Financial and Managerial Accounting, Study notes of Financial Accounting

Download Financial and Managerial Accounting and more Study notes Financial Accounting in PDF only on Docsity! SEM 1 Principle of accounting Equity = Owner’s wealth What is accounting? A system in which we measure and record financial processes and communicate to have a supporting decision by the shareholders. To estimate the firm value and make decision using the useful accounting information. Accounting, information system that identifies, record and communicates the economic events of the organisation. Types of Accounting Asset = Equity + Liability Financial Provide information for external user Managerial Provide information for internal user - manager Investors Budget Creditors Forecast Government Public Accounting equation elements Assets Economic resources Produce future benefits Liabilities Present obligations Result in an outflow of economic benefits Equity Represents shareholders’ residual claim to the entity’s assets Income Increases in economic benefits during an accounting period Expenses Decreases in economic benefits during an accounting period Total Revenue and gain - Total Expense and losses = Net income Equity = owner capital - owner withdrawal + revenue - expenses. Financial Statements INCOME STATEMENT STATEMENT OF CHANGES IN EQUITY BALANCE SHEET STATEMENT OF CASH FLOWS Financial statement classification ASSETS Current Expected to be converted to cash, sold, or consumed in the next 12 months or within the business cycle. Non-current held longer than one year. Includes: Cash Property, plant and equipment Short-term investments Land Receivables Buildings Inventory Computers Prepaid expenses Intangibles / long-term investment Liabilities Current Obligations or debts payable in the one year or within the business’s operating cycle Non-current Debts payable more than one year from balance sheet date Includes: Account payable Long – term notes payable Taxes payable Bonds Short – term notes payable Salaries/ wage payable Unearned revenue Equity Represents shareholders ownership of the business asset Share Capital Retained earnings Money it raises from selling common or preferred stock. A company may opt for a new offer of stock to increase the share capital on its balance sheet. Profit a company has left over after paying all its direct costs, indirect costs, income taxes and its dividends to shareholders. This represents the portion of the company's equity that can be used, for instance, to invest in new equipment, R&D, and marketing. Need to compute: Adverting expense Service revenue Rental expense Date Description & explanation 1st April Dr Cash 25000 Cr Shares 25000 3rd April Dr Office supplies 400 Cr Account Payable 400 5th April Dr Cash 5000 Cr Service revenue earned 5000 6th April Dr Account receivable 1000 Cr Service for customer 1000 11th April Dr Account payable 200 Cr Cash payment for supplies 200 23rd April Dr Cash 1000 Cr Cash Payment from customer 10000 28th April Dr Salary Expense 2000 Cr Salary 2000 Trial Balance (Eg) Dr Cr Cash Office Supplies Account Receivable Account Payable Expense Revenue Differences T-balance, Unadjusted T-balance, Adjusting T-balance. Accrual vs Cash basis accounting Accrual Cash Basis Records: During any types of transaction During CASH transaction only Revenue when earned Ignores underlying economic activities Expenses when incurred (matching principle) Used by very small operations Use by virtually all businesses Accrual accounting Cash transaction Non - cash transaction Collecting payments from customers Sales on account (Accounts receivable) Receiving cash from interest earned Purchases of inventory on account (Accounts payable) Paying salaries, rent, and other expenses Accrual of expenses incurred but not yet paid (Eg. Salaries payable) Borrowing money Depreciation expense (Allocation of consumption of assets) Paying off loans Usage of prepaid rent, insurance, and supplies Issuing shares Earning of revenue when cash was collected in advance Example of Accrual accounting: (A more accurate accounting) Finish job on 2018 October, but doesn’t get paid until 3month (Next year Jan) • Cash method: Only to write cash statements next year (2019), under cash method in stated of (2018) • Accrual method: You would record it in (2018) as account receivable/ revenue. Date Account DR CR X.X.2018 Accounts Receivable Revenue $XXX $XXX Example 1: Accrued Expenses Suppose a company owes $1,000 in utilities expenses for the current month (but hasn't received the bill yet). The journal entry would be: Debit Utilities Expense $1,000 Credit Accrued Liabilities (or Accounts Payable) $1,000 Example 2: Accrued Revenues Suppose a company has earned $2,000 in service revenue for the current month (but hasn't received payment from the customer yet). The journal entry would be: Debit Accrued Assets (or Accounts Receivable) $2,000 Credit Service Revenue $2,000 Adjusting accounts Adjusting entries are journal entries that bring the accounts up to date at the end of the month/year (i.e., on accrual basis) Frameworks Adjustment Paid (or received) cash for expense (or revenue) relating to the following period. Expense (or revenue) incurred but still not paid (or received) at the end of the current period Prepaid (Deferred) expenses Unearned (Deferred) revenues Accrued expense Accrued revenues Deferrals Business has paid or received cash in advance Prepaid expense Unearned revenue Recorded as an asset when purchased Recorded as a liability when payment is received Expensed when used or expired Recorded as revenue when earned Example of FIFO (Activity S2 Q1) A company reports the following beginning inventory and purchases for the month of January. On January 26, the company sells 730 units. Determine the value of the ending inventory and COGS for January assuming the company uses perpetual inventory system and FIFO. (Round per unit costs to three decimals, but inventory balances to the dollar.) Beginning inventory on January 1 640 unit $3.00 Cost Purchase on January 9 180 unit $3.20 Cost Purchase on January 25 220 unit $3.30 Cost Date Activity Units purchase at cost Unit sold at retail COGS Inventory balance JAN 1 Beginning 640 x $3.00 = $1,920 - - $1,920 JAN 9 Purchase 180 x $3.20 = $576 - - $1,920 + $576 = $2496 JAN 25 Purchase 220 x $3.30 = $726 - - $,2496 + $726 = $3,222 JAN 26 Sold - 730 (640 x $3) + (90 x $3.2) = $2,208 (90 x $3.2) + (220 x $3.3) = $1,014 Total 1040 units, $3,222 730 $2,208 FIFO: COGS $2,208 Inventory $1,014 Weighted average cost. Date Activity Units purchase at cost Unit sold at retail COGS Inventory balance JAN 1 Beginning 640 x $3.00 = $1,920 - - $1,920 JAN 9 Purchase 180 x $3.20 = $576 - - $1,920 + $576 = $2496 Avg = $2,496/(640+180) = $3.04 JAN 25 Purchase 220 x $3.30 = $726 - - $,2496 + $726 = $3,222 Avg = $3,222/(820+220) = $3.10 JAN 26 Sold - 730 (640 + 90) x $3.10 = $2,263 310 + 3.1 = $961 Total 1040 units, $3,222 730 $2,263 WAC: COGS $2,263 Inventory $961 Cash & cash equivalents Cash includes. A financial institution will accept Cash equivalents Deposit in bank accounts Short-term assets Money Highly liquid investment assets Cheque Readily convertible into cash Three principles of cash Separation of responsibility for handling and custodianship of cash from maintaining records for cash Banking intact each day’s cash receipts Making all payments by electronic transfer or by cheque - A good internal control system for handling cash and recording cash transactions. Types of receivables Accounts Receivable Customers owe you money, known as debt. Credit sales Notes Receivable Promissory note i.e. written promise to pay a specified amount of money, usually with interest Other Receivables Are receivables not related to goods or services Example of Account receivables and credit sales: On July 1, A Co. had a credit sale of $950 to B Co. and a collection of $720 from C Co. from a prior credit sale. Journal Entry (Example) Date Accounts DR CR July 1 Account receivable – B Co Sales (B Co. owe you money) $950 $950 July 1 Cash Account receivable (Collection of money from C Co.) $720 $720 - State sales if it’s a good if it’s a service should state service revenue. Bad and doubtful debts Two methods to account for bad debts Allowance method Direct write-off method Credit sales that remain uncollected Debts turns bad (Customer) - Key word is Account. Allowance method Based on the experience of similar businesses, A Co. estimated that $1,500 of its accounts receivable would be uncollectible Accounts DR CR 31 Dec Bad debts expense Allowance for doubtful debt $1,500 $1,500 Direct write-off A Co. decides that D Co.’s $520 account is uncollectible. Accounts DR CR 31 Dec Allowance for doubtful debt Account Receivable $520 $520 Note receivable example: On Dec. 13, A Co. accepted a $10,000, 45-day, 8% note dated December 13 in granting B company a time extension on her past-due account receivable. Accounts DR CR 13 Dec Note receivable – B Co. Account receivable $10,000 $10,000 On Dec. 31, A Co. prepared an adjusting entry to record the accrued interest expense on the B Co.’s Accounts DR CR 31 Dec Interest receivable – B Co. Interest revenue $40 13Dec to 31Dec = 18days interest. $10,000 x 0.08 x (18/360) = $40 Measures how quickly a product sold from inventory. Inventory turnover COGS 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 Average inventory Beg. inventory + Ending inventory 2 $500, loss because your depreciation is $3000, but sold for $2500. So a loss of $500. Intangible Assets Noncurrent assets without physical substance. - Record at cost (purchase + legal fee) Often provide exclusive rights or privileges. Useful life and residual value are often difficult to determine. With limited life span, amortised using straight line method (Patent, Copyrights, License) - With unlimited life, check for impairment annually Liabilities Current liabilities Long term liabilities Expected to be paid within one year or the company’s operating cycle, whichever is longer. Not expected to be paid within one year or the company’s operating cycle, whichever is longer. E.g., short-term loan, income tax, accrued expenses, and customer deposit. E.g., Long-term debt, warranty liabilities, lease obligations. Uncertainty in Liabilities Liabilities Estimated liabilities E.g., accounts payable, notes payable, payroll liabilities, sales taxes payable, and unearned revenues. E.g., Lawsuits and legal claims, warranty obligations, Tax liabilities Example of liabilities (Unearned revenue) On June 30, Beyonce sells $5,000,000 in tickets for eight concerts. Date Accounts DR CR 30 June Cash Unearned revenue - Ticket $5,000,000 $5,000,000 - online transactions. On Oct 31, Beyonce performs a concert. Date Accounts DR CR 31 Oct Unearned revenue - Ticket Ticket Revenue $625,000 $625,000 $5,000,000 / 8 = $625,000 Example of estimated liabilities On Dec. 1, 2011, a dealer sells a car for $16,000 with a maximum one year or 12,000-mile warranty covering parts. Experience indicates warranty expenses average 4% of a car’s selling price. Date Accounts DR CR 1 Dec 2011 Warranty Expense Estimated warranty liability $640 $640 - $16,000 x 0.04 = $640 On Jan. 9, 2012, the customer returns the car for repairs. The dealer replaces parts costing $200. Date Accounts DR CR 9 Jan 2012 Estimated warranty liability $200 Auto Parts Inventory $200 Dr Cash (Investor) Cr Share capital – Ord / Pref Shareholders receive a return on their investment in two ways: 1. through increases in the market value of the shares and 2. through cash dividends. Example of treasury shares: On May 8, Whitt, Inc. purchased 2,000 of its own shares in the open market for $4 per share. Date Accounts DR CR 8 May Treasury shares – ordinary Cash $8000 $8000 2,000 x $4 = $8000 Cash Dividends Regular cash dividends provide a return to investors and almost always affect the share’s market value. To pay a cash dividend, the corporation must have: 1. A sufficient balance in retained earnings; and 2. The cash necessary to pay the dividend. Example of accounting Cash dividends: On January 19, a $1 per share cash dividend is declared on Dana, Inc.’s 10,000 ordinary shares outstanding. The dividend will be paid on March 19 to shareholders of record on February 19 1. Date of Declaration (Record liability for dividend) Date Accounts DR CR 19 Jan Retained earnings Ordinary dividend payable $10,000 $10,000 2. Date of Record No Entry required on February 19, the date of record. 3. Date of Payment (Record payment of cash to shareholders) Date Accounts DR CR 19 Jan Ordinary dividend payable Cash $10,000 $10,000 Types of share capital Ordinary shares Preference shares rights to receive dividend if any o vote at shareholders’ meetings A separate class of shares, typically having priority over ordinary shares in Share equally in any assets Dividend distributions Remaining after creditors are paid in a liquidation Distribution of assets in case of liquidation SEM 4 Cash Flow, Ratio Analysis Purpose of the Statement of Cash Flows To report cash receipts and cash payments during the period Explains the changes in the cash balance. Facilitate the evaluation of a company’s ability to generate cash. Help creditors & investors to decide whether to lend or to invest. Importance of cash flow How did the business fund its operations? From operations, selling assets or borrowings? Does the business have sufficient cash to meet its obligations e.g. pay its debts as they mature? Where did the business spend its cash e.g. expenses, upgrading, dividend payments etc? Did the business have enough cash to pursue future projects? Why is cash flow from operations different from profit? Statement of profit or loss numbers are different from statement of cash flows. Accrual accounting (Records expenses when they are incurred, regardless of when the cash is “exchanged”. - Revenue earned ≠ cash collected or received. - Expenses incurred ≠ cash paid. - Interest expense ≠ Interest paid. - Income tax expense ≠ Income tax paid - Dividends declared ≠ dividends paid Example of tools of analysis Jet speed sales, end 31 December 2007 and 2008 31 Dec 2008 31 Dec 2007 Sales $20,917 $20,337 Net Profit 2142 1149 %Change in sales = ($20917 - $20337)/$20337 = 2.85% increase %Change in net profits = ($2142 - $1149)/$1149 = 86.4% increase Example of vertical Analysis Comparing a company’s financial condition and performance to a base amount. Formula: Net profit 2008 = 2142/20917 = 10.24% Net profit 2007 = 1149/20337 = 5.65% Example of trend analysis (Base year 2011) 2015 2011 Sales $282,880 $150,000 Trend percentage = Current year ÷ Base year The base period trend percentage is always 100. Trend percent (2015) = (282,800/150,000) x 100% = 189% Ratio Quiz Current ratio = Current asset/Current liabilities = (23900+2250+400+2500)/(12900+450+775) = 2.05 Quick ratio = (23900+2250+2500)/(12900+450+775) = 2.02 (Exclude inventory) Debt ratio = 14125/45275 = 0.311 31.1% is finance by debt, the rest is financed by shareholder’s equity. Ratio Analysis Measurement of key relations between financial statement items. Formula: Debt Ratio = Total Liabilities/Total Assets Gearing Ratio = Long term Liabilities + Total Equity Debt-to-Equity Ratio = Total Liabilities/Total Equity This ratio measures what portion of a company’s assets are contributed by creditors. A larger debt-to- equity ratio implies less opportunity to expand through use of debt financing. Times Interest Earned = Income before interest expense and income taxes/ Interest expense This is the most common measure of the ability of a company’s operations to provide protection to long-term creditors. Formulas: eal - Net profit - Preference dividends Weighted-average ordinary shares outstanding lg + Profit earned per 1 ordinary share + Earnings per share is one of the most widely cited accounting statistics. Market value (price) per share Price-Earnings Ratio | = Earnings per share + This ratio reveals information about the stock market’ s expectations for a company’s future growth in cash flows, earnings, dividends, and opportunities (i.e. market's wiliness to pay for company’s EPS) * Each company has different P/E depending on the future; higher ratio better Dividend Yield a Annual cash dividends per share Market value per share Shareholders’ equity applicable Book value per = to ordinary shares ordinary share Number of ordinary shares outstanding + Reflects the amount of shareholders’ equity applicable to ordinary shares on a per share basis. + Net asset book value per share when liquidation Price-Book Market value (price) per share Ratio _—— sl " Book value per ordinary share + Reflects market’s expectation of the company’s net asset book value + If P/B is lower than 1, the market price is lower than the net asset book value.  Manufacturing costs Direct materials Direct labour Manufacturing overhead Prime cost Conversion cost • Prime cost = DM+DL Expenditures directly identifies with the production of finished goods: including direct materials and direct labour. • Conversion cost = DL+OH Expenditures incurred in converting raw materials to finished goods: includes direct labour costs and factory overhead. Period costs > Income statement (Debit equity) Non-production costs (general and administrative expenses, such as rent, office depreciation, office supplies, and utilities Predetermined Overhead Rate (POHR) POHR = $200,000/$160,000 = 160% of direct labour Based on direct labour cost to apply overhead to jobs Difference between merchandisers and manufacturers Merchandisers Buy and sell finished goods Current Assets - Cash - Receivables - Merchandise Inventor Manufacturing Buy materials and produce/sell finished goods Current Assets - Cash - Receivables - Inventories - Raw Materials - Goods in Process - Finished Goods Reason to use POHR Overhead is not incurred uniformly during the year. Predetermined rate makes it possible to estimate job costs sooner Actual overhead rate might vary from month to month. 1. Overhead is not incurred uniformly during the year. 2. Actual overhead rate might vary from month to month. 3. Predetermined rate makes it possible to estimate job costs sooner. POHR = Estimated total manufacturing overhead cost for the coming period/ Estimated total direct labour costs for the coming period Activity-based cost allocation (ABC) To recognize that many activities within a department drive overhead costs. Steps 1. Identify activities that consumer resource 2. Assign costs to a cost pool for each activity 3. Identify cost drivers associated with each activity 4. Compute overhead rate for each cost pool. Rate = Estimated overhead costs in activity cost pool Estimated number of activity units 5. Assign costs to products. Overhead x Actual Activities Example of ABC costing: Activity centre Cost driver Overhead cost Unit of activity Deluxe Regular Purchasing Orders $84,000 400 800 Scrap rework Orders $216,000 300 600 Testing Tests $450,000 4000 11000 Machine related Hours $1,250,000 20000 30000 Total overhead $2,000,000 Activity centre Cost driver Overhead cost Unit of activity (Total) Rate Purchasing Orders $84,000 400 + 800 =1200 $70 Scrap rework Orders $216,000 300 + 600 = 900 $240 Testing Tests $450,000 4000 + 11000 = 15000 $30 Machine related Hours $1,250,000 20000 + 30000 = 50000 $25 Total overhead $2,000,000 With the Activity Based Costing method (ABC), we recognize that many activities within a department drive overhead costs. 5. Assign costs to products Overhead rate x Actual Activity ABC Method ($0.5 x 1000sqf) +($1x500) +($3x400) = $2200 Tradition method = $6x400 = $2400