CHAPTER 11 CASH MANAGEMENT

Three important principles:

- Separation of responsibility (handling/authorization, custodianship, maintaining records)
- Banking intact
- Payments using electronic transfer or checks
Bank Reconciliation:
1. The bank statement:
Statement of the bank’s liability to the entity
- deposits made: credit column
- checks and EFTs paid: debit column
2. Bank reconciliation – why?
- Recorded in books, not bank: un-presented checks, outstanding deposits
- Recorded in bank, not books: bank fees, dishonored checks, money collected by bank
- Errors by either side
3. Bank reconciliation – steps:
Balance as per bank statement
+ Outstanding deposits
- Un-presented checks
Balance as per Cash at bank account

CHAPTER 12 RECEIVABLES
Type of receivables:
- Accounts receivable (trade receivable): Result of the sales of goods or provision of services on
credit
- Bills receivable: Result of offering extended terms of credit or as a means of obtaining finance
- Other receivables: Result of offering loans, from income receivable, and from the sales of
NCA
Accounts receivable:
1. Recognition of accounts receivable: when services are provided or at the time of sale
Dr Accounts Receivables
Cr Sales/Revenue
2. Valuation of accounts receivable: reported as net realizable value (the amount the company
expects to be paid by customers = Net credit sales – Allowance for doubtful debts)
 Presentation on balance sheet

3. Bad debt expenses:

a. Method 1: Allowance method of accounting for bad debts
Dr Bad Debts Expense
Cr Allowance for Doubtful Debts (contra-asset account)
1. Estimating doubtful debts:
- Method 1: Percentage of net credit sales method (income statement approach):
Bad debt expense = uncollectibles percentage x net credit sales
- Method 2: Ageing of accounts receivable method (balance sheet approach):
Bad debt expense = uncollectibles percentage of each aging group x balance of
each group
2. Writing off bad debts:
Dr Allowance for Doubtful Debts account
Dr GST Payable
Cr Accounts Receivable Control-J. Evans
b. Method 2: Direct write‐off method
Writing off bad debts:
Dr Bad Debts Expense
Dr GST Payable
Cr Accounts Receivable Control-J.Evans
c. Recovery of an account written off: Reverse the original write-off entry and the cash
receipt is recorded as usual
4. Credit policy:
d. Credit terms
e. Settlement discount (cash discount)
f. Receivables factoring (with recourse or without recourse)

CHAPTER 13 INVENTORY
Recognition
- Initially recorded as cost (costs of purchase, costs of conversion, and other costs incurred in
bringing the inventory to a saleable condition and to its existing location)
- Valued at the lower of cost and net realizable value (item-by-item basis if possible)
 (Net realizable value = estimated normal selling price - less the estimated costs necessary to
make the sale)
- Reversal is allowed only to the amount written down
Assignment of costs to ending inventory (EI) or cost of sales (COS):
1. Cost flow assumptions:
– Specific identification
– First‐in, first‐out (FIFO): issues priced at oldest prices in inventory
– Last‐in, first‐out (LIFO): issues priced at latest prices in inventory
– Average cost: issues priced at a calculated weighted average
Average cost per unit = total cost of goods available for sale
total number of units available for sale
(Perpetual: new average calculated whenever a delivery is received
Periodic: single average calculated at end of each period)
? Which assumption to choose
? How profit defers among these assumptions
? How ending inventory differs among these assumptions
2. Methods to manage inventory
a. Perpetual inventory system: records the sale or purchase of inventory immediately, use
INVENTORY
*EI: determined by the system, physical stocktake is to verify balances recorded in the accounting
records
*COS: determined by the system

- Purchase:
Inventory
Accounts Payable
- Purchase Returns:
Accounts Payable
Inventory

- Sales:
Accounts Receivables
Sales
COS
Inventory
- Sales Returns:
 Sales Returns and Allowances
Accounts Receivables
Inventory
COS
b. Periodic inventory system: no update of inventory records, use PURCHASE
*EI: physical stocktake is done to determine ending inventory
*COS = BI + Net Purchases – EI
(Net Purchases = Purchases + Freight Inwards – Purchases R&A – Discount received)

- Purchase
Inventory Purchase
Accounts Payable
- Purchase Returns
Accounts Payable
Inventory Purchase Returns and Allowances
- Sales
Accounts Receivables
Sales
COS
Inventory
- Sales Returns
Sales Returns and Allowances
Accounts Receivables
Inventory
COS

CHAPTER 14&15 NON-CURRENT ASSETS

PPE: Assets used for the future production of goods or services over several accounting periods
The depreciable amount (acquisition cost less residual value): is allocated in a systematic manner over
their useful lives corresponding to the future economic benefits received
1. Recognition:
Acquisition cost = fair value of the items given up
= purchase price + any other costs associated with the acquisition
Dr Building
Cr Cash (or payables)
2. Depreciation:
Why depreciation?
- Physical wear and tear
- Expected usage of the asset
- Technical and commercial obsolescence
- Legal or similar limits on the use of an asset
Journal entry (adjusting entry at the end of each period)
Dr Depreciation expense- Building
Cr Accumulated depreciation- Building
Accumulated depreciation (contra-asset account): shows total depreciation expense over life to date
Presentation on balance sheet

Carrying
amount

Carrying amount (benefits that have not yet been used up) = cost – accumulated depreciation

Depreciation Methods:
 How to choose a depreciation method? -> Pattern of flow of benefits over the useful life
 Depreciable cost = acquisition cost - residual value
 Residual value (salvage value/trade‐in value/scrap value)
 Useful life: the estimated lifespan of a depreciable fixed asset, during which it can be expected to
contribute to company operations

1. Straight-line

Depreciation = Cost – Residual value

expense Useful life

2. Diminishing balance (Reducing balance)

 Depreciation expense = Carrying amount x depreciation rate

3. Sum-of-years digits

4. Units of production

3. Subsequent cost: costs incurred after the asset is recognized in the financial statement
Capitalization vs. Expenditure
• The money spent can either:
– make the asset more useful than it was (e.g. overhaul) -> capitalize the cost
(Increasing the useful life, or the production capacity or the residual value)
– keep the asset working as was expected (e.g. regular tune up on a car) -> expense the cost
• Capitalization (increase value to the asset on balance sheet)
Dr Machinery
Cr Cash
• Expenditure (increase expense on income statement)
Dr Repairs and maintenance expense
Cr Cash
Leasehold Improvements: Capitalize as an asset and depreciate over the unexpired period of the lease or
the useful lives of the improvements, whichever is the shorter
4. Revaluation
Each class of NCA must be measured using:
- the cost method or
- the revaluation model (use fair value)
* Reversal of revaluation increase/decrease: adjusted again previous increase/decrease

Impairment: permanent reduction in the value of the asset

- If carrying amount > recoverable amount -> recognize an impairment loss

5. Derecognition of assets (asset value is removed from the accounts)

a. Sales of assets
b. Disposal of assets

Intangible assets
- Patents, copyrights, trademarks, brandnames, franchises…: identifiable non‐monetary asset
without physical substance
- Amortization: the allocation of the depreciable amount of intangibles to the periods benefiting
from their use
- The useful life of the asset must be reviewed each period to determine whether events and
circumstances still continue to support the indefinite life assumption
- Goodwill: unidentifiable intangible asset in a business combination (only purchased goodwill
is recorded, no internally generated goodwill)
 Subject to an impairment test each year
 Impairment loss is recognized as an expense
 Cannot be revalued

CHAPTER 16 LIABILITIES

Liabilities Assets
Present obligation (legal, Resources controlled by entity
constructive)
Definition
Past events Past events
Future outflow of resources Future economic benefits
Probable occurrence of outflow Probable occurrence of inflow economic benefits
Recognition resources
Reliable measurement Reliable measurement
CL: due within a year/operating cycle CA: converted to cash within a year/operating
Classification A/P, Bill payable, other payable, GST cycle
payable, Accrued expenses, Cash, Inventory
 provisions (for warranties, doubtful
debts, taxes), employee benefits,
unearned revenue
NCL: term loans, mortgage payable,
debentures or bonds
Bill payable: net of discount
Valuation
(unexpired interest) on bill
A/R, Bill receivable, other receivable, GST
receivable, prepaid expenses
NCA: PPE, LT investment, intangible assets,
other assets
A/R: net of allowance for doubtful debts
Inventory: lower of cost or net realizable value

Type of payables:
- Accounts payable (trade payable): part of the business operating cycle
- Bills payable (evidenced by bill of exchange or a promissory note): often issued when a
business borrows money from a bank or other financial institution
- Others…

Presentation on Balance sheet (partial):

Current liabilities:
Accounts payable $46 500

Contra-liability
Bill payable $100 000
Unexpired interest on bill 4 932 95 068
Accrued expenses 6 700
$148 268
Liability:
- Present obligation as a result of past events
- Settlement is expected to result in an outflow of resources (payment)
Provision: a liability of uncertain timing or amount, set aside an amount for a known future liability
Recognize a provision if, and only if:
- Present obligation (legal or constructive) has arisen as a result of a past event (the obligating
event),
- Payment is probable ('more likely than not'), and
- The amount can be estimated reliably
Contingent liability: possible obligation arising from a past event that will be confirmed only by the
occurrence or non-occurrence of one or more uncertain future events that are not wholly within the
control of the entity
- Possible obligation depending on whether some uncertain future events occur, or
- Present obligation but payment is not probable or the amount cannot be measured reliably
 Probable outflow &
Liability
Reliable measrement

Present
Probable outflow &
Provision
Reliable measurement
Uncertain
Obligation amount & timing
No probable outflow
Contingent liability
No reliable measurement
Possible Contingent liability

Why finance through long‐term debt?

+ Avoids diluting the control of the existing owners

+ Creditors do not share in any excess profits

- Interest payments to creditors must be made each period regardless of profitability

CHAPTER 18 STATEMENT OF CASH FLOWS

Purposes of the statement of cash flows:
– evaluate the entity’s financial structure, including its liquidity and solvency
– assess the entity’s ability to generate cash in the future and predict future cash flows
– evaluate the entity’s ability to pay dividends and meet obligations
– check the accuracy of past assessments of future cash flows
– examine the relationship between profitability and net cash flow
Operating activities: Changes in Current Assets and Current Liabilities (relate to business main activities)
Investing activities: Changes in Non-current Assets (relate to PPE & Investment)
Financing activities: Changes in Non-current Liabilities & Equity (relate to owners and debtors)

Direct Method: directly calculate each cash flow

Cash flows from operating activities
+ receipts from customers
– payments to suppliers and employees
– income tax paid
– interest paid
+ interest or dividends received
Net cash from operating activities
Cash flows from investing activities
-/+ purchases/sales of property and equipment
-/+ purchases/sales of equity investments
-/+ purchases/sales of businesses
-/+ make/collection loans to other enterprises
+ Interest or Dividends received
Net cash used in investing activities
Cash flows from financing activities
+/- borrowing/repaying debt
+/- issuing shares/buy back of shares
- dividends paid
- Drawings
Net cash generated in financing activities
Net increase in cash and cash equivalents
Cash and cash equivalents at beginning of the year
Cash and cash equivalents at end of the year
Receipts from customers (A/R account) = Sales + BB - EB
Payments to suppliers (A/P account) = Purchases + BB – EB
Purchases (Inventory account) = COS – EI + BI
Cash paid to suppliers of services & labor
= accrual-basis expenses – decrease prepaid expense – increase accrued expense
Indirect Method: adjust net profit after tax for non-cash items
Cash flows from operating activities
Net income
Adjustments:
+ Depreciation/Amortization expense
- Gain on sale of PPE or Investment
+ Loss on sale of PPE or Investment
Change in working capital:
+ Decrease in current assets
+ Increase in current liabilities
- Increase in current assets
- Decrease in current liabilities
Net cash from operating activities
CHAPTER 19 FINANCIAL STATEMENT ANALYSIS
Percentage analysis:
1. Horizontal analysis: analysis of the proportional change from year to year in individual statement
items
The percentage change = the increase or decrease from the base year
the base-year amount
2. Trend analysis: For 3 or more years, the earliest period is the base period, with all subsequent periods
compared with the base

3. Vertical analysis: restating the dollar amount of each reported item reported as a percentage of a
specific item on the same statement (the base amount)

Ratio analysis: express a relationship between two relevant items

1. Profitability ratios: evaluate an entity’s financial performance during the period and are combined
with other data to forecast potential future performance
Return on assets: how profitable a company is relative to its total assets
ROA = profit/average total assets
Return in equity: the return on net assets
ROE = (profit – preference dividends)/average ordinary equity
Ordinary equity = total equity - preference shares
Gross profit margin: the amount of money left over from sales after deducting the cost of goods
sold
Gross profit margin = Gross profit/revenue
Profit margin (return on sales): percentage of sales has turned into profits
Profit margin = profit/revenue
Expense ratio: portion of each dollar of revenue that goes toward the expense items
Expense ratio = expense /revenue
 Earnings per share: the portion of a company's profit allocated to each outstanding share of
common stock
EPS = (Profit after tax - preference dividends)/Weighted average number of ordinary
shares issued
Price–earnings ratio: the share price relative to the annual net income earned by the firm per share
P/E ratio = Market price per ordinary share/EPS
Earnings yield: the average rate of return per share invested at market price
Earnings yield = EPS/Market price per share
Dividend yield: rate of return on an invested dollar
Dividend yield = Annual dividend per share/market price per share
Payout ratio: percentage of earnings distributed as dividends to the shareholders
Payout ratio = Total dividends to ordinary shares/(profit-preference dividends)
2. Liquidity ratios: measure ability to pay its short-term debts as they fall due
Current ratio: the entity’s ability to satisfy its obligations in the short term
Current ratio = (Cash + Receivables+Inventory) /CL
Quick ratio (acid-test ratio): the entity’s ability to satisfy its obligations in the short term with
quick assets
Quick ratio = (Cash + Receivables) /CL
Receivables turnover: how many times the average receivables balance is converted into cash
during the year

Receivables turnover = Net sales revenue/ Average receivables balance

Inventory turnover: number of times the average inventory balance was sold and then replaced
during the year

Inventory turnover = COS/ Average inventory balance

3. Financial stability ratios: the entity’s ability to continue operations in the long term and still have
sufficient working capital to operate
Debt ratio = total liabilities/total assets
Equity ratio = total equity/total assets
Capitalization ratio = total assets/total equity

Times interest earned = (profit before tax + net finance costs)/ net finance costs

Asset turnover ratio = Revenue/Average total assets

4. Cash sufficiency ratios: the entity’s relative ability to generate sufficient cash to meet the entity’s cash
flow needs

Limitations of financial analysis:

- Historical data
- Year-end data may not be typical
- One-off or non-recurring items may inhibit the determination of trends
- Ratio comparisons across companies can be misleading if different industries or different
accounting methods used
- Failure to adjust for inflation or market values results
- Ratios tell only part of the story
 ABC Inc.,
Statement of Profit or Loss
for the year ended December 31, 20XX
$000
Sales xxx
Less: Sales return (xxx)
Less: Discount allowed (xxx)
Net Sales xxx
Less Cost of Sales:
Beginning Inventory xxx
Purchases xxx
Less Purchases Return (xxx)
Less: Discount Received (xxx)
Net Purchases xxx
Add Freight Inwards xxx
Cost of goods available for sales xxx
Less Ending Inventory (xxx)
Cost of sales xxx
Gross Profit xxx
Add other income:
Royal revenue xxx
Rental revenue xxx xxx
Less Expenses:
Salaries expense xxx
Advertising expense xxx
Insurance expense xxx
Depreciation expense xxx
Other operating expenses xxx xxx
Profit xxx

ABC Inc.,
Statement of Changes in Equity
for the year ended December 31, 20XX
$000
Capital at the beginning of the year xxx
Add: Profit for the year xxx
Less: Drawings (xxx)
Capital at the end of the year xxx
 ABC Inc.,
Statement of Financial Position
as of December 31, 20XX
$000
Current Assets
Cash xxx
Accounts receivable xxx
Prepaid insurance xxx
Inventory xxx xxx

Non-current Assets
Machinery, at cost xxx
Accumulated Depreciation - Machinery (xxx)
Building, at cost xxx
Accumulated Depreciation - Building (xxx)
Land xxx xxx

Less Current Liabilities

Accounts payable xxx
Accrued expenses xxx
Unearned rental revenue xxx (xxx)
Less Non-current Liabilities
Loan Payable xxx (xxx)

Net assets xxx

Owner's equity
Capital xxx