Revision Notes Financial Accounting for Business Students - Chapter 1-12 (complete) - PDF

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Download Revision Notes Financial Accounting for Business Students - Chapter 1-12 (complete) - PDF

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Chapter 1 - Introduction to Financial Accounting and Financial Statements Key Financial Statements: -Statement of financial position (balance sheet) -Income statement -Statement of changes in shareholder’s equity/changes in retained earnings -Cash flow statement -notes to financial statements The Balance Sheet: Assets

Current Assets

Liabilities and Sh/E Current Liabilities

Noncurrent Liabilities

Noncurrent Assets

Contributed Capital

Retained Earnings

Assets = Liabilities + Owner’s Equity Assets are: future economic benefits controlled by the company. They arise from past transactions or events. Examples: cash, accounts receivable, inventory, fixed assets, intangible - patents, goodwill, copyrights, etc. Classification of assets: On a balance sheet, assets are ordered from most to least liquid. They are classified as current (expected to be converted to cash within one year) and non-current (will not be converted to cash for more than a year or will provide future benefits for more than one year. Current Assets: Cash - cash and cash equivalents, temporary investments Accounts Receivable - amounts receivable from customers, report at amount expect to receive.

Inventory - three types: finished goods (ready for sale), work in progress (partially complete), raw materials Non-Current Assets: are assets that will provide benefits over several periods. They are long-term investment There are capital (tangible) assets (land, building, equipment, vehicles) and intangible assets (patents, trademarks, goodwill) Liabilities: are future duties or responsibilities that are met by transfering assets or providing services. They are typically reported in order in which they are due. The company is obligated to pay them. They arise from past transactions or events (account payable, salaries and wages payable, taxes payable, notes/mortgage payable, unearned revenue) Current Liabilities: are dues or to be settled within on year. Examples: accounts payable, salaries payable, accrued liabilities, current portion of long-term debt, unearned revenue. They are typically reported int he order in which they are due and include current portion of long-term debt. Long-Term Liabilities: due at some point after one year. Examples: mortgages, notes payable, capital lease obligation, employee future benefit obligations. Shareholder’s Equity: owner’s equity in a firm is a residual interest. Owner’s have a claim only on asset, they are not required to meet the claims of creditors. •Common Stock/Common Shares: amount contributed directly by shareholders when stock or shares first issued. •Retained Earnings: represent cumulative net income retained by the company (less any dividends paid out to shareholders) over the life of the company; undistributed surplus. They are earnings which are reinvested in the company, rather than distributed to shareholders The Income Statement •Shows the company’s net income or net loss for a given period of time •“for the year ended December 31, 2011” •NI=Revenues - Expenses •Measures profitability or performance of business •Note: decision to measure performance for a one year period is arbitrary - it represents a standard convention.

Sales -Cost of Goods Sold Gross Profit -OperatingExpenses Operating Income +/- Other expenses/revenues Net Income Before Taxes -Income tax expense Net Income

Companies typically provide very little detail in their income statemnents Statement of Change in Shareholders’ Equity •Show the change in each of he shareholders’ equity items from the beginning of the year to the end of the year •Contributed capital (common stock/preferred stock) increases by new investments made by shareholders; decreases by repurchase of stock by company •Retained earnings increases by net income and decreases by dividends decalred to its shareholders Cash Flow Statement •This statement gives information on the sources and uses of a company’s cash which serves as a complement to the Balance Sheet and Income Statement •Sources and uses of cash can derive from operating activities, investing activities, and financing activities Accounting Standards in Canada •Publicly Accountable Companies must follow International Financial Reporting Standards (IFRS) •Private companies have the option to follow Accounting Standards for Private Enterprises (ASPE) or IFRS’s •Nonprofit organizations follow standards for non-profit enterprises

Chapter 2 - Accounting Information Systems Accounting Cycle Flowchart shows how we get to financial statements (See handout) Recording & Posting the Transaction: 7 step approach The Thinking Part 1. Understand the financial/economic transaction 2. Identify the accounts involved in the transaction (e.g. cash, revenue, see chart of accounts) 3. Determine whether the accounts identified in Step 2 are ASSET, LIABILITIES, EQUITY, REVENUES or EXPENSES 4. Identify the debit side (left) and credit side (right) of the transact ion The Recording Part 5. Write down the journal entry for the transaction in the General Journal (Journalizing) 6. Draw T-accounts for each identified in step 2. Record the amounts in the appropriate columns in the T-accounts (Posting). T-account could be considered General Ledger (G/L) Account. 7. Post to →Trial Balance: Total Debits = Total Credits and A = L + SE Completing the Cycle •Posting all journal entries to ledgers (T-Accounts) •Prepare a trial balance (next slide) [by taking final balance from each G/L account] •Prepare financial Statements

Chapter 3 - Accrual Accounting The Accounting Cycle •the chart of accounts - a listing of all accounts used by an entity •journal entries •posting to ledgers •the trial balance •financial statement preparation Transactions that Impact the Statement of Income •statement of financial position accounts are permanent accounts in that their balances carry over from one fiscal year to the next •income statement accounts are temporary because they get reset to zero at the beginning of each fiscal year Conceptual Framework •Objective of Financial Statements -useful information to creditors and shareholders for economic decision making -show results of management stewardship •Basis of Accounting - Accrual Accounting •Going concern assumption - entity will exist for foreseeable future •Matching principle Characteristics of Financial Statements

Income Statement Concepts •Two possibilities for measuring performance: 1. Cash basis • revenues are recorded (“recognized”) when cash is received from customers • expenses are recorded when cash is pais out to suppliers • NOT acceptable under IFRS or ASPE 2. Accrual Accounting -revenues are recognized when goods are sold or services rendered, regardless of timing of receipt of cash • gives rise to accounts receivable -expenses are recoded in the period in which the revenues to which they relate are recorded (matching principle) • gives rise to accrued liabilities Matching Principle • Match expenses to period in which corresponding revenue is recognized -prepaid expenses -depreciation expense -unearned revenue -expense accruals Adjusting Entries - Prepaid Expenses • costs are initially recoded as assets and allocated to expenses of future periods • examples: -prepaid rent and insurance -office supplies -plant and equipment Adjusting Entries - Unearned Revenues • Cash received in advance of service provided - the unearned revenues are classified as liabilities until the service is rendered • examples: -rent collected in advance -subscriptions collected in advance -gift certificates -deposits on special orders Adjusting Entries - Accrued Liabilities • expenses incurred in current period, but for which payment will occur in future periods -no cash flow on recording, only when paid • examples: payroll, income taxes, interest, electricity Adjusting Entries - Accrued Asset • record revenue and corresponding receivable in period earned, receive payment in the future

• examples: credit sale, rent revenue, interest receivable The Accounting Cycle Revisited 1. Collect and analyze information 2. Journalize transactions 3. Post journal entries to general ledger 4. Record and post adjusting journal entries 5. Prepare financial statements 6. Close the accounts Closing Accounts • all expense and revenue accounts are temporary accounts - at year end they get reset to zero; offsetting amount is net income and gets recorded to retained earnings • dividends are normally debited directly against the retained earnings account •

Chapter 4 - Revenue Recognition and Merchandising Operations Revenue: the gross inflow of economic benefits during the period arising in the course of the ordinary activities of an entity when those inflows result in increases in equity, other than increases relating to contributions from equity participants Revenues from the Sale of Goods • revenue from the sale of goods shall be recognized when all the following conditions have been satisfied -the entity has transferred to the buyer the significant risks and rewards of ownership of the goods; -the entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold; -the amount of revenue can be measured reliably; -it is probable that the economic benefits associated with the transaction will flow to the entity; and -the costs incurred or to be incurred in respect of the transaction can be measure reliably Revenues from the Rendering of Services • service revenue is to be recognized on the percentage of completion basis if the following conditions are present: -the amount of revenue can be measure reliably; -it is probable that the economic benefits associated with the transaction will flow to the entity; -the stage of completion of the transaction at the reporting date can be measure reliably; and -the costs incurred for the transaction can be measure reliably • when the outcome of the transaction involving the rendering of services cannot be estimated reliably, revenue shall be recognized only to the extent of the expenses recognized that are recoverable Rendering of Services Example A company sells 3 year extended warranties for $180 each. Assume that 100 of these extended warranties are sold on Jan 1, 20x1. In 20x1, costs to service the extended warranties are $3,000 and expected costs in 20x2 and 20x3 are $6,000. In 20x2, costs to service the extended warranties are $3,510 and expected costs in 20x3 are $2,790. Actual costs to service the extended warranties in 20x3 are $6,000. How much revenue and profit can be recognized on these contracts in each of the three years? Recognizing Revenue Using Percent of Completion 1. Costs incurred to date/Most recent estimated total cost = % completion 2. Estimated total revenue x % completion = Revenue to be recognized to date 3. Total revenue to be recognized to date - total revenue recognized in prior periods = Current period revenue 4. Current revenue - Current cost = Current profit

Contra Account • An account that is offset against (deducted from) a related account • Examples: -On the balance sheet >>Equipment and Accumulated Amortization -On the income statement >>Sales and: • Sales discounts • Sales returns • Sales allowances Trade and Quantity Discounts • trade discount - a selling price reduction given to a special class of customers • quantity discount - reduction in selling price for buying a large number of units of a product • these are NOT recorded in the accounting records - the actual selling price is the net amount, not the list price • adjustment to price is prior to sale Sales Discounts • discounts given to customers for early payment of their accounts -n/30 = payment due 30 days from invoice date -1/20, n30 = deduct 1% of invoice amount if paid within 20 days, otherwise full amount is due in 30 days -2/20, n/30 ??? Recording Sales Discounts - Gross Method • record sale normally: Dr. Accounts Receivable Cr. Sales • when payment is received: Dr. Cash Dr. Sales discounts Cr. Accounts Receivable Perpetual Inventory Systems • inventory is continually updated -inventory purchases and sales are recorded directly in he inventory account:

Periodic Inventory System • periodic system - inventory is counted at the end of each year -inventory purchases are debited to the ‘purchases’ account -cost of goods sold is computed at year end Periodic System - Calculating COGS • the purchase account and all contra accounts are closed out to zero • the inventory account is adjusted to what the ending balance should be • the amount needed to balance is equal to cost of goods sold Cost of Goods Sold Beginning Inventory + Purchases = Cost of goods available for sale - Ending Inventory = Cost of Good Sold (or cost of sales) Taking Possession of Inventory • when does the inventory purchases belong to you (i.e. and therefore included in inventory)? • depends on shipping terms: -FOB Destination - means that the seller owns the goods until you receive them; seller pays the shipping costs -FOB Shipping - means that you take possession once they are shipped; buyer pays the shipping costs • FOB - free on board • Impacts timing of recognition of sales or inventory transactions The Income Statement Revised Sales - Cost of Goods Sold = Gross Profit * + Other Income - Expenses = Net Income Before Taxes - Income Tax Expense = Net Income *(the amount left over to cover the rest of the expenses and profit)

Chapter 5 - Inventory Current Assets - Inventory -Three types • Finished goods (ready for sale) • Work in Process (partially complete) • Raw materials Inventory Valuation Methods • specific item valuation: used for items that can be specifically identified, i.e. with a serial number -Cars, jewelry, custom orders, etc. the debit to COGS/credit to inventory is equal to the actual cost of the item ✦ sold Cost Flow Assumptions • If cannot specifically identify an item, we have to assume a cost flow assumption: used for items that cannot be differentiated from one another or whose value is too small to justify specific item valuation First-in, first-out (FIFO) • • Last-in, first-out (LIFO) (not acceptable under IFRS) • Weighted average -Annual weighted average -Moving weighted average FIFO • the ending inventory is assumed to be made up of the most recent purchases -Older costs to income statement -Newer costs on balance sheet • no differences in inventory cost and COGS under the periodic and perpetual methods Average Cost • two versions: annual weighted average for periodic systems and moving weighted average for perpetual systems • periodic: unit cost = cost of goods available for sale/units available for sale • perpetual: unit cost is recalculated every time a purchase is made = cost of all goods on hand/number of units on hand Application of Lower of Cost or Market Rule • at the balance sheet date, the cost of each items of inventory are compared to their market value • market is defined as net realizable value - the sales price of the inventory item less any costs incurred in order to sell the item if • market value is less than cost, then each item must be written down to market: Dr. Inventory loss Cr. Inventory

Other Inventory Issues • gross profit method - used to estimate inventory by taking sales x gross profit % • inventory turnover = cost of goods sold/average inventory -tells us how often the inventory is sold during the year • inventory errors - impacts net income if inventory is understated/overstated

Chapter 6 - Cash Investments Cash • Cash consists of: -all bank accounts -cash float -petty cash -cash equivalents: short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value The Bank Statement • when received - agree all cheques and deposits to the company records • record items on bank statement that are not recorded in the company records -NSF cheques -service charges -interest charges/interest income collected on behalf of the company -bank/company errors Bank Reconciliation • a reconciliation between cash per our records and the cash per the bank records - two reconciling items: -deposits in transit: deposit made but not yet recorded on the bank statement -outstanding cheques: cheques written (and mailed out) but which have yet to clear the bank account - Balance per bank Add Deposits in transit Less Outstanding Cheques Balance per books

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Investment in the Shares of Other Corporations • investments in the shares of other corporations have to be classified in one of two categories on the date of acquisition: -Fair Value through Profit and Loss (FVTPL), or -Fair Value though Other Comprehensive Income (FVTOCI) • either way, the shares are adjusted to market value at each reporting period Classification of Investments • FVTPL -Investments expected to be held for short period only (i.e. held for trading purposes) with objective of making a profit -Elect to use FVTPL FVTOCI • -Investments which are Available for Sale, but not expected to be sold in near term or help for strategic reasons

Investments in the Shares of Other Corporations • if classified as FVPTL, the fair value difference flows to the income statement as a gain or loss • if classified as FVTOCI, the fair value difference flows to the Other Comprehensive Income of the Statement of Comprehensive Income

Chapter 7 - Accounts and Notes Receivable Accounts Receivable • accounts receivable are reported on the balance sheet at their net realizable value: the net amount we expect to collect = -Accounts Receivable -Less Allowance for Doubtful Accounts • methodology used to value the allowance for doubtful accounts = allowance method • allowance for doubtful accounts is a contra account to the accounts receivable account Application of the Allowance Method • when accounts are actually written off, they reduce both accounts receivable and allowance for doubtful accounts; dr. Allowance for doubtful accounts cr. Accounts receivable • when a previously written-off account subsequently gets recovered, we first reverse the entry made to write the account off: dr. Accounts receivable cr. Allowance for doubtful accounts we then record the collection of the account: dr. Cash cr. Accounts receivable • when the allowance for doubtful accounts is adjusted (typically at year-end), the corresponding debit or credit is bad debt expense: dr. Bad debt expense cr. Allowance for doubtful accounts Valuation of Accounts Receivable Two approaches: • balance sheet approach: we estimate the amount needed in the allowance for doubtful accounts; any remainder goes to bad debt expense -methodology: aging % of total receivables • income statement approach: we estimate the amount of bad debt expense directly (usually as a % of credit sales); any remainder goes to the allowance for doubtful accounts -methodology: % of credit sales • we cannot simultaneously estimate the allowance for doubtful account and bad debt expense Accounts Receivable Ratios • accounts receivable turnover: -Sales/Average Accounts Receivable -how often accounts receivable get collected in a year average collection period: • -365 days/Accounts receivable turnover

-how many days does it take, on average, to collect accounts receivable

Chapter 8 - Property, Plant & Equipment and Intangibles Cost of Fixed Assets • defined as tangible items that: -are held for use in the production or supply of goods and services, for rental to others, or for administrative purposes; and -are expected to be used during more than one period • general recognition principle - the cost of an item of property, plant and equipment can be classified as an asset if, and only if: -it is probable that future economic benefits associated with the item will flow to the entity, and -the cost of the item can be measure reliably Component Approach • significant parts of an asset have to be capitalized and depreciated separately -these are generally parts that have significant cost in relation to the total cost of the asset -i.e. Airframe, engines, seat configuration, in flight entertainment sys...