Financial Accounting: Tools For Business Decision Making: Chapter Outline

3/28/2023
Financial Accounting: Tools for Business Chapter Outline

Decision Making
Learning Objectives
Ninth Edition
LO 1 Identify the forms of business organization and the
Kimmel ● Weygandt ● Kieso
uses of accounting information.
LO 2 Explain the three principal types of business
activity.
Chapter 1
LO 3 Describe the four financial statements and how
they are prepared.
Introduction to Financial Statements
INSTRUCTOR: Ph.D Phi Thi Kieu Anh
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Business Organization and Accounting

Information Uses
Learning Objective 1 Forms of Business Organization
Identify the Forms of Business Sole Proprietorship Partnership Corporation
Organization and the Uses of • Simple to • Simple to • Easier to transfer
establish establish ownership
Accounting Information • Owner-controlled • Shared control • Easier to raise
• Tax advantages • Broader skills and funds
resources • No personal
• Tax advantages liability
LO1 Copyright ©2019 John Wiley & Sons, Inc. 3 LO1 Copyright ©2019 John Wiley & Sons, Inc. 4
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Questions Asked by Internal Users Accounting Across the Organization

Owning a Piece of the Bar
The original Clif Bar® energy bar was created in 1990 after six
months of experimentation by Gary Erickson and his mother in
her kitchen. Today, the company has almost 300 employees and
is considered one of the leading Landor’s Breakaway Brands®.
One of Clif Bar & Company’s proudest moments was the
creation of an employee stock ownership plan (E S O P). This
plan gives its employees 20% ownership of the company. The E S
O P also resulted in Clif Bar enacting an open-book management
program, including the commitment to educate all employee-
owners about its finances. Armed with basic accounting
knowledge, employees are more aware of the financial impact
of their actions, which leads to better decisions.
Questions Asked by External Users Accounting Across the Organization (1 of 2)

Spinning the Career Wheel
How will the study of accounting help you? A working knowledge
of accounting is desirable for virtually every field of business. Some
examples of how accounting is used in business careers follow.
General management: Managers of Ford Motors, Massachusetts
General Hospital, California State University–Fullerton, a
McDonald’s franchise, and a Trek bike shop all need to understand
accounting data in order to make wise business decisions.
Marketing: Marketing specialists at Procter & Gamble must be
sensitive to costs and benefits, which accounting helps them
quantify and understand. Making a sale is meaningless unless it is a
profitable sale.
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Accounting Across the Organization (2 of 2) Ethics in Financial Reporting (1 of 4)

Spinning the Career Wheel United States regulators and lawmakers were very
Finance: Do you want to be a banker for Citicorp, an investment concerned that the economy would suffer if investors lost
analyst for Goldman Sachs, or a stock broker for Merrill Lynch? confidence in corporate accounting because of unethical
These fields rely heavily on accounting knowledge to analyze
financial statements. In fact, it is difficult to get a good job in a financial reporting.
finance function without two or three courses in accounting. • Recent financial scandals include: Enron, WorldCom,
Real estate: Are you interested in being a real estate broker for HealthSouth, AIG, and others
Prudential Real Estate? Because a third party—the bank—is almost
always involved in financing a real estate transaction, brokers must • Congress passed Sarbanes-Oxley Act (SOX)
understand the numbers involved: Can the buyer afford to make
the payments to the bank? Does the cash flow from an industrial • Effective financial reporting depends on sound ethical
property justify the purchase price? What are the tax benefits of behavior
the purchase?
Ethics in Financial Reporting (2 of 4) Ethics in Financial Reporting (3 of 4)

Solving an Ethical Dilemma Solving an Ethical Dilemma
1. Recognize an ethical situation and the ethical issues 2. Identify and analyze the principal elements in the
involved. situation.
• Use your personal ethics to identify ethical • Identify the stakeholders—persons or groups who
situations and issues. may be harmed or benefited.
• Some businesses and professional organizations • Ask the question: What are the responsibilities and
provide written codes of ethics for guidance in obligations of the parties involved?
some business situations.
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Ethics in Financial Reporting (4 of 4) Ethics Insight: Dewey & LeBoeuf LLP

(1 of 2)
Solving an Ethical Dilemma
I Felt the Pressure—Would You?
3. Identify the alternatives, and weigh the impact of
“I felt the pressure.” That’s what some of the employees of the now-
each alternative on various stakeholders.
defunct law firm of Dewey & LeBoeuf LLP indicated when they helped
• Select the most ethical alternative, considering all to overstate revenue and use accounting tricks to hide losses and
the consequences. cover up cash shortages. These employees worked for the former
finance director and former chief financial officer (CFO) of the firm.
• Some situations involve more than one right Here are some of their comments:
solution. • “I was instructed by the CFO to create invoices, knowing they would
not be sent to clients. When I created these invoices, I knew that it
• These situations require you to evaluate each
was inappropriate.”
alternative and select the best one.
Ethics Insight Dewey & LeBoeuf LLP Do It! 1: Business Organization Forms
(2 of 2)
In choosing the organizational form for your outdoor guide service,
I Felt the Pressure—Would You? you should consider the pros and cons of each. Identify each of the
following organizational characteristics with the organizational
• “I intentionally gave the auditors incorrect information in the
form or forms with which it is associated.
course of the audit.”
1. Easier to raise funds. (Corporation)
What happened here? A small group of lower-level employees over a
period of years carried out the instructions of their bosses. Their 2. Simple to establish. (Sole proprietorship and partnership)
bosses, however, seemed to have no concern as evidenced by various
3. No personal legal liability. (Corporation)
e-mails with one another in which they referred to their financial
manipulations as accounting tricks, cooking the books, and fake 4. Tax advantages. (Sole proprietorship and partnership)
income. 5. Easier to transfer ownership. (Corporation)
Source: Ashby Jones, “Guilty Pleas of Dewey Staff Detail the Alleged Fraud,” Wall Street
Journal (March 28, 2014); and Sara Randazzo, “Dewey CFO Escapes Jail Time in Fraud
Case Sentencing,” Wall Street Journal (October 10, 2017).
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Users and Uses of Financial Information

Review Question
Which of the following did not result from the Sarbanes- Learning Objective 2
Oxley Act? Explain the Three Principal Types of
a. Top management must now certify the accuracy of Business Activity
financial information.
b. Penalties for fraudulent activity increased.
c. Independence of auditors increased.
d. Tax rates on corporations increased.
Principal Types of Business Activity Financing Activities - Borrowing

One primary source of outside funds
All businesses are involved in three types of activity • Borrowing money (debt)
• Financing • Amounts owed are called liabilities
• Investing
• Party to whom amounts are owed are
• Operating creditors
The accounting information system keeps track of the • Notes payable and bonds payable are
results of each of these business activities. different types of liabilities
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Financing Activities – Issuing Stock Investing Activities

Second primary sources of outside funds • Purchase of resources of which a company
• Issuing (selling) shares of stock for cash (equity) needs to operate
• Common stock • Resources owned by a business are called
assets
• The amount paid by stockholders for
shares they purchase • Examples of investing activities
• Payments to stockholders are called • Computers, delivery trucks, furniture,
buildings
dividends
• Investments in another company
Operating Activities (1 of 2) Operating Activities (2 of 2)

• Operations begin once a business acquires assets • Expenses incurred to earn revenue
• Revenues are generated • Costs of assets consumed or services used
• Amounts earned from the sale of products and • Include cost of goods sold, selling, marketing,
administrative, interest, and income taxes expense
other sources
• Liabilities arise from expenses
• Sales revenue, service revenue, interest revenue
• Include accounts payable, interest payable, wages
• Inventory is an asset that consists of goods available payable, sales taxes payable, and income taxes payable
for sale to customers
• Results
• Accounts receivable are the right to receive money
• Net income – when revenues exceed expenses
from a customer as the result of a sale
• Net loss – when expenses exceed revenues
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Do It! 2: Business Activities

Classify each item as an asset, liability, common stock,
revenue, or expense.
Solution Learning Objective 3
1. Cost of renting property. 1. Expense
2. Truck purchased. 2. Asset
Describe the Four Financial Statements
3. Notes payable. 3. Liability and How They Are Prepared
4. Issuance of ownership shares. 4. Common stock
5. Amount earned from performing 5. Revenue
service.
6. Amounts owed to suppliers. 6. Liabilities
The Four Financial Statements Income Sierra Corporation

Income Statement
Companies prepare four financial statements from Statement For the Month Ended October 31, 2022
(1 of 2) Revenues
summarized accounting data:
Service revenue $10,600
• Income Statement Expenses
Salaries and wages expense 5,200
• Retained Earnings Statement Rent expense 900
• Balance Sheet Supplies expense 1,500
Depreciation expense 40
• Statement of Cash Flows Interest expense 50
Insurance expense 50
International Note: Primary financial statements required by
Total expenses 7,740
IFRS and GAAP are the same. Net income $2,860
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Income Statement (2 of 2) Retained Sierra Corporation

Retained Earnings Statement
• Reports revenues and expenses for a specific period Earnings For the Month Ended October 31, 2022
of time Statement Retained earnings, October 1

Add: Net income
$ 0
2,860
• Net income results when revenues exceed expenses Blank 2,860
Less: Dividends 500
• Net loss results when expenses exceed revenues Retained earnings, October 31 $2,360
• Past net income provides information for predicting
future earnings • Shows amounts and causes of changes in retained
earnings during the period
Helpful Hint The financial statement heading identifies the company, the type of
statement, and the time period covered. Sometimes, another line indicates the • Time period is the same as income statement
unit of measure, e.g., “in thousands” or “in millions.”
• Users can evaluate dividend payment practices
Sierra Corporation
Balance Sheet
Interrelationships of Statements Balance October 31, 2022

Assets
Sierra Corporation Sierra Corporation

Sheet Cash
Accounts receivable
$15,200
200
Income Statement Retained Earnings Statement (1 of 2) Supplies 1,000
For the Month Ended October 31, 2022 For the Month Ended October 31, 2022 Prepaid rent 550
Equipment, net 4,960
Revenues Retained earnings, October 1 $ 0 Total assets $21,910
Service revenue $10,600 Add: Net income 2,860 Liabilities and Stockholders’ Equity
Blank 2,860 Liabilities
Expenses
Less: Dividends 500 Notes payable $ 5,000
Salaries and wages expense 5,200 Retained earnings, October 31 $2,360 Accounts payable 2,500
Rent expense 900 Unearned service revenue 800
Supplies expense 1,500 Salaries and wages payable 1,200
Interest payable 50
Depreciation expense 40
Net income is needed to Total liabilities $ 9,550
Interest expense 50
determine the ending Stockholders’ equity
Insurance expense 50 Common stock 10,000
balance in retained earnings.
Total expenses 7,740 Retained earnings 2,360
Net income $2,860 Total stockholders’ equity 12,360
Total liabilities and stockholders’ equity $21,910
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Sierra Corporation
Balance Sheet
Interrelationship of
Balance Sheet (2 of 2) October 31, 2022
Assets Balance Sheet to
Cash $15,200
• Reports assets and claims to assets at a specific Accounts receivable
Supplies
200
1,000
Retained Earnings
point in time Prepaid rent 550 Statement
Equipment, net 4,960
• Assets = Liabilities + Stockholders’ Equity Total assets
Liabilities and Stockholders’ Equity
$21,910
Ending balance in retained
Liabilities earnings is needed in
• Lists assets first, followed by liabilities and Notes payable $ 5,000 preparing the balance sheet.
stockholders’ equity Accounts payable
Unearned service revenue
2,500
800
Sierra Corporation
Salaries and wages payable 1,200
Retained Earnings Statement
Interest payable 50
For the Month Ended October 31, 2022
Helpful Hint The heading of a balance Total liabilities $ 9,550
sheet must identify the company, the Stockholders’ equity Retained earnings, October 1 $ 0
Common stock 10,000
statement, and the date. Retained earnings 2,360
Add: Net income 2,860
Blank 2,860
Total stockholders’ equity 12,360
Total liabilities and stockholders’
Less: Dividends 500
equity $21,910 Retained earnings, October 31 $2,360
Sierra Corporation
Statement Statement of Cash Flows
Statement of Cash Flows (2 of 2)
of Cash Provides answers to
Cash flows from operating activities Blank
Flows Cash receipts from operating activities $11,200
(1 of 2) Cash payments from operating activities (5,500) • Where did cash come from during the period?
Net cash provided by operating activities $5,700
Cash flows from investing activities Blank • How was cash used during the period?
Purchase of equipment (5,000)
Net cash used by investing activities (5,000) • What was the change in the cash balance during the
Cash flows from financing activities Blank period?
Issuance of common stock 10,000
Issuance of notes payable 5,000
Payment of dividends (500)
Net cash provided by financing activities 14,500
Net increase in cash 15,200
Cash at beginning of period 0
Cash at end of period $15,200
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Interrelationships of Balance Sheet to

Statement of Cash Flows Sierra Corporation
Balance Sheet
Financial Statements (1 of 4)
October 31, 2022
Sierra Corporation
Statement of Cash Flows Assets Review Question
For the Month Ended October 31, 2022 Cash $15,200
Cash flows from operating activities

Accounts receivable
Supplies
200
1,000 Net income will result during a time period when:
Cash receipts from operating activities $11,200 Prepaid rent 550
Cash payments from operating activities
Net cash provided by operating activities
(5,500)
$ 5,700
Equipment, net
Total assets
4,960
$21,910
a. assets exceed liabilities.
Cash flows from investing activities
Purchase of equipment (5,000)
Liabilities
Notes payable $ 5,000
b. assets exceed revenues.
Net cash used by investing activities (5,000) Accounts payable 2,500
Unearned service revenue 800 c. expenses exceed revenues.
Cash flows from financing activities
Interest payable 50
Issuance of common stock 10,000
Total liabilities $ 9,550 d. revenues exceed expenses.
Issuance of notes payable 5,000
Stockholders’ equity
Payment of dividends -500 Common stock 10,000
Net cash provided by financing activities 14,500 Retained earnings 2,360
Net increase in cash 15,200 Total stockholders’ equity 12,360
Cash at beginning of period 0 Total liabilities and
Cash at end of period $15,200 stockholders’ equity $21,910
Financial Statements (3 of 4) People, Planet, and Profit Insight

Review Question Beyond Financial Statements
Should we expand our corporate reports beyond the income statement, retained
Which of the following financial statements is prepared earnings statement, balance sheet, and statement of cash flows? Some believe
we should take into account ecological and social performance, in addition to
as of a specific point in time? financial results, in evaluating a company. The argument is that a company’s
responsibility lies with anyone who is influenced by its actions. In other words, a
a. Balance sheet. company should be interested in benefiting many different parties, instead of
only maximizing stockholders’ interests. A socially responsible business does not
b. Income statement. exploit or endanger any group of individuals. It follows fair trade practices,
provides safe environments for workers, and bears responsibility for
c. Retained earnings statement. environmental damage. Granted, measurement of these factors is difficult. How
to report this information is also controversial. But many interesting and useful
d. Statement of cash flows. efforts are underway. Throughout this textbook, we provide additional insights
into how companies are attempting to meet the challenge of measuring and
reporting their contributions to society, as well as their financial results, to
stockholders.
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Do It! 3a: Financial Statements (1 of 6) Do It! 3a: Financial Statements (2 of 6)

CSU Corporation began operations on January 1, 2022. The
CSU Corporation
following information is available for CSU on December 31, 2022: Income Statement
Accounts receivable $ 1,800 Insurance expense $ 1,000 For the Year Ended December 31, 2022
Accounts payable 2,000 Service revenue 17,000
Revenues
Rent expense 9,000 Supplies 4,000
Service revenue $17,000
Notes payable 5,000 Supplies expense 200
Expenses
Common stock 10,000 Cash 1,400
Rent expense $9,000
Retained earnings ? Dividends 600
Insurance expense 1,000
Equipment 16,000
Supplies expense 200
Prepare an income statement, a retained earnings statement, and Total expenses 10,200
a balance sheet. Net income $ 6,800
Do It! 3a: Financial Statements (3 of 6) Do It! 3a: Financial Statements (4 of 6)

CSU Corporation began operations on January 1, 2022. The
CSU Corporation
following information is available for CSU on December 31, 2022: Retained Earnings Statement
Accounts receivable $ 1,800 Insurance expense $ 1,000 For the Year Ended December 31, 2022
Accounts payable 2,000 Service revenue 17,000 Retained earnings, December 1 $ 0
Rent expense 9,000 Supplies 4,000 Add: Net income 6,800
Notes payable 5,000 Supplies expense 200 Blank 6,800
Common stock 10,000 Cash 1,400 Less: Dividends 600
Retained earnings ? Dividends 600 Retained earnings, December 31 $6,200
Equipment 16,000
Prepare an income statement, a retained earnings statement, and
a balance sheet.
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CSU Corporation
Do It! 3a: Financial Statements (5 of 6) Do It! 3a: Balance Sheet
December 31, 2022
CSU Corporation began operations on January 1, 2022. The Financial Assets
Cash $ 1,400
following information is available for CSU on December 31, 2022:
Statements Accounts receivable 1,800
Accounts receivable $ 1,800 Insurance expense $ 1,000 (6 of 6) Supplies 4,000
Equipment 16,000
Accounts payable 2,000 Service revenue 17,000 Total assets $23,200
Rent expense 9,000 Supplies 4,000 Liabilities and Stockholders’ Equity
Notes payable 5,000 Supplies expense 200 Liabilities
Common stock 10,000 Cash 1,400 Accounts payable 2,000
Retained earnings ? Dividends 600 Total liabilities 7,000
Equipment 16,000 Stockholders’ equity
Common stock 10,000
Prepare an income statement, a retained earnings statement, and a Retained earnings 6,200
Total stockholders’ equity 16,200
balance sheet. Total liabilities and stockholders’ equity $23,200
Other Elements of an Annual Report Elements of an Annual Report (1 of 6)

U.S. companies that are publicly traded must provide Management Discussion and Analysis (M D & A)
shareholders with an annual report. • Presents management’s view on the company’s ability
The annual report always includes: • To pay near-term obligations, and
• Financial statements • Its ability to fund operations and expansion, and
• Management discussion and analysis • Its results of operations
• Notes to the financial statements • Management must highlight

• Favorable or unfavorable trends, and
• Auditor's report
• Identify significant events and uncertainties that
affect these three factors
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Elements of an Annual Report (2 of 6) Elements of an Annual Report (3 of 6)

Partial Management Discussion and Analysis Notes to the Financial Statements
Columbia Sportswear Company • Clarify the financial statements
Management’s Discussion and Analysis of
Seasonality and Variability of Business • Provide additional detail
Our operations are affected by seasonal trends typical in the outdoor apparel and
footwear industry and have historically resulted in higher sales and profits in the
Notes are essential to understanding a company’s
third and fourth calendar quarters. This pattern has resulted primarily from the operating performance and financial position.
timing of shipments of fall season products to wholesale customers in the third and
fourth quarters and proportionally higher sales in our direct-to consumer channels in
the fourth quarter, combined with an expense base that is spread more consistent
throughout the year. We believe that our liquidity requirements for at least the next
12 months will be adequately covered by existing cash, cash provided by operations
and existing short-term borrowing arrangements.
Elements of an Annual Report (4 of 6) Elements of an Annual Report (5 of 6)

Notes to Financial Statements Auditor’s Report
Columbia Sportswear Company • Auditor’s opinion as to the fairness of the
Notes to Financial Statements presentation of the financial position and results of
Revenue Recognition
operations and their conformance with generally
We record wholesale, distributor, e-commerce and licensed product
revenues when title passes and the risks and rewards of ownership have
accepted accounting principles
passed to the customer. Title generally passes upon shipment to or upon • Only certified public accountants (CPAs) may perform
receipt by the customer depending on the terms of sale with the customer.
Retail store revenues are recorded at the time of sale. audits
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Do It! 3b: Components of Annual

Elements of an Annual Report (6 of 6) Report
Auditor’s Report State whether each of the following items is most closely associated with
the management discussion and analysis (MD&A), the notes to the
Columbia Sportswear Company financial statements, or the auditor’s report. Solution
Excerpt from Auditor’s Report
1. Descriptions of significant accounting 1. Notes.
In our opinion, such consolidated financial statements present fairly, in all policies.
material respects, the financial position of Columbia Sportswear Company 2. Unqualified opinion. 2. Auditor’s report
and subsidiaries as of December 31, 2016 and 2015, and the results of their
operations and their cash flows for each of the three years in the period 3. Explanations of uncertainties and 3. Notes
contingencies.
ended December 31, 2016, in conformity with accounting principles
generally accepted in the United States of America. Also, in our opinion, such 4. Description of ability to fund operations and 4. MD&A
financial statement schedules, when considered in relation to the basic expansion.
consolidated financial statements taken as a whole, presents fairly, in all 5. Description of results of operations. 5. MD&A
material respects, the information set forth therein.
6. Certified public accountant (CPA). 6. Auditor’s report
A Look at IFRS (1 of 3)
Similarities
Learning Objective 4 • The basic techniques for recording business transactions are
the same for U.S. and international companies.
Describe the Impact of International • Both international and U.S. accounting standards emphasize
Accounting Standards on U.S. Financial transparency in financial reporting.
• Both sets of standards are primarily driven by meeting the
Reporting needs of investors and creditors.
• The three most common forms of business organizations,
proprietorships, partnerships, and corporations, are also
found in countries that use international accounting
standards.
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A Look at IFRS (2 of 3) A Look at IFRS (3 of 3)

Differences Differences
• International standards are referred to as International • IFRS tends to be simpler in its accounting and disclosure
Financial Reporting Standards (IFRS) requirements; some people say it is more “principles-
based.” GAAP is more detailed; some people say it is more
• Developed by the International Accounting “rules-based.”
Standards Board
• The internal control standards applicable to Sarbanes-Oxley
• Accounting standards in the United States are referred (SOX) apply only to large public companies listed on U.S.
to as generally accepted accounting principles (GAAP) exchanges.
a. Developed by the Financial Accounting Standards • There is continuing debate as to whether non-U.S.
Board companies should have to comply with this extra layer of
regulation.
Copyright Financial Accounting: Tools for Business

Decision Making
Copyright © 2019 John Wiley & Sons, Inc. Ninth Edition
All rights reserved. Reproduction or translation of this work beyond that permitted in
Section 117 of the 1976 United States Act without the express written permission of the
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Chapter 2
copies for his/her own use only and not for distribution or resale. The Publisher assumes
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A Further Look at Financial Statements
or from the use of the information contained herein.
Prepared by
COBY HARMON
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Chapter Outline:
Learning Objectives
LO 1 Identify the sections of a classified balance sheet. Learning Objective 1
LO 2 Use ratios to evaluate a company’s profitability, Identify the Sections of a Classified
liquidity, and solvency.
Balance Sheet
LO 3 Discuss financial reporting concepts.
Copyright ©2019 John Wiley & Sons, Inc. 61 LO1 Copyright ©2019 John Wiley & Sons, Inc. 62
Franklin Corporation
Balance Sheet
October 31, 2022
The Classified Balance Sheet Classified Assets
Balance
Current assets
• Presents a snapshot at a point in time Cash
Debt investments
$ 6,600
2,000
• To improve understanding, companies group similar Sheet – Accounts receivable

Notes receivable
7,000
1,000
assets and similar liabilities together Assets Inventory
Supplies
3,000
2,100
Prepaid insurance 400
Standard Classifications Total current assets $22,100
Long-term investments
Assets Liabilities and Stockholders’ Equity Stock investments 5,200
Investment in real estate 2,000 7,200
Current assets Current liabilities Property, plant, and equipment
Land 10,000
Long-term investments Long-term liabilities Equipment $24,000
Less: Accumulated
Property, plant, and equipment Stockholders’ equity depreciation—equipment 5,000 19,000 29,000
Intangible assets Blank Intangible assets
Patents 3,100
Total assets $61,400
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Franklin Corporation
Balance Sheet
Classified October 31, 2022

Liabilities and Stockholders’ Equity Nature of Current Assets
Balance Current liabilities
• Assets a company expects to convert to cash or
Sheet – Accounts payable
Unearned sales revenue
2,100
900
use up within one year or the operating cycle,
Liabilities &
Interest payable
Total current liabilities
450
$16,050
whichever is longer
Stockholders’ Long-term liabilities
Mortgage payable 10,000 • Common types include cash, investments,
Equity Notes payable
Total long-term liabilities
1,300
11,300 receivables, inventories, and prepaid expenses
Total liabilities 27,350
Common stock 14,000
• Operating cycle
Retained earnings 20,050
Total stockholders’ equity 34,050 • Average time it takes from purchase of inventory,
Total liabilities and stockholders’ equity $61,400 to sale of goods, and then to collection of cash
from customers
Current Assets Presentation Current Assets (1 of 2)

Southwest Airlines Co. Review Question
Balance Sheet (partial)
(in millions) Cash, and other resources that are reasonably expected
Current assets to be realized in cash or sold or consumed in the business
Cash and cash equivalents $1,680 within one year or the operating cycle, are called:
Short-term investments 1,625
Accounts receivable 546 a. Current assets.
Inventories 337 b. Intangible assets.
Prepaid expenses and other current assets 310
Total current assets $4,498 c. Long-term investments.
Companies list current asset accounts in the order they expect to convert them d. Property, plant, and equipment.
into cash.
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Components of Long-Term Investments Long-Term Investments Presentation

• Investments in stocks and bonds of other
corporations that are held for more than one year
Alphabet Inc.
• Long-term assets such as land or buildings that a Balance Sheet (partial)
company is not currently using in its operating (in millions)
activities Long-term investments
• Long-term notes receivable Non-marketable investments $5,183
Nature of Property, Plant & Equipment Property, Plant, and Equipment

• Asset with long useful lives Presentation
• Currently used in operations Cooper Tire & Rubber Company
• Includes land, buildings, equipment, delivery vehicles, (in thousands)
and furniture Property, plant, and equipment Blank
Land and land improvements $ 47,767
• Are depreciated Buildings 282,960
• Cost is allocating to a number of years Machinery and equipment 1,742,449
Molds, cores, and rings 224,662 $2,297,838
• Accumulated depreciation Less: Accumulated depreciation 1,433,661
Net property, plant, and equipment $ 864,227
• Total amount of depreciation expensed to date in
an asset’s life
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Nature of Intangible Assets Intangible Assets Presentation

• Assets that do not have physical substance The Walt Disney Company
• Includes goodwill, patents, copyrights, and (in millions)
trademarks or trade names Intangible assets and goodwill

Character/franchise intangibles and copyrights $ 5,829
Other amortizable intangible assets 893
Accumulated amortization (1,635)
Helpful Hint Net amortizable intangible assets 5,087
Sometimes intangible assets are reported under a broader FCC licenses 624
heading called “Other assets.” Trademarks 1,218
Other indefinite lived intangible assets 20
Net amortizable intangible assets 6,949
Goodwill 27,810
Net intangible assets $34,759
Intangible Assets (1 of 2) Do It! 1a: Assets Section of Classified

Review Question Balance Sheet (1 of 2)
Patents and copyrights are Baxter Hoffman recently received the following information related
to Hoffman Corporation’s December 31, 2022, balance sheet.
a. Current assets. Prepaid insurance $ 2,300
b. Intangible assets. Inventory 3,400 Prepare the
Cash 800 asset section
c. Long-term investments. Equipment 10,700 of Hoffman
Accounts receivable 1,100 Corporation’s
d. Property, plant, and equipment. classified
Trademarks 4,700
balance sheet.
Debt investments (long-term) 2,100
Accumulated depreciation—Equipment 2,700
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Do It! Hoffman Corporation

Partial Balance Sheet
Nature of Current Liabilities
1a: December 31, 2022
(2 of 2) Assets • Obligations the company is to pay within the next

Current assets
Cash $ 800
year or operating cycle, whichever is longer
Accounts receivable 1,100 • Common examples
Inventory 3,400
Prepaid insurance 2,300 • Accounts payable, salaries and wages payable,
Total current assets $ 7,600 notes payable, interest payable, and income taxes
Long-term investments payable
Debt investments 2,100
Property, plant, and equipment • And current maturities of long-term obligations
Equipment 10,700
Less: Accumulated depreciation—equipment 2,700 8,000
• Payments to be made within the next year
Intangible assets on long-term obligations
Trademarks 4,700
Total assets $22,400
Current Liabilities Nature of Long-Term Liabilities

Alphabet Inc.
• Obligations a company expects to pay after one year
(in millions)
• Include bonds payable, mortgages payable, long-
Current liabilities term notes payable, lease liabilities, and pension
Accounts payable $ 1,931
Short-term debt 3,225
liabilities
Accrued compensation and benefits 3,539
Accrued expenses and other current liabilities 10,313
Income taxes payable, net 302
Total current liabilities $19,310
3/28/2023
Long-Term Liabilities Long-term Liabilities (1 of 2)

Review Question
Nike, Inc.
Balance Sheet (partial) Which of the following is not a long-term liability?
(in millions)
Long-term liabilities a. Bonds payable.
Bonds payable $5,474 b. Current maturities of long-term debt.
Deferred income taxes and other 1,907
Total long-term liabilities $7,381 c. Long-term notes payable.
d. Mortgages payable.
Stockholders’ Equity Do It! 1b: Balance Sheet Classifications

(1 of 3)
Components of stockholders’ equity
Match each of the account names on the next slide to its proper
• Common stock balance sheet classification, shown below. If the item would not
appear on a balance sheet, use “NA.”
• Investments of assets into the business by the
stockholders Current assets (CA) Current liabilities (CL)
Long-term investments (LTI) Long-term liabilities (LTL)
• Retained earnings Property, plant, and equipment (PPE) Stockholders’ equity (SE)
• Income retained for use in the business Intangible assets (IA) Blank
3/28/2023
Do It! 1b: Balance Sheet Classifications Do It! 1b: Balance Sheet Classifications
(2 of 3) (3 of 3)
Match each account to its proper balance sheet classification. If Match each account to its proper balance sheet classification. If
the item would not appear on a balance sheet, use “NA.” the item would not appear on a balance sheet, use “NA.”
Account Name Classification Account Name Classification
Salaries and wages payable Current liabilities (CL) Service revenue Not on balance sheet (NA)
Investment in real estate Long-term investments (LTI) Interest payable Current liabilities (CL)
Unearned service revenue Current liabilities (CL) Goodwill Intangible assets (IA)
Debt investments (short-term) Current assets (CA) Depreciation expense Not on balance sheet (NA)
Mortgage payable (due in 3 years) Long-term liabilities (LTL) Retained earnings Stockholders’ equity (SE)
Accumulated depreciation— Property plant, and Equipment Property plant, and equipment (PPE)
equipment equipment (PPE)
Analyzing the Financial Statements

Using Ratios
Learning Objective 2 • Ratio analysis
Use Ratios to Evaluate a Company's • Expresses the relationship among selected items
of financial statement data
Profitability, Liquidity, and Solvency • Ratio
• Expresses the mathematical relationship
between one quantity and another
• A single ratio by itself is not very meaningful
3/28/2023
Ratio Analysis Using the Income Statement

Best Buy Co., Inc.
Income Statements
For the Year Ended January 28, 2017,
and the Year Ended January 30, 2016 (in millions)
blank 2017 2016
Revenues
Net sales and other revenues $39,403 $39,528
Expenses
Cost of good sold 29,963 30,337
Selling, general, and administrative
expenses and other 7,603 7,791
Income tax expense 609 503
Total expenses 38,175 38,631
Net income (loss) $ 1,228 $ 897
Nature of Earnings per Share Earnings per Share Example

(in millions) 2017 2016
• A profitability ratio
Net income $ 1,228 $897
• measures the net income earned on each share Preferred (loss) -0- -0-
of common stock Share outstanding at beginning of year 324 352
Share outstanding at end of year 311 324
• Often called EPS
3/28/2023
Using the Income Statement (4 of 5) Using a Classified Balance Sheet (1 of 2)

Review Question Best Buy Co., Inc.
Balance Sheets
For 2022, Stoneland reported net income $26,000; net (in millions)
sales $400,000; and the weighted-average common Assets January 28, 2017 January 30, 2016
Current assets
shares outstanding 6,000. Preferred stock dividends were Cash and cash equivalents $ 2,240 $ 1,976
$2,000. What was the 2022 earnings per share? Short-term investments
Accounts receivable
1,681
1,347
1,305
1,162
Merchandise inventories 4,864 5,051
a. $4.00 Other current assets 384 392
Total current assets 10,516 9,886
b. $0.06 Property and equipment 8,143 8,107
Less: Accumulated depreciation 5,850 5,761
c. $16.67 Net property and equipment 2,293 2,346
Other assets 1,047 1,287
d. $66.67 Total assets $13,856 $13,519
Using a Classified Balance Sheet (2 of 2) (continued)

Current liabilities
January 28, 2017 January 30, 2016
Nature of Liquidity
Accounts payable $ 4,984 $ 4,450
Unredeemed gift card liabilities 427 409 • Liquidity
Accrued liabilities 865 802
Accrued income taxes 26 128 • The ability to pay obligations expected to become
Accrued compensation payable
Other current liabilities
358
462
384
752
due within the next year or operating cycle
Long-term liabilities
7,122 6,925
• Working capital
Long-term debt
Other long-term liabilities
1,321
704
1,339
877
• Difference between the amounts of current
Total long-term liabilities 2,025 2,216 assets and current liabilities
Total liabilities 9,147 9,141
Stockholders’ equity • Calculated as Current Assets – Current Liabilities
Common stock 31 32
Retained earnings and other 4,678 4,346 • Best Buy had working capital in 2017 of $3,394
Total stockholders’ equity 4,709 4,378
Total liabilities and stockholders’ equity $13,856 $13,519 million ($10,516 million − $7,122 million)
3/28/2023
Determining Liquidity Nature of Solvency

Liquidity ratios measure short-term ability to pay maturing • Solvency
obligations and meet unexpected needs for cash.
• The ability to pay interest as it comes due and to
repay the balance of a debt due at its maturity
• Solvency ratios
• Measure the ability of the company to survive
over a long period of time.
Helpful Hint Some users evaluate solvency using a ratio of liabilities

In 2017, for every dollar of current liabilities, Best Buy has divided by stockholders’ equity. The higher this “debt to equity”
$1.48 of current assets. ratio, the lower is a company’s solvency.
Debt to Assets Ratio Investor Insight

Measures the percentage of total financing provided by When Debt Is Good
creditors rather than stockholders Debt financing differs greatly across industries and
companies. Here are some debt to assets ratios for selected
companies in a recent year:
Blank Debt to Assets Ratio
Google 23%
Nike 41%
Microsoft 48%
ExxonMobil 48%
The 2017 ratio means that every dollar of assets was financed
by 66 cents of debt. General Motors 74%
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Evaluating Cash Flows Free Cash Flows Illustration

Cash provided by operating activities M P C produced and sold 10,000 personal computers this year.
• In the statement of cash flows It reported $100,000 cash provided by operating activities. In
• Fails to take into account that a company must invest in order to maintain production at 10,000 computers, M P C
new property, plant, and equipment and must maintain invested $15,000 in equipment. It chose to pay $5,000 in
dividends at current levels to satisfy investors dividends. Calculate free cash flow.
• Free cash flow Net cash provided by operating activities $100,000
• Describes the net cash provided by operating Less: Expenditures on property, plant, and equipment 15,000
activities after adjusting for capital expenditures Dividends paid 5,000
and dividends paid Free cash flow $80,000
Do It! 2: Ratio Analysis (2 of 4) Do It! 2: Ratio Analysis (2 of 4)

The following information is available for Ozone Inc.
Blank 2022 2021
(a) Compute earnings per share for 2022 and 2021 for Ozone.
Current assets $ 88,000 $ 60,800 Ozone’s primary competitor, Frost Corporation, had
Total assets 400,000 341,000 earnings per share of $2 in 2022.
Current liabilities 40,000 38,000
Total liabilities 120,000 150,000 Earnings per share
Net income 100,000 50,000
Net cash provided by operating activities 110,000 70,000 ($100,000 − $10,000)
Preferred dividends 10,000 10,000 2022 = $1.00
Common dividends 5,000 2,500
($120,000 + $60,000)/2
Expenditures on PP&E 45,000 20,000 ($50,000 − $10,000)
Shares outstanding at beginning of year 60,000 40,000 2021 = $.80
($60,000 + $40,000)/2
Shares outstanding at end of year 120,000 60,000
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Do It! 2: Ratio Analysis (3 of 4) Do It! 2: Ratio Analysis (4 of 4)

(b) Compute the current ratio and debt to assets ratio for (c) Compute free cash flow for each year.
each year. Solution
2022 2021 2022 2021
Net cash provided by operating
Current $88,000 $60,800 activities $110,000 $70,000
= 2.2:1 = 1.60:1
ratio $40,000 $38,000 Expenditures on PP&E (45,000) (20,000)
Preferred dividends (10,000) (10,000)
Debt to $120,000 $150,000 Common dividends (5,000) (2,500)
assets = 30% = 44% Free cash flow $ 50,000 $37,500
ratio $400,000 $341,000
Standard-Setting Environment
• Generally Accepted Accounting Principles
(GAAP)
Learning Objective 3 • A set of rules and practices
• Having substantial authoritative support, and
Discuss Financial Reporting Concepts
• That the accounting profession recognizes as
a general guide for financial reporting
purposes
• Determined by standard-setting bodies
3/28/2023
Standard-Setting Bodies Standard-Setting Environment (1 of 2)

United States Review Question
• Securities and Exchange Commission (SEC)
Generally accepted accounting principles are:
• Financial Accounting Standards Board (FASB)
a. a set of standards and rules that are recognized as a
• International Accounting Standards Board (IASB)
general guide for financial reporting.
• Public Company Accounting Oversight Board
b. usually established by the Internal Revenue Service.
(PCAOB)
International Over 115 c. the guidelines used to resolve ethical dilemmas.
• International Financial Reporting Standards countries d. fundamental truths that can be derived from the
use IFRS laws of nature.
(IFRS)
LO3 Copyright ©2019John Wiley & Sons, Inc. 109 LO3 Copyright ©2017 John Wiley & Sons, Inc. 110
Qualities of Useful Information Relevance and Faithful Representation

• FASB states Relevance
• Useful information should possess two fundamental • Makes a difference in a business decision
qualities • Provides information that has predictive value
• Has confirmatory value, confirms or corrects prior
• Relevance and expectations
• Faithful representation Faithful Representation
• Materiality • Information accurately depicts what really happened
• A company-specific aspect • Information must be
• An item is material when its size makes it likely to  Complete (nothing important has been omitted)
influence the decision of an investor or creditor.  Neutral (not biased toward one position or another)
 Free from error
3/28/2023
Enhancing Qualities of Useful Assumptions in Financial Reporting (1 of 2)

Information Monetary Unit Assumption
Comparability Information is Information has the

Requires that only those things that can be expressed in
results when verifiable if quality of money are included in the accounting records
different independent understandability if
companies use the observers, using the it is presented in a Economic Entity Assumption
same accounting same methods, obtain clear and concise
principles. similar results. fashion. States that every economic entity can be separately
identified and accounted for
Consistency means that a For accounting
company uses the same information to have
accounting principles and relevance, it must be
methods from year to year. timely.
Assumptions in Financial Reporting (2 of 2) Measurement Principles

Periodicity Assumption Historical Cost
States that the life of a business can be divided into • Dictates companies record assets at cost
artificial time periods • Also called the cost principle
Going Concern Assumption Fair Value
States that the business will remain in operation for the • Indicates that assets and liabilities should be reported
foreseeable future at fair value
Full Disclosure Principle
• Requires discloser of all circumstances and events that
would make a difference to financial statement users
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Cost Constraint Do It! 3: Financial Accounting Concepts and

Principles (1 of 4)
Accounting standard-setters weigh The following items guide the FASB when it creates accounting
standards.
• The cost that companies will incur to provide the
information Relevance Periodicity assumption
Faithful representation Going concern assumption
Against
Comparability Historical cost principle
• The benefit that financial statement users will gain Consistency Full disclosure principle
from having the information available. Monetary unit assumption Materiality
Economic entity assumption blank
Do It! 3: Financial Accounting Concepts and Do It! 3: Financial Accounting Concepts and
Principles (2 of 4) Principles (3 of 4)
Match each item with the appropriate concept or principle. Match each item with the appropriate concept or principle.
1. Ability to easily evaluate one company’s 5. The practice of preparing financial
results relative to another’s. statements at regular intervals.
2. Belief that a company will continue to 6. The quality of information that indicates
operate for the foreseeable future. the information makes a difference in a
decision.
3. The judgment concerning whether an item is
large enough to matter to decision-makers. 7. Belief that items should be reported on the
balance sheet at the price that was paid to
4. The reporting of all information that would acquire the item.
make a difference to financial statement
users. 8. A company’s use of the same accounting
principles and methods from year to year.
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Do It! 3: Financial Accounting Concepts and Standard-Setting Environment (1 of 2)

Principles (4 of 4)
Match each item with the appropriate concept or principle.
Review Question
9. Tracing accounting events to particular What is the primary criterion by which accounting
companies. information can be judged?
10. The desire to minimize errors and bias in a. Consistency
financial statements.
11. Reporting only those things that can be
b. Predictive value
measured in dollars. c. Usefulness for decision making
d. Comparability
Similarities
• IFRS generally requires a classified statement of financial
Learning Objective 4 position similar to the classified balance sheet under
GAAP.
Compare the Classified Balance Sheet • IFRS follows the same guidelines as this textbook for
Format Under GAAP and IFRS distinguishing between current and noncurrent assets
and liabilities.
Differences
• IFRS recommends but does not require the use of the title
“statement of financial position” rather than balance
sheet.
3/28/2023

• The format of the statement of financial position is often •Under IFRS, current assets are usually listed in the reverse order of
presented differently under IFRS. Although no specific liquidity. For example, under GAAP cash is listed first, but under
format is required, many companies that follow IFRS IFRS it is listed last.
present the statement of financial position information in •IFRS has many differences in terminology from those shown in
this order: your textbook.
 Non-current assets •Both GAAP and IFRS are increasing the use of fair value to report
 Current assets assets. However, at this point IFRS has adopted it more broadly.
 Equity • As examples, under IFRS companies can apply fair value to
property, plant, and equipment, and in some cases
 Non-current liabilities intangible assets.
 Current liabilities

Decision Making
Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up Chapter 3
no responsibility for errors, omissions, or damages, caused by the use of these programs The Accounting Information System
Prepared by
COBY HARMON Please disable animations if they
University of California, Santa Barbara
cause issues with your device.
Westmont College
3/28/2023
Chapter Outline
Learning Objectives
LO 1 Analyze the effect of business transactions on the Learning Objective 1
basic accounting equation.
Analyse the Effect of Business
LO 2 Explain how accounts, debits, and credits are used
to record business transactions. Transactions on the Basic Accounting
LO 3 Indicate how a journal is used in the recording Equation
process.
LO 4 Explain how a ledger and posting help in the
recording process.
LO 5 Prepare a trial balance.
Using the Accounting Equation to Accounting Information System

Analyze Transactions Accounting information systems rely on a process
referred to as the accounting cycle.
• Accounting Information System
Analyze
• System of business Journalize Post
Trial Adjusting
Balance Entries
transactions
• Collecting transaction data
• Processing transaction data Adjusted Financial Closing Post-Closing
Trial Balance Statements Entries Trial Balance
• Communicating financial information to
decision-makers
Most businesses use computerized accounting systems.
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Accounting Transactions Identify Accounting Transactions

Transactions Are the following events recorded in the accounting
records?
• Are economic events that require recording in the
Discuss guided trip
financial statements Event Purchase
options with potential Pay rent
computer
customer
• Not all activities require transactions
• Assets, liabilities, or stockholders’ equity items change Criterion Is the financial position (assets, liabilities, or stockholders’
as a result of an economic event equity) of the company changed?
• Have a dual effect on the accounting equation

Record/
Don’t Record
Analyzing Transactions Accounting Equation Effects

• The process of identifying the specific effects of • Accounting equation must always balance
economic events on the accounting equation • Each transaction has a dual effect on the equation
• If an asset is increased, there must be a corresponding
Basic Accounting Equation
 Decrease in another asset, or
+ Stockholders’  Increase in a specific liability, or

Assets = Liabilities
Equity
 Increase in stockholders’ equity.
3/28/2023
Expanded Accounting Equation Analyzing Transactions (1 of 11)

Event 1. On October 1, cash of $10,000 is invested in Sierra Corporation
Assets Liabilities Stockholder’s Equity by investors in exchange for $10,000 of common stock.
= +
Assets Liabilities Stockholders’ Equity
Retained Earnings
Prepd Equip- Notes Accts. Unearned Common
Cash + Supplies + Insur. + ment = Pay. + Pay. + Serv. Rev. + Stock + Rev. - Exp. - Div.
1 +$10,000 +$10,000
2 +5,000 +5,000
Common Stock + Retained Earnings 3
4
-5,000
+1,200
+$5,000
+1,200
5 +10,000 +$10,000
6 -900 -$900
7 -600 +600
8 +$2,500 +$2,500
9
10 -500 -$500
Revenues - Expenses - Dividends 11 -4,000 -4,000
$ 15,200+ $2,500 + $600 + $5,000 = $5,000 + $2,500 + $1,200 + $10,000 + $10,000 - $4,900 - $500
$23,300 $23,300
Analyzing Transactions (2 of 11) Analyzing Transactions (3 of 11)

Event 2. On October 1, Sierra borrowed $5,000 from Castle Bank by Event 3. On October 2, Sierra purchased equipment by paying $5,000
signing a 3-month, 12%, $5,000 note payable. cash to Superior Equipment Sales Co.
Assets Liabilities Stockholders’ Equity Assets Liabilities Stockholders’ Equity
Retained Earnings Retained Earnings
Prepd Equip- Notes Accts. Unearned Common Prepd Equip- Notes Accts. Unearned Common
Cash + Supplies + Insur. + ment = Pay. + Pay. + Serv. Rev. + Stock + Rev. - Exp. - Div. Cash + Supplies + Insur. + ment = Pay. + Pay. + Serv. Rev. + Stock + Rev. - Exp. - Div.
1 +$10,000 +$10,000 1 +$10,000 +$10,000
2 +5,000 +5,000 2 +5,000 +5,000
3 -5,000 +$5,000 3 -5,000 +$5,000
4 +1,200 +1,200 4 +1,200 +1,200
5 +10,000 +$10,000 5 +10,000 +$10,000
6 -900 -$900 6 -900 -$900
7 -600 +600 7 -600 +600
8 +$2,500 +$2,500 8 +$2,500 +$2,500
9 9
10 -500 -$500 10 -500 -$500
11 -4,000 -4,000 11 -4,000 -4,000
$ 15,200+ $2,500 + $600 + $5,000 = $5,000 + $2,500 + $1,200 + $10,000 + $10,000 - $4,900 - $500 $ 15,200+ $2,500 + $600 + $5,000 = $5,000 + $2,500 + $1,200 + $10,000 + $10,000 - $4,900 - $500
$23,300 $23,300 $23,300 $23,300
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Event 4. On October 2, Sierra received a $1,200 cash in advance from R. Event 5. On October 3, Sierra received $10,000 in cash from Copa
Knox, a client. Company for guide services performed.
1 +$10,000 +$10,000 1 +$10,000 +$10,000
2 +5,000 +5,000 2 +5,000 +5,000
3 -5,000 +$5,000 3 -5,000 +$5,000
4 +1,200 +1,200 4 +1,200 +1,200
5 +10,000 +$10,000 5 +10,000 +$10,000
6 -900 -$900 6 -900 -$900
7 -600 +600 7 -600 +600
8 +$2,500 +$2,500 8 +$2,500 +$2,500
9 9
10 -500 -$500 10 -500 -$500
11 -4,000 -4,000 11 -4,000 -4,000
$ 15,200+ $2,500 + $600 + $5,000 = $5,000 + $2,500 + $1,200 + $10,000 + $10,000 - $4,900 - $500 $ 15,200+ $2,500 + $600 + $5,000 = $5,000 + $2,500 + $1,200 + $10,000 + $10,000 - $4,900 - $500
$23,300 $23,300 $23,300 $23,300

Event 6. On October 3, Sierra Corporation paid its office rent for the Event 7. On October 4, Sierra paid $600 for a one-year insurance policy
month of October in cash, $900. that will expire next year on September 30.
1 +$10,000 +$10,000 1 +$10,000 +$10,000
2 +5,000 +5,000 2 +5,000 +5,000
3 -5,000 +$5,000 3 -5,000 +$5,000
4 +1,200 +1,200 4 +1,200 +1,200
5 +10,000 +$10,000 5 +10,000 +$10,000
6 -900 -$900 6 -900 -$900
7 -600 +600 7 -600 +600
8 +$2,500 +$2,500 8 +$2,500 +$2,500
9 9
10 -500 -$500 10 -500 -$500
11 -4,000 -4,000 11 -4,000 -4,000
$ 15,200+ $2,500 + $600 + $5,000 = $5,000 + $2,500 + $1,200 + $10,000 + $10,000 - $4,900 - $500 $ 15,200+ $2,500 + $600 + $5,000 = $5,000 + $2,500 + $1,200 + $10,000 + $10,000 - $4,900 - $500
$23,300 $23,300 $23,300 $23,300
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Event 8. On October 5, Sierra purchased an estimated three months of Event 9. On October 9, Sierra hired four new employees to begin work on
supplies on account from Aero Supply for $2,500. October 15.
1 +$10,000 +$10,000 1 +$10,000 +$10,000
2 +5,000 +5,000 2 +5,000 +5,000
3 -5,000 +$5,000 3 -5,000 +$5,000
4 +1,200 +1,200 4 +1,200 +1,200
5 +10,000 +$10,000 5 +10,000 +$10,000
6 -900 -$900 6 -900 -$900
7 -600 +600 7 -600 +600
8 +$2,500 +$2,500 8 +$2,500 +$2,500
9 9
10 -500 -$500 10 -500 -$500
11 -4,000 -4,000 11 -4,000 -4,000
$ 15,200+ $2,500 + $600 + $5,000 = $5,000 + $2,500 + $1,200 + $10,000 + $10,000 - $4,900 - $500 $ 15,200+ $2,500 + $600 + $5,000 = $5,000 + $2,500 + $1,200 + $10,000 + $10,000 - $4,900 - $500
$23,300 $23,300 An accounting transaction has not occurred.

$23,300 $23,300

Event 10. On October 20, Sierra paid a $500 dividend. Event 11. Employees have worked two weeks, earning $4,000 in salaries,
which were paid on October 26.
1 +$10,000 +$10,000 1 +$10,000 +$10,000
2 +5,000 +5,000 2 +5,000 +5,000
3 -5,000 +$5,000 3 -5,000 +$5,000
4 +1,200 +1,200 4 +1,200 +1,200
5 +10,000 +$10,000 5 +10,000 +$10,000
6 -900 -$900 6 -900 -$900
7 -600 +600 7 -600 +600
8 +$2,500 +$2,500 8 +$2,500 +$2,500
9 9
10 -500 -$500 10 -500 -$500
11 -4,000 -4,000 11 -4,000 -4,000
$ 15,200+ $2,500 + $600 + $5,000 = $5,000 + $2,500 + $1,200 + $10,000 + $10,000 - $4,900 - $500 $ 15,200+ $2,500 + $600 + $5,000 = $5,000 + $2,500 + $1,200 + $10,000 + $10,000 - $4,900 - $500
$23,300 $23,300 $23,300 $23,300
3/28/2023
Do It! 1: Transaction Analysis

A tabular analysis of the transactions for the month of August is shown
below. Describe each transaction.
Learning Objective 2
Explain How Accounts, Debits, and
Service Rev. Credits Are Used to Record Business
Rent Exp.
Transactions
1. Company issued shares of stock for $25,000 cash.
2. Company purchased $7,000 of equipment on account.
3. Company received $8,000 cash in exchange for services performed.
4. Company paid $850 for this month’s rent.
Accounts, Debits, and Credits Debit and Credit Procedures (1 of 2)

Debit and Credit Procedures If Debits are greater than Credits, the account will have a
debit balance.
• Double-entry system
Account Name
• Each transaction must affect two or more Debit / Dr. Credit / Cr.
accounts to keep the basic accounting equation in
Transaction #1 10,000 3,000 Transaction #2
balance
Transaction #3 8,000
• Recording must consist of at least one debit and one
credit
Balance 15,000
• DEBITS must equal CREDITS
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Debit and Credit Procedures (2 of 2) Procedures for Assets and Liabilities

If Credits are greater than Debits, the account will have a • Asset accounts → Debits should exceed credits
credit balance. • Liability accounts → Credits should exceed debits
Account Name
Debit / Dr. Credit / Cr.
Transaction #1 10,000 3,000 Transaction #2

8,000 Transaction #3
Balance 1,000
HELPFUL HINT
The normal balance is the side where increases in the account are recorded.
Procedures for Stockholders’ Equity (1 of 3) Procedures for Stockholders’ Equity (2 of 3)

• Investments by stockholders Stockholders’
Stockholders’ Equity
Debit / Dr. Credit / Cr. • Dividends and expenses incurred Stockholders’
Stockholders’ Equity
and revenues earned increase

decrease stockholder’s equity

stockholders’ equity accounts with debits
as credits Normal Balance Normal Balance
Chapter
Chapter 3-25
3-25
Common Stock Retained Earnings Dividends Common Stock Retained Earnings Dividends
Debit / Dr. Credit / Cr. Debit / Dr. Credit / Cr. Debit / Dr. Credit / Cr. Debit / Dr. Credit / Cr. Debit / Dr. Credit / Cr. Debit / Dr. Credit / Cr.
Normal Balance Normal Balance Normal Balance Normal Balance Normal Balance Normal Balance
Chapter Chapter Chapter Chapter Chapter Chapter

3-25 3-25 3-23 3-25 3-25 3-23
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Procedures for Stockholders’ Equity (3 of 3) Investor Insight Chicago Cubs

• Revenues increase stockholders’ equity Keeping Score
• Expenses decrease stockholders’ equity The Chicago Cubs baseball team has these major revenue
• The effect on revenue and expense accounts is the and expense accounts:
same as their respective effects on stockholders’
equity Revenues Expenses
Admissions (ticket sales) Players’ salaries
Concessions Administrative salaries
Television and radio Travel
Advertising Ballpark maintenance
Financial
Statement Debit/Credit Rules
Relationships Normal Balance Debit Normal Balance Credit
Assets Liabilities
Expense
Normal Balance
Normal Balance
Chapter
3-23
Chapter
3-24
Normal Balance
Chapter
3-27
LO2 Copyright ©2019 John Wiley & Sons, Inc. 159 LO2 160
Copyright ©2019 John Wiley & Sons, Inc.
3/28/2023
Summary of Debit/Credit Rules (1 of 2) Summary of Debit/Credit Rules (2 of 2)

Relationship among the assets, liabilities and
Balance Sheet Income Statement
Asset = Liability + Equity + Revenue − Expenses stockholders’ equity:
Basic Assets = Liabilities + Stockholders’ Equity
Equation
Debit Expanded
Basic
Equation
• The equation must be in balance after every

Credit
transaction.
• For every dollar of debits, there must be the same
dollar of credits.
Summary of Debit/Credit Rules (1 of 4) Summary of Debit/Credit Rules (3 of 4)

Review Question Review Question
Debits: Accounts that normally have debit balances are:
a. increase both assets and liabilities. a. assets, expenses, and revenues.
b. decrease both assets and liabilities. b. assets, expenses, and equity.
c. increase assets and decrease liabilities. c. assets, liabilities, and dividends.
d. decrease assets and increase liabilities. d. assets, dividends, and expenses.
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The Recording Process (1 of 2)

T
Steps to record:
Learning Objective 3 1. Analyze each transaction in terms of its effect on the
Indicate How a Journal is Used in the accounts.
Recording Process 2. Enter the transaction information in a journal.
3. Transfer the journal information to the appropriate
accounts in the ledger.
Analyze Journalize Post to

business the ledger
transactions transaction accounts
The Recording Process (2 of 2)

T The General Journal
• Transactions are recorded in chronological order in a
Analyze business Journalize the Post to ledger
transactions transaction accounts journal before they are transferred to the accounts.
• Journal contributes to the recording process because
it
1. Discloses the complete effect of a transaction
2. Provides a chronological record of transactions
1. Examine source 3. Helps to prevent or locate errors because the
document and
determine
2. Enter transaction in
3. Transfer from journal to ledger.
debit and credit amounts can be readily
the general journal.
effect on compared
accounts.
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Journalizing Journalize Stock Issued for Cash

• The process of entering transaction data in the journal October 1, Sierra issued common stock in exchange for
$10,000 cash.
Illustration: Presented below is information related to
Sierra Corporation. Assets = Liabilities + Stockholders’ Equity
Cash = Common Stock
October 1, Sierra issued common stock in exchange for
+$10,000 = +$10,000 Issued stock
$10,000 cash.
October 1, Sierra borrowed $5,000 by signing a note. GENERAL JOURNAL
October 2, Sierra purchased equipment for $5,000. Date Account Titles and Explanations Debit Credit
2022
Journalize these transactions. Oct. 1 Cash 10,000
Common Stock 10,000
Journalize Borrowing Cash with a Note Journalize Purchase of Equipment

October 1, Sierra borrowed $5,000 by signing a note. October 2, Sierra purchased equipment for $5,000.
Assets = Liabilities + Stockholders’ Equity
Notes Assets = Liabilities + Stockholders’ Equity
Cash = Payable Cash + Equipment =
+$5,000 = +$5,000 -$5,000 +$5,000 =
GENERAL JOURNAL GENERAL JOURNAL

Date Account Titles and Explanations Debit Credit Date Account Titles and Explanations Debit Credit
2022 2022
Oct. 1 Cash 5,000 Oct. 2 Equipment 5,000
Notes Payable 5,000 Cash 5,000
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Summary of Journal Entries Do It! 3: Journal Entries (1 of 2)

GENERAL JOURNAL The following events occurred during the first month of business
Date Account Titles and Explanations Debit Credit of Hair It Is Inc., Kate Browne’s beauty salon:
2022
Oct. 1 Cash 10,000
1. Issued common stock to shareholders in exchange for
Common Stock 10,000 $20,000 cash.
(Issued stock for cash)
2. Purchased $4,800 of equipment on account (to be paid in 30
1 Cash 5,000 days).
Notes Payable 5,000
3. Interviewed three people for the position of stylist.
(Issued 3-month, 12% note payable for
cash) The three activities are recorded as presented on the next slide..
2 Equipment 5,000
Cash 5,000
(Purchased equipment for cash)
Do It! 3: Journal Entries (2 of 2)

1. Issued common stock in exchange for $20,000 cash.
Cash 20,000 Learning Objective 4
Common Stock 20,000
Explain How a Ledger and Posting Help
2. Purchased $4,800 of equipment on account.
in the Recording Process
Equipment 4,800
Accounts Payable 4,800
3. Interviewed three people for the position of stylist.
No entry because no transaction occurred.
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The Accounting Cycle The Ledger

The ledger is comprised of the entire group of accounts
maintained by a company.
Analyze Journalize Post to
Trial Adjusting
business the ledger
Balance Entries
transactions transaction accounts
Adjusted
Financial Closing Post-Closing
Trial
Statements Entries Trial Balance
Balance
Chart of Accounts Accounts in Red are used in this chapter.

The Posting Process
Assets Stockholder's Equity
GENERAL JOURNAL J1
Cash Common Stock
Accounts Receivable Retained Earnings Date Account Titles and Explanations Ref. Debit Credit
Supplies Dividends Oct. 1 Cash 101 10,000
Common Stock 301 10,000
Prepaid Insurance Income Summary
Equipment
Accumulated Depreciation—Equipment Revenues
Service Revenue
Liabilities Expenses Cash Common Stock
Notes Payable Salaries and Wages Expense Oct. 1 10,000 Oct. 1 10,000
Accounts Payable Supplies Expense
Interest Payable Rent Expense
Unearned Service Revenue Insurance Expense Post the amount of the debit Post the amount of the credit
Salaries and Wages Payable Interest Expense entry to the debit side of the entry to the credit side of the
Depreciation Expense account being debited. account being credited.
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Posting (1 of 2) Recording Process Illustrated (1 of 12)

Review Question Steps in the Recording Process
Posting: 1. Determine what type of account is involved.
a. normally occurs before journalizing. 2. Determine what items increased or decreased and
b. transfers ledger transaction data to the journal. by how much.
c. is an optional step in the recording process. 3. Translate the increases and decreases into debits
and credits.
d. transfers journal entries to ledger accounts.
Recording Process Illustrated (2 of 12) Recording Process Illustrated (3 of 12)
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Recording Process Illustrated (12 of 12)
Journalizing Summary (1 of 4)
GENERAL JOURNAL
Date Account Titles and Explanations Debit Credit
2022
Oct. 1 Cash 10,000
Common Stock 10,000
1 Cash 5,000
Notes Payable 5,000
(Issued 3-month, 12% note payable for
cash)
2 Equipment 5,000
Cash 5,000
(Purchased equipment for cash)
Journalizing Summary (2 of 4) Journalizing Summary (3 of 4)

GENERAL JOURNAL GENERAL JOURNAL
Date Account Titles and Explanations Debit Credit Date Account Titles and Explanations Debit Credit
2022 2022
Oct. 2 Cash 1,200 Oct. 4 Prepaid Insurance 600
Unearned Service Revenue 1,200 Cash 600
(Received advance from R. Knox for (Paid 1-year policy; effective date Oct. 1)
future services)
5 Supplies 2,500
3 Cash 10,000 Accounts Payable 2,500
Service Revenue 10,000 (Purchased supplies from Aero Supply
(Received cash for services performed) on account)
3 Rent Expense 900 20 Dividends 500

Cash 900 Cash 500
(Paid cash for October office rent) (Declared and paid a cash dividend)
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Posting Summary
General
Journalizing Summary (4 of 4) Ledger
GENERAL JOURNAL
Date Account Titles and Explanations Debit Credit
2022
Oct. 26 Salaries and Wages Expense 4,000
Cash 4,000
(Paid salaries to date)
Do It! 4: Posting (2 of 2)
GENERAL JOURNAL
Do It! 4: Posting (1 of 2) Date Account Titles and Explanations Debit Credit
July 1 Cash 30,000
Selected transactions from the journal of Faital Inc. during its first
Common Stock 30,000
month of operations are presented below. Post these transactions
to T-accounts. 9 Accounts Receivable 6,000
Service Revenue 6,000
GENERAL JOURNAL
Date Account Titles and Explanations Debit Credit 24 Cash 4,000
July 1 Cash 30,000 Accounts Receivable 4,000
Common Stock 30,000
Cash Accounts Receivable
9 Accounts Receivable 6,000 July 1 30,000 July 9 6,000 July 24 4,000
Service Revenue 6,000 24 4,000
24 Cash 4,000 Common Stock Service Revenue

Accounts Receivable 4,000 July 1 30,000 July 9 6,000
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Prepare a Trial Balance

The Accounting Cycle
Prepare
Prepare a Trial Balance Analyze
business
Journalize
the Post a Trial
Adjusting
Entries
transactions transaction Balance
Adjusted
Trial
Statements Entries Trial Balance
Balance
Nature of a Trial Balance Trial Balance Sierra Corporation

Trial Balance
October 31, 2022
• A list of accounts and their balances at a given time Debit Credit
Cash $ 15,200
• Accounts are listed in the order in which they appear Supplies 2,500
in the ledger Prepaid Insurance 600
Equipment 5,000
• Assets, liabilities, stockholders’ equity, revenues, Notes Payable $ 5,000
and expenses Accounts Payable 2,500
Unearned Service Revenue 1,200
• Purpose is to prove that debits equal credits Common Stock 10,000
Dividends 500
• May uncover errors in journalizing and posting Service Revenue 10,000
Salaries and Wages Expense 4,000
• Useful in the preparation of financial statements Rent Expense 900
Totals $ 28,700 $ 28,700
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Limitations of a Trial Balance Do It! 5: Trial Balance (1 of 2)

The trial balance may balance even when The following accounts come from the ledger of SnowGo
Corporation at December 31, 2022.
• a transaction is not journalized
Equipment $88,000 Common Stock $20,000
• a correct journal entry is not posted Dividends 8,000 Salaries and Wages
• a journal entry is posted twice Accounts Payable 22,000 Payable 2,000
Salaries and Wages Notes Payable (due in
• incorrect accounts are used in journalizing or Expense 42,000 3 months) 19,000
posting, or Accounts Receivable 4,000 Utilities Expense 3,000
• offsetting errors are made in recording the amount Service Revenue 95,000 Prepaid Insurance 6,000
Cash 7,000
of a transaction.
Prepare a trial balance in good form.
Do It! 5 (2 of 2) SnowGo Corporation

Trial Balance
December 31, 2022
Debit Credit
Cash
Accounts Receivable
$ 7,000
4,000
Prepaid Insurance
Equipment
6,000
88,000
Compare the Procedures for the
Notes Payable
Accounts Payable
$ 19,000
22,000
Recording Process under GAAP and
Salaries and Wages Payable
Common Stock
2,000
20,000
IFRS
Dividends 8,000
Utilities Expense 3,000
Totals $ 158,000 $ 158,000
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Similarities Similarities
• Transaction analysis is the same under IFRS and • Dollar signs are typically used only in the trial balance
GAAP. and the financial statements.
• Both the IASB and the FASB go beyond the basic • The same practice is followed under IFRS, using
definitions provided in the textbook for the key the currency of the country where the reporting
elements of financial statements, that is assets, company is headquartered.
liabilities, equity, revenues, and expenses. • A trial balance under IFRS follows the same format as
• The implications of the expanded definitions are discussed shown in the text.
in more advanced accounting courses.
A Look at IFRS (3 of 3) Copyright

Differences
Copyright © 2019 John Wiley & Sons, Inc.
• IFRS relies less on historical cost and more on fair All rights reserved. Reproduction or translation of this work beyond that permitted in
value than do FASB standards. Section 117 of the 1976 United States Act without the express written permission of the
• Internal controls are a system of checks and balances copyright owner is unlawful. Request for further information should be addressed to the
designed to prevent and detect fraud and errors. Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up
• Most public U.S. companies have these systems in place.
• Many non-U.S. companies have never completely or from the use of the information contained herein.
documented the controls nor had an independent auditor
attest to their effectiveness.
LO6 Copyright ©2019 John Wiley & Sons, Inc. 211 Copyright ©2019 John Wiley & Sons, Inc. 212
3/28/2023
Financial Accounting Chapter Outline

Ninth Edition Learning Objectives
Kimmel Weygandt Kieso LO 1 Explain the accrual basis of accounting and the
reasons for adjusting entries.
LO 2 Prepare adjusting entries for deferrals.
LO 3 Prepare adjusting entries for accruals.
Chapter 4
LO 4 Prepare an adjusted trial balance and closing
Accrual Accounting Concepts entries.
Prepared by
Coby Harmon
Copyright ©2019 John Wiley & Son, Inc. 214
Westmont College
Periodicity Assumption
Accountants divide the economic life of a business into
Learning Objective 1 artificial time periods generally a month, quarter, or year.
.....
Explain the Accrual Basis of Jan. Feb. Mar. Apr. Dec.
Accounting and the Reasons for

Adjusting Entries
• Quarterly and annual financial statements HELPFUL HINT
• Prepared by most large companies An accounting time
period
• Reporting periods can be that is one year
• Calendar year from January 1 to long is
called a fiscal year.
December 31
LO 1 Copyright ©2019 John Wiley & Sons, Inc. 215 LO 1 Copyright ©2019 John Wiley & Son, Inc. 216
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Accrual-Basis and Periodicity Accrual-Basis and Revenue Recognition

What is the periodicity assumption? Revenue Recognition Principle
a. Companies should recognize revenue in the Revenue Recognition
Recognize revenue in the Satisfied
accounting period in which services are accounting period in which the performance
performed. performance obligation is
obligation
b. Companies should match expenses with revenues. satisfied.

Customer Cash
c. The economic life of a business can be divided into requests received
artificial time periods. service
Revenue should be
d. The fiscal year should correspond with the recognized in the
accounting period in which
calendar year. the service is performed.
LO 1 Copyright ©2019 John Wiley & Son, Inc. 217 LO 1 Copyright ©2019 John Wiley & Son, Inc. 218
Revenue Recognition
A contract is an agreement between two parties that
Step 1: Identify the contract
with customers.
creates enforceable rights or obligations. Sierra has a
contract with the Lewis family to provide guide Accrual-Basis and Expense Recognition
services.
Sierra has only one performance obligation—to

Expense Recognition Principle
Step 2: Identify the separate
provide guide services. If Sierra also agreed to sell Expense Recognition
performance obligations in
the contract.
the customer camping equipment, a separate Companies recognize expenses in
performance obligation is recorded for this promise. Matching
the period in which they make Revenues
Step 3: Determine the

The transaction price is the amount of consideration efforts (consume assets or incur
that a company expects to receive from a customer
transaction price. in exchange for transferring a good or service. The liabilities) to generate revenue.
transaction price for Sierra is $1,500.
Delivery
Step 4: Allocate the transaction
Sierra has only one performance obligation—to
price to the separate
performance obligations.
provide guide services to the Lewis family. “Let the expenses
Sierra recognizes revenue of $1,500 for providing
follow the revenues.” Advertising Utilities
Step 5: Recognize revenue
guide services to the Lewis family when it satisfies its
when each performance Expenses
performance obligation—the completion of the
obligation is satisfied.
guide trip.
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Revenue and Expense Recognition

Periodicity Assumption GAAP Accrual-Basis of Accounting
Relationships
Economic life of business can be Which of the following statements about the accrual basis of
divided into artificial time periods. accounting is false?
Revenue Recognition Expense Recognition

a. Events that change a company’s financial statements
Principle Principle are recorded in the periods in which the events occur.
Recognize revenue in the Recognize expenses with revenues b. Revenue is recognized in the period in which services
accounting period in which the in the period when the company are performed.
performance obligation is satisfied. makes efforts to generate those
revenues. c. This basis is in accordance with generally accepted
accounting principles.
Revenue and Expense Recognition
In accordance with generally d. Revenue is recorded only when cash is received, and
accepted accounting principles expense is recorded only when cash is paid.
(GAAP).
Accrual versus Cash Basis Accounting (1 of 2) Accrual- versus Cash Basis Accounting (2 of 2)
Accrual-Basis Accounting Cash-Basis Accounting
• Transactions recorded in the periods in which the • Revenues recognized when cash is received
events occur • Expenses recognized when cash is paid
• Companies recognize revenues when they perform • Cash-basis accounting is not in accordance with
services rather than when they receive cash generally accepted accounting principles (GAAP)
• Expenses are recognized when incurred rather than
when paid
• In accordance with generally accepted accounting
principles (GAAP)
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Comparing Accrual- versus Cash Basis Need for Adjusting Entries

2021 2022 • To ensure that the revenue recognition and expense
Purchased paint, painted Received payment for work
recognition principles are followed
Activity
building, paid employees done in 2021 • Necessary because the trial balance may not contain
Revenue $80,000 Revenue $0 up-to-date and complete data
Accrual
Expense 50,000 Expense 0 • Required every time a company prepares financial
basis
Net income $30,000 Net Income $0
statements
Cash
Revenue $0 Revenue $80,000 • Will include one income statement account and one
Expense 50,000 Expense 0 balance sheet account
basis
Net loss $(50,000) Net income $80,000
The Need for Adjusting Entries Categories of Adjusting Entries

Adjusting entries are made to ensure that
Deferrals Accruals
a. expenses are recognized in the period in which
they are incurred. 1. Prepaid Expenses. Expenses 1. Accrued Revenues.
paid in cash before they are Revenues for services
b. revenues are recorded in the period in which used or consumed. performed but not yet
services are performed. received in cash or recorded.
c. balance sheet and income statement accounts 2. Unearned Revenues. 2. Accrued Expenses.
have correct balances at the end of an Cash received before Expenses incurred but not
accounting period. services are performed. yet paid in cash or recorded.
d. All the responses above are correct.
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Trial Balance
Sierra Corporation
Trial Balance
October 31, 2022
DO IT! 1 Timing Concepts
Debit Credit Below is a list of timing concepts (a) Monthly and quarterly time periods.
Cash $15,200 in the left column, with a
Subsequent (b) Efforts (expenses) should be matched
Supplies 2,500 description of the concept in the
examples are with results (revenues).
Prepaid Insurance 600 right column. There are more
based on this
Equipment 5,000 descriptions provided than (c) Accountants divide the economic life of
trial balance
Notes Payable $ 5,000 concepts. Match the description a business into artificial time periods.
from Chapter 3.
Accounts Payable 2,500 to the concept
Unearned Service Revenue 1,200 (d) Companies record revenues when they
Common Stock 10,000 f Accrual-basis accounting.
1. ___ receive cash and record expenses when
Retained Earnings 0 they pay out cash.
Dividends 500 e Calendar year.
2. ___ (e) An accounting time period that starts
Service Revenue 10,000 on January 1 and ends on December 31.
c Periodicity assumption.
3. ___
Rent Expense 900 b Expense recognition (f) Companies record transactions in the
4. ___
period in which the events occur.
$28,700 $28,700 principle.
Adjusting Entries for Deferrals

Deferrals are costs or revenues that are recognized at a date
Learning Objective 2 later than the point when cash was originally exchanged
Prepare Adjusting Entries for Deferrals Types of deferrals:

• Prepaid expenses
• Unearned revenues
Journalize
Trial
Analyze Journalize Post and Post
Balance
AJEs
Adjusted
Trial
Balance Statements Entries Trial Balance
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Prepaid Expenses Prepaid Expenses

Payments of expenses that are recorded as an asset to • Expire either with the passage of time or through use
show the service or benefit the company will receive in • Adjusting entry
the future.
 Increase (debit) to an expense account and
Cash Payment BEFORE Expense Recorded  Decrease (credit) to an asset account
Prepayments often occur in regard to
Asset Expense
• insurance • rent
Unadjusted Credit Debit
• supplies • equipment Balance Adjusting Adjusting
• buildings Entry (-) Entry (+)
• advertising
Adjustment for Supplies

Basic The expense Supplies Expense is increased $1,500; the asset Supplies is
Supplies Analysis decreased $1,500.
Illustration: Sierra Corporation purchased supplies costing Assets = Liabilities + Stockholders’ Equity
Equation
$2,500 on October 5. Sierra recorded the payment by Analysis
Supplies = Supplies Expense
increasing (debiting) the asset Supplies. This account shows a (1) -$1,500 = -$1,500
balance of $2,500 in the October 31 trial balance. An Debit-Credit Debits increase expenses: debit Supplies Expense $1,500.
inventory count at the close of business on October 31 Analysis Credits decrease assets: credit Supplies $1,500.
reveals that $1,000 of supplies are still on hand.
Oct. 31 Supplies Expense 1,500
Journal
Oct. 31 Supplies Expense 1,500 Entry
Supplies 1,500
Supplies 1,500 (To record supplies used)
(To record supplies used) Supplies Supplies Expense

Posting
to Oct. 5 2,500 Oct. 31 Adj. 1,500 Oct. 31 Adj. 1,500
Ledger Oct. 31 Bal. 1,000 Oct. 31 Bal. 1,500
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Adjustment for Insurance
Insurance Equation
Assets
Prepaid Insurance
=
=
Liabilities + Stockholders’ Equity
Insurance Expense
Analysis
Illustration: On October 4, Sierra Corporation paid $600 for a (1) -$50 = -$50
one-year fire insurance policy. Coverage began on October 1. Basic The expense Insurance Expense is increased $50; the asset Prepaid
Sierra recorded the payment by increasing (debiting) Prepaid Analysis Insurance is decreased $50.
Insurance. This account shows a balance of $600 in the Debit-Credit Debits increase expenses: debit Insurance Expense $50.
October 31 trial balance. Insurance of $50 ($600 ÷ 12) Analysis Credits decrease assets: credit Prepaid Insurance $50.
expires each month.
Oct. 31 Insurance Expense 50
Journal
Prepaid Insurance 50
Entry
Oct. 31 Insurance Expense 50 (To record insurance expired)
Prepaid Insurance Insurance Expense
(To record expired insurance) Posting
to Oct. 4 600 Oct. 31 Adj. 50 Oct. 31 Adj. 50
Ledger Oct. 31 Bal. 550 Oct. 31 Bal. 50
LO 2 Copyright ©2019 John Wiley & Son, Inc. 237 LO2 Copyright ©2019 John Wiley & Son, Inc. 238
Depreciation Depreciation
• Buildings, equipment, and motor vehicles (assets that Illustration: For Sierra Corporation, assume that depreciation
provide service for many years) are recorded as on the equipment is $480 a year, or $40 per month.
assets, rather than an expense, on the date acquired
• Depreciation is the process of allocating the cost of Oct. 31 Depreciation Expense 40
an asset to expense over its useful life Accumulated Depreciation 40
(To record depreciation)
• Depreciation does not attempt to report the actual
change in the value of the asset Accumulated Depreciation is called a contra asset account.
 An allocation concept, not a valuation concept
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Adjustment for Depreciation (1 of 2) Adjustment for Depreciation (2 of 2)
Basic The expense Depreciation Expense is increased $40; the contra asset
Oct. 31 Depreciation Expense 40
Analysis Accumulated Depreciation—Equipment is increased $40. Journal
Entry Accumulated Depreciation—
Equipment 40
Equation Accumulated
Analysis Depreciation—Equipment = Depreciation Expense
Posting Equipment Depreciation Expense
-$40 = -$40 to Oct. 2 5,000 Oct. 31 Adj. 40
Ledger Oct. 31 Bal. 5,000 Oct. 31 Bal. 40
Debits increase expenses: debit Depreciation Expense $40. Credits
Debit-Credit
increase contra assets: credit Accumulated Depreciation— Accumulated Depreciation—Equipment
Analysis
Equipment $40. Oct. 31 Adj. 40
Oct. 31 Bal. 40
Journal
Entry Accumulated Depreciation—
Equipment 40
ILLUSTRATION 4.9
LO2 Copyright ©2019 John Wiley & Son, Inc. 241 LO2 Copyright ©2019 John Wiley & Son, Inc. 242
Reporting Depreciation Prepaid Expenses

• Accumulated Depreciation
Accounting for Prepaid Expenses
• A contra asset account with a normal credit balance
Accounts
• Offsets the related asset account on the balance Reason for Before Adjusting
sheet Examples Adjustment Adjustment Entry
• Book value is the difference between the cost of any Insurance, Prepaid expenses Assets Dr. Expenses
supplies, originally recorded overstated. Cr. Assets
depreciable asset and its accumulated depreciation advertising, rent, in asset accounts Expenses or Contra
depreciation have been used. understated. Assets
Equipment $5,000
Less: Accumulated depreciation—equipment 40
$4,960
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Unearned Revenues Unearned Revenues

Receipt of cash before the service is performed is • Adjusting entry is made to record the revenue for
recorded as a liability—unearned revenue. services performed during the period and to show
the liability that remains at the end of the period
Cash Receipt BEFORE Revenue Recorded • Results in a decrease (debit) to a liability account and
an increase (credit) to a revenue account
Unearned revenues often occurs in regard to:
Liability Revenue
• Rent • Magazine subscriptions Debit Unadjusted Credit
• Airline tickets • Customer deposits Adjusting Balance Adjusting
Entry (-) Entry (+)
Adjustment for Unearned Revenue

Basic The liability Unearned Service Revenue is decreased $400; the revenue
Unearned Revenues Analysis Service Revenue is increased $400.
Illustration: Sierra Corporation received $1,200 on October 2 Assets = Liabilities + Stockholders’ Equity
from R. Knox for advertising services expected to be Equation Unearned
Analysis = Service Revenue Service Revenue
completed by December 31. Unearned Service Revenue
= -$400 +$400
shows a balance of $1,200 in the October 31 trial balance.
Analysis reveals that the company performed $400 of Debit-Credit Debits decrease liabilities: debit Unearned Service Revenue $400.
Analysis Credits increase revenues: credit Service Revenue $400.
services in October.
Journal Oct. 31 Unearned Service Revenue 400
Entry Service Revenue 400
Oct. 31 Unearned Service Revenue 400
Unearned Service Revenue Service Revenue
Service Revenue 400 Posting Oct. 31 Adj. 400 Oct. 2 1,200 Oct. 3 10,000
to
Ledger 31 Adj. 400
Oct. 31 Bal. 800 Oct. 31 Bal. 10,400
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Unearned Revenue DO IT! 2: Adjusting Entries Deferrals (1 of 5)

The ledger of Hammond Inc. on March 31, 2022, includes these selected accounts
before adjusting entries are prepared.
Accounting for Unearned Revenues Debit Credit
Prepaid Insurance $ 3,600
Accounts
Supplies 2,800
Reason for Before Adjusting
Equipment 25,000
Examples Adjustment Adjustment Entry Accumulated Depreciation—Equipment $5,000
Rent, Unearned revenues Liabilities Dr. Liabilities Unearned Service Revenue 9,200
magazine recorded in liability overstated. Cr. Revenues An analysis of the accounts shows the following.
subscriptions, accounts are now Revenues 1. Insurance expires at the rate of $100 per month.
customer recognized as understated. 2. Supplies on hand total $800.
deposits for revenue for services 3. The equipment depreciates $200 a month.
future service performed.
4. During March, services were performed for $4,000 of the unearned service
revenue reported.
Prepare the adjusting entries for the month of March.
DO IT! 2: Adjusting Entries Deferrals (2 of 5) DO IT! 2: Adjusting Entries Deferrals (3 of 5)

The ledger of Hammond Inc. on March 31, 2022, includes these selected accounts The ledger of Hammond Inc. on March 31, 2022, includes these selected accounts
before adjusting entries are prepared. before adjusting entries are prepared.
Debit Credit Debit Credit
Prepaid Insurance $ 3,600 Prepaid Insurance $ 3,600
Supplies 2,800 Supplies 2,800
Equipment 25,000 Equipment 25,000
Accumulated Depreciation—Equipment $5,000 Accumulated Depreciation—Equipment $5,000
Unearned Service Revenue 9,200 Unearned Service Revenue 9,200
1. Insurance expires at the rate of $100 per month. 2. Supplies on hand totaled $800.
Oct. 31 Insurance Expense 100
Oct. 31 Supplies Expense 2,000
Supplies 2,000
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DO IT! 2: Adjusting Entries Deferrals (4 of 5) DO IT! 2: Adjusting Entries Deferrals (5 of 5)

The ledger of Hammond Inc. on March 31, 2022, includes these selected accounts The ledger of Hammond Inc. on March 31, 2022, includes these selected accounts
before adjusting entries are prepared. before adjusting entries are prepared.
Debit Credit Debit Credit
Prepaid Insurance $ 3,600 Prepaid Insurance $ 3,600
Supplies 2,800 Supplies 2,800
Equipment 25,000 Equipment 25,000
Accumulated Depreciation—Equipment $5,000 Accumulated Depreciation—Equipment $5,000
Unearned Service Revenue 9,200 Unearned Service Revenue 9,200
3. The equipment depreciates $200 a month. 4. During March, services were performed for $4,000 of the
unearned service revenue reported.
Accumulated Depreciation- Oct. 31 Unearned Service Revenue 4,000
……..Equipment 200 Service Revenue 4,000
Adjusting Entries for Accruals

Accruals are made to record
Learning Objective 3 • Revenues for services performed but not yet
recorded at the statement date
Prepare Adjusting Entries for Accruals
• Expenses incurred but not yet paid or recorded at the
statement date
Journalize
Trial
Analyze Journalize Post and Post
Balance
AJEs
Adjusted
Trial
Balance Statements Entries Trial Balance
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Accrued Revenues Accrued Revenues

Revenues for services performed but not yet received in • Adjusting entry records the receivable that exists and
cash or recorded. records the revenues for services performed
• Adjusting entry:
Revenue Recorded BEFORE Cash Receipt  Increases an asset account with a debit
 Increases a revenue account with a credit
Accrued revenues occur for
Asset Revenue
• Interest earned
Debit Credit
• Services performed Adjusting Adjusting
Entry (+) Entry (+)
• Rent rentals
Adjustment for Accrued Revenue

Basic The asset Accounts Receivable is increased $200; the revenue Service
Accrued Revenues Analysis Revenue is increased $200.
Illustration: In October Sierra Corporation performed Assets = Liabilities + Stockholders’ Equity

Equation
services worth $200 that were not billed to clients on or Analysis
Accounts Receivable = Service Revenue
before October 31. +$200 = +$200
Debit-Credit Debits increase assets: debit Accounts Receivable $200.

Oct. 31 Accounts Receivable 200 Analysis Credits increase revenues: credit Service Revenue $200.
Service Revenue 200
Journal Oct. 31 Accounts Receivable 200
Entry Service Revenue 200
On November 10, Sierra receives cash of $200 for the
services performed. Accounts Receivable Service Revenue
Posting Oct. 31 Adj. 200 Oct. 3 10,000
to 31 400
Nov. 10 Cash 200 Ledger 31 Adj. 200
Accounts Receivable 200 Oct. 31 Bal. 200 Oct. 31 Bal. 10,600
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Accrued Revenues Accrued Expenses

Expenses incurred but not yet paid in cash or recorded.
Accounting for Accrued Revenues
Accounts Expense Recorded BEFORE Cash Payment
Examples Adjustment Adjustment Entry
Accrued expenses are often recognized for
Interest, Services performed Assets Dr. Assets
rent, services but not yet received understated. Cr. Revenues • Rent • Taxes
in cash or recorded. Revenues • Interest • Salaries
understated.
Accrued Expenses Accrued Interest

• Adjusting entry records the obligation and recognizes Illustration: Sierra Corporation signed a three-month note
the expense payable in the amount of $5,000 on October 1. The note
 Increase an expense account with a debit requires Sierra to pay interest at an annual rate of 12%.
 Increase a liability account with a credit Face Value Annual Time in Terms
of Note x Interest Rate x of One Year = Interest
Expense Liability
Debit Credit $5,000 x 12% x 1/12 = $50
Adjusting Adjusting
Entry (+) Entry (+) Oct. 31 Interest Expense 50
Interest Payable 50
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Adjustment for Accrued Interest

Basic
Analysis
The expense Interest Expense is increased $50; the liability Interest
Payable is increased $50.
Accrued Salaries
Assets = Liabilities + Stockholders’ Equity Illustration: Sierra Corporation paid salaries and wages on
Equation
Analysis
= Interest Payable Interest Expense October 26; the next payment of salaries will not occur until
= +$50 -$50 November 9. The employees receive total salaries of $2,000
for a five-day work week, or $400 per day.
Debit-Credit Debits increase expenses: debit Interest Expense $50.
Analysis Credits increase liabilities: credit Interest Payable $50.
Journal Oct. 31 Interest Expense 50

Entry Interest Payable 50
(To record interest on notes payable)
Posting Interest Expense Interest Payable

to Oct. 31 Adj. 50 Oct. 31 Adj. 50
Ledger Oct. 31 Bal. 50 Oct. 31 Bal .50
Adjustment for Accrued Salaries

Basic The expense Salaries and Wages Expense is increased $1,200; the
Analysis liability Salaries and Wages Payable is increased $1,200. Accrued Expenses ILLUSTRATION 4.23
Accounting for accrued expenses
Equation Salaries and Wages Salaries and Wages Accounting for Accrued Expenses
Analysis = Payable Expense
= +$1,200 -$1,200 Accounts
Debit-Credit Debits increase expenses: debit Salaries and Wages Expense $1,200. Examples Adjustment Adjustment Entry
Analysis Credits increase liabilities: credit Salaries and Wages Payable $1,200.
Interest, Expenses have Expenses Dr. Expenses
Journal Oct. 31 Salaries and Wages Expense 1,200 rent, salaries been incurred but understated. Cr. Liabilities
Entry Salaries and Wages Payable 1,200 not yet paid in Liabilities
Salaries and Wages Expense Salaries and Wages Payable cash or recorded. understated.
Posting
Oct. 26 4,000 Oct. 31 Adj. 1,200
to
Ledger 31 Adj. 1,200
Oct. 31 Bal. 5,200 Oct. 31 Bal. 1,200
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Summary of Adjustments DO IT! 3: Adjusting Entries Accruals (1 of 3)

Micro Computer Services began operations on August 1, 2022. At
Type of Adjustment Accounts Before Adjustment Adjusting Entry the end of August 2022, management prepares monthly financial
Prepaid expenses Assets overstated. Dr. Expense statements. The following information relates to August.
Expenses understated Cr. Assets or 1. At August 31, the company owed its employees $800 in
Contra Assets
salaries and wages that will be paid on September 1.
Unearned revenues Liabilities overstated. Dr. Liabilities
2. On August 1, the company borrowed $30,000 from a local
Revenues understated. Cr. Revenues
bank on a 15-year mortgage. The annual interest rate is 10%.
Accrued revenues Assets understated. Dr. Assets
3. Revenue for services performed but unrecorded for August
Revenues understated. Cr. Revenues
totaled $1,100.
Accrued expenses Expenses understated. Dr. Expenses
Liabilities understated. Cr. Liabilities Prepare the adjusting entries needed at August 31, 2022.
DO IT! 3: Adjusting Entries Accruals (2 of 3) DO IT! 3: Adjusting Entries Accruals (3 of 3)

Prepare the adjusting entries needed at August 31, 2022. Prepare the adjusting entries needed at August 31, 2022.
1. At August 31, the company owed its employees $800 in 3. Revenue for services performed but unrecorded for August
salaries and wages that will be paid on September 1. totaled $1,100.
Aug. 31 Salaries and Wages Expense 800 Aug. 31 Accounts Receivable 1,100
Salaries and Wages Payable 800 Service Revenue 1,100
2. On August 1, the company borrowed $30,000 from a local
bank on a 15-year mortgage. The annual interest rate is 10%.
Aug. 31 Interest Expense 250

Interest Payable 250
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Nature of the Adjusted Trial Balance

• Prepared after adjusting entries are journalized and
Learning Objective 4 posted
Prepare an Adjusted Trial • Proves equality of debit and credit balances
Balance and Closing Entries • Basis for the preparation of financial statements
Trial Journalize and

Analyze Journalize Post
Balance Post AJEs
Adjusted Prepare
Closing Post-Closing
Trial Financial Entries Trial Balance
Balance Statements
Sierra Corporation
Adjusted Trial Balance
Adjusted October 31, 2022
Trial Balance Cash

Debit
$15,200
Credit
Adjusted Trial Balance Review
with Accounts Receivable
Supplies
200
1,000 Which of the following statements is incorrect concerning the
Adjusted Prepaid Insurance 550
adjusted trial balance?
Equipment 5,000
Accounts Accumulated Depreciation—Equipment $ 40
Highlighted Notes Payable 5,000 a. An adjusted trial balance proves the equality of the total
Accounts Payable
Unearned Service Revenue
2,500
800
debit balances and the total credit balances in the ledger
Salaries and Wages Payable 1,200 after all adjustments are made.
Interest Payable 50
Common Stock 10,000 b. The adjusted trial balance provides the primary basis for the
Retained Earnings 0
Dividends 500 preparation of financial statements.
Salaries and Wages Expense 5,200 c. The adjusted trial balance lists the account balances
Supplies Expense 1,500
Rent Expense 900 segregated by assets and liabilities.
Insurance Expense 50
Interest Expense 50 d. The adjusted trial balance is prepared after the adjusting
Depreciation Expense 40
$30,190 $30,190
entries have been journalized and posted.
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Preparing Statements from the Trail Balance
Preparing Financial Statements

Financial Statements are prepared directly from the
Adjusted Trial Balance.
Retained
Income Balance
Earnings
Statement Sheet
Statement
Preparing the Balance Sheet
DO IT! 4a: Trial Balance (1 of 4)

Skolnick Co. was organized on April 1, 2022. The company prepares quarterly
financial statements. The adjusted trial balance at June 30 are shown below.
Debit Credit
Cash $ 6,700 Accumulated Depreciation $ 850
Accounts Receivable 600 Notes Payable 5,000
Prepaid Rent 900 Accounts Payable 1,510
Supplies 1,000 Salaries and Wages Payable 400
Equipment 15,000 Interest Payable 50
Dividends 600 Unearned Rent Revenue 500
Salaries and Wages Expense 9,400 Common Stock 14,000
Rent Expense 1,500 Retained Earnings 0
Depreciation Expense 850 Service Revenue 14,200
Supplies Expense 200 Rent Revenue 800
Utilities Expense 510
Interest Expense 50
$37,310 $37,310
LO4 Copyright ©2019 John Wiley & Son, Inc. 279 LO 4 Copyright ©2019 John Wiley & Son, Inc. 280
3/28/2023
DO IT! 4a: Trial Balance (2 of 4) DO IT! 4a: Trial Balance (3 of 4)

a. Determine the net income for the quarter April 1 to June 30. b. Determine the total assets and total liabilities at June 30, 2022.
Revenues Debit Credit
Service revenue $14,200 Cash $ 6,700 Notes Payable $5,000
Rent revenue 800 Accounts Receivable 600 Accounts Payable 1,510
Total revenues $15,000 Prepaid Rent 900 Salaries and Wages Payable 400
Expenses Supplies 1,000 Interest Payable 50
Salaries and wages expense 9,400 Equipment 15,000 Unearned Rent Revenue 500
Rent expense 1,500 Accumulated Depreciation (850)
Depreciation expense 850 Total assets $23,350 Total liabilities $7,460
Utilities expense 510
Supplies expense 200
Interest expense 50
Total expenses 12,510
Net income $ 2,490
DO IT! 4a: Trial Balance (4 of 4) Closing the Books

c. Determine the amount of retained earnings at June 30, 2022. At the end of the accounting period, the company makes
Retained earnings, April 1 $ 0 the accounts ready for the next period.
Add: Net income 2,490
Less: Dividends 600 Analyze Journalize Post
Trial Adjusting
Balance Entries
Retained earnings, June 30 $1,890
Adjusted Post-Closing
Financial Closing
Trial Trial
Balance Statements Entries
Balance
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Temporary and Permanent Accounts Nature of Closing Entries

TEMPORARY PERMANENT
• Closing entries formally recognize in the ledger the
These accounts are closed These accounts are not closed transfer of
• Net income (or net loss) to retained earnings
All revenue accounts All asset accounts • Owner’s drawings to retained earnings
• Produce a zero balance in each temporary account.
All expense accounts All liability accounts
• Generally journalized and posted only at end of the
Stockholders’ equity annual accounting period
Dividends
accounts
Preparing Closing Entries Close Revenue and Expense Accounts

GENERAL JOURNAL
Date Account Titles and Explanations Ref. Debit Credit
Revenue 2022 Service Revenue 10,600
Accounts Oct. 31 Income Summary 10,600
Income (To close revenue account)
Summary
Expense 31 Income Summary 7,740
Retained Salaries and Wages Expense 5,200
Accounts Earnings Supplies Expense 1,500
Rent Expense 900
Insurance Expense 50
Interest Expense 50
Dividends Depreciation Expense 40
(To close expense accounts)
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Posting of Closing Entries

Close Income Summary and Dividends
GENERAL JOURNAL
Date Account Titles and Explanations Ref. Debit Credit
2022
Oct. 31 Income Summary 2,860
Retained Earnings 2,860
(To close net income)
31 Retained Earnings 500
Dividends 500
(To close dividends)
Summary of the Accounting Cycle DO IT! 4b: Closing Entries (1 of 3)

1. Analyze business transactions
Hancock Company has the following balances in selected accounts
of its adjusted trial balance.
9. Prepare a post-closing trial
2. Journalize the transactions Accounts Payable $27,000 Dividends $15,000
balance
Service Revenue 98,000 Retained Earnings 42,000
8. Journalize and post closing
3. Post to ledger accounts
Rent Expense 22,000 Accounts Receivable 38,000
entries
Salaries and Wages Supplies Expense 7,000
7. Prepare financial Expense 51,000
4. Prepare a trial balance
statements
Prepare the closing entries at December 31.
6. Prepare an adjusted trial 5. Journalize and post
balance adjusting entries Dec. 31 Service Revenue 98,000
Income Summary 98,000
(To close revenue)
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DO IT! 4b: Closing Entries (2 of 3) DO IT! 4b: Closing Entries (3 of 3)

Accounts Payable $27,000 Dividends $15,000 Accounts Payable $27,000 Dividends $15,000
Service Revenue 98,000 Retained Earnings 42,000 Service Revenue 98,000 Retained Earnings 42,000
Rent Expense 22,000 Accounts Receivable 38,000 Rent Expense 22,000 Accounts Receivable 38,000
Salaries and Wages Supplies Expense 7,000 Salaries and Wages Supplies Expense 7,000
Expense 51,000 Expense 51,000
Prepare the closing entries at December 31.
Dec. 31 Income Summary 18,000
Dec. 31 Income Summary 80,000 (To close income summary)
Rent Expense 22,000 Retained Earnings 15,000
Supplies Expense 7,000 Dividends 15,000
(To close expense accounts) (To close dividends)
Appendix 4A - Using a Worksheet

• Multiple-column form used in the adjustment
Learning Objective 5 process and in preparing financial statements
Describe the Purpose and the Basic • Not a permanent accounting record
Form of a Worksheet • May be a computerized worksheet

• Use of worksheet is optional
• Prepared using a five-step process
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Steps in Preparing a Worksheet Completed Worksheet Sierra Corporation

Worksheet
Sierra Corporation Adjusted Income
Worksheet Trial Balance Adjustments Trial Balance Statement Balance Sheet
Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
For the Month Ended October 31, 2022 Cash 15,200 15,200 15,200
Adjusted Income Supplies 2,500 (a) 1,500 1,000 1,000
Trial Balance Adjustments Trial Balance Statement Balance Sheet Prepaid Insurance 600 (b) 50 550 550
Equipment 5,000 5,000 5,000
Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Notes Payable 5,000 5,000 5,000
Cash 15,200 15,200 15,200 Accounts Payable 2,500 2,500 2,500
Supplies 2,500 (a) 1,500 1,000 1,000 Unearned Service Revenue 1,200 (d) 400 800 800
Prepaid Insurance 600 (b) 50 550 550 Common Stock 10,000 10,000 10,000
Retained Earnings 0 0 0
Equipment 5,000 5,000 5,000
Dividends 500 500 500
Notes Payable Step 1 5,000 Step 2 Step 3 5,000 Step 4 5,000 Service Revenue 10,000 (d) 400 10,600 10,600
Prepare a Enter Enter Extend adjusted (e) 200
Salaries and Wages Expense 4,000 (g) 1,200 5,200 5,200
trial balance adjustment adjusted balances to appropriate Rent Expense 900 900 900
on the data. balances. statement columns. Totals 28,700 28,700
Supplies Expense (a) 1,500 1,500 1,500
worksheet. Step 5 Insurance Expense (b) 50 50 50
Total the statement Accumulated Depreciation (c) 40 40 40
Depreciation Expense (c) 40 40 40
columns, Accounts Receivable (e) 200 200 200
compute net income Interest Expense (f) 50 50 50
Interest Payable (f) 50 50 50
(or net loss), and Salaries and Wages Payable (g) 1,200 1,200 1,200
complete worksheet. Totals 3,440 3,440 30,190 30,190 7,740 10,600 22,450 19,590
Net Income 2,860 2,860
Totals 10,600 10,600 22,450 22,450
A Look at IFRS
Similarities
Learning Objective 6 • Companies applying IFRS also use accrual-basis accounting
to ensure that they record transactions that change a
Compare the Procedures for Adjusting company’s financial statements in the period in which
events occur.
Entries Under GAAP and IFRS • Similar to GAAP, cash-basis accounting is not in accordance
with IFRS.
• IFRS also divides the economic life of companies into
artificial time periods. Under both GAAP and IFRS, this is
referred to as the periodicity assumption.
• The general revenue recognition principle required by GAAP
that is used in this text is the same as that used under IFRS.
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A Look at IFRS A Look at IFRS

Similarities Differences
• Revenue recognition fraud is a major issue in U.S. financial • The terminology used for revenues and gains, and expenses and
reporting. The same situation occurs in countries using losses, differs somewhat between IFRS and GAAP.
IFRS. • Income under IFRS includes both revenues, which arise
• As evidenced by revenue recognition breakdowns at Dutch during the normal course of operating activities, and gains,
software company Baan NV , Japanese electronics giant which arise from activities outside of the normal sales of
NEC , and Dutch grocer Ahold NV goods and services.
• Under GAAP income refers to the net difference between
Differences revenues and expenses.
• Under IFRS, revaluation (using fair value) of items such as • Under IFRS, expenses include both those costs incurred in the
land and buildings is permitted. IFRS allows depreciation normal course of operations as well as losses that are not part
based on revaluation of assets, which is not permitted of normal operations. This is in contrast to GAAP, which defines
under GAAP. each separately.

Decision Making
copies for his/her own use only and not for distribution or resale. The Publisher assumes Chapter 5
Merchandising Operations and the
Multiple-Step Income Statement
Prepared by
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Westmont College
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Chapter Outline
Learning Objectives
LO 1 Describe merchandising operations and inventory
systems.
LO 2 Record purchases under a perpetual inventory system. Describe Merchandising Operations
LO 3 Record sales under a perpetual inventory system. and Inventory Systems
LO 4 Prepare a multiple-step income statement and a
comprehensive income statement.
LO 5 Determine cost of goods sold under a periodic
inventory system.
LO 6 Compute and analyze gross profit rate and profit
margin.
Merchandising Operations and Measuring Income for a Merchandising

Inventory Systems Company
Merchandising Companies
Buy and Sell Goods
Retailer
Cost of goods sold is the

total cost of merchandise
sold during the period.
The primary source of revenues is referred to as sales revenue or sales.
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Operating Cycles Flow of Costs and Systems
Companies use either a perpetual inventory system or a

periodic inventory system to account for inventory.
Perpetual Inventory System Periodic Inventory System

A company A company
• Maintains detailed records of the cost of each • Does not keep detailed records of goods on hand
inventory purchase and sale • Determines cost of goods sold determined by a count
• Maintains inventory records such that inventory that • Calculates its cost of goods sold as
should be on hand is continuously updated
Beginning inventory $100,000
• Determines cost of goods sold each time a sale occurs Add: Purchases, net 800,000
Goods available for sale 900,000
Less: Ending inventory 125,000
Cost of goods sold $775,000
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Advantages of the Perpetual System Do It! 1: Merchandising Operations

• Traditionally used for merchandise with high unit
and Inventory Systems
Indicate whether the following statements are true or false. If false,
values indicate how to correct the statement.
• Shows quantity and cost of inventory that should 1. The primary source of revenue for a merchandising
company results from performing services for
be on hand at any time customers.
• Provides better control over inventories than a 2. The operating cycle of a service company is usually
shorter than that of a merchandising company.
periodic system
3. Sales revenue less cost of goods sold equals gross
profit.
4. Ending inventory plus the cost of goods purchased
equals cost of goods available for sale.
Recording Purchases Under a Perpetual

System
Learning Objective 2 • Made using cash or credit
Record Purchases Under a Perpetual (on account)
System • Normally record when
goods are received from
the seller
• Purchase invoice should
support each credit
purchase
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Record Purchases of Merchandise Freight Costs (1 of 2)

Illustration: Sauk Stereo (the buyer)
uses as a purchase invoice the sales
invoice prepared by PW Audio Supply,
Inc. (the seller).
Prepare the journal entry for Sauk
Stereo for the invoice from PW Audio Ownership of the goods Ownership of the goods
Supply. passes to the buyer when the remains with the seller until
public carrier accepts the the goods reach the buyer.
May 4 Inventory 3,800 goods from the seller.
Freight costs incurred by the seller are an operating expense.
Freight Costs (2 of 2) Purchase Returns and Allowances

Illustration: Assume upon delivery of the goods on May 6, Purchaser may be dissatisfied because goods are
Sauk Stereo pays Public Freight Company $150 for freight damaged or defective, of inferior quality, or do not meet
charges, the entry on Sauk Stereo’s books is: specifications.
May 6 Inventory 150
Cash 150 Purchase Return
Return goods for credit if the sale was made on credit, or
If the freight terms had required PW Audio Supply to pay for a cash refund if the purchase was for cash.
the freight charges, the entry by PW Audio Supply would be:
Purchase Allowance
May 4 Freight-Out (or Delivery Exp) 150 May choose to keep the merchandise if the seller will
Cash 150
grant a reduction of the purchase price.
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Recording Purchase Returns and Purchase Returns and Allowances (1 of 2)

Allowances Review Question
Illustration: Assume Sauk Stereo returned goods costing In a perpetual inventory system, a return of defective
$300 to PW Audio Supply on May 8. merchandise by a purchaser is recorded by crediting:
a. Purchases
May 8 Accounts Payable 300
Inventory 300 b. Purchase Returns
c. Purchase Allowance
d. Inventory
Nature of Purchase Discounts Common Purchase Discounts

• Credit terms may permit buyer to claim a cash 2/10, n/30
discount for prompt payment. 2% discount if paid within 10 days, otherwise net amount
• Advantages: due within 30 days
• Purchaser saves money 1/10 EOM
• Seller shortens the operating cycle by converting 1% discount if paid within first 10 days of next month
the accounts receivable into cash earlier
n/10 EOM
Example: Credit terms may read 2/10, n/30. Net amount due within the first 10 days of the next
month
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Accounting for Purchase Discounts (1 of 2) Accounting for Purchase Discounts ( 2 of 2)

Illustration: Assume Sauk Stereo pays the balance due of Illustration: If Sauk Stereo failed to take the discount, and
$3,500 (gross invoice price of $3,800 less purchase returns instead made full payment of $3,500 on June 3, what would
and allowances of $300) on May 14, the last day of the the journal entry be?
discount period. Prepare the journal entry Sauk Stereo makes
on May 14 to record the payment.
Jun 3 Accounts Payable 3,500
Discount = $3,500 × 2% = $70 Inventory 70
May 14 Accounts Payable 3,500

Inventory 70
Cash 3,430
Cost of Not Taking a Purchase Discount Summary of Purchasing Transactions

Should discounts be taken when offered?
Inventory
Discount of 2% on $3,500 $70.00 Debit Credit
$3,500 borrowed at 10% for 20 days 19.18 May 4 Purchase 3,800 300 May 8 Return
Savings by taking the discount $50.82 May 6 Freight-in 150 70 May 14 Discount
Example: 2% for 20 days = Annual rate of 36.5% 3,580

($3,500 × 36.5% × 20) ÷ 365 = $70
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Do It! 2: Purchase Transactions

On September 5, De La Hoya Company buys merchandise on
account from Junot Diaz Company. The purchase price of the
goods is $1,500. On September 8, De La Hoya returns defective
goods with a selling price of $200. Record the transactions on the Record Sales Under a Perpetual System
books of De La Hoya Company.
Sept. 5 Inventory 1,500

Sept. 8 Accounts Payable 200

Inventory 200
Recording Sales Under a Perpetual Sales Invoice

Inventory System A sales invoice
• Sales may be made on credit or for cash should
• Sales revenue, like service revenue, is recorded when support each
the performance obligation is satisfied credit sale.
• Performance obligation is satisfied when goods are
transferred from seller to buyer
• A sales invoice should support each credit sale
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Entries to Record Sales Recording Sales on Account

Illustration: PW Audio Supply records the sale of $3,800 on
Record the Revenue May 4 to Sauk Stereo on account as follows. The
Accounts Receivable XXX merchandise cost PW Audio Supply $2,400.
Selling
Sales Revenue XXX Price
May 4 Accounts Receivable 3,800
Sales Revenue 3,800
Record the Expense
Cost of Goods Sold 2,400
Cost of Goods Sold XXX
Cost Inventory 2,400
Inventory XXX
Sales Returns and Allowances Recording Sales Returns and Allowances (1 of 2)
• “Flip side” of purchase returns and allowances Illustration: Prepare the entry PW Audio Supply would make
to record the credit for returned goods that had a $300
• Contra revenue account to Sales Revenue with a
selling price with a $140 cost. The goods were not defective.
normal debit balance
• Sales revenue is not reduced (debited) because May 8 Sales Returns and Allowances 300
Accounts Receivable 300
 Would obscure importance of sales returns and
allowances as a percentage of sales Inventory 140
 Could distort comparisons Cost of Goods Sold 140
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Recording Sales Returns and Allowances (2 of 2) Sales Returns and Allowances (1 of 2)

Illustration: Assume the returned goods were defective and Review Question
had a scrap value of $50, PW Audio would make the
following entries: The cost of goods sold is determined and recorded each
time a sale occurs in:
May 8 Sales Returns and Allowances 300 a. periodic inventory system only.
b. a perpetual inventory system only.
Inventory 50
Cost of Goods Sold 50 c. both a periodic and perpetual inventory system.
d. neither a periodic nor perpetual inventory system.
Sales Discounts Recording Sales Discounts

• Offered to customers to promote prompt payment of Illustration: Assume Sauk Stereo pays the balance due of
the balance due $3,500 (gross invoice price of $3,800 less purchase returns
and allowances of $300) on May 14, the last day of the
• Contra revenue account to Sales Revenue with a discount period. Prepare the journal entry PW Audio Supply
normal debit balance makes to record the receipt on May 14.
[($3,800 − $300) × 2%]
May 14 Cash 3,430
Sales Discounts 70
Accounts Receivable 3,500
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Do It! 3: Sales Transactions (1 of 2) Do It! 3: Sales Transactions (2 of 2)

On September 5, De La Hoya Company buys merchandise on On September 5, De La Hoya Company buys merchandise on
account from Junot Diaz Company. The selling price of the account from Junot Diaz Company. The selling price of the
goods is $1,500, and the cost to Diaz Company was $800. On goods is $1,500, and the cost to Diaz Company was $800. On
September 8, De La Hoya returns goods with a selling price September 8, De La Hoya returns goods with a selling price
of $200 and a fair value of $30. Record the sale on the books of $200 and a fair value of $30. Record the return on the
of Junot Diaz Company. books of Junot Diaz Company.
Sept. 5 Accounts Receivable 1,500 Sept. 8 Sales Returns and Allowances 200
Sales Revenue 1,500 Accounts Receivable 200
Cost of Goods Sold 800 Inventory 30

Inventory 800 Cost of Goods Sold 30
Single-Step Income Statement (1 of 2)

• Subtract total expenses from total revenues
Learning Objective 4 • All data classified into two categories
Prepare a Multiple-Step Income • Revenues
Statement and a Comprehensive • Expenses
Income Statement • Two reasons for using the single-step format:
1. Company does not realize any profit or income
until total revenues exceed total expenses
2. Form is simple and easy to read
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Single-Step Income Statement (1 of 2)

Nature of the Multiple-Step Income
Recreational Equipment
Income Statement (in thousands) Statement
Blank For the year ended
• Highlights of net income
Blank December 31, blank January 2,
Blank 2016 blank 2016 • Three important line item
Revenues blank
Net sales $2,557,543 blank $2,423,221 1. gross profit

Expenses blank
Cost of goods sold 1,460,433 blank 1,388,125 2. income from operations

Payroll-related expenses 494,820 478,474
3. net income
blank
Occupancy, general and administrative 420,898 blank 381,147

Patronage refunds and other 121,401 blank 121,853
Income taxes 21,716 blank 18,250
Blank 2,519,268 blank 2,387,849
Net income $ 38,275 blank $ 35,372
PW Audio Supply, Inc.

Income Statement
Components Recreational Equipment
Income Statement (in thousands) Multiple- Sales
For the Year Ended December 31, 2022
Blank
of the Blank
For the Year Ended
December 31, January 2,
Step Income Service revenue
Less: Sales returns and allowances $12,000
Blank
Blank
$480,000
Multiple-Step Blank
Net sales
2016
$2,557,543
2016
$2,423,221
Statement
Sales discounts
Net sales
Cost of goods sold
8,000 Blank
Blank
20,000
460,000
316,000
Income (1 of 6) Blank
Cost of goods sold 1,460,433 1,388,125 Gross profit Blank 144,000
Gross profit 1,097,110 1,035,096 Operating expenses
Statement
Blank
Operating expenses Key Items: Salaries and wages expense

Utilities expense
64,000
17,000
Blank
Blank
Payroll-related expenses 494,820 478,474 Advertising expense 16,000
• Sales
Blank
Occupancy, general and Depreciation expense 8,000 Blank

Freight-out 7,000
administrative 420,898 381,147 Insurance expense 2,000
Blank
Blank
Total operating expenses 915,718 859,621 Total operating expenses Blank 114,000
Income from operations 181,392 175,475 Income from operations 30,000
Other revenues and gains
Other revenues and gains Blank
Interest revenue 3,000 Blank
Other revenues 0 0 Gain on disposal of plant assets 600 Blank 3,600
Other expenses and losses Other expenses and losses Blank
Patronage refunds and other 121,401 121,853 Interest expense 1,800 Blank
Casualty loss from vandalism 200 Blank 2,000
Income before income taxes 59,991 53,622 Income before income taxes Blank 31,600
Income taxes 21,716 18,250 Income tax expense Blank 10,100
Net income $ 38,275 $ 35,372 Net income Blank $ 21,500
LO4 Copyright ©2019 John Wiley & Sons, Inc. 347 LO 4 Copyright ©2019 John Wiley & Sons, Inc. 348
3/28/2023
PW Audio Supply, Inc. PW Audio Supply, Inc.

Income Statement Income Statement
Multiple- Sales
Blank
Multiple- Sales
Blank

Blank
Blank
$480,000
Blank
Blank
$480,000
Statement Sales discounts

Net sales
Cost of goods sold
8,000 Blank
Blank
20,000
460,000
316,000
Statement
Sales discounts
Net sales
Cost of goods sold
8,000 Blank
Blank
20,000
460,000
316,000
(2 of 6) Gross profit
Blank
Blank 144,000 (3 of 6) Gross profit
Blank
Blank 144,000
Operating expenses Operating expenses
Key Items:
Blank Blank
Salaries and wages expense 64,000 Salaries and wages expense 64,000
Utilities expense 17,000
Blank
Blank
Key Items: Utilities expense 17,000
Blank
Blank
• Sales Advertising expense 16,000 Blank Advertising expense 16,000 Blank

Depreciation expense 8,000 Blank • Sales Depreciation expense 8,000 Blank
Freight-out 7,000 Freight-out 7,000
• Gross Profit Blank Blank
Insurance expense
Total operating expenses
2,000 Blank
Blank 114,000
• Gross Profit Insurance expense
2,000 Blank
Blank 114,000
Income from operations 30,000 Income from operations 30,000
Other revenues and gains Blank • Operating Other revenues and gains Blank
Interest revenue
Gain on disposal of plant assets
3,000
600
Blank
Blank 3,600
Expenses Interest revenue
3,000
600
Blank
Blank 3,600
Other expenses and losses Blank Other expenses and losses Blank
Interest expense 1,800 Blank Interest expense 1,800 Blank
Casualty loss from vandalism 200 Blank 2,000 Casualty loss from vandalism 200 Blank 2,000
Income before income taxes Blank 31,600 Income before income taxes Blank 31,600
Income tax expense Blank 10,100 Income tax expense Blank 10,100
Net income Blank $ 21,500 Net income Blank $ 21,500
LO4 Copyright ©2019 John Wiley & Sons, Inc. 349 LO 4 Copyright ©2019 John Wiley & Sons, Inc. 350

Income Statement
Multiple- Sales
Blank Nonoperating Activities (5 of 6)
Blank
Blank
$480,000
Revenues and expenses and gains and losses unrelated to
Statement
Sales discounts 8,000 Blank 20,000
Net sales Blank 460,000 company’s main line of operations. Examples include:
Cost of goods sold 316,000
(4 of 6) Gross profit
Blank
Blank 144,000 Other Revenues and Gains
Operating expenses Blank
Key Items: Salaries and wages expense 64,000 Blank • Interest revenue from notes receivable and marketable securities
Utilities expense 17,000
• Sales Advertising expense 16,000
Blank
Blank
• Dividend revenue from investments in capital stock
Depreciation expense 8,000
Freight-out 7,000
Blank
• Rent revenue from subleasing a portion of the store
• Gross Profit Blank
Insurance expense
2,000 Blank
Blank 114,000
• Gain from the sale of property, plant, and equipment
• Operating Income from operations 30,000 Other Expenses and Losses
Expenses Other revenues and gains Blank
Interest revenue
3,000
600
Blank
3,600
• Interest expense on notes and loans payable
• Nonoperating Blank
Activities
Other expenses and losses
Interest expense 1,800
Blank
• Casualty losses from such causes as vandalism and accidents
Blank
Casualty loss from vandalism
Income before income taxes
200 Blank 2,000
31,600
• Loss from sale of property, plant, and equipment
Blank
Income tax expense
Net income
Blank 10,100
$ 21,500
• Loss from strikes by employees and suppliers
Blank
LO 4 Copyright ©2019 John Wiley & Sons, Inc. 351 LO4 Copyright ©2019 John Wiley & Sons, Inc. 352
3/28/2023

Income Statement
Multiple- For the Year Ended December 31, 2022
Step Income
Sales
Service revenue
Blank
Blank $480,000 Multiple-Step Income Statement (1 of 2)
Less: Sales returns and allowances $12,000 Blank
Statement
Sales discounts
Net sales
8,000 Blank
Blank
20,000
460,000 Review Question
Cost of goods sold 316,000
(6 of 6) Blank
Gross profit
Operating expenses
Blank 144,000
The multiple-step income statement for a merchandiser
Key Items:
Blank
Salaries and wages expense
Utilities expense
64,000
17,000
Blank
Blank
shows each of the following features except:
• Sales Advertising expense 16,000 Blank
Depreciation expense
Freight-out
8,000
7,000
Blank a. gross profit.
• Gross Profit Insurance expense 2,000
Blank
b. cost of goods sold.

Blank
Total operating expenses Blank 114,000
• Operating Income from operations 30,000
Expenses
Other revenues and gains
Interest revenue 3,000
Blank
Blank
c. a sales revenue section.
Gain on disposal of plant assets 600 Blank 3,600
• Nonoperating Other expenses and losses Blank
d. investing activities section.
Interest expense 1,800
Activities
Blank
Casualty loss from vandalism 200 Blank 2,000
Income before income taxes Blank 31,600
• Net Income Income tax expense
Net income
Blank 10,100
$ 21,500
Blank
Comprehensive Income Statement Do It! 4: Multiple-Step Income

Presents items not included in the determination of net Statement (1 of 3)
income. The following information is available for Art Center Corp. for the
Items included in comprehensive income are either reported year ended December 31, 2022.
in a combined statement of net income and comprehensive Other revenues and gains $ 8,000 Sales revenue $462,000
income, or in a separate comprehensive income statement. Other expenses and losses 3,000 Operating expenses 187,000
PW Audio Supply, Inc. Cost of goods sold 147,000 Sales discounts 20,000
Comprehensive Income Statement blank blank Other comprehensive
For the Year Ended December 31, 2022 income 10,000
Net income
Other comprehensive income $21,500 Prepare a multiple-step income statement and comprehensive
Unrealized holding gain on investment securities (net of $400 tax) 2,300 income statement for Art Center Corp. The company has a tax rate of
Comprehensive income $23,800 25%. This rate also applies to other comprehensive income.
3/28/2023
Art Center Corp.

Do It! 4: Income Statement Do It! 4: Multiple-Step Income
Multiple- For the Year Ended December 31, 2022
Statement (3 of 3)
Sales
Step Service revenue
Blank
$462,000
Prepare a comprehensive income statement.
Blank
Income Sales discounts Blank 20,000

Tax rate is 25%.
Net sales 442,000
Statement Cost of goods sold
Blank
147,000
(2 of 3) Blank
Art Center Corp.
Gross profit Blank 295,000 Comprehensive Income Statement
Operating expenses 187,000 For the Year Ended December 31, 2022
Prepare a Blank
Income from operations 108,000

multiple-step Blank
Net income $84,750
Other revenues and gains $8,000 Blank Blank
income Other comprehensive income

Other expenses and losses 3,000 Blank 5,000
statement. (net of $2,500 tax) 7,500
Income before income taxes 113,000
Blank
Tax rate is 25%.

Blank
Comprehensive income $92,250
Income tax expense 28,250
Blank
Blank
Net income Blank $ 84,750
Periodic Inventory System

• No running account of changes in inventory is
Learning Objective 5 maintained
Determine Cost of Goods Sold Under a • Ending inventory determined by physical count
Periodic Inventory System • Cost of goods sold not determined until the end of
the period
3/28/2023
Cost of Goods Sold under a Periodic System Do It! 5: COGS—Periodic System (1 of 2)

Cost of Goods Sold
Aerosmith Company’s accounting records show the following at
For the Year Ended December 31, 2022 the year-end December 31, 2022.
Cost of goods sold Purchase Discounts $ 3,400 Freight-In $ 6,100
Inventory, January 1 $ 36,000
Purchases 162,500 Beginning Inventory 18,000
Purchases $325,000
Less: Purchase returns and allowances $10,400 Ending Inventory 20,000 Purchase Returns and
Purchase discounts 6,800 17,200 Allowances 5,200
Net purchases 307,800
Add: Freight-in 12,200 Assuming that Aerosmith Company uses the periodic system,
Cost of goods purchased 320,000 compute (a) cost of goods purchased and (b) cost of goods sold.
Cost of goods available for sale 356,000
Inventory, December 31 40,000
Cost of goods sold $316,000
Gross Profit Rate (1 of 2)

• May be expressed as a percentage by dividing the
Learning Objective 6 amount of gross profit by net sales
Compute and Analyze Gross Profit Rate • Possible causes of a decline in the rate
and Profit Margin • Selling products with a lower “markup”

• Increased competition may result in a lower selling
price
• Company forced to pay higher prices to its suppliers
without being able to pass these costs on to its
customers
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Gross Profit Rate (2 of 2) Profit Margin (1 of 2)

• Measures the percentage of each dollar of sales that
results in net income
• How do the gross profit rate and profit margin ratio
differ?
• Gross profit rate measures the margin by which
selling price exceeds cost of goods sold
The gross profit rate often differs across retailers because of • Profit margin ratio measures the extent by which
differences in the nature of their goods. selling price covers all expenses (including cost of
goods sold)
Profit Margin (2 of 2) Do It! 6: Gross Profit Rate

Rachel Rose, Inc. reported the following in its income statements.
2022 2021
Net sales $80,000 $120,000
Cost of goods sold 40,000 60,000
Operating expenses 14,000 28,000
Income tax expense 8,000 12,000
Net income $18,000 $20,000
Possible causes of a decline in the rate may be caused by a change Determine the company’s gross profit rate.
in
2022 2021
• The amount of operating expenses relative to sales, or
($80,000  $40,000) ($120,000  $60,000)
• The amount of other items relative to sales  50%  50%
$80,000 $120,000
3/28/2023
Do It! 6: Profit Margin

Rachel Rose, Inc. reported the following in its income statements.
2022 2021 Learning Objective 7
Net sales $80,000 $120,000
Cost of goods sold 40,000 60,000 Record Purchases and Sales of
Operating expenses
Income tax expense
14,000
8,000
28,000
12,000
Inventory Under a Periodic Inventory
Net income $18,000 $20,000 System
Determine the company’s profit margin.
2022 2021
$18, 000 $20, 000
 22.5%  16.7%
$80,000 $120, 000
Appendix 5A Periodic Inventory System Recording Purchases of Merchandise

Recording Merchandise Transactions Illustration: PW Audio Supply records the sale of $3,800 on
May 4 to Sauk Stereo on account as follows. The
• Record revenues when sales are made
merchandise cost PW Audio Supply $2,400. Sauk Stereo
• Do not record cost of merchandise sold on the date records the $3,800 purchase as:
of sale
• Physical inventory count determines cost of May 4 Purchases 3,800
merchandise on hand and sold during the period Accounts Receivable 200
• Record purchases in Purchases account
• Purchase returns and allowances, purchase
discounts, and freight costs are recorded in separate
accounts
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Freight Costs Paid by the Purchaser Purchase Returns and Allowances

Illustration: If Sauk pays Public Freight Company $150 for Illustration: Sauk Stereo returns $300 of goods to PW Audio
freight charges on its purchase from PW Audio Supply on Supply and prepares the following entry to recognize the
May 6, the entry on Sauk’s books is: return.
May 6 Freight-In (Transportation-In) 150 May 8 Accounts Payable 300

Cash 150 Purchase Returns and Allowances 300
Purchase Discounts Recording Sales of Merchandise

Illustration: On May 14 Sauk Stereo pays the balance due on Illustration: PW Audio Supply, records the sale of $3,800 of
account to PW Audio Supply, taking the 2% cash discount merchandise to Sauk Stereo on May 4 for sales invoice No.
allowed by PW Audio for payment within 10 days. Sauk 731 as follows.
Stereo records the payment and discount as follows.
May 4 Accounts Receivable 3,800
May 14 Accounts Payable 3,500 Sales Revenue 3,800
Purchase Discounts 70
Cash 3,430
No entry is recorded for cost of goods sold at the time of the
sale under a periodic system.
3/28/2023
Sales Returns and Allowances Sales Discounts

Illustration: To record the returned goods received from Illustration: On May 14, PW Audio Supply receives payment
Sauk Stereo on May 8, PW Audio Supply records the $300 of $3,430 on account from Sauk Stereo. PW Audio honors
sales return as follows. the 2% cash discount and records the payment of Sauk’s
account receivable in full as follows.
May 8 Sales Returns and Allowances 300
Accounts Receivable 300 May 14 Cash 3,430
Sales Discounts 70
Comparison of Entries— Comparison of Entries—

Perpetual vs. Periodic (1 of 2) Perpetual vs. Periodic (2 of 2)
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Adjusting Entries for Credit Sales with

Returns and Allowances (1 of 5)
Learning Objective 8 Illustration: On January 1, Rainbow Company sells 100 pairs
of shoes for $100 each on account to Tanner Inc. Rainbow
Appendix 5B allows Tanner to return any unused shoes within 45 days of
Prepare Adjusting Entries for Credit purchase. The cost of each product is $60. Rainbow records
the sale as follows.
Sales with Returns and Allowances
Jan. 1 Accounts Receivable 10,000
Sales Revenue 10,000
Cost of Goods Sold 6,000
Inventory 6,000
Adjusting Entries for Credit Sales with Adjusting Entries for Credit Sales with
Returns and Allowances (2 of 5) Returns and Allowances (3 of 5)
Illustration: On January 24, Tanner returns two pairs of Illustration: On January 31, Rainbow prepares monthly financial
shoes with a selling price of $100 each and a cost of $60 statements and estimates that it is likely that one more pair of
each because they were the wrong color. Rainbow records shoes will be returned. The selling price is $100 per pair with a
the return as follows. unit cost of $60. Rainbow records two adjusting entries to account
for this estimate.
Jan. 24 Sales Returns and Allowances 200
Accounts Receivable 200 Jan. 31 Sales Returns and Allowances 100
Allowance for Sales Returns and Allowances 100
Inventory 120
Cost of Goods Sold 120 Estimated Inventory Returns 60
Cost of Goods Sold 60
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Adjusting Entries for Credit Sales with Adjusting Entries for Credit Sales with
Returns and Allowances (4 of 5) Returns and Allowances (5 of 5)
Illustration: On February 18, Tanner returns another pair of shoes Illustration: If Tanner had initially paid for the shoes in cash
to Rainbow. The selling price is $100 per pair with a unit cost of or paid its balance due on a credit purchase prior to
$60. If Tanner has not already paid Rainbow for the shoes, returning the shoes on February 18, Rainbow would credit
Rainbow records the entry as follows. Accounts Payable rather than Accounts Receivable as shown
Feb. 18 Allowance for Sales Returns and Allowances 100 in the following entry.
Accounts Receivable 100 Jan. 31 Allowance for Sales Returns and Allowances 100
Inventory 60 Accounts Payable 100
Estimated Inventory Returns 60 Inventory 60
Estimated Inventory Returns 60
Similarities
Learning Objective 9 • Under both GAAP and IFRS, a company can choose to use
either a perpetual or a periodic inventory system.
Compare the Accounting for • The definition of inventories is basically the same under GAAP
Merchandising Under GAAP and and IFRS.
IFRS • Basic accounting entries for merchandising are the same under
both GAAP and IFRS.
3/28/2023

• Both GAAP and IFRS require that income statement • Under GAAP, companies generally classify income statement
information be presented for multiple years. items by function.
• Classification by function leads to descriptions like
• For example, IFRS requires that 2 years of income
administration, distribution, and manufacturing.
statement information be presented, whereas GAAP
requires 3 years. • Under IFRS, companies classify expenses either by nature or
by function.
• Classification by nature leads to descriptions such as the
following: salaries, depreciation expense, and utilities
expense.
• If a company uses the functional-expense method, disclosure
by nature is required in the notes to the financial statements.

Differences
• Presentation of the income statement under GAAP follows
either a single-step or multiple-step format. IFRS does not All rights reserved. Reproduction or translation of this work beyond that permitted in
mention a single-step or multiple-step approach. Section 117 of the 1976 United States Act without the express written permission of the
• Under IFRS, revaluation of land, buildings, and intangible
assets is permitted. Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up
• The initial gains and losses resulting from this revaluation
are reported as adjustments to equity, often referred to as no responsibility for errors, omissions, or damages, caused by the use of these programs
other comprehensive income. The effect of this difference or from the use of the information contained herein.
is that the use of IFRS results in more transactions affecting
other comprehensive income.
3/28/2023
Financial Accounting: Tools for Business Chapter Outline:

Decision Making
Learning Objectives
Ninth Edition
LO 1 Discuss how to classify and determine inventory.
LO 2 Apply inventory cost flow methods and discuss
their financial effects.
Chapter 6 LO 3 Explain the statement presentation and analysis of

inventory.
Reporting and Analyzing Inventory
This slide deck contains animations. Please disable animations if they
Prepared by
cause issues with your device.COBY HARMON
University of California, Santa Barbara Copyright ©2019 John Wiley & Sons, Inc. 394
Westmont College
Classifying and Determining Inventory

Merchandising Manufacturing
Learning Objective 1 Company Company
Discuss How to Classify and Determine One Classification: Three Classifications:
Inventory • Merchandise • Raw Materials
Inventory • Work in Process
• Finished Goods
Helpful Hint
Regardless of the classification, companies report all inventories
under Current Assets on the balance sheet.
3/28/2023
Determining Inventory Quantities Taking a Physical Inventory

Physical inventory is taken for two reasons under each • Involves counting, weighing, or measuring each
system: kind of inventory on hand
Perpetual System • Is performed
1. Check accuracy of inventory records • when the business is closed or business is slow
2. Determine amount of inventory lost due to wasted
• at the end of the accounting period
raw materials, shoplifting, or employee theft
Periodic System
1. Determine the inventory on hand
2. Determine cost of goods sold for the period
Determining Ownership of Goods Freight Costs

• Goods in transit
• Purchased goods that are not yet received
• Sold goods that are not yet delivered
• Goods in transit should be included in the inventory of
the company that has legal title to the goods. Ownership of the goods Ownership of the goods
passes to the buyer when the remains with the seller until
• Legal title is determined by the terms of sale
public carrier accepts the the goods reach the buyer.
goods from the seller.
Freight costs incurred by the seller are an operating expense.
3/28/2023
Determining Ownership of Goods (1 of 2) Consigned Goods

Review Question • Goods held that are owned by other parties
Goods in transit should be included in the inventory of • Consignee tries to sell the goods for the consignor
the buyer when the: (owner) for a fee, without taking ownership of the
goods
a. public carrier accepts the goods from the seller.
• Many car, boat, and antique dealers sell goods on
b. goods reach the buyer.
consignment. Why?
c. terms of sale are FOB destination.
d. terms of sale are FOB shipping point.
Do It! 1: Rules of Ownership (1 of 2) Do It! 1: Rules of Ownership (2 of 2)

Hasbeen Company completed its inventory count. It arrived at a Solution
total inventory value of $200,000. You have been given the
information listed below. Discuss how this information affects the 1. Goods of $15,000 held on consignment should be deducted
reported cost of inventory. from the inventory count.
2. The goods of $10,000 purchased FOB shipping point should be
1. Hasbeen included in the inventory goods held on consignment
added to the inventory count.
for Falls Co., costing $15,000.
3. Item 3 was treated correctly
2. The company did not include in the count purchased goods of
$10,000, which were in transit (terms FOB shipping point). Inventory = $200,000 − $15,000 + $10,000 = $195,000
3. The company did not include in the count inventory that had
been sold with a cost of $12,000, which was in transit (terms
FOB shipping point).
3/28/2023
Inventory Methods and Financial Effects

Inventory is accounted for at cost.
Learning Objective 2 • Cost includes all expenditures necessary to acquire goods
and place them in a condition ready for sale
Apply Inventory Cost Flow Methods • Unit costs are applied to quantities to determine the total
and Discuss Their Financial Effects cost of inventory and cost of goods sold using the
following costing methods:
 Cost flow assumptions
 Specific identification
 First-in, first-out
 Last-in, first-out
 Average-cost
Nature of Specific Identification Specific Identification (1 of 2)

• An actual physical flow costing method in which items Illustration: Crivitz TV Company purchases three identical 50-
still in inventory are specifically costed to arrive at the inch TVs on different dates at costs of $700, $750, and $800.
total cost of the ending inventory During the year, Crivitz sold two TVs at $1,200 each.
• Practice is relatively rare Data summary:
Purchases Blank
• Most companies make cost flow assumptions about
February 3 1 TV at $700
which units were sold
March 5 1 TV at $750
May 22 1 TV at $800
Sales Blank
June 1 2 TVs for $2,400 ($1,200 × 2)
3/28/2023
Specific Identification (2 of 2) Cost Flow Assumptions Used by U.S.

Crivitz sold the TVs it purchased on February 3 and May 22. Companies
Cost of goods sold = $700 + $800 = $1,500
The cost flow
Ending inventory = $750 assumption used does
not need to be
consistent with the
physical movement of
goods.
Data for Cost Flow Assumptions Nature of First-In, First-Out (FIFO)

Illustration: Data for Houston Electronics’ Astro condensers. • Costs of the earliest goods purchased are the first to
be recognized in determining cost of goods sold
• Often parallels actual physical flow of merchandise
• Companies determine units and costs of ending
inventory starting with the unit cost of the most
recent purchase and working backward until all units
of inventory have been costed
Beginning Inventory + Purchases − Ending Inventory = Cost of Goods Sold
3/28/2023
First-In, First-Out (FIFO) (1 of 2) First-In, First-Out (FIFO) (2 of 2)
Helpful Hint
Another way of thinking
about the calculation of FIFO
ending inventory is the LISH
assumption—last-in still-
here.
Nature of Last-In, First-Out (LIFO) Last-In, First-Out (LIFO) (1 of 2)

• Costs of the latest goods purchased are the first to
be recognized in determining cost of goods sold
• Seldom coincides with actual physical flow of
merchandise
• Exceptions include goods stored in piles, such as
coal or hay
3/28/2023
Last-In, First-Out (LIFO) (2 of 2) Nature of Average-Cost

• Allocates cost of goods available for sale on basis of
weighted-average unit cost incurred
• Applies weighted-average unit cost to units on hand
to determine cost of ending inventory
Helpful Hint
Another way of thinking about the calculation of LIFO ending inventory is the
FISH assumption—first-in still-here.
Average-Cost (1 of 2) Average-Cost (2 of 2)
3/28/2023
Financial Statement and Tax Effects Income Statement Effects of Inflation

In periods of inflation, the cost flow assumption can have
significant impacts both on income and on evaluations of
income.
• FIFO produces a higher net income because lower
unit costs of the first units purchased are matched
against revenue.
• LIFO produces a lower net income because higher
unit costs of the last goods purchased are matched
against revenue.
Income Statement Effects of Falling Prices Cost Flow Assumptions (1 of 4)

In periods of declining prices, the cost flow assumption Review Question
can have significant impacts both on income and on
The cost flow method that often parallels the actual
evaluations of income.
physical flow of merchandise is the
• Results from the use of FIFO and LIFO are reversed
a. FIFO method.
• FIFO will report the lowest net income and LIFO
b. LIFO method.
the highest.
c. average cost method.
• Regardless of whether prices are rising or falling,
average-cost produces net income between FIFO d. gross profit method.
and LIFO.
3/28/2023
Cost Flow Assumptions (3 of 4) Using Inventory Cost Flow Methods

Review Question Consistently
• Method should be used consistently
In a period of inflation, the cost flow method that results
in the lowest income taxes is the • Enhances comparability
a. FIFO method. • Although consistency is preferred, a company may change
its inventory costing method
b. LIFO method.
Quaker Oats
c. average cost method. Notes to the Financial Statements
Note 1: Effective July 1, the Company adopted the LIFO cost flow assumption for
d. gross profit method. valuing the majority of U.S. Grocery Products inventories. The Company believes
that the use of the LIFO method better matches current costs with current
revenues. The effect of this change on the current year was to decrease net
income by $16.0 million.
Do It! 2: Cost Flow Methods (1 of 3) Do It! 2: Cost Flow Methods (2 of 3)

The accounting records of Shumway Ag Implements show the The accounting records of Shumway Ag Implements show the
following data. following data.
Beginning inventory 4,000 units at $3 Beginning inventory 4,000 units at $3
Purchases 6,000 units at $4 Purchases 6,000 units at $4
Sales 7,000 units at $12 Sales 7,000 units at $12
Determine the cost of goods sold during the period under a Determine the cost of goods sold during the period under a
periodic system using FIFO. periodic system using LIFO.
Solution 4,000 units × $3 = $12,000 Solution 6,000 units × $4 = $24,000
3,000 units x $4 = 12,000 1,000 units x $3 = 3,000
$24,000
$27,000
3/28/2023
Do It! 2: Cost Flow Methods (3 of 3)

The accounting records of Shumway Ag Implements show the
following data.
Beginning inventory 4,000 units at $3 = $12,000
Purchases 6,000 units at $4 = 24,000 Explain the Statement Presentation
Sales 7,000 units at $12
$36,000
and Analysis of Inventory
Determine the cost of goods sold during the period under a
periodic system using average-cost.
Solution
$36,000 ÷ 10,000 units = $3.60 average cost per unit
$36,000 − ($3,000 ending units × $3.60) = $25,200
Inventory Presentation Note Presentation

• Inventory is classified in the balance sheet as a WAL-MART STORES, INC.
Notes to the Financial Statements
current asset immediately below receivables
Note 1. Summary of Significant Accounting Policies
• In a multiple-step income statement, cost of goods Inventories
The Company values inventories at the lower of cost or market as determined
sold is subtracted from net sales primarily by the retail method of accounting, using the last-in, first-out
(“LIFO”) method for substantially all of the Wal-Mart U.S. segment’s
• Disclosure is required of inventories. The inventory at the Walmart International segment is valued
primarily by the retail inventory method of accounting, using the first-in, first-
• Major inventory classifications out (“FIFO”) method. The retail method of accounting results in inventory
being valued at the lower of cost or market since permanent markdowns are
• Basis of accounting (cost, or lower-of-cost-or-net immediately recorded as a reduction of the retail value of inventory. The
realizable value) inventory at the Sam’s Club segment is valued using the L I F O method. At
January 31, 2017 and 2016, the Company’s inventories valued at L I F O
• Cost method (FIFO, LIFO, or average-cost) approximate those inventories as if they were valued at F I F O.
3/28/2023
Lower-of-Cost-or-Net Realizable Value Lower-of-Cost-or-Net Realizable Value

(1 of 3) (2 of 3)
When the value of inventory is lower than its cost When the value of inventory is lower than its cost
• Companies must “write down” inventory to its net • Applied to items in inventory after the company has
realizable value in the period in which the price used one of the cost flow methods (specific
decline occurs identification, FIFO, or average-cost) to determine
• Example of conservatism cost
• Net realizable value is the net amount a company • Companies that use LIFO or the retail inventory
expects to realize from the sale of inventory method are not required to use lower-of-cost-or-net
realizable value, instead they use a lower-of-cost-or-
market approach
Lower-of-Cost-or-Net Realizable Value Analysis

(3 of 3)
Inventory management is a critical task because
Illustration: Assume that Ken Tuckie TV has the following lines
of merchandise with costs and market values as indicated. • High inventory levels lead to
Net • Storage costs
Cost per Realizable Lower-of-Cost-or-Net
Blank Units Unit Value per Unit Realizable Value
• Interest cost on funds tied up in inventory
Flat-screen TVs 100 $600 $550 $ 55,000 ($550 x 100) • Costs associated with the obsolescence of technical
Satellite radios 500 90 104 45,000 ($90 x 500) goods or shifts in fashion
DVD recorders 850 50 48 40,800 ($48 x 850)
• Low inventory levels lead to
DVDs 3,000 5 6 15,000 ($5 x 3,000)
Total inventory $155,800 • Lost sales
3/28/2023
Inventory Turnover (1 of 2) Inventory Turnover (2 of 2)

Illustration: Data for Wal-Mart
(in millions) 2016 2015
Ending inventory $ 43,046 $44,469
Cost of goods sold 361,256 Blank
Adjustments for LIFO Reserve (1 of 3) Adjustments for LIFO Reserve (2 of 3)

Companies using LIFO are required to report the If Caterpillar had used F I F O all along, its inventory
• Difference between inventory reported using LIFO and would be $11,112 million, rather than $8,614 million.
Inventory using FIFO (in millions)
• Referred to as the LIFO reserve 2016 inventory using LIFO $8,614
Caterpillar Inc. 2016 LIFO reserve 2,498
Notes to the Financial Statements 2016 inventory assuming FIFO $11,112
Inventories: Inventories are stated at the lower of cost or market. Cost is
principally determined using the last-in, first-out (LIFO) method . . . .
If the FIFO (first-in, first-out) method had been in use, inventories would have been
$2,139 million and $2,498 million higher than reported at December 31, 2016, and
2015, respectively.
3/28/2023
Adjustments for LIFO Reserve (3 of 3) Do It! 3: LCNRV

The LIFO reserve can have a significant effect on ratios Tracy Company sells three different types of home heating stoves,
analysts commonly use. gas, wood, and pellet. The cost and net realizable value of its
inventory of stoves are:
Cost Net Realizable Value
Gas $ 84,000 $ 79,000
Wood 250,000 280,000
Pellet 112,000 101,000
Determine the value of the company’s inventory under the
lower-of-cost-or-net realizable value approach.
Gas $79,000, wood $250,000, and pellet $101,000 = $430,000.
Do It! 3: Inventory Turnover (1 of 2) Do It! 3: Inventory Turnover (2 of 2)

Early in 2022, Westmoreland Company switched to a just-in-time 2021 2022
inventory system. Its sales, cost of goods sold, and inventory Sales revenue $2,000,000 $1,800,000
amounts for 2021 and 2022 are shown below. Cost of goods sold 1,000,000 910,000
2021 2022 Beginning inventory 290,000 210,000
Sales revenue $2,000,000 $1,800,000 Ending inventory 210,000 50,000
Cost of goods sold 1,000,000 910,000 Determine inventory turnover and days in inventory for both years.
Beginning inventory 290,000 210,000 Inventory Turnover
Ending inventory 210,000 50,000 2021 2022
Determine the inventory turnover and days in inventory for 2021 $1,000,000 = 4 $910,000 = 7
($290,000 + $210,000) ÷ 2 ($210,000 + $50,000) ÷ 2
and 2022.
Days in Inventory
365 ÷ 4 = 91.3 days 365 ÷ 7 = 52.1 days
3/28/2023
Inventory Cost Flow Methods in a

Perpetual Inventory System
Appendix 6A
Apply Inventory Cost Flow Methods to
Perpetual Inventory Records
Assuming the Perpetual Inventory System, compute cost of goods

sold and ending inventory under FIFO, LIFO, and average-cost.
First-In, First-Out (FIFO) Perpetual Last-in, First-Out (LIFO) Perpetual
Cost of Goods Sold Ending Inventory Cost of Goods Sold Ending Inventory
3/28/2023
Average-Cost Perpetual
Appendix 6B
Indicate the Effects of Inventory Errors
on the Financial Statements
Cost of Goods Sold Ending Inventory
Effects of Inventory Errors Income Statement Effects of Errors (1 of 5)

Common causes of inventory errors Inventory errors affect the computation of cost of goods
sold, ending inventory, and net income in two periods.
• Failure to count or price inventory correctly
• An error in costing ending inventory of the current
• Not properly recognizing the transfer of legal title to
period will have a reverse effect on net income of the
goods in transit
next accounting period
• Errors affect both the income statement and balance
• Over the two years, the total net income is correct
sheet
because the errors offset each other
• Ending inventory depends entirely on the accuracy of
counting and costing the inventory
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Income Statement Effects of Errors (2 of 5) Income Statement Effects of Errors (3 of 5)

Inventory errors affect the computation of cost of goods
sold and net income. Beginning inventory
+ Cost of goods purchased
− Ending inventory
= Cost of goods sold
Inventory Error Cost of Goods Sold Net Income
Beginning inventory understated Understated Overstated
Beginning inventory overstated Overstated Understated
Combined income for
Ending inventory understated Overstated Understated 2-year period is
correct.
Ending inventory overstated Understated Overstated
Income Statement Effects of Errors (4 of 5) Balance Sheet Effects of Errors

Review Question • Effect determined by using the basic accounting
equation
Understating ending inventory will overstate
a. assets.
• Effects of errors in ending inventory on the balance
b. cost of goods sold.
sheet
c. net income. Ending Stockholders'
Inventory Error Assets Liabilities Equity
d. owner’s equity.
Overstated Overstated No effect Overstated
Understated Understated No effect Understated
3/28/2023
Similarities
Learning Objective 6 • IFRS and GAAP account for inventory acquisitions at historical
cost and value inventory at the lower-of-cost-or-market
Compare the Accounting for subsequent to acquisition.
Inventories Under GAAP and IFRS • Accounting for who owns the goods—goods in transit or
consigned goods—and costs to include in inventory are the
same under IFRS and GAAP.

Differences
• The requirements for accounting for and reporting inventories
are more principles based under IFRS. That is, GAAP provides All rights reserved. Reproduction or translation of this work beyond that permitted in
more detailed guidelines in inventory accounting. Section 117 of the 1976 United States Act without the express written permission of the
• A major difference between IFRS and GAAP relates to the
LIFO cost flow assumption. Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up
• GAAP permits the use of LIFO for inventory valuation.
• IFRS prohibits its use. FIFO and average-cost are the only or from the use of the information contained herein.
two acceptable cost flow assumptions permitted.
• Both sets of standards permit specific identification where
appropriate.
3/28/2023

Decision Making
Learning Objectives
Ninth Edition
LO 1 Define fraud and the principles of internal control.
LO 2 Apply internal control principles to cash.
Chapter 7 LO 3 Identify the control features of a bank account.
LO 4 Explain the reporting of cash and the basic
Fraud, Internal Control, and Cash principles of cash management.
Prepared by
COBY HARMONPlease disable animations if they
cause issues with your device.Westmont College
Fraud
• A dishonest act by an employee that results in
Learning Objective 1 personal benefit to the employee at a cost to the
employer
Define Fraud and the Principles of
• Why fraud occurs
Internal Control
• Fraud triangle
illustrates three
contributing
factors
3/28/2023
The Sarbanes-Oxley (SOX) Act Purposes of Internal Control

• Applies to publicly traded U.S. corporations • To safeguard assets
• Requirements imposed • To enhance accuracy and reliability of accounting
• Required to maintain a system of internal control records
• Corporate executives and boards of directors must • To increase efficiency of operations
ensure that these controls are reliable and effective
• To ensure compliance with laws and regulations
• Independent outside auditors must attest to
adequacy of internal control system
• SOX created Public Company Accounting Oversight
Board (PCAOB)
Internal Control (1 of 2) Internal Control Components

Review Question Five Primary Components
Internal control is used in a business to enhance the 1. Control environment
accuracy and reliability of its accounting records and to: 2. Risk assessment
a. safeguard its assets. 3. Control activities
b. prevent fraud. 4. Information and communication
c. produce correct financial statements. 5. Monitoring
d. deter employee dishonesty.
3/28/2023
Principles of Internal Control Activities Principles of Internal Control Activities

(1 of 6) (2 of 6)
Establishment of Responsibility Segregation of Duties

• Control is most effective when only • Different individuals should be
one person is responsible for a responsible for related activities
given task • Responsibility for record-keeping for
• Establishing responsibility often an asset should be separate from
requires limiting access only to physical custody of that asset
authorized personnel, and then
identifying those personnel

(3 of 6) (4 of 6)
Documentation Procedures Physical

• Companies should use Controls
prenumbered documents,
and all documents should
be accounted for
• Employees should promptly
forward source documents
for accounting entries to
the accounting department
3/28/2023

(5 of 6) (6 of 6)
Independent Internal Human Resource Controls

Verification • Bond employees who
• Records periodically handle cash
verified by an • Rotate employees’ duties
employee who is and require vacations
independent
• Conduct background
• Discrepancies checks
reported to
management
Principles of Internal Control (1 of 2) Data Analytics and Internal Controls

Review Question • Different aspects of journal entries can be monitored
continuously
The principles of internal control do not include
• Large dollar amounts in risky areas can be flagged
a. establishment of responsibility.
and investigated quickly
b. documentation procedures.
• Recipients of payments can be easily screened to
c. management responsibility. ensure that payments only go to authorized
d. independent internal verification. individuals and vendors
• Sophisticated models can be used to continually
estimate critical measures
3/28/2023
Limitations of Internal Control Do It! 1: Control Activities

• Costs should not exceed benefits Identify which control activity is violated in
Solution
each of the following situations.
• Human element 1. The person with primary responsibility for
• Size of the business reconciling the bank account and making all Segregation of
bank deposits is also the company’s duties
accountant.
2. Wellstone Company’s treasurer received an Human
Helpful Hint award for distinguished service because he resource
Controls may vary with the risk level of the activity. For example, had not taken a vacation in 30 years. controls
management may consider cash to be high risk and maintaining
inventories in the stockroom as lower risk. Thus, management 3. In order to save money on order slips and to
would have stricter controls for cash. reduce time spent keeping track of order Documentation
slips, a local bar/restaurant does not buy procedures
prenumbered order slips.
Cash Receipt Controls (1 of 6)
Apply Internal Control Principles to
Cash
3/28/2023
Cash Receipt Controls (2 of 6) Cash Receipt

Controls (3 of 6)
Over-the-Counter
Receipts
• Segregation of
recordkeeping from
physical custody
• An important
internal control
principle
Cash Receipt Controls (4 of 6) Cash Receipt Controls (5 of 6)

Mail Receipts Review Question
• Should be opened by two people, a list prepared, and Permitting only designated personnel such as cashiers to
each check endorsed “For Deposit Only” handle cash receipts is an application of the principle of
• Each mail clerk signs the list to establish responsibility a. segregation of duties.
for the data b. establishment of responsibility.
• Original copy of the list, along with checks, is sent to c. independent internal verification.
cashier’s department
d. human resource controls.
• Copy of list is sent to accounting department for
recording, clerks keep a copy
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Cash Disbursement Controls (1 of 6) Cash Disbursement

Generally, internal control over cash disbursements is Controls (2 of 6)
more effective when companies pay by check or
electronic funds transfer (EFT) rather than by cash.
Applications:
• Voucher system controls
• Petty cash fund (Appendix 7A)
Cash Disbursement Controls (3 of 6) Cash Disbursement Controls (4 of 6)

Review Question
The use of prenumbered checks in disbursing cash is an
application of the principle of
a. establishment of responsibility.
b. segregation of duties.
c. physical controls.
d. documentation procedures.
3/28/2023
Cash Disbursement Controls (6 of 6) Do It! 2: Control over Cash Receipts (1 of 2)

Voucher System L. R. Cortez is concerned about the control over cash receipts in his
fast-food restaurant, Big Cheese. The restaurant has two cash
• A network of approvals by authorized individuals, registers. At no time do more than two employees take customer
acting independently, to ensure all disbursements by orders and enter sales. Work shifts for employees range from 4 to 8
check are proper hours. Cortez asks your help in installing a good system of internal
control over cash receipts.
• A voucher is an authorization form prepared for each
expenditure in a voucher system Solution
• A separate cash register drawer should be assigned to each
employee at the start of each work shift, with register totals
set at zero.
Do It! 2: Control over Cash Receipts (2 of 2)

Solution
•Each employee should have access to only the assigned register Learning Objective 3
drawer to enter all sales.
•Each customer should be given a receipt.
Identify the Control Features of a Bank
•At the end of the shift, the employee should do a cash count. A Account
separate employee should compare cash count with register tape
(or point-of-sale records) to be sure they agree.
•Cortez should install an automated point-of-sale system that
would enable the company to compare orders entered in the
register to orders processed by the kitchen.
3/28/2023
Control Features of a Bank Account Electronic Funds Transfer (EFT) System

Use of a bank contributes significantly to good internal EFTs
control over cash. • Disbursement systems that use wire, telephone, or
• Minimizes amount of currency on hand computers to transfer cash from one location to
• Creates a double record of bank transactions another
• Bank records create an independent record of which • Use is quite common

to agree the company’s books with the bank records • Normally result in better internal control since no
• Bank reconciliation cash or checks are handled by company employees
Helpful Hint
Essentially, the bank statement is a copy of the bank’s records sent
to the customer or made available online for review.
Bank Bank Statements (2 of 5)

Statements Show the following
(1 of 5)
• Checks paid and other debits that reduce the
Each month, the balance
company receives • Debit card transactions
from the bank a
bank statement • Electronic funds transfers for bill payments
showing its bank • Deposits and other credits that increase the balance
transactions and • Direct deposit
balances.
• Automated teller machine
• Electronic funds transfer
3/28/2023
Bank Statements (3 of 5) Bank Statements (4 of 5)

Show the following Review Question
• Debit Memorandum The control features of a bank account do not include
• Bank service charge a. having bank auditors verify the correctness of the
• NSF check (not sufficient funds) bank balance per books.
• Credit Memorandum b. minimizing the amount of cash that must be kept on
• Collection of notes receivable hand.
• Interest earned c. providing a double record of all bank transactions.
• The account balance after each day’s transactions d. safeguarding cash by using a bank as a depository.
Reconciling the Bank Account Reconciliation Procedures

• Reconcile the balance per books and balance per bank
to their “correct or true” balance
• Reconciling Items
• Due to time lags
• Deposits in transit
• Outstanding checks
• Bank memoranda
• Due to errors
3/28/2023
Bank Reconciliation Illustrated (1 of 5) Bank Reconciliation Illustrated (2 of 5)

The bank statement for Laird Company shows a balance per bank of $15,907.45 on April Illustration: Prepare a bank reconciliation at April 30.
30, 2022. On this date the balance of cash per books is $11,709.45. Laird determines the
following reconciling items. Cash balance per bank statement $15,907.45
Deposits in transit: April 30 deposit (received by bank on May 1). $2,201.40 Deposit in transit 2,201.40
Outstanding checks: No. 453, $3,000.00; No. 457, $1,401.30; No. 460, Outstanding checks (5,904.00)
$1,502.70. 5,904.00
Adjusted cash balance per bank $12,204.85
Other deposits: Unrecorded electronic receipt from customer on account on
April 9 determined from bank statement. 1,035.00
Other payments: Unrecorded charges determined from the bank statement
Cash balance per books $11,709.45
are as follows: Blank Electronic funds transfer received $1,035.00
Returned NSF check on April 29 425.60 Error in recording check No. 443 36.00
Debit and credit card fees on April 30 120.00 NSF check (425.60)
Bank service charges on April 30 30.00 Debit and credit card fees (120.00)
Company errors: Check No. 443 was correctly written by Laird for $1,226 and Bank service charge (30.00)
was correctly paid by the bank on April 12.
However, it was recorded as $1,262 on Laird’s books. 36.00 Adjusted cash balance per books $12,204.85
Bank Reconciliation Illustrated (3 of 5) Bank Reconciliation Illustrated (4 of 5)

Entries resulting from bank reconciliation Book Error: The cash disbursements journal shows that check
no. 443 was a payment on account to Andrea Company, a
• Collection of EFT for a payment of account by a
supplier. The correcting entry is:
customer
Apr. 30 Cash 36.00
Apr. 30 Cash 1,035.00
Accounts Payable 36.00
Accounts Receivable 1,035.00
NSF Check: As indicated earlier, an NSF check becomes an
account receivable to the depositor. The entry is:
Apr. 30 Accounts Receivable 425.60
Cash 425.60
3/28/2023
Bank Reconciliation Illustrated (5 of 5) Bank Reconciliation (1 of 2)

Bank Charges Expense: Fees for processing debit and credit Review Question
card transactions are normally debited to the Bank Charges
The reconciling item in a bank reconciliation that will
Expense account, as are bank service charges. The entry is:
result in an adjusting entry by the depositor is
Apr. 30 Bank Charge Expense 150.00 a. outstanding checks.
Cash 150.00 b. deposit in transit.
c. a bank error.
d. bank service charges.
Do It! 3: Bank Reconciliation

Sally Kist, owner of Linen Kist Fabrics, asks you to explain how she
should treat the following reconciling items when reconciling the
company’s bank account: (1) a debit memorandum for an NSF Learning Objective 4
check, (2) a credit memorandum for an electronic funds transfer
from a customer, (3) outstanding checks, and (4) a deposit in
Explain the Reporting of Cash and the
transit. Basic Principles of Cash Management
Solution
Sally should treat the reconciling items as follows.
1. NSF check Deduct from balance per books
2. Electronic funds transfer Add to balance per books
3. Outstanding checks Deduct from balance per bank
4. Deposit in transit Add to balance per bank
3/28/2023
Reporting of Cash Cash Equivalents

• Cash consists of coins, currency (paper money), • Cash equivalents are short-term, highly liquid
checks, money orders, and money on hand or deposit investments that are both
• Balance sheet reports amount of cash available at a • Readily convertible to known amounts of cash,
given point in time and
 Listed first in current assets section • So near their maturity that their market value is
• Statement of cash flows shows sources and uses of relatively insensitive to changes in interest rates
cash during a period of time • Restricted cash
• Cash that is not available for general use
Reporting Cash on the Balance Sheet Reporting Cash (1 of 2)

Review Question
Delta Air Lines, Inc.
Balance Sheet (partial) Which of the following statements correctly describes the
(in millions) reporting of cash?
Assets Blank a. Cash cannot be combined with cash equivalents.
Current assets
Cash and cash equivalents $2,844 b. Restricted cash funds may be combined with Cash.
Short-term investments 959 c. Cash is listed first in the current assets section.
Restricted cash 122
d. Restricted cash funds cannot be reported as a
current asset.
3/28/2023
Do It! 4a: Reporting Cash Operating Cycle of a Merchandising

Indicate whether each of the following statements is true or false. Company
1. Cash and cash equivalents are comprised of coins,
currency (paper money), money orders, and N S F False
checks.
2. Restricted cash is classified as either a current asset
True
or noncurrent asset, depending on the circumstances.
3. A company may have a negative balance in its bank
account. In this case, it should offset this negative
False
balance against cash and cash equivalents on the
balance sheet.
4. Because cash and cash equivalents often includes
short-term investments, accounts receivable should False
be reported as the first item on the balance sheet.
Cash Management Cash Budgeting

• Shows anticipated cash flows, usually over a one- to
two-year period
 Cash receipts
 Cash disbursements
 Financing activities
• Enables company to plan ahead to cover possible
cash shortfalls and to make investments of idle funds
• Contributes to more effective cash management
3/28/2023
Cash Do It! 4b: Cash Budget

Budget Martian Company’s management wants to maintain a minimum monthly
cash balance of $15,000. At the beginning of March, the cash balance is
$16,500, expected cash receipts for March are $210,000, and cash
disbursements are expected to be $220,000. How much cash, if any, must
Martian borrow to maintain the desired minimum monthly balance?
Beginning cash balance $ 16,500
Add: Cash receipts for March 210,000
Total available cash 226,500
Less: Cash disbursements for March 220,000
Excess of available cash over cash disbursements 6,500
Financing
Add: Borrowings 8,500
Ending cash balance $ 15,000
Operation of a Petty Cash Fund

• Used to pay small amounts
Learning Objective 5 • Involves
Appendix 7A • Establishing the fund
Explain the Operation of a Petty Cash • Making payments from the fund
Fund • Replenishing the fund
3/28/2023
Establishing the Petty Cash Fund Making Payments From Petty Cash (1 of 2)
Illustration: If Laird Company decides to establish a $100 • Custodian has the authority to make payments from
fund on March 1, the entry is: the fund
• Size of expenditures is limited by management
March 1 Petty Cash 100
• Use of fund is limited to certain types of transactions
Cash 100
• Payments are documented on a prenumbered receipt
• Signatures of both the custodian and the individual
receiving payment are required on the receipt
• Supporting documents should be attached to receipt
Making Payments From Petty Cash (2 of 2) Replenishing the Petty Cash Fund (1 of 2)
• Custodian keeps receipts in petty cash box until fund Illustration: On March 15 the petty cash custodian requests a
is replenished check for $87. The fund contains $13 cash and petty cash
receipts for postage $44, freight-out $38, and miscellaneous
• Sum of receipts and money in fund should equal expenses $5. The entry is:
established total at all times
March 15 Postage Expense 44
Freight-Out 38
Miscellaneous Expense 5
Cash 87
3/28/2023
Replenishing the Petty Cash Fund (2 of 2)

Illustration: Assume in the preceding example that the
custodian had only $12 in cash in the fund plus the receipts as
listed. The request for reimbursement would therefore be for
$88. The entry is: Compare the Accounting Procedures
:March 15 Postage Expense 44 for Fraud, Internal Control, and Cash
Freight-Out 38 Under GAAP and IFRS
Miscellaneous Expense 5
Cash Over and Short 1
Cash 88

• The fraud triangle is applicable to all international companies. • GAAP takes a “rules-based” approach to accounting.
• Some of the major frauds on an international basis are • IFRS takes a “principles-based” approach.
Parmalat (Italy), Royal Ahold (the Netherlands), and • Accounting scandals have re-ignited the debate over the
Satyam Computer Services (India). relative merits of GAAP. The FASB announced that it intends to
• Rising economic crime poses a growing threat to introduce more principles-based standards.
companies, with 34% of all organizations worldwide
being victims of fraud in a recent 12-month period.
3/28/2023

• A parody of the Nobel Prizes, the Ig Nobel Prizes (read Ignoble, • Internal controls are actions required under SOX.
as not noble) are given each year in early October for 10 • While most companies have internal control systems in place,
achievements that “first make people laugh, and then make many have never completely documented them, nor had an
them think.” independent auditor attest to their effectiveness.
• At one time the Ig Nobel Prize in Economics went to the CEOs • Internal control review is a costly process but badly needed.
of those companies involved in the corporate accounting
scandals of that year for “adapting the mathematical concept • One study estimates the cost of SOX compliance for U.S.
of imaginary numbers for use in the business world.” companies at over $35 billion, with audit fees doubling in
the first year of compliance.

• Accounting and internal control procedures related to cash are • SOX internal control standards apply only to companies listed
essentially the same under both IFRS and GAAP. on U.S. exchanges.
• The definition used for cash equivalents is the same. • There is continuing debate over whether foreign issuers should
• Most companies report cash and cash equivalents together have to comply with the SOX extra layer of regulation.
under IFRS and GAAP.
• IFRS follows the same accounting policies related to the
reporting of restricted cash.
3/28/2023

Decision Making
copyright owner is unlawful. Request for further information should be addressed to the Chapter 8
no responsibility for errors, omissions, or damages, caused by the use of these programs Reporting and Analyzing Receivables
This slide deck containsINSTRUCTOR: Ph.D Phi Thi Kieu Anh
animations.
PreparedPlease
cause issues with your device.COBY HARMON
Westmont College
Chapter Outline:
Learning Objectives
LO 1 Explain how companies recognize accounts Learning Objective 1
receivable. Explain How Companies Recognize
LO 2 Describe how companies value accounts receivable Accounts Receivable
and record their disposition.
LO 3 Explain how companies recognize, value, and
dispose of notes receivable.
LO 4 Describe the statement presentation of receivables
and the principles of receivables management.
3/28/2023
Types of Receivables (1 of 2) Types of Receivables (2 of 2)

Amounts due from individuals and companies that are expected to Amounts due from individuals and companies that are expected to
be collected in cash. be collected in cash.
Amounts customers Written promise Nontrade receivables Receivables as a Company

owe on account that (formal instrument) such as interest, Company Percentage of Total Assets
result from the sale for amount to be loans to officers, Ford Motor Company 43.2%
of goods and received. advances to
services. employees, and General Electric 41.5
income taxes Minnesota Mining and 12.7
refundable. Manufacturing Company (3M)
Accounts Notes Other DuPont Co. 11.7
Receivable Receivable Receivables Intel Corporation 3.9
Recognizing Accounts Receivable (1 of 6) Recognizing Accounts Receivable (2 of 6)

• Service organizations record a receivable when they Illustration: Assume that Jordache Co. on July 1, 2022, sells
performs services on account merchandise on account to Polo Company for $1,000 terms
2/10, n/30. Prepare the journal entry to record this
• Merchandisers record receivables at point of sale of transaction on the books of Jordache Co.
merchandise on account
Jul. 1 Accounts Receivable 1,000
• Seller may offer a discount to encourage early
payment Sales Revenue 1,000
• Buyer might return goods found to be unacceptable

 Sales returns reduce receivables
3/28/2023

Illustration: On July 5, Polo returns merchandise worth $100 Illustration: On July 11, Jordache receives payment from Polo
to Jordache Co. Company for the balance due.
Jul. 5 Sales Returns and Allowances 100 Jul. 11 Cash ($900 − $18) 882
Accounts Receivable 100 Sales Discounts ($900 × .02) 18

Illustration: Some retailers issue their own credit cards. If you still owe the $300 from the June 15 transaction at the
Assume that you use your JCPenney Company credit card to end of the month, JCPenney charges interest of 1.5% per
purchase clothing with a sales price of $300 on June 15. month on the balance due. JCPenney makes an adjusting
entry to record interest revenue on June 30 as follows.
Jun. 15 Accounts Receivable 300
Sales Revenue 300 Jun. 30 Accounts Receivable 2.25
Interest Revenue 2.25
($300 × 1.5% × ½)
3/28/2023
Do It! 1 Recognizing Accounts Do It! 1 Recognizing Accounts

Receivable (1 of 3) Receivable (2 of 3)
On May 1, Wilton sold merchandise on account to Bates for On May 1, Wilton sold merchandise on account to Bates for
$50,000 terms 3/15, net 45. On May 4, Bates returns merchandise $50,000 terms 3/15, net 45. On May 4, Bates returns merchandise
with a sales price of $2,000. On May 16, Wilton receives payment with a sales price of $2,000. On May 16, Wilton receives payment
from Bates for the balance due. Prepare journal entries to record from Bates for the balance due. Prepare journal entries to record
the May transactions on Wilton’s books. (Ignore cost of goods sold the May transactions on Wilton’s books. (Ignore cost of goods sold
entries.) entries.)
May 1 Accounts Receivable 50,000 May 4 Sales Returns and Allowances 2,000
Sales Revenue 50,000 Accounts Receivable 2,000
Do It! 1 Recognizing Accounts

Receivable (3 of 3)
On May 1, Wilton sold merchandise on account to Bates for Learning Objective 2
$50,000 terms 3/15, net 45. On May 4, Bates returns merchandise
with a sales price of $2,000. On May 16, Wilton receives payment Describe How Companies Value
from Bates for the balance due. Prepare journal entries to record
the May transactions on Wilton’s books. (Ignore cost of goods sold
Accounts Receivable and Record Their
entries.) Disposition
May 16 Cash ($48,000 − $1,440) 46,560
Sales Discounts ($48,000 × .03) 1,440
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Valuation of Accounts Receivable Accounting for Uncollectible Accounts

• Valued at net realizable value Direct Write-Off Method
• Uncollectible accounts receivable • No matching
• Sales on account raise possibility of accounts not • Receivable not stated at net realizable value
being collected • Not acceptable for financial reporting
• Seller records losses that result from extending Allowance Method
credit
• Better matching
• Reported as Bad Debt Expense
• Receivable stated at net realizable value
• Required by GAAP
Reporting Accounts Receivable (1 of 3) Reporting Accounts Receivable (2 of 3)

How are these accounts used in accounting for accounts ABC Corporation Balance Sheet (partial)
receivable presented on the balance sheet? Current Assets
Cash $ 330
Allowance for
Accounts Doubtful Accounts receivable $500
Receivable Accounts Less: Allowance for doubtful accounts (25) 475
Beginning 500 25 Beginning Inventory 812
Prepaid expense 40
Ending 500 25 Ending Total current assets $1,657
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Reporting Accounts Receivable (3 of 3) Sale on Account

Alternate Presentation Journal entry for credit sale of $100
Accounts Receivable 100 Blank
ABC Corporation Balance Sheet (partial) Sales Blank 100
Current Assets
Cash $ 330 Allowance for
Accounts receivable, net of $25 allowance 475 Accounts Doubtful
Inventory 812 Receivable Accounts
Prepaid expense 40 Beginning 500 25 Beginning
Sale 100
Total current assets $1,657
Ending 500 25 Ending
Collection on Account Recognize Bad Debt Expense

Collect $333 on account Adjustment of $15 for estimated bad debts.
Cash 333 Blank Bad Debts Expense 15 Blank
Accounts Receivable Blank 333 Allowance for Doubtful Accounts Blank 15
Allowance for Allowance for

Accounts Doubtful Accounts Doubtful
Receivable Accounts Receivable Accounts
Beginning 500 333 Collect 25 Beginning Beginning 500 333 Collect 25 Beginning
Sale 100 Sale 100 15 Estimate
Ending 267 25 Ending Ending 267 40 Ending
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Write-Off Uncollectible Receivable Net Realizable Value Reporting

Write-off of uncollectible accounts of $10.
Allowance for Doubtful Accounts 10 Blank ABC Corporation Balance Sheet (partial)
Accounts Receivable Blank 10 Current Assets
Cash $ 330
Allowance for
Accounts receivable, net of $30 allowance 227
Accounts Doubtful Inventory 812
Receivable Accounts Prepaid expense 40
Beginning 500 333 Collect 25 Beginning
Sale 100 10 Write-off 10 15 Estimate
Ending 257 30 Ending
Direct Write-Off Method for Features of the Allowance Method for

Uncollectible Accounts Uncollectible Accounts
Illustration: Assume that Warden Co. writes off M. E. Doran’s • Estimate uncollectible accounts receivable
$200 balance as uncollectible on December 12. Warden’s
entry is: • Debit Bad Debt Expense and credit Allowance for
Doubtful Accounts
Bad Debt Expense 200
• Credit is to a contra-asset account
• At the time the specific account is written off as
uncollectible
Not acceptable for financial reporting unless bad debt losses
are insignificant. • Debit Allowance for Doubtful Accounts
• Credit Accounts Receivable
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Allowance Method for Uncollectibles Allowance Method for Uncollectibles

(1 of 4) (2 of 4)
Recording Estimated Uncollectibles Hampson Furniture

Illustration: Hampson Furniture has credit sales of $1,200,000
in 2022, of which $200,000 remains uncollected at December Current Assets
31. The credit manager estimates that $12,000 of these sales Cash $ 14,800
will prove uncollectible. Accounts receivable $200,000
Less: Allowance for doubtful accounts 12,000 188,000
Dec. 31 Bad Debt Expense 12,000 Inventory 310,000
Allowance for Doubtful Accounts 12,000 Prepaid expense 25,000
Allowance Method for Uncollectibles Allowance Method for Uncollectibles

(3 of 4) (4 of 4)
Write-Off of an Uncollectible Account Recovery of an Uncollectible Account

Illustration: On March 1, 2023, Hampson Furniture writes-off Illustration: On July 1, R. A. Ware pays the $500 amount that
$500 owed by R. A. Ware. The entry to record the write-off is: Hampson Furniture had written off on March 1. Hampson
Mar. 1 Allowance for Doubtful Accounts 500 makes these entries:
Accounts Receivable 500 July 1 Accounts Receivable 500
Allowance for Allowance for Doubtful Accounts 500
Accounts Doubtful
Receivable Accounts
Cash 500
Jan. 1 200,000 12,000 Jan. 1
500 Write-off 500
Mar. 1 199,500 11,500 Mar. 1
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Note Disclosure of the Allowance Estimating the Allowance Using the

Method Percentage-of-Receivables Basis
Nike, Inc. • Basing estimates on outstanding receivables
Allowance for Uncollectible Accounts Receivable
• Management establishes a percentage
Accounts receivable, net consist primarily of amounts receivable from customers. The relationship between amount of receivables and
Company makes ongoing estimates relating to the collectability of its accounts expected losses from uncollectible accounts
receivable and maintains an allowance for estimated losses resulting from the
inability of its customers to make required payments. In determining the amount of • Amount of bad debt expense to be recorded is
the allowance, the Company considers historical levels of credit losses and makes
judgments about the creditworthiness of significant customers based on ongoing difference between
credit on evaluations. Accounts receivable with anticipated collection dates greater
than 12 months from the balance sheet date and related allowances are considered • Required balance and
non-current and recorded in Deferred income taxes and other assets. The allowance
for uncollectible accounts receivable was $19 million and $43 million at May 31, 2017 • Existing balance in allowance account
and 2016, respectively.
Aging Accounts Receivable Recording the Allowance Estimate (1 of 2)

Aging of Accounts Receivable Illustration: The unadjusted trial balance shows Allowance
for Doubtful Accounts with a credit balance of $528. Prepare
the adjusting entry assuming $2,228 is the estimate of
uncollectible receivables from the aging schedule.
Dec. 31 Bad Debt Expense 1,700
Replace Allowance for Doubtful Accounts 1,700
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Recording the Allowance Estimate (2 of 2) Disclosure of Accounts Receivable

Illustration: Assume the unadjusted trial balance shows Skechers USA
Allowance for Doubtful Accounts with a debit balance of Notes to the Financial Statements
$500. Prepare the adjusting entry assuming $2,228 is the The likelihood of a material loss on an uncollectible account would be mainly
dependent on deterioration in the overall economic conditions in a particular country
estimate of uncollectible receivables. or region. Reserves are fully provided for all probable losses of this nature. For
receivables that are not specifically identified as high risk, we provide a reserve based
Dec. 31 Bad Debt Expense 2,728 upon our historical loss rate as a percentage of sales. Gross trade accounts receivable
Allowance for Doubtful Accounts 2,728 were $368.5 million and $368.2 million, and the allowance for bad debts, returns,
sales allowances and customer chargebacks were $41.6 million and $24.3 million, at
December 31, 2016 and 2015, respectively. Our credit losses charged to expense for
the years ended December 31, 2016, 2015 and 2014 were $12.7 million, $5.3 million,
and $11.8 million, respectively. In addition, we recorded sales return and allowance
expense for the years ended December 31, 2016, 2015 and 2014 of $18.1 million,
$2.3 million, and $2.3 million, respectively.
Do It! 2a: Bad Debt Expense Sale of Receivables to a Factor (1 of 2)

Brule Co. has been in business five years. The unadjusted • A method of disposing of accounts receivable
trial balance at the end of the current year shows:
• Receivables are sold to a finance company or bank
Accounts Receivable $30,000 Dr.
• Factors buys receivables from businesses and then
Sales Revenue $180,000 Cr.
Allowance for Doubtful Accounts $2,000 Dr.
collect payments directly from customers
• Typically charges a commission to company that is
Bad debts are estimated to be 10% of receivables. Prepare the
entry to adjust Allowance for Doubtful Accounts. selling receivables
• Fee ranges from 1% to 3% of receivables
Bad Debt Expense 5,000*
purchased
Allowance for Doubtful Accounts 5,000
* [(10% × $30,000) + $2,000]
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Sale of Receivables to a Factor (2 of 2) National Credit Card Sales (1 of 2)

Illustration: Assume that Hendredon Furniture factors • A method of disposing of accounts receivable
$600,000 of receivables to Federal Factors. Federal Factors
• Retailer pays card issuer a fee of 2 to 4% of invoice
assesses a service charge of 2% of the amount of
receivables sold. price
Journal entry to record the sale by Hendredon Furniture • Recorded same as cash sales
• Advantages to retailer
Cash 588,000
 Issuer does credit investigation of customer
Service Charge Expense 12,000
Accounts Receivable 600,000  Issuer maintains customer accounts
 Issuer undertakes collection and absorbs losses
($600,000 × 2% = $12,000)
 Receives cash more quickly
National Credit Card Sales (2 of 2) Do It! 2b: Factoring

Illustration: Anita Ferreri purchases $1,000 of sound Peter M. Kell Wholesalers Co. needs to raise $120,000 in cash
equipment for her restaurant from Karen Kerr Music Co., to safely cover next Friday’s employee payroll. Kell has
using her Visa First Bank Card. First Bank charges a service fee reached its debt ceiling. Kell’s present balance of outstanding
of 3%. receivables totals $750,000. Kell decides to factor $125,000 of
its receivables on September 7, 2022, to alleviate this cash
Journal entry to record the sales crunch. Record the entry that Kell would make when it raises
Cash 970 the needed cash. (Assume a 1% service charge.)
Service Charge Expense 30 Cash 123,750
Sales Revenue 1,000 Service Charge Expense 1,250
($1,000 × 3% = $30) Accounts Receivable 125,000
($125,000 × 1% = $1,250)
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Nature of Notes Receivable

Companies may grant credit in exchange for a promissory
note.
• A promissory note is a written promise to pay a
Explain How Companies Recognize, specified amount of money on demand or at a definite
Value, and Dispose of Notes Receivable time.
• Promissory notes may be used
• When lending or borrowing money
• When amount of transaction and credit period
exceed normal limits
• In settlement of accounts receivable
Notes Receivable Determining the Maturity Date

To the payee, the promissory note is a note receivable. Maturity date of a promissory note may be stated in one
To the maker, the promissory note is a note payable. of three ways
• On demand
• On a stated date
• At the end of a stated period of time
Note terms are expressed in
• Months
• Days
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Computing Interest Recognizing Notes Receivable

Face Value of Note × Annual Interest Rate × Time in Terms Illustration: Calhoun Company wrote a $1,000, two-
of One Year = Interest month, 12% promissory note dated May 1, to settle an
When counting days, omit date note is issued, but include open account. Prepare entry would Wilma Company
due date makes for the receipt of the note.
May 1 Notes Receivable 1,000

Valuing Notes Receivable Disposing of Notes Receivable (1 of 2)

• Report short-term notes receivable at their cash (net) 1. Notes may be held to their maturity date
realizable value 2. Maker may default and payee must make an
• Estimation of cash realizable value and recording bad adjustment to the account
debt expense and related allowance are similar to 3. Holder speeds up conversion to cash by selling the
accounts receivable note receivable
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Disposing of Notes Receivable (2 of 2) Honor of Notes Receivable

Honor of Notes Receivable Illustration: Wolder Co. lends Higley Inc. $10,000 on June 1,
accepting a five-month, 9% interest note. If Wolder presents
• A note is honored when its maker pays it in full at its
the note to Higley Inc. on November 1, the maturity date,
maturity date. Wolder’s entry to record the collection is:
Dishonor of Notes Receivable
Nov. 1 Cash 10,375
• A dishonored note is not paid in full at maturity. Notes Receivable 10,000
• Dishonored note receivables are no longer negotiable Interest Revenue 375
($10,000 × 9% x 5/12 = $375)
Accrual of Interest Receivable (1 of 2) Accrual of Interest Receivable (2 of 2)

Illustration: Suppose instead that Wolder Co. prepares Illustration: Prepare the entry Wolder’s would make to record
financial statements as of September 30. The adjusting entry the honoring of the Higley note on November 1.
by Wolder is for four months ending Sept. 30.
Nov. 1 Cash 10,375
Notes Receivable 10,000
Interest Receivable 300
Interest Revenue 75
Sept. 30 Interest Receivable 300 ($10,000 × 9% x 1/12 = $75)

Interest Revenue 300
($10,000 × 9% x 4/12 = $300)
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Dishonor of Notes Receivable (1 of 2) Dishonor of Notes Receivable (2 of 2)

Illustration: Assume that Higley Co. on November 1 indicates Illustration: If instead on November 1 there is no hope of
that it cannot pay at the present time. If it does expect collection, the note holder would write off the face value of the
eventual collection, Wolder Co. would make the following note by making the following entry at the time the note is
entry at the time the note is dishonored assuming no previous dishonored assuming no previous accrual of interest).
accrual of interest.
Nov. 1 Allowance for Doubtful Accounts 10,000
Nov. 1 Accounts Receivable 10,375 Notes Receivable 10,000
Interest Revenue 375
Do It! 3: Recognizing Notes Receivable

Gambit Stores accepts from Leonard Co. a $3,400, 90-day, 6% note
dated May 10 in settlement of Leonard’s overdue open account.
The note matures on August 8. What entry does Gambit make at
the maturity date, assuming Leonard pays the note and interest in Describe the Statement Presentation of
full at that time?
Solution
Receivables and the Principles of
Interest payable at maturity date = $3,400 x 6% x 90/360 = $51 Receivables Management
Cash 3,451
Interest Revenue 51
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Financial Statement Presentation of Managing Receivables

Receivables Five steps in managing accounts receivable
Deere & Company • Determine to whom to extend credit.
(in millions) • Establish a payment period.
Receivables Blank
Receivables from unconsolidated subsidiaries $ 30 • Monitor collections.
Trade accounts and notes receivable 3,278
Financing receivables 27,583
• Evaluate the liquidity of receivables.
Restricted financing receivables 4,616 • Accelerate cash receipts from receivables when
Other receivables 1,500
Total receivables 37,007 necessary.
Less: Allowance for doubtful trade receivables 175
Net receivables $36,832
Managing Receivables by Extending Managing Receivables with Payment

Credit Periods
• If credit policy is too tight, customers and sales will be
lost • Companies should determine a required payment
period and communicate that policy to their
• If credit policy is too loose, sales may be made to customers
customers who will pay either very late or not at all
• Payment period should be consistent with that of
• It is important to competitors
 Check references on potential new customers
 Check financial health of continuing customers
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Managing Receivables Through Collections Evaluating Liquidity of Receivables (1 of 2)

• Monitoring Collections Accounts Receivable Turnover
• Prepare an accounts receivable aging schedule at least • Assess liquidity of receivables
monthly • Measure number of times, on average, a company
• Helps managers estimate timing of future cash collects receivables during the period
inflows Average Collection Period
• Provides information about collection experience • Assess effectiveness of credit and collection policies
of company and identifies problem accounts
• Should not exceed credit term period
• Significant concentrations of credit risk must be
discussed in notes to financial statements
Evaluating Liquidity of Receivables (2 of 2) Accelerating Cash Receipts

Three reasons receivables are sold
• Size
• May be the only reasonable source of cash
• Billing and collection are often time-consuming and
Replace costly
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Managing Receivables Do It! 4: Analysis of Receivables

In 2022, Lebron James Company had net credit sales of $923,795
for the year. It had a beginning accounts receivable (net) balance
of $38,275 and an ending accounts receivable (net) balance of
$35,988. Compute Lebron James Company’s accounts receivable
turnover and average collection period in days.
Similarities
Learning Objective 5 • Recording receivables, recognition of sales returns and
allowances and sales discounts, and the allowance
Explain Compare the Accounting for method to record bad debts are the same for GAAP and
IFRS.
Receivables Under GAAP and IFRS • Both IFRS and GAAP use the term impairment to indicate
that a receivable that may not be collected.
• The FASB and IASB have worked to implement fair value
measurement for financial instruments, such as
receivables.
• Both Boards have faced bitter opposition from various
factions.
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• IFRS implies that receivables with different characteristics • IFRS and GAAP differ in the criteria used to determine
should be reported separately. how to record a factoring transaction.
• There is no standard that mandates this segregation. • IFRS uses a combination approach focused on risks
• IFRS differentiates the approach for estimating and rewards and loss of control.
uncollectible accounts for receivables with a significant • GAAP uses loss of control as the primary criterion.
financing component (e.g., notes receivable). • IFRS permits partial derecognition of receivables; GAAP
• Based on whether the receivables have experienced a does not.
deterioration in credit quality.

Decision Making
copies for his/her own use only and not for distribution or resale. The Publisher assumes Chapter 9
or from the use of the information contained herein. Reporting and Analyzing Long-Lived Assets
Prepared Please
COBY HARMON
device. of California, Santa Barbara
Copyright ©2019 John Wiley & Sons, Inc. 607 Westmont College
3/28/2023
Chapter Outline
Learning Objectives
LO 1 Explain the accounting for plant asset Learning Objective 1
expenditures. Explain the Accounting for Plant Asset
LO 2 Apply depreciation methods to plant assets.
Expenditures
LO 3 Explain how to account for the disposal of plant
assets.
LO 4 Identify the basic issues related to reporting
intangible assets.
LO 5 Discuss how long-lived assets are reported and
analyzed.
Plant Asset Expenditures Plant Assets

Plant assets are resources that have Plant assets are critical to a company’s success.
• physical substance (a definite size and shape),
• are used in the operations of a business,
• are not intended for sale to customers,
• are expected to provide service to the company for a
number of years, except for land.
Referred to as property, plant, and equipment; plant and
equipment; and fixed assets.
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Valuing Plant Assets Revenue and Capital Expenditures

• Historical cost principle • Revenue expenditures
• Requires that companies record plant assets at cost • Costs incurred to acquire a plant asset that are
• Cost consists of all expenditures necessary to acquire expensed immediately
an asset and make it ready for its intended use
• Capital expenditures
• Measured by the cash paid in a cash transaction or the
cash equivalent price paid • Costs included in a plant asset account
• Cash equivalent price is
• Fair value of asset given up or
• Fair value of asset received
whichever is more clearly determinable
Cost of Land (1 of 3) Cost of Land (2 of 3)

• Include all necessary costs incurred in making land Illustration: Hayes Company acquires real estate at a cash cost
ready for its intended use of $100,000. The property contains an old warehouse that is
razed at a net cost of $6,000 ($7,500 in costs less $1,500
• Increase the Land account with a debit
proceeds from salvaged materials). Additional expenditures
• Costs typically include are the attorney’s fee, $1,000, and the real estate broker’s
• Cash purchase price commission, $8,000.
• Closing costs such as title and attorney’s fees Required: Determine the amount to be reported as the cost
of the land.
• Real estate brokers’ commissions
• Accrued property taxes and other liens on land
assumed by purchaser at acquisition
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Cost of Land (3 of 3) Cost of Land Improvements

Required: Determine amount to be reported as the cost of • Includes all expenditures necessary to make the
the land. improvements ready for their intended use
Blank Land
• Limited useful lives
Cash price of property ($100,000) $100,000
Net removal cost of warehouse ($6,000) 6,000 • Expense by depreciating over the useful lives
Attorney's fees ($1,000) 1,000 • Examples: driveways, parking lots, fences, landscaping,
Real estate broker’s commission ($8,000) 8,000 and underground sprinklers
Cost of Land $115,000
Cost of Buildings (7 of 11) Cost of Equipment (2 of 3)

• Includes all costs related directly to purchase or • Include all costs incurred in acquiring the equipment
construction and preparing it for use
• Purchase costs • Costs typically include
• Purchase price, closing costs such as attorney’s fees, title
• Cash purchase price
insurance, etc. and real estate broker’s commission
• Remodeling and replacing or repairing the roof, floors, • Sales taxes
electrical wiring, and plumbing • Freight charges
• Construction costs • Insurance during transit paid by purchaser
• Contract price plus payments for architects’ fees, building • Expenditures for assembling, installing, and testing
permits, and excavation costs
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Cost of Equipment (2 of 3) Cost of Equipment (3 of 3)

Illustration: Lenard Company purchases a delivery truck at a Illustration: Lenard Company purchases a delivery truck at a
cash price of $22,000. Related expenditures are sales taxes cash price of $22,000. Related expenditures are sales taxes
$1,320, painting and lettering $500, motor vehicle license $1,320, painting and lettering $500, motor vehicle license
$80, and a three-year accident insurance policy $1,600. $80, and a three-year accident insurance policy $1,600.
Compute the cost of the delivery truck. Prepare the journal entry to record these costs.
Blank Truck
Cash price $22,000 Equipment 23,820
License Expense 80
Sales taxes 1,320
Prepaid Insurance 1,600
Painting and lettering 500 Cash 25,500
Cost of Delivery Truck $23,820
Expenditures During Useful Life To Buy or Lease?

Ordinary repairs • Lease
• Expenditures to maintain the operating efficiency • A contractual agreement in which the owner of an
and productive life of the unit asset (lessor) allows another party (lessee) to use the
asset for a period of time at an agreed price
• Debited to Maintenance and Repairs Expense
• Advantages of leasing
Additions and improvements
• Reduced risk of obsolescence
• Costs incurred to increase the operating efficiency,
productive capacity, or useful life of a plant asset • Little or no down payment
• Debited to the related plant asset account • Shared tax advantages
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Do It! 1: Cost of Plant Assets

Drummond Corp. purchases a delivery truck and incurs
the costs below. Explain how the company should Learning Objective 2
account for each of these costs. Apply Depreciation Methods to Plant
Invoice cost of $15,000 cash Cost of truck
Assets
Sales taxes of $900 Cost of truck
Delivery costs of $500 Cost of truck
$200 for painting and lettering Cost of truck
$600 for an annual insurance policy Operating expense
$80 for a motor vehicle license Operating expense
Depreciation Factors in Computing Depreciation

• Process of allocating to expense the cost of a plant asset
over its useful life in a rational and systematic manner
• Process of cost allocation, not asset valuation
• Applies to land improvements, buildings, and equipment,
not land
• Allocated and depreciable, because the revenue-producing
ability of the asset will decline over the asset’s useful life
Accumulated depreciation
Depreciation expense
Reported on the balance sheet
Reported on the income
as a deduction from plant
statement
assets
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Selecting a Depreciation Method Calculating Depreciation

Management selects the method it Illustration: Bill’s Pizzas purchased a small delivery truck on
believes best measures an asset’s January 1, 2022.
contribution to revenue over its
Cost $13,000
useful life.
Expected salvage value $1,000
1) Straight-line method Estimated useful life (in years) 5
Estimated useful life (in miles) 100,000
2) Declining-balance method
3) Units-of-activity method Required: Compute depreciation using:
(a) Straight-Line. (b) Units-of-Activity. (c) Declining-Balance.
Straight-Line Method (1 of 3) Straight-Line Method (2 of 3)

Depreciation expense is same amount each year. Blank Computations Blank Blank End of Year − $2,400
*$13,000
Depreciable Annual Accumulated Book
Year Cost x Rate = Expense Depreciation Value
2022 $12,000 x 20% = $ 2,400 $ 2,400 $10,600*
2023 12,000 x 20 = 2,400 4,800 8,200
2024 12,000 x 20 = 2,400 7,200 5,800
2025 12,000 x 20 = 2,400 9,600 3,400
2026 12,000 x 20 = 2,400 12,000 1,000
$12,000
Annual Journal Entry
Dec. 31 Depreciation Expense 2,400
Accumulated Depreciation 2,400
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Straight-Line Method (3 of 3) Do It! 2a: Straight-Line Depreciation

If the delivery truck was purchased on April 1, 2022. On January 1, 2022, Iron Mountain Ski Corporation purchased a
new snow-grooming machine for $50,000. The machine is
Blank Computations Blank End of Year
Blank
estimated to have a 10-year life with a $2,000 salvage value. What
Depreciable Annual Partial Depreciation Accum. journal entry would Iron Mountain Ski Corporation make at
Year Cost x Rate = Expense x Year = Expense Deprec.
December 31, 2022, if it uses the straight-line method of
2022 $12,000 x 20% = $ 2,400 x 9/12 = $ 1,800 $1,800
depreciation?
2023 12,000 x 20 = 2,400 x = 2,400 4,200 Salvage Annual
2024 12,000 x 20 = 2,400 x = 2,400 6,600 Year Cost - Value x Rate = Expense
2025 12,000 x 20 = 2,400 x = 2,400 9,000 2022 $50,000 - $2,000 x 10% = $4,800
2026 12,000 x 20 = 2,400 x = 2,400 11,400
2027 12,000 x 20 = 2,400 x 3/12 = 600 12,000 2022 Depreciation Expense 4,800
$12,000 Dec. 31 Accumulated Depreciation 4,800
Declining-Balance Method (1 of 3) Declining-Balance Method (2 of 3)

• Accelerated method Blank Computations Blank Blank End of Year
Beginning Annual Accumulated Book
• Decreasing annual depreciation expense over asset’s
Year Book Value x Rate = Expense Depreciation Value
useful life
2022 $13,000 x 40% = $ 5,200 $ 5,200 $7,800 (a)
• Double-declining-balance rate is double the straight- 2023 7,800 x 40 = 3,120 8,320 4,680
line rate 2024 4,680 x 40 = 1,872 10,192 2,808
2025 2,808 x 40 = 1,123 11,315 1,685
• Rate applied to book value 2026 1,685 x 40 = 685 (b) 12,000 1,000
$12,000
(a) $13,000 − $5,200

(b) $1,685 x 40% = $674, expense adjusted to $685 to result in salvage value of $1,000.
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Declining-Balance Method (3 of 3) Units-of-Activity Method (1 of 2)

Assume the delivery truck was purchased on April 1, 2022. • Companies estimate total units of activity to calculate
Blank Computations Blank Blank End of Year depreciation cost per unit
Beginning Annual Partial Depreciation Accum. • Expense varies based on units of activity
Year Book Value x Rate = Expense x Year = Expense Deprec.
2022 $13,000 x 40% = $ 5,200 x 9/12 = $ 3,900 $3,900 • Depreciable cost is cost less salvage value
2023 9,100 x 40 = 3,640 x Blank = 3,640 7,540
2024 5,460 x 40 = 2,184 x Blank = 2,184 9,724 Depreciable Total Units Cost
2025 3,276 x 40 = 1,310 x Blank = 1,310 11,034 Cost ÷ of Activity = per Unit
2026 1,966 x 40 = 786 x = 786 11,820
$12,000 ÷ 100,000 = $0.12
2027 1,180 x 40 = 472 x = 180 (a) 12,000
$12,000
(a) Expense adjusted to $180 to result in salvage value of $1,000.
Units-of-Activity Method (2 of 2) Management’s Choice: Comparison (1 of 2)

Blank Computations Blank Blank End of *$13,000
Year − $1,800 Straight- Declining- Units-of-
Miles Annual Accumulated Book Year Line Balance Activity
Year Driven x Rate = Expense Depreciation Value 2022 $ 2,400 $ 5,200 $ 1,800
2022 15,000 x $.012 = $ 1,800 $ 1,800 $11,200*
2023 2,400 3,120 3,600
2023 30,000 x .012 = 3,600 5,400 7,600
2024 20,000 x .012 = 2,400 7,800 5,200
2024 2,400 1,872 2,400
2025 25,000 x .012 = 3,000 10,800 2,200 2025 2,400 1,123 3,000
2026 10,000 x .012 = 1,200 12,000 1,000 2026 2,400 685 1,200
$12,000 $12,000 $12,000 $12,000
Journal Entry
2022 Depreciation Expense 1,800
Annual depreciation expense varies, but total depreciation
Dec. 31 Accumulated Depreciation 1,800 expense is the same ($12,000) for the five-year period.
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Management’s Choice: Comparison (2 of 2) Depreciation and Income Taxes

• IRS does not require taxpayers to use the same
depreciation method on the tax return that is used in
preparing financial statements.
• IRS requires either
• Straight-line method
• Modified Accelerated Cost Recovery System
(MACRS)
• Special accelerated-depreciation method
• NOT acceptable under GAAP
Depreciation Disclosure in the Notes Revising Periodic Depreciation (1 of 4)

• Accounted for in period of change and future periods
Southwest Airlines
• Considered to be a change in estimate
• Not handled retrospectively
Property and equipment Depreciation is provided by the
straight-line method to estimated residual values over periods • Not considered to be an error
ranging from 23 to 25 years for flight equipment.
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Revising Periodic Depreciation (2 of 4) Revising Periodic Depreciation (3 of 4)

Illustration: Arcadia purchased equipment for $510,000 with Calculation of depreciation expense for first 7 years.
an estimated useful life of 10 years and a salvage value of Equipment cost $510,000
$10,000 at the end of that time. Depreciation has been Salvage value − 10,000
recorded for 7 years on a straight-line basis. In 2022 (year 8), Depreciable base 500,000
it determined that the total estimated life should be 15 years Useful life (original) ÷ 10 years
with a salvage value of $5,000 at the end of that time. Annual depreciation $ 50,000 × 7 years = $350,000
Question: Net book value at date of change in estimate (after 7 years).

Plant Assets:
What is the journal entry to correct the No Entry
Equipment $510,000
prior years’ depreciation? Required Accumulated depreciation 350,000
Net book value $160,000
Revising Periodic Depreciation (4 of 4) Impairments

Calculation of depreciation expense for 2022, year 8. • Permanent decline in the fair value of an asset
Net book value after year 7 $160,000
• Asset is written down to its new fair value during the
Salvage value (revised) − 5,000
Depreciable base 155,000 year in which the decline in value occurs
Remaining life ÷ 8 years • Avoids overstating the asset in the accounting records
Annual depreciation $ 19,375
Journal entry for 2022 and future years

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Do It! 2b: Revised Depreciation (1 of 3) Do It! 2b: Revised Depreciation (2 of 3)

Chambers Corporation purchased a piece of equipment for Calculation of depreciation expense for first 2 years.
$36,000. It estimated a 6-year life and $6,000 salvage value. Thus, Equipment cost $ 36,000
straight-line deprecia on was $5,000 per year [($36,000 − $6,000) Salvage value − 6,000
÷ 6]. At the end of year three (before the depreciation adjustment), Depreciable base 30,000
it estimated the new total life to be 10 years and the new salvage
Useful life (original) ÷ 6 years
value to be $2,000.
Annual depreciation $ 5,000 × 2 years = $10,000
Compute the revised depreciation.
Net book value at date of change in estimate (after 2 years).
Plant Assets:
Equipment $36,000
Accumulated depreciation 10,000
Net book value $26,000
Do It! 2b: Revised Depreciation (3 of 3)

Calculation of revised depreciation expense for remaining years.
Net book value after year 2 $26,000 Learning Objective 3
Salvage value (revised) − 2,000
Depreciable base 24,000 Explain How to Account for the
Remaining life
Annual depreciation
÷ 8 years
$ 3,000
Disposal of Plant Assets
Journal entry for each remaining year

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Disposal of Plant Assets Determining Gain or Loss on the Sale of

Three ways companies dispose of plant assets Plant Assets
• Compare the book value of the asset with the
proceeds received from the sale
• If proceeds exceed the book value, a gain on
disposal occurs
Accounting for disposals
• If proceeds are less than the book value, a loss on
• Record depreciation up to the date of disposal disposal occurs
• Eliminate asset by
• Debiting Accumulated Depreciation, and
• Crediting the asset account
Accounting for Sale of Plant Assets (1 of 3) Accounting for Sale of Plant Assets (2 of 3)
Illustration: On July 1, 2022, Wright Company sells office Cost of office furniture $60,000
furniture for $16,000 cash. The office furniture originally cost Less: Accumulated depreciation ($41,000 + $8,000) 49,000
$60,000 and as of January 1, 2022, had accumulated Book value at date of disposal 11,000
depreciation of $41,000. Depreciation for the first six months Proceeds from sale 16,000
of 2022 is $8,000. Wright records depreciation expense and Gain on disposal of plant asset $ 5,000
updates accumulated depreciation to July 1 as follows.
Wright records the sale as follows on July 1.
Jul. 1 Depreciation Expense 8,000 Jul. 1 Cash 16,000
Accumulated Depreciation 8,000 Accumulated Depreciation 49,000
Equipment 60,000
Gain on Disposal of Plant Assets 5,000
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Accounting for Sale of Plant Assets (3 of 3) Retirement of Plant Assets

Illustration: Assume that instead of selling the office furniture • No cash is received
for $16,000, Wright sells it for $9,000.
• Decrease Accumulated Depreciation with a debit for
Cost of office furniture $60,000 full amount of depreciation taken over life of asset
Less: Accumulated depreciation ($41,000 + $8,000) 49,000
Book value at date of disposal 11,000 • Decrease asset account with a credit for original cost
Proceeds from sale 9,000 of asset
Loss on disposal of plant asset $ 2,000
Jul. 1 Cash 9,000

Loss on Disposal of Plant Assets 2,000
Equipment 60,000
Do It! 3: Plant Asset Disposal (1 of 2) Do It! 3: Plant Asset Disposal (2 of 2)

Overland Trucking has an old truck that cost $30,000 and has Overland Trucking has an old truck that cost $30,000 and has
accumulated depreciation of $16,000. accumulated depreciation of $16,000.
Assume two different situations: Assume two different situations:
1. The company sells the old truck for $17,000 cash. 1. The company sells the old truck for $17,000 cash.
2. The truck is worthless, so the company simply retires it.
2. The truck is worthless, so the company simply retires it.
What entry should Overland use to record scenario 1?
What entry should Overland use to record scenario 2?
Cash 17,000
Accumulated Depreciation 16,000 Accumulated Depreciation 16,000
Equipment 30,000 Loss on Disposal of Plant Asset 14,000
Equipment 30,000
Gain on Disposal of Plant Assets 3,000
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Intangible Assets
• Are rights, privileges, and competitive advantages that
Learning Objective 4 result from ownership of long-lived assets that do not
possess physical substance
Identify the Basic Issues Related to
• May have a limited or an indefinite life
Reporting Intangible Assets
• Common types of intangibles
• Patents • Trademarks
• Copyrights • Trade names
• Franchises or licenses • Goodwill
Accounting For Intangibles Cost of Patents

Limited-life intangibles • Exclusive right to manufacture, sell, or otherwise
control an invention for a period of 20 years from
• Amortize to expense date of grant
• Credit asset account or accumulated amortization • Capitalize costs of purchasing a patent and amortize
Indefinite-life intangibles over its 20-year life or its useful life, whichever is
shorter
• No foreseeable limit on time asset is expected to
provide cash flow • Expense any R&D costs in developing a patent
• Legal fees incurred successfully defending a patent
• No amortization are capitalized to Patent account
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Amortizing Patents Research and Development Costs

Illustration: National Labs purchases a patent at a cost of $60,000 • Expenditures that may lead to
on June 30. National estimates the useful life to be eight years.
Prepare the journal entry to record the amortization for the six- • Patents
month period ended December 31. • Copyrights
Cost $60,000
Useful life ÷ 8 • New processes
Depreciable base 7,500 • New products
6 months × 6/12
Amortization $ 3,750 • All R&D costs are expensed when incurred
Dec. 1 Amortization Expense 3,750

Patents 3,750
Copyrights Trademarks and Trade Names

• Gives owner exclusive right to reproduce and sell an • Word, phrase, jingle, or symbol that distinguishes or
artistic or published work identifies a particular enterprise or product
• Granted for life of creator plus 70 years  Wheaties, Monopoly, Sunkist, Kleenex, Coca-Cola,
• Capitalize costs of acquiring and defending Big Mac, and Jeep
• Amortized to expense over useful life • Legal protection for indefinite number of 20-year
renewal periods
• Capitalize acquisition costs
• No amortization
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Franchises Goodwill
• Contractual arrangement between a franchisor and a • Includes exceptional management, desirable location,
franchisee good customer relations, skilled employees, high-
 Toyota, Shell, Subway, and Marriott are quality products, etc.
franchises • Only recorded when an entire business is purchased
• Franchise (or license) with a limited life should be • Goodwill is recorded as the excess of ...
amortized to expense over life of franchise • FMV of identifiable net assets acquired over
• Franchise with an indefinite life should be carried at • Purchase price
cost and not amortized
• Internally created goodwill should not be capitalized
Do It! 4: Classification Concepts (1 of 3) Do It! 4: Classification Concepts (2 of 3)

Match the term most directly associated with each statement. Match the term most directly associated with each statement.
Copyright Amortization Copyright Amortization
Intangible assets Franchise Intangible assets Franchise
Research and development costs Research and development costs
1. The allocation to expense of the cost of an 3. An exclusive right granted by the federal
intangible asset over the asset’s useful life. government to reproduce and sell an artistic
or published work.
2. Rights, privileges, and competitive
advantages that result from the ownership 4. A right to sell certain products or services or
of long-lived assets that do not possess to use certain trademarks or trade names
physical substance. within a designated geographic area.
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Do It! 4: Classification Concepts (3 of 3)

Match the term most directly associated with each statement.
Copyright Amortization Learning Objective 5
Intangible assets Franchise
Research and development costs
Discuss How Long-Lived Assets Are
5. Costs incurred by a company that often
Reported and Analyzed
lead to patents or new products. These
costs must be expensed as incurred.
Statement Presentation of Long-Lived Assets

Artex Company
(in thousands) Return on Assets In Millions
Current assets Net income, 2017 $1,147
Cash $ 430 Use this information for Total assets, 12/31/17 9,781
Accounts receivable 100 JetBlue to calculate return
Inventory 910 Total assets, 12/31/16 9,323
Total current assets $ 1,440 on assets for 2017.
Property, plant, and equipment Net sales, 2017 7,015
Land 920
Buildings $7,600
Less: Accumulated depreciation—buildings 500 7,100
Equipment 3,870
Less: Accumulated depreciation—equipment 620 3,250
Total property, plant, and equipment 11,270
Intangible assets
Patents 440
Trademarks 180
Goodwill 900 1,520
Total assets $14,230 Indicates the amount of net income generated by each dollar of assets
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Asset Turnover In Millions

Profit Margin Revisited (1 of 2)
Net income, 2017 $1,147
Use this information for Total assets, 12/31/17 9,781 Indicates how effective a company is in turning its sales
JetBlue to calculate asset into income—that is, how much income each dollar of
Total assets, 12/31/16 9,323
turnover for 2017. sales provides
Net sales, 2017 7,015
Indicates how efficiently a company uses its assets to generate sales

Profit Margin Revisited (2 of 2) Do It! 5: Asset Turnover

Paramour Company reported net income of $180,000, net
sales of $420,000, and had total assets of $460,000 on
January 1, 2022, and total assets on December 31, 2022, of
$540,000. Determine Paramour’s asset turnover for 2022.
Net Sales ÷ Average Total Assets = Asset Turnover
Southwest was more effective at generating sales from $460,000 + $540,000

its assets, while JetBlue was better at deriving profit $420,000 ÷ = 0.84
2
from its sales.
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Learning Objective 6 Learning Objective 7

Compute Periodic Depreciation Using Compare the Accounting For Long-lived
the Declining-Balance Method and the Assets Under GAAP and IFRS
Units-Of-Activity Method
Previously illustrated in Learning Objective 2

• The definition for plant assets for both IFRS and GAAP is • Under both IFRS and GAAP, interest costs incurred during
essentially the same. construction are capitalized. Recently, IFRS converged to
GAAP requirements in this area.
• Both IFRS and GAAP follow the historical cost principle when
accounting for property, plant, and equipment at date of • The accounting for subsequent expenditures (such as ordinary
acquisition. repairs and additions) is essentially the same under IFRS and
GAAP.
• Cost consists of all expenditures necessary to acquire the
asset and make it ready for its intended use. • IFRS also views depreciation as an allocation of cost over an
asset’s useful life. IFRS permits the same depreciation
methods (e.g., straight-line, accelerated, and units-of-activity)
as GAAP.
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• Under both GAAP and IFRS, changes in the depreciation • The accounting for exchanges of nonmonetary assets has
method used and changes in useful life are handled in current recently converged between IFRS and GAAP. GAAP now
and future periods. Prior periods are not affected. requires that gains on exchanges of nonmonetary assets be
• GAAP recently conformed to international standards in the recognized if the exchange has commercial substance. This is
accounting for changes in depreciation methods. the same framework used in IFRS.
Differences
• The accounting for plant asset disposals is essentially the same
under IFRS and GAAP. • IFRS uses the term residual value rather than salvage value to
• The definition of intangible assets is essentially the same refer to an owner’s estimate of an asset’s value at the end of
its useful life for that owner.
under IFRS and GAAP

• IFRS allows companies to revalue plant assets to fair value at • IFRS requires component depreciation. Component
the reporting date. depreciation is allowed under GAAP but is seldom used.
• Companies that choose to use the revaluation framework • Component depreciation specifies that any significant parts
must follow revaluation procedures. of a depreciable asset that have different estimated useful
• If revaluation is used, it must be applied to all assets in a lives should be separately depreciated.
class of assets.
• Assets that are experiencing rapid price changes must be
revalued on an annual basis, otherwise less frequent
revaluation is acceptable.
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Differences
• As in GAAP, under IFRS, the costs associated with research and
development are segregated into the two components. All rights reserved. Reproduction or translation of this work beyond that permitted in
• Costs in the research phase are always expensed under
both IFRS and GAAP.
• Under IFRS, however, costs in the development phase are copies for his/her own use only and not for distribution or resale. The Publisher assumes
capitalized as Development Costs once technological
feasibility is achieved.
• IFRS permits revaluation of intangible assets (except for
goodwill). GAAP prohibits revaluation of intangible assets.

Decision Making
Learning Objectives
Ninth Edition
LO 1 Explain how to account for current liabilities.
LO 2 Describe the major characteristics of bonds.
LO 3 Explain how to account for bond transactions.
Chapter 10 LO 4 Discuss how liabilities are reported and analyzed.
Reporting and Analyzing Liabilities

Prepared Please
COBY HARMON
device. of California, Santa Barbara
Westmont College Copyright ©2019 John Wiley & Sons, Inc. 692
3/28/2023
What Is a Current Liability? (1 of 3)

• A debt that a company expects to pay
Learning Objective 1 • from existing current assets or through the creation of
other current liabilities, and
Explain How to Account for Current • within one year or the operating cycle, whichever is
Liabilities longer.
• Current liabilities include notes payable, accounts
payable, unearned revenues, and accrued liabilities
such as taxes, salaries and wages, and interest.
What Is a Current Liability? (2 of 3) Notes Payable

Review Question • Written promissory note
To be classified as a current liability, a debt must be • Usually requires borrower to pay interest
expected to be paid within • Frequently issued to meet short-term financing needs
a. 1 year. • Issued for varying periods of time
b. the operating cycle. • Usually classified as current liability if due for
c. 2 years. payment within one year of balance sheet date
d. (a) or (b), whichever is longer.
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Accounting for Notes Payable (1 of 3) Accounting for Notes Payable (2 of 3)

Illustration: First National Bank agrees to lend $100,000 on Illustration: If Cole Williams Co. prepares financial statements
September 1, 2022, if Cole Williams Co. signs a $100,000, annually, it makes an adjusting entry at December 31 to
12%, four-month note maturing on January 1. When a recognize interest.
company issues an interest-bearing note, the amount of
assets it receives generally equals the note’s face value. Interest Expense = $100,000 x 12% x 4/12 = $4,000
Sept. 1 Cash 100,000 Dec. 31 Interest Expense 4,000

Notes Payable 100,000 Interest Payable 4,000
Accounting for Notes Payable (3 of 3) Sales Taxes Payable

Illustration: At maturity (January 1), Cole Williams Co. must • Sales taxes are expressed as a stated percentage of
pay the face value of the note plus interest. the sales price
It records payment as follows. • Selling company
 Collects tax from customer
Jan. 1 Notes Payable 100,000
Interest Payable 4,000  Remits collections to the state’s department of
Cash 104,000 revenue
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Sales Taxes Payable (1 of 2) Sales Taxes Payable (2 of 2)

Illustration: The March 25 cash register readings for Cooley If sales taxes are not rung up separately on the cash register
Grocery show sales of $10,000 and sales taxes of $600 based Illustration: Cooley Grocery rings up total receipts of $10,600
on a sales tax rate of 6%. and has a 6% sales tax rate. Because the amount received
Journal entry to record the sales and sales taxes from the sale is equal to the sales price 100% plus 6% of sales,
the journal entry is
Mar. 25 Cash 10,600 Sales revenue = $10,600 ÷ 1.06 = $10,000
Sales Taxes Payable 600 Mar. 25 Cash 10,600
Sales Taxes Payable 600
Unearned Revenues (1 of 2) Unearned Revenues (2 of 2)

Revenues that are received before goods are delivered Illustration: Superior University sells 10,000 season football
or services are performed. tickets at $50 each for its five-game home schedule.
1. Company increases (debits) Cash and increases Entry for the sales of season tickets
(credits) a current liability account, Unearned Aug. 6 Cash (10,000 × $50) 500,000
Revenue. Unearned Ticket Revenue 500,000
2. When the company recognizes revenue, it decreases As each game is completed, Superior records the earning
(debits) the unearned revenue account and increases of revenue.
(credits) a revenue account.
Sep. 7 Unearned Ticket Revenue 100,000
Ticket Revenue 100,000
Type of Business = Airline, Magazine publisher, Hotel
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Current Maturities of Long-Term Debt Do It! 1a: Current Liabilities (1 of 2)

• Portion of long-term debt that comes due in current year You and several classmates are studying for the next
• No adjusting entry required accounting examination. Answer the following questions.
1. If cash is borrowed on a $50,000, 6-month, 12% note on
Illustration: Wendy Construction issues a five-year, interest- September 1, how much interest expense will be incurred
bearing $25,000 note on January 1, 2022. This note specifies
by December 31?
that each January 1, starting January 1, 2023, Wendy should pay
$5,000 of the note. When the company prepares financial
statements on December 31, 2022, what amount should be
reported as a
1. Current liability?
2. Long-term liability?
Do It! 1a: Current Liabilities (2 of 2) Payroll and Payroll Taxes Payable (1 of 4)

Answer the following questions. • The term “payroll” pertains to both
• Salaries
2. The cash register total including sales taxes is $23,320, and
• managerial, administrative, and sales
the sales tax rate is 6%. What is the sales taxes payable?
personnel (fixed monthly or yearly rate)
• Wages
• Store clerks, factory employees, and manual
laborers (rate per hour)
3. If $15,000 is collected in advance on November 1 for 3
• Determining the payroll involves computing
months’ rent, what amount of rent revenue should be
• Gross earnings
recognized by December 31?
• Payroll deductions
• Net pay
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Payroll and Payroll Taxes Payable (2 of 4) Payroll and Payroll Taxes Payable (3 of 4)
Illustration: Assume Cargo Corporation records its payroll for Payroll tax expense results from three taxes that
the week of March 7 as follows: governmental agencies levy on employers
Mar. 7 Salaries and Wages Expense 100,000
FICA Taxes Payable 7,650
These taxes are
Federal Income Taxes Payable 21,864 • FICA tax
State Income Taxes Payable 2,922
Salaries and Wages Payable 67,564 • Federal unemployment tax
Record the payment of this payroll on March 7. • State unemployment tax

Mar. 7 Salaries and Wages Payable 67,564
Cash 67,564
Payroll and Payroll Taxes Payable (4 of 4) Payroll Taxes (1 of 2)

Illustration: Based on Cargo Corp.’s $100,000 payroll, the Review Question
company would record the employer’s payroll tax expense
and liability for these payroll taxes on March 7 as follows. Employer payroll taxes do not include
a. federal unemployment taxes.
Mar. 7 Payroll Tax Expense 13,850 b. state unemployment taxes.
FICA Taxes Payable 7,650
Federal Unemployment Taxes Payable 800 c. federal income taxes.
State Unemployment Taxes Payable 5,400
d. FICA taxes.
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Do It! 1b: Wages and Payroll Taxes (1 of 2) Do It! 1b: Wages and Payroll Taxes (2 of 2)
During September, Lake Corporation’s employees earned wages of During September, Lake Corporation’s employees earned wages of
$60,000. Withholdings related to these wages were $4,590 for Social $60,000. Withholdings related to these wages were $4,590 for Social
Security (FICA), $6,500 for federal income tax, and $2,000 for state Security (FICA), $6,500 for federal income tax, and $2,000 for state
income tax. Costs incurred for unemployment taxes were $90 for income tax. Costs incurred for unemployment taxes were $90 for
federal and $150 for state. Prepare the September 30 journal entries federal and $150 for state. Prepare the September 30 journal entries
for (a) salaries and wages expense and salaries and wages payable, for (b) the company’s payroll tax expense.
assuming that all September wages will be paid in October.
Sept. 30 Payroll Tax Expense 4,830
Sept. 30 Salaries and Wages Expense 60,000 FICA Taxes Payable 4,590
FICA Taxes Payable 4,590 Federal Unemployment Taxes Payable 90
Federal Income Taxes Payable 6,500 State Unemployment Taxes Payable 150
State Income Taxes Payable 2,000
Salaries and Wages Payable 46,910
Major Characteristics of Bonds

• Bonds
Learning Objective 2 • A form of interest-bearing notes payable issued
by corporations, universities, and governmental
Describe the Major Characteristics of agencies
Bonds • Sold in small denominations
• Usually $1,000 or multiples of $1,000
• When a corporation issues bonds, it is borrowing
money.
• The person who buys the bonds (the bondholder) is
investing in bonds.
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Types of Bonds (1 of 2) Types of Bonds (2 of 2)

Secured and Unsecured Bonds Convertible and Callable Bonds
• Secured bonds have specific assets of issuer pledged • Convertible bonds can be
as collateral for bonds converted into common stock at
• Unsecured bonds are issued against general credit of bondholder’s option
borrower • Callable bonds can be redeemed
(bought back), by issuing company,
at a stated dollar amount prior to
maturity
Bond Certificate
Bond Terminology
• Bond certificate
 Issued to investor
 Provides name of company issuing bonds, face
value, maturity date, and contractual (stated)
interest rate
• Face value - principal due at maturity
• Maturity date - date final payment is due
• Contractual interest rate – annual rate used to
determine cash interest paid
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Bond Trading Determining the Price of a Bond (1 of 2)

• Bondholders can sell their bonds at any time on • Current market price, the present value of a bond is a
national securities exchanges function of three factors
• Prices are quoted as a percentage of face value • Dollar amounts to be received
• Corporation makes journal entries only when it • Length of time until amounts are received
issues or buys back bonds, or when bondholders • Market rate of interest
convert bonds into common stock
• Discounting
• Market information for bonds
• The process of finding the present value of bonds
Issuer Bonds Maturity Close Yield
Time Warner Cable 6.75 June 15, 2039 116.4 5.49
• Removing interest from future bon cash flows
Determining the Price of a Bond (2 of 2) Do It! 2: Bond Terminology

Illustration: Assume that Acropolis Company on January 1, Indicate whether each of the following statements is true or false.
2022, issues $100,000 of 9% bonds, due in five years, with 1. Mortgage bonds and sinking fund bonds are both
interest payable annually at year-end. examples of secured bonds.
2. Unsecured bonds are also known as debenture
bonds.
3. The contractual interest rate is the rate investors
demand for loaning funds.
4. The face value is the amount of principal the issuing
Present value of $100,000 received in 5 years $ 64,993 company must pay at the maturity date.
Present value of $9,000 received annually for 5 years 35,007 5. The market price of a bond is equal to its maturity
Market price of bonds $100,000 value.
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Accounting for Bond Transactions

• A corporation records bond transactions when
Learning Objective 3  it issues (sells) or redeems (buys back) bonds
Explain How to Account for Bond  bondholders convert bonds into common stock
Transactions • Bonds may be issued at
 face value
 below face value at a discount
 above face value at a premium
• Bond prices are quoted as a percentage of face value
Issuing Bonds (1 of 2) Bonds Issued at Face Value (1 of 2)

Review Question Illustration: Candlestick Inc. issues 100, five-year, 10%, $1,000
bonds dated January 1, 2022, at 100 (100% of face value).
The market interest rate:
Journal entry to record the issuance
a. is the contractual interest rate used to
Jan. 1 Cash 100,000
determine the amount of cash interest paid by Bonds Payable 100,000
the borrower.
b. is listed in the bond indenture. Journal entry Candlestick would make to accrue interest on
December 31
c. is the rate investors demand for loaning funds. Interest expense = $100,000 x 10% x 12/12) = $10,000
d. more than one of the above is true. Dec. 31 Interest Expense 10,000
Interest Payable 10,000
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Bonds Issued at Face Value (2 of 2) Discount or Premium on Bonds (1 of 3)

Journal entry to be made by Candlestick to pay the interest Interest Rates and Bond Prices
on Jan. 1, 2023
Jan. 1 Interest Payable 10,000

Cash 10,000
Discount or Premium on Bonds (2 of 3) Issuing Bonds at a Discount (1 of 2)

Review Question Illustration: Assume that on January 1, 2022, Candlestick Inc.
sells $100,000, five-year, 10% bonds at 98 (98% of face value)
Laurel Inc. issues 10-year bonds with a maturity value of $200,000. with interest payable on January 1.
If the bonds are issued at a premium, this indicates that:
a. the contractual interest rate exceeds the market interest
rate.
Jan. 1 Cash 98,000
b. the market interest rate exceeds the contractual interest Discount on Bonds Payable 2,000
rate. Bonds Payable 100,000
c. the contractual interest rate and the market interest rate
are the same.
d. no relationship exists between the two rates.
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Issuing Bonds at a Discount (2 of 2) Total Cost of Borrowing (1 of 2)

Statement Presentation Bonds Issued at a Discount
Annual interest payments
Candlestick Inc.
Balance Sheet (partial) ($100,000 × 10% = $10,000; $10,000 × 5) $50,000
Add: Bond discount ($100,000 − $98,000) 2,000
Long-term liabilities Total cost of borrowing $52,000
Bonds payable $100,000
Less: Discount on bonds payable 2,000 $98,000 Bonds Issued at a Discount
Principal at maturity $100,000
Issuing corporation must pay Annual interest payments ($10,000 × 5) 50,000
Cash to be paid to bondholders 150,000
• Contractual interest payments over the term of the bonds
Less: Cash received from bondholders 98,000
• Face value of bonds at maturity Total cost of borrowing $52,000
Amortization of Bond Discount Issuing Bonds at a Premium (1 of 2)

• Allocated to expense in each period Illustration: Assume that the Candlestick Inc. bonds
• Increases amount of interest expense reported each previously described sell at 102 rather than at 98.
period Journal entry to record the sale
• Amount of interest expense reported each period will
Jan. 1 Cash 102,000
exceed contractual amount paid Bonds Payable 100,000
• As discount is amortized, its balance declines Premium on Bonds Payable 2,000
• Carrying value of bonds will increase, until at maturity

carrying value of bonds equals their face amount
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Issuing Bonds at a Premium (2 of 2) Total Cost of Borrowing (2 of 2)

Statement Presentation Bonds Issued at a Premium
Candlestick Inc. Annual interest payments Blank

Balance Sheet (partial) ($100,000 × 10% = $10,000; $10,000 × 5 years) $50,000
Add: Bond discount ($102,000 − $100,000) 2,000
Long-term liabilities Total cost of borrowing $48,000
Add: Premium on bonds payable 2,000 $102,000 Bonds Issued at a Premium
Principal at maturity $100,000
• Borrower pays only the face value of the bonds at maturity Annual interest payments ($10,000 × 5 years) 50,000
• Not required to pay the bond premium at the maturity date Cash to be paid to bondholders 150,000
Less: Cash received from bondholders 102,000
• Bond premium is considered a reduction in the cost of
Total cost of borrowing $ 48,000
borrowing
Amortization of Bond Premium Do It! 3a: Bond Issuance

• Allocated to expense in each period Giant Corporation issues $200,000 of bonds for $189,000.
• Decreases amount of interest expense reported each (a) Journal entry to record the issuance of the bonds
period
Cash 189,000
• Amount of interest expense reported each period will be Discount on Bonds Payable 11,000
less than contractual amount paid Bonds Payable 200,000
• As premium is amortized, its balance declines (b) Show how the bonds would be reported on the balance
• Carrying value of bonds will decrease, until at maturity sheet at the date of issuance.
carrying value of bonds equals their face amount Long-term liabilities
Less: Discount on bonds payable 11,000 $189,000
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Redeeming Bonds at Maturity Redeeming Bonds before Maturity (1 of 2)

Candlestick records the redemption of its bonds at maturity • When a company retires bonds before maturity, it is
as follows: necessary to
• Eliminate carrying value of bonds at redemption date
Jan. 1 Bonds Payable 100,000
Cash 100,000 • Record cash paid
• Recognize gain or loss on redemption
• Carrying value of the bonds at the redemption date
• Face value of the bonds less unamortized bond discount
or
• Face value of the bonds plus unamortized bond premium
Redeeming Bonds before Maturity (2 of 2) Do It! 3b: Bond Redemption

Illustration: At the end of the fourth period, Candlestick Inc., R & B Inc. issued $500,000, 10-year bonds at a discount. Prior
having sold its bonds at a premium, retires the bonds at 103 to maturity, when the carrying value of the bonds is $496,000,
after paying the annual interest. The carrying value of the bonds the company redeems the bonds at 98.
at the redemption date is $100,400 (principal $100,000 and
Prepare the entry to record the redemption of the bonds.
premium $400). Candlestick records the redemption at the end
of the fourth interest period, January 1, 2026, as
Jan. 1 Bonds Payable 500,000
Jan. 1 Bonds Payable 100,000 Discount on Bonds Payable 4,000
Premium on Bonds Payable 400 Cash 490,000
Loss on Bond Redemption 2,600 Gain on Bond Redemption 6,000
Cash 103,000
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Presentation of Liabilities on the Balance Sheet

Marais Company
Liabilities
Learning Objective 4 Current liabilities
Discuss How Liabilities Are Reported Accounts payable
Current maturities of long-term debt
125,000
300,000
and Analyzed Accrued liabilities
75,000
$ 750,000
Long-term liabilities
Bonds payable 1,000,000
Less: Discount on bonds payable 80,000 920,000
Notes payable, secured by plant assets 540,000
Lease liability 500,000
Total long-term liabilities 1,960,000
Total liabilities $2,710,000
Analysis (1 of 5) Analysis (2 of 5)
General Motors Company Liquidity General Motors
Balance Sheets
December 31, 2017 and 2016 (in millions)
(in millions)
Ratio 2017 2016
Assets 2017 2016
Current Ratio $68,744 $76,203
Total current assets $ 68,744 $ 76,203 = .89:1 = .89:1
Noncurrent assets 143,738 145,487 $76,890 $85,181
Total assets $212,482 $221,690
Total current liabilities $ 76,890 $ 85,181
Liquidity ratios measure the short-term ability of a
Noncurrent liabilities 99,392 92,434 company to pay its maturing obligations and to meet
Total liabilities 176,282 177,615 unexpected needs for cash.
Total stockholders’ equity 36,200 44,075
Total liabilities and stockholders’ equity $212,482 $221,690
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Analysis (3 of 5) Analysis (4 of 5)
Solvency Solvency
Total Liabilities ($ in millions) 2017 2016
Debt to Assets Ratio =
Total Assets Net income $(3,882) $9,268
Interest expense 575 563
Income tax expense 11,533 2,739
Net Income + Interest Expense +
Income Tax Expense General Motors (in millions)
Times Interest Earned =
Interest Expense Ratio 2017 2016
$176,282
Solvency ratios measure the ability of a company to Debt to Assets Ratio = 83% 80%
$212,482
survive over a long period of time.
Analysis (5 of 5) Contingencies
($ in millions) 2017 2016
Solvency • Events with uncertain outcomes that may represent
Net income $(3,882) $9,268
potential liabilities
Interest expense 575 563
Income tax expense 11,533 2,739 • Common types of contingencies
 Lawsuits
General Motors (in millions)
Ratio 2017  Product warranties
Times Interest $(3,882) + $575 + $11,533  Environmental cleanup obligations

Earned = 14.3 times
$575 • Accounting rules require that companies disclose
contingencies in the notes
2016
22.3 times
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Off-Balance-Sheet-Financing Do It! 4: Analyzing Liabilities (1 of 3)

Intentional effort by a company to structure its financing Trout Company provides you with the following balance sheet information as of
December 31, 2022.
arrangements so as to avoid showing liabilities on its
Current assets $10,500 Current liabilities $ 8,000
balance sheet. Long-term assets 24,200 Long-term liabilities 16,000
Total assets $34,700 Stockholders’ equity 10,700
Total liabilities and
stockholders’ equity $34,700
Trout reported net income for 2022 of $14,000, income tax expense of $2,800,
and interest expense of $900.
(a) Compute the current ratio and working capital for Trout for 2022.
Current ratio = $10,500 ÷ $8,000 = 1.31:1
Working capital = $10,500 − $8,000 = $2,500
Do It! 4: Analyzing Liabilities (2 of 3) Do It! 4: Analyzing Liabilities (3 of 3)

Trout Company provides you with the following balance sheet information as of Trout Company provides you with the following balance sheet information as of
December 31, 2022. December 31, 2022.
Current assets $10,500 Current liabilities $ 8,000 Current assets $10,500 Current liabilities $ 8,000
Long-term assets 24,200 Long-term liabilities 16,000 Long-term assets 24,200 Long-term liabilities 16,000
Total assets $34,700 Stockholders’ equity 10,700 Total assets $34,700 Stockholders’ equity 10,700
Total liabilities and Total liabilities and
stockholders’ equity $34,700 stockholders’ equity $34,700
Trout reported net income for 2022 of $14,000, income tax expense of $2,800, Trout reported net income for 2022 of $14,000, income tax expense of $2,800,
and interest expense of $900. and interest expense of $900.
(b) Assume that Trout used $2,000 cash to pay off $2,000 of accounts payable. (c) Compute debt to assets ratio and times interest earned for Trout for 2022.
Current ratio = $8,500 ÷ $6,000 = 1.42:1 Debt to assets ratio = $24,000 ÷ $34,700 = 69.2%
Working capital = $8,500 − $6,000 = $2,500 Times interest earned = ($14,000 + $2,800 + $900) ÷ $900 = 19.67 times
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Straight-Line Amortization
Amortizing Bond Discount
Learning Objective 5 To follow the expense recognition principle, companies
Apply the Straight-Line Method of allocate bond discount to expense in each period in
which the bonds are outstanding.
Amortizing Bond Discount and Bond
Premium Bond Number of Bond Discount
÷ =
Discount Interest Periods Amortization
Bond Discount Amortization Schedule

Amortizing Bond Discount Candlestick Inc.
Illustration: Candlestick, Inc. sold $100,000, five-year, 10% Bond Discount Amortization Schedule
Straight-Line Method—Annual Interest Payments
bonds on January 1, 2022, for $98,000 (discount of $2,000). $100,000 of 10%, 5-Year Bonds
Interest is payable on January 1 of each year. (A) (B) (C) (D) (E)
Interest to Interest Expense Discount Unamortized Bond
Journal entry to accrue interest and amortize the bond Interest Be Paid to Be Recorded Amortization Discount Carrying Value
discount at Dec. 31, 2022 Periods (10% x $100,000) (A) + (C) ($2,000 ÷ 5) (D) − (C) ($100,000 − D)
Issue date $2,000 $98,000
Dec. 31 Interest Expense 10,400 1 10,000 10,400 400 1,600 98,400
Discount on Bonds Payable 400 2 10,000 10,400 400 1,200 98,800
Interest Payable 10,000 3 10,000 10,400 400 800 99,200
4 10,000 10,400 400 400 99,600
5 10,000 10,400 400 0 100,000
$50,000 $52,000 $2,000
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Bond Premium Amortization Schedule

Amortizing Bond Premium Candlestick Inc.
Illustration: Candlestick, Inc., sold $100,000, five-year, 10% Bond Premium Amortization Schedule
Straight-Line Method—Annual Interest Payments
bonds on January 1, 2022, for $102,000 (premium of $2,000). $100,000 of 10%, 5-Year Bonds
Interest is payable on January 1 of each year. (A) (B) (C) (D) (E)
Interest to Interest Expense Premium Unamortized Bond
Journal entry to accrue interest and amortize the bond Interest Be Paid to Be Recorded Amortization Premium Carrying Value
premium at Dec. 31, 2022 Periods (10% x $100,000) (A) + (C) ($2,000 ÷ 5) (D) − (C) ($100,000 − D)
Issue date $2,000 $102,000
Dec. 31 Interest Expense 9,600 1 10,000 9,600 400 1,600 101,600

Premium on Bonds Payable 400 2 10,000 9,600 400 1,200 101,200
Interest Payable 10,000 3 10,000 9,600 400 800 100,800
4 10,000 9,600 400 400 100,400
5 10,000 9,600 400 0 100,000
$50,000 $48,000 $2,000
Effective-Interest Method (1 of 2)
• Amortization of the discount or premium results in
Learning Objective 6 interest expense equal to a constant percentage of the
carrying value.
Apply the Effective-Interest Method of
• Required steps
Amortizing Bond Discount and Bond
1. Compute bond interest expense.
Premium 2. Compute bond interest paid or accrued.
3. Compute amortization amount.
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Effective-Interest Method (2 of 2) Amortizing Bond Discount (1 of 4)

Amortization of the discount or premium results in Illustration: Candlestick, Inc., sold $100,000, five-year,
interest expense equal to a constant percentage of the 10% bonds on January 1, 2022, for $98,000. The
carrying value. effective-interest rate is 10.5348% and interest is payable
on Jan. 1 of each year.
Prepare the bond discount amortization schedule.
Amortizing Bond Discount (2 of 4) Amortizing Bond Discount (3 of 4)

Candlestick Inc. Illustration: Candlestick, Inc. records the accrual of interest
Bond Discount Amortization Schedule
Effective-Interest Method—Annual Interest Payments
and amortization of bond discount on Dec. 31, as follows:
10% Bonds Issued at 10.5348%
(B)
(A) Interest Expense (C) (D) (E) Dec. 31 Interest Expense 10,324
Interest to to Be Recorded Discount Unamortized Bond
Interest Be Paid (10.5348% × Preceding Amortization Discount Carrying Value Discount on Bonds Payable 324
Periods (10% x $100,000) Bond Carrying Value) (B) – (A) (D) − (C) ($100,000 − D) Interest Payable 10,000
Issue date $2,000 $ 98,000
1 $10,000 $10,324 (10.5348% × $98,000) $ 324 1,676 98,324
2 10,000 10,358 (10.5348% × $98,324) 358 1,318 98,682
3 10,000 10,396 (10.5348% × $98,682) 396 922 99,078
4 10,000 10,438 (10.5348% × $99,078) 438 484 99,516
5 10,000 10,484 (10.5348% × $99,516) 484 0 100,000
$50,000 $52,000 $2,000
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Amortizing Bond Discount (4 of 4) Amortizing Bond Premium (1 of 3)

For the second interest period Illustration: Candlestick Inc. sells the bonds described
Bond interest expense = $98,324 × 10.5348% = $10,358 above for $102,000 rather than $98,000.
Discount amortization =$358 This would result in
At December 31, Candlestick makes the following adjusting Bond premium = $102,000 − $100,000 = $2,000
entry. This premium results in an effective-interest rate of
Dec. 31 Interest Expense 10,358 approximately 9.4794%.
Discount on Bonds Payable 358
Interest Payable 10,000
Amortizing Bond Premium (2 of 3) Amortizing Bond Premium (3 of 3)

Candlestick Inc. Illustration: Candlestick, Inc. records the accrual of interest
Bond Premium Amortization Schedule
Effective-Interest Method—Annual Interest Payments
and amortization of premium discount on Dec. 31, as follows:
10% Bonds Issued at 9.4794%
(B)
(A) Interest Expense (C) (D) (E) Dec. 31 Interest Expense 9,669
Interest to to Be Recorded Premium Unamortized Bond Premium on Bonds Payable 331
Interest Be Paid (9.4794% × Preceding Amortization Premium Carrying Value Interest Payable 10,000
Periods (10% x $100,000) Bond Carrying Value) (A) – (B) (D) − (C) ($100,000 − D)
Issue date $2,000 $ 102,000
1 $10,000 $ 9,669 (9.4794% × $102,000) $ 331 1,669 101,669
2 10,000 9,638 (9.4794% × $101,669) 362 1,307 101,307
3 10,000 9,603 (9.4794% × $101,307) 397 910 100,910
4 10,000 9,566 (9.4794% × $100,910) 434 476 100,476
5 10,000 9,524* (9.4794% × $100,476) 476* 0 100,000
$50,000 $48,000 $2,000
* Rounded
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Accounting for Long-Term Notes Payable

• May be secured by a mortgage that pledges title to
Learning Objective 7 specific assets as security for a loan
• Typically terms require borrower to make
Explain How to Account for Long-Term installment payments over term of loan. Each
Notes Payable payment consists of
1. interest on unpaid balance of loan
2. a reduction of loan principal
• Companies initially record mortgage notes payable
at face value
Long-Term Notes Payable (1 of 2) Long-Term Notes Payable (2 of 2)

Illustration: Porter Technology Inc. issues a $500,000, 8%, 20- Illustration: Porter Technology records the mortgage loan and
year mortgage note on December 31, 2022. The terms first installment payment as follows:
provide for annual installment payments of $50,926.
(B) (C) (D)
Dec. 31 Cash 500,000
(A) Interest Reduction of Principal Mortgage Payable 500,000
Interest Cash Expense Principal Balance
Period Payment (D) × 8% (A) − (B) (D) − (C) Interest Expense 40,000
Mortgage Payable 10,926
Issue date $500,000
Cash 50,926
1 $50,926 $40,000 $10,926 489,074
2 50,926 39,126 11,800 477,274
3 50,926 38,182 12,744 464,530
4 50,926 37,162 13,764 450,766
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Similarities
Learning Objective 8 • The basic definition of a liability under GAAP and IFRS is very
similar.
Compare the Accounting for Liabilities • Liabilities as defined by the IASB
• A present obligation of the entity arising from past
Under GAAP and IFRS events, the settlement of which is expected to result in
an outflow from the entity of resources embodying
economic benefits

• Accounting for current liabilities such as notes payable, • Under IFRS, liabilities are classified as current if they are
unearned revenue, and payroll taxes payable are similar expected to be paid within 12 months.
between GAAP and IFRS. • Similar to GAAP, items are normally reported in order of
• IFRS requires that companies classify liabilities as current or liquidity.
noncurrent on the face of the statement of financial position • Companies sometimes show liabilities before assets.
• Except in industries where a presentation based on liquidity • Sometimes long-term liabilities are shown before current
would be considered to provide more useful information liabilities.
(such as financial institutions) • The basic calculation for bond valuation is the same under
• When current liabilities (also called short-term liabilities) GAAP and IFRS. In addition, the accounting for bond liability
are presented, they are generally presented in order of transactions is essentially the same between GAAP and IFRS.
liquidity.
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• IFRS requires use of the effective-interest method for • Accounting for convertible bonds differs between IFRS and
amortization of bond discounts and premiums. GAAP.
• GAAP also requires the effective-interest method, except that • Unlike GAAP, IFRS splits the proceeds from the convertible
it allows use of the straight-line method where the difference bond between an equity component and a debt
is not material. component.
• Under IFRS, companies do not use a premium or discount • The equity conversion rights are reported in equity.
account but instead show the bond at its net amount. For • Under IFRS, companies sometimes will net current liabilities
example, if a $100,000 bond was issued at 97, under IFRS a against current assets to show working capital on the face of
company would record: the statement of financial position.
Cash 97,000
Bonds Payable 97,000
Financial Accounting: Tools for Business Chapter Outline:

Decision Making Learning Objectives
Ninth Edition LO 1 Discuss the major characteristics of a corporation.
Kimmel ● Weygandt ● Kieso LO 2 Explain how to account for the issuance of
common, preferred, and treasury stock.
Chapter 11 LO 3 Explain how to account for cash dividends, stock
dividends, and stock splits.
Reporting and Analyzing
LO 4 Discuss how stockholders’ equity is reported and
Stockholders’ Equity analyzed.
Prepared by
COBY HARMON Please disable
animations if they
cause issues with your device. Westmont College
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Corporate Form of Organization

An entity separate and distinct from its owners.
Discuss the Major Characteristics of a
Corporation
Characteristics of a Corporation (1 of 2) Characteristics of a Corporation (2 of 2)

Characteristics that distinguish corporations from Characteristics that distinguish corporations from
proprietorships and partnerships proprietorships and partnerships.
Advantages Disadvantages
• Separate legal existence • Corporation management
• Limited liability of stockholders • Government regulations
• Transferable ownership rights • Additional taxes
• Ability to acquire capital
• Continuous life
• Corporation management
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Corporation Organization Chart Other Forms of Business Organization

• Limited partnerships
• Limited liability partnerships (LLPs)
• Limited liability companies (LLCs)
• S Corporations
 No double taxation
 Cannot have more than 100 shareholders
Forming a Corporation Stockholder Rights (1 of 3)

• Initial steps of forming 1. Vote in election of
• File application with Secretary of State board of directors and
on actions that require
• State grants charter
stockholder approval
• Corporation develops by-laws
• Companies generally incorporate in a state whose laws 2. Share the corporate
are favorable to the corporate form of business. earnings through
• Corporations engaged in interstate commerce must receipt of dividends
obtain a license from each state in which they do
business.
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Stockholder Rights (2 of 3) Stockholder Rights (3 of 3)

3. Keep the same percentage ownership when new 4. Share in assets upon liquidation in proportion to their
shares of stock are issued (preemptive right) holdings
• Called a residual claim
Stock Certificate
Stock Issue Considerations (1 of 5)
Authorized Stock
• Charter indicates the number of shares of stock that a
corporation is authorized to sell
• Number of authorized shares is often reported in
stockholders’ equity section
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Stock Issue Considerations (2 of 5) Stock Issue Considerations (3 of 5)

Issuance of Stock Par and No-Par Value Stocks
• Corporation can issue common stock • Par value stock has been assigned a value per share
 Directly to investors or • Years ago, par value determined legal capital per
share that a company must retain in business for
 Indirectly through an investment banking firm protection of corporate creditors
• Many states do not require a par value
• No-par value stock is fairly common
• In many states, the board of directors assigns a stated
value to no-par shares
Stock Issue Considerations (4 of 5) Do It! 1a: Corporate Organization

Review Question Indicate whether each of the following statements is true or false.
1. Similar to partners in a partnership, stockholders of a
Which of these statements is false?
corporation have unlimited liability.
a. Ownership of common stock gives the owner a 2. It is relatively easy for a corporation to obtain capital
voting right. through the issuance of stock.
b. The stockholders’ equity section begins with paid- 3. The separation of ownership and management is an
in capital. advantage of the corporate form of business.
4. The journal entry to record the authorization of capital
c. The authorization of capital stock does not result in stock includes a credit to the appropriate capital stock
a formal accounting entry. account.
d. Legal capital is intended to protect stockholders. 5. All states require a par value per share for capital stock.
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Corporate Capital (1 of 2) Corporate Capital (2 of 2)

Paid-in Capital in Paid-in Capital in
Common Stock Common Stock
Excess of Par-Common Excess of Par-Common
Account Account
Account Account
Paid-in Capital Paid-in Capital
Paid-in Capital in Paid-in Capital in
Preferred Stock Preferred Stock
Excess of Par-Preferred Excess of Par-Preferred
Account Account
Account Account
Two Primary Retained Earnings Two Primary Retained Earnings

Sources of Equity Account Sources of Equity Account
Paid-in capital is the total amount of cash and other Retained earnings is net income that a corporation
assets paid in to the corporation by stockholders in retains for future use.
exchange for capital stock.
Retained Earnings (1 of 2) Retained Earnings (2 of 2)

Illustration: Net income is recorded in Retained Earnings by a If Delta Robotics has a balance of $800,000 in common stock
closing entry that debits Income Summary and credits. and $130,000 in retained earnings at the end of its first year,
Retained Earnings. Assuming that net income for Delta its stockholders’ equity section is as follows.
Robotics in its first year of operations is $130,000, the closing
entry is Delta Robotics
Paid-in capital
Common stock $800,000
Total stockholders’ equity $930,000
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Capital Comparison DO IT! 1b: Corporate Capital

Comparison of accounts reported on the balance sheet as Illustration: At the end of its first year of operation, Doral
owners’ equity and stockholders’ equity Corporation has $750,000 of common stock and net income of
$122,000.
(a) Prepare the closing entry for net income.
(b) Prepare the stockholders’ equity section at year-end.
Common Stock $750,000
Accounting for Common Stock

• Primary Objectives
Learning Objective 2 • Identify the specific sources of paid-in capital
Explain How to Account for the • Maintain the distinction between paid-in capital and
Issuance of Common, Preferred, and retained earnings
Treasury Stock • Other than consideration received, the issuance of

common stock affects only paid-in capital accounts.
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Issuing Par Value Common Stock for Cash

(1 of 2)
Issuing Par Value Common Stock for Cash
Illustration: Hydro-Slide, Inc. issues 1,000 shares of $1 par (2 of 2)
value common stock. Prepare Hydro-Slide’s journal entry if
Hydro-Slide, Inc.
(a) 1,000 share are issued for $1 per share Balance Sheet (partial)
Cash 1,000 Stockholders' equity
Common Stock (1,000 × $1) 1,000 Paid-in capital
Common stock $ 2,000
(b) 1,000 shares are issued for $5 per share Paid-in capital in excess of par value 4,000
Cash 5,000 Total paid-in capital 6,000
Common Stock (1,000 × $1) 1,000 Retained earnings 27,000
Paid-in Capital in Excess of Par Value 4,000 Total stockholders' equity $33,000
Issuing Stated Value Common Stock Issuing No-Par Value Common Stock for
Illustration: Hydro-Slide, Inc. issues $5 of no-par value stock
Cash
with a stated value of $1 and the company issues 5,000 shares Illustration: Hydro-Slide, Inc. issues no-par stock that has no
at $8 per share for cash. stated value. The company issues 5,000 shares at $8 per share
for cash.
Cash 5,000
Common Stock (1,000 × $1) 1,000 Cash 40,000
Paid-in Capital in Excess of Stated Common Stock 40,000
Value 4,000
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Accounting for Preferred Stock (1 of 2) Accounting for Preferred Stock (2 of 2)

• Typically, preferred stockholders have a priority as to Illustration: Stine Corporation issues 10,000 shares of $10 par
value preferred stock for $12 cash per share.
• Distributions of earnings (dividends)
• Assets in event of liquidation
• Generally do not have voting rights Cash 120,000
Preferred Stock (10,000 × $1) 100,000
• Accounting for preferred stock at issuance is similar to Paid-in Capital in Excess of Par Value-
that for common stock. Preferred Stock 20,000
Preferred stock may have a par value or no-par value.
DO IT! 2a: Issuance of Stock (1 of 2) DO IT! 2a: Issuance of Stock (2 of 2)

Illustration: Cayman Corporation begins operations on March Illustration: On March 28, Cayman issues 1,500 shares of $10
1 by issuing 100,000 shares of $1 par value common stock for par value preferred stock for cash at $30 per share.
cash at $12 per share. Journalize the issuance of preferred shares.
Journalize the issuance of the common shares.
Cash 45,000
Cash 1,200,000 Preferred Stock (1,500 × $10) 15,000
Common Stock (100,000 × $1) 100,000 Paid-in Capital in Excess of Par
Paid-in Capital in Excess of Par Value-Preferred Stock 30,000
Value-Common Stock 1,100,000
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Stockholders’ Equity with Treasury Stock Treasury Stock

Paid-in Capital in
Common Stock
Excess of Par-Common • Treasury stock is a corporation’s own stock that it has
Account
Account reacquired from shareholders but not retired.
Paid-in Capital
Preferred Stock
Paid-in Capital in • Corporations acquire treasury stock for various reasons
Excess of Par-Preferred
Account
Account • To reissue the shares to officers and employees
under bonus and stock compensation plans
Two Primary Retained Earnings
Sources of Equity Account • To enhance the stock’s market value.
• To have additional shares available for use in the
Less: acquisition of other companies
Treasury Stock
Account • To increase earnings per share
Purchase of Treasury Stock

Accounting for Treasury Stock Mead, Inc.
• Companies generally use cost method
• Debit Treasury Stock for price paid to reacquire Paid-in capital
shares Common stock, $5 par value, 400,000 shares
authorized, 100,000 shares issued and outstanding $500,000
• Considered to be issued but not outstanding shares Retained earnings 200,000
• Number of issued shares does not change
• Reduces stockholders’ equity Illustration: On February 1, 2022, Mead acquires 4,000 shares of its
stock at $8 per share.
Treasury Stock (4,000 × $8) 32,000

Cash 32,000
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Treasury Stock on the Balance Sheet

Mead, Inc.
Treasury Stock (1 of 2)
Balance Sheet (partial) Review Question
Stockholders’ equity Treasury stock may be repurchased
Paid-in capital
Common stock, $5 par value, 400,000 shares a. to reissue the shares to officers and employees
authorized, 100,000 shares issued, 96,000 under bonus and stock compensation plans.
outstanding $500,000
b. to signal to the stock market that management
Total paid-in capital and retained earnings 700,000
believes the stock is underpriced.
Less: Treasury stock (4,000 shares) 32,000 c. to have additional shares available for use in the
Total stockholders’ equity $668,000 acquisition of other companies.
Both the number of shares issued (100,000) and the number of d. More than one of the above.
shares held as treasury (4,000) are disclosed.
DO IT! 2b: Issuance of Stock

Santa Anita Inc. purchases 3,000 shares of its $50 par value
common stock for $180,000 cash on July 1. It expects to hold
the shares in the treasury until resold.
Journalize the treasury stock transaction.
Explain How to Account for Cash
Dividends, Stock Dividends, and Stock
July 1 Treasury Stock 180,000 Splits
Cash 180,000
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Nature of Dividends Cash Dividend Requirements

• Dividends are a distribution of cash or stock to • For a corporation to pay a cash dividend, it must have
stockholders on a pro rata (proportional to ownership) • Sufficient retained earnings
basis. • Payment of cash dividends from retained
• Types of dividends earnings is legal in all states
• Cash • Adequate cash
• Property • A declaration of dividends by Board of Directors
• Stock
• Scrip (promissory note)
Cash Dividend Dates Recording Cash Dividends

• Three dividend dates Illustration: On December 1, the directors of Media General
declare a $0.50 per share cash dividend on 100,000 shares of
• Declaration date
$10 par value common stock. The dividend is payable on
• Record date January 20 to shareholders of record on December 22.
• Payment date Dec. 1 Cash Dividends 50,000
Dividends Payable 50,000
• Companies make accounting entries on the declaration (To record the declaration of cash dividends)
date and the payment date.
22 No entry - Date of declaration
Jan. 20 Dividends Payable 50,000
Cash 50,000
(To record the payment of cash dividends)
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Cash Dividends (1 of 2) Dividend Preferences

Review Question • Right to receive dividends before common
stockholders
Entries for cash dividends are required on the:
• Per share dividend amount is stated as a percentage
a. declaration date and the record date.
of preferred stock’s par value or as a specified
b. record date and the payment date. amount
c. declaration date, record date, and payment date. • Cumulative Dividend
d. declaration date and the payment date.  Preferred stockholders must be paid current-year
dividends and any unpaid prior-year dividends
before common stockholders receive dividends
Cumulative Dividend Feature Cumulative Dividend (1 of 2)

Illustration: Scientific Leasing has 5,000 shares of 7%, $100 Review Question
par value, cumulative preferred stock outstanding. Each $100
U-Bet Corporation has 10,000 shares of 8%, $100 par
share pays a $7 dividend (.07 × $100). The annual dividend is
value, cumulative preferred stock outstanding at
$35,000 (5,000 × $7 per share). If dividends are two years in December 31, 2022. No dividends were declared in 2020
arrears, preferred stockholders are entitled to receive the or 2021. If U-Bet wants to pay $375,000 of dividends in
following dividends. 2022, common stockholders will receive
Dividends in arrears ($35,000 × 2) $ 70,000 a. $0.
Current-year dividends 35,000
Total preferred dividends $105,000 b. $295,000.
c. $215,000.
d. $135,000.
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DO IT! 3a: Preferred Stock Dividends (1 of 3) DO IT! 3a: Preferred Stock Dividends (2 of 3)
MasterMind Corporation has 2,000 shares of 6%, $100 par value MasterMind Corporation has 2,000 shares of 6%, $100 par value
preferred stock outstanding at December 31, 2022. At December preferred stock outstanding at December 31, 2022. At December
31, 2022, the company declared a $60,000 cash dividend. 31, 2022, the company declared a $60,000 cash dividend.
Determine the dividend paid to preferred stockholders and Determine the dividend paid to preferred stockholders and
common stockholders if common stockholders if
Preferred stock is noncumulative, and the company has not missed 2. Preferred stock is noncumulative, and the company did not pay
any dividends in previous years. a dividend in each of the two previous years.
Preferred stockholders are paid only this year’s dividend Past unpaid dividends do not have to be paid
Preferred stockholders = $12,000 (2,000 x .06 x $100) Preferred stockholders = $12,000 (2,000 x .06 x $100)
Common stockholders = $48,000 ($60,000 − $12,000) Common stockholders = $48,000 ($60,000 − $12,000)
DO IT! 3a: Preferred Stock Dividends (3 of 3) Reasons for Stock Dividends

MasterMind Corporation has 2,000 shares of 6%, $100 par value • A pro rata (proportional to ownership) distribution of
preferred stock outstanding at December 31, 2022. At December the corporation’s own stock to stockholders
31, 2022, the company declared a $60,000 cash dividend.
Determine the dividend paid to preferred stockholders and • Reasons why corporations issue stock dividends
common stockholders if
• Satisfy stockholders’ dividend expectations without
3. Preferred stock is cumulative, and the company did not pay a spending cash
dividend in each of the two previous years.
• Increase marketability of corporation’s stock
Past unpaid dividends do not have to be paid
Preferred stockholders = $36,000 (3 × 2,000 × .06 × $100) • Emphasize a portion of stockholders’ equity has
Common stockholders = $24,000 ($60,000 − $36,000) been permanently reinvested in business
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Small and Large Stock Dividends Effects of Stock Dividends

• Small stock dividend Before After
• Less than 20–25% of corporation’s issued stock Dividend Change Dividend
• Recommendation is to record at the fair market
Paid-in capital
value of the stock
Common stock, $10 par $500,000 $ 50,000 $550,000
• Based on assumption that a small stock dividend Paid-in capital in excess of par 25,000 25,000
will have little effect on market price of Total paid-in capital 500,000 +75,000 575,000
outstanding shares Retained earnings 300,000 -75,000 225,000
• Large stock dividend Total stockholders’ equity $800,000 $ 0 $800,000
• Greater than 20–25% of issued stock Outstanding shares 50,000 +5,000 55,000
• Normally recorded at par value Par value per share $ 10.00 $ 0 $ 10.00
Stock Splits (1 of 2) Stock Splits (2 of 2)

• Issuance of additional shares to stockholders Effect of 4-for-1 stock split for stockholders
according to their percentage ownership
• Reduction in par or stated value per share
• Increase in number of shares outstanding
• Reduces market value of shares
• No journal entry recorded, no affect on any balance
in stockholders’ equity
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Stock Split Effects Before 2 for 1 After Stock Dividend vs Stock Split Effects
Stock Split Change Stock Split
Differences between the effects of stock dividends and
stock splits
Paid-in capital
Common stock, $10 par Item Stock Dividend Stock Split
(before: 50,000 $10 par shares; Total paid-in capital Increase No change
after: 100,000 $5 par shares) $500,000 $500,000
Total retained earnings Decrease No change
Paid-in capital in excess of par 0 0
Total par value (common stock) Increase No change
Total paid-in capital 500,000 $ 0 500,000
Retained earnings 300,000 0 300,000 Par value per share No change Decrease
Total stockholders’ equity $800,000 $ 0 $800,000 Shares outstanding Increase Increase
Outstanding shares 50,000 +50,000 100,000 Total stockholders' equity No change No change
Par value per share $ 10.00 $ 5.00 $ 5.00
Stock Dividends (1 of 2) DO IT! 3b: Stock Dividends and Splits (1 of 2)

Review Question Due to five years of record earnings at Sing CD Corporation, the
market price of its 500,000 shares of $2 par value common stock
Which of these statements about stock dividends is true? tripled from $15 per share to $45. During this period, paid-in
a. Stock dividends reduce a company’s cash balance. capital remained the same at $2,000,000. Retained earnings
increased from $1,500,000 to $10,000,000. President Joan Elbert is
b. A stock dividend has no effect on total considering either a 10% stock dividend or a 2-for-1 stock split.
stockholders’ equity. Show the before-and-after effects of each option on (a) retained
c. A stock dividend decreases total stockholders’ earnings, (b) total stockholders’ equity, and (c) par value per share.
equity.
d. A stock dividend ordinarily will increase total
stockholders’ equity.
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DO IT! 3b: Stock Dividends and Splits (2 of 2)

Sing CD Corporation has had five years of record earnings. Due to
this success, the market price of its 500,000 shares of $2 par value
common stock has tripled from $15 per share to $45. President
Joan Elbert is considering either a 10% stock dividend or a 2-for-1 Discuss How Stockholders’ Equity is
stock split.
Run slide in presentation mode to reveal Original After After Reported and Analyzed
solution.
Balances Dividend Split
Paid-in capital $ 2,000,000 $ 4,250,000 $ 2,000,000
Retained earnings 10,000,000 7,750,000 10,000,000
Total stockholders’ equity $12,000,000 $12,000,000 $12,000,000
Outstanding shares 500,000 550,000 1,000,000
Par value per share $2.00 $2.00 $1.00
Retained Earnings Presentation of Accumulated Deficit

• Is net income that a company retains in the business Groupon, Inc.
• Net income increases Retained Earnings and a net (in thousands)
loss decreases Retained Earnings Stockholders’ equity
Paid-in capital
• Retained earnings is part of the stockholders’ claim Common stock $ 70
on the total assets of the corporation Paid-in capital in excess of par value 1,885,301
Total paid-in capital 1,885,371
• Debit balance in Retained Earnings is identified as a Accumulated deficit (921,960)
deficit Total paid-in capital and retained earnings 963,411
Less: Treasury stock 198,467
Total stockholders’ equity $ 764,944
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Retained Earnings Restrictions Balance Sheet Presentation of

Restrictions can result from Stockholders’ Equity
• Legal restrictions • Reported in the stockholders’ equity section of the balance
sheet
• Contractual restrictions
• Paid-in capital, retained earnings, accumulated other
• Voluntary restrictions comprehensive income, and treasury stock
• Paid-in capital components
Tektronix Inc.
Notes to the Financial Statements • Capital stock. Preferred stock appears before common stock
Certain of the Company’s debt agreements require compliance with because of its preferential rights
debt covenants. Management believes that the Company is in • Additional paid-in capital. Excess amounts paid in over par or
compliance with such requirements. stated value and paid-in capital from treasury stock
Stockholders’ Equity Presentation

Graber Inc.
Paid-in capital
DO IT! 4a: Stockholders’ Equity Section
Capital stock
9% preferred stock, $100 par value, cumulative, Jennifer Corporation has issued 300,000 shares of $3 par
10,000 shares authorized, 6,000 shares issued value common stock. It is authorized to issue 600,000 shares.
and outstanding $ 600,000
Common stock, no par, $5 stated value,
The paid-in capital in excess of par value on the common
500,000 shares authorized, 400,000 shares stock is $380,000. The corporation has reacquired 15,000
issued, and 390,000 outstanding 2,000,000 shares at a cost of $50,000 and is currently holding those
Total capital stock 2,600,000 shares. It also had a cumulative other comprehensive loss of
Additional paid-in capital
Paid-in capital in excess of par value—preferred stock $ 30,000 $82,000. The corporation also has 4,000 shares issued and
Paid-in capital in excess of stated value—common stock 1,050,000 outstanding of 8%, $100 par value preferred stock. It is
Total additional paid-in capital 1,080,000 authorized to issue 10,000 shares. The paid-in capital in excess
Retained earnings (Restricted for the cost of treasury stock) 1,050,000 of par value on the preferred stock is $97,000. Retained
Total paid-in capital and retained earnings 4,730,000 earnings is $610,000.
Accumulated other comprehensive income 110,000
Less: Treasury stock (10,000 common shares) 80,000 Prepare the stockholders’ equity section of the balance sheet.
Total stockholders’ equity $4,760,000
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DO IT! 4a: Stockholders’ Equity Section

Jennifer Corporation
Paid-in capital
Analysis of Stockholders’ Equity (1 of 2)
Capital stock
8% preferred stock, $100 par value, cumulative, Dividend Record
10,000 shares authorized, 4,000 shares issued
and outstanding $ 400,000 Illustration: Payout ratio for Nike in 2016 and 2015.
Common stock, $3 par value, 600,000 shares
authorized, 300,000 shares issued, and Blank 2016 2015
285,000 shares outstanding 900,000
Total capital stock 1,300,000
Dividends (in millions) $1,133 $1,022
Additional paid-in capital Nel income (in millions) 2,440 3,760
Paid-in capital in excess of par value—preferred stock $ 97,000
Paid-in capital in excess of stated value—common stock 380,000
Total additional paid-in capital 477,000
Total paid-in capital and retained earnings 2,387,000
Accumulated other comprehensive loss 82,000
Less: Treasury stock (15,000 common shares) 50,000
Total stockholders’ equity $2,255,000
Analysis of Stockholders’ Equity (2 of 2) Debt Versus Equity Decision

Earnings Performance Bond Financing Advantages
1. Stockholder control is not affected.
Illustration: Return on common stockholders’ equity ratio for Bondholders do not have voting rights, so current owners
Nike in 2016 and 2015. (stockholders) retain full control of the company.
(in millions) 2016 2015 2014 2. Tax savings result.

Preferred dividends $ -0- $ -0- $ -0- Bond interest is deductible for tax purposes; dividends on
Common stockholders' equity 12,407 12,258 12,707 stock are not.
3. Return on common stockholders' equity may be higher.

Although bond interest expense reduces net income, return
on common stockholders' equity often is higher under bond
financing because no additional shares of common stock are
issued.
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Return on Common Stockholders’ Effects on Return on Common

Equity Stockholders’ Equity (1 of 2)
Illustration: Microsystems Inc. currently has 100,000 shares of
common stock outstanding issued at $25 per share and no debt. It
is considering two alternatives for raising an additional $5 million:
Plan A involves issuing 200,000 shares of common stock at the
current market price of $25 per share.
Plan B involves issuing $5 million of 12% bonds at face value.
Income before interest and taxes will be $1.5 million; income taxes
are expected to be 30%.
The alternative effects on the return on common stockholders’
equity are shown in the next Illustration.
Effects on Return on Common Do It! 4b: Analyzing Stockholders’

Stockholders’ Equity (2 of 2) Equity (1 of 2)
Plan A: Plan B: On January 1, 2022, Siena Corporation purchased 2,000 shares of
Issue Stock Issue Bonds treasury stock. Other information is provided below.
Income before interest and taxes $1,500,000 $1,500,000 2022 2021
Interest (12% × $5,000,000) 0 600,000 Net income $110,000 $110,000
Income before income taxes 1,500,000 900,000 Dividends on preferred stock $10,000 $10,000
Income tax expense (30%) 450,000 270,000 Dividends on common stock $1,600 $2,000
Net income $1,050,000 $630,000 Common stockholders’ equity, beg. of year $400,000* $500,000
Common stockholders’ equity, end of year $400,000 $500,000
Common stockholders’ equity $7,500,000 $2,500,000
Return on common stockholders’ equity 14% 25.2% *Adjusted for purchase of treasury stock.
Compute the return on common stockholders’ equity for each year.
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Do It! 4b: Analyzing Stockholders’

Equity (2 of 2) 2022 2021
Net income $110,000 $110,000 Learning Objective 5
Dividends on preferred stock $10,000 $10,000
Dividends on common stock $1,600 $2,000 Appendix 11A
Common stockholders’ equity, beg. of year
Common stockholders’ equity, end of year
$400,000*
$400,000
$500,000
$500,000
Prepare Entries for Stock Dividends
*Adjusted for purchase of treasury stock.
Compute the return on common stockholders’ equity for each year.
Entries for Stock Dividends Entries for Stock Dividends (5 of 5)

Illustration: Medland Corporation declares a 10% stock Medland Corporation
dividend on its 50,000 shares of $10 par value common stock. Balance Sheet (partial)
The current fair market value of its stock is $15 per share. Paid-in capital
Common stock $500,000
Record the entry on the declaration date
Common stock dividends distributable 50,000
Paid-in capital in excess of par—common stock 25,000
Stock Dividends 75,000
Total paid-in capital $575,000
Common Stock Dividends Distributable 50,000
Paid-in Capital in Excess of Par Value 25,000 Record the journal entry for the issuance of the dividend shares.
Common Stock Dividends Distributable 50,000
Common Stock 50,000
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Similarities
Learning Objective 6 • Aside from the terminology used, the accounting transactions
for the issuance of shares and the purchase of treasury stock
Compare the Accounting for are similar.
• Like GAAP, IFRS does not allow a company to record gains or
Stockholders’ Equity Under GAAP and losses on purchases of its own shares.
IFRS • The accounting related to prior period adjustments is
essentially the same under IFRS and GAAP.
• The computations related to earnings per share are essentially
the same under IFRS and GAAP.

• The income statement using IFRS is called the statement of • Under IFRS, the term reserves is used to describe all equity
comprehensive income. accounts other than those arising from contributed (paid-in)
• The statement of comprehensive income is presented in a one- or capital.
two-statement format. • Includes reserves related to retained earnings, asset
• The single-statement approach includes all items of income and revaluations, and fair value differences
expense, as well as each component of other comprehensive • Many countries have a different mix of investor groups than in the
income or loss by its individual characteristic. United States.
• In the two-statement approach, a traditional income statement • In Germany, financial institutions like banks are not only major
is prepared. It is then followed by a statement of comprehensive creditors of corporations but often are the largest corporate
income, which starts with net income or loss and then adds stockholders as well.
other comprehensive income or loss items.
• In the United States, Asia, and the United Kingdom, many
• Regardless of approach, reporting income tax expense is required. companies rely on substantial investment from private investors.
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• There are often terminology differences for equity accounts. • A major difference between IFRS and GAAP relates to the account
GAAP IFRS Revaluation Surplus.
Common stock Share capital—ordinary • Arises under IFRS because companies are permitted to revalue their
Stockholders Shareholders property, plant, and equipment to fair value under certain
Par value Nominal or face value circumstances.
Authorized stock Authorized share capital • Part of general reserves under IFRS and is not considered contributed
Preferred stock Share capital—preference capital
Paid-in capital Issued/allocated share capital
Paid-in capital in excess of par—common stock Share premium—ordinary • IFRS often uses terms such as retained profits or accumulated profit
Paid-in capital in excess of par—preferred stock Share premium—preference or loss to describe retained earnings. The term retained earnings is
Retained earnings Retained earnings or Retained profits
Retained earnings deficit Accumulated losses also often used.
Accumulated other comprehensive income General reserve and other reserve • Equity is given various descriptions under IFRS, such as shareholders’
accounts
equity, owners’ equity, capital and reserves, and shareholders’ funds.
Copyright
Copyright ©2019 John Wiley & Sons, Inc. 871 Copyright ©2019 John Wiley & Sons, Inc. 872

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3/28/2023

Financial Accounting: Tools for Business Chapter Outline

Business Organization and Accounting

Questions Asked by Internal Users Accounting Across the Organization

Questions Asked by External Users Accounting Across the Organization (1 of 2)

Accounting Across the Organization (2 of 2) Ethics in Financial Reporting (1 of 4)

Ethics in Financial Reporting (2 of 4) Ethics in Financial Reporting (3 of 4)

Ethics in Financial Reporting (4 of 4) Ethics Insight: Dewey & LeBoeuf LLP

Users and Uses of Financial Information

Principal Types of Business Activity Financing Activities - Borrowing

Financing Activities – Issuing Stock Investing Activities

Operating Activities (1 of 2) Operating Activities (2 of 2)

Do It! 2: Business Activities

The Four Financial Statements Income Sierra Corporation

Income Statement (2 of 2) Retained Sierra Corporation

of time Statement Retained earnings, October 1

Interrelationships of Statements Balance October 31, 2022

Sierra Corporation Sierra Corporation

Interrelationships of Balance Sheet to

Cash flows from operating activities

Financial Statements (3 of 4) People, Planet, and Profit Insight

Do It! 3a: Financial Statements (1 of 6) Do It! 3a: Financial Statements (2 of 6)

Do It! 3a: Financial Statements (3 of 6) Do It! 3a: Financial Statements (4 of 6)

Other Elements of an Annual Report Elements of an Annual Report (1 of 6)

• Notes to the financial statements • Management must highlight

Elements of an Annual Report (2 of 6) Elements of an Annual Report (3 of 6)

Elements of an Annual Report (4 of 6) Elements of an Annual Report (5 of 6)

Do It! 3b: Components of Annual

A Look at IFRS (2 of 3) A Look at IFRS (3 of 3)

Copyright Financial Accounting: Tools for Business

• To improve understanding, companies group similar Sheet – Accounts receivable

Classified October 31, 2022

Current Assets Presentation Current Assets (1 of 2)

Components of Long-Term Investments Long-Term Investments Presentation

Nature of Property, Plant & Equipment Property, Plant, and Equipment

Nature of Intangible Assets Intangible Assets Presentation

trademarks or trade names Intangible assets and goodwill

Intangible Assets (1 of 2) Do It! 1a: Assets Section of Classified

Do It! Hoffman Corporation

(2 of 2) Assets • Obligations the company is to pay within the next

Current Liabilities Nature of Long-Term Liabilities

Long-Term Liabilities Long-term Liabilities (1 of 2)

Stockholders’ Equity Do It! 1b: Balance Sheet Classifications

Analyzing the Financial Statements

Ratio Analysis Using the Income Statement

Nature of Earnings per Share Earnings per Share Example

Using the Income Statement (4 of 5) Using a Classified Balance Sheet (1 of 2)

Using a Classified Balance Sheet (2 of 2) (continued)

Determining Liquidity Nature of Solvency

Helpful Hint Some users evaluate solvency using a ratio of liabilities

Debt to Assets Ratio Investor Insight

Evaluating Cash Flows Free Cash Flows Illustration

Do It! 2: Ratio Analysis (2 of 4) Do It! 2: Ratio Analysis (2 of 4)

Do It! 2: Ratio Analysis (3 of 4) Do It! 2: Ratio Analysis (4 of 4)

Standard-Setting Bodies Standard-Setting Environment (1 of 2)

Qualities of Useful Information Relevance and Faithful Representation

Enhancing Qualities of Useful Assumptions in Financial Reporting (1 of 2)

Comparability Information is Information has the

Assumptions in Financial Reporting (2 of 2) Measurement Principles