Unit
1
2
Chapter
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Chapter
Packet
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4
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Unit 1 Packet
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ACCT 3110 – Marquardt – Adapted from Hanlon et al., Intermediate Accounting 3e
Unit 1 Continuing Class Packet
1. Marco Polo Company has been in operation for a few years and has a fiscal year of August
1 to July 31. The following transactions occurred during the fiscal year beginning August
1, 2018. Prepare a journal entry for each transaction below and post it to the general
a-
ledger. (All amounts in $ thousands.)
financing a. 8/1/18: Owners invest an additional $50,000 cash in the corporation in exchange for
5,000 shares of common stock.
investing
b. 10/1/18: The Company purchases equipment for $20,000 cash.
c. 10/15/18: The Company purchases inventory for $13,000 on account.
N/A
financing d. 12/1/18: The Company borrows $30,000 from a local bank and signs a note payable.
e. 12/10/18: The Company sells inventory for $40,000 on account. The cost of inventory
N/ A
sold is $22,000.
operating
f. 2/1/19: The Company collects $15,000 of accounts receivable from customers.
operating
g. 2/15/19: The Company pays $20,000 of accounts payable to its inventory supplier.
financing
h. 6/20/19: The Company pays its shareholders a cash dividend of $1,000.
operating
i. 7/31/19: The Company pays salaries of $8,000 for work performed during the year.
2. Prepare an unadjusted trial balance as of July 31, 2019.
(
3. Prepare any necessary adjusting journal entries at July 31, 2019 and post them to the
*☆
→
ads
s
*
affect
ledger. The following information is also available.
a. Depreciation on the equipment is $500 for the year.
b. Marco Polo estimates that bad debt expense for the year is $1,000.
c. The note payable requires the principal plus interest at 10% to be paid on 12/1/22.
10%
annually
,
$301000
,
8 months
=
$2,000
4. Prepare an adjusted trial balance as of July 31, 2019.
5. Prepare Marco Polo’s financial statements for the fiscal year.
6. Prepare the necessary closing journal entries and post them to the ledger.
7. Prepare a post-close trial balance as of July 31, 2019.
1
General Journal
Date
08-01-18
Account Title
Cash
Debit
$
50,000
Common stock
10-01-18
$
Equipment
$
Inventory
$
Cash
A /R
$
$
COGS
$
Cash
A /P
$
Dividend
$
salaries Expense
$
$
Depreciation Expense
07-31-19
$
Bad Debt Expense
Allowance
40,000
$
22,000
$
151000
$
20,000
$
11000
$
for
$
Interest
payable
$
500
$
1,000
$
2.000
1,000
Bad Debt
Interest Expense
8,000
500
Accumulated Depreciation
07-31-19
$
8,000
cash
07-31-19
30,000
1,000
cash
07-31-19
$
201000
cash
06-20-19
13,000
151000
AIR
02-15-19
$
22,000
Inventory
02-01-19
20,000
40,000
sales Revenue
12-10-18
$
30,000
NIP
12-10-18
50,000
13,000
A /P
12-01-18
$
20,000
Cash
10-15-18
Credit
2,000
2
General Ledger
Cash
BB
5,000
50,000
A/R
13,000
BB
201000
10,000
Allowance for Bad Debts
1,000
15,000
40,000
1,000
351000
2,000
1,000
30100.0
81000
15,000
BB
58,000
Inventory
BB
20,000
Accumulated Depreciation
Equipment
22,000
BB
13,000
6,000
1,000
BB
500
20,000
1,500
20,000
16,000
BB
0
13,000
BB
BB
2. °O°
30,000
R/E
0
21000
30,000
191000
3,000
Interest Payable
N/P
A/P
C/S
BB
20,000
BB
50,000
¥
3
General Ledger
Sales Revenue
0
Salaries Expense
COGS
BB
40,000
BB
0
BB
221000
8,0002
¥
Depreciation Expense
BB
0
500
500
Dividends
BB
0
0
8,000
Interest Expense
Bad Debt Expense
BB
BB
0
/
'
°O°
0
2,000
1,000
2,000
Income Summary
0
BB
1,000
1,000
4
Unadjusted Trial Balance
7/31/2019
Debit
Credit
Cash
Accounts Receivable
Allowance for Bad Debts
Inventory
Equipment
Accumulated Depreciation
Accounts Payable
Notes Payable
Interest Payable
Retained Earnings
Common Stock
Sales Revenue
Cost of Goods Sold
Wages Expense
Depreciation Expense
Bad Debt Expense
Interest Expense
Dividends
TOTAL
Adjusted Trial Balance
7/31/2019
Debit
Credit
511000
51,000
35,000
35,000
2,000
1,000
11,000
11,000
261000
261000
1,500
11000
9,000
9,000
30,000
30,000
2,000
0
3,000
3,000
70,000
70,000
401000
401000
22,000
22000
8,000
81000
0
500
0
1,000
0
2,000
11000
1541000
Post-close Trial Balance
7/31/2019
Debit
Credit
1,000
1541000
5
Marco Polo Company
Income Statement multiple step
For the year ended July 31, 2019
$
sales Revenue
$
(COGS)
40,000
( 22,0003
Gross Profit
18,000
Operating Expenses
(8/000)
Wages Exp
Depreciation Exp
Bad Debt
Total
operating
operating
(500)
11,000)
Exp
(9,500)
F- xp
8,500
Income
Non-operating Income / Exp
Interest
(2,000)
Exp
61500
Net Income
Marco Polo Company
Statement of Shareholders Equity
For the year ended July 31, 2019
Common Stock
Beginning 08/01/18
:
issue
common
20,000
stock
paid dividends
07/31/19
Earnings
3,000
501000
net income
Ending
Retained
:
701000
Total Stockholder's Entity
23,000
50,000
61500
6,500
( 1,000)
( 1,000)
8,500
78,500
Marco Polo Company
Balance Sheet classified
As of July 31, 2019
Current
July
31,2018
AIR
net of
,
*
use
bb of T
operating
Assets
Cash
allowance of
$2,000
Inventory
Current Assets
Total
As of
$511000
5000
$33
9000
,
000
$11,000
20000
$95,000
34000
↑
Non Current Assets
-
Property
Total Non
,
Plant , É Equip net of ace
.
Current Assets
-
.
dep $1,500
.
$24,500
5000
$24,500
5000
"
$119,500
Assets
Total
39000
Current liabilities
A
/P
$9,000
-
Noles
Total Non
Total
liabilities
Payable
Interest
-
Payable
Current
0
$2,000
0
liabilities
16000
Equity
45
$70 ,
ME
$8,500
Total shareholder's
Total
$30,000
liabilities
Shareholder's
↓ 7,000
16000
Total current liabilities
Non Current
16000
liabilities
+
Equity
Shareholder's
ooo
20000
3000
23000
Equity
39000
↑
as in Accts
24,000
↓ 9,000
2,000
account
Marco Polo Company
Statement of Cash Flows
For the year ended July 31, 2019
Direct Method
Cash
operating
Flows from
Collection from customers
Payment for
Payment for
Inventory
salaries
Activities
Indirect Method
Cash Flows from
Net Income
$6,500
($20,000)
Depreciation Expense
$500
( $8,000)
Accounts Receivable
($24,000)
Inventory
$9,000
Interest
Cash Flows from
cash Flows from
Purchase
($131000)
Operations
Activities
Investing
Total Cash Flows from
Investing
($20,000)
Received
Notes
Payable
Paid Dividend
*
all pos cash flows
.
Received
$1,000)
Paid Dividend
↳
might
be newer
$461000
from
company
as
Investing
Activities
Investing
common stock
$30,000
coming
( $13,000)
Equipment
Notes
($20,000)
($20
000)
financing
they tripled AIR
Payable
$50,000
$30,000
$1,000)
$79000
$79,000
Total Cash Flows
$2.000
operations
Total Cash Flows from
Issued
$50,000
Common Stock
Payable
Total cash Flows from
Purchase
( $7,000)
Cash Flows from Financing Activities
Cash Flows from Financing Activities
Issued
Payable
Cash Flows from
($20,000)
Equipment
Activities
$15,000
Accounts
Total
Operating
Total Cash Flows
$ 46,000
Chapter
© forLittleLion
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ACCT 3110 – Marquardt – Adapted from Hanlon et al., Intermediate Accounting 3e
Chapter 2 Class Packet: Accounting Information System
Learning Objective 2-1: Analyze the effects of economic transactions using the accounting
equation.
•
The Accounting Equation:
creditors
assets
=
owners
liabilities
-1
stockholder's
equity
o All of a company’s economic resources are claimed by either its:
creditors
or
owners
assets
o Every transaction recorded will affect at least two accounts so the equation stays in balance.
•
Practice: How does each event affect the accounting equation?
Transaction
Assets
A local business person
invested $45,000 to open
A
Cash
A
cash
liability
Equity
Ads
a hardware store.
$25,000 was borrowed
from a bank.
$15,000 was paid for one
A notes
payable
to cash
year’s rent of a retail
location.
A
prepaid
hent
Inventory costing
$10,000 was purchased
on account.
Inventory costing $6,000
was sold on account for
$12,000.
lhinuentoy
MAIR
d inv
A
Alp
a sales
4
COGS
revenue
>>
a
faulty
←
due to expenses
sub from
revenue
1
↑ Credit
↑ Credit
↑ Debit
↑ Debit
Revenues
Gains
Expenses
Losses
↑ Debit
Net
Income
Dividends
paid
to
shareholders
from RIE
Breaking down the
Accounting Equation
↑ Credit
↑ Credit
Common
Stock
Preferred
Stock
Paid-in Capital
(“Amounts invested”)
Retained Earnings
(“Amounts earned”)
↑ Debit
Assets
↑ Credit
=
Liabilities
↑ Credit
+
Shareholders’ Equity
2
Learning Objective 2-2: Identify, record, and post transactions.
Learning Objective 2-3: Prepare an unadjusted trial balance.
•
Key attributes of an accounting information system:
Listing of all accounts: their names, reference numbers, and
Chart
of Accounts
corresponding FS element (asset, liability, etc.)
Detailed record of all account, their beginning balances,
General
Ledger
bunch of
T
-
accounts
a
transactions over a period, and ending balances. Ex: T-account
Chronological record of transactions over a period. Might also have
General Journal
special subsidiary journals for routine or repetitive transactions.
Listing of all accounts and their ending balances (debits or credits)
=
Trial Balance
•
as of a certain point in time.
All accounts can either be classified as Permanent or Temporary:
Temporary Account
Permanent Account
Balances carried over from one period to the
Balances closed out (start over at zero) at
next.
the beginning of each new period.
Measured at a point in time.
Measured for a period of time.
Balance Sheet Accounts
Dividends
Income Statement Accounts
you don't
revenues
•
"
have
or
"
dividends just like
don't
you
,
"
have
"
expenses
Practice: Classify the following as permanent or temporary:
Salaries expense
T
Sales revenue
T
T
Accounts payable
P
Dividends
Cost of goods sold
T
Gain on sale of investment
Cash
P
Common stock
on
incstmt
T
P
3
•
The Accounting Cycle:
o The process of recording economic events, eventually leading to the preparation of the
financial statements.
• We record transactions for economic events that directly affect the financial position of
the company.
• Might be external or internal:
o External: exchanges
•
'
exchange
resources
goods /services paying
vendors
do not
third
,
o Internal:
recorded at
•
Adjusted
'
-
Ex
a
third
involve
a
or
-
party
,
recorded
throughout
the
period
employees
party
but
,
Smith is still
earned
or
owed
period end
Journal Entries
Depreciation
:
/ obligations with
a¥rer party
with
Ex : sales of
of
,
Prep aids , interest
,
bad debt
external economic
I
,
& impairments
events
1
]
Hanlon et al., Intermediate Accounting 3e Exhibit 2-6
4
intend
economic
events
|
•
During the accounting period:
o Identify, record, and post transactions.
o Primarily external economic events.
•
accounting
a
g.
End of accounting period:
o Identify, record, and post adjusting journal entries.
o Primarily internal economic events.
o Prepare the financial statements.
•
Before opening the next accounting period:
o Close out the temporary accounts.
•
Review: Review the journal entry to record the gain or loss on the sale of an asset:
1. Debit the consideration received (usually cash).
2. Credit the book value of the asset sold.
3. Plug the difference to a gain or loss.
put
in
→
after assets:
cash
[
d
cash
Loss ( ping)
c
100
zo
asset
120
what
we
received
is less than what
we have on
our
books
Yash
14%
)
gain (plug
asset
20
120
•
In your own words: Explain the purpose of adjusting journal entries.
•
Practice recording external economic events and preparing an unadjusted trial balance in the
Unit 1 Continuing Class Packet.
Learning Objective 2-4: Identify, record, and post adjusting journal entries.
Learning Objective 2-5: Prepare an adjusted trial balance.
•
Adjusting Journal Entries:
o Result from the use of accrual accounting. We don’t just record transactions when cash
exchanges hands!
5
o Some revenues/expenses are earned/incurred over time. We may owe someone (or they
may owe us) even if no new event has passed between us lately.
•
Deferrals: Cash exchanges hands first, then earning/incurring of revenue/expense.
o Examples:
FYE
7
,
cash flow
•
AJE
Accruals: Revenue/expense has been earned/incurred, even though cash won’t exchange
hands until the future.
o Examples: Interest
,
taxes , YE accruals
for utilities and
wages
FYE
A
µ
cashflow
AJE
•
Review: How to record simple interest.
o Interest rates given to you in this class will always be stated annually.
o Accrue interest expense or interest revenue at period end for the portion of the year the
loan has been outstanding.
o For now, focus on simple interest. Compound interest is discussed in Ch 6.
principle
✗
Annual Interest
Rate
✗
Time
=
Interest Accrued
6
•
Practice: Employee salaries for the month of June for Charles Company were $65,000.
Employees are always paid on the first day of the next month for a given month’s work. Prepare
Charles’ adjusting journal entry on June 30, the company’s fiscal year end.
¥→
record
,
gne.ws
when
6/30
:
salaries
salaries
(accrued
,
:
gaian.es
payayu
Ñ
they
paid
•
Expense
cash
65,000
65,000
Payable
salaries)
65,000
65,000
Practice: Mathis Company borrowed $30,000 at 6% (annual) interest on May 1, 2022, with
/
principal and interest due on April 30, 2023. The company’s fiscal year ends December 31.
Prepare the adjusting journal entry to record interest expense on December 31, 2022.
SKIP
If Mathis failed to record the adjusting journal entry, what would be the impact on the income
statement for 2022?
7
•
Practice: Every year on August 1, Cork Company pays for a one-year flood insurance policy.
On August •31, 2022, Cork renewed the policy for the upcoming year for $24,000. Using the
information below, prepare journal entry to record the payment on August 1, plus the adjusting
journal entry needed on December 31, the company’s fiscal year end.
Prepaid insurance
BB
10,800
Angl
24,000
101000
Dec 31
:(repaid
Cash
:(
24,000
Expense
20,800
Prepaid 1ns
old balance (Jahl
+ new
balance
DR
24,000
insurance
insurance
24,800
CR
( Angl
20,800
-
-
Jul-31)
Dec 31)
20,800
•
Practice recording adjusting journal entries and preparing an adjusted trial balance in the Unit
1 Continuing Class Packet.
Learning Objective 2-6: Prepare financial statements from an adjusted trial balance.
•
Five financial statements:
o Income Statement – primary FS for communicating performance (profit/loss)
o Balance Sheet – accounting equation at FYE
o Statement of Cash Flows – explains the change in cash year-over-year
o Statement of Shareholders’ Equity – explains the change in SE year-over-year
o Statement of Comprehensive Income – net income plus other comprehensive income
o Example: Nordstrom
•
Financial statements are the company’s primary method for communicating financial
information to external users.
•
We will learn the details on each of these in Chapters 3-5.
8
Learning Objective 2-7: Prepare and post closing entries and prepare a post-closing trial
balance.
•
Close out temporary accounts
o First to an intermediary account
o Second to
:
Summary
Income
Retained Earnings
•
Allows temporary accounts to “start over” at zero at the beginning of the next period
•
Ensures ending retained earnings account reflects net income
•
Practice: On December 31, 2021, the partial adjusted trial balance of the Hoffmeister
Company included the following. Prepare Hoffmeister’s closing journal entries.
Debit
close)
P
Accounts receivable
T
Dividends
T
Cost of goods sold
450,000
T
Commission expense
120,000
T
Sales revenue
700,000
p
Retained earnings
245,000
(Bait : nothing
to
10,000
!
④
① Closeout
Income Summary
0
5,000
Credit
BB
700,000
""
10,000
③
yd
120,000
corona
'
[
Revenue
Inc
"" "
(
Inc
CR
summary
570,000
COGS
.
450,000
Exp
120,000
Closeout Dividends
(
summary
DR
CR
1201000
120,000
RYE
700,000
"""
Com
RIE
summary
7001000
summary
Inc
[
Inc
DR
Revenue
move to
10,000
Dividends
/
"" °o°
revenue
COGS
exp
Dividends
COM
R/E
450,000
1201000
101000
120,000
we 000
/
What is the beginning balance of Retained Earnings on January 1, 2022?
$365,000
9
•
We will practice closing entries and preparing a post-close trial balance again at the conclusion
of the Unit 1 Continuing Class Packet.
Learning Objective 2-8: Describe the use of special purpose frameworks and the
conversion from cash basis income to accrual basis income (Appendix 2A).
•
US GAAP is required for the financial reporting of US public companies.
•
The only generally accepted accrual-basis standard for private entities too.
•
But sometimes a company might not Khotan
file US GAAP if its users do not demand it:
-
-
•
very
small
lenders
entities
might
not
care
Common alternate financial reporting bases:
o Cash basis or modified cash basis
instead
€
o Tax basis used for filing tax returns
of GAAP
o Reminder: PCC issues US GAAP simplifications for private companies. But these are still
approved by FASB and still considered US GAAP!
•
If a company uses a financial reporting framework other than US GAAP:
o It must make this clear in its financial statements.
o Disclose the basis used and how it differs from US GAAP.
o Do not use financial statement titles similar to US GAAP.
Hanlon et al., Intermediate Accounting 3e
•
Converting between cash basis and accrual basis:
o Useful when a company operates on a cash basis, but reports on an accrual basis.
o Helps demonstrate the relationship between accounts and transactions.
10
•
Practice: Banks Company paid $12,000 cash for insurance premiums during the fiscal year.
There was $3,000 in prepaid insurance at the beginning of the year and $6,000 at the end of
the year. What was insurance expense for the year?
Prepaid insurance
3000
[Prpqiadsh
"
#
É
12000
9000
[
DR
insexp
Ck
9000
prepaid ins
9000
6000
•
Practice (E-2-44): The balance sheets for Experts Inc. reported salaries payable of $3,000 and
year
end
$1,400 on its December 31, 2019 and 2020 balance sheets, respectively. If salaries paid during
2020 were $200,000, what was salaries expense for the current year?
DR
Salaries payable
3000
2001000
[
Salaries expense
salaries
payable
ok
198,400
198,400
198,400
1400
•
Practice: The balance sheets for the Denton Times reported deferred subscription revenue of
$16,000 and $18,400 on its December 31, 2020 and 2021 balance sheets, respectively. Its 2021
income statement reported subscription revenue of $70,200. How much cash was received
from customers for subscriptions during 2021?
Deferred subscr. revenue
11
I.
Company
Company
A:
A
received $32,000
B
a credit
starting next
to
3. The purposes of
A:
from
month
.
Company B
on
company
A 's
as
prepayment
books
,
a
closing
[
AIR
[
COGS
Inv
on
entries
are to
Company
will
d-
will
provide
include
service to
:
:
RIE & Update the
Account to cast
←
xx
Rev
.
JE for this transaction
dividends declared
inventory
service
Deferred Revenue
transfer balances of temporary accounts to
4. Sold
for
xx ←
inc
asset
inc
equity
← dec
xx
xx
←
equity
die asset
© forLittleLion
balance of
RIE
for the effect of net
income loss
and
Chapter
© forLittleLion
3
ACCT 3110 – Marquardt – Adapted from Hanlon et al., Intermediate Accounting 3e
Chapter 3 Class Packet: Income Statement and Comprehensive Income
Learning Objective 3-1: Prepare an income statement using single-step and multiple-step
formats, focusing on income from continuing operations.
Learning Objective 3-2: Report the impact of unusual or infrequent items.
•
The Income Statement:
o Reports a company’s profits for a period of time.
o Primary financial statement communicating performance
o Revenues, expenses, gains, and losses
o Elements of the income statement can be relatively more:
permanent
(continue
transient
OR
(
in
future )
▪
Why would investors/creditors want to know if something is permanent or transitory?
predictive value
•
not to
in
:
to better
predict
future performance
Income from Continuing Operations:
o Profit or loss from segments of the business that are expected to continue in the future.
▪
As opposed to segments that have been discontinued (discussed later)
o Companies have discretion in how they organize this section. In real life, it’s a spectrum,
but we’ll talk about two extremes: Single step and multiple step.
Single Step
Multiple Step
subcategories
I. list Revenues & Gains
for :
I. Gross profit
2. list
Expenses &
Losses
2.
operating
3. Non
•
Unusual or Infrequent items: not
a
lot of
discretion
allowed
o If the company has a material
-
Income
operating Income
from FASB
unusual or infrequent item in Income from
Continuing Operations, it must be reported as its own line item or disclosed in footnotes.
o Ex: Natural disasters, impairment losses, litigation/settlements, restructuring
o Why?
transient items
not
a
,
continual
/
income
loss
1
continue
future )
Multiple Step
Single Step
f-
Cost of Goods Sold
Gross Profit
Operating Expenses
Examples (Exhibit 3-1):
Selling, general, and administrative
(advertising, wages, bad debts, rent,
utilities, depreciation/amortization)
-
Research and development
-
+
_
Gain or loss on sale of operating assets
-
Expenses and Losses
Nonoperating Income
Income from Continuing Operations
Sales Revenue
:
Restructuring costs (ex: employee
termination, relocation) cutting costs
Impairment losses
Operating Income
Examples (Exhibit 3-1):
Investment or peripheral revenues
✓
Interest expense
+
-
Gain or loss on sale of investments
-
Losses on litigation or disaster
Income from Continuing Operations before Tax
Income Tax on Continuing Operations
Income from Continuing Operations
Discontinued Ops.
Net Income
Operating Income
Gross Profit
Revenues and Gains
Income from Discontinued Operations, net of Tax
Net Income
2
•
Practice: What are permanent earnings?
a. Earnings from transactions that are likely to generate similar profits in the future
b. Earnings from transactions that are either not likely to occur again or likely to have a
different impact on income in the future
c. Balance sheet accounts that are not closed out at the end of each fiscal period
•
Practice: Belle Co. had the following results for the year ended December 31, 2020. All data
are before tax, and Belle Co. has a tax rate of 25%.
o For each item, state which subcategory of the income statement it belongs in (gross profit,
operating expense, nonoperating income/expense, or discontinued operations).
Income Category
Sales revenue
$8,200
Cost of goods sold
4,800
Selling, general, and administrative expenses
2,000
gross profit
gross profit
operating expense
Gain on sale of investments
300
Non
Loss on discontinued operations
500
Discontinued
Restructuring costs
280
Research and development expense
250
Interest revenue
25
Loss on sale of PP&E
100
-
Operating
Income
Operating
Operating Expense
Operating Expense
Non Operating
-
Income
Operating Expense
o What is Belle’s gross profit for 2020?
$ 8,200
-
$4,800
$-3,400
o What is Belle’s operating income for 2020?
2,000
280
250
31400
-493¥
-10€
2
,
630
3
o What is Belle’s income from continuing operations for 2020?
Operation income $770
=
81325-4
1-
Inc from cont beforetax:$
.
non
-
op Inc
1095
tax
in from cont after tax
:$%2°
o What is Belle’s net income for 2020?
in from cont
loss
on
.
disc op
.
after tax
.
before tax
tax benefit (tux from
loss
on
:($
821
500
)
$ 125 ←
:($375 )
loss)
disc op aftertax
:
net income :
•
$
:
used
to
offset not receiving money from IRS
,
$446
In your own words: If you were an investor, would you prefer to see a single step or
multiple step income statement?
Learning Objective 3-3: Prepare an income statement to include discontinued operations.
•
What is a discontinued operation?
o A major strategic shift away from a certain line of business, component, or segment.
▪
More significant than a restructuring. Involves shutting down an entire segment.
o Reported separate from continuing operations on the income statement. Why?
disc op
•
are
transient
so
,
would
be
beneficial for
investors to
see
disc op
separate
Two parts to Income from Discontinued Operations:
o Always: Income or loss from the segment’s operations during the period until shut down
o Maybe: Gain or loss related to disposition of assets in the segment
▪
Depends on whether the segment has been sold or is still held for sale
o If both apply, they can be listed separately or combined (and disclosed separately).
o Intraperiod tax allocation: Reported net of tax
dividing taxes btwn disc ops & op
.
.
.
inc
.
4
Decision Tree for Discontinued Operations: What is included in Income (Loss) from Discontinued Operations?
1. ALWAYS
Income or Loss
from Operations of
the discontinued
component over the
period
2. Gain or Loss on the actual disposal of
the component’s assets
Book Value vs. Consideration Received
"
cash
"
Maybe
Has the
component been
sold by the
period end?
Fair Value
=
Market value
2a. BV < FV*
Compare:
Book Value vs. Fair Value*
Do Nothing! No additional gain
(until we actually sell it).
Good News
*Less Expected Cost to Sell
2b. BV > FV*
diff btwn
BV & FV
Record an Impairment Loss
for the excess.
Bad News
5
•
Practice: In October 2021, Michael Company decided to sell one of its divisions. The fiscal
year end is December 31, 2021, and the tax rate is 25%. For each of the following cases, what
is Michael’s income (loss) from discontinued operations for 2021?
o The division was sold on December 18, 2021. From January 1, 2021 through disposal, the
division had a pre-tax loss from operations of $7,000,000. The assets of the division had a
net selling price of $11,000,000 and a book value of $10,000,000.
operations
gain
before
on
loss
( 7.
sale
ooo
,
ooo
Book value
)
10M
<
Price
um
1,000,000
[
( 6,000,000 )
tax
0.75
after tax
cash
gdii n
11m
iii.
( 41500,000 )
o On December 31, 2021, the division had not yet been sold. For the year, the division
reported a pre-tax loss from operations of $7,000,000. On December 31, 2021, assets of the
division had a book value of $10,000,000 and a fair value, minus anticipated cost to sell, of
$9,000,000.
operations
impairment
before taxes
loss
loss
( 7,000,000 )
( 1,000,000 )
( 8,000,000)
0.75
after taxes
BV
FV
10M
>
9m
impairment
[
loss
loss
1M
department
1M
( 6,000,000 )
6
o On December 31, 2021, the division had not yet been sold. For the year, the division
reported a pre-tax loss from operations of $7,000,000. On December 31, 2021, assets of the
division had a book value of $10,000,000 and a fair value, minus anticipated cost to sell, of
$12,000,000.
BV
Operating
before
(7,000
loss
10M
,
TV
<
12M
)
ooo
( 7,000,000)
tax
0.75
after tax
( 5,250,000 )
Learning Objective 3-4: Disclose earnings per share on the income statement.
•
EPS: A company’s profits expressed on a per share basis ( earnings per
•
Reported for:
share)
o Continuing operations, discontinued operations, and net income
"
hypothetical
"
o Basic and diluted shares outstanding
▪
Diluted includes securities/compensation convertible into common shares.
referring to
commonshares
pretend
shares
dividends get paid first
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 − 𝑃𝑟𝑒𝑓𝑒𝑟𝑟𝑒𝑑 𝑆𝑡𝑜𝑐𝑘 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠
𝐵𝑎𝑠𝑖𝑐 𝐸𝑃𝑆 =
𝑊𝑒𝑖𝑔ℎ𝑡𝑒𝑑 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑆ℎ𝑎𝑟𝑒𝑠 𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔
ᵗ#É
•
In your own words: Why might it be helpful to have information about profit expressed per
share outstanding?
-
helps
↳
-
-
important for comparability
investors
ex
account for firm size
:
price
know their
to
earnings
ROI
ratio
7
Demonstration of a Weighted Average: Earnings Per Share
This example demonstrates how to calculate a weighted average. The calculation of EPS requires
a weighted average for the denominator. For demonstration, we first calculate a simple average,
which will allow us to easily transition to a weighted average.
Sandy Corp. reports net income of $5,000,000 for the year ended 12/31/20. The company declared
preferred stock dividends of $400,000. As of 1/1/20, there were 2 million shares outstanding. The
company issued another 1 million shares on 4/1/20.
•
Identify each unique level of shares outstanding that existed during the year. Each unique value
is an element in the average.
•
•
1/1/20 – 3/30/20 (3 months): 2 million
•
4/1/20 – 12/31/20 (9 months): 3 million
Simple average: Weight each element equally.
2,000,000 + 3,000,000
= 2,500,000
2
Equal weights
Or stated differently…
2,000,000 3,000,000
+
= (2,000,000 × 6⁄12 ) + (3,000,000 × 6⁄12) = 2,500,000
2
2
•
Weighted average: Assign different weights for each element. Weights are based on relative
degree of importance/influence. Here, that is the proportion of time that element existed.
•
1/1/20 – 3/30/20: 2 million outstanding for 3/12 months of the year
•
4/1/20 – 12/31/20: 3 million outstanding for 9/12 months of the year
(2,000,000 × 3⁄12 ) + (3,000,000 × 9⁄12) = (500,000) + (2,250,000) = 𝟐, 𝟕𝟓𝟎, 𝟎𝟎𝟎
Weighted average
shares outstanding
•
Practice: Calculate earnings per share.
𝐵𝑎𝑠𝑖𝑐 𝐸𝑃𝑆 =
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 − 𝑃𝑟𝑒𝑓𝑒𝑟𝑟𝑒𝑑 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠
𝑊𝑡. 𝐴𝑣𝑔. 𝑆ℎ𝑎𝑟𝑒𝑠 𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔
5,000,000
-
400,000
=
21750 ,
ooo
$1.67 / share
8
Learning Objective 3-5: Report other comprehensive income.
•
Comprehensive Income: Includes net income plus other changes in shareholders’ equity that
are not transactions with owners
•
Other Comprehensive Income (OCI) examples:
o Unrealized holding gains and losses on some investments
o Gains and losses from postretirement benefit plans
o Deferred gains and losses from derivatives
o Foreign currency translation
o These are advanced accounting topics. We will not study how these amounts are calculated.
You should just be aware that they are typical OCI items.
•
Just like net income accumulates on the balance sheet in retained earnings, OCI accumulates
in Accumulated Other Comprehensive Income (AOCI).
•
If a company has OCI, it must report Comprehensive Income either:
o As one continuous statement, including both net income and OCI
or
o An income statement immediately followed by a statement of comprehensive income
(which lists the OCI items)
▪
•
Example: Alphabet
Practice: Which of the following is not an example of other comprehensive income?
a. Unrealized gains and loss on postretirement benefit plans
b. Foreign currency translation adjustments
c. Deferred gains from derivatives
d. Salaries expense
9
Learning Objective 3-6: Describe the statement of stockholders’ equity.
•
Statement of stockholders’ equity:
o Shows the changes in the components of stockholders’ equity over the period.
▪
Ex: Retained earnings, common stock, preferred stock, AOCI
▪
Beginning balances tie to last year’s balance sheet
▪
Ending balances tie to current year’s balance sheet
o Example: Alphabet
•
Practice: Prepare an income statement and statement of stockholders’ equity in the Unit 1
Continuing Class Packet.
Learning Objective 3-7: Report changes in accounting estimate, changes in accounting
principle, and error corrections.
•
We will focus on concepts only for this learning objective for now. We’ll see numerical
examples throughout the remainder of the semester.
•
Error Corrections:
o Errors are common. Most are caught and corrected before the financial statements are
issued. But what do we do when we discover a material misstatement that wasn’t corrected
before financial statement issuance?
o Three steps:
1.
Record
Prior Period
Adjustment (JE)
a. Adjust balance sheet accounts, possibly including the beginning balance of
retained earnings if the error affected prior period net income.
2.
Restate prior financial
3.
Disclose
the
statements
that
were
affected
by
if
error is
JES ,
then
from prior to
closing
Fmust include R /
error
correction
•
Example: WeWork restatement first disclosed in an 8-K December 2021
•
Changes to financial accounting (other than errors) could be addressed one of three ways,
depending on the circumstances:
10
– Determine cumulative impact of change and record prior
Retrospective
period adjustment to beginning retained earnings.
Implementation
– Restate all prior periods presented comparatively.
old years need to
be
using
– Essentially as if we’ve used the new method all along.
updated
new
– Determine cumulative impact of change and record prior
Modified
Retrospective
Implementation
– Like retrospective, but not required to restate comparative
periods.
– Use the new method going forward only
Prospective
– No adjustment to prior periods
Implementation
•
period adjustment to beginning retained earnings
Change in Accounting Principle:
Voluntary change
FASB update to ASC
Ex: Switching inventory costing methods
LIFO , FIFO
-
-
Retrospective
,
weighted away
implementation
g.
asingleupdate
(ASU)
Ex: Standard updates to revenue recognition
Varies
,
dictated by FASB
Disclose reason
o In your own words: Why might FASB require retrospective implementation for voluntary
changes to accounting principles?
-
-
•
disinutivire
keep
changing
comparability
Change in Accounting Estimate:
o Update of estimate or its assumptions due to new information
o Ex: Allowance for bad debts, fair values, future warranty expenses, depreciation inputs
(useful life, residual value) or method (straight line, etc.)
o Accounted for
prospectively
o Disclose in a footnote if material
11
method
Chapter
© forLittleLion
4
ACCT 3110 – Marquardt – Adapted from Hanlon et al., Intermediate Accounting 3e
Chapter 4 Class Packet: Balance Sheet and Financial Reporting
Learning Objective 4-1: Describe classification of asset, liability, and equity accounts on the
balance sheet.
Learning Objective 4-2: Prepare a classified balance sheet.
•
The Balance Sheet:
o Reports a company’s financial position at a point in time.
o Accounting equation.
o A “snapshot” of:
▪
What the company owns (A)
▪
What it owes (L)
▪
What’s left over for shareholders (SE)
o Primary financial statement for communicating:
financial health
↳
•
liquidity
,
solvency , flexibility
,
constrain
Classifying Assets and Liabilities into Current and Noncurrent:
o For most companies:
▪
Current assets = Cash and assets expected to be consumed or converted to cash within
one year.
▪
Current liabilities = Liabilities expected to be satisfied within one year.
o Unless the company’s operating cycle is greater than one year. Then we designate
current/noncurrent based on the length of the operating cycle.
o What is the operating cycle?
1. Use cash to
acquire inventory
• The period of time in which cash turns over
for the sale of goods or services (from outlay
4. Collect cash from
customer
2. Prepare inventory
for sale to customer
to receipt).
• Not many industries have operating cycles
greater than one year. Examples?
3. Deliver inventory
to customer
alcohol
,
tobacco ,
construction
1
•
Typical examples of Current Assets (Exhibit 4-4):
o Listed in order of decreasing
liquid
Most
Short-term investments
1
least
•
Cash and cash equivalents
Accounts receivable (i.e., trade receivables)
Contra-asset: Allowance for doubtful accounts
Notes and nontrade receivables
Inventories (raw materials, WIP, finished goods)
liquid
Prepaid expenses
Typical examples of Noncurrent Assets (Exhibit 4-5):
Long-term investments
i
assets held for
Property, plant, and equipment
used
speculation
in
( sinking funds )
operations
Contra-account: Accumulated depreciation
Intangible assets
Leased assets
Other noncurrent assets
•
deferred
taxes ,
restricted cash
Classifying Investments:
o A security or asset where we expect to earn a return (appreciation, interest, or dividends).
o Ex: Stocks or bonds of other companies, other securities, real estate, assets held for
speculation, nonconsolidated subsidiaries.
cash
equivalent
Short Term
Investment
Why Tom
Investment
Highly liquid, low-risk security
Original maturity of 3 months or less
Ex: Commercial paper, money markets, Treasury bills (if ≤ 3 mo.)
Any investment that management has the intent and ability to sell
the “current” window (one year)
Any investment that management does not intend to sell within the
“current” window (one year)
2
•
Typical examples of Current Liabilities (Exhibit 4-6):
o No required ordering; usually by materiality or relevance to the company.
Accounts payable (i.e., trade payables)
Accrued liabilities
Some formal debt contracts:
Short-term notes payable
Current portion of long-term debt and leases (e.g., installments or interest)
Callable debt
tender
call
can
repayment
of
anytime
Deferred revenues
•
Typical examples of Noncurrent Liabilities (Exhibit 4-7):
Bonds or notes payable
Pension or other post-retirement benefit liabilities
Leases
Other noncurrent liabilities
•
Practice: Marble Company took out a $1,000,000 note payable with its local bank on March
1, 2021. For each of the following scenarios, how should Marble present the note payable on
its balance sheet as of December 31, 2021? Ignore interest.
due
within
year
of
one
this
Current
Noncurrent
Liability
Liability
The full amount of the loan is due on December
31, 2027.
0
1M
The full amount of the loan is due on September
30, 2022.
IM
The loan must be repaid in installments. Marble
must pay $100,000 on February 28 of each year
100K
900K
for 10 years.
3
•
Typical examples of Stockholders’ Equity (Exhibit 4-8):
o Listed in order of
permanence
o Sometimes called Net Assets or the company’s Book Value.
Paid in capital
move
phnmnant
4s
,
Pls
,
Par
value,
excess
of
par
Number of shares outstanding at FYE
§
Retained earnings
Accumulated other comprehensive income
Treasury stock
contra account
Noncontrolling interest
less
If the company owns enough of a subsidiary to consolidate FS (>50%), but not 100%.
permanent
•
Practice: Prepare a classified balance sheet in the Unit 1 Continuing Class Packet.
•
In your own words: What is the purpose of the balance sheet? For example, what can we
learn from analyzing the balance sheet?
Learning Objective 4-3: Explain notes to financial statements.
•
Full disclosure principle: Disclosure notes (i.e., footnotes) to the financial statements provide
important detail and context to the summary information on the financial statements.
•
The major footnotes: disiloswher
o Summary of significant accounting policies:
▪
Financial accounting involves judgment and can be complex. This footnote aims to
explain to readers the accounting treatment of material activities or accounts.
▪
Especially important when:
4
▪
Ex: Revenue recognition, inventory costing (LIFO, FIFO), depreciation, fair value
▪
Fair value: An estimate of the hypothetical price we would expect today to receive to
sell an asset or pay to transfer a liability.
•
Might be based on observable market prices, similar transactions, estimated
replacement cost, or discounted cash flow models.
•
Categorized into “levels” based on degree of management subjectivity involved:
Level 3: Significant unobservable inputs (ex: discounted cash flows)
Level 2: Significant observable inputs (ex: similar assets)
Level 1: Quoted prices for identical assets in active markets
•
US GAAP requires fair value measurement for some financial assets and liabilities.
It gives companies the option to measure some other assets and liabilities at fair value.
o Subsequent events:
▪
A major event that occurs after a company’s fiscal year-end but before the financial
statements are issued
▪
Ex: Issuance of debt or equity, merger or acquisition, update on contingencies
Fiscal
Mr End
10
Team
we
want
o Related party transactions:
▪
Transactions between the company and its owners, management, their families, affiliate
companies (parent, subsidiary, sister), etc.
▪
Concern whether it was an “arm’s-length transaction.” Did the other party get special
terms?
▪
It is not prohibited to engage in these activities. But we need to disclose them so there is
transparency about their terms.
5
o Additional details on material accounts (varies by company)
o Errors, fraud, and illegal acts
o Segments and major customers (LO 4-5)
•
Practice (E5-54 adapted): The following selected normal balances are from a partial trial
balance as of December 31. The following additional information is also available.
Cash
150,000
Investments
196,000
Accounts receivable
150,000
Allowance for bad debts
?
Inventory
Note receivable
* we
gave money
to
someone else
$ 56,000
$150,000
c
200,000
NC
?
; $50,000
current ;
$
non
-
current
140.000 Nc
C
160,000
Interest receivable
Equipment
$ 100,000 Current
$200,000
160,000
NC
Accumulated depreciation
30,000
NC
Franchise
30,000
(
✗ 0.05
✗
0.06
contra
=
×
$7,500
3/12
C
( Contra
AR)
$3,000 C
=
equipment)
NC
o Included in Cash is $50,000 of cash restricted for 18 months due to a debt agreement.
o Included in Investments is $56,000 of short-term investments, and the remaining is longterm. Both are recognized at fair value.
o 5% of Accounts Receivable is estimated to be uncollectible. allowance for bad
debt
o The Note Receivable is due in 21 months. The interest rate is 6%, and the note originated
on September 30 of the current year. Interest is paid annually with the first payment due
September 30 of next year.
o What are total current assets?
$ 100,000
+
$56 ,
000
-
$7,500
+
160,000
t
$3,000 +
$1501000
=
$461
,
soo
o What are total noncurrent assets?
$50,000T $140,000
+$200
,
000 + $160 , ooo
-
$30,000T
$30 ooo
,
=
$550,000
o What are some significant accounting policies the company would likely include in its
summary of significant accounting policies footnote?
-
depreciation / amortization
method
-
-
-
-
-
possibly
how
note receivable
debt
they estimate bad
restricted cash
-
investment @ fair value
inventory accounting
revenue
method
*
recognition always want
to
explain
6
I
•
In your own words: Why are the disclosure notes an important element of the annual report?
Learning Objective 4-4: Describe SEC filings of publicly traded companies in the US.
•
Most common required SEC financial filings:
Full financial statements and disclosures.
Audited. Due 60-90 days after FYE.
Financial statements and some condensed disclosures.
Not audited. Due 40-45 days after FQE.
As applicable, reports specific material events like M&A or
changes in auditors or directors.
•
Audit Report:
o Management is ultimately responsible for following US GAAP. Why is an audit valuable?
increase
credibility
of statements
o SEC requires a financial statement audit for all US public companies (and an audit of
internal controls for most of them).
o Four types of opinions the auditor can issue:
unqualified
qualified
adverse
disclaimer
FS are presented in conformity with GAAP
Misstatement in FS contained to specific area or scope limitation
Pervasive misstatements. FS should not be relied upon.
Auditor was unable to gather sufficient evidence to issue an opinion.
o Which opinion do you think is most common?
o Example: Lululemon Athletica
▪
What type of opinion was issued here?
o Report also defines the critical audit matters.
o Report might also contain an explanatory paragraph providing more context.
o Memory hint: Think of a qualifier like an exception. So “unqualified” means “without
exception” (good), and “qualified” means “with exception” (bad).
7
•
So far, we’ve discussed the financial statements and footnotes, both of which are audited.
The rest of the 10-K is unaudited. Some major components include:
o Management discussion and analysis (MD&A)
▪
Management explains their views and opinions on the financial results, operations,
trends, risks, and future plans.
o Business risks
o Supplementary data, e.g., quarterly highlights
o Management certifications of controls and financial statements
o Other corporate governance details
▪
Often referenced to the proxy statement (DEF 14-A)
o Although these sections are unaudited, the auditor is still likely to review them for overall
reasonableness.
•
Practice (R4-04): Match each of the following 10-K excerpts of real companies with one of
the following four sections where we are most likely to find it: MD&A, audit report, or
management certification. Answers may be used more than once.
Based on the assessment, management concluded that, as of December 31,
2020, the Company’s internal control over financial reporting is effective.
(Source: 3M Company 10-K)
In our opinion, the financial statements present fairly, in all material
respects, the financial position of the Company as of December 31, 2020
and 2019, and the results of its operations and its cash flows for each of the
three years in the period ended December 31, 2020, in conformity with
audit
MPF.wgwalopinion
ifo.ec
accounting principles generally accepted in the United States of America.
(Source: The Boeing Company 10-K)
Our net sales for fiscal 2020 decreased $2.6 billion, or 16 percent, compared
with fiscal 2019, reflecting a 39 percent decline in store sales, partially
offset by a 54 percent increase in online sales. (Source: Gap Inc. 10-K)
8
Learning Objective 4-5: Identify segment reporting requirements.
•
US GAAP requires companies to disclose some financial highlights for its segments.
o Segment income and total assets.
o Other data points if available.
•
Operating segments:
o Management approach: Follow how management defines operating segments internally.
o Report if the segment comprises at least 10% of total assets, total revenues, or absolute
profit or loss.
o Keep adding segments until at least 75% of revenue is captured.
•
Also required to disclose geographic segments (US and material non-US) and major
customers (individually provide 10% of revenues)
•
In your own words: Why might an investor want to know how assets or income are divided
across segments or major customers?
9
5
Chapter
© forLittleLion
ACCT 3110 – Marquardt – Adapted from Hanlon et al., Intermediate Accounting 3e
Chapter 5 Class Packet: Statement of Cash Flows and Financial Analysis
Learning Objective 5-1: Identify operating, investing, and financing activities.
•
The Statement of Cash Flows:
o Explains the year-over-year change in cash → sources of cash inflows and outflows.
o Includes cash, cash equivalents, and restricted cash.
o Organized into three categories: operating, investing, and financing.
o Why is this helpful?
solvency
-
liquidity
acknowledge that
-
-
-
•
&
must make
if
no
-
we
more
cash flows
:
ability
have
lots
pay debts
get paid
to
cash than
and
to
you
of
to
survive
spend
accusals
,
could
be
Grand
Operating Cash Flows:
o Inflows and outflows that result from core operations.
o Approximates net income on a cash basis.
▪
Study tip: If there is a related accrual-basis revenue, expense, gain, or loss on the income
statement, that cash flow belongs in operating activities!
o Companies can choose to report using either the direct or indirect method.
o Common examples (Exhibit 5-1):
Inflows
Dividend
→
Renner
interest
→
Revenue
Outflows
From customers for the sale of goods/services
To suppliers for inventory, supplies.
Refunds received from suppliers
Payment of salaries, rent, utilities, etc.
Dividend received on investments *
Payment of income taxes
Interest received on receivables *
Interest paid on debt *
*
might
be
tricky
←
interest
expense
Classifying Interest and Dividends on the Statement of Cash Flow:
Received
Paid
operating
operating
Interest
•
"
Dividends
theres
•
operating
financing
no
dividends expense
paid directly
out of
THE
Investing Cash Flows:
o Inflows and outflows related to the acquisition and disposition of long-term fixed assets
and investments.
o Common examples (Exhibit 5-2):
Inflows
Outflows
Sale of fixed assets (ex: PP&E) and intangibles Purchase of fixed assets or intangibles
Sale of investments (ex: stocks/bonds of other Purchase of investments
entities)
Collection of the principal on a loan to another Loans made to another entity
entity
•
Financing Cash Flows:
o Inflows and outflows related to external financing transactions with the company’s owners
and creditors.
o Common examples (Exhibit 5-3):
Inflows
Outflows
Issuing stock (or resale of treasury stock)
Share repurchases (treasury stock)
Issuing bonds or taking out a loan
Payment of the principal on a loan
paying
b%
bonds
given
to us
Retirement of bonds or other debt
Payment of dividends
"
,
•
What if we have an investing or financing activity that doesn’t involve cash (or only partially)?
o Disclose at the bottom of SCF or in the footnotes.
Ex :
100,000
Building
10,000
Cash
NIP
•
90,000
Practice: Which of the following items would not be included as a cash flow from operating
activities in a statement of cash flows?
a.
r
Collection of cash from customers
b. Purchase of machinery
Inv
.
c. Purchase of inventory
d. Collection of interest on a note receivable
/
•
Practice (BE 5-24 & 25): Gomez Corp. reported the following cash flows for the year.
Calculate net cash provided (used) by investing activities and financing activities.
Purchased an investment in debt securities for cash
Sold equipment previously used in operations for cash
Paid cash for dividends
Issued common stock for cash
($ 30,000) investing / outflow
25,000
investing / inflow
(10,000) financing / outflow
100,000 financing /inflow
( 80,000/
/ outflow
Retired a 10-year bond payable
financing
Sold investment in equity securities
Borrowed cash by signing a nine-month note payable
11,000 investing/ inflow
15,000
/ inflow
Extended a loan to a customer for a building expansion
(8,000)
investing
=
financing
investing
/ outflow
(30/000)+25,000+11,000 + (8,0003--12,000)
financing
=
(10/000)+100,000
+
(80/000)+151000
=
25,000
Learning Objective 5-2: Prepare a statement of cash flows using the indirect method to
present cash flows from operating activities.
Learning Objective 5-8: Prepare a statement of cash flows using the direct method to
present cash flows from operating activities.
•
The distinction of direct vs. indirect method only matters for operating activities.
o Investing and financing activities only use direct method.
•
Net cash flows from operating activities are the same regardless of method. The two methods
just organize the information differently.
•
Summarizing the direct method:
*
pretty
rare
o Directly lists each type of cash inflow or outflow.
▪
Cash received from customers, Cash paid to suppliers, etc.
▪
Example: CVS
o If you use the direct method, you must also reconcile net income to OCF in a
:
supplementary schedule (effectively reporting both methods!).
•
Practice: All of Castro Company’s sales are made on account. It had sales revenue of
$5,000,000 for the year ended June 30, 2031. The balances of accounts receivable on June 30,
2020 and 2021 were $450,000 and $375,000, respectively. What would Castro report as cash
collected from customers in its statement of cash flows, using the direct method?
AR
450,000
450,000 *
[AIR
5M
→
5,000,000
sales Rev 5M
✗
5,000,000
5,450,000
51075,000
375,000
-
=
=
✗
375
✗
3751000
=
,
on + ×
Summarizing the indirect method:
recon
net income
with OCF (operating cash to- s )
o Used by the majority of public companies. Example: Walgreens
o If you use the indirect method, you must also disclose the cash paid for interest and taxes.
o Three step process:
1. Start with net income
2. Adjust for noncash items
a. Add back noncash expenses and losses
ex
:
depreciation / amortizationFadd
b. Subtract noncash revenues and gains
already in
investing
#:geim
on
back to
doesn't
loss on sale
essentially
it
reverse since
actually happen )
sale
c. Why? These items affected net income, but they don’t affect cash. So, when
calculating operating cash flows, we basically reverse them.
3. Adjust for changes in operating accounts
Assets
o Classifying changes in operating accounts under the indirect method:
Liabilities
•
Increase
Decrease
subtract
add
add
subtract
o Explaining why:
▪
If assets increase, we had less cash available to us (e.g., still waiting on A/R, paid more
into a prepaid asset). That feels like an outflow, so we subtract. * we gained inventory AYR
,
to pay
for
▪
If assets decrease, we had more cash available. That feels like an inflow, so we add. * sold
▪
If liabilities increase, we had more cash available to us (e.g., got to delay paying a bill
and hold onto the cash). That feels like an inflow, so we add. *
▪
we
haven't
paid the
etc
we
had
.
assets
liabilities
yet
If liabilities decrease, we must have paid them off. That feels like an outflow, so we *
subtract.
,
it
we
paid the
liabilities
•
indirect method
-
Practice: Marvin Co. reported net income of $530,000 for the year ended December 31, 2019.
begs
end
Accounts payable balances at the beginning and end of the year were $72,000 and $64,000,
beg
end
respectively. Beginning and ending inventory balances were $80,000 and $95,000,
respectively. Purchases of inventory were $180,000. What would Marvin Co. would report as
↑
operating cash flows?
.
Inc
.
AP
( $8,000)
Inventory
( $15,000)
operating
•
CF
method
indirect
$530,000
Net Income
Dec
not included in
=
← we
←
we
paid
paid
A / P with cash (neg cash fww)
for
inventory
with
cash ( neg cash flow)
$507,000
Practice (adapted from E5-42): Calex had the following selected balance sheet information
Sales
as of December 31. Assume there were no dispositions of equipment in the current year. Based
on these account balances, what can we infer related to operating and/or investing activities?
Prior Year
10,000
15,000
Accumulated Depreciation
(1,000)
(2,000)
-
Equipment increased by
Accumulated
$5k
( Investment activity
Depreciation increased by
↳ we recorded
•
Current Year
Equipment
-
depreciation
expense
$1k
=
used
to
add back
to
operating activity
Practice: Prepare a statement of cash flows under the direct and indirect methods in the Unit
1 Continuing Class Packet.
Learning Objective 5-3: Describe the interrelations of the financial statements.
•
↓ 8K
We address this LO by examining the relationships in the Unit 1 Continuing Class Packet.
↑ 15K
Learning Objective 5-4: Perform an investment analysis using the DuPont framework.
•
Financial Statement Analysis: Investors and other intermediaries use the financial statements
to make investment decisions/recommendations. The financial statements can provide insights
on the amount, timing, and risk of expected future cash flows.
o Although individual data points can be informative, we can often gain richer insights by
examining their relationships.
o Exhibit 5-7 has a full list of ratios described by this textbook. We’ll discuss the most
important ones in class.
o Practical tips:
▪
Ratios and metrics can be modified as needed to fit a given situation. The ratios we study
in this class are in their simplest, most common form.
▪
Each ratio or data point is just one piece of the puzzle. Never make an investment
decision based on a single one! Context is important.
▪
In order to analyze a ratio or data point, you usually need a benchmark of comparison.
Ex: Trends over time, industry averages, debt covenant requirements, numerical
thresholds.
•
Profitability Ratios:
Generally better if…
Return on Equity
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
𝐴𝑣𝑔. 𝑆𝐸
Profit Margin
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠
𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠
Gross Profit Percentage
Higher
Higher
Higher
•
Activity Ratios:
Generally better if…
Accounts Receivable Turnover
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠
𝐴𝑣𝑔. 𝐴𝑅
Average Days to Collect Receivables
365
𝐴𝑅 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟
𝐶𝑂𝐺𝑆
𝐴𝑣𝑔. 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
Inventory Turnover
Average Days in Inventory
•
Higher
Lower
Higher
365
𝐼𝑛𝑣. 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟
lower
Practice: Mabel Inc. began the year with inventory of $320,000. At year-end, inventory was
$250,000. Cost of goods sold was $1,400,000, and sales revenue was $2,500,000 for the year.
Calculate the average days in inventory (rounded).
1-41
COI
•
4.91
=
=
( 320k -1250k)
/z
avg.tw?wIwnan- 3Y.a- 74dayrNetlnc.DuPont Framework:
o Three drivers to shareholders’ return on equity:
Return on Equity
=
Profit Margin
×
Asset Turnover
×
Leverage
Nlt
Netsaus_
avg.Assetsn-vg.se
Arg Equity
=
Net sales
Shareholders
earn a higher
return when…
higher profit
per
unit
sold
×
×
.
Arg
sell
.
Assets
more
units
or
bemoeeltieient
financing
growth
wwsownes other
than
equity
o Another visual depiction of the DuPont Framework:
Hanlon et al., Intermediate Accounting 3e Exhibit 5-5
Learning Objective 5-5: Perform a credit analysis using key ratios.
•
Creditors (i.e., lenders) care about profitability. However, their “upside” is limited to a full
return of principal and interest. So above all else, they care about default risk.
•
Default risk: The risk that the borrower will be unable to repay its debts (principal and
interest), either in the short or long-term.
•
Liquidity Ratios:
o Focused on short-term default risk.
Generally better if…
Current Ratio
Working Capital
Quick Ratio
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
higher
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 − 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
higher
𝐶𝑎𝑠ℎ + 𝑆𝑇 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡𝑠 + 𝐴𝑅
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
higher
o Why might the quick ratio be a superior measure of liquidity than the current ratio?
takes into account
liquid
assets
not
•
Practice: Calculate the current ratio and quick ratio of Barton Springs Bikes based on the
following information:
current
o Cash of $6,000
=
6ᵗ'%I
=
2
o Accounts receivable of $10,000
quick
o Inventory of $20,000
=
6+,-
=
0.89
o Accounts payable of $18,000
o Long-term note payable of $25,000
•
Solvency Ratios:
o Focused on long-term default risk.
Generally better if…
Total Liabilities to
Equity
Times Interest
Earned
•
𝑇𝑜𝑡𝑎𝑙 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
𝑇𝑜𝑡𝑎𝑙 𝑆𝐸
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑏𝑒𝑓𝑜𝑟𝑒 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑎𝑛𝑑 𝑇𝑎𝑥𝑒𝑠 (𝐸𝐵𝐼𝑇)
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝑥𝑝𝑒𝑛𝑠𝑒
Practice: Garner Inc. has total assets of $1,000,000 and total liabilities of $600,000. The
average debt-to-equity ratio in its industry is 1.20. Calculate Garner’s debt-to-equity ratio and
indicate how the company’s default risk compares to its industry.
a. 0.60; Higher default risk
b. 0.60; Lower default risk
c. 1.50; Higher default risk
d. 1.50; Lower default risk
•
Practice: Which of the following transactions would increase a company’s liquidity
ratios (current ratio and quick ratio)?
a. Receive cash from customers on accounts receivable
b. Purchase office supplies with cash
c. Pay dividends to shareholders
d. Borrow cash by signing a three-year note
Learning Objective 5-6: Perform horizontal and vertical analysis.
•
Horizontal analysis: Examining trends across time.
Net Income
•
2015
1,000
2016
1,500
2017
1,200
2000
1000
0
2015
2016
2017
Vertical analysis: Examining the distribution of categories within a broader amount.
Current Assets
2,500
25%
Noncurrent Assets
7,500
75%
Total Assets
10,000
Learning Objective 5-7: Recognize non-GAAP financial measures.
•
Management may voluntarily disclose some metrics that don’t fully comply with GAAP. If
so, the SEC requires they also report the GAAP-based measure, as well as a reconciliation.
o Common examples: EBIT, EBITDA, free cash flow
Pros to reporting non-GAAP
•
Example: Ford
Cons to reporting non-GAAP