. Split remaining (Temporary) into futu re tax increases(Depreciation) and tax deductions (Warranty Liabilities)

cost/expenses relative to sales Can manipulate Net Income using year end purchases 4. Calculate 3 by the expected incometax rate to receivedeferred tax liabilities and deferred tax assets
IncomeTaxExpense  IncStm t  IncomeS tm t to Shareholders
IncomeTaxPayable TaxStm t  Effective cash due to TaxAu thorities

Merchandising Inventory.........................X
If TaxableIncome(TaxStm t) < Pre-TaxIncome(IncStm t)

• High indicates a lower cost for given sales level How much did company save by adopting LIFO?  IncomeTaxPayable < Income TaxExpense
 Deferred TaxLiability (credited) ( JE 43 )
Income Statemen t appr oach
O pposite=JE 44

Invested capital Turnover (ICT) = Rev / IC (average) • Difference in Ending Inventory (FIFO - LIFO) * Tax Rate 1. O n TaxStm t: calculate “Income TaxPayableC urren t”
Cash (Operations.)...................................X
9. Buildings & Equipment Acquisition
= EBT TaxStm t * tc

• Measures firm’s ability to generate sales from Average Cost 2. Deferred IncomeTaxes= ( EBT TaxStm t – EBT IncS tm t) * tc

3. Buildings & Equipment............................X

• CoGs available for sale / Number of Units available for
O n IncStm t: insert “Income TaxExpense” =

particular level of investment in assets IncomeTaxPayable– Deferred IncomeTaxes= EBT IncStm t * tc

• Breaks down into A/R, Inventory & Plant Asset Turnovers sale (= avg cost per unit) 14. Shareholders Equity 10.
Cash (Investments)..................................X
Accounts Payable Increase
• To improve it, increase sales without investing in assets • Operating Margin + Realised and Unrealised Holding Fundamental Principle: issuance, repurchase, distribution of
• Any other assets? Gains is same for LIFO & FIFO Cash (Operations)....................................X
stock should have no impact on net income
• High indicates that company requires less total assets • If inventory turnover is high, little difference between Accounts Payable .....................................X
Check Price-to-book value ratio. On average co with low P/B
per sales dollar methods 11. Salaries Payable Increase
perform better.
Leverage = IC (average) / CSE (average) • All transactions involving inventory affect Operations Cash (Operations)....................................X
Companies are sold 3 or 4 times their book value (not true for
• Increas es ROE when ROIC > after-tax cost of debt part of Cash Flow Salaries Payable ......................................X
holdings: P/B=1)
Return on Invested Capital (ROIC) = PMR * ICT Usually • NI FIFO >NI Avg Cost >NI LIFO (rising prices for Contributed Capital = Common Stock (par) + APIC 12. Long Term Bond issue
between 5% and 12% See Dupont inventory) Common Shares (vote + dividends + residual claim) Cash (Financing).......................................X
Return on Common Shrhlder Equit (ROE) = PMR * ICT * Inventory Tracking Table • Usually have par value, when issued, "APIC" is the Bonds Payable ..........................................X
Leverage (≈20%) Total values Units Unit Cost FIFO LIFO Wghtd excess of received market value over par: 13. Retirement of Asset
• Measures firm’s performance in using assets to Av. Cash (100x100)...............................10,000 Cash .................................................1,000
generate profits Inventory (Start Period) 100 2,200 2,000 2,100 Capital Stock (100x10).....................1,000 Accumulated Depreciation..............5,000
• Explicitly considering financing Purchases (June 12) 100 12 1,200 1,200 1,200 Additional Paid-In Capital (100x90)..........9,000 Equipment..........................................5,500
• Primary interest to investors in firm's common stocks Goods available 200 3,400 3,200 3,300 Preferred Shares (senior Claim + often dividend) Gain on Sale of Equipment (IS)..........500
• Numerator: deduct preferred shareholder’s dividend Withdrawl (June 14) (120) (2,440)(1,600) • Cumulative div. pref: div. in arrears must be paid 14. Bad Debt Write-Off

even if none declared if there is a cumulative feature (1,980) before common div.
15. One specific account value $ 1.000 becomes uncollectible

Inventory (End Period) 80 1,000 1,600 1,320 16. Increased Depreciation Allowance for Year Y
• Denominator: CS + CS’s share of PIC + CS’s share of RE Employee Stock options Bad Debt Expense from Year Y Sales (I/S)........X
(less cumulative preferred dividends) - treasury stock Periodic • No entry when stock option is granted (JE 31) Allowance for Uncollectible Accounts (or A/R)
• To calculate Leverage from ROE, PMR and ICT we must • Count inventory at end of period Can’t measure Convertible Bonds (JE 36-37) - two options under GAAP: X
assume no minority interest shrinkage • Ignore the market price of the bond 17. Decreased Depreciation Allowance for Year Y
• When Leverage ≠ ROE / ROIC there must be some • Group all purchases together and calculate ending • Convertible Bonds Payable + Loss = Market value of Allowance for Uncollectible Accounts from Year Y sales
minority interest inventory / COGS using LIFO / FIFO / Average Weighted shares X
ROE > ROIC Perpetual (JE 19) Retained Earnings Gain from allowance for Uncollectible Accounts (or
• Earning more on borrowed money than cost of it • Record COGS when take item from inventory • Portion of the profits reinvested in the company (RE = A/R) X
ROE approaching value of ROIC Physical count enables measurement of shrinkage NI – DIV)
18. Decreased Value of Inventory (Lower of Cost
•
•
Company entirely financed by equity
Denominator in ratio - use CS only
11. Depr/Amort - PP&E Treasury Shares (JE 38-39) (GAAP don’t cancel buy-backs 
reissue) or Market)
Acquisition Loss from decline in value of Inventory X
Earnings / Share of CS approaching value of Price / Earnings • All “profits/losses” from resale of treasury shares are
• All NECESSARY expenditures made in acquiring & Inventory...................................................X
ratio set against Additional paid in Capital (if not possible, debit
preparing the asset (JE 104) 19. Inventory Loss after Stock Count
• Compare to industry norms Retained Earnings)
INDUSTRY TRENDS • Discounts are substracted (of the acq. cost) Interests Loss from Inventory Shrinkage..............X
• Assumption for treasury shares is either FIFO or
• HOTELS : low inventories, high PP&E are expensed Inventory...................................................X
weighted average
• BANKS : No inventory, lots of $ A/R and marketable Depreciation / Amortization (allocate asset cost over a 20. Bond: Issue
• Requirement of firm’s common stocks 21. Bond: First interestpayment (after 6 month)

securities, high Debt certain time) 22. Bond: Second Interest Payment (after 12 month)
• If reissue price < purchase, debit Additional PIC when 23. Bond: Last Interest payment

• AIRLINES: high PP&E, low receiv., low inventory • Depreciation  Tangible assets♦ Amortization  24. Bond: Repayment of Principal
possible, if not debit Retained Earnings
(replacements) Intangible assets 25. Operating Lease (Lessee)
• Used for stock options
• SERVICE Co (adv): low or no inventory, high SG&A, high • All Depreciation Expenses are journalised in a contra Rent Expense...................................19,709
Stock Split
receivables asset account (Depreciation Expense / Accumulated Cash..................................................19,709
• No entry required, just adjust par value
• RETAILER: high COGS, low profit margin, low A/R, high Depreciation) : (JE 2) 26. Operating Lease (Lessor)
• Decreases Share Price  more liquidity  increases
PP&E • Economic useful life(benefit) vs. Acquision Inception
value
• TECH co: High R&D, little inventory(outsource), low debt cost=depreciable basis Equipment (based on cost) 39,000
Stock Dividend (split < 25%) JE 40
due high risk • Salvage can be negative (require disposal expendures) ..........................................Inventory...........39,000
• Amount transferred from Retained Earnings to CS+APIC
• SOFTWARE: No inventory, intensive R&D, high profit • NetBookValue = Cost less Accum Depreciation w/o Periodic Entries
Book Value per share = Book Value of Total SE / # shares
• PHARMA: high R&D,high profit margin, high FCF subtracting salvage value Cash ...............................................19,709
outstanding
• MOTOR : some R&D, everything is average • Depreciation stops when NetBV reaches Salvage Rent Revenue ..................................19,709
• UTILITY: massive assets, high D/E ratio, High Depr., Low
•
Value(plains)
Repair and maintenance are expenses (JE 105)
Marketable Sec & Investments Depreciation Expense (based on cost)13,000
margin Minority Passive Investments (Market Value Method/Cost Accumulated Depreciation ............13,000
• TELECOM OP: High Fixed assets, high LT Debt, high • Improvements need to be capitalised (JE 106) Method) 1. Capital Lease (Lessee)
SG&A (increase) 1. Straight Line (time) Method • < 20 %  No influence Inception
• CONSUMER : spend enormous amount on Advertising • Period Depr = (Cost - Salvage Value) / Estimated useful • Marketable Securities(ST securites)  Market method Capital Leased Asset (PV of asset based on PMT)
and some R&D Life • Debt securities  Cost method 45,000
2. Straight Line (units of product) Method (km,barrol of Capital Lease Liability (in Long-Term Debt)
8. Valuation oil)
Trading Securities (TS):ST -buy and sell .(changes in MV-
>IS,violating earning) (JE 50) 45,000
Shareholder Value - Value based management (EV=DCF) • Rate = (Cost - Salvage Value) / Estimated units prodced Available-for-sale account (AFS): LT -wait for dividend 2. ............................Periodic Entries
• VALUE = FCF1/(1+WACC)+FCF2/(1+WACC)^2+… over Life income/capital gain (common) Interest Expense (i.e. 15 % of 45,000)6,750
(DCF ) 3. Declining Balance Method /Acclerated Mathod-good for (changes in MV->BS. (Dr. Investment(the diff), Cr. OCI(the diff)(SE Capital Lease Liability (plug : 19,709 - 6,750)12,959
• FCF=EBIT(1-T)+depreciation-investment=NOPAT- tax account)) (JE 51) Cash (agreed PMT)..........................19,709
change in IC • Period Depr = NetBV at start of period * FACT%(=2) / 1. Acquisition: record initial investment at acquisition cost (JE Depreciation Expense (PV of asset / n )15,000
• IC=investment in working capital+PP&E- depreciation Periods of Life 45) Acc Depr of Leased Asset (e.g.Computer)
• EconomicProfit=EVA=NOPAT(I/S)-(Invested Capital(B/S- • Salvage value is not taken in account up front 15,000
debt+SE) * WACC) = (ROIC – WACC)*IC 3. Converting Operating Lease into Capital Lease
Inception
FINANCIAL ACCOUNTING (D. YOUNG) 3 OCTOBER 2007
Leased Asset (PV of operating leases) 8,000 39. Liability (Mortgage): End of year (mid-period Repair expense ..................................X
Lease Liability (in Long-Term Debt).........8,000 with respect to loan payment) Cash...........................................................X
4. ............................Periodic Entries Interest Expense.......................................X 80. PP&E: improvment
Interest Expense (i.e. 10 % of 8,000).800 Interest Payable .......................................X PP&E .....................................................X
Lease Liability (plug : 1,300-800).......500 40. Liability (Mortgage): Periodic mortgage Cash...........................................................X
Cash (operating leases payments)..........1,300 payment 81. PP&E: Impairment
Depreciation Expense (PV of asset / n )15,000 Interest Expense.......................................X Loss on Impariment ...........................X
Acc Depr of Leased Asset ()...........15,000 Interest Payable (only after mid of Y)....X PP&E ..........................................................X
Mortgage Payable ....................................X 82. Provisions: charges
5. Employee Stock option Cash...........................................................X Expenes & Losses ..............................X
Cash & Tax Payable(sharet @ mkt price + Tax benefit) 41. Liability (Notes Receivable): At Purchase Provisions ..................................................X
35,000 Equipment.................................................X 83. Provisions: Reversals
Common Shares (Par)......................5,000 Note Payable (cash price of equipment). X Provisions ............................................X
Additional Paid-in Capital...............30,000 42. Liability (Notes Receivable): End of Year Cash...........................................................X
6. Stock Warrant:: Issue Interest Expense.......................................X 84. Provisions: Unused provisions
Cash ...............................................15,000 Note Payable ............................................X Provisions ............................................X
Common Stock Warrants...............15,000 43. Liability (Notes Receivable): At Payment Other Incme & Expenses........................X
7. Stock Warrant:: Exercise Note Payable .............................................X Operating Profit.......................................X
Cash .............................................200,000 Cash...........................................................X Income Tax expenses ..............................X
Common Stock Warrants...............15,000 44. Recognise Revenues 85. Contingencies: establishment of provision for litigation
Common Stock - Par value.............50,000 Asset (A) Increase OR Liability(L) Decrease ....X Litigation Expenses ............................X
Additional Paid in Capital...............165,000 Revenues (IS)............................................X Provisions ..................................................X
8. Stock Warrant:: If warrant expires without 45. Record Expense 86. Contingencies: litigation-related expenditures
exercise Expense (SE).............................................X Provisions ............................................X
Common Stock warrants ...............15,000 Asset (A) Decrease OR Liability(L) Increase Cash...........................................................X
Additional paid in capital...............15,000 X 87. Contingencies: increase provisions
9. Convertible Bonds: Issue 46. Dividend Declaration Litigation expenses ............................X
Cash ...............................................10,000 Retained Earning (SE)..............................X Provision...................................................X
Convertible Bond Payable .............10,000 Dividends Payable (L).............................X
10. Convertible Bonds: Conversion 47. Record Dividend Payment
Convertible Bonds Payable (book value) 10,000 Dividends Payable (L)..............................X
Common Stock (par value)..............2,500 Cash...........................................................X
Additional Paid in Capital (C)...........7,500 48. Purchase Merchandise on account
11. Convertible Bonds: Using Market Price of Merchandise Inventory............................X
Shares Accounts Payable .....................................X
Convertible Bonds Payable ...........10,000 49. Sell Merchandise for Cash & On Account
Loss (Gain - C) on conversion of bonds 5,000 Cash ........................................................X
Common Shares (par value)...........2,500 A/R ........................................................X
Additional Paid in Capital...............12,500 Sales Revenue (SE)..................................X
12. Treasury Shares: Purchase of 1,000 shares par 50. Cost of Goods Sold
value $ 1 for $ 1,200 Cost of goods sold (SE)............................X
Treasury shares - common stock....1,200 Merchandise Inventory............................X
Cash (no IS or RE effect on resale of own shares) 51. Record Salaries Payment
1,200 Salaries Expense ......................................X
13. Treasury Shares: Sale @ $ 1.400 Cash...........................................................X
Cash .................................................1,400 52. Income Recognition: Completed Contract
Treasury shares (at acquisition cost JE 38) Method
1,200 Cash ........................................................X
APIC (credit/debit if reissue >< purchase price) Advance from customer ..........................X
....................................................200 Construction in progress.........................X
14. Dividends: Declaration (can go via Dividends Cash (actual outgoings)...........................X
Payable) 53. Income Recognition: When work is completed
Retained Earnings.............................1,000 Cash (remaining payment).....................X
Dividends payable ............................1,000 Advance from Customer (balance of prepayment) X
Dividends payable ............................1,000 Sales Revenue..........................................X
Cash....................................................1,000 Expenses ...................................................X
Stock Dividend Construction in progress (balance in account)
Retained Earnings (limits future availability of dividends) X
X Cash (outgoings in period) .....................X
Common Stock.........................................YAdditional
Paid in Capital......................................................Z 54. Adjusting Entry: Recognition of Accrued
Revenues (Interest earned but not due)
15. Income Taxes (Deferral) Interest Receivable (A)............................X
Income Tax Expense............................800 Interest Revenue (IS)...............................X
Deferred Tax Asset (Calc. 4 Yr 2 - Calc. 4 Yr 1)200 55. Adjusting Entry: Recognition of Accrued
Deferred Tax Liability (Calc.4 Yr 2 - Calc.4 Yr 1) Expenses (e.g. Salaries accrued (not paid) during
100 last days of accounting period)
Cash or Income Tax Payable ..............900 Salaries Expense (IS)...............................X
16. Long Term Minority Passive Investments (adjusting to LCM)
Salaries Payable (L).................................X
17. Deferred Liability: Incurring Taxes
56. Adjusting Entry: Prepaid Operating Costs
Income Tax Expense................................X
(Payment of 3 year insurance premium (1/1))
Income Tax Payable or Cash..................Y
Prepaid Insurance....................................X
Deferred tax Liabilities...........................Z
Cash...........................................................X
18. Deferred Liability: Paying Deferred Tax
57. Adjusting Entry: (31/12) to Recognise
Income Tax Expense................................X
Insurance Expense
Deferred Tax Liabilities...........................Z
Insurance Expense ...................................X
Income Tax Payable or Cash..................Y
Prepaid Insurance....................................X
19. Investment: Acquisition (incl. tax + other) 58. Adjusting Entry: Depreciation
1,000 @ 45 Depreciation Expense (IS)......................X
Investment.......................................45,000 Accumulated Depreciation (XA).............X
Cash..................................................45,000 59. Adjusting Entry: Valuation of Liability
20. Investment: Declared Revenue from Dividend 1/12 - Receive 1 year’s rent
Cash (or Dividend Receivable) ...............X Cash ....................................................600
Dividend Revenue (IS).............................X Advance from tenants.........................600
21. Investment: Valuation at LCM (end Yr2 market 31/12 - Recognise 1 month’s rent revenue
price @ 41) Advance from tenants (L)......................50
Unrealised Loss (TSIS ♦ AFSBS SE) 4,000 Rent Revenue (IS)..................................50
Investment.........................................4,000 60. Closing Temporary Accounts: Debit Balance
22. Investment: Valuation at LCM (end Yr3 market (Expense Account)
price @ 44) Retained Earnings (SE) ...........................X
Investment.........................................3,000 Account with Debit Balance....................X
Unrealised Loss (TSIS♦AFSBS SE)......3,000 61. Closing Temporary Accounts: Credit Balance
23. Investment: Selling (market price @ 55) (Revenue Account)
Trading Security Account with Credit Balance ..............X
Cash ...............................................55,000 Retained Earnings (SE)............................X
Investments (at BS value)..............44,000
62. Accrual Basis: Buy Raw Material on Account
Realized Gain on Sale (IS)..............11,000
Raw Material Inventory..........................25
Security Available for Sale
Account Payment...................................25
Cash ...............................................55,000
63. Accrual Basis: Transfer Raw Material of 20 to
Investment (at acquisition cost)....45,000
Production Department
Realized Gain on Sale of AFS (IS)..10,000
Work-in-Process Inventory....................20
Investment.........................................1,000
Raw Material Inventory.........................20
Unrealized Loss (BS SE)...................1,000
64. Accrual Basis: Pay Salaries (40 to Factory
24. Investment:chng in Market Value- Workers & 20 to Administration)
AFS( cost@5000,MarketValue@6000) Work-in-Process Inventory....................40
Investment 1000 Salaries Expense ....................................20
Other Comprehensive Income(BS SE)......1000 Cash.........................................................60
25. Investment:chng in Market Value- 65. Accrual Basis: Depreciation on Building &
TS( cost@5000,MarketValue@6000) Equipment Factory (-8) & Administration (-2)
Investment 1000 Work-in-Process Inventory......................8
Unrealized Gain..................................1000 Depreciation Expense ..............................2
26. Accounts Receivable: Increase Accumulated Depreciation ...................10
Account Receivable (BS)..........................X Accrual Basis: Finished Goods (FG) Inventory 40
Sales Revenue (IS)...................................X Work-in-Process Inventory....................40
27. Uncollectible: Direct Write Off 66. Accrual Basis: Sales (Total 75)
Bad Debt Expense (IS)............................X Cash ......................................................50
Accounts Receivable (BS).......................X Accounts Receivable ..............................25
28. Collection after Write Off: Direct Write Off Sales Revenue........................................75
Cash (BS)...................................................X 67. Accrual Basis: Costs of Goods Sold ( Total 42)
Other Income (IS).....................................X Cost of Goods Sold (SE)..........................42
29. Uncollectible: Allowance Method (at time of Finished Good Inventory (A).................42
sale) 68. Long Term Investment: Purchase (pay 50, 30%
Bad Debt Expense (IS).............................X investment)
Allowance for Uncollectible Accounts (~A A/R) Equity Investment (Full Cost)................50
X Cash.........................................................50
30. Uncollectible: Allowance Method (write off for 69. Long Term Investment: Subsidiary Income (20
next period) NetIncome,30%)
Allowance for Uncollectible Accounts (BS)........Y Equity Investment (% Ownership of Earnings). 6
Accounts Receivable (BS).......................Y Equity Income (IS)....................................6
31. Collection after Write Off: Allowance Method 70. Long Term Investment: Dividend from
Cash (BS)....................................................Y Subsidiary (10 dividend,30%)
Allowance for Uncollectible Accounts (BS) Cash (Ownership % of Total Payout)......3
Y Investment in Stock of X..........................3
71. Long Term Investment: Income from Subsidiary
32. Notes Receivable: At Year End before Note 72. Long Term Investment: Goodwill Amortisation
Payment (Overpaymt/Periods)
Interest Payable ........................................E Investment Income (Cost over Market Value / Periods)
Interest Revenue......................................E 30
33. Fixed Asset: Bring Depreciation up to Sale Investment in Stock of Company X (% Ownership)
Date 30
Cash .......................................................23 73. Long Term Investment: Sale
Accumulated Depreciation....................30 Cash ....................................................660
Equipment...............................................50 Investment in Stock of Company X...........633
Gain on sale of equipment (to I/S) .........3 Gain on Sale of Investment in Company X
34. Liabilities: Recognising Contingency 27
Loss from Damage Claim (I/S)................X 74. Inventory :purches
Estimated Liability for Damages (B/S).....X Raw materials and supplies ...................X
35. Liability: Deferred Performance (receipt for Cash/Account Payable .............................X
future service/good) 75. Inventory: manufacturing process begin
Cash ........................................................X Work in process inventory......................X
Advances From Customer .......................X Raw materials and supplies ...................X
36. Liability: Warranty Outstanding 76. Inventory: when product completed
Warranty Expense (I/S)............................X Finished goods inventory........................X
Estimated Warranty Liability..................X Work in process inventory......................X
37. Liability: Specific Repair Made 77. Inventory: inventory sold
Estimated warranty liability....................X COGS .....................................................X
Cash/Inventory.........................................X Finished goods inventory........................X
38. Liability (Mortgage): Borrow the money 78. PP&E: initial recognition
Cash ........................................................X PP&E .....................................................X
Mortgage Payable ....................................X Liability......................................................X
79. PP&E: repair