Accounting Exam Notes

Cash flow/net income = quality of income

 Example Transactions
a. HKUST Inc. Issues $10,000 worth of common stock to investors and receives cash
b. HKUST Inc. takes a loan of $20,000 for 5 years from HSBC Bank. The interest rate is
10% per year.
c. HKUST Inc. uses cash to buy a $10,000 restaurant space to prepare food.
d. HKUST Inc. uses cash to buy $10,000 worth of machines for preparing sandwiches
e. HKUST Inc. receives $15,000 of materials from a supplier for making sandwiches
(chicken, bread, etc.) and says that it will pay after 12 months
f. HKUST Inc. hires 5 people to make the sandwiches who it pays $1,000 each
g. HKUST Inc. uses the $15,000 of materials to make the sandwiches (Hint:
supplies/works in progress get converted to Inventory here)
h. HKUST Inc. sells all the sandwiches for $30,000 in Cash.
i. HKUST Inc. receives $20,000 in materials from a supplier but does not pay them in cash.
j. HKUST Inc. issues $50,000 worth of stock to investors and receives cash.
k. HKUST Inc. acquires Clearwater Inc. for $40,000. Clearwater Inc. is a restaurant that had
land worth $20,000 and had no other assets but had a very good brand name. People liked
and trusted the name of Clearwater Inc.. (Hint: Goodwill. Goodwill is created when a
company buys a smaller company (generally with a good name) for more than its
value. The reason companies do this is to bring the brand of a good company under
its name. Let’s side-track to the Apple Beats acquisition first.)
l. HKUST Inc. uses $10,000 of the materials to make sandwiches. (Hint: supplies/WiP get
converted to Inventory here, but only half of the materials – from transaction (i) we
know that we have 20,000 in materials, and we only use 10,000 of it, so 10,000
remains)
m. HKUST Inc. sells all the sandwiches for $25,000 to a customer who will pay within 12
months.
n. HKUST Inc. records $5,000 in depreciation expense on the restaurant space, and $2,000
on the machines.
o. HKUST Inc. pays $5,000 to its staff for administration and accounting expenses.
p. HKUST pays HSBC bank $2,000 in interest expense using its cash.
We’ll prepare the Balance Sheet, Income Statement, & Cash Flow Statement. We’ll also
calculate Current Ratio, Return on Equity, Debt to Equity Ratio, and Interest Coverage Ratio.

Notes:
1. When an asset increases it gets debited, and the asset gets credited when it decreases.
2. When a liability or equity increases it gets credited and the liability or equity gets debited
when it decreases.
3. When we receive revenue, it gets credited because that revenue becomes part of equity
(because the revenues becomes income after deducting expenses) that the investors will
eventually get back at some point or the other.
4. Expenses, similarly, get debited because they reduce profits (they get deducted from
revenue), and hence the company will give investors less if it makes less profit.
5. Debits must equal credits & Assets = Liabilities + Shareholders’ Equity
6. Whenever a revenue transaction occurs (such as selling goods), we record two
transactions. One where the inventory is reduced and we expense it. The second
transaction to record the money received or the receivable that we now have for that sale.
7. Keep track of your T-accounts. Every entry will affect 2 T-accounts.