Financial Accounting
Foundations
Summary Notes
Basic Functions of an Accounting
System
 Interpret
and record
business
transactions.
 Classify
similar
transactions
into useful
reports.
 Summarize
and
communicate
information to
decision makers.
External Users of Accounting
Information
•Owners
•Creditors
•Potential investors
•Labor unions
•Governmental agencies
•Suppliers
•Customers
•Trade associations
•General public
Objectives of External Financial
Reporting
Provide specific information about economic
resources, claims to resources, and changes in
resources and claims.
Provide information useful in assessing amount,
timing and uncertainty of future cash flows.
Provide general information useful in making
investment and credit decisions.
Users of Internal Accounting
Information
• Board of directors
• Chief executive officer (CEO)
• Chief financial officer (CFO)
• Vice presidents
• Business unit managers
• Plant managers
• Store managers
• Line supervisors
Introduction to Financial
Statements
Balance Sheet
Income Statement
Statement of Cash Flows
Describes where
the enterprise
stands at a specific
date.
Introduction to Financial
Statements
Balance Sheet
Income Statement
Statement of Cash Flows
Depicts the
revenue and
expenses for a
designated period
of time.
Introduction to Financial
Statements
Balance Sheet
Income Statement
Statement of Cash Flows
Depicts the ways
cash has changed
during a
designated period
of time.
Assets
Vagabond Travel Agency
Balance Sheet
December 31, 2011
Assets
Liabilities & Owners' Equity
Cash
$ 22,500 Liabilities:
Notes receivable
10,000
Notes payable
$ 41,000
Accounts receivable
60,500
Accounts payable
36,000
Supplies
2,000
Salaries payable
3,000
Land
100,000
Total liabilities
$ 80,000
Building
90,000 Owners' Equity:
Office equipment
15,000
Capital stock
150,000
Retained earnings
70,000
Total
$ 300,000 Total
$ 300,000
Assets are economic
resources that are
owned by the
business and are
expected to benefit
future operations.
Assets
These accounting principles support cost as
the basis for asset valuation.
Stable-Dollar
Assumption
Cost
Principle
Objectivity
Principle
Going-Concern
Assumption
Liabilities
Vagabond Travel Agency
Balance Sheet
December 31, 2011
Assets
Liabilities & Owners' Equity
Cash
$ 22,500 Liabilities:
Notes receivable
10,000
Notes payable
$ 41,000
Accounts receivable
60,500
Accounts payable
36,000
Supplies
2,000
Salaries payable
3,000
Land
100,000
Total liabilities
$ 80,000
Building
90,000 Owners' Equity:
Office equipment
15,000
Capital stock
150,000
Retained earnings
70,000
Total
$ 300,000 Total
$ 300,000
Liabilities are debts
that represent
negative future
cash flows for the
enterprise.
Owners’ Equity
Vagabond Travel Agency
Balance Sheet
December 31, 2011
Assets
Liabilities & Owners' Equity
Cash
$ 22,500 Liabilities:
Notes receivable
10,000
Notes payable
$ 41,000
Accounts receivable
60,500
Accounts payable
36,000
Supplies
2,000
Salaries payable
3,000
Land
100,000
Total liabilities
$ 80,000
Building
90,000 Owners' Equity:
Office equipment
15,000
Capital stock
150,000
Retained earnings
70,000
Total
$ 300,000 Total
$ 300,000
Owners’ equity
represents the
owners’ claims on
the assets of the
business.
The Accounting Equation
Assets = Liabilities + Owners’ Equity
$300,000 =
$80,000 +
$220,000
Vagabond Travel Agency
Balance Sheet
December 31, 2011
Assets
Liabilities & Owners' Equity
Cash
$ 22,500 Liabilities:
Notes receivable
10,000
Notes payable
$ 41,000
Accounts receivable
60,500
Accounts payable
36,000
Supplies
2,000
Salaries payable
3,000
Land
100,000
Total liabilities
$ 80,000
Building
90,000 Owners' Equity
Office equipment
15,000
Capital stock
150,000
Retained earnings
70,000
Total
$ 300,000 Total
$ 300,000
Debit and Credit Entries
Debits and credits affect accounts as follows:
A = L + OE
ASSETS
Debit for
Increase
Credit for
Decrease
LIABILITIES
Debit
Credit for
for
Increase
Decrease
EQUITIES
Debit
for
Decrease
Credit for
Increase
Double Entry AccountingThe Equality of
Debits and Credits
A = L + OE
=
Debit
balances
Credit
balances
In the double-entry accounting system,
every transaction is recorded by equal dollar
amounts of debits and credits.
The Matching Principle: When To
Record Revenue
Matching Principle
Revenue should be
recognized at the time
goods are sold and
services are rendered.
The Matching Principle: When To
Record Expenses
Matching Principle
Expenses should be
recorded in the period in
which they are used up.
Debit and Credit Rules for
Revenue and Expenses
Expenses
decrease
owners’ equity.
EQUITIES
Debit
for
Decrease
EXPENSES
Debit
for
Increase
Credit
for
Decrease
Credit for
Increase
Revenues
increase
owners’ equity.
REVENUES
Debit
for
Decrease
Credit for
Increase
JJ's Lawn Care Service
Unadjusted Trial Balance
May 31, 2011
Cash
$
3,925
Accounts receivable
75
Tools & equipment
2,650
Truck
15,000
Notes payable
$
Accounts payable
Capital stock
Dividends
200
Sales revenue
Gasoline expense
50
Total
$
21,900 $
13,000
150
8,000
750
21,900
All balances are taken from the ledger accounts on May 31 after
considering all of JJ’s transactions for the month.
Adjusting Entries
Adjusting
entries are
needed whenever
revenue or expenses affect
more than one
accounting
period.
Every adjusting
entry involves a
change in either a
revenue or expense
and an asset
or liability.
Types of Adjusting Entries
 Converting
assets to
expenses
 Converting
liabilities to
revenue
 Accruing
unpaid
expenses
 Accruing
uncollected
revenue
Converting Assets to Expenses
End of Current Period
Prior Periods
Transaction
Paid cash in
advance of
incurring expense
(creates an asset).
Current Period
Future Periods
Adjusting Entry
 Recognizes portion
of asset consumed
as expense, and
 Reduces balance of
asset account.
Converting Assets to Expenses
$2,400 Insurance Policy
Coverage for 12 Months
$200 Monthly Insurance Expense
Jan. 1
Dec. 31
On January 1, Webb Co. purchased a oneyear insurance policy for $2,400.
Converting Liabilities to Revenue
End of Current Period
Prior Periods
Transaction
Collect cash in
advance of earning
revenue
(creates a liability).
Current Period
Future Periods
Adjusting Entry
 Recognizes portion
earned as revenue,
and
 Reduces balance of
liability account.
Converting Liabilities to Revenue
$6,000 Rental Contract
Coverage for 12 Months
$500 Monthly Rental Revenue
Jan. 1
Dec. 31
On January 1, Webb Co. received $6,000 in
advance for a one-year rental contract.
Accruing Unpaid Expenses
End of Current Period
Prior Periods
Current Period
Adjusting Entry
 Recognizes expense
incurred, and
 Records liability for
future payment.
Future Periods
Transaction
Pay cash in
settlement of
liability.
Accruing Unpaid Expenses
$3,000 Wages
Expense
Monday,
May 29
Wednesday,
May 31
Friday,
June 2
On May 31, Webb Co. owes wages of $3,000.
Payday is Friday, June 2.
Accruing Uncollected Revenue
End of Current Period
Prior Periods
Current Period
Adjusting Entry
Recognizes revenue
earned but not yet
recorded, and
Records receivable.
Future Periods
Transaction
Collect cash in
settlement of
receivable.
Accruing Uncollected Revenue
$170 Interest
Revenue
Saturday,
Jan. 15
Monday,
Jan. 31
Tuesday,
Feb. 15
On Jan. 31, the bank owes Webb Co. interest
of $170. Interest is paid on the 15th day of
each month.
Effects of the Adjusting Entries
Income Statement
Adjustment
Type I
Converting Assets to Expenses
Type II
Converting Liabilities to Revenue
Type III
Accruing Unpaid Expenses
Type IV
Accruing Uncollected Revenue
Revenue Expenses
No effect Increase
Increase
Assets
Liabilities
Decrease Decrease No effect
No effect Increase
No effect Increase
Increase
Net
Income
Balance Sheet
No effect Decrease
Decrease No effect Increase
No effect Increase
Increase
No effect
Owners'
Equity
Decrease
Increase
Decrease
Increase
JJ's Lawn Care Service
Unadjusted Trial Balance
May 31, 2011
Cash
$
3,925
Accounts receivable
75
Tools & equipment
2,650
Truck
15,000
Notes payable
$
Accounts payable
Capital stock
Dividends
200
Sales revenue
Gasoline expense
50
Total
$
21,900 $
13,000
150
8,000
750
21,900
All balances are taken from the ledger accounts on May 31 after
considering all of JJ’s transactions for the month.
Adjusted Trial Balance
JJ's Lawn Care Service
Adjusted Trial Balance
May 31, 2011
Cash
$
3,925
Accounts receivable
75
Tools & equipment
2,650
Accum. depreciation: tools & eq.
$
50
Truck
15,000
Accum. depreciation: truck
250
Notes payable
13,000
Accounts payable
150
Capital stock
8,000
Dividends
200
Sales revenue
750
Gasoline expense
50
Depreciation exp.: tools & eq.
50
Depreciation exp.: truck
250
Total
$
22,200 $ 22,200
All balances are
taken from the
ledger accounts
on May 31 after
preparing the
two depreciation
adjusting entries.
JJ's Lawn Care Service
Adjusted Trial Balance
May 31, 2011
Cash
$
Accounts receivable
3,925
75
Tools & equipm ent
Accum ulated depreciation: tools &
equipm ent
2,650
$
Truck
15,000
Accum um lated depreciation: truck
250
Notes payable
13,000
Accounts payable
150
Capital stock
8,000
Dividends
200
Sales revenue
750
Gasoline expense
50
Depreciation expense: tools & equipm ent
50
Depreciation expense: truck
Total
50
250
$
22,200
$
22,200
Now, let’s prepare the financial statements for JJ’s
Lawn Care Service for May.
The Income Statement
JJ's Lawn Care Service
Income Statement
For the month ending May 31, 2011
Sales revenue
$
750
Operating expenses:
Gasoline expense
Depreciation: tools & equipment
Depreciation: truck
Net income
$
50
50
250
350
$
Net income also appears on the
Statement of Retained Earnings.
400
The Statement of Retained
Earnings
JJ's Lawn Care Service
Statement of Retained Earnings
For the Month Ended May 31, 2011
Retained earnings, May 1
Add: Net income
Subtotal
Less: Dividends
Retained earnings, May 31
$
400
$ 400
200
$ 200
Now, let’s prepare the Balance Sheet.
The Balance Sheet
JJ's Lawn Care Service
Balance Sheet
May 31, 2011
Assets
Cash
Accounts receivable
Tools & equipment
$
2,650
Less: Accumulated depreciation
50
Truck
$
15,000
Less: Accumulated depreciation
250
Total assets
Liabilities & Stockholders' Equity
Liabilities:
Notes payable
Accounts payable
Total liabilities
Stockholders' equity:
Capital stock
$
8,000
Retained earnings
200
Total stockholders' equity
Total liabilities & stockholders' equity
$
3,925
75
2,600
$
$
14,750
21,350
$
13,000
150
13,150
$
8,200
21,350
Relationships among the Financial
Statements
JJ's Lawn Care Service
Income Statement
For the month ending May 31, 2011
JJ's Lawn Care Service
Balance Sheet
May 31, 2011
Assets
Cash
Accounts receivable
Tools & equipment
$
2,650
Less: Accumulated depreciation
50
Truck
$
15,000
Less: Accumulated depreciation
250
Total assets
Liabilities & Stockholders' Equity
Liabilities:
Notes payable
Accounts payable
Total liabilities
Stockholders' equity:
Capital stock
$
8,000
Retained earnings
200
Total stockholders' equity
Total liabilities & stockholders' equity
$
3,925
75
2,600
$
$
14,750
21,350
$
13,000
150
13,150
$
8,200
21,350
Sales revenue
Operating expenses:
Gasoline expense
Depreciation: tools & equipment
Depreciation: truck
Net income
$
$
750
$
350
400
50
50
250
JJ's Lawn Care Service
Statement of Retained Earnings
For the Month Ended May 31, 2011
Retained earnings, May 1
Add: Net income
Subtotal
Less: Dividends
Retained earnings, May 31
$
400
$ 400
200
$ 200
Closing the Temporary Accounts
Close Revenue accounts to
Income Summary.
Close Expense accounts to
Income Summary.
Close Income Summary
account to Retained
Earnings.
Close Dividends to Retained
Earnings.
The closing process gets
the temporary accounts
ready for the next
accounting period.
Closing the Temporary Accounts
JJ's Lawn Care Service
Adjusted Trial Balance
May 31, 2011
Cash
$
3,925
Accounts receivable
75
Tools & equipment
2,650
Accum. depreciation: tools & eq.
$
50
Truck
15,000
Accum. depreciation: truck
250
Notes payable
13,000
Accounts payable
150
Capital stock
8,000
Dividends
200
Sales revenue
750
Gasoline expense
50
Depreciation exp.: tools & eq.
50
Depreciation exp.: truck
250
Total
$
22,200 $ 22,200
Closing Entries for Revenue
Accounts
Since Sales Revenue has a credit balance, the closing
entry requires a debit to the Sales Revenue account.
GENERAL JOURNAL
Date
Account Titles and Explanation
May 31 Sales Reveune
Income Summary
To close the revenue account.
Debit
Credit
750
750
Closing Entries for Expense
Accounts
Since expense accounts have a debit balance, the
closing entry requires a credit to the expense
accounts.
GENERAL JOURNAL
Date
Account Titles and Explanation
May 31 Income Summary
Debit
Credit
350
Gasoline Expense
50
Depreciation Exp.: Tools & Equipment
50
Depreciation Exp.: Truck
To close the expense accounts.
250
Closing the Income Summary
Account
Since Income Summary has a $400 credit balance,
the closing entry requires a debit to Income
Summary.
GENERAL JOURNAL
Date
Account Titles and Explanation
May 31 Income Summary
Retained Earnings
To close Income Summary.
Debit Credit
400
400
Closing the Dividends Account
Since the Dividends account has a debit balance,
the closing entry requires a credit to the Dividends
account.
GENERAL JOURNAL
Date
Account Titles and Explanation
May 31 Retained Earnings
Dividends
To close the Dividends account.
Debit Credit
200
200
After-Closing Trial Balance
JJ's Lawn Care Service
After-Closing Trial Balance
May 31, 2011
Cash
$
3,925
Accounts receivable
75
Tools & equipment
2,650
Accum. depreciation: tools & eq.
$
50
Truck
15,000
Accum. depreciation: truck
250
Notes payable
13,000
Accounts payable
150
Capital stock
8,000
Retained earnings
200
Total
$
21,650 $ 21,650
Operating Cycle of a Merchandising
Company
Income Statement of a
Merchandising Company
Computer City
Condensed Income Statement
For the Year Ended December 31, 2011
Revenue from sales
$ 900,000
Less: Cost of goods sold
540,000
Gross profit
$ 360,000
Less: Expenses
270,000
Net income
$ 90,000
Cost of goods
sold
represents
the expense
of goods that
are sold to
customers.
Gross profit is a useful means of measuring the
profitability of sales transactions.
Closing Entries in a Perpetual
Inventory System
 Close Revenue accounts (including
Sales) to Income Summary.
 Close Expense accounts (including
Cost of Goods Sold) to Income
Summary.
 Close Income Summary account
to Retained Earnings.
 Close Dividends to Retained
Earnings.
The closing entries
are the same!
Credit Terms and Cash Discounts
When manufacturers and wholesalers sell
their products on account, the credit terms
are stated in the invoice.
Read as: “Two ten, net thirty”
2/10, n/30
Percentage of
Discount
# of Days
Discount Is
Available
Otherwise, the
Full Amount Is
Due
# of Days when
Full Amount Is
Due
Recording Purchases at Net Cost
On July 6, Jack & Jill, Inc. purchased $4,000 of
merchandise on credit with terms of
2/10, n/30 from Kid’s Clothes.
Prepare the journal entry for Jack & Jill, Inc.
GENERAL JOURNAL
Date
Account Titles and Explanation
July 6 Inventory
Accounts Payable (Kid's Clothes)
$4,000  98% = $3,920
Debit
Credit
3,920
3,920
Transactions Related to Sales
Computer City
Partial Income Statement
For the Year Ended December 31, 2011
Revenue
Sales
Less: Sales returns and allowances $
Sales discounts
Net sales
$ 912,000
8,000
4,000
12,000
$ 900,000
Credit terms and merchandise returns affect
the amount of revenue earned by the seller.
The Valuation of Financial Assets
Basis for Valuation in
Type of Financial Assets
the Balance Sheet
Cash (and cash equivalents) Face amount
Short-term investments
Current market value
(marketable securities)
Receivables
Net realizable value
Estimated collectible amount
Presentation of Marketable Securities
in the Balance Sheet
Reflecting Uncollectible Accounts in
the Financial Statements
At the end of each period, record an
estimate of the uncollectible accounts.
GENERAL JOURNAL
Date
Account Titles and Explanation
Uncollectible Accounts Expense
Credit
$$$$
Allowance for Doubtful Accounts
Selling expense
Debit
$$$$
Contra-asset account
The Allowance for Doubtful
Accounts
The net realizable value is the amount of
accounts receivable that the business
expects to collect.
Accounts receivable
Less: Allowance for doubtful accounts
Net realizable value of accounts receivable
Monthly Estimates of Credit Losses
At the end of each month,
management should
estimate the probable
amount of uncollectible
accounts and adjust the
Allowance for Doubtful
Accounts to this new
estimate.
Two Approaches to Estimating Credit Losses
1. Balance Sheet Approach
2. Income Statement Approach
Estimating Credit Losses — The
Balance Sheet Approach
 Year-end Accounts Receivable is
broken down into age classifications.
 Each age grouping has a different
likelihood of being uncollectible.
 Compute a separate allowance for
each age grouping.
Estimating Credit Losses — The
Balance Sheet Approach
At December 31, the receivables for EastCo,
Inc. were categorized as follows:
EastCo, Inc.
Schedule of Accounts Receivable by Age
Days Past Due
Current
1 - 30
31 - 60
Over 60

December 31, 2009
Accounts
Estimated
Estimated
Receivable Bad Debts Uncollectible
Balance
Percent
Amount
$
$
45,000
15,000
5,000
2,000
67,000

1% $
3%
5%
10%
$

450
450
250
200
1,350
Estimating Credit Losses — The
Balance Sheet Approach
EastCo’s unadjusted balance
in the allowance account is
$500.
Per the previous computation,
the desired balance is $1,350.
Allowance for
Doubtful Accounts
500
850
1,350
GENERAL JOURNAL
Date
Account Titles and Explanation
Dec. 31 Uncollectible Accounts Expense
Allowance for Doubtful Accounts
Debit
Credit
850
850
Estimating Credit Losses — The
Income Statement Approach
Uncollectible accounts’ percentage is based on
actual uncollectible accounts from prior years’ credit
sales.
Net Credit Sales
 % Estimated Uncollectible
Amount of Journal Entry
Estimating Credit Losses — The
Income Statement Approach
In the current year, EastCo had credit sales of
$60,000. Historically, 1% of EastCo’s credit
sales has been uncollectible. For the current
year, the estimate of uncollectible accounts
expense is $600.
($60,000 × .01 = $600)
GENERAL JOURNAL
Date
Account Titles and Explanation
Dec. 31 Uncollectible Accounts Expense
Allowance for Doubtful Accounts
Debit
Credit
600
600
Notes Receivable and Interest
Revenue
The interest formula includes three
variables:
Interest = Principal × Interest Rate × Time
When computing interest for one year, “Time” equals 1.
When the computation period is less than one year, then
“Time” is a fraction.
For example, if we needed to compute interest for 3
months, “Time” would be 3/12.
Notes Receivable and Interest
Revenue
On November 1, Hall Company loans $10,000 to
Porter Company on a 3 month note earning 12
percent interest. On December 31st, Hall Company
needs an adjusting entry to record the interest
revenue on the Porter Company note.
Date
Description
Dec. 31 Interest Receivable
Interest Revenue
Debit
Credit
200
$10,00012% 2/12 = $200
200
Notes Receivable and Interest
Revenue
What entry would Hall Company
make on February 1, the maturity date?
$10,00012% 3/12 = $300
Date
Description
Feb. 1 Cash
Interest Receivable
Interest Revenue
Notes Receivable
Debit
Credit
10,300
200
100
10,000
The Flow of Inventory Costs
BALANCE SHEET
Purchase costs (or
manufacturing costs)
Asset
Inventory
INCOME STATEMENT
Revenue
Cost of goods sold
Gross profit
Expenses
Net income
as goods are
sold
Inventory Valuation Methods: A Summary
Costs Allocated to:
Valuation
Cost of Goods
Method
Sold
Inventory
Comments
Specific
Actual cost of
Actual cost of units Parallels physical flow
identification
the units sold
remaining
Logical method when units
are unique
May be misleading for
identical units
Average cost
Number of units
Number of units on Assigns all units the same
sold times the
hand times the
average unit cost
average unit cost average unit cost
Current costs are averaged
in with older costs
First-in, First-out Cost of earliest
Cost of most
Cost of goods sold is based
(FIFO)
purchases on
recently
on older costs
hand prior to the purchased units
Inventory valued at current
sale
costs
May overstate income during
periods of rising prices; may
increase income taxes due
Last-in, First-out Cost of most
Cost of earliest
Cost of goods sold shown at
(LIFO)
recently
purchases
recent prices
purchased units
(assumed still in
Inventory shown at old (and
inventory)
perhaps out of date) costs
Most conservative method
during periods of rising
prices; often results in lower
income taxes
Importance of an Accurate Valuation
of Inventory
Average-Cost Method
On August 14, TBC sold 20 bikes for $130 each.
Purchases
Date
Units
Unit Cost
Total
Cost of Goods Sold
Unit
Cost
Units
Total
Inventory Balance
Units
Unit Cost
Aug. 1
10
@
$
91
= $
910
10 @
$
Aug. 3
15
@
$
106
= $
1,590
25 @
$
5 @
$
Aug. 14
The average cost per unit
must be computed prior to
each sale.
20
@
$
100
= $
2,000
Total
91 =
$
910
100
= $
2,500
100
= $
500
$2,500  25 = $100 avg. cost
Average-Cost Method
Additional purchases were made on August 17 and August
28. On August 31, an additional 23 units were sold.
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Purchases
Unit
Cost
Units
Total
Inventory Balance
Cost of Goods Sold
Unit
Unit
Cost
Total
Units Cost
Total Units
10
@
$
91
=
$
910
10 @
$
15
@
$ 106
=
$ 1,590
25 @
$ 100
= $ 2,500
5 @
$ 100
= $
20
@
$ 100
= $ 2,000
91 =
$
910
500
20
@
$ 115
=
$ 2,300
25 @
$ 112
= $ 2,800
10
@
$ 119
=
$ 1,190
35 @
$ 114
= $ 3,990
12 @
$ 114
= $ 1,368
23
@
$ 114
= $ 2,622
$114 = $3,990  35
Average-Cost Method
Inventory Balance
Cost of Goods Sold
Unit
Unit
Cost
Total
Units Cost
Total Units
Income Statement
20
@
$ 100
= $ 2,000
COGS = $4,622
23
@
$ 114
= $ 2,622
10 @
$
91 =
$
910
25 @
$ 100
= $ 2,500
5 @
$ 100
= $
25 @
$ 112
= $ 2,800
35 @
$ 114
= $ 3,990
12 @
$ 114
= $ 1,368
500
Balance Sheet
Inventory = $1,368
First-In, First-Out Method (FIFO)
On August 14, TBC sold 20 bikes for $130 each.
Date
Aug. 1
Aug. 3
Aug. 14
Purchases
Unit
Cost
Units
Total
Inventory Balance
Cost of Goods Sold
Unit
Unit
Cost
Total
Units Cost
Total Units
10
@
$
91
=
$
910
10 @
$
91
15
@
$ 106
=
$ 1,590
10 @
$
91
15
@
$ 106
5
@
$ 106
10
@
$
91
10
@
$ 106
= $ 1,970
= $
910
=
$ 2,500
=
$
The Cost of Goods Sold for the August 14 sale is $1,970, leaving 5 units,
with a total cost of $530, in inventory.
530
First-In, First-Out Method (FIFO)
Additional purchases were made on Aug. 17 and Aug. 28.
On August 31, an additional 23 units were sold.
Date
Aug. 1
Aug. 3
Purchases
Unit
Cost
Units
Total
10
@
$
91
=
$
910
10 @
$
91
15
@
$ 106
=
$ 1,590
10 @
$
91
15
@
$ 106
5
@
$ 106
Aug. 14
Aug. 17
Inventory Balance
Cost of Goods Sold
Unit
Unit
Cost
Total
Units Cost
Total Units
20
@
$ 115
=
10
@
$
91
10
@
$ 106
= $ 1,970
$ 2,300
5 @
20
Aug. 28
Aug. 31
10
@
$ 119
=
$ 1,190
5
@
$ 106
18
@
$ 115
= $ 2,600
$ 106
@
$ 115
5 @
$ 106
20
@
$ 115
10
@
$ 119
2 @
$ 115
10
@
$ 119
= $
910
=
$ 2,500
=
$
530
= $ 2,830
= $ 4,020
= $ 1,420
First-In, First-Out Method (FIFO)
Inventory Balance
Cost of Goods Sold
Unit
Unit
Cost
Total
Units Cost
Total Units
10
@
$
91
10
@
$ 106
= $ 1,970
10 @
$
91
10 @
$
91
15
@
$ 106
5
@
$ 106
5 @
Income Statement
COGS = $4,570
5
@
$ 106
18
@
$ 115
= $ 2,600
20
$ 106
@
$ 115
5 @
$ 106
20
@
$ 115
10
@
$ 119
2 @
$ 115
10
@
$ 119
= $
910
=
$ 2,500
=
$
530
= $ 2,830
= $ 4,020
Balance Sheet
= $ 1,420
Inventory = $1,420
Last-In, First-Out Method (LIFO)
On August 14, TBC sold 20 bikes for
$130 each.
Date
Aug. 1
Aug. 3
Aug. 14
Purchases
Unit
Cost
Units
Total
Inventory Balance
Cost of Goods Sold
Unit
Unit
Cost
Total
Units Cost
Total Units
10
@
$
91
=
$
910
10 @
$
91
15
@
$ 106
=
$ 1,590
10 @
$
91
15
@
$ 106
5
@
$
15
@
$ 106
5
@
$
= $ 2,045
91
= $
910
=
$ 2,500
=
$
455
91
The Cost of Goods Sold for the August 14 sale is $2,045, leaving 5
units, with a total cost of $455, in inventory.
Last-In, First-Out Method (LIFO)
Additional purchases were made on Aug. 17 and Aug. 28. On
Aug. 31, an additional 23 units were sold.
Date
Aug. 1
Aug. 3
Purchases
Unit
Cost
Units
Total
10
@
$
91
=
$
910
10 @
$
91
15
@
$ 106
=
$ 1,590
10 @
$
91
15
@
$ 106
5
@
$
91
$
91
Aug. 14
Aug. 17
Inventory Balance
Cost of Goods Sold
Unit
Unit
Cost
Total
Units Cost
Total Units
20
@
$ 115
=
15
@
$ 106
5
@
$
= $ 2,045
Aug. 31
10
@
$ 119
=
910
=
$ 2,500
=
$
455
91
$ 2,300
5 @
20
Aug. 28
= $
$ 1,190
@
5 @
10
@
$ 119
13
@
$ 115
= $ 2,685
$
91
20
@
$ 115
10
@
$ 119
5 @
$
7
$ 115
@
= $ 2,755
$ 115
91
= $ 3,945
= $ 1,260
Last-In, First-Out Method (LIFO)
Inventory Balance
Cost of Goods Sold
Unit
Unit
Cost
Total
Units Cost
Total Units
15
@
$ 106
5
@
$
= $ 2,045
10 @
$
91
10 @
$
91
15
@
$ 106
5
@
$
91
$
91
= $
910
=
$ 2,500
=
$
455
91
5 @
Income Statement
COGS = $4,730
10
@
$ 119
13
@
$ 115
= $ 2,685
20
@
5 @
$ 115
$
91
20
@
$ 115
10
@
$ 119
5 @
$
7
$ 115
@
= $ 2,755
91
= $ 3,945
Balance Sheet
= $ 1,260
Inventory = $1,260
Major Categories of Plant Assets
Tangible Plant
Assets
Intangible
Assets
Natural
Resources
Long-term
assets having
physical substance.
Noncurrent assets
with no physical
substance.
Sites acquired for
extracting valuable
resources.
Land, buildings,
equipment,
furniture, fixtures.
Patents, copyrights,
trademarks,
franchises, goodwill.
Oil reserves,
timber, other
minerals.
Accountable Events in the
Lives of Plant Assets
1. Acquisition.
2. Allocation of the acquisition
cost to expense over the
asset’s useful life
(depreciation).
3. Sale or disposal.
Acquisition of Plant Assets
Cost
=
Asset price
+
Reasonable and
necessary costs . . .
. . . for getting the
asset to the desired
location.
. . . for getting the
asset ready for use.
Capital Expenditures and Revenue
Expenditures
Capital
Expenditure
Revenue
Expenditure
Any material expenditure
that will benefit several
accounting periods.
Expenditure for
ordinary repairs
and maintenance.
To capitalize an expenditure
means to charge it to an
asset account.
To expense an expenditure
means to charge it to an
expense account.
Depreciation
The allocation of the cost of a plant asset to
expense in the periods in which services are
received from the asset.
Balance Sheet
Purchase
cost as assets
purchased
Assets:
Plant and
equipment
Income Statement
Revenues:
Expenses:
Depreciation
as the services are
received
Depreciation
Book Value
Cost – Accumulated Depreciation
Depreciation
 Contra-asset
 Represents the portion of an asset’s cost
that has already been allocated to expense.
Causes of Depreciation
 Physical deterioration
 Obsolescence
Straight-Line Depreciation
Depreciation
Expense per Year
=
Cost - Residual Value
Years of Useful Life
Straight-Line Depreciation
On January 2, S&G Wholesale Grocery buys a new
delivery truck. The truck cost $24,000, has an
estimated residual value of $3,000, and an estimated
useful life of 5 years.
Compute annual depreciation using the straight-line
method.
Cost – Residual Value
$ 24,000 – $ 3,000
=
Years of Useful Life
5
= $
4,200 per year
Straight-Line Depreciation
S&G will record $4,200 depreciation each year for five
years. Total depreciation over the estimated useful life of
the equipment is:
Year
First
Second
Third
Fourth
Fifth
Depreciation
Expense
(debit)
$
$
4,200
4,200
4,200
4,200
4,200
21,000
Accumulated
Depreciation
(credit)
$
$
4,200
4,200
4,200
4,200
4,200
21,000
Accumulated
Depreciation
Balance
$
4,200
8,400
12,600
16,800
21,000
Salvage Value
Undepreciated
Balance
(book value)
$
24,000
19,800
15,600
11,400
7,200
3,000
Declining-Balance Method
Depreciation in the early years of an asset’s estimated
useful life is higher than in later years.
Accelerated
Depreciation
Remaining
=
× Depreciation
Expense
Book Value
Rate
The double-declining balance depreciation rate is
200% of the straight-line depreciation rate of
(1÷Useful Life).
Declining-Balance Method
On January 2nd , S&G buys a new delivery truck
paying $24,000 cash. The truck has an estimated
residual value of $3,000 and an estimated useful
life of 5 years.
Compute depreciation for the first year using the
double-declining balance method.
First Year
Expense
=
=
=
=
Remaining
×
Book Value
$
24,000 ×
$
24,000 ×
$
9,600
Accelerated
Depreciation Rate
2 × 1/5
40%
Declining-Balance Method
Total depreciation over the estimated useful
life of an asset is the same using either the
straight-line method or the decliningbalance method.
Year
Computation
First
$ 24,000 × 40%
Second
14,400 × 40%
Third
8,640 × 40%
Fourth
5,184 × 40%
Fifth
Plug year # 5
Total Depreciation
Depr.
Accumulated
Book
Expense Depreciation
Value
$ 9,600 $
9,600 $ 14,400
5,760
15,360
8,640
3,456
18,816
5,184
2,074
20,890
3,110
110
21,000
3,000
$ 21,000
Disposal of Plant and Equipment
If Cash > BV, record a gain (credit).
If Cash < BV, record a loss (debit).
If Cash = BV, no gain or loss.
Recording cash
received (debit).
Removing accumulated
depreciation (debit).
Recording a
gain (credit)
or loss (debit).
Removing the
asset cost (credit).
Disposal of Plant and Equipment
Assume that a machine costing $10,000, had
accumulated depreciation of $8,000 and book
value of $2,000 (10,000 - $8,000) at the time it
was sold for $3,000 cash.
Determine the gain or loss on sale of this
machine.
Cost of machine
Accumulated depreciation
Book value at time of sale
Cash received
Gain on sale of machine
$ 10,000
(8,000)
2,000
3,000
$ 1,000
Disposal of Plant and Equipment
Assume that a machine costing $10,000, had
accumulated depreciation of $8,000 and book
value of $2,000 (10,000 - $8,000) at the time it
was sold for $3,000 cash.
Determine the gain or loss on sale of this
machine.
Description
Cash
Accumulated Depreciation: Machinery
Gain on Disposal of Plant Asset
Machinery
Debit
Credit
3,000
8,000
1,000
10,000
Trading in Used Assets
for New Ones
Assume that Essex Company exchanges a used
earthmover and $35,000 cash for a new
earthmoving machine. The old machine
originally cost $40,000, had up-to-date
accumulated depreciation of $30,000, and a
fair value of $4,000.
+ $35,000
Trading in Used Assets
for New Ones
Cost of equipment
Accumulated derpreciation: Equipment
$
40,000
30,000
Book value of equipment
Fair market value of equipment
Loss on disposal of plant asset
$
10,000
4,000
6,000
Description
Equipment (New earthmover)
Accumulated depreciation: Equipment
Loss on Disposal of Asset
Equipment (Old earthmover)
Cash
$
Debit
Credit
39,000
30,000
6,000
40,000
35,000
Intangible Assets
Noncurrent assets
without physical
substance.
Often provide
exclusive rights
or privileges.
Characteristics
Useful life is
often difficult
to determine.
Usually acquired
for operational
use.
Intangible Assets
Record at
current cash
equivalent cost,
including
purchase price,
legal fees, and
filing fees.
•
•
•
•
Patents
Copyrights
Leaseholds
Leasehold
Improvements
• Goodwill
• Trademarks and
Trade Names
The Nature of Liabilities
Defined as debts or obligations arising from
past transactions or events.
Maturity = 1 year or less
Maturity > 1 year
Current Liabilities
Noncurrent
Liabilities
Distinction Between Debt and Equity
The acquisition of assets is financed
from two sources:
DEBT
Funds from creditors, with a
definite due date, and
sometimes bearing interest.
EQUITY
Funds from
owners.
Current Liabilities: Accounts Payable
Short-term obligations to suppliers for
purchases of merchandise and to others for
goods and services.
Merchandise
inventory
invoices
Office
supplies
invoices
Examples
Shipping
charges
Utility and
phone bills
Current Liabilities: Notes Payable
When a company borrows money, a note payable is
created.
Current Portion of Notes Payable
The portion of a note payable that is due within one
year, or one operating cycle, whichever is longer.
Current Notes Payable
Total Notes
Payable
Noncurrent Notes Payable
Accrued Liabilities
Accrued liabilities arise from the recognition of
expenses for which payment will be made in the
future. Accrued liabilities are often referred to as
accrued expenses.
Examples include:
1. Interest payable,
2. Income taxes payable, and
3. Accrued payroll liabilities.
Payroll Liabilities
Gross Pay
Net Pay
Less Deductions:
Social
Security and
Medicare
Workman’s
Compensation
Federal
Income Tax
State and Local
Income Taxes
Voluntary
Deductions
Unearned Revenue
Cash is sometimes collected from the customer
before the revenue is actually earned.
As the earnings
process is completed
Cash is
received in
advance.
Deferred
revenue is
recorded.
a liability account.
Earned
revenue is
recorded.
Long-Term Liabilities
Relatively small debt needs can
be filled from single sources.
Banks
or
Insurance Companies
or
Pension Plans
Long-Term Liabilities
Large debt needs are often filled by
issuing bonds.
Installment Notes Payable
Long-term notes that call for a series of
installment payments.
Each payment covers
interest for the period
AND a portion of the
principal.
With each payment, the
interest portion gets smaller
and the principal portion gets
larger.
Allocating Installment Payments
Between Interest and Principal
1. Identify the unpaid principal balance.
2. Interest expense = Unpaid Principal × Interest
rate.
3. Reduction in unpaid principal balance =
Installment payment – Interest expense.
4. Compute new unpaid principal balance.
On January 1, Year 1, King’s Inn purchased furnishings
at a cost of $7,581.57. The loan was a five-year loan
and had an interest rate of 10%. The annual payment is
$2,000.
Let’s prepare an amortization table for King’s Inn.
Preparing an Amortization Table
Date
Payment
Jan 1, Year 1
Dec. 31, Year 1 $ 2,000.00
Dec. 31, Year 2
2,000.00
Dec. 31, Year 3
2,000.00
Dec. 31, Year 4
2,000.00
Dec. 31, Year 5
2,000.00
Interest
Expense
$
758.16
633.97
497.37
347.11
181.82
Reduction in
Unpaid
Balance
$
1,241.84
1,366.03
1,502.63
1,652.89
1,818.18
Unpaid
Balance
$ 7,581.57
6,339.73
4,973.70
3,471.07
1,818.18
0.00
$7,581.57 × 10% = $758.16
$2,000 - $758.16 = $1,241.84
$7,581.57 - $1,241.84 = $6,339.73
Using the Amortization Table
The information needed for the journal entry can be
found on the amortization table. The cash payment
amount, the interest expense, and the principal
reduction amount are all in the table.
Date
Description
Dec. 31 Interest Expense
Interest Payable
Debit
758.16
Credit
758.16
Using the Amortization Table
On January 1, Year 2, the first annual payment will be
made on the installment note. Refer to the previous
entry and amortization for the amounts shown.
Date
Jan. 1
Description
Interest Payable
Note Payable
Cash
Debit
758.16
1,241.84
Credit
2.000.00
Bonds Payable
• Bonds usually involve the
borrowing of a large sum of
money, called principal.
• The principal is usually paid
back as a lump sum at the end
of the bond period.
• Individual bonds are often
denominated with a par value,
or face value, of $1,000.
Bonds Payable
• Bonds usually carry a stated rate of interest,
also called a contract rate.
• Interest is normally paid semiannually.
• Interest is computed as:
Principal × Stated Rate × Time = Interest
Bonds Payable
• Bonds are issued through an intermediary
called an underwriter.
• Bonds can be sold on organized securities
exchanges.
• Bond prices are usually quoted as a
percentage of the face amount.
For example, a $1,000 bond priced
at 102 would sell for $1,020.
Types of Bonds
Mortgage
Bonds
Debenture
Bonds
Convertible
Bonds
Junk
Bonds
Accounting for Bonds Payable
On March 1, 2011, Wells Corporation issues
$1,500,000 of 12%, 10-year bonds payable. Interest
is payable semiannually, each March 1 and
September 1.
Assume the bonds are issued at face value.
Record the issuance of the bonds.
Date
Description
Mar. 1 Cash
Bonds Payable
Debit
Credit
1,500,000
1,500,000
Accounting for Bonds Payable
Record the interest payment on September 1, 2011.
Date
Description
Sep. 1 Interest Expense
Cash
$1,500,000 × 12% × ½ = $90,000
Debit
Credit
90,000
90,000
Bonds Issued Between Interest Dates
•
•
Bonds are often sold between interest dates.
The selling price of the bond is computed as:
Present value of the bond
+ Accrued interest since the
last interest payment
= Selling price of the bond
Bonds Issued at a Discount or a Premium
The selling price of the bond is
determined by the market based
on the time value of money.
Stated interest rate is
Above market rate
Equal to market rate
The bonds sells:
At a premium
(Cash received is greater than face
amount)
At face amount
(Cash received is equal to face
amount)
At a discount
Below market rate
(Cash received is less than face
amount)
Bonds Issued at a Discount
Wells, Corp. issues bonds on January 1, 2011.
Principal = $1,000,000
Issue price = $950,000
Stated Interest Rate = 9%
Interest Dates = 6/30 and 12/31
Maturity Date = Dec. 31, 2030 (20 years)
Principal
$1,000,000
Cash
Proceeds
Discount
- $ 950,000 = $ 50,000
Bonds Issued at a Discount
To record the bond issue, Well, Inc. would
make the following entry on January 1, 2011:
Date
Description
Jan. 1 Cash
Discount on Bonds Payable
Bonds Payable
Debit
Credit
950,000
50,000
1,000,000
Bonds Issued at a Discount
Partial Balance Sheet as of January 1, 2011
Long-term Liabilities:
Bonds Payable
Less: Discount on Bonds Payable
$ 1,000,000
50,000 $ 950,000
Maturity Value
Carrying Value
Bonds Issued at a Discount
Amortizing the discount over the term of the
bond increases Interest Expense each
interest payment period.
Using the straight-line method, the
discount amortization will be $1,250
every six months.
$50,000 ÷ 40 periods = $1,250
Amortization of the Discount
Interest paid every six months is calculated as follows:
$1,000,000 × 9% × ½ = $45,000
We prepare the following journal entry to record
the first interest payment.
Date
Description
Jun. 30 Interest Expense
Discount on Bonds Payable
Cash
Debit
Credit
46,250
1,250
45,000
Bonds Issued at a Discount
$50,000 – $1,250 – $1,250
Partial Balance Sheet as of December 31, 2011
Long-term Liabilities:
Bonds Payable
Less: Discount on Bonds Payable
$ 1,000,000
47,500
$ 952,500
Maturity Value
The carrying value will
increase to exactly $1,000,000
on the maturity date.
Carrying Value
Bonds Issued at a Discount
Wells Corporation will repay the principal amount
on December 31, 2030 with the following entry:
Date
Description
Dec. 31 Bonds Payable
Cash
Debit
Credit
1,000,000
1,000,000