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Sell on credit provide them the good/service now and they pay you later.
Companies offer a discount in order to collect cash quicker when they need cash
It is very costly to offer a discount, but necessary if the company is not able to
Sales
- Sales Discount
= Net Sales
Journal entries for sales on credit and payment received when a discount is offered:
Payment Payment
A/R
The sales and the accounts receivable is always for the full amount of the sale.
The cash is the amount actually received (sales x 1 discount % if discount is taken)
- Allowance for Uncollectible Accounts - Amount you dont think you will collect
The asset reported on the balance sheet, net accounts receivable, must be the amount you
Allowance for uncollectible accounts represents the total amount you do not
expect to collect it is an estimate, you dont know who wont pay or how much
Bad debt expense the current period estimate of what you wont collect
There are 4 key transactions that must be recorded for accounts receivables:
3) The estimate of bad debt expense: you dont know exactly how much wont be
collected from customers, but you know you wont collect it all from past history.
You must estimate the expense at the end of the period to match with sales.
4) The write off of an accounts receivable when you know who wont pay you
and exactly how much wont be collected. This occurs much later after the sale.
Accounts Receivable:
Decreases when an account is written off you know who wont pay and amount
Allowance for Uncollectible Accounts:
The allowance account represents the total estimate of what wont be collected.
The company is not sure who wont pay or exactly how much. When they know
who and how much wont pay, they take it out of this account and take it off the
Changes ONLY when you estimate bad debt at the end of the period
If you overestimated in prior periods you can take some expense away when
Accounts Receivable
Beg. Bal
Write-offs
Sales
Collections
___________________ ___________________
Amount
customers
owe
Beginning balance
Write-offs
Estimate of bad
debt expense
___________________ ___________________
Sales
Provide Goods
Estimate of
this period
Bad Debt Expense: Occurs when you do not get paid for a receivable.
The bad debt expense must be recorded in the same period the sale is made.
(This follows the matching principle: match revenues with all expenses)
Problem: You dont know how much you wont collect in the period of the sale.
You wont know until much later when the customer doesnt pay.
Solution: You must estimate, (based on past history) the amount you wont collect
There are two ways to estimate the amount of bad debt expense for the current
% of Sales Method:
Sales
You are doing a direct match of the bad debt expense to sales. This amount
is also added to the account that accumulates the total amount of accounts
Accounts Receivable
Make your journal entry for the amount (plug) it takes to get the balance in the
Beginning balance
Write-offs
___________________ ___________________
Plug? or Plug?
___________________ ___________________
Ending Balance**
The journal entry for the amount of the plug will either be:
When you have an aging report which shows how old the accounts are and the % that is
estimated to be uncollectible for each category, you must multiply the balance x the
% given for each category and add them all up to get the total amount you do not
expect to collect. (See Practice As You Learn for an example). When you have the
The difference between the two methods: % of Sales & % of A/R (aging)
% of Sales: You are calculating the total bad debt expense for the period
% of A/R: You are calculating a cumulative amount that you do not expect
to collect using the total amount that customers owe you from
The expense for this period is the change in the cumulative amount
There are two methods used to report investments that are related to the purpose of
making the investment: Fair Market Value Method and Equity Method
Fair Market Value Method: (FASB 115) Records investments made for appreciation and income
Use this method when:
1) You have no significant influence or control (usually owning < 20% indicates) 2) The market price is reliable
there is a bid ask quote, traded on an exchange
There are 3 categories of investments under this method:
Held to maturity:
Trading Securities:
Adjust the investment to fair market value at the end of each period
if fair market value is reliable there is a bid ask quote
The change in fair market value is reported on the income statement
under other revenues and expenses unrealized gain/loss account
Record dividends received as dividend income
Adjust the investment to fair market value at the end of the period
if fair market value is reliable there is a bid ask quote
The change in fair market value is reported on the balance sheet as
part of owners equity accumulated gain/loss an owners equity account
Record dividends received as dividend income
Important to notice: The only difference in trading and available for sale is the account that is used to adjust to fair
market value. Trading uses unrealized gain/loss which is reported on the income statement. Available for sale uses
accumulated gain/loss which is reported on the balance sheet in owners equity.
Equity Method:
Use when you own an equity investment in a company and have significant influence
Significant influence exists when you own > 20%, and you have
- Access to financial information
- Seat(s) on the board of directors
- Influence company policies and procedures
The objective of the equity method is to show the investment as if it represents the owners equity in the company
you purchased. When the companys owners equity increases (earn income), your investment balance should
increase. When the companys owners equity decreases (losses and dividends paid), your investment balance
should decrease.
The companys owners equity changes with income and loss and dividends paid.
These are the things that also change your investment balance.
Profit Losses
Dividends Cash
Received Investment in X
When you sell your investment, under both FMV and Equity methods:
2) Take the investment off your books at the current balance in your
Investment T account times the % you are selling (credit investment)
3) Plug to realized gain (credit) or realized loss (debit) to balance the entry
Cash (db)
Realized loss (db) or realized gain (cr)
Investment (cr)
Accounts that are reported on the income statement current year only:
Unrealized Gain/Loss
Realized Gain/Loss
Dividend Income
Accounts that are reported on the balance sheet cumulative balance:
Investment
Accumulated Gain/Loss (Owners Equity)
Cash
$100,000
Common
Stock $100,000
Furniture
$10,000
Cash $10,000
Equipment
$30,000
Cash $18,000
Notes
Payable $12,000
Debit Credit
For each type of account, whether it is a debit or a credit depends on if it is increasing or decreasing. Follow the
chart below.
Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit
+ -- -- + -- + -- + + --
First -- decide what account is being affected and what type of account it is
Second -- decide if that account is increasing or decreasing
Third use the previous guidelines to determine if the change is a debit or a credit
Write the journal entry to show the accounts that are changing:
Balancing T accounts:
Make a T account for each account name used one T account for each account
The T account is used to summarize the account and determine the balance
Take the amounts in the journal entries and put them in the T accounts
5) Take the largest number less the smallest number and put the difference
on the largest side
Inventory: Items that you buy or make only for the purpose of selling the items to
customers for a profit.
Terms related to purchasing inventory that determines who owns the inventory when
it is in transit (in shipment between the seller and the buyer)
Calculating Cost of Goods Sold: The cost of the inventory sold to customers
Reported on the income statement as an expense
Beginning Inventory
+ Purchases
= Available for sale
- Ending Inventory **
= Cost of Goods Sold
** Ending inventory is valued at the quantity on hand x the cost for each one
The ending inventory is the amount reported on the balance sheet.
On the Balance Sheet - reported inventory as the total $ of all items = quantity x cost:
Item B 50 10 500
Total 8,500
Which cost do you use to value inventory when the same item is purchased at
different unit costs and items are exactly the same?
Example: Purchased 150 units of Item A at $24 and 200 units of Item A at $27 and
300 units of Item A at $26. You sold 550 to customers. What cost
should you multiply by the total 100 quantity left to get the ending
inventory amount? All items look the same and you can not tell what was
actually paid for the items that are left.
FASB gives you a choice of methods to use to value ending inventory when the same
items are purchased at different costs:
Units purchased first are sold first. The last units purchased are the ones you have left
Units purchased last are sold first. The first units purchased are the ones you have left
Weighted Average:
Specific Identification:
Use when you are able to tell the specific cost of the item in inventory.
Each method will give a different cost of goods sold expense and inventory cost.
In times of inflation:
FIFO gives a lower cost of goods sold and higher income than LIFO
In times of deflation:
FIFO gives a higher cost of goods sold and a lower income than LIFO
A company may not report inventory on their balance sheet at more than they expect
to benefit from the sale of the inventory.
You must determine if the inventory has lost value below cost:
If cost is more than market, the reported cost must be reduced to market.
If cost is less than market, no adjustment is made, do not adjust up.
The journal entry to adjust for the difference down to LCM is:
It is possible that inventory must go up to get to what you really have if not enough
was really shipped to the customer or inventory received was incorrectly recorded.
*** Notice that the balance in the inventory account and the cost of goods sold account
is the same under both the periodic and perpetual methods at the end of the period.
Journal entries for recording inventory transactions:
Periodic Perpetual
CGS original
Inventory cost
Adjusting Entry
CGS CGS
Purchase Returns Inventory
Inventory(ending)
Inventory (beginning) either account can be
Purchases the debit or credit
Inventory Errors:
Inventory costs are reported as either inventory on the balance sheet or cost of
goods sold on the income statement.
Total cost = Inventory + Cost of Goods Sold
Typically, inventory is counted and valued to determine the inventory balance and
cost of goods sold is the other part of the cost.
When ending inventory is incorrect, cost of goods sold and income will be
incorrect also
Ending inventory too high, cost of goods sold too low, income too high
Ending inventory too low, cost of goods sold too high, income too low
To illustrate the accounting for a note receivable, assume that Butchko initially sold $10,000 of merchandise on
account to Hewlett. Hewlett later requested more time to pay, and agreed to give a formal three-month note bearing
interest at 12% per year. The entry to record the conversion of the account receivable to a formal note is as follows:
At maturity, Butchkos entry to record collection of the maturity value would appear as follows:
Dishonored Note
If Hewlett dishonored the note at maturity (i.e., refused to pay), then Butchko would prepare the following entry:
The debit to Accounts Receivable reflects the hope of eventually collecting all amounts due, including interest. If
Butchko anticipated difficulty collecting the receivable, appropriate allowances would be established in a fashion
similar to those illustrated earlier in the chapter.
MyExceLab
In the illustrations for Butchko, all of the activity occurred within the same accounting year. However, if Butchko had a
June 30 accounting year end, then an adjustment would be needed to reflect accrued interest at year-end. The
appropriate entries illustrate this important accrual concept:
Entry to record collection of note (including amounts previously accrued at June 30):
When money is spent, you must either capitalize or expense the benefit:
General rules:
Capitalize all costs necessary to get the asset to the point it can be used to
produce revenues
Capitalize all costs incurred before you begin using to produce revenues
Expense all costs that benefit this period only or no probable future benefit
Common items that are added to purchase price that become part of the cost of the asset
Land sales tax, title search and transfer cost, attorneys fees, real estate commission,
remove old buildings from land, bulldozing, survey fees, back taxes
Buildings sales tax, title search and transfer costs, real estate commission,
attorneys fees, remodel before using, architect fees, back taxes
The cost of an asset does not include damages or fines that could have been avoided
Depreciation: Expense the cost of the property, plant, equipment over the period
it is used to produce revenues (follows the matching concept)
Residual/Salvage Value: What you estimate you will sell it for when you
are done using it
Estimated Useful Life: The number of years you expect to USE the asset
Methods of Depreciation:
then: $ Cost per unit x units produced this period = expense this period
Intangible Assets
Capitalize the cost associated with securing the asset if purchased - you
paid someone outside the company
Some intangible assets have indefinite life; others do not have indefinite life:
Definite life means there is a set amount of years benefit will occur
Intangible assets with indefinite useful life must be tested for impairment
Impairment means the cost is more than the future benefit
When the benefit is lower, the asset must be reduced to the future benefit
Intangible assets with a defined useful life must be expensed over the useful
life the benefit is received. The straight-line method is used.
This expense is called amortization expense
Associated costs that are also part of the asset cost are geographic
surveys and exploration costs
Changes in estimated useful life or costs added to the asset (subsequent expenditures) after you are using
the asset :
You must change your depreciation calculation in order to expense the total cost over
estimated total time you will use it
Get the book value at time of the change and re-compute depreciation expense
for future years:
then
Impairment: Lost value company will never recover the cost of the asset
Estimate future net cash flow, if not more than cost, reduce the asset.
Follow these steps to record the sale of any long term asset:
2) Credit the asset you are selling for the original total cost
3) Debit accumulated depreciation for the total up to the date you sell it
If you sell it in the middle of the year, you will need to expense
that part of the first year see practice problem
4) Record a realized gain or a loss for the amount that will make
the journal entry balance debits equal credits
Current or short term means it will be paid within one year of the balance sheet date
Sales Tax Payable: a tax levied on retail sales. The business must charge this
and collect the money and then pay it to the state or city
Each state/city sets its own %. This is not a revenue or an
expense to the business. They collect the cash and have an
obligation to pass it on to the city/state.
Cash $XXXX
Sales revenue $XXXX
Sales Tax Payable $ XX
Unearned Revenues: occurs when the company collects money from a customer
before providing the goods or services they owe the customer
the goods or services. This is normally short term.
Short Term Notes Payable: A written promise to pay an amount borrowed, with interest
Short term means the principle will be repaid in < 1 year
Notes payable typically have monthly periodic payments
Gross Pay the total amount the employee earns (hrs worked x $ per hr)
Net Pay the amount the employee receives after deductions are taken
Salary Expense *
FICA tax payable
Medicare tax payable
Federal income tax payable
Medical insurance payable
Union dues payable
Pension payable
Salaries payable **
Employers must pay FICA/Social Security tax and Medicare tax for the
same amount the employee pays 6.2% and 1.45%
** Payroll tax expense is the total of all the other payables that
are calculated based on the given % x earnings
1) Probable
2) Reasonable Possible
3) Remote
Second: Determine a high low range that may be paid for the obligation
if possible. Sometimes a reasonable estimate can not be made.
Bonds Payable borrow from investors who invest in the bond to earn a return of
interest income
The bond is a contract with the investor that loaned the money.
Every bond is a contract which has the following:
Market Yield/Effective interest rate: The interest the company really incurs,
and the investor really earns
The bond will pay $100 interest ($1,000 MV * 10% stated) the amount of
interest paid is in the bond contract and does not change
The investor varies the rate of return they earn by what they are willing to pay.
Whatever percent the investor earns is the same percent the company really
incurs in interest expense. The real rate of return is the market/effective rate.
In most cases, the cash exchanged will not be equal to the maturity value because the market rate does not equal the
stated (coupon) rate. This creates a:
Regardless of what is paid at the beginning, the face value must be paid on the
maturity date.
The actual bond market the bonds trade on determine the acceptable market rate that
investors are willing to invest to earn. The market / effective rate changes every day.
The stated coupon rate does not change.
A bond that trades at 98 means: 98% (.98) x the maturity value is paid
For a $300,000 maturity value bond priced at 98, the investor pays
$294,000 ($300,000 x .98)
For a $200,000 maturity value bond priced at 125.75, the investor pays
$251,500 ($200,000 x 1.2575, move the decimal point over 2 places)
Note: Most Financial Accounting professors will not have you calculate the price of
the bond and the bond price will be given to you as a number % or total amount.
If the bond price is not stated, it can be calculated using the effective interest rate,
the number of periods until maturity, and the coupon rate.
= Amount paid now to get the effective interest rate return on your money
Use the PV tables to get the factor for the total number of cash payments the
bond will make (years to maturity x payments each year) and the
effective / market interest rate.
The amount received is the cash that is exchanged between the investor and the company. This is often called
issuing a bond, which means borrowing money.
Issue:
Cash Cash
Premium Discount
Bond Payable (MV) Bond Payable (MV)
Interest paid:
Amortization Table:
Use an Amortization Table to determine how much of the cash payment is interest expense and how much is a
discount or premium. The interest expense uses the effective/market yield rate and the cash paid is from the coupon
rate. These two rates are most likely different.
______________________________________________________________________
You must determine how much of the payment is for interest expense and how much
is for repayment of loan. We use and amortization schedule for this:
Example: You borrowed $800,000 at 10% and your annual payment is $89,750.
$800,000
Journal entries:
Borrow:
Cash $800,000
Note Payable $800,000
Corporation: A separate legal entity that owns assets and incurs liabilities.
The business applies for a charter from the state it will incorporate in.
Articles of Incorporation are issued that specify the general rules
for conducting the business of the corporation.
Issued the cumulative total number of shares the corporation has sold
Par Value: a value per share that is assigned in the corporate charter
Common
Stockholders: Do not participate in the day to day operations of the business
Elect the BOD and vote on important issues of the Company
BOD makes major decisions, hires the management of the Company
2) No voting rights
Preferred Dividends are computed as: Number of shares x Par Value x Stated %
Cumulative: If not declared this year, the board may declare this years dividend
Non-cumulative: If not declared this year, the board may not declare in the future
For preferred shares issued, use the same journal entry and replace CS with PS
Treasury Stock: The company buys back its own stock from investors to
1) reissue the shares to employees as compensation
2) reduce the number of shares outstanding to increase
earnings per share
3) show other investors they have confidence in the value
of the company
Purchase Treasury Stock: record at what was paid the original cost
** Record the difference in FMV and original cost to balance the J/E
When a debit is needed to balance you may debit PIC TS for
up to the amount you have in the account and then the rest must
be a debit to R.E.
Dividends: Distributions to shareholders, can be cash or additional shares of stock
Declaration date: The date the board of directors officially declares the dividend Record Date:
The date the corporation prepares the list of owners that will
be paid the dividend if you own on this date you get paid
Payment Date: The date the payment is made to shareholders on record
Example: 20% stock dividend when there are 1,000,000 shares issued
means that 200,000 additional shares will be issued
Large > 20-25% Debit R.E. for Par value of stock x # shares
Small < 20-25 % Debit R.E. for Fair MV of stock x # shares
The result of a stock dividend is no change to total owners equity. The amounts
in the owners equity accounts are moved from one account to another
Stock Split
Does not change owners equity. Nothing is issued or received by the company.
The par value is divided and the number of shares increases by the
ratio determined by the board of directors.
Cash Flow Statement: Shows what the Company does with their cash
Reconciles cash basis to accrual basis
Used to determine:
- the companys ability to generate future cash flows
- the companys ability to repay debt
- how much cash was spent investing in assets
- how much cash was received from borrowing
Cash Equivalents: Short term, highly liquid CDs, 3 month treasury, money market
Treated the same as cash on the cash flow statement
**** For Investing and Financing Activities only the cash received or paid
from the transaction is reported on the cash flow statement
Cash from operating activities can be reported using the direct method or the indirect method. Investing and
financing activities are reported the same under both methods.
Net Income
+ - Non cash revenues (-) and expenses(+) gains(-) and losses (+)
Net Income
Dividend/Interest Income
+ beginning receivable
- ending receivable
= Cash collected from dividends/interest
Paid to suppliers:
Expense
+ Beginning matching payable
- Ending matching payable
= Cash Paid for expense
Expense
- Beginning matching asset
+ ending matching asset
= Cash paid for expense