Assets | = | Liabilities | + | Equity | |||
Dr | Cr | Dr | Cr | Dr | Cr | ||
↑ | ↓ | ↓ | ↑ | ↓ | ↑ | ||
Revenues | - | Expenses | = | Net Income | |||
Dr | Cr | Dr | Cr | No Account | |||
↓ | ↑ | ↑ | ↓ | ||||
Journal Entry:
- Accrued Revenue ∙ Accrued Expense
Debit: Accrued Receivable……..XXX Debit: Accrued Expense ……..XXX
Credit: Accrued Revenue …….. XXX Credit: Accrued Payable …….. XXX
- Revenue ∙ Expense
Debit: Accounts Receivable (or Cash)…….. XXX Debit: COGS ……..XXX
Credit: Revenue …….. XXX Credit: Inventory …….. XXX
- Interest Revenue ∙ Interest Expense
Debit: Interest Receivable……..XXX Debit: Interest Expense……..XXX
Credit: Interest Revenue …….. XXX Credit: Interest Payable …….. XXX
- Prepaid Operating Costs
Debit: Prepaid Insurance……..XXX Debit: Insurance Expense……..XXX
Credit: Cash …….. XXX Credit: Prepaid Insurance …….. XXX
- Sale of Long Term Asset ∙ Depreciation (Contra Account)
Debit: Cash……..XXX à Add to NI for Cash flow Debit: Depreciation Expense……..XXX
Debit: Accumulated Depreciation…..XXX Credit: Accumulated Depreciation …….. XXX
Credit: Asset …….. XXX
Credit: Gain …….. XXX à Subtract from NI for Cash flow
- Bad Debt Expense (adjusting entry) ∙ Write-Offs
Debit: Bad Debt Expense……. XXX Debit: Allowance for Uncollectible Accounts… XXX
Credit: Allowance for Uncollectible Accounts… XXX Credit: Account Receivable… XXX
- Bad Debt Recovery (First undo write-off) ∙ Bad Debt Recovery (Second collect cash)
Debit: Account Receivable… XXX Debit: Cash… XXX
Credit: Allowance for Uncollectible Account… XXX Credit: Account Receivable… XXX
- Raw Materials ∙ Work in Progress
Debit: Raw Material…XXX (100) Debit: Work in Progress… XXX (80)
Credit: Cash… XXX (100) Credit: Raw Material… XXX (80)
- Finished Goods Debit: WIP – Direct Labor… XXX (30)
Debit: Finished Goods…XXX (160) Debit: WIP – Electricity… XXX (50) (not expensed)
Credit: WIP… (160) Credit: Cash… XXX (80)
- Reducing Inventory (lower of cost or market value) ∙ Income Tax Deferred tax can either be Dr or Cr
Debit: COGS…XXX (160) – determined by LIFO, FIFO etc Debit: Tax Expense…XXX If DràAssetàPaid to IRS > Owed to IRS
Credit: Inventory… (160) Credit: Tax Payable…XXX If CràLiabilityàPaid to IRS < Owed to IRS
- Interest Expense = Bond Value X Yield (or, historical market Interest rate at the time of issuing the bond)
- Issued at premium Interest Expense Interest Payment
Dr: Cash 108,111 Dr: Interest Expense 4,324 (=4% X 108,111) Dr: Interest Payable 5,000
Cr: Bonds Payable 108,111 Dr: Bonds Payable 676 (=5000-4324) Cr: Cash 5,000
Cr: Interest Payable 5,000
- Issue at discount Interest Expense Interest Payment
Dr: Cash 108,111 Dr: Interest Expense 5000+XXX Dr: Interest Payable 5,000
Cr: Bonds Payable 108,111 Cr: Bonds Payable XXX Cr: Cash 5,000
Cr: Interest Payable 5,000
- Issued at premium Interest Expense Interest Payment
Financial Statement Analysis:
- Profitability Analysis
- Return on Assets (ROA): how well the firm uses its assets to generate income; independent of the source of financing (does not consider leverage)
- ROA = (Net Income + Interest Expense net of income tax) / Average Total Assets
- ROA = (Profit Margin for ROA) * (Total Asset Turnover)
- Average Total Assets = (Total Assets_Begin + Total Assets_End) / 2
- Profit Margin for ROA = (Net Income + Interest Expense net of income tax) / Sales
- Total Asset Turnover = Sales / Average Total Assets; ability to generate sales from a given level of assets; Higher ratio is preferred to a lower one
- A/R Turnover = Sales / Average A/R; Measures how quickly a firm collects cash; Higher ratio is preferred to a lower one
- Inventory Turnover = COGS / Average Inventory; How fast firms sell merchandise; higher ratio is preferred
- ROA = (Net Income + Interest Expense net of income tax) / Average Total Assets
- Return on Common Equity (ROCE): residual return left for the common shareholders. Since it may be low in poor years but high in good years, it has a risk, that is, the residual return is not known
- ROCE = (Net Income – preferred dividends) / Average common shareholders' equity
- ROCE = (Profit Margin for ROCE) * (Total Assets Turnover) * (Leverage Ratio)
- Profit Margin for ROCE = (Net Income – preferred dividends) / Sales
- Leverage Ratio = Average Total Assets / Average Common Shareholders' Equity; high leverage indicates firm has a lot of assets and shareholders have less of their own investments at risk; good in good years because the common shareholders capture all profits over what is needed to service the debt; Bad in poor years because the debt has to be serviced
- ROCE = (Net Income – preferred dividends) / Average common shareholders' equity
- Earnings per Share (EPS): Diluted includes certain securities that may be converted to a common share e.g. Options, convertible bonds, vendor agreements that involve stock payouts
- EPS = (Net Income – preferred dividends) / Weighted average of common equity
- P/E = market share price / EPS; lower is preferred; also called earnings multiple
- EPS = (Net Income – preferred dividends) / Weighted average of common equity
- Risk Analysis
- Short Term Risk
- Current Ratio = Current Assets / Current Liabilities; Measures ability to pay short-term liabilities
- Quick Ratio = Current liquid assets / Current Liabilities; includes bank a/c but NOT inventories
- CFO / Current Liabilities; ability of the firm to pay current liabilities without borrowing
- Working Capital = Current Assets - Current Liabilities
- Current Ratio = Current Assets / Current Liabilities; Measures ability to pay short-term liabilities
- Long Term Risk
- Debt to Equity Ratio = Total Liabilities / Shareholder's Equity; indicates the financing provided by debtors or creditors; firm is said to be highly leveraged when this ratio is large
- CFO / Total Liabilities; ability to pay all liabilities from cash without new debt or investment
- Interest Coverage Ratio= EBIT / Interest Exp; protection operating profit provides to debtors
- Debt to Equity Ratio = Total Liabilities / Shareholder's Equity; indicates the financing provided by debtors or creditors; firm is said to be highly leveraged when this ratio is large
- Pro Forma Financial Statements: projection of what the financial statements might look like if certain future conditions prevail; only as good as the forecast of the future conditions
- Valuation
- Comparison to similar transaction - Adjusted book Value - Valuation Multiples - DCF
- Comparison to similar transaction - Adjusted book Value - Valuation Multiples - DCF
- Basic Objectives
- Useful to present and potential investors, creditors, and other users
- In assessing the amount, timing, and uncertainty of future cash flows (SFAC 1)
- Provides information about 1) economic resources, 2) the claims to those resources, and 3) the changes in them
- Useful to present and potential investors, creditors, and other users
- Fundamental Qualities: To be useful, financial information must be
- Relevant
- Reliable (i.e., verifiable, neutral, faithfully represented)
- Comparable – cross sectional
- Consistent – time series
- Relevant
- Assumptions
- Going Concern
- Monetary Unit
- Economic Entity
- Periodic Reporting (assumes that business operations can be recorded and separated into different periods)
- Going Concern
- Key Principles
- The Historical Cost Principle
- Revenue Recognition Principle
- Matching Principle
- The Historical Cost Principle
- Key Constraints
- Materiality (whether an item affects the decision of a reasonable individual)
- Conservatism
- Materiality (whether an item affects the decision of a reasonable individual)
Balance Sheet: Snapshot in time of investing and financing activities
- Assets – resource that has a potential future economic benefit (inventory, A/R, cash, building, prepaid rent)
- Liabilities – arises when a firm receives benefits or services and in exchange promises to pay for these at a definite future time (A/P, notes, bonds, salaries, taxes, mortgage payable)
- Equity – Assets – Liability (original contribution + retained earnings)
- Contributed Capital
– original investment by owners- Common Stock: A Par/face/Stated value of the shares which has a legal definition
- Additional Paid-In Capital (APIC): A measure of the of cash or other assets received in the issuance of common or preferred stock in excess of par or stated value
- Common Stock: A Par/face/Stated value of the shares which has a legal definition
- Retained Earnings
– amount of earnings left in the firm after the payment of dividends to the owners- Cumulative sum of profits earned from the inception of a business – Cumulative sum of all dividends distributed to the owners from the inception of a business
- Cumulative sum of profits earned from the inception of a business – Cumulative sum of all dividends distributed to the owners from the inception of a business
- Treasury Stock – stock that the company buys back and keeps in its treasury. It is a reduction to shareholders' equity
- Assets = Liabilities + Shareholders' Equity
- Investing (A) = Financing (L + E)
- Resources (A) = Sources of Resources (L + E)
- Investing (A) = Financing (L + E)
- RetainedEarnings_End = RetainedEarnings_Begin + Net Income - Dividends
Income Statement: Measures the "performance" of a company over a period of time
- Revenues: measure economic benefits generated by sale of products or providing services over a period of time
- Expenses: measure economic sacrifices incurred to "earn" the revenues for a given period of time
- Gains or Positive Other Income: increases in equity from peripheral or incidentaltransactions of an entity
- Losses or Negative Other Income: decreases in equity from peripheral or incidentaltransactions of an entity
- Net Income (Profit) = Revenues – Expenses + Gains – Losses
- Net Income (Profit) = Revenues – Expenses + Gains – Losses
- EPS: net income divided by the average number of common shares outstanding
- Basic: True EPS
- Diluted: Pretends that "stock equivalents" are converted into stock
- Basic: True EPS
Cash Flow Statement:
- Operations: cash from customers less cash paid in carrying out the firm's operating activities
- Investing: cash paid to acquire noncurrent assets less amounts from any sale of noncurrent assets
- Financing: cash from issues of long -term debt or new capital, less dividends
Opinion Letter:
- 1st paragraph: indicates the financial statements covered by the opinion and that the responsibility for the statements rests with management
- 2nd paragraph: affirms that the auditor followed Generally Accepted Auditing Standards (GAAS), accepted by the accounting profession (unless otherwise noted and described)
- 3rd paragraph: actual auditor's opinion – unqualified or qualified
- F/S presents fairly, in all materials respects, the financial position, the results of operations, etc.
- F/S are in conformity with GAAP
- Assessment of the effectiveness of the internal control
- Qualified opinions are either a disclaimer of opinion or an adverse opinion
- F/S presents fairly, in all materials respects, the financial position, the results of operations, etc.
Asset: To recognize an asset, TWO conditions must be met:
- An exchange must take place: This precludes all promises and future contracts as being assets unless some payment has been made
- The future benefit must be quantifiable: This precludes, for example, R&D expenses
Asset Valuation: assignment of a monetary amount to an asset
- Historical Cost
- Prepaid Costs
- Land
- Prepaid Costs
- Depreciated/Amortized Historical Cost
- Buildings and Equipment
- Patents
- Buildings and Equipment
- Market Value
- Marketable Securities
- Marketable Securities
Liability: To recognize a liability, TWO conditions must be met
- The firm has received benefits, and in exchange, promised to pay the provider: This precludes all promises and future contracts as liabilities unless the firm has received some service or asset in the past
- The amount to be sacrificed is quantifiable and will occur at a definite future time: This precludes unsettled lawsuits since the firm does not know if it will win or lose the suit
Liability Valuation: assignment of a monetary amount to a liability
- Liabilities due within one year past B/S date are generally valued at amount of the cash payment (e.g., Accounts Payable, Interest Payable)
- Liabilities due after one year from B/S date are generally valued at the net present value of the future cash payments (Bonds, Capital Leases, Mortgages)
Accrual Accounting: amount and the timing of the recognition of revenues and expenses
- Revenue Recognition: when BOTH of the following are met:
- EARNED: Delivery has occurred or services have been rendered
- REALIZED: Cash collection is 'reasonably assured' and measurable
- EARNED: Delivery has occurred or services have been rendered
- Revenue Amount:
- Revenues
are measured by the cash or equivalent that it expects to receive - Uncollectible Accounts
have no value by definition and are not included in revenue - Sales Discounts and Allowances
are reductions in price and not included in revenue - Sales Returns
are a reversal of the sale and are not included in revenue
- Revenues
- Expense Amount = Cost of the Asset Consumed
- Expense Recognition: The MATCHING PRINCIPLE – Expenses are recorded in the same time period as the related revenues are recognized
- Product Costs can be directly matched to the sale:
- Period Costs
cannot be directly matched to the sale e.g. depreciation expense, interest expense
- Product Costs can be directly matched to the sale:
- Closing:
At the end of the accounting period, revenues and expenses are cleared (reset to zero) for the new accounting period. Their balances flow into Retained Earnings
Cash Flow:
- Change in Cash = Change in Liabilities + Change in Shareholder's Equity – Change in Non-cash Assets
- Operating cash flows (CFO): Result from events or transactions that affect net income; i.e., the cash-based revenues and expenses of a company – generally changes current assets
- Operating (Current) Assets ↑ (e.g. A/R) OR Operating (Current) Liabilities ↓ (e.g. A/P) à Subtract from NI
- Operating (Current) Assets ↓ (e.g. A/R) OR Operating (Current) Liabilities ↑ (e.g. A/P) à Add to NI
- Depreciation à Add to NI ∙ Gains à Subtract from NI ∙ Loss à Add to NI
- Operating (Current) Assets ↑ (e.g. A/R) OR Operating (Current) Liabilities ↓ (e.g. A/P) à Subtract from NI
- Investing cash flows (CFI): Result from the purchase or sale of productive assets like PP&E, marketable securities, and from acquisitions and divestitures – generally changes in non-current assets
- PP&E ∙ Marketable Securities ∙ Businesses
- PP&E ∙ Marketable Securities ∙ Businesses
- Financing cash flows (CFF): Result from stocks/bonds issuance, dividend payment, repurchases, or borrowing/repayment of debts – generally changes in equity and non-current liabilities
- Borrowing and Paying Back Debt ∙ Issuing and Buying Back Own Equity Securities ∙ Pay Dividends
- Borrowing and Paying Back Debt ∙ Issuing and Buying Back Own Equity Securities ∙ Pay Dividends
- Dividends: Paid à CFF ∙ Received à CFO
- Loans: Principal à CFF ∙ Interest à CFO
- Non-Operating (non-current): Assets à CFI ∙ Liabilities à CFF
- Red Flags
- Large increase in Inventories ∙ Large increases over time in A/P ∙ Large increase in A/R
- Large increase in Inventories ∙ Large increases over time in A/P ∙ Large increase in A/R
| CFO | CFI | CFF |
Growth | - | - | + (equity) |
Mature | + | - | - (dividend) |
Dying | - | + (sell off) | + (debt) |
Write-Offs:
- Estimating Bad Debt:
- %age of sales ∙ %age of A/R ∙ Aging of accounts
- %age of sales ∙ %age of A/R ∙ Aging of accounts
- Aging of accounts:
Assume firm has $115,000 A/R
- 1-30 days ∙ 31-60 days ∙ 61-90 days ∙ Over 90 days
100,000 5,000 5,000 5,000
% write-off: 0.1% 1% 5% 90%
Allowance: 100 50 250 4,500
- Ending balance in Allowance for Uncollected is 4,900 (credit)
- If existing balance is 2,500 (credit), Bad Debt Expense is 2,400
- Estimated bad debt expense for the period is $2,300 using the allowance method
Debit: Bad Debt Expense………. 2,300
Credit: Allowance for Uncollectible Accounts …….. 2,300
- A firm writes-off specific customers' accounts totaling $450 as uncollectible under the allowance method
Debit: Allowance for Uncollectible Accounts ……….450
Credit: A/R …….. 450
- A firm writes-off specific customers' accounts totaling $495 as uncollectible under the direct write-off method
Debit: Allowance for Uncollectible Accounts ……….495
Credit: A/R …….. 495
A/R | Allowance for Uncollectible A/C | Bad Debt Expense | |||||
BB |
| BB | BB | ||||
|
| 2,300 | 2,300 | ||||
| 450 | 450 |
| ||||
| 495 |
|
| 495 |
| ||
EB |
| EB | EB |
Inventories: Dollar amount of goods the firm has available for sale
- Costs such as freight, facility, and handling should be expensed and no longer can be capitalized as inventories
- Merchandising Firms: Purchase Inventories; One account
- Manufacturing Firms: Produce Inventories; Several accounts
- Raw material ∙ Work in progress (process) ∙ Finished goods
- Raw material ∙ Work in progress (process) ∙ Finished goods
- Cash Flow Assumptions: In a few industries, it is possible to identify which particular units have been sold (e.g., jewelry, automobile). These firms use specific identification inventory costing. Most firms use cost flow assumption
- COGS = Inventory_Begin + Purchases – Inventory_End
- Specific Identification ∙ FIFO ∙ LIFO ∙ Weighted Average
- LIFO Liquidation - Old LIFO layers are liquidated and "matched" against sales
- Lower of Cost or Market Value (replacement cost) - Cost is value for ending inventory using FIFO, LIFO etc
- Beginning inventory 100 units @ 2.00 200
Purchase #1 300 units @ 2.10 630
Purchase #2 400 units @ 2.25 900
Goods available for sale 800 1,730
300 units sold. 500 units left
FIFO:
- 300 units sold. COGS: 100*2 + 200*2.10 = $620
- 500 units left. Ending Inventory: 100*2.10 + 400*2.25 = $1,110
LIFO:
- 300 units sold. COGS: 300*2.25 = $675
- 500 units left. Ending Inventory: 100*2+300*2.1+100*2.25= $1,055
Weighted Average:
- Cost per unit = $1,730/800 = $2.1625
- 300 units sold. COGS: 300*2.1625 = $648.75
- 500 units left. Ending Inventory: 500*2.1625 = $1081.25
- 300 units sold. COGS: 100*2 + 200*2.10 = $620
- COGS = Inventory_Begin + Purchases – Inventory_End
Long Lived Tangible and Intangible Assets: Assets the company expects to keep for more than one year
- Tangible Assets
- Property, Plant and Equipment ∙ Leased Buildings and Equipment
- Property, Plant and Equipment ∙ Leased Buildings and Equipment
- Intangible Assets: to be recognized as an asset, the intangible asset must be purchased from a third party
- Patents ∙ Franchises ∙ Copyrights ∙ Brand names ∙ Goodwill
- Patents ∙ Franchises ∙ Copyrights ∙ Brand names ∙ Goodwill
- Expensing Long Term Assets over Time
- Balance Sheet Income Statement
Building and Equipment Depreciation
Natural Resources Depletion
Intangibles Amortization
Land Not expensed
Goodwill Not expensed (Impairment test)
- Issues in depreciation:
- Measuring the depreciable basis of the asset
- Acquisition Cost – Salvage (Residual) Value
- Acquisition Cost includes all costs of acquiring and putting the asset in use
- the fair value of what was given up in exchange for the asset (such as cash), or
- the fair value of what was received; whichever is more easily determined
- the fair value of what was given up in exchange for the asset (such as cash), or
- Salvage Value estimates market price in the future. Rarely, it may be –ve if disposal costs are very high
- Acquisition Cost – Salvage (Residual) Value
- Estimating its useful life (economic life or service life): Most difficult task as obsolescence typically results from forces outside the firm. Accountants reconsider assets' estimated service lives every few years
- Deciding on the pattern of depreciation
- accelerated depreciation (A) - straight-line depreciation (S)
- decelerated depreciation (D) - expense immediately (E)
- no depreciation (N)
- accelerated depreciation (A) - straight-line depreciation (S)
- Acceptable methods (GAAP):
- straight line - Units of Production (use) - Accelerated (Declining bal; Sum of years' digits)
- straight line - Units of Production (use) - Accelerated (Declining bal; Sum of years' digits)
- Acceptable methods (Tax): MACRS = Modified Accelerated Cost Recovery System (similar to declining balance)
- Straight line (time) depreciation: most common method
- Basis = (cost – salvage value) & Rate = 1/ service life in years
- Annual depreciation = Basis * Rate = (cost – salvage value) / (service life in years)
- Basis = (cost – salvage value) & Rate = 1/ service life in years
- Units of Production depreciation: Sometimes the exhaustion of assets can be better measured by units of output or production e.g. a delivery truck may be good for 200,000 miles before wear and tear make it uneconomically useful. It may matter little whether the miles are driven in a few years or many
- Depreciation Cost per Unit = (cost - salvage Value) / Estimated Number of Units
- Annual depreciation = (Depreciation Cost per Unit) * (Number of Units Produced that period)
- Depreciation Cost per Unit = (cost - salvage Value) / Estimated Number of Units
- Accelerated (sum of years' digits method):
- Sum of years' digits = n*(n+1) / 2 e.g. 5 years = 1+2+3+4+5 = 5*6/2 = 15
- Basis = (cost – salvage value) & Rate = (remaining years) / (sum of years' digits)
- Annual depreciation = Basis * Rate
- Sum of years' digits = n*(n+1) / 2 e.g. 5 years = 1+2+3+4+5 = 5*6/2 = 15
- Repairs generally restore usefulness. As such, repairs are expensed in the period they occur
- Improvements increase usefulness and thus they are usually added to the cost of the asset and a new depreciation may have to be determined
- Patents expire after 20 years in the U.S.; R&D and advertising should be expensed immediately
- Impairment Test: Goodwill and Other Intangibles tested for impairment
- Calculate undiscounted cash flows from an asset àUCF
- Check whether book value > UCF. If yes
- Reduce asset book value to fair value, or, Discounted Cash Flows (DCF)
- New book value on Balance sheet = PV of DCF
- Impairment loss on Income Statement = Old book value – New book value
- Reduce asset book value to fair value, or, Discounted Cash Flows (DCF)
- Calculate undiscounted cash flows from an asset àUCF
Liabilities: Some (e.g. mortgage) may be noncurrent but have a current portion (payments due within the operating cycle)
- Mortgage or Notes for borrowing small amounts • Bonds to raise larger amounts
- Bond indenture (agreement) • Can issue at par, discount, premium • Coupon / No Coupon
- Types: Debenture bond – no collateral (most common) & Convertible bond
- Coupon Payment = Face Value X Coupon Rate
- Coupon Rate > Market Rate à Bond Price > Face Value à Issued at Premium
- Coupon Payment = Face Value X Coupon Rate
- Off-Balance Sheet Financing: any means that secures the use of assets for the firm without having to recognize an offsetting liability
- Can make key financial ratios look more favorable
- It lowers the cost of borrowing if lenders are not aware of the unrecorded liabilities
- It avoids violating some debt covenants (Examples: structured investment vehicles (SIV))
- It avoids violating some debt covenants (Examples: structured investment vehicles (SIV))
- Can make key financial ratios look more favorable
- Leases: Firms may lease assets instead of purchasing them. Some leases are so inflexible that they are tantamount to a purchase
- Capital Lease: recognizes lease as if it were a purchase
- Both the leased asset (leasehold) and the lease liability (PV of the lease obligations) are recognized
- The leased asset may be depreciated over time and the lease liability is amortized as payments are made
- Signing the lease Payments
Dr: Leased Assets…XXX Dr: Interest Expense…YYY & Dr: Lease Liability…ZZZ
Cr: Lease Liability…XXX Cr: Cash…YYY+ZZZ
- Both the leased asset (leasehold) and the lease liability (PV of the lease obligations) are recognized
- Operating lease: recognizes the lease as rent
- A lease expense is recognized as payments are made or adjusted entries are required
- NO asset or long-term liability are recognized
- A lease expense is recognized as payments are made or adjusted entries are required
- Conditions to recognize as Capital Lease:
- Transfers ownership to lessee at end of lease - Contains a bargain purchase option
- Lease term = 75% of the asset's useful life - PV of lease payments = 90% of asset's fair market value
- Transfers ownership to lessee at end of lease - Contains a bargain purchase option
- B/S Impact: Capital leases result in higher assets and higher liabilities
- I/S impact: Capital leases result in higher costs in earlier years; Operating leases result in higher costs in later years; over the life same
Contingencies, Income Taxes, Pension Obligations
- Contingencies: an existing situation involving uncertainty as to possible gain or loss to a company that will ultimately be resolved when one or more future events occur or fail to occur example: litigation
- Probable: the future event(s) is likely to occur: Accrue it
- Reasonably possible: the chance of the future event(s) occurring is more than remote but less than likely: Disclose it
- Remote: the chance of the future event(s) occurring is slight: No accrual/Disclosure
- Accrue loss contingencies if both of the following conditions are met:
- Information indicates that it is probable what an asset has been impaired.
- The amount of the loss can be reasonably estimated.
- Information indicates that it is probable what an asset has been impaired.
- Probable: the future event(s) is likely to occur: Accrue it
- Income taxes are expenses and should be matched like other expenses, regardless of the cash tax payments
- Defined Benefit (Pension) Plans
- Promise to disburse a stream of payments to a retiree after they cease to be employed
- Cost recognized over estimated career ∙ Payments disbursed over estimated retirement period
- Promise to disburse a stream of payments to a retiree after they cease to be employed
- Defined Contribution Plans (401k)
- Employer agrees to make a fixed payment, each year on employee's behalf
- Cost recognized each year as the payment is made ∙ Typically a "Match" of the employee contribution
- Employer agrees to make a fixed payment, each year on employee's behalf
- Other Post-Employment Benefits e.g. Health care coverage; Same accounting recognition as pension plan
Marketable securities: are bonds/stocks for which there is a reliable, liquid mkt; initially recorded at acquisition cost; later can be adjusted to the mkt value
- Classified as Marketable Securities when: ∙ firm can easily convert it to cash ∙ Intends to do so when it needs cash, i.e., temporary investment
- Investments are held either for profit (resold at a higher price) or for control purposes
- If held for profit, the current market value provides useful information on that profit potential. Thus, GAAP provides for certain securities to be valued at market value
- If held for control, then the profit of the subsidiary firm provides useful information. Both the equity method and consolidations require the parent firm to recognize accrued income of the subordinate
- If held for profit, the current market value provides useful information on that profit potential. Thus, GAAP provides for certain securities to be valued at market value
- Three classes of Marketable Securities for the purposes of valuation after acquisition:
- Debt Held to Maturity: firm has both intent & ability to hold to maturity; shown on the B/S at the amortized acquisition cost (like bond)
- Held for Trade (Trading Securities): held for short-term profit; unrealized gains or losses that result from adjustments to mkt value pass through the income st. and increase or reduce net income
- Securities Available for Sale: acquired for long-term return; unrealized gains or losses that result from adjustments to market value do not pass through the income statement but stay on the balance sheet as an equity account (OCI)
- Debt Held to Maturity: firm has both intent & ability to hold to maturity; shown on the B/S at the amortized acquisition cost (like bond)
- Minority, Passive Investments (<20%) - Held for Short Term
- Minority, Active Investments (20%-50%) - Held for Influence; Requires the Equity Method of accounting:
- Initial purchase is recorded as an asset at the acquisition cost
- Each period, the investing firm recognizes revenue = to its proportionate share of the firm
- Dividends reduce the asset and are not revenue but rather a return of capital
- Initial purchase is recorded as an asset at the acquisition cost
- Majority, Active Investments (subsidiary, >50%) - Held for Full Control; portion of the subsidiary not owned by the parent is called the Minority Interest
- Financial statements of legally separate entities be combined under one controlling economic entity
- Financial statements of legally separate entities be combined under one controlling economic entity
- (A)OCI: (Accumulated) Other Comprehensive Income
- Treasury Shares – contra account to shareholder's equity
- Recorded at cost and kept in a separate acct so that the firm can more easily resell it.
- TS do not receive cash dividends or vote. They may split or receive dividends in stock.
Operating Lease Journal Entry (for lessor)
Dr: Cash…XXX
Cr: Rent Revenue…XXX
Dr: Depreciation Expense…XXX
- Recorded at cost and kept in a separate acct so that the firm can more easily resell it.
Cr: Acc Dep…XXX
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