Financial Accounting - Designed primarily for external decision makers Includes information about company protability and nancial

health. Useful to various parties who wish to engage in contracts with the rm, including investors, creditors, employees, customers and governments. Assets 1. Owned or controlled by the company 2. Possess expected future benets that can be measured Current Asset - Used up or convert within one year ! Presented in order of liquidity ! Cash, Marketable Securities, Accounts Receivable, Inventory, Prepaid Expenses Noncurrent Asset - Not used up or converted in one year ! Long-term nancial investments, PPE, intangible and other assets Assets typical reported on the B/S at their historical cost with adjustments for depreciation Securities are often reported at fair market value or current market price Liability A probable future economic sacrice resulting from a current or past event. Must be reported when: 1. The future sacrice is probable. 2. The amount of the obligation is known or can reasonably be estimated. 3. The transaction or event that caused the obligation has occurred Current Liability - Requiring payment within one year ! Accounts payable, accrued liabilities, short-term borrowings, deferred revenues, ! current maturities of long-term debt Noncurrent Liability - Not requiring payment within on year ! Long-term debt, other long-term liabilities Equity - Capital provided by owners of the company. Contributed Capital ! Common Stock ! Additional Paid-in capital ! Treasury stock (amount paid for reacquired company stock) Earned Capital ! Retained Earnings ! Accumulated other comprehensive income or loss

Net Income = Revenues - Expenses Operating Expenses - Usual and customary costs that a company incurs to support its main business activities. Nonoperating Expenses & Revenues - Relate to the companys nancing and investing activities, and include interest revenue and interest expense. Revenue Recognition - Revenue should be recognized when it is earned. Matching Principle - Expenses are recorded by matching them with revenues when incurred, even if not yet paid in cash, as assets are used or obligations created. Revenue - Cost of Goods Sold = Gross Prot Dividends - Subtracted from retained earnings for distribution to shareholders

Adjusting entries 1. Occur at the end of a reporting period 2. Almost never involve cash; changes in cash require a transaction, and adjusting entries are not transactions Deferred (Unearned) Revenue - Allocate earned portion of unearned revenue to revenue to reect revenues earned in the period. GIFT CARDS! ! ! Debit (L-) Unearned Revenue ! Credit (R+) Sales Revenue

Deferred (Prepaid) Expenses - Allocate used or expired assets to expense to reect expenses incurred in the period. PREPAID INSURANCE ! ! Debit (+E) Insurance Expense ! Credit (A-) Prepaid Insurance

Depreciation - Allocate the cost of equipment, vehicles and buildings to the periods benetting from their use. Accumulated in CONTRA ASSET ACCOUNTS, which record offsets or reductions against a related account. ! ! Debit (E+) Depreciation Expense ! Credit (XA+) Accumulated Depreciation

Accrued Revenues - Record revenues to reect revenues earned in the period that are not yet received in cash or recorded. RECEIVABLES ! ! Debit (A+) Accounts Receivable ! Credit (R+) Sales Revenue

Accrued Expenses - Record expenses to reect expenses incurred in the period that have not yet been paid or recorded. PAYABLES ! ! Debit (E+) Wages Expense ! Credit (L+) Wages Payable

Closing Process 1. Close revenue accounts. Debit each revenue account equal to its balance, credit retained earnings for the total of revenues 2. Credit each expense account for an amount equal to its balance, and debit retained earnings for the total of expenses

Statement of Cash Flows - How the company generated cash (inows) and how it used cash (outows). This statement helps understand a rms liquidity (ability to pay nearterm liabilities) and solvency (ability to pay long-term liabilities). Cash Equivalents - Short term, highly liquid investments that are: 1. Easily convertible into a known cash amount 2. Close enough to maturity that their market value is not sensitive to interest rate changes (generally investments with initial maturities of 3 months or less. Typical cash equivalents - Treasury bills, commercial paper (short-term corporate notes) and money market funds. Operating Activities - Typically selling goods or services, but broad enough to include any cash receipts or payments not classied as investing or nancing. ! ! ! ! ! Inows - Cash receipts or sales or services, receipts of interest or dividends, lawsuit settlements, refunds from suppliers. Outows - Cash payments to employees, supplies, to purchase inventories, payments of interest to creditors, payment of taxes, contributions to charity, lawsuit settlements

Investing Activities 1. Acquisition and disposal of property, plant and equipment assets and intangible assets 2. Purchase and sale of government securities and those of other companies, including stocks, bonds, and other securities that are not classied as cash equivalents 3. The lending and subsequent collection of money ! ! ! ! ! Inows - Cash receipts from sales of PPE and intangible assets, sales of investments in government and other company securities, cash receipts from repayments of loans by borrowers Outows - Cash payments to purchase PPE, govt & other company securities, cash payments made to lend money to borrowers

Financing Activities - Reception of capital from owners, returns capital to owners, borrows from creditors and repays amounts borrowed. ! ! ! Inows - Cash receipts from issuance of common stock and preferred stock and sales of treasury stock, cash receipts from issuances of bonds payable, mortgage notes payable and other notes payable

! ! !

Outows - Cash payments to acquire treasury stock, payment of dividends, payments to settle outstanding bonds payable, mortgage notes payable, and other notes payable

Direct Method (Cash Flow from Operating Activities) - Presents the components of cash ow from operating activities as a list of gross cash receipts and gross cash payments. Indirect Method (Cash Flow from Operating Activities) - Begins with net income and applies a series of adjustments to net income to convert it to net cash ow from operating activities. ! Net Income +/- Adjustments = Cash ow from operating activities

Noncash investing and nancing activities - Issuance of stocks, bonds or leases in exchange for PPE assets or intangible assets. DOES NOT AFFECT CURRENT CASH FLOWS Appendix A FV = PV * (1 + interest rate)^n PV = FV / (1 + discount rate)^n Chapter 6 Revenue Recognition GAAP 1. Realized or realizable - the companys net assets increase. It must receive an asset or satisfy a liability as a result of a transaction or event 2. Earned - The seller has executed its duties under the terms of the sales agreement and the title has passed to the buyer. SAB 101 1. There is persuasive evidence that a sales agreement exists 2. Delivery has occurred or services have been rendered 3. The sellers price is xed or determinable 4. Collectibility is reasonably assured Right of Return - Sometimes the expected returns are estimated and deducted from revenue when reporting the sale in the income statement. If the return period is long or the amount is difcult to estimate, the revenue should not be recognized until the return period expires.

Installment Method - Recognize revenue in proportion to the amount of cash received relative to the total amount owed. The revenue and expenses are recognized in proportion. Bundled Sales - The sales price should be allocated among the various elements of the sale in proportion to their fair value. Revenue allocated to the elements that have not been delivered (maintenance, customer support, warranty coverage) must be deferred and recognized as the service is rendered in future periods. Criteria for Identifying Separate Units of Account A. The item has a value on a stand-alone basis and is (or can be) sold separately. B. There is reliable evidence of the fair value of the undelivered item C. If the delivered item has a general right of return, then the delivery of the undelivered item is still under the control of the company (i.e. it is not the case that if the customer returns the delivered item they can cancel the undelivered item) Determining the Individual Selling Price of each unit of account 1. Vendor-Specic Objective Evidence (VSOE) a. The price actually charged by the vendor, or b. the price approved for charging by someone authorized to approve pricing in the company 2. Third-Party Evidence (TPE) - This is the price charged by the vendor or a competitor for a largely interchangeable product or service on a standalone basis 3. Estimated Selling Price (ESP) - This is the vendors best estimate of the price at which they would sell the item if they were to regularly sell it on a standalone basis. Net Realizable Value - The net amount that the seller expects to collect from accounts receivable. It is receivables net of allowances for doubtful accounts. Allowance for Uncollectible accounts - CONTRA ASSET account that offsets account receivables based on the estimated amount of uncollectible receivables based on aging analysis or percentage of sales calculations. ! ! Bad Debts Expense (+E) ! Allowance for Uncollectible Accounts (XA+/A-)

NOTE: The bad debt expense is recognized AT TIME OF SALE, not at the time of write-off later. Aging Analysis - Provides a percentage of uncollectible receivables based on number of days or months that the related invoices are outstanding. Percentage of Sales - An alternate way of estimating uncollectible receivables. Provides a simple percentage of total sales as the uncollectible amount.

GROSS Accts Receivable = AR, Net + Allowance for Doubtful Accts Receivables Cash Received = Beginning AR + Sales Revenue on Acct - Ending AR Write-off Amount = ! Beginning Allowance for Doubtful Accts + Provisions for Doubtful Accts - Ending ! Allowance for Doubtful Accts Bad Debt Write-Offs ! ! Allowance for Uncollectible Accounts (XA-/A+) ! Accounts Receivable (A-)

Cookie Jar Reserve - Some companies may overestimate its allowance for bad debts some years. Intentional overestimations attempt to manage earnings by building up a reserve that can be drawn down in subsequent periods. This is called a cookie jar reserve. Chapter 7 Direct Association (Expense recognition) - Any cost that can be directly associated with a specic source of revenue should be recognized as an expense at the same time that the related revenue is recognized. COST OF GOODS SOLD/INVENTORY Immediate Recognition (Expense recognition) - Period costs necessary for generating revenues and income but cannot be directly associated with specic revenues. GENERAL, SALES & ADMINISTRATIVE Systematic Allocation (Expense recognition) - Costs that benet more than one accounting period and cannot be associated with specic revenues or assigned to a specic period must be allocated across all periods benetted. DEPRECIATION EXPENSE Gross Prot = Sales revenue - Cost of goods sold ! ! ! ! ! ! Inventory (A+) ! Cash (A-) Cash (A+) ! Sales Revenue (R+, SE+) Cost of Goods Sold (E+, SE-) ! Inventory (A-)

Net-of-discount Method - When a discount is received (for example, 1/10, n/30), the inventory is capitalized as the net of cost.

! ! ! ! ! ! ! ! !

Inventory (A+) ! Accounts Payable (L+) Payment Accounts Payable (L-) ! Cash (A-) Loss of Discount Accounts Payable (L-) Interest Expense, discounts lost (E+, SE-) ! Cash (A-)

Inventory reporting for manufacturing rms: ! ! Raw Materials - Cost of parts and materials purchased from supplies for use in ! the production process ! ! ! ! Work-in-Process - Cost of partially completed goods. Includes the materials used in the production, LABOR and OVERHEAD COSTS. Finished Goods - Cost of the stock of completed products ready for delivery to customers.

FIFO - First In, First Out. Assumes that the rst costs recorded in inventory (rst in) are the rst costs transferred from inventory (rst out) to cost of goods sold. LIFO - Last In, First Out. Assumes that the most recent costs recorded in inventory (last in) are the rst costs transferred from inventory (rst out). ! ! ! ! In general, LIFO puts more recent costs into cost of goods sold expense, so LIFO COGS will be higher than the FIFO COGS. Gross prot is then correspondingly lower. This holds true when the costs of inventory are rising over time.

Average Cost - Determined from the total cost of goods available for sale divided by the number of units available for sale. Lower of Cost or Market - The process that occurs when companies are required to write down the carrying amount of inventories on the balance sheet, IF the reported cost (using FIFO or LIFO, for example) exceeds the market value (determined by current replacement cost). ! LCM Write Down

! !

Cost of Goods Sold (E+, SE-) ! Inventory (A-)

Inventory shrink (loss due to theft, breakage, damage, spoilage, etc.) is debited to Cost of Goods Sold (E+) LIFO Reserve - The difference between the ending inventorys FIFO (or current) cost and its LIFO cost. ! ! LIFO INVENTORY + LIFO RESERVE = FIFO INVENTORY FIFO COGS = LIFO COGS - Change in LIFO Reserve

EXAM TIPS 1. 2. Calculate Purchases for given inventory accounting method (LIFO or FIFO) using t-account analysis. Use: Beginning Inventory - Cost of Sales - Ending Inventory = Purchases (ignore sign change) Plug Purchases into t-account analysis for inventory method (LIFO or FIFO) you are calculating. Use: Beginning Inventory + Purchases - Ending Inventory = Cost of Sales

Unrealized Holding Gain - A gain resulting from holding inventory as prices are rising. ! The value of the LIFO reserve can be viewed as an unrealized holding gain. Chapter 8 - Long-term Assets (PPE) Cost - The amount of cash spent or liability incurred to acquire something. Expense - The consumption of the cost. Capitalize - The value of a long-term physical asset should include all of the costs necessary to acquire the asset and prepare it for its intended use. Depreciation - Intended to recognize the decline in value of asset as it is being used to generate revenue and the associated expense. Repair or Revenue Expenditure - An expense incurred to maintain the production level of PPE. Capital Expenditure - Incurred to extend the life or improve the functionality of PPE. Intangible Benets - Assets that lack physical substance but provide future benets to the owner in the form of specic competitive advantage or legal rights. These are often

uncertain and difcult to quantify, and useful lives of some intangible assets are often impossible to estimate with condence. Common Intangible Assets - Patents, non-competition agreements, customer lists, unpatented technology, formulas, processes, goodwill. When to record an intangible asset: GAAP - When purchased (developed externally) IFRS - Demonstrate the following: technical feasibility of completing, intention to complete, ability to use or sell, probable future economic benet, the availability of resources to complete the development and use or sell and the ability to measure reliably the expenditure attributable to developing the asset. Intangible assets are recorded at cost. Goodwill = Amount paid in acquisition - FV of assets required, including identiable nonGW intangible assets. Test for Impairment: Intangible Assets - If Net BV > Current Fair Value (Discounted Future Cash Flows) -> Impair ! ! Impairment Loss! xxx ! Intangible Asset! xxx

Tangible Assets (PPE) - If Net BV > Undiscounted Future Cash Flows -> Impair ! ! ! IMPAIR USING DISCOUNTED CASH FLOWS!!! Impairment Loss! xxx ! Tangible Asset! xxx

Chapter 9 - Liabilities Product Warranty - A promise to repair the product if necessary for a period of time. This warranty comes with the product and does have to be purchased separately. ! ! ! ! ! Revenue is recorded when the product is sold and estimate and accelerate the expense associated with providing the warranty service into the same period. Viewed in the same light as sales returns and allowances. ! ! Warranty Expense (or provision)! xxx ! Warranty Liability ! ! ! xxx

Extended Warranty - Purchased separately. It usually comes with additional coverage and/or a longer coverage period. ! ! ! Revenue is deferred and recorded over the warranty period. ! ! Cash! ! ! ! xxx ! Deferred (warranty) revenue! xxx

Contingent Liabilities - Arise when an existing condition, situation or set of circumstances involving uncertainty as to possible loss to an entity that will ultimately be resolved when one or more future events occur or fail to occur. A contingent loss is: - Recognized as a liability if settlement payments are probable (likely) and !estimable. - Disclosed in the notes if settlement payments are reasonably possible, with the settlement amount disclosed if it is estimable. - Not required to even be disclosed in the notes if settlement payments are remote. ! ! ! Contingency Loss! xxx ! Contingency Liability! xxx

Asset Retirement Obligation - Liability incurred as an obligation when an asset is retired. ! ! ! ! ! ! ! ! Asset! ! xxx ! Cash/AP! xxx xxx

Asset (ARO Add)! xxx ! Asset Retirement Obligation!

Could be combined: ! ! ! ! ! ! Asset! ! xxx ! Cash/AP! ! ARO! ! xxx xxx

As interest accrues (accretion): ! ! ! ! Accretion expense! xxx ! ARO! ! ! xxx

After retirement: ! ! ! ! ! ! ! ! Loss! ARO! ! ! ! ! Cash! Gain! xxx xxx ! !

xxx xxx

Chapter 10 - Leases Capitalize leases (record liability) if it meets any one of the following conditions: - The lease agreement automatically transfers ownership to the lessee - The lease agreement provides for a bargain purchase - The term of the lease is at least 75% of the useful life of the asset - The present value of the lease is at least 90% of the assets market value ! ! Lease Asset! ! xxx ! Lease Liability!

xxx

- later ! ! ! Interest Expense! Lease Liability! ! Cash! ! Outstanding Liability * i Remaining payment to principle ! Payment Amt

TI-83 NPV Calc = npv(%, 0, {p1, p2, ...} Asset & Liability are accounted for using NPV. Payments made as outlined above (int Exp + Liability = Cash Payment)