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Introduction to Accounting

Ivana Dražić Lutilsky

Room 35, 2.floor, North Tutorials: Wednesday 10 -12 18-19

The act of gathering and reporting about the financial information of a company Accounting is a continual process of:


Capturing financial data Organizing it Producing financial reports

 Accountancy

(profession) or accounting (methodology) is the measurement, statement, or provision of assurance about financial information primarily used by managers, investors, tax authorities and other decision makers to make resource allocation decisions within companies, organizations, and public agencies.

 Accounting

is a service activity.  Its function is to provide quantitative information primarily financial in nature, about economic entities, that is intended to be useful in making economic decisions, and in making reasoned choices among alternative courses of action.

 It

is also the discipline of measuring, communicating and interpreting financial activity.  Accounting is also widely referred to as the "language of business".

 Accounting/accountancy

attempts to create accurate financial reports that are useful to managers, regulators, and other stakeholders such as shareholders, creditors or owners.  The day-to-day record-keeping involved in this process that is known as bookkeping.

Internal Users - managers use it to plan, organize and run a business. External Users

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Investors (Current and Potential) Creditors Others

   

Taxing authorities Regulatory agencies Customers Labor unions Economic planners

An organization’s financial statements provides managers with information to determine present and future decisions. Such actions include:
Granting credit  Making investments  Borrowing money  Adhering to regulations  Determining executive compensation  Evaluating competition  Evaluating potential litigation

Accounting planning
Bookkeeping Accounting control

Accounting analysis
Providing information

 Financial accounting  Cost accounting accounting  Managerial .

 This system was first used in medieval Europe. .  The sum of all debits should always equal the sum of all credits.  This system involves making at least two entries for every transaction: a debit in one account. although claims have been made that the system dates back to Ancient Rome or Greece. providing a simple way to check for errors. At the heart of modern financial accounting is the double-entry bookkeping system. and a corresponding credit in another account.

Organization (Entity) Operates in an environment that makes decisions and takes actions to make it economically better or worse “Filter” Economic Concepts Accounting Conventions Institutional Context Financial Reports Balance Sheet Income Statement Cash Flow Statement .

owned by one person Partnership .organized as a separate legal entity and owned by stockholders .Sole Proprietorship .owned by more than one person Corporation .

finance and marketing) Easier to transfer ownership or raise money No personal liability  Partnership   Corporation   ..e. Sole    Proprietorship Simple to establish Owner controlled Tax advantages Same as sole proprietorship except now with additional individual(s) the organization has a broader skill base (i.

 Accounting Conventions – The accounting rules that apply the economic concepts to practical situations. . Economic Concepts – The economic principles guiding the construction of accounting reports.  Institutional Context – The environment that shapes the consequences of adopting specific accounting conventions.

. specifically the financial statements.The “filters” can be viewed as the financial process the organization goes through in producing the annual report.

liabilities.Economic Concepts Financial Values Attach to individual assets. revenues and expense items by the accounting process Financial Statements Balance Sheet Assets Liabilities Equity Income Statement Revenue Expenses Net Income Wealth Measured by equity at a point in time Cash Flow Statement Operating cash flow Investing cash flow Financing cash flow Economic Income Change in wealth measured by net income .

Financial Statements  Balance Sheet  Income Statement  Statement of Cash Flows  Statement of Retained Earnings  Notes to the financial statements .

.The financial statements are part of a comprehensive financial report referred to as the annual report.

 Asset  Liabilities  Equity  Revenues  Expenses  Financial results .

 A= L + SE . Shows relationship between assets. liabilities and equities--on a particular date (i..  Assets and liabilities and stockholders' equity must balance. point in time).e.

. – The probable future sacrifice of economic benefits arising from an entity’s obligation to transfer assets or provide services  Liabilities for a past transaction. Assets – A probable future economic benefit obtained by entering into a transaction. Creditors claims on total assets (obligations or debts of the business). The resources owned by the business.

 Stockholders' Equity – The difference between an entity’s assets and liabilities. . The owners’ claim on total assets.

If expenses exceed revenue.  Summarizes . Reports success or failure of the company's operations during the period. or year. the result is a (net loss). If revenues exceed expenses. all revenue and expenses for period-month. quarter. the result is a net income.

 Expenses – decreases in net assets resulting from an entity’s operation over a period of time. Revenues – increases in net assets resulting from an entity’s operation over a period of time.  Net Income . .the excess of revenues over expenses.

describes the flow of cash into and out of an organization during an accounting period. Investing activities – The change in cash resulting from actions taken to acquire or dispose of productive company assets.The Cash Flow Statement . These flows are classified in three categories: Operating activities – The change in cash resulting from actions intended to generate net income. .

.g.Financing activities – The change in cash resulting from payments to or receipts from suppliers of money to the firm (e. common shareholders or debt holders)..

changes in retained earnings balance during period covered by statement. and amount of net income or net loss for period. amount paid out in dividends.  Shows . Indicates amount invested by owners.

. goods and services will be properly valued.Financial value – The amount of money an item would bring if sold.  Accurate financial valuation depends on how well a market functions. In a well-functioning market.

Competitive – The market should reflect the true financial value. Organized and regulated – The market in which the good is traded has standard definitions for making transactions and is open to new. efficient methods for improvement. . Low transaction costs – The price paid to buy/sell the good requires few operational resources to complete the transaction. No chance for a seller to make abnormal profits.

e.Wealth – The sum of the financial values of all things an organization owns.. Defined by the balance sheet (i. accounting identity) description: Assets = Liabilities + Equity .

 Reflected in the income statement (revenues minus expenses) for a period. excluding capital transactions with its owners.  This measure describes an organization’s success using its economic resources in a period.Economic income – The change in an organization’s wealth.  Owner investments (issuing new shares of stock) are excluded because the increase in wealth attributable to them is NOT generated by use of the organization’s resources! .

organizing. .Generally Accepted Accounting Principles known as GAAP are the commonly understood and accepted conventions for gathering. and reporting the financial history of an organization.

Generally GAAP applies to one or more of the following three broad areas:    Accounting Valuation Recognition Disclosure .

It provides guidance and restrictions on the accounting values used in the financial statements.” .Accounting Valuation . Example: describes how Union Plaza values plant and equipment…. “Plant and equipment are carried at cost less accumulated depreciation and amortization.GAAP helps to specify the value of the items reported.

does an advertising campaign have future benefits? Example: shows how Novell utilizes GAAP to guide their recognition….Recognition – How should an item be treated in the accounting records? Should an item be treated as an asset or an expense? For instance. . An advertising campaign is deemed to have no future value and the cost of advertising is expensed as incurred.

etc.Disclosure – The act of providing information about the organization and construction of its accounting reports. GAAP requires the disclosure of measurement methods. that add to the information content of the annual report.. Example: shows that Kmart values its inventory using LIFO and discloses the value of the inventory. It also discloses what the inventory would be valued if Kmart used an alternative method (FIFO). . assumptions.

.Market richness – Where the market for a good is a well-functioning one (i.e. it is competitive and experiences low transaction costs).. GAAP will use market valuations to drive the accounting.

g.Complexity of the transactions – When transactions are simple (e. CEO compensation including a salary. bonus. . GAAP will be complex.. When transactions are complex (e. exchange of cash for a Big MacTM . GAAP is simple. pension plan and stock options)..g.

Form of the organization – GAAP differs depending upon the type of business entity (e. not-for-profit.g. governmental). . partnership. sole proprietor.. corporation.

 Croatian Association of Accountants and Financial Experts has approx. the Law does not define formal education requirements or diplomas. An accountant does not need to have an university diploma or any form of certificate to prove his adequacy. In order to be an accountant.    Accountants have not yet obtained qualifications compliant with International federation of accountants’ education requirements  it is an important notion for legislative authorities! . 30. he/she needs to follow the regulations set by the Law of accounting and by the profession itself. while auditors need to obtain the license from the Chamber of auditors (formed in 2006).000 members.

 Regardless to their asset. revenue of 65 mil. revenues and more employees than the medium companies. investment funds. Kn  Max.   The basic division between types of companies according to the accounting regulations: A) Small companies:  Total asset is not larger than 32. insurance companies. revenue not larger than 260 mil. Kn  Have no more than 250 employees C) Large companies:  These have larger asset. Kn  Have at most 50 employees B) Medium companies:  Total asset is not larger than 130 mil. and pension plans.5 mil. large companies are also all banks. leasing companies. Kn  Max.  . revenue and number of employees. all other saving institutions.

 It defines:           subjects that are obliged to use the law.Defines the institutional accounting framework in Croatia. business books.  The newest one has been issued in 2007. It foresees the usage of International financial reporting standards. . bookkeeping documents. standards of their presentation. penalties. and the act determines the Financial reporting council. list of assets and liabilities. financial reports.

 Religious institutions  Political parties. business books and financial reports the act also states that:  most documents are to be kept within the company for 7 years.  Sindycates.profit institutions.  . except:  Government agencies  Central and local state funds  Health institutions.  financial reports are to be kept in original form for at least 11 years.  Other non. The Act must be used by all private and legal entities who are working in the interest of obtaining profit and thus have an obligation to pay income tax. Besides defining the bookkeeping documents.  The Act functions in compliance with the Company act (largely influenced by the German legal system).

like Croatia. and thus in those who want to join the EU. . only large companies. financial institutions and those listed on the Zagreb stock exchange are obligatory to use the IFRS.  . In Croatia. only entities of public interest are obligatory to use IFRS.Croatian Financial Reporting Standards Both sets of accounting standards are to be published in the “Narodne novine” (National newspapers) before they are put into use.  Smaller companies must use the standards defined by the croatian Financial reporting council that is controlled by the Ministry of finance. The international financial reporting standards are to be used in all EU Countries.   In other words. .

 FINA  (financial agency) Receives all financial statements and reports from every profit & non-profit institution in Croatia. ***NOTE: Ensuring public availability of full financial statements is not common practice in Croatia. Publishes standardized summary financial statements of all companies (it includes only the key financial figures without the audit report).   .

HANFA (Croatian financial services supervisory agency) and the MoF (Department for financial systems of the Ministry of finance) are responsible for financial reporting of the financial sector:   HNB  responsible for the development and implementation of financial reporting requirements applicable to the banking sector. HNB (Croatian national bank). HANFA  responsible for the rest of the financial sector .

 Management  Notes Discussion and Analysis to Financial Statements Report  Auditor's .

ability to pay near-term obligations  capital resources .ability to fund operations and expansions  results of operation .profitability and efficiency .Covers three aspects of a company:  liquidity .

Exhibits 1. percentage of international sales. market share.g.. Provide  Does additional information not included in body of statements not have to be numeric  Examples:  Description of accounting policies or explanation of uncertainties and contingencies (e.)  . etc.4 and 1.5) Company statistics (e.g.

and cash flows in accordance with GAAP.  Auditor gives an unqualified opinion if the financial statements present the financial position. Auditor. results of operations. a professional accountant who conducts an independent examination of the financial accounting data presented by a company. .

Ivana Dražić Lutilsky .

these set of guidelines provide the basis in the preparation of financial statements.  To ensure uniformity and comparability between financial statements prepared by different companies. . making international comparisons of companies difficult. a set of guidelines and rules are used. Different countries have developed their own accounting principles over time.  Commonly referred to as Generally Accepted Accounting Principles (GAAP).

are under consideration in South Africa and other countries.  The United States Federal Accounting Standards Board has made a commitment to converge the U. Canada and the European Union (for publicly quoted companies only).S.Recently there has been a push towards standardizing accounting rules made by the International Accounting Standards Board ("IASB"). GAAP and IFRS over time.  .  IASB develops International Financial Reporting Standards that have been adopted by Australia.

generally accepted accounting concepts generally accepted principles generally accepted standards .

going concern concept. assumptions) are theoretical basis and their appliance is taking into consideration formulation of accounting principles. .accrual basis of accounting concept. Concepts by the IFRS are: . .  Concepts (or conventions.

monetary by the GAAP are: unit. .Concepts .going concern concept.time period. .economic entity and . .

.Monetary Unit – Money is the unit used to measure economic activity. In short. Economic Entity – This concept provides a context or “point of view” for the economic events (i. “Whose liability is it?” .e. “Whose asset is it?”. it answers the questions. transactions) captured by the financial statements.

Time Period – A business can be divided into artificial time periods. .A company is expected to carry out its operations into the foreseeable future. Going Concern . The most commonly used time periods for public corporations is quarterly and annually.

 Principles are based on concepts and they are further determining accounting and it’s basic characteristics for accounting policies. .

 - - Principles by the GAAP are: Cost principle (troškovno načelo) Objecivity principle (načelo objektivnosti) Realization principle (načelo realizacije) Matching principle (načelo sučeljavanja prihoda i rashoda) Materiality principle -substance over form principle (suština važnija od forme) .

- Full-disclosure principle (načelo potpunosti) Consistency principle (načelo konzistentnosti) Conservatism principle (načelo opreznosti) .

.     Principles by the IFRS are: understand ability principle relevance principle materiality principle reliability principle      truly presentation principle substance over form principle neutrality principle prudence principle full disclosure principle  comparability principle.

 Relevance .  Reliability .information makes a difference in decisions. .information must be free of error and bias.

companies must use the same accounting principles and methods from year to year.ability to compare information of different companies. .  Consistency . Comparability .

.Cost Principle – Assets acquired are recorded at cost. Full Disclosure Principle – Information that would effect an investor or creditors view of the company should be disclosed.

GAAP doesn’t have to be followed .if item doesn’t make a difference.in “gray” areas choose guide which does not overstate assets or income  Conservatism .Permits companies to modify GAAP without hurting the usefulness of information  Materiality .

. providing accounting information and presentations of financial statements and it’s elements. They are further concretization of accounting principles in a view of methods in recording accounting data.

 IFRS – International financial reporting standards – precondition for globalization  NS – national standards – made for national levels and their specifics in accounting .

 They are part of company business policies  With accounting policies company can deliberate influence the elements in financial statements  Freedom of choices is given through accounting standards .

. like: .Revenues….amortization. .Inventories. . Companies have obligation of presenting their accounting policies through notes  Accounting policies could influence financial statements.

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Generally contains the following standard classifications:     Current Assets Long-Term Investments Property. and Equipment Other Assets    Current Liabilities Long-Term Liabilities Stockholders' Equity . Plant.

ASSETS NON CURRENT CURRENT .

other rights .goodwill .account receivables  is expected to be realized within more than 1 year after the balance sheet date .advance payments for intangible assets - land buildings plants equipments motor cars advance payments for tangible assets - bought securities given deposits given loans other long term investments .NON CURRENT ASSETS INTANGIBLE TANGIBLE FINANCIAL RECEIVABLES .concession .patents .license .

given deposits .state receivables .cash at bank .cash in hand • is expected to be realized within 1 year after the balance sheet date .other receivables .CURRENT INVENTORIES .advance payments for inventories RECEIVABLES FINANCIAL CASH .raw materials .employee receivables .other short term investments .given loans .production inventories .bought securities .work in progress .merchandise inventories .account receivables .

The probable future economic benefit an entity obtains by entering into a transaction .

Assets that are expected to be converted to cash or used in the business within a short period of time.  Examples:      Cash Short-term investments Receivables Inventories Prepaid expenses . Current assets are listed in order of liquidity. usually one year.

checking and/or money market account). bonds). Short-term investments . Sometimes referred to as “Marketable Securities”..g.An entity’s investment in another entity’s stock or debt (i.Money in the form of cash or bank deposits (e.Cash . These assets yield a higher return (dividends.e.. appreciation or interest) than is available through checking and money market accounts. .

The material that it needs to make the goods is referred to as raw materials.Inventories . finished) is referred to as work in process. The raw material in process of being completed (i. ..e.The goods an entity has on hand is referred to as a finished good.

. .g.Prepaid expenses – The amounts an entity has already paid for services/goods to be delivered in the future (e. car insurance).

The amounts due from customers for goods they purchased on credit. Because all customers do not pay their bills. Example .075) Net accounts receivable $ 25. the balance is reduced by an “allowance” (an estimate of what will not be collected).OshKosh December 29.Accounts Receivable .467 . 2001: Total Accounts receivable $ 32.542 Less: Allowance ( 7.

Assets that are expected to benefit the business over a long period of time. Non-current assets are usually listed in order of importance to the entity.  Examples:    Property plant and equipment Long-term investments Other assets .

and Equipment . buildings.The land.Property. Plant. . equipment. furniture and fixtures that are used in operating the business.

SOURCES OF ASSETS EQUITY NON CURRENT LIABILITIES CURRENT LIABILITIES .

accounts payables (long term) - accounts payables salaries payables received short term loans issued short term securities issued checque income tax liabilities VAT liabilities dividend payables received advanced payments .received long term loans .loss .SOURCES OF ASSETS EQUITY NON CURRENT LIABILITIES CURRENT LIABILITIES - owner’s equity legal reserves statutory reserves revalorization reserves other reserves retention (retained earnings) .net income .issued long term securities .

.Liabilities – The probable future sacrifice of economic benefits arising from an entity’s obligations to transfer assets or provide services as a result of a past transaction or event.

Examples:      accounts payable accrued liabilities short-term borrowings dividend payable unearned revenue .Liabilities that are expected to be paid by the business within a short period of time. usually one year. Current liabilities are listed in order of liquidity.

Accounts payable – The amount an entity owes to suppliers for goods previously delivered. Sometimes referred to as “trade payables” or “trade accounts payable”. .

Accrued liabilities .181 8.182 17. rent. wages. Example: OshKosh A summary of 12/29/01 accrued liabilities follows: Compensation Workers’ compensation Income taxes Other Total $ 7. More detail is offered in the Notes to the Financial Statements. etc.403 .140 $38.The amounts an entity owes for taxes.900 5.

Short-term borrowings – Monetary amounts due within one year for repayment of bank loans, notes payable and other commercial paper.

Dividends payable – The amount owed by a corporation to its shareholders when dividends declared by the board of directors have not yet been paid.

Unearned revenues – The monetary amounts received by an entity that accepts up-front payments of cash in exchange for future delivery of its products. Example: Your advance cash payment for a threeyear subscription to Fortune Magazine requires their sacrifice of future economic benefits (they are liable) to provide the magazine. It is termed “unearned” as it represents a service (i.e., the subscription) that has NOT yet been completed (i.e., delivered to your door). It will be “earned” as delivery takes place.

Debts expected to be paid after one year. Examples:
    

warranties employee benefit plan liabilities leases bonds payable long-term obligations

Warranties – The entity’s obligation to replace defective merchandise within a specified time period.

Employee benefit plan liabilities – The “sacrifice” of cash that an entity must make for pensions, retirement health care and other retirement benefits.
Lease – The “sacrifice” of cash that an entity must make to secure equipment or for the use of property to conduct operations

Bonds payable – The amount due to bond purchasers under terms of the bond issue. Long-term borrowings – Monetary amounts for bank loans, notes payable and other commercial paper that does not have to be repaid within one year.

Stockholders' Equity – The difference between total assets and total liabilities. Stockholders’ equity arises from the contributions of owners.

 


Risk capital, liable capital, proprietorship, net worth After all liabilities are paid, ownership equity is the remaining interest in assets Equity = Assets - Liabilities At the start of a business, owners put some funding into the business to finance assets (equity capital) Bankruptcy → creditors have the first claim on the proceeds, ownership equity is paid at the end Shareholder’s equity → when the owners are shareholders

Owner ’s equity

Paid in capital – comes from the shareholders through the purchase of the company’s stock

Earned capital – comes from profitable operations (retained earnings)

Net worth of a company is reflected in its balance sheet as owner’s (shareholders') equity  Net worth is an important determinant of the value of a company, considering it is composed primarily of all the money that has been invested since its inception, as well as the retained earnings for the duration of its operation  Net worth can be used to determine creditworthiness because it gives a snapshot of the company's investment history  Market price per share ≠ equity per share

Ownership of a share entitles the holder to a vote on major corporate decisions and a residual claim to the entity’s assets in the event of liquidation. . The amount recorded in this account represents the legal capital per share that must be retained in the business.Common Stock – Shareholders’ investment in the entity through acquisition of stock.

.Additional paid-in-capital – The amount paid by the investor for a share of stock in excess of its par value.

Preferred Stock – Another vehicle available to corporations for raising owner contributions. A preferred owner typically is not allowed to vote on major corporate issues. these shareholders receive the stated value of their shares. In the event of liquidation. .

equity (net income) generated from operations less what has been returned to the shareholders in dividends.Retained Earnings . . The adjective “retained” reveals that these earnings have not been distributed to shareholders in the form of dividends.

.Constructing the Balance Sheet Analyze the effect of business transactions on the basic accounting identity: Assets = Liabilities + Stockholders’ Equity Remember: The Accounting Identity must always balance.

.Transaction Analysis Transaction Analysis determines if and how the transaction impacts the financial statements.

Transactions can be divided into two types: F External events F Internal events Only external transactions must be recorded in the financial statements. .

.External events occur between the company and some outside party. It involves an exchange of assets. or stockholders' equity between a company and an outside party Internal events are economic events that occur entirely within one company. liabilities. For example the act of hiring of an employee.

1. . An account would be cash. accounts payable etc. 3. 2. Analyze each transaction Journalize each transaction Post each transaction to a T account.

T . Journal .transferring of information from the journals to the general ledger accounts (i.determine how the transaction affects the balance sheet (i. increase or decrease assets.).e.e. Posting .Analyze .accounting record where the transactions are recorded in chronological order...Accounts) . liabilities etc.

Liability.Account An individual accounting record of increases and decreases in a specific Asset. Three parts : 1) the Title of the account 2) a left or Debit side 3) a right or Credit side . or Stockholders’ Equity item.

Account TITLE DEBIT CREDIT .T .

the account has a Debit Balance .Total the Entries to Each Side TITLE Debit Credit Total Debits Total Credits If the greater sum is on the left.

Total the Entries to Each Side TITLE Debit Credit Total Debits Total Credits If the greater sum is on the right. the account has a Credit Balance .

DEBITS Increase – Assets Decrease – Liability and Equity Accounts CREDITS Decrease – Assets Increase – Liability and Equity Accounts .

. debit or credit) that is increased. Normal Debit Balance: Assets Normal Credit Balance: Liabilities Stockholders’ Equity .The term normal balance for an account is the side (i.e.

Let’s Practice Transaction Analysis .

 Record . the debit and credit effects on specific accounts for each transaction.The basic steps in the recording process are:  Analyze each transaction in terms of its effect on the accounts.

On January 1. How does this affect the accounting equation? .000 is invested in Rhody Corporation in exchange for common stock. $40.

A +  Assets = L + SE + increase  Stockholders’ equity increases What asset account and stockholders’ equity account is affected? .

.000 Note: Debits are always written first and you always indent the credit.000 Common Stock (credit) $40.Cash (debit) $40.

000 of equipment for cash.Also on January 1 Rhody purchases $20. How does this affect the accounting equation? .

A +  Assets = = L + SE increase  Assets decrease What asset accounts are affected? .

Equipment (debit) $20.000 Cash (credit) $20. .000 Note: Debits are always written first and you always indent the credit.

000 on account. How does this affect the accounting equation? .On January 5 Rhody purchases inventory of $14.

A +  Assets = L + + SE increase  Liabilities increase What asset account and liability account is affected? .

000 Note: Debits are always written first and you always indent the credit. .Inventory (debit) $14.000 Accounts Payable (credit) $14.

On March 6 Rhody buys $4. How does this affect the accounting equation? .000 of supplies for cash.

A +  Assets = = L + SE increase  Assets decrease What asset accounts are affected? .

Supplies (debit) $4.000 Cash (credit) $4. .000 Note: Debits are always written first and you always indent the credit.

How does this affect the accounting equation? .000 to insure its cars for the next year.On April 1 Rhody pays $12.

A + +  Assets = L + SE increases  Assets decrease What asset accounts are affected? .

Prepaid Insurance (debit) $12.000 Note: Debits are always written first and you always indent the credit.000 Cash (credit) $12. .

000 in advance for services to be performed in the future. Rhody receives $18.On September 1. How does this affect the accounting equation? .

A +  Assets = L + + SE increase  Liabilities increase What asset account and liability account is affected? .

Cash (debit) $18.000 (credit) Note: Debits are always written first and you always indent the credit.000 Unearned Revenue $18. .

and carries an interest rate of 9%. How does this affect the accounting equation? . Rhody lends the Minutemen Corporation $10. The note is due on September 30.October 1. 2005.000 in the form of a note receivable. 2004.

A +  Assets = L + SE increase  Assets decrease What asset accounts are affected? .

000 Note: Debits are always written first and you always indent the credit.000 Cash (credit) $10. .Note Receivable (debit) $10.

000 (see next slide). . For example. the T-Account for cash would have an ending debit balance of $12.Remember every journal entry will be posted to the appropriate account. based on the entries made.

000 4.000 Balance 12.000 10.000 (Debit) .000 12.000 20.000 CASH 18.000 46.000 58.1/1 1/1 3/6 4/1 9/1 10/1 40.

•A list of all the accounts and their balances at a given time. assuming credible software is used). •It aids in the preparation of financial statements. •It serves to prove the mathematical equality of debits and credits after posting (shouldn’t be critical. .

000 18.000 40.000 12.000 10.000 14.000 4.000 .Rhody Corporation Trial Balance December 31.000 $72. 2004 Cash Note Receivable Supplies Inventory Prepaid Insurance Office Equipment Accounts Payable Unearned Service Revenue Common Stock Debit Credit $12.000 20.000 $ 72.000 14.

and Expenses 1 . Revenues.Income Statement Concepts: Income.

Income statement • Income statement reports about the revenues and expenses for a specific period of the time. • Dinamic statement .

As a minimum. the face of the income statement shall include line items that present the following amounts for the period: (a)revenues. . (b) expenses (costs). (f) profit or loss.

other than those relating to contributions from equity participants.• Revenue is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity. .

. other than those relating to distributions to equity participants.• Expenses (cost) are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrence's of liabilities that result in decreases in equity.

• You are reasonably certain to collect the revenue.Revenue Recognition Principle • Dictates that revenue be recognized in the accounting period in which it is earned. 6 . • Revenue is earned when the service has been provided or when the goods are delivered (i.e. an exchange has taken place..

over a period of time. resulting from operations. 7 .Income Concepts Net Income (Loss) – The increase (decrease) in net assets. Net Assets – The excess of an entity’s economic resources (assets) over its obligations (liabilities). NET ASSETS (EQUITIES) = ASSETS – LIABILITIES Equities – Another name for net assets.

exchanging shares of the entity’s common stock for cash increases net assets. since INCOME only results from operations. it does not result from INCOME. 8 . However. the cause of an increase (decrease) in NET ASSETS from one period of time is INCOME (LOSS). but rather from an additional equity investment by owners.Changes in Net Assets Generally.

Changes in Net Assets Also. the payment of dividends reduces net assets as it does not result from LOSS.. but rather from the withdrawal of assets from the entity for use by the stockholders (i.e. 9 . owners).

Effect of Net Income From Operations on Net Assets Beginning Balance Sheet 1/01/10 Ending Balance Sheet 12/31/10 Income for the Period 1/1/10 –12/31/10 10 .

Sales of Services or Total Billings –Used by service firms. Alternative Names for Revenue: Sales – Used by merchandising entities and manufacturing concerns.Revenue Revenues – increase in net assets resulting from an entity’s operation over a period of time. 11 .

Revenue (continued) Interest Revenue – Used by financial institutions that earn revenues by lending money and charging interest.. Premium Revenue – Used by insurance companies. Merrill Lynch) for fees charged for the different financial services performed for customers. Commissions. Asset Management and Portfolio Service Fees– Used by brokerage firms (e.g. 12 .

the gain (loss) is reported separately on the income statement and not as part of income from continuing operations. An example is the sale of equipment.Gains and Losses The difference between what is received by an entity and the book value of what is given up by the entity is reported as a gain or loss. 13 . Since the selling of assets is not the primary purpose of the business.

or year. If expenses exceed revenue. the result is a net income. the result is a (net loss).Income Statement • Reports success or failure of the company's operations during the period. 14 . If revenues exceed expenses. quarter. • Summarizes all revenue and expenses for period of time --month.

It is net income that is retained in the business not paid to shareholders. 15 .Retained Earnings Retained earnings is net income minus dividends paid since the formation of the business. The balance in retained earnings is part of the stockholders' claim on the total assets of the corporation.

000 in cash. 16 . The income resulting from the excess of revenues over expenses may have been used to purchase other assets--buildings.000 in retained earnings does not mean that there should be $100. equipment. etc.Retained Earnings Example: A balance of $100.

Expenses (E) = NI One should view the retained earnings statement as the “bridge” that connects the income statement with the balance sheet.Articulation of The Financial Statements Assets = Liabilities + Stockholders’ Equity A = L + Common + Retained Stock Earnings Revenue (R) . 17 .

18 .Matching Principle Requires that expenses be recorded in the same period in which the revenues they helped produce are recorded.

Expenses Accounting conventions relating to expenses are more involved than revenue’s “substantial completion of the earnings process”. salaries of administrative staff). Some expenses “follow” the earning of revenue (e. Others follow a “systematic” process (e.g..g. 19 .Accounting Conventions .. depreciation of plant and equipment is often straightline or simply a fixed amount per year).

Plant and Equipment.Expense Concepts Expenses – The resources consumed in the process of earning revenues. Examples of expenses: Cost of sales – The expense associated with the cost of merchandise sold to customers by a merchandiser. Rent expense – The cost of renting offices or warehouses. Depreciation – The cost of using long-term assets such as “Property. This consumption results in a decrease in net assets over a period of time.” 20 .

21 .Depreciation Depreciation .is the rational and systematic process of allocating the cost of a plant asset over its useful (service) life. By expensing an asset’s cost over its useful life results in a better match of the expense to the periods the asset is expected to generate revenue.

Effect of Debits/Credits on Accounts DEBITS Increase – Expenses and Dividends Decrease – Revenues CREDITS Decrease – Expenses and Dividends Increase – Revenues 22 .

. Normal Debit Balance:Expenses. debit or credit) that is increased. Dividends Normal Credit Balance: Revenues 23 .Normal Balance The term normal balance for an account is the side (i.e.

Let’s Continue With Transaction Analysis 24 .

– Record the debit and credit effects on specific accounts for each transaction. 25 .Transaction Analysis Recall the basic steps in the recording process are: – Analyze each transaction in terms of its effect on the accounts.

000 in cash for services performed. • How does this affect the accounting equation? 26 .Recording A Transaction • On October 17 Rhody receives $40.

revenue) What asset account and “indirectly” what Stockholders’ equity account is affected? 27 .e.Recording A Transaction A + = L + SE + • Assets increase • Stockholders’ equity increases via retained earnings (i..

000 Note: The income statement account revenue is directly affected.000 Service Revenue (credit) $40. this indirectly affects stockholders’ equity Recall: Debits are always written first and you always indent the credit. 28 .Recording A Transaction Cash (debit) $40. However.

000 for work performed. • How does this affect the accounting equation? 29 .Recording A Transaction • On November 5 Rhody pays its employees $5.

e. wage expense) What asset account and “indirectly” what Stockholders’ equity account is affected? 30 .Recording A Transaction A = L + SE - • Assets decrease • Stockholders’ equity decreases via retained earnings (i..

Recording A Transaction Salary Expense (debit)$5. 31 . this indirectly affects stockholders’ equity Recall: Debits are always written first and you always indent the credit. However.000 Cash (credit) $5.000 Note: The income statement account expense is directly affected.

Recording A Transaction • On November 22 Rhody performs services and bills the client $15.000 for the services • How does this affect the accounting equation? 32 .

Recording A Transaction A + = L + SE + • Assets increases • Stockholders’ equity increases via retained earnings (i.revenue) What asset account and “indirectly” what Stockholders’ equity account is affected? 33 .e..

000 Note: The income statement account revenue is directly affected.Recording A Transaction Accounts Receivable (debit)$15. 34 . this indirectly affects stockholders’ equity Recall: Debits are always written first and you always indent the credit. However.000 Revenue (credit) $15.

Recording A Transaction • On December 12 Rhody pays a dividend to its stockholders. • How does this effect the accounting equation? 35 .

dividends) What asset account and “indirectly” what Stockholders’ equity account is affected? 36 .e..Recording A Transaction A - = L + SE - • Assets decrease • Stockholders’ equity decreases via retained earnings (i.

37 . this indirectly affects stockholders’ equity Recall: Debits are always written first and you always indent the credit. However.Recording A Transaction Dividends (debit) Cash $500 (credit) $500 Note: The retained earnings statement is directly affected.

000 (see next slide). the T-Account for revenue would have an ending credit balance of $55. For example. 38 . based on the entries made.T-Account Remember every journal entry will be posted to the appropriate account.

000 55.Account 10/17 11/22 Balance REVENUE 40.T .000 (Credit) 39 .000 55.000 15.

000 40 . 2004 Cash Note Receivable Supplies Inventory Prepaid Insurance Office Equipment Accounts Payable Unearned Service Revenue Common Stock Debit Credit $12.000 14.000 4.000 12.000 20.000 $72.000 $ 72.Rhody Corporation Trial Balance (From lecture 2) December 31.000 14.000 18.000 10.000 40.

000 41 .Rhody Corporation Updated Trial Balance December 31.000 5.000 $127.000 20. 2004 Cash Supplies Accounts Receivable Note Receivable Inventory Prepaid Insurance Office Equipment Accounts Payable Unearned Service Revenue Common Stock Dividends Service Revenue Salaries Expense Debit $46.500 4.000 500 55.000 $127.000 40.000 10.000 12.000 15.000 18.000 Credit 14.000 14.

Accrual Basis Accounting Thus. revenue is recorded only when earned not when cash is received and Expense is recorded only when incurred not when cash paid 42 .

• Therefore. adjusting entries are needed to ensure that the revenue recognition and matching principles are followed.The Need for Adjusting Entries • Companies are on a calendar or fiscal year and business transactions can cut across two years. 43 .

31 Mar.1 Dec.The Need for Adjusting Entries Calendar year Jan.1 Transaction Period 44 . 1 Sept.

45 .Rule For Adjusting Entries Every adjusting entry will affect an income statement account and a balance sheet account. The balance sheet account NEVER will be CASH.

Major Types Of Adjusting Entries Adjusting entries can be classified as either Prepayments or Accruals Each of these classes has two subcategories. 46 .

47 .Adjusting Entries For Prepayments Prepayments fall into two categories-– Prepaid expenses and – Unearned revenues.

Prepayments Cash has been spent but the item acquired has not been used or consumed or Cash has been collected before revenue is earned 48 .

Prepaid expenses expire with the passage of time (i..Prepaid Expenses Prepaid expenses . e.expenses have been paid in cash and are recorded as assets until they are used or consumed. e. supplies or depreciation).. 49 . rent or insurance) or they are consumed (i.

000 Cash (credit) $12.Prepaid Expenses Recall on April 1.000 for a one-year insurance policy. Original Entry: Prepaid Insurance (debit) $12.000 50 . Rhody paid $12.

000 Prepaid Insurance (credit) Calculation: $12.000 51 .Prepaid Expenses Adjusting Entry: Insurance Expense (debit) $9.000 x 9 = $9.000 12 $9.

Original Entry: Equipment (debit) $20.000 for equipment. The equipment has a useful life of 5 years.Prepaid Expenses Recall on January 1. Rhody paid $20.000 Cash (credit) $20.000 52 .

Prepaid Expenses Adjusting Entry: Depreciation Expense (debit) $4.000 53 .000 Calculation: $20.000 / 5 = $4.000 Accumulated Depreciation (credit) 4.

54 .Unearned Revenues • Revenues received in cash and recorded as liabilities before they are earned.

Unearned Revenues Recall On September 1. Original Entry: Cash (debit) $18. The lease is for 1 year.000 Unearned rent revenue (credit) 18.000 55 .000 for rent from one of its tenants. Rhody received $18.

000 x 4 = $6.000 Rent revenue (credit) $6.000 12 56 .000 Calculation: $18.Unearned Revenues Adjusting Entry: Unearned rent revenue (debit) $6.

Adjusting Entries For Accruals Accruals fall into two categories – Accrued revenue and – Accrued expenses 57 .

58 .Accrued Revenue Accrued revenues are revenues that have been earned but not yet received in cash.

and carries an interest rate of 9%. 2005. Original Entry: Note Receivable (debit) $10. The note is due on September 30.000 Cash (credit) $10.000 in the form of a note receivable. Rhody lent the Minutemen Corporation $10.Accrued Revenues Recall on October 1.000 59 . 2004.

Accrued Revenues Interest receivable is the amount of income a company receives for the use of its money. Information needed to compute interest income: • Face value of note • Interest rate (expressed as annual rate) • The length of time note is outstanding 60 .

000 x 9% = $900 x 3 = $225 12 61 .Accrued Revenues Adjusting Entry: Interest Receivable (debit) $225 Interest income (credit) $225 Calculation: $10.

Accrued Expenses Accrued expenses are expenses that have been incurred but not yet paid in cash and there is no original entry. 62 .

What adjusting entry must be made at the end of December? Original Entry: NO ENTRY 63 . The total payroll is $80.Friday. The employees work only Monday . Assume that the last payday in December is the 26th and that the next payday is January 9.000 every two weeks.Accrued Expenses Rhody pays its workers every 2 weeks on Friday.

(3) Red days in 2005 – (7) The 26th and 9th are paydays 64 .Accrued Expenses December/January S M T W TH F S 21 28 22 29 23 30 24 31 25 1 26 2 27 3 4 5 6 7 8 9 10 Green days in 2004 .

000 Calculation: $80.000 x 3 days = $24.000 10 days 65 .000 Salary payable (credit) $24.Accrued Expenses Adjusting Entry: Salary expense (debit)$24.

• Put in proper T – accounts (done by computer). • Prepare a trial balance. • Journalize and post adjusting entries--prepayments and accruals. • Prepare an adjusting trial balance. 66 . • Journalize the transactions.The Accounting Cycle • Analyze business transactions.

The Accounting Cycle • Prepare financial statements. Note the financial statements must be prepared in this order since the income flows into the retained earnings statement which flows into the balance sheet: – Income statement – Retained earnings statement – Balance sheet • Close out all temporary accounts 67 .

The Nature And Purpose of an Adjusted Trial Balance • The adjusted trial balance is prepared after all adjusting entries have been journalized and posted. 68 . • Financial statements are prepared from the adjusted trial balance. • The adjusted trial balance shows the balances of all accounts.

500 4.000 4.000 9.000 10.000 40.000 4.000 9.000 14.000 $127.000 Credit Debit Credit Debit Credit 46.000 12.000 $43.000 225 15.000 10.225 $155.500 4.000 $127.000 4.000 9.000 4.000 225 225 6.000 6.000 500 55.000 12.000 14.000 24.000 24.000 24.000 14.000 29. 2004 Debit Cash Supplies Note Receivable Interest Receivable Accounts Receivable Inventory Prepaid Insurance Office Equipment Accum.000 500 55.225 69 .000 40.000 20.225 $155.000 5.Rhody Corporation Adjusted Trial Balance December 31.000 14.000 18.000 225 15.000 6.000 3.000 20.225 $43. Depreciation Accounts Payable Salary Payable Unearned Service Revenue Common Stock Dividends Service Revenue Salaries Expense Insurance Expense Depreciation Expense Interest Income Rent Revenue Totals $46.

2004 Revenue: Service Revenue Rent Revenue Interest Income Total Revenue Expenses: Salaries Expense Insurance Expense Depreciation Expense Total Expenses Net Income $55. 2004 .000 $19.000 4.000 42.000 225 $61.December 31.000 9.Rhody Corporation Income Statement January 1.000 6.225 $29.225 70 .

Rhody Corporation Retained Earnings Statement December 31.Dividends Retained Earnings on 12/31/04 $ 0 19.725 71 .225 500 $18. 2004 Retained Earnings on 1/1/04 + Net Income (From Income Statement) .

725 $20.500 15. 2004 ASSETS Cash Accounts Receivable Note Receivable Interest Receivable Supplies Inventory Prepaid Insurance Total Current Assets Office Equipment Accum.725 72 .000 (4.000 18.000 14.000 $108.000 40.000) LIABILITIES Accounts Payable Salary Payable Unearned Service Revenue Total Current Liabilities STOCKHOLDERS’ EQUITY Common Stock Retained Earnings (FROM Retained Earnings Statement) TOTAL LIABILITIES & STOCKHOLDERS’ EQUITY $14.000 24.000 $92.Rhody Corporation Balance Sheet January 1.000 3.000 225 4.000 10.725 16. Depreciation TOTAL ASSETS $ 46.725 $108. 2004 .December 31.000 $50.000 12.

. going concern concept). one year). The income statement accounts are zeroed out because an income statement is limited to a period of time (i..e.e. • The permanent balance sheet accounts are never zeroed out since they continue forever (i. income statement accounts revenue and expenses) and the dividend account.Temporary/Permanent Accounts • The computer will zero out all temporary accounts (i..e. 73 .

Thus. 74 . all assets should be stated as a percentage of total assets and all expenses should be stated as a percentage of sales. that number is sales. that number is assets. either the balance sheet or the income statement as a percentage of a selected number. and for the income statement. For the balance sheet.Common-Sized Financials A common-sized statement recast.

000 4.41% 75 .225 100.59% 31.36% 14.70% 6.000 $42.000 9.000 $19. 2004 .53% 68.00% $29.Rhody Corporation Common-Sized Income Statement January 1. 2004 Revenue: Service Revenue Rent Revenue Interest Income Total Revenue Expenses: Salaries Expense Insurance Expense Depreciation Expense Total Expenses Net Income $55.225 47.000 6.December 31.000 225 $61.

68% 12.000 225 4.04% 45.68)% 100.88% 22.00% 76 .000 14.000 (4.725 42.39% (3.20% .22% 100.000) $108.07% 11.Rhody Corporation Common-Sized -Balance Sheet January 1.28% 18.02% 3.88% 2.80% 9.000 12.725 20. Depreciation TOTAL ASSETS LIABILITIES Accounts Payable Salary Payable Unearned Service Revenue Total Current Liabilities STOCKHOLDERS EQUITY Common Stock Retained Earnings TOTAL LIABILITIES & STOCKHOLDERS EQUITY $ 46.79% 17.00% $ 14.76% 85.000 24.725 12. 2004 .December 31.000 3.99% 36.000 50.000 40.000 18.500 15.725 $108. 2004 ASSETS Cash Accounts Receivable Note Receivable Interest Receivable Supplies Inventory Prepaid Insurance Total Current Assets Office Equipment Accum.000 $92.77% 13.000 10.

and Financing Activities .Statement of Cash Flows— Operating. Investing.

This conversion may be done using either of two methods: – Indirect Method – Direct method We will focus only on the Indirect Method. .Purpose of Cash Flow Statement The purpose of a cash flow statement is to convert the income statement from an accrual basis to a cash basis.

and other interested parties want to now what is happening to a company’s most liquid asset.Why Focus on Cash? Because investors. . creditors. CASH.

The reasons for the difference between net income and net cash provided (used) by operating activities 4. 2.Statement of Cash Flows The Statement of Cash Flow helps to evaluate: 1. The investing and financing transactions during the period. . The entity's ability to pay dividends and meet obligations 3. The entity's ability to generate future cash flows.

Statement of Cash Flows The Statement of Cash Flow can help answer the following questions: • How did cash increase when there was a net loss for the period? • Is cash flow greater or less than net income? • How was the expansion in the plant and equipment financed? • How was the the debt retired? • How much money was borrowed during the year? • What amount was paid in dividends? .

. • investing. and • financing activities of a company during a period.The Statement of Cash Flows The cash flow statement provides information about the company’s – cash receipts and cash payments – the net change in cash resulting from: • operating.

you need: – Current income statement (only current year) – Comparative balance sheet (2 years) – Additional information . financial value. and economic income don’t affect the cash flow statement. Notice wealth. Therefore.Sources of Information for the Statement of Cash Flows Recall (see next slide) that the cash flow statement is a created statement that relies on information from the income statement and balance sheet. to prepare the cash flow statement.

liabilities.Framework for Understanding Accounting Information Economic Concepts Financial Values Attach to individual assets. revenues and expense items by the accounting process Financial Statements Balance Sheet Assets Liabilities Equity Income Statement Revenue Expenses Net Income Wealth Measured by equity at a point in time Cash Flow Statement Operating cash flow Investing cash flow Financing cash flow Significant non-cash Economic Income Change in wealth measured by net income .

Format of the Statement of Cash Flows Cash Flow Statement has Four Sections: – operating – investing – financing – significant non-cash investing and financing activities .

.. normal revenues and expenses transactions) have on the company’s cash flow.e.Operating Activities Operating activities – captures the effects operating transactions (i.

Operating Activities
Income Statement Information Needed:
– Net income

– Depreciation and amortization (non-cash expenditures) – Gain(loss) on sale of assets or investments

Balance Sheet Information Needed: – Change in Current Assets – Change in Current Liabilities

Examples of Cash Flows Operating Activities
Cash inflows: – From sale of goods or services – From interest received and dividends received Cash outflows: – To suppliers for inventory – To employees for services – To government for taxes – To lenders for interest – To others for expenses

Investing Activities
Investing activities - captures a company’s purchase and sale of assets and its use of cash to acquire a long-term investment position in another company and the sale of these investments.

Investing Activities
Income Statement Information Needed : – Gain(Loss) of Assets Balance Sheet Information Needed : – Change in Long-Term Assets
• Property Plant and Equipment • Long-Term Investments

Examples of Transactions That Affect Investing Activities
Cash inflows: – From sale of property, plant, and equipment – From sale of debt or equity securities of other entities – From collection of principal on loans to other entities Cash outflows: – To purchase property, plant, and equipment – To purchase debt or equity securities of other entities – To make loans to other entities

Financing Activities
Financing activities - captures a company borrowing and repaying long-term loans and selling or buying back shares of its own stock. In addition, it reflects any dividends paid by the company.

Financing Activities
Income Statement Information Needed: – None Balance Sheet Information Needed: – Change in Long-Term Liabilities – Change in Stockholders’ Equity
Retained Earnings Stmt Information:
– Dividends Paid

Examples of Transactions That Affect Financing Activities
Cash inflows: – From issuance of equity securities (company's own stock) – From issuance of debt (bonds and notes) Cash outflows: – To stockholders as dividends – To redeem long-term debt or reacquire company’s stock

Significant Non-Cash Activities
Transactions that do not affect cash are NOT reported in the body of the statement of cash flows. However, these items are reported:
– In a separate schedule at the bottom of the statement of cash flows or – In a separate note or supplementary schedule to the financial statements.

2. 4.Examples of Significant Non-Cash Activities 1. . Conversion of bonds into common stock. Issuance of common stock to purchase assets. Exchanges of plant assets. Issuance of debt to purchase assets. 3.

depreciation) .Expenses Incurred + - Net Income Decreases in Current Assets Increases in Current Liabilities Increases in Current Assets Decreases in Current Liabilities Cash Flow From Operations .g.Converting Net Income to Cash Flow From Operations Accrual Method Revenue Earned Cash Method + Noncash expenses (e.

Note: This will serve as the check figure. 4. 5. Determine the cash provided (used) by operations. Determine the cash provided (used) by investing. Determine any significant noncash transactions that should be disclosed. Determine the cash provided (used) by financing. .Steps in Preparing Cash Flow Statement 1. Determine the net Increase (decrease) in cash. 3. 2.

Add (subtract) the changes in the current asset and current liability accounts. an increase (decrease) in current liabilities is an increase (decrease) in cash flow. 3.Determine Net Cash Provided (Used) Operating Activities By 1. Get net income from the income statement. Add to net income for items that did not affect cash (i. .e. An increase (decrease) in current assets is a decrease (increase) in cash flow. depreciation and amortization). 2. Whereas.

Cash Flow Statement Let’s Do An Example .

for the year Rhody has net income of $200. What impact does this information have on the cash flow statement? . In addition.000 and depreciation and amortization of $15.000.Cash Flow Example Assume that Rhody has a beginning cash balance of $20.000.000 and an ending cash balance of $244.

In essence.000.Change in Cash Account The $224. The cash flow statement will show how this $224. this will serve as a “check figure” to make sure the sum of cash flow from operations. and financing reflects an increase of $224.000 increase was achieved.000 indicates that Rhody’s total cash flow for the year will increase by $224.000 and an ending cash balance of $244. investing. .000.000 increase between the beginning cash balance of $20.

.000 of depreciation is a non-cash expense.Depreciation and Amortization The $15. since we have “overstated” our cash expenses by the amount of depreciation. Remember.000. Therefore. so that amount must be added to net income. we need to increase net income by $15. the goal is to go from net income (accrual basis) to “net income” on the cash basis.

000 $215.Rhody Company Statement of Cash Flows--Indirect Method For the Year Ended December 31.000 .000 15. 2004 Cash flows from operating activities Net income Depreciation & amortization Net cash flow from operations $200.

000 and the ending balance is $55.000. What impact does this have on the cash flow statement? Remember.Impact of Change in Accounts Receivable (Current Asset) Assume that Rhody had sales of $385. .000 and all of its sales are on credit. the goal is to go from net income (accrual basis) to “net income” on the cash basis. The beginning balance in accounts receivable was $42.

we need to reduce net income by the increase in the accounts receivable.000 12/31 55. Thus. However.000 as sales.Analysis Via T–Account ACCOUNTS RECEIVABLE 1/1 42.000 Notice that the income statement reports $385. we only collected $372.000 Cash Collections 372. .000 of it in cash.000 Sales 385.

Rhody Company Statement of Cash Flows--Indirect Method For the Year Ended December 31, 2004

Cash flows from operating activities
Net income Depreciation & amortization Increase in accounts receivable Net cash flow from operations $200,000 15,000 (13,000) $202,000

Impact of Change in Accounts Payable (Current Liability)
Assume that Rhody’s operating expenses reported in the income statement were $185,000, of which $170,000 were expenditures requiring the future outlay of cash (i.e., other than depreciation). The beginning balance in accounts payable was $25,000 and the ending balance is $35,000. What impact does this have on the cash flow statement? Remember, the goal is to go from net income (accrual basis) to “net income” on the cash basis.

Analysis Via T–Account
ACCOUNTS PAYABLE 1/1 25,000 Expenses Incurred 170,000 Cash Payments 160,000 12/31 35,000

See explanation on next slide!

Impact of Change in Accounts Payable (Current Liability)
The income statement reports $185,000 of expenses.
However, $15,000 of these expenses are for depreciation, which is a non-cash expense and would not be recorded as a payable (i.e., recall the credit is to accumulated depreciation). This leaves $170,000 of potential expenses to be paid for with cash. Since the payable account increased by $10,000, only $160,000 of these expenses were actually paid in cash. Thus, we need to increase net income by the increase in the accounts payable.

Rhody Company Statement of Cash Flows--Indirect Method For the Year Ended December 31, 2004

Cash flows from operating activities
Net income Depreciation & amortization Increase in Accounts receivable Increase in Accounts payable Net cash flow from operations $200,000 15,000
(13,000) 10,000 $212,000

Determine Net Cash Provided (Used) Investing Activities

By

Add (subtract) the changes in the noncurrent asset accounts (i.e., property, plant, and equipment) . An increase (decrease) in property, plant, and equipment is a decrease (increase) in cash flow.

Impact of Change in PP&E (Non Current Asset)
Assume that Rhody acquired $40,000 of equipment and sold equipment with a book value (original cost minus accumulated depreciation) of $20,000 for $25,000. What impact does this have on the cash flow statement? Remember, the goal is to go from net income (accrual basis) to “net income” on the cash basis.

Analysis of Impact
The purchase of equipment is a cash outflow and the sale of the equipment is a cash inflow. However,
the sale of equipment also affects the accrual basis income statement, since the $5,000 gain ($25,000 sales price - $20,000 book value) on the sale is included in net income. Since we are creating a cash flow statement, the gain must be removed from net income (see operating activities section) and the cash flow from this transaction (e.g., $20,000) is reported in the investing activities section.

Rhody Company Statement of Cash Flows--Indirect Method For the Year Ended December 31, 2004
Cash flows from operating activities:
Net income Depreciation & amortization Increase in Accounts receivable Increase in Accounts payable Gain on sale of equipment Net cash flow from operations $200,000 15,000 (13,000) 10,000 (5,000) $207,000 $ 25,000 (40,000) (15,000)

Cash flows from investing activities:
Sale of equipment Purchase of equipment Net cash flow from investing

.e.long-term debt) and add (subtract) the changes the stockholders’ equity accounts..Determine Net Cash Provided (Used) Financing Activities By Add (subtract) the changes in the noncurrent liabilities accounts (i. An increase (decrease) in long-term debt is an increase (decrease) in cash flow.

What impact does this have on the cash flow statement? Remember. the goal is to go from net income (accrual basis) to “net income” on the cash basis.Impact of Change in Long-Term Debt (Non-Current Liability) Assume that Rhody borrowed $40.000 in dividends to its shareholders. .000 from Explorer bank and paid $8.

The payment of $8.000 increase in Rhody’s cash flow from financing.Analysis of Impact The borrowing of money from the bank is a financing transaction that increases the amount of cash Rhody has available. this is a $40. . Thus.000 in dividends is a financing transaction that reduces Rhody’s cash flow.

000) 32.000) Cash flows from financing activities: Cash from long-term borrowings Payment of dividends Net cash flow from financing 40.000 Net Increase (Decrease) in Cash Cash at beginning of period Cash at end of period $224.000 $244.000 (15.000 (8.000 20.Rhody Company Statement of Cash Flows--Indirect Method For the Year Ended December 31. 2004 Net cash flow from operations Net cash flow from investing $207.000 .

Let’s Do Another Cash Flow Example-Comparative Basis .

000 decrease 4.000 (3.000 0 $74.000 increase 10.000 Change Increase/Decrease $22.000 increase .000 20.000) $383.000 increase 3.000 (11.000 4.000) 27.000 increase 11.Rhody Company Comparative Balance Sheet With Change in Accounts December 31.000 0 0 0 0 10. 2004 Assets Cash Accounts Receivable Prepaid Expenses Land Building Accumulated depreciation-building Equipment Accumulated depreciation-equipment Total 2004 $56.000 increase 130000 increase 160.000 2003 $34.000 increase 17.000 160.000 130.000 30.

000 2003 $4.Rhody Company Comparative Balance Sheet With Change in Accounts December 31.000 0 50.000 144. 2004 Liabilities and Stockholders’ Equity Accounts payable Bonds payable Common stock Retained earnings Total 2004 $59.000 increase .000 increase 130.000 20.000 130.000 increase No Change 124.000 $383.000 50.000 $74.000 Change $55.

000 3.Rhody Company Income Statement For the Year 1/1/04 through 12/31/04 Revenues Operating expenses Depreciation expenses Loss on sale of equipment Income from operations Income tax expense Net income $507.000 261.000 228.000 15.000 279.000 89.000 .000 $139.

000 cash dividend.000 of long-term bonds.000 was also purchased for cash.Additional Information • • • • In 2004. An office building costing $160. . The company obtained land through the issuance of $130.000 (original cost $8.000 was purchased for cash. equipment costing $25. the company sold equipment with a book value of $7.000 less accumulated depreciation $1. During 2004.000 cash.000) for $4. the company declared and paid a $15.

Determine Net Cash Provided (Used) Operating Activities By 1. depreciation and amortization). Whereas. An increase (decrease) in current assets is a decrease (increase) in cash flow. an increase (decrease) in current liabilities is an increase (decrease) in cash flow. Add to net income for items that did not affect cash (i. Get net income from the income statement. 2.e. 4. . 3. Add (subtract) the changes in the current asset and current liability accounts. Add (subtract) any loss (gain) on sale of assets or investments.

2004 Cash flows from operating activities Net income Depreciation & amortization Loss on sale of equipment Decrease in Accounts receivable Increase in Prepaid expenses Increase in Accounts payable Net cash flow from operations $139.000 79.000 10.000 $218.000 (4.000 3.000 15.Rhody Company Statement of Cash Flows--Indirect Method For the Year Ended December 31.000) 55.000 .

Since we are creating a cash flow statement. However. . the $3.000 loss ($4. the loss must be added back to net income.000 sales price $7.Analysis of Impact of Equipment Sale The sale of the equipment is a cash inflow (shown later in the investing section).000 book value) on the sale of equipment is shown in net income.

the changes had on cash. if any. Changes in each non-current account are analyzed using selected transaction data to determine the effect. .Determine Net Cash Provided (Used) Investing Activities By Study the balance sheet to determine changes in non-current assets.

Determine Net Cash Provided (Used) Investing Activities By The land of $130. it is a significant noncash investing and financing activity that must be disclosed. Although the exchange of bonds payable for land has no effect on cash.000 was purchased through the issuance of long-term bonds. .

000. – a purchase of equipment for $25. The additional information provided reveals that this net increase resulted from two transactions: – sale of equipment costing $8. By .000 The purchase of equipment should be shown as a $25. The equipment account increased by $17.000 outflow of cash and the sale of equipment should be shown as a cash inflow of $4.000 is a use of cash.000.Determine Net Cash Provided (Used) Investing Activities The increase in the building of $160.000 for $4.000.

000 $8.000 25.Analysis Via T–Account 1/1 Sale Purchase 12/31 EQUIPMENT 10.000 27.000 .

000) 55.Rhody Company Statement of Cash Flows--Indirect Method For the Year Ended December 31.000) (25.000 Cash flows from investing activities: Purchase of building Purchase of equipment Sale of equipment Net cash flow from investing (160. 2004 Cash flows from operating activities: Net income Depreciation & amortization Loss on sale of equipment Decrease in Accounts receivable Increase in Prepaid expenses Increase in Accounts payable Net cash flow from operations $139.000 15.000 (4.000 79.000 3.000 10.000 $218.000) .000 (181.000) 4.

. the changes had on cash.Determine Net Cash Provided (Used) Financing Activities By Study the balance sheet to determine changes in non-current liabilities and stockholders’ equity. if any. Changes in each non-current liability and stockholders’ equity are analyzed using selected transaction data to determine the effect.

000 payment of dividends that decreased Retained Earnings. .000 and the $15. • Payment of the dividend is a cash outflow that is reported as a financing activity.000 is a result of net income of $139. • Net income is the starting point of the cash flow statement and is presented in net cash provided by operations.Determine Net Cash Provided (Used) Financing Activities By The net increase in Retained Earnings of $124.

000) Cash flows from Financing investing activities: Payment of dividends Net cash flow from financing Net Increase (Decrease) in Cash Cash at beginning of period Cash at end of period Noncash investing and financing activities: Issuance of bonds payable to buy land $22.000 (181.000 . 2004 Net cash flow from operations Net cash flow from investing $218.000 $130.000) $15.000 (15.000 34.000 $56.Rhody Company Statement of Cash Flows--Indirect Method For the Year Ended December 31.

The phase a company is in affects its cash flows.A Company Life Cycle A series of phases all companies experience. The phases are often referred to as the: – introductory phase – growth phase – maturity phase – decline phase. .

Cash Flow All companies go through business phases. The phase a company is in will affect its cash flows. but a segment of the business or a product line of the business will experience these phases.The phases are often referred to as the: – introductory phase – growth phase – maturity phase – decline phase. The whole business might not go through each phase. .

the company needs to issue stock or debt. . – cash from financing to be positive.Introductory Phase To support asset purchases. Since the operations are just starting. Expect: – cash from operations to be negative – cash from investing to be negative.

– cash from financing to be positive. .Growth Phase The company is striving to expand its production and sales. Expect: – cash from operations to generate a small amount of cash – cash from investing to be negative.

Thus. – cash from financing to be negative (paying back loans). Expect: – cash from operations to be moderately positive. . – cash from investing to be neutral.Growth Phase The company’s sales and production begin to level off. investing will consist of replacing some long-term assets and selling others.

– cash from financing to be negative (paying back loans). – cash from investing to be neutral or negative. Note: This phase is not true of all companies. .Decline Phase The company’s sales and production begin to decline. but will certainly affect a segment of a company. Expect: – cash from operations to be minimally positive.

One disadvantage to the cash-based measures is that no published industry averages are readily available for comparison.Cash-Based Ratio Measures Accrual-based measures allow too much management discretion. .

) . A disadvantage of the current ratio is that it uses year-end balances of current assets and current liabilities (may not be representative of a company's position during most of the year.Liquidity Recall that liquidity is the ability of a business to meet its immediate obligations and that one measure of liquidity is the current ratio.

. it is often considered a better representation of liquidity on the average day.Current Cash Debt Coverage Ratio A ratio that partially corrects this is the current cash debt coverage ratio. Cash provided by operations Average current liabilities Since cash from operations involves the entire year rather than a balance at one point in time.

Solvency Recall that solvency is the ability of a firm to survive over the long term. . One measure of solvency is the debt to total assets ratio.

.Solvency A measure of solvency that uses cash figures Is the cash debt coverage ratio. Cash Provided By Operations Average Total Liabilities This ratio measures a company's ability to repay its liabilities from cash generated from operations.

(d) the amounts of transactions with equity holders acting in their capacity as equity holders. (c) for each component of equity. is recognised directly in equity. and . and the total of these items. the effects of changes in accounting policies and corrections of errors recognised in accordance with IAS 8. (e) the balance of retained earnings (ie accumulated profit or loss) at the beginning of the period and at the balance sheet date. and the changes during the period. showing separately distributions to equity holders. (b) each item of income and expense for the period that. • It shows: (a) profit or loss for the period.Statement of changes in equity • Shows the changes in owner’s equity for a specific period of time.

. statement of changes in equity or cash flow statement. • (b) disclose the information required by IFRSs that is not presented on the face of the balance sheet. and • (c) provide additional information that is not presented on the face of the balance sheet. income statement. statement of changes in equity or cash flow statement.Notes The notes shall: • (a) present information about the basis of preparation of the financial statements and the specific accounting policies. income statement. but is relevant to an understanding of any of them.

Disclosure of accounting policies An entity shall disclose in the summary of significant accounting policies: • (a) the measurement basis (or bases) used in preparing the financial statements. . and • (b) the other accounting policies used that are relevant to an understanding of the financial statements.

RECEIVABLES CASH INVENT ORIES FINANCIAL ASSETS .

Cash or cash equivalent. except if it has limited possibility of exchange or liabilities settlement for period of at least 12 month from the balance-sheet date.11.2012 .(CURRENT ASSETS) are assets which fulfil following conditions:  It is expected that it will be realized or it is held for sale or for consumption in regular business performance. It is expected that it will be realized in the 12 month period from the balance-sheet date. Short – term assets 2    14. Primarily is held for trading.

2012 Short – term assets 3 .11.Types of short-term assets: Inventories Receivables Financial assets Cash 14.

2012 consumption of inventories Si x 4 Short – term assets .S0 x procuration of inventories 14.11.

2012 Short – term assets 5 .occur in several forms: Inventories of merchandise.  Inventories of small inventory.11.  Inventories of spare parts.  14.  Inventories of raw materials and materials.  Production inventories (work in progress).  Inventories of finished goods.  Advances for inventories.

depending on what is lower (IAS 2 Inventories. Evaluation:  INITIAL EVALUATION – per purchasing cost  AFTERWARDS EVALUATION– per purchasing cost or  per net market value.2012 Short – term assets 6 .) 14. Are held for sale in regular business performance by subjects that are performing commercial services ( wholesale and retail sale). 9.11. art.

Procuration and stocking of merchandise in 1) Per purchasing cost Per selling price (purchasing cost + difference in price) 2) 14.11.2012 Short – term assets 7 .

11.2012 Short – term assets 8 .1) Recording of merchandise procuration per purchasing cost Purchasing price Depending costs discounts Purchasing cost 14.

1) Recording of merchandise on inventories per purchasing cost Accounts payables Purchasing price Calculation of supply Merchandise inventories (1a) Transportation costs (3) (3) (2) Purchasing cost (1b) Customs (1c) (3) (1d) Irreversible taxes (3) VAT receivables (1a) (1b) 14.2012 Short – term assets 9 .11.

2012 Short – term assets 10 .11.2) Recording of merchandise on inventories per selling prices Purchasing price Depending costs Purchasing cost Difference in price (margin) Selling price Without VAT 14.

cost (2) Selling price Difference in price (1b) Customs (1c) (3) (2) DIP (1d) Irreversible taxes (3) VAT receivables (1a) (1b) 14.Recording of merchandise on inventories per selling price Accounts payables Purchasing price Calculation of supply Merchandise inventories (1a) Transportation cost (3) (3) (2) Purch.2012 Short – term assets 11 .11.

2012 Short – term assets 12 .Merchandise wholesale and decrease of inventories ( for merchandise inventories held per ACCOUNT RECEIVABLES (1) SP+VAT VAT PAYABLES VAT(1) REVENUES FROM SOLD MERCHANDISE SP (1) MERCHANDISE INVENTORIES SX PC (2) EXPENSES FROM SOLD MERCHANDISE (COSTS OF PURCHASED MERCHANDISE) (2) PC Expenditures methods: •FIFO method •Weighted average price method 14.11.

 By Croatian Law: FIFO method and average cost. LIFO.There are some methods for determening those costs. HIFO and AVERAGE COST.  13 .  They are: FIFO.

 14 . first out.  HIFO method: highest in.  LIFO method: last in.FIFO method: first in. first out.  Average costs: total value in HRK dividing with total quantity of raw material. first out.

Merchandise wholesale and decrease of inventories (for merchandise inventories held per ACCOUNTS RECEIVABLES (1) SP+VAT VAT PAYABLES VAT (1) REVENUES FROM SOLD MERCHANDISE SP (1) MERCHANDISE INVENTORIES SX SP without VAT (2) RASHODI OD PRODAJE (TROŠKOVI NABAVE ROBE) (2) SP without VAT (2a) DIFFERENCE IN PRICE (2a) DIP of sold SX merchandise 14.11.2012 Short – term assets 15 .

2012 Short – term assets 16 .11.Procuration and stocking of merchandise in 1) Transfer of merchandise from wholesale in retail sale Direct procuration in shop (recording of merchandise per selling price with calculated VAT) 2) 14.

14. Calculation per selling price can be managed as  Calculation in margin system.2012 INVENTORIES IAS 2 17 .  Calculation with known selling price or as  Calculation in discount system.Calculation of retail price  Calculation of retail price include   According to regulation this calculation must be in shops.11.

Transfer of merchandise from wholesale to retail shop WHOLESALE MERCHANDISE MERCHANDISE IN SHOP DIFFERENCE IN THE PRICE OF MERCHANDISE RETAIL MARGIN CALCULATED VAT CALCULATED VAT 14.11.2012 Short – term assets 18 .

2012 Short – term assets 19 .11.(recording of merchandise per selling price with calculated VAT) ACCOUNTS PAYABLES PURCHASING COSTS DIFFERENCE IN THE PRICE OF MERCHANDISE RETAIL MARGIN MERCHANDISE IN RETAIL SHOP CALCULATED VAT CALCULATED VAT 14.

2012 SX DIFFERENCE IN PRICE (2a) DIP of sold SX merchandise Short – term assets 20 .Merchandise retail selling and decrease of inventories ACCOUNTS RECEIVABLES (1) SP+VAT VAT PAYABLES VAT (1) REVENUES FROM SOLD MERCHANDISE SP (1) MERCHANDISE IN SHOP SX SP + VAT (2) EXPENSES FROM SOLD MERCHANDISE (COSTS OF PURCHASED MERCHANDISE) (2) SP+ VAT (2a) (2b) CALCULATED VAT (2b) calculated VAT of sold merchandise 14.11.

11.2012 Short – term assets 21 .costs x Transfer of costs on revenues burden TRADE COSTS (EXPENSES OF THE PERIOD) Σx costs x costs x 14.

 Production inventories. Inventories of spare parts and inventories of small inventory.11. package and cartyres – PLEASE READ IN YOUR BOOKS. production inventories and finished goods inventories will be explained in detail within PRODUCTION.  Initially are recorded at .  Inventories of spare parts. depending on what is lower. Note: Inventories of raw and material.OTHER TYPES OF INVENTORIES: Inventories of raw and material. 14. and afterwards at .2012 Short – term assets 22 .  Inventories of small inventory.  Finished goods inventories.

11.S0 x decrease of receivables increase of receivables Si x 14.2012 Short – term assets 23 .

participation interests. employees. Most often that are receivables from:        related companies.2012 . and other short –term receivables. Include receivables with maturity under one year.11. government. customers (accounts receivables). Short – term assets 24 14.

11. 14. That asset is REAL in its appearance and is treated as transient form of asset from material form to cash.   There are:  ACCOUNTS RECEIVABLES (DOMESTIC)  ACCOUNTS RECEIVABLES IN ABROAD. Occur as a consequence of goods and services delivery.2012 Short – term assets 25 .

14.  Given short – term loans.  Shortages and other damages (responsibility of employees).11. Occur on the basis of:  Extrapayed salaries to employees.  Payed advances for official trips.2012 Short – term assets 26 .

2012 Short – term assets 27 .  overpaid custom duties.  Except that receivables from government can also occur also for:   overpaid personal income tax on salaries.11.  and similar….The most common that are VAT RECEIVABLES by ingoing invoices.  overpaid income tax. 14.  overpaid contributions from and on salaries.

S0 x increase of assets decrease of assets Si x 14.11.2012 Short – term assets 28 .

2012 Short – term assets 29 .  Other short – term investments.  Money is invested in form of:   Given short – term loans to other business subjects. investment in short – term bonds).  Investemnt in shares and stakes in related companies. 14.11. investemnt in treasury bills.  Investemnts in short – term securities (investment in commercial bills.  Given deposits on the period within one year.Occurs as a consequnce of invested money of certain business subject on the period up to one year.

2012 Short – term assets 30 .S0 x increase of cash decrease of cash Si x 14.11.

2012 . Currency account. Letter of credit.   Cash in bank and cash in register consist of:     Cash at bank account.11. Cash is divided on cash in bank and cash in register. Payments between business subjects are made CASHLESS above cash at bank account. Other cash assets. Short – term assets 31 14.

11.CASH AT BANK So X X (2) CASH REGISTER So X (1) X (2) Received bank statement X (1) (1) Cash withdrawal from cash at bank account and payment on cash register 14.2012 Short – term assets 32 .

CASH AT BANK So X (2) X

CASH REGISTER So X x (1)

(2) Received bank statement for that payment

(1) X

X (2)
(1) Cash withdrawal from cash register and payment on cash at bank

14.11.2012

Short – term assets

33

LETTER OF CREDIT – an instrument of payment
insurance
 A letter of credit is a document that a financial institution or

similar party issues to a seller of goods or services which provides that the issuer will pay the seller for goods or services the seller delivers to a third-party buyer

14.11.2012

34

CASH AT BANK So X X (1)

ACCOUNTS PAYABLES (2) X So X

(1) X
(1) Letter of credit opening

X (2)
(2) Payment to a supplier from open letter of credit

14.11.2012

Short – term assets

35

Thank You for Your attention!!!

14.11.2012

kratkotrajna imovina

36

PhD. Ivana Dražić Lutilsky

 Is

not aimed for sale and has characteristic of permanency is expected that it will be realized into money in period longer than one business year its value gradually on new effects

 It

 Transfers

21.11.2012

LONG-TERM ASSETS

INTANGIBLE
• expenditures for
development • patents • licence • software • concession • franchise • trademarks • goodwill •Advance payment for intangible assets

TANGIBLE
• land and forest
• buildings • machines and equipment • tools • plant and office inventory • furniture • transport vehicles • long-term biological assets • advanced payment for tangible assets • tangible assets in preparation • other tangible assets

FINANCIAL
• stakes (shares) by related companies • given loans to related companies • participate intersts • investments in securities • given deposits • other long-term financial assets

RECEIVABLES
• receivables from related companies
• receivables from slaes on credit • other receivables

21.11.2012

softwer

Trade mark

franchise

21.11.2012

Intangible assets that is not in physical format  Assets acquired because of its usage in business performance  Heavily predictible life cycle  Heavily measurement of future economic benefits from its usage  Heavily transferabillity of those assets  Sometimes does not exsist the possibility of individual sale because that asset is specific for certain company
 

Tax regulation: value> 3.500 kn, n > 1 god.

21.11.2012

2012 . value of goodwill of acquired company). government injection in form of import allowance). Acquiring of long-term intangible assets as a part of business acquisitions (for instance.  INTERNAL DEVELOPMENT EXTERNAL ACQUIRING (PURCHASE OR OTHER RELATIONS WITH OTHERS)  Examples of external acquiring:     Separete acquiring of long-term intangible assets (for instance. Acquiring of long-term intangible assets by asset exchange (exchange of patents between two companies) 21. Acqisition of long-term intangible assets by using government injections (for instance.11. licence purchase).

 IF IT HAS LIMITED TIME OF USAGE.  In internally developed intangible assets which is not recognized as balance sheet position following positions are included: internally developed trademarks. lists of buyers and other similar positions.  21.2012 .11. signs. publication names. production or preparation of that position for its usage. ACQUIRED ASSETS IS CAPITALIZED IF FOLLOWING REQUIREMENTS ARE FULFILLED:  IF IT IS SEPARABLE. INTERNAL DEVELOPMENT  For internaly developed positions of long-term intangible assets purchasing cost is detemined on the basisi of all investments (costs) that have occured during creating.

11. but in shorter form 21. MRS  38 INTANGIBLE ASSETS Link on standard: IAS 38 Intangible assets  CFRS  5 Long-term intangible assets Determines issues of recognition.2012 . measurement and recording of long-term intangible assets as well as IAS 38.

      Expenditures for research and development Patents Licence Software Concession Franchise     Trademarks Other rights Goodwill (externally acquired) Advances for intangible assets 21.2012 .11.

11.2012 . EXPENDITURES FOR RESEARCH which are recognized as expense in period in which they ocurr.    The exsistance of long-term intangible assets which should give certain future economic benefits can not be proved in research phase Examples of those activities are activities which goal is acquiring new knowledge In the moment of research work and acquiring of new knowledges when it is not sure in which activity new knowledge will be applied 21.1.

.  Intention for finishing of intangible assets and its usage or sale.  Possibility of usage or sale of intangible assets. EXPENDITURES FOR DEVELOPMENT – are recognized as intangible assets if following requirements are fulfilled:  Technical feasibility of intangible assets which is finished in order to be available for usage or sale. or for usefulness of intangible assets in case that it is used 21. Business subject needs to prove market exsistance for the production of intangible assets or for intangible assets itself.  Way in which intangible assets will give promising economic benefits.2.2012 internally.11.

Avalilability of appropriate technical. or for usefulness of intangible assets in case that is is used internally. DEVELOPMENT COSTS ARE PERIOD EXPENSES! 21. financial and other sources for finishing of development and usage or sale of intangible assets. Possibility of reliable cost detrmining which can be credited to intangible assets development IF ABOVE MENTIONED REQUIREMENTS ARE NOT SATISFIED.2012 .   Subject needs to prove market existance for intangible assets production or for intangible assets itself.11.

Costs which ocurr related with research activity.2012 . wages and other costs of employees that are directly included in creating of that asset.11.  Fees for legal rights registering. and which could be capitalized are: Material and service costs which are used or spent in creating of intangible assets  Salaries.  Depreciation of patents and licences which are used for creating of tangible assets  21.

bridges) and on concessions which are related to natural resources exploatation (water.11.2012 . oil. Concession is “an agreement by which concession provider (government or other unit) is obliged to divide certain economic rights to concessionaire for ceratin fee Concessions are usually divided on public interests (building of roads.) Concession payment according to contract is recorded as intangible long-term assets and through depreciation calculation is divided on periods of concession   21. etc. gass.

By patent registering. offer or selling that patented inovation Patent can be ycquired externally (purchase from others) or developed internally   21. inovation is protected from incompetent usage. Patent is exclusive right of uage of own inovation after patent registration by competent governement institution.2012 .11. the owner of the patent retain exclusive right of usage.

 If patent is developed internally it a result of research and development activities and in that case is recognized through positions of development Patent can be separate position of long-term intangible assets if it is acquired externally In that case patent is recorded per purchasing cost which consists of purchasing price enlarged for depending purchasing costs (fees for legal services. administartive fees and similar)   21.2012 .11.

franchise in fast-food industry For recording of patents. purpose and field. purchase of production rights of certain product on certain period of time. licence or franchise are recorded as long-term intangible assets. Licence purchase means. for instance. licences and franchise it is important to know if the fee is payed in advance for several periods (business years) or it is payable in rates.2012    . For example. Licence is redeemed right of usage of foreign patented inovation. 21. In first case patent. Franchise is exclusive right in case when one company pays to other company fee for certain business for certain period of time.11.

11.2012 . Trademark has promotion goals and is needed to be patented in order to protect it from fraud Trademark can be: developed internally – it is not recognized as intangible assets. Trademark represents symbol of certain company by which this company is different from other companies and similar products.  Item of purchase – it is recognized as intangible assets.    21.

   21. Goodwill is company reputation which can be a result of company’s reputation or monopolistic position or competitive strenght.2012 . Internally acquired goodwill isn’t capitalized.11. Goodwill can’t be seperatly identified and valued . Goodwill is esential part of the whole company and it’s value and couldn’t be measured as seperate item.

 Goodwill is not amortized but it must be written down if its value is determined to have declined (been permanently impaired). Goodwill is recorded only when there is a transaction that involves the purchase of an entire business.  21. Eksternally acquired goodwill can be capitalized.2012 .  Goodwill is the excess of cost over the fair market value of the net assets (assets less liabilities) acquired.11.

Acquisition Usage Alienation 21.11.2012 .

Acquisition by exchange for some other type of asset.     Acquisition at market. Acquisition under business combinations. Internally acquired. Acquisition under governement support.2012 . 21.11.

or Revalorization model– under fair value 21. At  beginning: under cost principle (acquisition cost)  After  valuation( after the begininng valuation):  Cost model– acquisition cost minus amortization and minus losses for write – offs of value (value adjustments).11.2012 .

11. Excise duties. Dependable costs of acquisition. 21.2012 . customs. Acquisition     cost are: Purchasing price after all deductions of discounts.

11.Account payables (1) (2) LTIA in preparation Purchasing (1) price + (2) Dependable cost (1) + (2) LTIA in usage Acquisition cost Vat receivables (1) (2) 21.2012 .

2012 .acquisition Usage Alienation 21.11.

 Amortization will started after that asset has started to be used (next month). Why depreciable asset? Because the usefulness to the company and revenue – producing ability of each asset will decline over the asset useful life.11. Depreciation is a process of cost allocation. not a process of asset valuation.2012 . 21. Amortization Is the allocation of the cost of an asset expense over its useful life in a rational and systematic manner. or for renting or for administrative purposes. selling goods or providing services. Asset which amortize must satisfiy following terms: a)    b) c) It is expected that this asset will be used in business activity for a longer period That asset must have usefull life That asset is held by the company for production.

Period of amortization – period of usage (usefull life) AMORTIZATION METHODS 1) TIMELINE METHODS a) b) c)   Proportional or straightline method progressiv degressiv 21.11.2012 . Basis for amortization is acquisition cost.

11.Accumulated deprecistion of LTIA Amortization cost X X 21.2012 .

11.acquisition usage alienation 21.2012 .

 Some forms of LTIA are not transferable or reneweable or there isn’t a possibility of independent valuation (goodwill.   LTTA stops being recognized in business books. 21. trade mark and similar).11. Some forms are acquired under special terms and because of that it sales is limited (concession).2012 .

2012 . Write down (value adjustment) is necessary if in afterwards valuation estimates that recovarable amount is lower than book-keeping value. Book-keeping amount is– acquisition cost minus accumulated depreciation.11.  Recovarable amount is– higher amount between fair value and value in usage.  21.

11.Value correction LTIA Expenses of write downs off LTTA X X 21.2012 .

11.Long term tangible asset 28.2012 .

2012 .Long term asset Intangible Tangible •land and forest • buildings • machines and equipment • tools • plant and office inventory • furniture • transport vehicles • long-term biological assets • advanced payment for tangible assets • tangible assets in preparation • other tangible assets Financial Receivables 28.11.

2012 .Disclosure framework • • • • IAS 16 –Property.11. plant and equipment IAS 36 – Imapairment of asset IAS 40 –Investment property IFRS 5 'Non-current Assets Held for Sale and Discontinued Operations' • CFRS 6 – Long term asset • CFRS 7 – Investment property • CFRS 8 –Non-current Assets Held for Sale and Discontinued Operations 28.

– It will remain in the same form for a period longer then 1 year and it will not be spent in one production cycle.2012 .11. tangible) is those which: – Is used in production. delivering goods or for providing services. n > 1 year. 28. for renting or in administrative purposes.• Asset in material form (touchable.500 kn. • Transfers its value gradually on new effects  Tax regulation: value> 3.

11.Accounting process Acquisition Usage Alienation 28.2012 .

Internally deployed. Financial leases.2012 . Surpluses. Exchange. Business combinations. Donations.11. 28.Acquisition of LTTA • • • • • • • • Acquisition on market. Government support.

11. and – If acquisition cost could be realiable measured.2012 . 28.• Acquisition cost of LTTA should be recognized as asset if: – It is probable that it will bring future economic benefits.

delivery and handling. • This would include not only its original purchase price but also costs of site preparation.11.2012 . related professional fees for architects and engineers. and the estimated cost of dismantling and removing the asset and restoring the site. • Cost includes all costs necessary to bring the asset to working condition for its intended use. installation.Initial recognition of LTTA • ACQUISITION COST of LTTA when purchased comprehend: • Purchasing price including custom and excise duties after all discounts. 28.

Accounting recording Account payables (1) (2) LTTA in preparation Purchasing (1) (1) + (2) LTTA in usage Acquisition costs price + (2) Other costs VAT receivables (1) (2) 28.11.2012 .

– Costs for arrangement of surfaces ment for usage (acess roads. enviroment etc). telephone. etc.) – Necessary licenses for water. 28. heating. – Projects and other documentation based on which building was build (architect. geodesist etc.11.• Cost includes all costs necessary to bring the building to working condition for its intended use : – Preparation of building site.2012 .

11.2012 .• Temporary settlement situation – has a character of invoices – Used when is a longterm period of building – Method for gradation of finishing buiding • After every ethap there is a settlement by temporary situation.has a total amount of all temporary situations. – Method of completed contract (finished building) 28. • Total settlement situation .

plant and equipment whose fair value could be reliable measured should be recognized under revaluated amount – fair value on the date of revaluation reduced for latter accumulated depreciation and latter accumulated losses from value adjustments.Afterwards recognition: • Cost method – After initial recognition as asset. property.2012 . plat and equipment should be shown under cost reduced for accumulated depreciation and accumulated losses from value adjustments.11. • Revaluation method or revalorization (under fair value) – Property. 28.

Advance paymemt Given advances for LTTA Money Given advances for LTTA S0 X Taken advances Money Payables for takn advances S0 X 28.2012 .11.

2012 .11.  If actual balance is higher then the bookkepping balance INVENTORY SURPLUS VALUE CORRECTION ASSET (1) (1) SURPLUS (1) 28.Inventory process and inventory differences  INVENTORY PROCESS is a list of asset and liabilities of a company and it is done with a purpose of adjustments bookkepping balance with an actual balance.

2) If actual balanve is lower then bookkepping balance INVENTORY DEFICIT VALUE CORRECTION (1) (1) S0 X ASSET S0 X DEFICIT (1) 28.11.2012 .

11.2012 .Accounting process Acquisition Usage Alienation 28.

Amortization of LTTA • Amortization Is the allocation of the cost of an asset expense over its useful life in a rational and systematic manner. not a process of asset valuation.  Amortization will started after that asset has started to be used (next month). or for renting or for administrative purposes.  Why depreciable asset? Because the usefulness to the company and revenue – producing ability of each asset will decline over the asset useful life. 28.  Asset which amortize must satisfiy following terms: a) b) c) It is expected that this asset will be used in business activity for a longer period That asset must have usefull life That asset is held by the company for production. • Depreciation is a process of cost allocation.11.2012 . selling goods or providing services.

2012 .11. Basis for amortization is acquisition cost.  Period of amortization – period of usage (usefull life)  AMORTIZATION METHODS 1) TIMELINE METHODS a) Proportional or straightline method b) progressiv c) Degressiv 2) Functional method or units of activity 28.

28.11.Depreciation is not used for: • • • • • • Land. Archives. Advances for LTTA. Art.2012 . Forrest. Asset in preparation.

2012 .Depreciation recording Accumulated depreciation of LTTA Depreciation cost X X 28.11.

Timeline methods o PROPORTIONAL – amount of depreciation is the same in useful life o DEGRESSIV MEHOD – amount of depreciation declines in useful life o PROGRESSIV METHOD – amount of depreciation inclines in useful life. Depreciation is an accounting policy which is influencing financial result .

Proportional method Annual depreciation rate = 100/useful life (years) Annual depreciation amount = (acquisition cost * annual depreciation rate)/100 Quaterly amount ofdepreciation = annual amount/4 .

Functional method or units of activity • Is based on estimations of possible effects Annual depreciation amount= (acquisition cost/ n) * n1 n = estimated number of effects in total useful life n1 = actual number of effects in one period .

11.2012 .Accounting process Acquisition Usage Alienation 28.

2012 .11.Alienation processes: • • • • Sale Disposal Donations Inventory surplases Extraordinary revenue / expenses 28.

LTTA in usage S0 AC DEP S0 CA Account receivables VAT payables Revenues from sold LTTA SP and VAT VAT SP Carrying amunt(CA) = AC-DEP +all other costs related to sale 28.11.2012 26 .SALES Accumulated depreciation Expenses of sold LTTA – carrying amount .

11.2012 27 .donation LTTA in usage Accumuated depreciation Carrying amount S0 AC DEP S0 CA 28.

11.Impairing test of LTTA (Value adjustments) • Bookkepping value>recovarable amount – Recognized as loss of value adjustment – Value adjustment – alue correction and expenses • External and internal sources of information • Determening of recovarable amount – net sales value or value in usage depending in which is higher 28.2012 .

2012 .11.Value adjustment recording Value correction of LTTA Expenses of value adjustments X X 28.

2012 .11.Long term financial asset 28.

LONG TERM ASSET INTANGIBLE TANGIBLE FINANCIAL • stakes (shares) by related companies • given loans to related companies • participate intersts • investments in securities • given deposits • other long-term financial assets RECEIVABLES 28.11.2012 .

TERM definitions • Financial asset is considered to be all financial instrumemt which could be measured and recognized.11. • By investments and holding financial asset they could gain certain benefits which depends about the type of investments like interest rate. • LTFA are all financial investments for a period longer than 1 year. etc.2012 . 28. dividends .

2012 .11.Disclosure framework • IAS 32 FINANCIAL INSTRUMENTS • IAS 39 FINANCIAL INSTRUMENTS • IFRS 7 FINANCIAL INSTRUMENTS: disclosure • CFRS 9 FINANCIAL ASSET 28.

2012 .11.LT RECEIVABLES 28.

– other receivables 28. • FORMS: – Receivables from related companies.2012 .11. – receivables from sales on credit.LT RECEIVABLES • Comprehend receivables with the maturity date longer then 1 year.

Equities .

Classified by purpose and ownership Purpose .publicly or privately held Transparency 13-2 .Corporation Is a legal entity that is formed through a corporate charter and can operate in various states (must have a license from each state in which it does business).profit or nonprofit Ownership . but is incorporated in only one state.

Transparency 13-3 . It specifies the types of equities and their terms. number of shares that can be issued (authorized). and the par value of these issues.Corporation Corporate charter – The legal document establishing a corporation under the laws of its appropriate jurisdiction.

Privately Held Corporation May have few stockholders and does not offer its stock for sale to general public.Ownership Publicly Held Corporation May have thousands of stockholders and its stock is regularly traded on national securities markets. Transparency 13-4 .

Characteristics of a Corporation         Separate legal existence Limited liability of stockholders Transferable ownership rights Ability to acquire capital Continuous life Corporation management Government regulations Additional taxes Transparency 13-5 .

Separate Legal Existence Acts under its own name and may buy. pays its own taxes. sell property. borrow money. own. may sue or be sued. enter into legally binding contracts. Transparency 13-6 . Stockholders cannot bind corporation unless the stockholder is acting as an agent of the corporation.

Limited Liability of Stockholders Creditors have recourse only against corporate assets to satisfy claims. Transparency 13-7 . creditors have no legal claim on personal assets of owners unless fraud has occurred. Liability of stockholders limited to investment in corporation. Thus.

Transferable Ownership Rights Transfer of ownership among stockholders has no effect on corporation’s operating activities or assets.e. sale) of shares after the original issuance of the stock. Transparency 13-8 . Remember that a corporation does not receive any payments on the transfer (i.. liabilities and total stockholders' equity.

death. thus. a corporation is continuous and is not affected by withdrawal. Transparency 13-9 . or incapacity of any stockholder.Continuous Life Corporation is separate legal entity.

 Board of directors  formulates operating policies  selects officers to execute policy and to perform daily management functions.Corporation Management  The corporation establishes by-laws upon incorporation.  Stockholders manage corporation indirectly through board of directors. Transparency 13-10 .

 Entitled to pro rata share (based on ownership percentage) of the assets in liquidation Transparency 13-11 .Stockholder Rights  Vote on the election of Board of Directors  Can share in corporate profits through dividends – assuming declared  Entitled to keep the same percentage of ownership if new shares are offered for sale.

Difference Between Equity and Debt First. Transparency 13-12 .. debt determines the maximum payment a debt holder can receive. dividends can be unlimited). Second. debt agreements specify payments due to their holders. This is not the case with equity (i. In other words.e.. debt holders are entitled to receive payments specified in the debt agreement and possess legal recourse if promised payments are not made (i. there is no requirement to pay dividends).e.

a senior position).Difference Between Equity and Debt  Third. as long as a default has not occurred. debt holders have the right to be paid before equity holders (i. equity holders possess decision rights in the entity (as discussed in previous slides).  Fourth..e. Transparency 13-13 . if a corporation defaults.

Questions in Issuing Stock  How many shares should be issued?  At what price should the shares be issued? Transparency 13-14 .

Factors Involved in Setting Price of Stock  Company's anticipated future earnings  Its expected dividend rate per share  Its current financial position  Current state of the economy  Current state of the securities market Transparency 13-15 .

.shares issued minus shares reacquired – treasury stock).Stock Terms Authorized Stock Maximum amount of stock a corporation is allowed to sell as authorized by corporate charter.e. Amount must be disclosed on balance sheet. Outstanding Stock Number of shares held by stockholders (i. Issued Stock Number of shares originally sold to stockholders. Transparency 13-16 .

NOTE: Par value has NO relationship to the market value of the stock.Par Value Par value is the legal capital per share that must be retained in the business. Transparency 13-17 .

Stockholders’ Equity Section of The Balance Sheet Stockholders’ equity consists of two categories (contributed capital and earned capital): Contributed capital (paid capital) Par Value Additional paid-in capital  Earned capital Retained earnings Transparency 13-18 .

When the issuance of common stock for cash is recorded.Accounting for Common Stock Issues The issuance of common stock affects only the contributed capital accounts. The portion of the proceeds above par value is recorded in a separate paid-in account referred to as either additional paid-in capital or paid-in capital in excess of par. the par value of the shares is credited to Common Stock. Transparency 13-19 .

there is no additional paid-in capital Transparency 13-20 .000 100. The entry is: Cash Common Stock 100.000 NOTE: Since the stock is issued at par.Issuing Stock at Par Rhody issues 100.000 shares of the $1 par value common stock for cash at $1 per share.

The entry is: Cash 500.000 shares of the $1 par value common stock for cash at $5 per share.000 Transparency 13-21 .000 Additional Paid-in Capital 400.000 Common Stock 100.Issuing Stock Above Par Assume Rhody issues another 100.

000 400.Rhody’s Balance Sheet Stockholders' Equity Paid-in capital Common stock Paid-in capital in excess of par Total paid-in capital Retained earnings Total stockholders' equity $200.000* $800.000 * For illustrative purposes.000 $600. . we assume beginning retained earnings is $200.000.000 200.

Treasury Stock Treasury stock is a corporation's issued and outstanding stock that has been reacquired by the corporation and held in “treasury” for future use. Transparency 13-23 .

 Increase trading of company's stock in securities market in hopes of enhancing market value. Transparency 13-24 .Why Does A Corporation Reacquire Its Own Stock?  Reissue shares to officers and employees under bonus and stock compensation plans.  Have additional shares available for use in acquisition of other companies.

 Prevent a hostile takeover. thereby increasing earnings per share.Why Does A Corporation Reacquire Its Own Stock  Reduce number of shares outstanding. Transparency 13-25 .

000 Transparency 13-26 .000 32.Purchase of Treasury Stock On February 1.000 shares of its stock at $8 per share. 2004. Rhody acquires 4. Treasury Stock Cash 32.

000) of the shares (i.e..Treasury Stock  The Treasury Stock account is debited for the cost ($32.  The original amount of Common Stock is not affected because the number of issued shares does not change. Transparency 13-27 .  Treasury stock is considered a contra equity account (i.. it has a debit balance when the normal balance is a credit) and thus reduces the stockholders' equity section of the balance sheet. contra equity account).e.

000 32.000 shares issued and 196.$5 par value.000 200.000 $768.000 outstanding Additional Paid-in Capital Retained Earnings Total stockholders’ equity Less: Treasury Stock Total stockholders’ equity $ 200.000 400.Rhody’s Balance Sheet After Treasury Stock Stockholders' equity Paid-in capital Common stock.000 800. 200.000 .

Preferred Stock A type of stock that has contractual preferences over common stock. Preferred stockholders do not have voting rights. Preferences Dividends Assets in the event of liquidation Transparency 13-29 .

000 Transparency 13-30 .Preferred Stock Assume Rhody issues 1.PS 100.000 shares of $100 par value preferred stock for $12 cash per share.000 20. Cash 120.000 Preferred Stock Additional Paid-in Capital .

$100 par value 1. 200.000 400.000 100.000 200.000 shares issued and 196.Rhody’s Balance Sheet After Preferred Stock Stockholders' equity Common stock.$5 par value.000 $888.000 outstanding Additional Paid-in Capital Preferred stock.000 outstanding Additional Paid-in Capital – PS Retained Earnings Total stockholders’ equity Less: Treasury Stock Total stockholders’ equity $ 200.000 20.000 .000 32.000 920.000 shares issued and 1.

Dividend Preferences  Preferred stockholders have the right to the distribution of corporate income before common stockholders. the per share dividend amount is stated as either a percentage of the par value or as a specified amount. common shareholders will not receive any dividends until preferred stockholders have received their dividends. Transparency 13-32 .  Therefore.  Generally.

it does require that before the company can pay a dividend to common stockholders. it must pay preferred stockholders a dividend for all prior years that they did not receive a dividend (including a dividend for the current year). owning common or preferred stock does not guarantee the payment of a dividend. While being “cumulative” does not guarantee that a company will pay preferred stockholders a dividend in a specific year. Therefore. Transparency 13-33 . to protect preferred stockholders. most preferred stock is cumulative.Cumulative Preferred Stock As we have discussed.

Dividends in Arrears Unpaid prior-year dividends are referred to as dividends in arrears and are not considered a liability. No liability exists until the dividend is declared by the board of directors. Transparency 13-34 . Thus. the amount must be disclosed in the notes to the financial statements. this is an example of an unrecorded economic liability. However.

Dividends in Arrears Example Rhody has 1.000 (1.000 x 2) $ 14. What amount must Rhody pay preferred stockholders before common stockholders can receive a dividend? Dividends in arrears ($7. Dividends are 2 years in arrears. $100 par value cumulative preferred stock outstanding.000 Current-year dividends 7.000 Total preferred dividends $ 21.000 x $7 per share). The annual dividend is $7.000 shares of 7%.000 Transparency 13-35 .

 Dividends come in two forms: cash stock. you will receive 10% of the dividend. However.  Pro rata means that if you own 10% of the common shares. dividends are reported on a per share amount. Transparency 13-36 .Dividend  A dividend is a distribution by a corporation to its stockholders on a pro rata basis.

a corporation must have 2 things to pay cash dividends Retained earnings Adequate cash Transparency 13-37 . Generally.Cash Dividend A cash dividend Is a pro rata distribution of cash to stockholders.

Entries for Cash Dividends Three dates are important in connection with dividends:  the declaration date  the record date  the payment date Transparency 13-38 .

The Declaration Date The declaration date is the date that the board of directors declares the cash dividend and commits the corporation to a binding legal obligation that cannot be rescinded. Transparency 13-39 .

in essence. the directors of Rhody declare a $. The dividend is $49.000 x $.000 shares (200. would be paying dividends to ourselves.000 NOTE: We don’t pay dividends on treasury stock.000 issued – 4. Retained Earnings 49.Accounting on the Declaration Date On December 1. 2004.000 treasury) of $1 par value common stock. Transparency 13-40 .25).000 (196.000 Dividends Payable 49. 25 per share cash dividend on 196. since that.

Since this is an internal not external transaction: NO ENTRY IS NECESSARY Transparency 13-41 .Accounting on the Date of Record Represents the date ownership of the outstanding shares is determined for dividend purposes.

000 outstanding Additional Paid-in Capital Preferred stock.000 20. $100 par value 1.000 100.000 32.Rhody’s Balance Sheet After Declaration of Dividend Stockholders' equity Common stock.000 shares issued and 196.000 400. 200.000 outstanding Additional Paid-in Capital – PS Retained Earnings Total stockholders’ equity Less: Treasury Stock Total stockholders’ equity $ 200.000 921.$5 par value.000 151.000 .000 $839.000 shares issued and 1.

000 49. 2005.Accounting on the Date of Payment When the dividend is paid on January 20. the entry is Dividends Payable Cash 49.000 Transparency 13-43 .

Results in a decrease in retained earnings and an increase in paid-in capital.Thus.A Stock Dividend A stock dividend Is a pro rata distribution of the corporation's own stock to stockholders. it does not decrease total stockholders' equity or total assets. Is often issued by companies that do not have adequate cash to issue a cash dividend. Transparency 13-44 .

600).312 /215. but your ownership interest has not changed. Transparency 13-45 .000 x 10%) and you would receive 392 (2% x 19.Stock Dividends Assume you own 2% of Rhody (3.600 shares (196. Rhody would issue an additional 19. Note: You now own more shares of stock.000 shares of outstanding common stock) and it declares a 10% stock dividend.920 of its 196.600) shares. After the stock dividend your ownership interest would remain at 2% (4.

To emphasize that a portion of stockholders' equity has been permanently reinvested in business and is unavailable for cash dividends. To increase marketability of its stock by increasing number of shares outstanding and decreasing market price per share. Transparency 13-46 .Reasons for a Stock Dividend To satisfy stockholders' dividend expectations without spending cash.

the number of new shares created does not increase the total number of shares outstanding by more than 25%. A small stock dividend reduces retained earnings by the number of new shares issued multiplied by the fair market value of the stock. That is.Accounting for Stock Dividends Generally. most stock dividends are considered “small stock” dividends. Transparency 13-47 .

Stock Dividend Example Rhody’s declares a 2% stock dividend on its shares of $1 par value common stock.000. The current fair market value of the stock is $7 per share. Recall that its balance in retained earnings is $151. How many shares will be issued? What is the journal entry to record the stock dividend? Transparency 13-48 .

800 Additional Paid-in Capital 58.Accounting on the Declaration Date The number of shares to be issued is 9.4.600 (9.800 Transparency 13-49 .000 .800 x $7).800 (200. The number of new shares is then multiplied by the fair market value ($7) of the stock and Retained Earnings is decreased by $68.600 Common Stock to be distributed 9.000) x 2%). Journal Entry: Retained Earnings 68.

Accounting on the Issuance Date Journal Entry: Common Stock to be distributed Common Stock 9.800 9. a stock dividend rearranges the composition of stockholders' equity. Transparency 13-50 .800 Note: Although total stockholders' equity remains the same.

000 100.600 Retained earnings 151.000 Additional paid-in capital .Rhody’s Balance Sheet After Declaration of Dividend Before After Dividend Dividend Stockholders' equity Common stock $200.800 Transparency 13-51 .000) (32.PS 20.000 $209.800 Preferred stock 100.CS 400.000 Total paid-in capital 720.000 205.000 82.000) Total stockholders' equity $839.000 458.000 Outstanding shares 196.000 $839.000 20.400 Less: Treasury stock ( 32.800 Additional paid-in capital .000 788.

retained earnings. and total stockholders' equity Transparency 13-52 . A stock split does not have any effect on total paid-in capital. An increase in number of shares.Stock Split Is the issuance of additional shares of stock to stockholders accompanied by: A reduction in the par or stated value.

Rhody issues a 2-for-1 stock split on its 196.Stock Split Assume that instead of issuing a 2% stock dividend.000 shares of common stock. EFFECTS OF STOCK SPLIT  No journal entry is necessary.  Par Value per Share decreases and number of shares outstanding increases Transparency 13-53 .

000 20.000 151.000 Additional paid-in capital .PS 20.000 100.000 Outstanding shares 196.000 720.000 $839.000 392.000 $200.000 Retained earnings 151.Rhody’s Balance Sheet After Stock Split Before Split After Split Stockholders' equity Common stock $200.000) Total stockholders' equity $839.000 Less: Treasury stock ( 32.CS 400.000 Transparency 13-54 .000 Additional paid-in capital .000 400.000 Preferred stock 100.000 Total paid-in capital 720.000) (32.

Comparison of Stock Dividend and Stock Split Item Total paid-in capital Total retained earnings Total par value Par value per share Stock Split No change No change No change Decrease Stock Dividend Increase Decrease Increase No change Transparency 13-55 .

Retained Earnings Retained earnings represents the net income that is retained in the business. Retained earnings does not represent a claim on any specific asset. Transparency 13-56 . The balance in retained earnings is part of the stockholders' claim on the total assets of the corporation. Retained earnings is net income minus dividends paid since the formation of the business.

000 in cash. Transparency 13-57 . a $100.000 balance in retained earnings does not mean that there should be $100.Retained Earnings For example.

contractual or voluntary circumstances that make a portion of retained earnings currently unavailable for dividends. Transparency 13-58 .Retained Earnings Restrictions Are legal. This can be due to debt covenants as discussed in lecture 8.

However. This is permitted as long as the stock price equaled or was lower than the exercise price at the time the options were issued.Stock Options Generally. the entity must disclose in the pro forma the effect the stock options would have had on net income and diluted EPS if it was recognized as an expense. compensation expense is not recorded upon issue of the stock options. Transparency 13-59 .

Stock Options On December 1. Rhody issues 5.000 stock options to the company president. 2004. What would Rhody record as compensation expense at the date of issuance? Transparency 13-60 . the fair market value of the stock ($15) is equal to the exercise price ($15). At the time.

When the stock options are exercised. Transparency 13-61 . it would record the entry for the issuance of the stock.Stock Options Rhody would not make a journal entry to record compensation expense. it must make a footnote disclosure in the financial statements to reflect the effect this would have had on net income and EPS. However.

the president of Rhody exercises his option to buy the 5. 2006.000 shares of stock when the fair market value of the stock is $30. Recall that the exercise price was $15 and the par value of Rhody stock is $1.Stock Options On March 1. How does Rhody record the effect of the issuance of stock? Transparency 13-62 .

000 shares) Transparency 13-63 .000* Common Stock 5.000 * ($15 exercise price x 5.000 Additional paid-in capital 70.Stock Options Rhody would make the following journal entry: Cash $75.

Transparency 13-64 .Measuring Corporate Performance One way that companies reward stock investors for their investment is to pay them dividends. The payout ratio and dividend yield measure a corporation’s dividend performance.

The Payout Ratio Measures the percentage of earnings distributed in the form of cash dividends to common stockholders Total Cash Dividends on Common Stock Net Income Transparency 13-65 .

Dividends Per Share of Common Stock Stock Price at Year-End Transparency 13-66 .The Dividend Yield The rate of return an investor earns from dividends.

Earnings Per Share Measures the net income earned on each share of common stock. Net Income .Preferred Stock Dividends Average Number of Shares of Common Stock Outstanding Transparency 13-67 .

Market Price Per Share Earnings Per Share Alternatively as discussed in Chapter 7: Market Capitalization Book Value Transparency 13-68 .Price-Earnings Ratio/Market Cap The price-earnings ratio reflects the investors‘ assessment of a company's future earnings.

Net Income – Preferred Stock Dividends Average Common Stockholders’ Equity Transparency 13-69 .Return on Common Stockholders’ Equity Ratio Measures the profitability from the stockholders’ point of view.