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Revenue is recognized when: 1) the good or service has been provided, and

2) you expect that you will be paid

Sell on credit provide them the good/service now and they pay you later.

When payment is due is based on the terms agreed upon

Example: 2/10, net30 means 2% discount / if pay in 10 days,

or, full payment is due in 30 days

net60 no discount offered, payment due in 60 days

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

borrow money at a lower interest rate

When a payment (cash) discount is taken it is called a sales discount

Sales discounts are reported on the income statement as:

Sales

- Sales Discount

= Net Sales

Journal entries for sales on credit and payment received when a discount is offered:

(this method is referred to as the gross method of accounting for receivables)

Payment Payment

Sales received -take discount received no discount taken

A/R Sales Discount Cash

Sales Cash A/R

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)

The sales discount amount is: sales $ x discount % offered

The balance sheet for accounts receivable will show:

On the Balance Sheet: It means:

Accounts Receivable Total amount customers owe you

- Allowance for Uncollectible Accounts - Amount you dont think you will collect

= Net Accounts Receivable = Amount you do think you will collect

The asset reported on the balance sheet, net accounts receivable, must be the amount you

expect to be a future benefit. There is no benefit to an uncollectible accounts receivable.


The accounts that are used to record accounts receivable transactions are:

Sales represents the amount of goods or services provided

Accounts receivable represents the amount the customer owes

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:

1) The sale on credit, which creates the accounts receivable

2) The collection of the accounts receivable when a customer pays

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.

Journal entries for the 4 transactions are:

Sales on credit Collect accounts receivable

Accounts Receivable Cash

Sales Accounts Receivable

Estimate bad debt expense: Write off accounts receivable:

Bad debt expense Allowance for uncollectible accounts

Allowance for uncollectible accounts Accounts Receivable

(Bad debt expense can be a credit

when using the % of A/R method)

The accounts are changed by the following transactions:

Accounts Receivable:

Increases when a sale is made on credit

Decreases when the customer pays

Decreases when an account is written off you know who wont pay and amount
Allowance for Uncollectible Accounts:

Increases when estimating bad debt expense using % sales method

Increases or decreases when estimating bad debt expense using % of accounts

receivable (the up or down depends on how much is already in the account)

Decreases when an account is written off

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

accounts receivable list and out of the accounts receivable account.

Bad Debt Expense:

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

you are using the % of accounts receivable (aging) method.

The 4 transactions change the accounts:

Accounts Receivable

Beg. Bal

Write-offs

Sales

Collections

___________________ ___________________

Amount

customers

owe

Allowance for Uncollectible Accounts

Beginning balance

Write-offs

Estimate of bad

debt expense

___________________ ___________________

Amount you do not


expect to collect

Sales

Provide Goods

Bad Debt Expense

Estimate of

bad debt expense

this period

Bad debt expense can be a credit

when using % of A/R (aging) method

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

and record this expense in the same period as the sale

There are two ways to estimate the amount of bad debt expense for the current

period: % of sales & % of accounts receivable

% of Sales Method:

Sales

X % of sales the company historically doesnt collect (given)

= Bad debt expense

Record the bad debt expense amount you calculated

Bad Debt Expense $XXXX

Allowance for uncollectible accounts $XXXX

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

receivable you do not expect to collect (the allowance account).

% of Accounts Receivable (aging method):

Accounts Receivable

X % of accounts receivable the company historically does not collect (given)

= The total amount of accounts receivable the company does not


expect to collect

This amount must be the ending balance in the

allowance for uncollectible accounts account

Make your journal entry for the amount (plug) it takes to get the balance in the

allowance account to be the amount you calculated above.

Allowance for Uncollectible Accounts

Beginning balance

Write-offs

___________________ ___________________

Balance before estimate

Plug? or Plug?

___________________ ___________________

Ending Balance**

** The ending balance must be the number you calculated above

The journal entry for the amount of the plug will either be:

Allowance for uncollectible accounts Bad debt expense

Bad debt expense or Allowance for uncollectible accounts

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

total, follow the same procedures described above.

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

You are estimating using this periods sales only

% 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

this period and all prior periods.

The expense for this period is the change in the cumulative amount

you dont expect to collect


Investors make investments for three primary reasons:
1) appreciation in market value
2) income from interest and dividends
3) significant influence and control

Investments are made in bonds (debt) and equities (stocks)

The journal entry to record all types of investments is:

Investment $$cost, including commissions


Cash $$cost, including commissions

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:

1) Held to Maturity : Intend to hold investments in bonds to maturity


2) Trading Securities: Intend to hold for less than one year
3) Available For Sale: Intend to hold for one year or more

Held to maturity:

Do not adjust to fair market value.


Adjust the cost of the bond investment each period for interest using
the amortization schedule, as interest is earned and received

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

Available for Sale:

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

Journal entries: Record 2 things each period

1) adjust to fair market value trading unrealized gain/loss


- available for sale accumulated gain/loss
2) record dividends received

Trading Available for sale

Investment Adjust to FMV Investment


Unrealized Gain/Loss at end of period Accumulated Gain/Loss
(use investment T account)
The investment account will be a debit when the investment goes up
The investment account will be a credit when the investment goes down
The other account is the opposite, debit or credit, for the same amount

Cash Receive Dividends Cash


Dividend Income 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.

Journal entries are:

Profit Losses

Profit/Loss Investment in X Investment Expense


Investment Income Investment in X

Dividends Cash
Received Investment in X

When you sell your investment, under both FMV and Equity methods:

1) Record the cash you get as a debit

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)

Journal Entry: format used to record and summarize


transactions of the company

Debits are written on top


Credits are written on bottom, slightly to the
right
Total debits must equal total credits (top must
equal bottom)
Each journal entry has at least one debit and at
least one credit

Examples of journal entries:

Cash
$100,000
Common
Stock $100,000

Furniture
$10,000

Cash $10,000

Equipment
$30,000

Cash $18,000
Notes
Payable $12,000

Debit has no meaning except that it goes on


top in a journal entry and on the
left in a T account.
Credit has no meaning except that it goes on
the bottom in a journal entry and
on the right in a T account

Transaction Refresher: (see the two sections on


recording on a spreadsheet
if you need more help with
this)

All company transactions fall into one of the following


categories:

Related to the balance sheet only assets,


liabilities, and owners equity

1) Receive cash from investors or pay


dividends to investors
2) Trade an asset for another asset (or buy an
asset and pay cash)
3) Buy an asset and incur a liability you will
pay later
4) Pay cash to reduce what is owed reduce a
liability

Related to the income statement revenues


and expenses
When you record a revenue you also must
record an increase to asset
When you record an expense you also must
record an increase to a
liability or a decrease to an asset.

1) Provide goods or services (revenue +) and


receive cash now (cash +)
2) Provide goods or services (revenue +) and
get paid later (receivable +)
3) Receive a service (expense -) and pay cash
now (cash -)
4) Receive a service (expense -) and pay cash
later (payable +)
5) Use an asset (expense -) and decrease an
asset or increase accumulated depreciation

Transactions can be summarized this way:

1) You get something (asset) and you give up


something to get it (an asset or a liability)
2) You provide goods or services in exchange for
an asset
3) You are provided services (expense) that you
pay for now or will pay for later
4) You use an asset in your day to day business
to get revenues (expense)

There are always at least two things


changing for each transaction

Each asset, liability, owners equity, revenue and


expense account gets a T account.
It is called a T account because you draw a T first.

Debit is always on the left


Credit is always on the right
_________________

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.

Asset Liability Owner's Equity Revenue Expense

Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit
+ -- -- + -- + -- + + --

Assets & Expenses --- Increases are debits


Decreased are credits

Liabilities, Owners Equity, Revenues --- Increases are credits


Decreases are debits

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:

Debit account name $XXX


Credit account name $XXX

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

1) Put the debits on the left


2) Put the credits on the right

3) Add up all the debits, the left side


4) Add up all the credits, the right side

5) Take the largest number less the smallest number and put the difference
on the largest side

Assets and Expenses - will always have a debit balance

Liabilities/Owners Equity/Revenues will always have a credit balance

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)

F.O.B. Destination: Buyer owns when they receive the goods

F.O.B. Shipping: Buyer owns at the time it is shipped (owns in transit)

Goods on Consignment: A company holds inventory for someone else, and


does not take title. The company that has title to the
inventory records the inventory.

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:

Quantity x Each Cost = Total Cost

Item A 100 25 2,500

Item B 50 10 500

Item C 200 15 3,000

Item D 500 5 2,500

Total 8,500

Inventory will be reported at a cost of $8,500 on the balance sheet

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:

FIFO (first in first out):

Units purchased first are sold first. The last units purchased are the ones you have left

LIFO (last in first out):

Units purchased last are sold first. The first units purchased are the ones you have left

Weighted Average:

Inventory is valued at the average purchase cost.


Total available cost divided by total available units = average cost per unit

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

Which method gives a higher income depends on inflation/deflation of the product.

Lower of Cost or Market (LCM)

Inventory is initially valued at the purchase cost.

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:

Compare cost to market value (also called replacement 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:

Cost of goods sold (or loss on inventory)


Inventory (or inventory reserve)

Write-down of inventory is called impairment


Inventory is not increased above cost.

Two Methods for Recording Inventory transactions Periodic or Perpetual:

Periodic Record inventory purchases initially as purchases - an expense


Record sales without recording the change to the inventory
Adjust at the end of the period to record CGS and:
1) Get inventory to what you really have
2) Get purchases to equal 0 (the real expense is CGS)
** Dont use the inventory account until the final adjustment

Perpetual Record to the inventory account every time inventory moves


Record inventory purchases initially as an asset called inventory:
Record sales at the sales price and the reduction of inventory at cost:
Final adjustment at the end of the period to get inventory to be
what you really have on hand.

A reduction in inventory is due to employee theft, damage to inventory, or the


wrong thing being put into the box and shipped to the customer. This is often
called shrinkage. You can not determine shrinkage using the periodic method.

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

Purchases Purchase Inventory


Cash or A/P Cash or A/P

A/P Return A/P


Purchase Returns Inventory

A/R Sale A/R price to


Sales Sales customer

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

** Income has the same error as the ending inventory error.

When beginning inventory is incorrect, the opposite occurs.

Accounting for Notes Receivable

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.

Notes and Adjusting Entries

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 set up note receivable:


Entry to accrue interest at June 30 year end:

Entry to record collection of note (including amounts previously accrued at June 30):

Tangible - Physical substance you can touch them


Called property plant and equipment or fixed assets

3 kinds of tangible assets

1) Land not depreciated


2) Buildings, fixtures, equipment, autos, computers - depreciated
3) Natural resources metals, timber, oil - depleted

Intangible - Grant a right to the owner


Have no physical substance, they can not be touched

Copyrights, patents, franchises, licenses, trademarks, goodwill

When money is spent, you must either capitalize or expense the benefit:

Capitalize means call it an asset and report it on the balance sheet.


Put an asset on the balance sheet and expense it over the time used
The expenditure is expected to benefit future periods

Expense: Used to produce revenue this period or future benefit is unpredictable

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

Capitalize costs to extend the useful life or increase productivity or increase


the quality after you are using the asset (often called subsequent
expenditures)

Expense routine repairs and maintenance (these have to be repeated)

Expense all costs that benefit this period only or no probable future benefit

Property, Plant, Equipment: Assets used long term to produce revenues

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

Equipment sales tax, delivery costs/ freight-in/ shipping, installation, training

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

Depreciable Cost/Base: Cost Residual Value

Estimated Useful Life: The number of years you expect to USE the asset

Methods of Depreciation:

Straight-line: Cost Residual Value / Useful life in years

Double Declining Balance: 100% / life X 2 X Book Value

Book Value = Cost Accumulated Depreciation (changes each year)


Units of Production: Cost - Estimated Residual Value / total estimated units = $ cost per unit

then: $ Cost per unit x units produced this period = expense this period

Use this journal entry for all methods of depreciation:

Depreciation Expense $XXXX


Accumulated depreciation $XXXX

Intangible Assets

Capitalize the cost associated with securing the asset if purchased - you
paid someone outside the company

Expense the cost if you do it yourself (ex. salaries to develop a patent)

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

Patents 17 year life


Trademarks Indefinite life
Copyrights 50 year life
Franchises life is the amount of time purchased
Goodwill Indefinite life

Goodwill: Occurs only when you purchase another company


This asset has indefinite life.

Price paid for the company


FMV of the assets and liabilities purchased
= Goodwill

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

Impairment Loss $XXXX


Goodwill or Trademark $XXXX

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

Amortization Expense $XXXX


Asset or Accumulated Amortization $XXXX

Natural Resources: Long term inventories

Associated costs that are also part of the asset cost are geographic
surveys and exploration costs

Depletion: Units of production method is used:


Total estimated costs / total estimated units = $ cost per unit

$ Cost per unit x units produced this period = depletion expense

The expense will vary with the actual units produced

Depletion Expense $XXXX


Asset name $XXXX

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:

Total Cost include new costs added


- Accumulated depreciation to date
= Book value

then

Book Value New Residual Value


New useful life from here on = new depreciation expense
each year going forward
Change in fair market value of Assets:

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.

Loss on Impairment $XXX


Asset $XXX

Never increase above historical cost


Retirement and Sale of the Assets :

Follow these steps to record the sale of any long term asset:

1) Record the cash you receive

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

Realized Loss on Sale **


Cash
Accumulated Depreciation
Asset
Realized Gain on Sale **
** Plug to gain (need credit) or loss (need debit) to balance the journal entry
(You will not use both the gain and loss accounts, only use one of them)

Liability probable future payment of assets (usually cash) or services which


1) occurs from a past transaction or event
2) is a present obligation
3) is a future payment

Current or short term means it will be paid within one year of the balance sheet date

Common Current or Short Term Liabilities:

Accounts Payable: amounts owed to suppliers for goods or services purchased


on credit, normally 30 days, no interest charged

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.

Journal entry for sales tax collection and payable:

Cash $XXXX
Sales revenue $XXXX
Sales Tax Payable $ XX

Part of what is collected is revenue and part is owed to city/state.

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

Payroll Liabilities: Amounts assessed to the business by the government and


amounts taken out of the employees check that must be paid to
the government for them:

Gross Pay the total amount the employee earns (hrs worked x $ per hr)
Net Pay the amount the employee receives after deductions are taken

Payroll deductions Withholdings

Employee FICA tax (Social Security) 6.2% up to a set amount


Medicare tax 1.45% of total amount earned
Income tax depends on how much is earned & the employees tax rate
Voluntary Deductions Health insurance, union dues, pension savings

Journal entry for the employees paycheck:

Salary Expense *
FICA tax payable
Medicare tax payable
Federal income tax payable
Medical insurance payable
Union dues payable
Pension payable
Salaries payable **

* Salary expense is what the employee earns hrs x rate per hr


** Salaries payable is the check to the employee after deductions

Employer Payroll Taxes:

Employers must pay FICA/Social Security tax and Medicare tax for the
same amount the employee pays 6.2% and 1.45%

Employers are required to pay unemployment taxes so that laid off


workers will be able to receive unemployment benefits. This must
be paid to the state (SUTA) and to the federal government (FUTA).

State: usually 1% to 5.4% of the first $7,000 earned, based on history


Federal: usually .8% of first $7,000 earned, considering state was paid

Journal entry for recording employers taxes to be paid

Payroll tax expense **


FICA/SS tax payable
Medicare tax payable
SUTA payable
FUTA payable

** Payroll tax expense is the total of all the other payables that
are calculated based on the given % x earnings

Warranty Liabilities: the sellers obligation to replace goods or provide service to


defective products within a set period of time

Sometimes extra is paid for the warranty and sometimes the


warranty comes with the product.

The matching principle requires the warranty expense to be


recorded in the same period as the sale. We do not know the
exact amount that will occur in the future, so we must estimate.

Sales this period


x % of warranty historically occurs
= warranty expense for this period

Record the warranty obligation for the calculated amount:

Warranty Expense $XXXX


Warranty liability $XXXX

Contingent Liabilities: An obligation that may occur, dependant on a future event to


happen, in order for you to know how much will be paid to who.

Contingent liabilities may be short term or long term depending on when


the estimated amount is expected to be paid.

Examples: Lawsuits, environmental cleanups, debt guarantees

First: Classify the obligation based on how likely it is to occur:


FASB did not give a definition of each category.

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.

Third: Based on the classification, report the following

1) Probable record an expense and a liability for the low end


of the estimated amount if you can estimate it
- disclose the situation in the footnotes

If you can not estimate it you do not record an expense

2) Reasonable Possible disclose the situation in the footnotes


stating the low and high estimate that might be paid
or state that you can not reasonably estimate the loss

3) Remote do nothing, dont expense or disclose

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:

Maturity Value: Amount that must be repaid (usually in $1,000s)


Maturity Date: Date the maturity value amount must be repaid
Stated Interest Rate: Coupon amount paid as interest, periodically-
monthly, semi-annually or annually

Market Yield/Effective interest rate: The interest the company really incurs,
and the investor really earns

Simplified Example: $1,000 Maturity Value (MV) due to be paid in 10 years


10% Stated interest (annual coupon)

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.

If pay $1,000, actually earn 10% $100/$1000 = 10%

If pay $900, actually earn 11.1% $100/$900 = 11.1%

If pay $1,100, actually earn 9.1% $100/$1100 = 9.1%

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:

Discount: Cash exchanged is less than face value

Premium: Cash exchanged is more than face value

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.

Determining the price of the bond:

Bonds trade on the open market at a percent of maturity value.

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.

Total periodic coupon payment** x present value factor of an annuity


+
Maturity value x present value factor of a single amount

= Amount paid now to get the effective interest rate return on your money

** Periodic coupon payment = Maturity Value x coupon % / number of payments


per year

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.

Journal Entries related to the bond payable:

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 Bonds Premium: Issue Bonds Discount:


Cash received > MV Cash received < MV

Issue:

Cash Cash
Premium Discount
Bond Payable (MV) Bond Payable (MV)

Interest paid:

Interest Expense Interest Expense


Premium Discount
Cash Cash

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.
______________________________________________________________________

Effective Coupon Discount or Amount owed-


Interest Exp. - Interest = Difference Premium +/- Carrying value

Yield % Stated % or Begin with the price

Market % coupon % of the bond


The cash exchanged
x the last x MV (not the MV)
amount owed (same for
all periods)

Interest Cash Discount or End with the


Expense Premium maturity value

Long Term Installment Loans / Notes Payable / Mortgage Payable:

Borrow money from bank


Repay in equal payments.

The payments must cover interest expense and repayment of principle

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.

Payment Interest 10% Difference: Amount Owed


to repay principle (Carrying Value)

$800,000

1) $89,750 $80,000 $9,750 $790,250

2) $89,750 $79,025 $10,725 $779,525

Journal entries:

Borrow:

Cash $800,000
Note Payable $800,000

Interest 1st year payment

Interest Expense $80,000


Note Payable $ 9,750
Cash $89,750

Interest 2nd year payment

Interest Expense $79,025


Note Payable $10,725
Cash $89,750

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.

The corporation acquires capital through issuing shares to stockholders


who then become owners of the company.

Common Stock - Shares of Ownership

Authorized the maximum number of shares the corporation can sell

Issued the cumulative total number of shares the corporation has sold

Outstanding shares currently held by investors outside the corporation


This is equal to issued shares less treasury shares

Par Value: a value per share that is assigned in the corporate charter

1) It is the legal capital that must be retained in the business


2) Companys set par value very low - $0.01 per share
3) It has no relationship to fair market value
4) Some states allow for a par value of 0 no-par value stock

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

Common Stockholder rights:

1) attend all stockholder meetings; vote in board members


2) share in dividends declared by the board
3) share in the proceeds of any liquidation
4) can sell their investment in shares at any time
5) have liability limited to their investment in the corporation
Preferred stock may also be issued to raise capital. Preferred stockholders
give capital in return for income and are not seeking voting ownership.
Preferred stock typically has a stated fixed dividend rate.

Preferred Stockholders get:

1) preference for receiving dividends (before common)

2) No voting rights

Preferred Dividends are computed as: Number of shares x Par Value x Stated %

Dividends paid to preferred shareholders must be declared by the board of directors


before they are paid

Cumulative: If not declared this year, the board may declare this years dividend

at some point in the future

Non-cumulative: If not declared this year, the board may not declare in the future

Dividends in Arrears: Cumulative dividends not paid to preferred shareholders - must be


paid before common shareholders are paid

When a company issues stock to raise capital:

CASH $ = FMV per share x # shares


Common Stock (par) $ = Par Value per share x # shares
Paid in Capital - CS The difference in par value and FMV

** The total value received by the company is CS + Paid in Capital (PIC)

** When one investor sell stock to another investor, there is no


impact on the corporation and no entry is recorded.

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

The treasury stock account is a contra owners equity. It is subtracted from


owners equity. A company cannot create an asset by investing in itself.

When treasury stock is sold back to investors there is no gain or loss.


The gain or loss is reported as an addition or subtraction of paid in capital

Purchase Treasury Stock: record at what was paid the original cost

Treasury Stock $XXX


Cash $XXX

Sell treasury stock back to investors:

Cash (FMV amount received)


Treasury Stock (at original cost per share x # shares)
PIC TS **

** 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

Declaration Date: Retained Earnings $XXX


Dividend Payable $XXX

Record Date: No J/E

Payment Date- Dividends Payable $XXX


for a cash dividend: Cash $XXX

Stock Dividend: The corporation issues to current shareholders additional


shares issued as a percentage of what is already held

Example: 20% stock dividend when there are 1,000,000 shares issued
means that 200,000 additional shares will be issued

Declaration Date: Retained Earnings $XXX


Dividend Payable $XXX

Record Date: No J/E

Payment Date- Dividends Payable $XXX


for a stock dividend: Common stock $XXX
PIC CS $XXX

common stock is at par


PIC CS is the difference, a plug

The question is what amount is recorded to retained earnings?


Is the company giving stock for fair market value or for par value

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.

Example: 2:1 split par value is now half the amount


issued shares are now doubled

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

The cash flow statement is separated into three sections:

Operating Activities: Relates to the production and delivery of goods/services:


Net Income (revenues less expenses)
Show Non-cash revenues and expenses separately
Changes in current assets and current liabilities

Investing Activities: Long term assets - investments, p/p/e, intangibles


- purchases and sales of long-term assets

Financing Activities: Long term liabilities and Owners equity


- borrow and repay debt
- pay dividends to shareholders
- issue stock
- repurchase treasury stock

**** 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.

Format of the Direct Method:

Cash received from:


customers selling goods and services
dividend income from investments
interest income from investments
Total cash received:

- Cash paid for:


purchases of goods (inventory) and services
salaries and wages to employees
income taxes to the government
interest expense to lenders
other cash expenses
Total cash paid:

= Cash flow from operating activities

Format of the Indirect Method:

Net Income

+ - Non cash revenues (-) and expenses(+) gains(-) and losses (+)

+ - changes in current assets and liabilities

= Cash flow from operating activities

Preparing the Cash Flow Statement using the Indirect Method:

Net Income

+- Adjustments for Noncash Items - add expenses and losses


- subtract revenues and gains
+- Change in Current Assets and Liabilities

Assets: increase from prior year subtract


decrease from prior year- add **assets and liabilities
are opposite
Liabilities: increase from prior year add
decrease from prior year subtract
______________________________________
= Cash from operating activities

Preparing the Cash Flow Statement using the Direct Method:

Collected from customers:

Sales or other revenue


+ beginning receivable
- ending receivable
= Cash collected from customers

Collected from investments dividend and interest income:

Dividend/Interest Income
+ beginning receivable
- ending receivable
= Cash collected from dividends/interest

Paid to suppliers:

Cost of Goods Sold


- Beginning Inventory
+ Ending Inventory
+ Beginning A/P
- Ending A/P
= Cash Paid to Suppliers

Paid for all other expenses:

Expense
+ Beginning matching payable
- Ending matching payable
= Cash Paid for expense

Expense
- Beginning matching asset
+ ending matching asset
= Cash paid for expense

Always: + Beginning Ending, except when matching an asset with an expense

Noncash Activities: Trade an asset for another asset or liability


A transaction where no cash is involved
This is not reported in the cash flow statement and is
listed at the bottom of the statement