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FINANCIAL ACCOUNTING
University of New York Prague
Martin Kolmhofer
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Course Objectives
Terminology and definitions used in the accounting language. Identify why accounting is a necessary skill.
Summarize the history of accounting.
Identify and describe assets, liabilities and owners' equity.
Demonstrate the effects of business transactions on the accountingequation
Recognize and compare the major financial reports. Describe and create a company's Income Statement.
Compare and contrast a company's revenue, expenses, income, andretained earnings.
Identify the key elements of a Balance Sheet.
Balance the accounting equation and properly chart debits and credits.
Describe the accounting cycle.
Define key terms: inventory, FIFO, LIFO, Cost of Goods Sold.
Summarize cash flow, identify fixed assets, and describe depreciation.
Know what to expect in an audit.
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Bean Counting vs. Big Picture
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Overview Day 1
Accounting Introduction
History - What is accounting?
Why do we need accounting?
The role of monetary calculation in society
Inherent Limitations of financial accounting
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What is accounting?
Definition
The systematic recording, reporting, and analysis of
financial transactions of a business.
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History of Accounting Luca Pacioli (1445 1514)
1494:
"Summa de Arithmetica, Geometria,
Proportioni et Proportionalita"
("Everything About Arithmetic, Geometry and
Proportion).
Double-entry bookkeeping:
For every credit entered into a ledger there
must be a debit
Merchants of Venice
Accounting was created in response to thedevelopment of trade and commerce during the
medieval times
Trading voyages needed to be financed
The system that was in use by these Venetian
merchants was nearly the same as we use today
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History of Accounting)
"Double-entry bookkeeping is one of the most beautiful
discoveries of the human spirit
(Johann Wolfgang Von Goethe 1796)
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Accountant vs. Bookkeeper
Whats the difference?
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WHY STUDY ACCOUNTING ?
Growing field due to increasedregulation (Sarbanes -Oxley)
Many different areas to
spezialize in (AP, AR...)
Lots of job growth opportunity
in all industries
Gives opportunity to move to
other areas of business
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What is accounting?
Functions of Money
Money as:
Store of Value (enables saving, lending, borrowing) Medium of Exchange (Alternative: Barter)
Unit of Account (common measurement in which valuesare expressed)
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Money as a Unit of Account
But if everybody charges in the
same item, that is money, itbecomes very clear who has thelowest price.
What if one supplierwants to be paid inbabysitting, another onein computer help andanother in petsitting andso on
Standard unit of measurement = Language of business
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Why do we need accounting?
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Why do we need accounting
What is finance all about?
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Why do we need accounting?
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Why do we need accounting?
It s all about people
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Why do we need accounting?
Unlimited Wants vs. Limited Resources
Unlimited Wants: Only perfect beings want nothing
Limited Resources: Time, Energy, Money
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Why do we need accounting?
Choices must be made
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Why do we need accounting?
Economic (calculation) problem
ECONOMICS is the study of how
people chose to use their scarce
resources in an attempt to satisfy
their unlimited wants
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Why do we need accounting?
SCARCITY exists when there is not enough
of something (product/service/resource)
to satisfy everyones wantsAT A ZERO PRICE
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The Price Mechanism
How to distribute resources rationally in the economy?
Capitalist solution is the Price Mechanism
Those who are willing to pay the price will get the goods and services
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Price Mechanism
How does the Price Mechanism work?
3 Magic Words: Supply and Demand
Example: Pencil vs. Watch
Common misconceptions about how prices
are determined (by suppliers, by cost of
production)
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Equilibrium Price
Subjective preference rankings interact to yield objective money prices
Equilibrium occurs when quantity supplied equals quantity demanded
Market price will be stable, that is it wont tend to change, whenyou reach the point at which willingness to buy coincides with
willingness to sell in the market
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Equilibrium Price
Subjective preference rankings interact to yield objective money prices
At 3 dollars every seller can find a willing buyer
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Equilibrium Price
Subjective preference rankings interact to yield objective money prices
No other price would be stableAll other prices would have a tendency to change
Example:
At a price of 1 dollar therewould be a SHORTAGE(quantity demanded isgreater than the quantitysupplied)Result:Upward pressure on price
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Equilibrium Price - ShortageSubjective preference rankings interact to yield objective money prices
Buyers start to compete to get the available units
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Equilibrium Price
Subjective preference rankings interact to yield objective money prices
Price goes up and consequentlyquantity demanded drops andquantity supplied rises until we getto equilibrium again
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Equilibrium PriceSubjective preference rankings interact to yield objective money prices
What about a higher price, like 5 dollars?
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Equilibrium Price - Surplus
Subjective preference rankings interact to yield objective money prices
When the quantity demanded isless than the quantity supplied wehave a surplus and the price willdrop.
At 5 dollars sellers are happyproviding 5 units but buyers areunhappy, they only want one unit.
3 Dollars = MARKET CLEARING PRICE (clears the market of all
surpluses and shortages)
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Equilibrium Price - Surplus
Subjective preference rankings interact to yield objective money prices
.
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Disadvantages of the Price Mechanism
In our market economy it s the market that determines price and priceserves as the rationing mechanism to determine who gets the scarceproduct or service and who does not.
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Alternative Rationing Mechanisms
Queuing (Waiting in line as a means ofdistributing goods and services )
Ration Coupons (Tickets or coupons that
entitle individuals to purchase a certainamount of a given product per month )
Favored Customers (Those who receive special
treatment from dealers during situations ofexcess demand. )
Problem:
EXCESS DEMAND is created but not eliminated
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Alternative Rationing Mechanisms
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Price Mechanism Rationing, Price Ceilings
What would happen if you force a price that is not the equilibrium price?
Example: Government imposes price ceiling on gasoline
At the imposed price of 2,50 the quantity demanded is greater thanquantity supplied. This means that not everyone is going to get thegasoline that they want, because there is a shortage.
WHAT WILL HAPPEN?
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Price Mechanism Rationing, Price Ceilings
Would you ratherKNOW that you are going to get gas as long asyou are willing to pay 4 USD/gallon, orHOPE that you can get gasat the price ceiling of 2,50 USD?
CONCLUSION: Price mechanism is usually a good and effective
way to allocate resources
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Market Failures
Market Failures:3 examples where the price mechanism may not work -
may not allocate scarce resources efficiently
Public Goods (Free Rider Problem Non Excludability,Examples: Street lighting, national defence) People will
not pay for it Solution: goods are provided collectively by
the government and then financed through taxation
CANY
OU TH
INK OF EXAMPLES? Externalities (Environmental Pollution etcExample CO2
Certificates) factories are not calculating certain costs
Market Power (Monopolists - Price is higher and output is
lower under monopoly than in a competitive market )
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Video Price Mechanism in Action
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VIDEO Price Mechanism in Action
Example: Supply of a big city. Who coordinates?NOBODY
Process of impersonal social interaction is coordinated
through prices
Prices are signals that tell us what we have to do in
order to be useful for other people - This is how it was
possible to create a society based on the division of
labour
Millions of people in society coordinate their plans
through markets
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The Invisible Hand Adam Smith
Adam Smith was the first economist who investigated how
this process of social coordination works.
Rational, self-interested behaviour does not produce chaos, butusually produces social coordination
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Market Phenomena Laws of Social Cooperation
It is not from the benevolence of the butcher, the brewer orthe baker, that we expect our dinner, but from their regard
to their own self interest. We address ourselves, not to their
humanity but to their self-love, and never talk to them of
our own necessities but of their advantages.(Adam Smith, The Wealth of Nations 1776)
Market phenomena
Laws of social cooperation
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Division of Labour
Coordination through money prices
Supply, demand, and prices in input and output markets determine theallocation of resources and the ultimate combinations of things produced.
EXAMPLES OF CREATIVE DESTRUCTION:PolaroidCameras, Typewriter, SteamTrains....
CONSUMER
LABOUR LAND - CAPITAL
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Division of Labour Cost and Profit to the Firm
All social phenomena result from
interactions among the choices that
individuals make after calculating the
expected benefits and costs to
themselves
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Division of Labour Cost and Profit to the Firm
Social coordination through money prices.Therefore it is important to calculate Profit correctly
Accounting Profit = is total revenue minus explicit cost.
Economic Profit = total revenue minus opportunity cost
Accountants do not include implicit costs because they
are difficult to measure.
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Division of Labour Cost and Profit to the Firm
Opportunity Cost:
How much does it cost to go to university for a
year?
Explicit costs: tuition, books, school supplies, etc.
Implicit cost: The amount that the student could have earned if she had
worked rather than attended university
Implicit costs are costs that do not require a money payment. The
opportunity cost includes both explicit and implicit costs.
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Division of Labour Cost and Profit to the Firm
The opportunity cost ofanydecision is what isgiven up as a result of that decision.
Opportunity cost includes both explicit costsand implicit costs. The firms economic profits
are calculated using opportunity costs.
Accounting profits are calculated using onlyexplicit costs. Therefore, accounting profits
are higher than economic profits.
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Division of Labour Cost and Profit to the Firm
Method of reasoning - Ability to identify trueopportunity cost!
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Division of Labour Cost and Profit to the Firm
Identify true opportunity cost:
Story: The businessman and the fisherman
Conclusion: Does your profit cover all your costs?
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Division of Labour Cost and Profit to the Firm
When there is no profit the loss is obvious
(Old Chinese Merchants Proverb)
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Summary Day 1
Money as Unit of Account Unlimited Wants/Limited Resources
Scarcity
Price Mechanism
Equilibrium Price
Disadvantages of the Price Mechanism Market Failures
Alternative Rationing Mechanisms (Price Ceilings)
Division of Labour
Opportunity Cost
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Users of accounting information
Internal
Shareholders / Investors
Staff / Employees
Trade Unions
Managers
External
Customers
Government (Taxation)
Lenders (Banks, Analysts)
Suppliers
The Public
Competitors
The preparation of information for external users is calledFinancialAccounting. (vs. ManagementAccounting)
U f ti i f ti
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Users of accounting information
Internal: Shareholders / Investors
Companys shareholders are the real owners of a business and needinformation from those who manage the business on their behalf
They need information to help them determine whether theyshould buy, hold or sell (increase or decrease their holding).Shareholders are also interested in information which enables them
to assess the ability of the enterprise to pay dividends.
Question: How does stock price affect a company?
No direct impact. Once the shares are sold into the market, thecompany is no longer affected directly by the share price.However, some indirect effects:
Low Price: Danger ofHostile Takeovers, hard to raise future capital
Users of accounting information
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Users of accounting information
Shareholders / Investors
ANALYST COVERAGE:
Financial Analyst:
A financial professional who studies various industries and companies, providing
research and valuation reports, and making buy, sell, and hold
recommendations.
Users of accounting information
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Users of accounting information
Shareholders / Investors
Users of accounting information
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Users of accounting information
Internal: Staff / Employees
Interested in information about:
Stability and profitability of their employers
Ability of the enterprise to provide remuneration,
retirement benefits, employment prospects
Pay and benefits obtained by senior management
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Users of accounting information
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Users of accounting information
Internal: Managers
Management is also interested in the informationcontained in the financial statements even though it hasaccess to additional management and financial information
This is because the highly summarised nature of financialaccounts allows management to assess whether thecompany's strategic and tactical objectives are being met.
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Users of accounting information
External: Customers
Customers have an interest in information about thecontinuance of an enterprise, especially when they have along-term involvement with, or are dependent on, the
enterprise. They will look at the companies finances tomake sure the company is not in trouble and that theirsupplies are not about to dry up.
Example: Strategic Suppliers regular financial check-up!
Users of accounting information
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Users of accounting information
External: Government
Tax (Corporate Tax, Capital Gains, VAT) Regulation (Compliance)
National Statistics (GDP, Intrastat)
GDP:Total market value of all final goods and servicesproduced in a country in a given year, equal to totalconsumer, investment and government spending,plus the value of exports, minus the value ofimports.
Intrastat:Statitics on the trade in goods between countries ofthe European Union. (Balance of Payments)
Users of accounting information
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Users of accounting information
External: Lenders (Banks)
They need to make sure a company is in a healthy financial
situation before they start to lend money.
Concerned with debt repayment
Prefer to deal with a financially strong company with ahealthy cash flow
CREDIT BUREAUS (for individuals)
CREDIT RATING AGENCIES (for corporations + sovereign debt):
Baa1, Baa2, Baa3, Ba1, Ba2, Ba3
A1, A2, A3
B++, B+, B, B-, C++, C+, C, C-,
A.M. Best, Dun & Bradstreet, Standard & Poor's, Moody's, Fitch Ratings
Users of accounting information
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Users of accounting information
External: Lenders (Banks)
Examples of SovereignCredit Ratings:
Credit rating determines how much interest you have to pay for your debt
Important to INSTITUTIONAL INVESTORS (pension funds, Insurance companies
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Users of accounting information
External: Suppliers
Suppliers will look at a companys balance sheet and profit and lossaccount to see if and how much credit they are willing to give:
METHODS OF PAYMENT IN INTERNATIONAL TRADE:
Rule (especially for international trade):
NEVER sell on open account to a new customer
(only against credit card or advance payment)
Users of accounting information
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Users of accounting information
External: The Public
Contribution to the local economy (number of people theyemployed)
Patronage of local suppliers
Although not everyone in the public might understandfinancial accountsfinancial statemens also includewritten outlook:
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Users of accounting information
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Users of accounting information
Can you distinguish between managementaccounting and financial accounting?
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Overview Day 2
Users of Accounting Information
Accounting Principles
Financial Reports
Accounting Equation / Balance Sheet
How Transactions impact the Accounting Equation
Four basic types of transactions
The four core financial statements Accounts, Debits and Credits
The Journal The General Ledger
Posting
Chart of Accounts
Financial Statements from the Trial Balance
Accrual Accounting Revenue Recognition / Expense Recognition
Adusting Entries
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Accounting Principles
Question: Why have rules?
So that everyone plays the game the same way
What if owners and managers could prepare their business's
financial statements the way they felt like ?
If a business was wanting a loan or credit, they would have a tendency to
overstate the value of their assets and the value of their business. If it came to
taxes (we don't like to have to pay them), let's expense and write off everything.
As for measuring performance (profitability) and comparing businesses in thesame industry, you'd have no idea as to who was actually doing well and who
wasn't.
You couldn't even compare your own business from year to year
A i P i i l
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Accounting Principles
Rule making and standards setting organizations:
FASB: Financial Accounting Standards Board
= private sector organization in the United States that
establishes financial accounting and reporting standards.
Responsible for developingUS GAAP : Generally Accepted Accounting Principles
IASB: International Accounting Standards Board
= is an independent, privately-funded accounting standard-
setter based in London. Responsible for developing
IFRS: International Financial Reporting Standards
Harmonization Discussion: US - special accounting standards
for special industries
ll d l
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Generally Accepted Accounting Principles - GAAP
The most important accounting concepts are:
Economic Entity Assumption
Monetary Unit Assumption
Historical Cost Principle
Accruals Time Period Assumption
Dual Aspects
Matching Principle
Materiality
Going concern Consistency
Substance over form
Prudence
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Accounting Principles - Business Entity
Definition The activities of the entity
are to be kept separate
from the activities of its
owner and all other
economic entities
Example Pharmacist records the
purchase of two boxes of
Listerine to be sold in the
shop.
On the other hand, she
cannot record 1kg ofbeef
she buys for Sunday lunch
as it is her and only her
private expense. PROBLEMS?
The income tax authorities have thousands of rules as to what may andmay not be included as a deduction from revenue
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Accounting Principles - Monetary Unit Assumption
Assumptions:
1) Stable currency is the unit of record:
Dollar's purchasing power has not changed over time. Accountants ignore
the effect of inflation
For example, dollars from a 1960 transaction are combined with dollars
from a 2010 transaction Example LAND
Realistic Assumption?
USD-Gold Exchange Rate vs. Consumer Price Index (= official inflation
rate)
2) Record only transactions that can be expressed in terms of money
If an asset cannot be expressed as a dollar amount, it cannot be entered
in the general ledger:
Skills of the management team EXAMPLES?
A ti P i i l M t U it A ti
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Accounting Principles - Monetary Unit Assumption
A ti P i i l Hi t i l C t P i i l
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Accounting Principles Historical Cost Principle
You record items at what you paid for them.
A ti P i i l Hi t i l C t P i i l
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Accounting Principles Historical Cost Principle
Historical Cost vs. Fair Value From an accountant's point of view, the term "cost" refers to the amount
spent when an item was originallyobtained, whether that purchase
happened last year or thirty years ago = historical cost
For example, land is initially recorded in the accounting records at its
purchase price. That historical cost will not be adjusted even if the fair
value is perceived as increasing. Difference to Monetary Unit Assumption?
While this enhances the "reliability" of reported data, it can also pose a
limitation on its "relevance.
An exception is certain investments in stocks and bonds that are actively
traded on a stock exchange (Mark-to-market valuation) If you want to know the current value of a company's long-term assets, you
will not get this information from a company's financial statementsyou
need to look elsewhere, perhaps to a third-party appraiser.
Accounting Principles Time Period Principle
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Accounting Principles Time Period Principle
The Time-period principle implies that the economicactivities of an enterprise can be divided into
artificial time periods
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Accounting Principles Matching
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Accounting Principles - Matching
Definition
Revenue for a given period
is matched against the costs
incurred in the same period
when generating this
revenue. This concept enables for a
true and fair view of profit
for the given period.
Examples:
Accrued Expenses
Deferred Expenses
Depreciation
ACCRUAL ACCOUNTING
vs.
CASH BASED ACCOUNTING
Example Deferred Expense:
You hold a CONFERENCE that you prepaid for in January, but the conference actually happens in March, you should
recognize the expense for it in March as well as the revenue for the attendees.
Example Depreciation:
If a machine is bought for $100,000, has a life span of 10 years, and can produce the same amount of goods each
year, then $10,000 of the cost of the machine is matched to each year, rather than charging $100,000 in the first
year and nothing in the next 9 years. So, the cost of the machine is offset against the sales in that year.
Accounting Principles Materiality
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Accounting Principles - Materiality
Definition Unless the item is significant
in value when compared to
the entitys size, it may be
excluded from the decision
making.
$5,000 might be immaterial
for a large, profitable
corporation (say General
Motors), but it will bematerial or significant for a
small company that has
very little profit
Example A classic example of the materiality
concept or the materiality principle is
the immediate expensing of a $10
wastebasket that has a useful life of
10 years. The matching principle
directs you to record the wastebasket
as an asset and then depreciate its
cost over its useful life of 10 years.
The materialityprinciple allows you
to expense the entire $10 in the year
it is acquired instead of recording
depreciation expense of $1 per year
for 10 years. The reason is that no
investor, creditor, or other interested
party would be misled by not
depreciating the wastebasket over a
10-year period.
Accounting Principles Going Concern
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Accounting Principles - Going Concern
Definition
The business entity will
continue in operations for
the foreseeable future (ruleof thumb 12 months).
Allows for the accruals
principle to be reasonable
Book values vs liquidation
values
EXAMPLES?
Example
With previous matching /
accruals principle it would
not make sense to recordthe rent prepayment as a
cost of the next period if the
entity were not going to
continue in operation.
Accounting Principles Consistency
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Accounting Principles - Consistency
Definition
The accounting policies
should be consistent over
time. I.e. similar items should be
treated in a similar manner
within one as well as over
several accounting periods.
This allows for reasonable
comparison over time.
Example
If the entity changes the
accounting currency every
month, the month-to-month comparison would
be impossible.
Examples:
Valuation of Inventory
(FIFO, LIFO)
Depreciation Methods
Accounting Principles
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Substance over form
Definition
The financial statements of
the entity should reflect the
business reality rather than
the legal form of the events
or transactions.
Example
A group of employees is sent
for one week trip to Africa.
They spend one day in training
and for the remaining time
they go for safari. The whole trip could be
expensed as seminar.
In fact and in accordance with
the Principle, it is an additionalbenefit for the employees and
should be taxed accordingly
When it is a cat but it was disguised in alegal form to look like a dog, then you
would still treat it as a cat.
Example: Sale-and-Lease-Back contracts
Accounting Principles - Prudence
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Accounting Principles - Prudence
One should not try to make things look prettier than they are.
Typically, a revenue should be recorded only when it is certain and a
provision should be entered for an expense which isprobable.
Revenues should be recognized when they are to be realized withcertainty (100% sure about the revenue).
EXAMPLE: If there is a dispute about sales, the company is encouraged
not to report the disputed revenue.
Expenses should be recognized when they are probable to be incurred
(more than 50% chance that the cost will be incurred).
EXAMPLE: if there is a lawsuit that may require the company to pay
fines/fees, it has to be reported (at least in the notes).
Accounting Principles - Prudence
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Accounting Principles - Prudence
Accounting Principles - Conflict of the Principles
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Accounting Principles Conflict of the Principles
If the conflict arises, there is no right or
wrong answer, the accountant needs to use
his/her own judgment
In conflicts between the prudence
convention and any of the others, the
prudence principle should be considered as
the dominant one = OVERRIDING PRICIPLE
Accounting Principles - Conflict of the Principles
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Accounting Principles Conflict of the Principles
QUESTIONS?
Overview Day 2
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Overview Day 2
Users of Accounting Information
Accounting Principles
Financial Reports
Accounting Equation / Balance Sheet
How Transactions impact the Accounting Equation
Four basic types of transactions
The four core financial statements
Accounts, Debits and Credits
The Journal The General Ledger
Posting
Chart of Accounts
Financial Statements from the Trial Balance
Accrual Accounting Revenue Recognition / Expense Recognition
Adusting Entries
Financial Reports
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Financial Reports
4 MAIN TYPES:
Balance sheet (BS)
Income statement (IS) or Profit & Loss S. (P&L) Statement of Retained Earnings
Cash Flow Statement (CF)
Financial Reports 5 Types of Accounts
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Financial Reports 5 Types of Accounts
Balance Sheet Accounts
Assets
Liabilities
Owners Equity (Stockholders Equity for a corporation)
Profit and Loss Accounts (= Income Statement Accounts)
Revenues Expenses
Double-entry accounting uses five and only five account types to
record all the transactions that can possibly be recorded in an accounting
system. There are sub-types of the following list, but all financialtransactions can be recorded using these five types of accounts.
The profit and loss accounts are temporary accounts which track revenues
and expenses for a yearlong fiscal period and are then closed, with balances
transferred to an equity account.
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Accounting Equation
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Accounting Equation
Why is Balance Sheet in Balance?
ASSETS = LIABILITIES + EQUITY
What exists? = Who owns it?
There cannot be anything that does not belong to anybody
Example: Money does not simply appear in the company:
1. You either earn it via a sale, then it is Equity
2. ...or you borrow it from the bank...then it would be a Liability
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Accounting Equation
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g q
ASSETS = LIABILITIES + EQUITY+ Revenues
- Expenses
+ Gains- Losses
+ Contributions
- Withdrawals
The additional items under Equity are tracked in temporaryaccounts until the end of the accounting period, at which time
they are closed to Equity.
Example:
What is special about these accounts?
Accounting Equation
S D fi iti
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Some Definitions
Revenues: Increases to owners equity resulting from main business operations(such as selling merchandise or providing services)
Expenses: Decreases to owners equity resulting from main business operations
Gains: Increases to owners equity resulting from non-business operations
(such as selling the old delivery truck, a storage building)
Losses: Decreases to owners equity resulting from non-business operations
Contributions: Increases to owners equity resulting from owner contributions
Withdrawals:Decreases to owners equity resulting from owner withdrawals
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Balance Sheet
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Gives an overview ofwhat the company owns and owes
Provides a snapshot of the entity at one particular moment
Summarizes the entitys assets, liabilities and equity
Indicates how much a company is worth "on the books.
Portrays financial position (or condition)
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Liabilities and Equity
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q y
Definition. An amount owed to an external party
Informal Definition: Other's claims to the business's good stuff. Amounts thebusiness owes to others.
Additional Explanation: Usually one of a business's biggest liabilities is to supplierswhere a business has bought goods and services and charged them.
Examples?
For a family, bank overdraft, credit card, or loan from parents would be consideredas liability that finances a purchase of a new washing machine. Familys savingsused for the same purpose would be considered as equity.
Money borrowed from a bank Rent for use of a building
Money owed to suppliers for materials
Payroll a company owes to its employees
Taxes owed to the government
Owners Equity
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Definition:The owner's rights to the property (assets) of the business; also called
proprietorship and net worth.
Informal Definition: What the business owes the owner. The good stuff left for theowner assuming all liabilities (amounts owed) have been paid.
Sub-categories:
Who are the owners? The answer to this question depends on the legal form ofthe entity
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Balance Sheet - Equity
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Types Of Business Organization
Sole Proprietorship
Partnership (General vs. Limited) Corporation
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Balance Sheet - Equity
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Types Of Business Organization Corporation
is a very common entity form, with its ownership interest being
represented by divisible units of ownership called shares of stock. These
shares are easily transferable, with the current holder(s) of the stock being
the owners. The total owners equity (i.e., stockholders equity) of a
corporation usually consists of several amounts, generally corresponding
to the owner investments in the capital stock (by shareholders) and
additional amounts generated through earnings that have not been paid
out to shareholders as dividends (dividends are distributions to
shareholders as a return on their investment). Earnings give rise toincreases in retained earnings, while dividends (and losses) cause
decreases.
Examples?
Balance Sheet - Equity
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Balance Sheet - Equity
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Types of Business organization - Factors toconsider:
Tax consequences
Degree of control
Liability
Ability to raise money
Type of business (license required ?)
Balance Sheet - Equity
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How Transactions impact the Accounting Equation
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ASSETS = LIABILITIES + EQUITY
Let's use our accounting equation and get an overview of the types of
transactions that can occur and their effects on our equation:
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How Transactions impact the Accounting Equation
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Transactions
Assets = Liabilities + Owner's Equity
Left Side Right Side Right Side
Increase Decrease Decrease Increase Decrease Increase
1. ABC mows a client's yard and receives a check fromthe customer for $50 for the service provided.
2. ABC purchases $100 worth of office supplies andstores them in their storage room. The office supplystore gives them an invoice that allows them to pay forthem in 15 days (on account).
3. ABC places an ad in the local newspaper receives theinvoice from the supplier and writes a check for $25 tothe newspaper.
4. ABC purchases five mowers for $10,000 and finances
them with a loan from the local bank.
5. ABC mows another customer's yard and sends thecustomer a $75 bill (invoice) for the service theyperformed. They allow their customer ten (10) days topay them for this service (on account).
6. The owner of ABC needs a little money to pay somepersonal bills and writes himself a check for $500.
7. ABC pays the office supply company $100 with acheck for the office supplies that they charged (promisedto pay).
8. ABC receives a check from the customer who theybilled (invoiced) $75 for services and allowed 10 days topay.
9. ABC purchased some mulch for $60 and received aninvoice from their supplier who allows them 15 days topay. The mulch was used on a customer's yard.
10. ABC bills (prepares an invoice) the customer $80 forthe mulch and mowing his yard and receives a check for$80 from the customer.
Totals $10,380 $700 $100 $10,160 $585 $205
Net Change $9,680 Increase $10,060 Increase $380 Decrease
Total Net Changes $9,680 Increase $9,680 Increase
How Transactions impact the Accounting Equation
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What do these transactions have in common?
2) You buy an asset against credit
4) You buy an asset with a bank loan7) You pay your debts
8) You collect an existing account receivable
Answer: They do not make you richer or poorer
How Transactions impact the Accounting Equation
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When do you get richer / poorer?
1) Richer:
You receive $50 for work done on your bank account
= REVENUE(Revenues are enhancements resulting from providing goods and services
to customers)
2) Poorer:
You spend money on advertisement= EXPENSE(Expenses can generally be regarded as costs of doing business)
How Transactions impact the Accounting Equation
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Distinguishing Between the Terms Revenue and Income:
REVENUE EXPENSE = INCOME
How Transactions impact the Accounting Equation
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All the transactions that make you richer or poorer affectyour EQUITY account.
It would be very impractical to post all the Revenues and
Expenses directly into the Equity Account.
(Important information gets lost!)
Therefore you use temporary (Profit and Loss) accounts.
They will tell you HOW the earnings / losses were achieved.
Equitys Kids
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Instead of recording transactions directly to Capital"
(Owner's Equity), proper bookkeeping actually uses Revenue,
Expense, and Withdrawals to record the increases and
decreases to "Capital" (Owner's Equity) in order to provide us
with the answers to the how and why the owner's claim to
the business's property increased or decreased.
These accounts are TEMPORARY (only exist during the year)
Revenues, Expenses, and Withdrawals eventually are allmerged together and become a part of the Ending Owner's
Equity Balance.
= CLOSING THE BOOKS
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How Transactions impact the Accounting Equation
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Proper Recording Actually Uses Revenue,Expense & Draws Instead Of Owner's Equity Original Recording Proper Recording Uses
Transactions
Owner's Equity
Revenue Expense WithdrawalRight Side
Decrease Increase
RevenueIncreasesResulting Inan Increaseto Equity
ExpensesIncreaseResulting Ina Decreaseto Equity
WithdrawalsIncreaseResulting in aDecrease toEquity
1. ABC mows a client's yard and receives a check fromthe customer for $50 for the service provided. 50
3. ABC places an ad in the local newspaper receivesthe invoice from the supplier and writes a check for$25 to the newspaper. 25
5. ABC mows another customer's yard and sends thecustomer a $75 bill (invoice) for the service theyperformed. They allow their customer ten (10) days topay them for this service (on account). 75
6. The owner of ABC needs a little money to pay somepersonal bills and writes himself a check for $500. 500
9. ABC purchased some mulch for $60 and received aninvoice from their supplier who allows them 15 days topay. The mulch was used on a customer's yard. 60
10. ABC bills (prepares an invoice) the customer $80for the mulch and mowing his yard and receives acheck for $80 from the customer. 80
How Transactions impact the Accounting Equation
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CONCLUSION:
There are countless transactions, and each can be
described by its impact on assets, liabilities, and equity.
Importantly, no transaction will upset the balance of theaccounting equation.
The accounting equation holds at all times over the life of a
business. When a transaction occurs, the total assets of abusiness may change, but the equation will remain in
balance
The Four Core Financial Statements
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Balance Sheet
Income Statement
Statement of Retained Earnings Statement of Cash Flow
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Income Statement
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A single-step income statement is one of two commonlyused formats for the income statement or profit and lossstatement. It uses only one subtraction to arrive at net
income.
REVENUE EXPENSES = NET INCOME
An extremely condensed income statement in the single-
step format would look like this:
Income Statement
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A multiple-step income statement uses multiplesubtractions in computing the net income shown onthe bottom line.
The multiple-step profit and loss statementsegregates the operating revenues and operatingexpenses from the nonoperating revenues,nonoperating expenses, gains, and losses. Themultiple-step income statement also shows the gross
profit (net sales minus the cost of goods sold).
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Income Statement
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Statement of Retained Earnings
(Statement of Equity)
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The statement of retained earnings reports how
net income and dividends affected a company sfinancial position during the period.
Note that the Income Statement must be preparedbefore the Statement of Retained Earnings
Example: Statement of Equity
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Many companies provide an expanded statement of stockholders equity instead of the
required statement of retained earnings. The statement of stockholders equity portrays not
only the changes in retained earnings, but also changes in other equity accounts. Theseother equity accounts include capital stock and potentially a lot of other amounts related to
topics like par value, preferred stock, treasury stock, and the like
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Statement of Retained Earning
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Retained earnings will change over time because of
several factors. Which of the following factors would
explain an increase in retained earnings?
a. Net loss.
b. Net income.c. Dividends.
d. Investments by stockholders.
Statement of Cash Flows
cannot be manipulated with accounting tricks
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Financial Statements Connection:
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Quick Test: Financial Statements
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Accounts, debits and credits
ACCOUNTS
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TRANSACTIONS AFFECT TH
E ACCOUNTINGEQUATION
H
OW DOY
OU TRACK CH
ANGES ?
A SYSTEM IS NEEDED!
Accounts, debits and credits
ACCOUNTS
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The records that are kept for the individual asset,
liability, equity, revenue, expense, and dividendcomponents are known as accounts.
Accounts, debits and credits
DEBITS AND CREDITS
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The next basic accounting concept
For every transaction
DEBITS = CREDITS
The Double entry system requires that the same dollar amount of the
transaction must be entered on both the leftside of one account,
and on the rightside of another account. Instead of the word left,accountants use the word debit; and instead of the word right,
accountants use the word credit.
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Accounts, debits and credits
DEBITS AND CREDITS
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ASSETS = LIABILITES + STOCKHOLDERS (or OWNERS) EQUITY
Just as assets are on the left side (or debit side) of the accounting
equation, the asset accounts have their balances on the left side. To
increase an asset account's balance, you put more on the left side of the
asset account. In accounting jargon, you debit the asset account. To
decrease an asset account balance you credit the account, that is, you
enter the amount on the right side.
Just as liabilities and stockholders' equity are on the right side (or credit
side) of the accounting equation, the liability and equity accounts have
their balances on the right side. To increase the balance in a liability orstockholders' equity account, you put more on the right side of the
account. In accounting jargon, you credit the liability or the equity
account. To decrease a liability or equity, you debit the account, that is,
you enter the amount on the left side of the account.
Accounts, debits and credits
DEBITS AND CREDITS
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DEBIT CREDIT SOLL HABEN
DEBITO CREDITO
. . . .
LEFT RIGHT
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Accounts, Debits & Credits
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T-Account
Accounts, Debits and Credits
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QUICK TEST: Accounts, Debits and Credits
Overview Day 2
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Users of Accounting Information
Accounting Principles Financial Reports
Accounting Equation / Balance Sheet
How Transactions impact the Accounting Equation
Four basic types of transactions
The four core financial statements
Accounts, Debits and Credits The Journal The General Ledger
Posting
Chart of Accounts
Financial Statements from the Trial Balance
Accrual Accounting
Revenue Recognition / Expense Recognition Adusting Entries
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THE GENERAL LEDGER
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The journal contains page after page of detailed accounting
transactions. In contrast, the general ledger contains a page foreach and every account in use by a company.
POSTING
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To POST means:
to copy the entries listed in the journal into
their respective ledger accounts.
recording amounts as credits, (right side), and
amounts as debits, (left side), in the pages of
the general ledger
POSTING
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To post means to copy the entries listed in the journal into
their respective ledger accou
nts.
POSTING Computerized Processing
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Source Documents
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No Posting without Source Document!
Source document is the original record of a transaction
Supports the underlying transaction
Examples:
Sale Invoice
Expense Receipt
Collection of accounts receivables - Bank Statement
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THE TRIAL BALANCE
After all transactions have been posted from the journal to the ledger, it
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p j g
is a good practice to prepare a trial balance. A trial balance is simply a
listing of the ledger accounts along with their respective debit or creditbalances:
THE TRIAL BALANCE
Since each transaction was journalized in a way that insured that
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debits equaled credits, one would expect that this equality would be
maintained throughout the ledger and trial balance. If the trialbalance fails to balance, an error has occurred and must be located.
THE TRIAL BALANCE
However, balanced trial balance is no guarantee of correctness:
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Transaction omissionTransaction duplication
Posting to the wrong accounts
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Overview Day 2
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Users of Accounting Information
Accounting Principles Financial Reports
Accounting Equation / Balance Sheet
How Transactions impact the Accounting Equation
Four basic types of transactions
The four core financial statements
Accounts, Debits and Credits The Journal The General Ledger
Posting
Chart of Accounts
Financial Statements from the Trial Balance
Accrual Accounting
Revenue Recognition / Expense Recognition Adusting Entries
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FINANCIAL STATEMENTS FROM THE TRIAL BALANCE
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Overview Day 2
U f A ti I f ti
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Users of Accounting Information
Accounting Principles Financial Reports
Accounting Equation / Balance Sheet
How Transactions impact the Accounting Equation
Four basic types of transactions
The four core financial statements
Accounts, Debits and Credits The Journal The General Ledger
Posting
Chart of Accounts
Financial Statements from the Trial Balance
Accrual Accounting
Revenue Recognition / Expense Recognition Adusting Entries
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FINANCIAL STATEMENTS FROM THE TRIAL BALANCE
EXAMPLE PROBLEM
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STEP 1:Classify the accounts as assets, liabilities, equity,
revenue or expenses.
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STEP 1:Classify the accounts as assets, liabilities, equity,
revenue or expenses:
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ASSETS
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STEP 1:Classify the accounts as assets, liabilities, equity,
revenue or expenses:
SS S S Q Y S
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ASSETS, LIABILITES, EQUITY, REVENUES,
EXPENSES
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STEP 3:Prepare the Statement of Retained Earning
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STEP 4:Prepare the Balance Sheet
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FINANCIAL STATEMENTS FROM THE TRIAL BALANCE
EXAMPLE PROBLEM
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FINANCIAL STATEMENTS FROM THE TRIAL BALANCE
EXAMPLE PROBLEM
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FINANCIAL STATEMENTS FROM THE TRIAL BALANCE
Now try yourself
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The periodicity assumption and itsaccounting implications
Under the accrual basis of accounting,
revenues are reported on the income
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revenues are reported on the income
statement when they are earned. (not
when the cash is received.)
Under the accrual basis of accounting,
expenses are matched with the related
revenues and/or are reported when the
expense occurs, not when the cash is
paid. The result of accrual accounting is
an income statement that bettermeasures the profitability of a company
during a specific time period.
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Overview Day 2
Users of Accounting Information
Accounting Principles
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Accounting Principles
Financial Reports
Accounting Equation / Balance Sheet
How Transactions impact the Accounting Equation
Four basic types of transactions
The four core financial statements
Accounts, Debits and Credits The Journal The General Ledger
Posting
Chart of Accounts
Financial Statements from the Trial Balance
Accrual Accounting
Revenue Recognition / Expense Recognition Adusting Entries
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The adjusting process and related entries
A common characteristic of an adjusting entry is that it will
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involve one income statement account and one balance sheetaccount. (The purpose of each adjusting entry is to get both the
income statement and the balance sheet to be accurate.)
Sometimes an adjusting entry is needed because:
1 Revenue has been earned but it has not yet been recorded
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1. Revenue has been earned, but it has not yet been recorded.
2. An expense may have been incurred, but it hasnt yet been
recorded.
3. A company may have paid for six-months of insurance coverage,
but the accounting period is only one month. (This means that five
months of insurance expense is prepaid and should not be
reported as an expense on the current income statement.)
4. A customer paid a company in advance of receiving goods or
services. Until the goods or services are delivered, the amount is
reported as a liability. After the goods or services are delivered, an
entry is needed to reduce the liability and to report the revenues.
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The adjusting process and related entriesExample: Prepaid insurance
A three-year insurance policy was purchases on January 1, 20x1, for$9,000. The following entry would be needed to record the transactionon January 1:
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on January 1:
The adjusting process and related entriesExample: Prepaid Rent
Assume a two-month rent is entered and rent paid in advance on March 1, 20X1,for $3,000. By March 31, 20X1, half of the rental period has lapsed, and financial
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$ , y , , p p ,
statements are to be prepared. The following entries would be needed to recordthe transaction on March 1, and adjust rent expense and prepaid rent on March31:
The adjusting process and related entriesHow often are adjustments needed?
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Adjustments should be made every time
financial statements are prepared
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The adjusting process and related entriesDepreciation
FIXED ASSETS: Buildings, machinery, equipment, furniture,computers, parking lots, cars, and trucks are examples of assets that
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computers, parking lots, cars, and trucks are examples of assets thatwill last for more than one year.
During each accounting period (year, quarter, month, etc.) a portionof the cost of these assets is being used up. The portion being usedup is reported as Depreciation Expense on the income statement.
In effect depreciation is the transfer of a portion of the asset's costfrom the balance sheet to the income statement during each yearof the asset's life = ADJUSTING ENTRY
Depreciation Expense1
00
Asset
(or Contra Account Accumulated Depreciation)
100
The adjusting process and related entriesDepreciation
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The adjusting process and related entriesUnearned revenue
Often, a business will collect monies in advance of providing goodsor services. For example, you sell a one-year software licence and
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collect the full payment at the beginning of the subscription period:
EXAMPLES?
The adjusting process and related entriesACCRUALS
Accruals are expenses and revenues that
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gradually accumulate throughout an accountingperiod (salaries, interest, rent, utilities)
The adjusting process and related entriesACCRUALS Accrued salaries
Few, if any, businesses have daily payroll. Typically, businesses will pay employees
once or twice per month. Therefore, salary obligations gradually accumulate
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When creating financial statements you have to ESTABLISH A LIABILITY for theaccumulated obligations:
The journal entry on the actual payday needs to extinguish the previously
established liability (Liabilities decrease, Cash decreases):
Salaries Payable 3,000
Cash 3,000
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The adjusting process and related entriesACCRUALS Accrued interest
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The adjusting process and related entriesACCRUALS Accrued rent
Accrued rent = opposite of prepaid rent
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Accrued rent relates to rent that has not yet been paid, even though utilization of theasset has already occurred. For example, assume that office space is leased, and the
terms of the agreement stipulate that rent will be paid within 10 days after the end of
each month at the rate of $400 per month.
During December of 20X1, Cabul Company occupied the lease space, and the
appropriate adjusting entry for December follows:
The adjusting process and related entriesACCRUALS Accrued revenue
Many businesses provide services to clients under an understanding that
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they will be periodically billed for the hours (or other units) of serviceprovided. As a result, money has been earned during a month, even though
it wont be billed until the following month. Accrual accounting concepts
dictate that such revenues be recorded when earned. The following entry
would be needed at the end of December to accrue revenue for services
rendered to date (even though the physical billing of the client may not occur
until January):
EXAMPLES?
The adjusting process and related entriesACCRUALS Questions
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QUESTIONS?
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Summary
Users of Accounting Information
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Accounting Principles Financial Reports
Accounting Equation / Balance Sheet
How Transactions impact the Accounting Equation
Four basic types of transactions
The four core financial statements
Accounts, Debits and Credits The Journal The General Ledger
Posting
Chart of Accounts
Financial Statements from the Trial Balance
Accrual Accounting
Revenue Recognition / Expense Recognition
Adusting Entries
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EXAMPLE:Financial Statements from the adjusted trial balance
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EXAMPLE: Post Entries to the LedgerFinancial Statements from the adjusted trial balance
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Prepare Adjusted Trial Balance from LedgerFinancial Statements from the adjusted trial balance
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Prepare Balance SheetFinancial Statements from the adjusted trial balance
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Overview Day 3
Classified Balance Sheets
Current Assets
I
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Inventory
Accounts Receivable
Fixed Assets
Depreciation Methods
Intangibles & Goodwill
Current Liabilites Accounts Payable
Ratio Analysis
Compliance
Internal Controls
VAT What to expect in an Audit
Classified Balance Sheets
To facilitate proper analysis, accountants will often divide the balance
sheet into categories or classifications. The result is that important groups
of accounts can be identified and subtotaled. Such balance sheets are
ll d l ifi d b l h t
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called classified balance sheets.
Classified Balance Sheets
The asset side of the balance sheet may be divided into the following SUB-
CATEGORIES:
Current assets; Fixed Assets; Intangible assets; Other assets.
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Classified Balance SheetsCurrent Assets
Current Assets include cash and those assets that will be converted into cash
or consumed in a relatively short period of time; specifically, those assets that
will be converted into cash or consumed within one year or the operating
cycle whichever is longer
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cycle, whichever is longer.
Classified Balance SheetsCurrent Assets
The operating cycle for a particular company is the period of time it takes
to convert cash back into cash (i.e., purchase inventory, sell the inventory
on account, and collect the receivable); this is usually less than one year.
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It is determined by adding the number of days inventory is held and the
collection period for accounts receivable
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Inventory
Investors want as little money as possible tied up in inventory.It is fine to have a lot of inventory on the balance sheet if it isbeing sold at a fast enough rate there is little risk of becoming
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being sold at a fast enough rate there is little risk of becomingobsolete or spoiled.
Just -in-time Delivery
INVENTORY Inventory Valuation
You dont write:
7000 bottles of wine
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7000 bottles of wine
but rather:Wine 30.000 EUR
Therefore you have to assign a value to your inventory
Ending inventory= Beginning inventory + Purchases during the period - Cost of goods sold
How much is Cost of Goods Sold / Value of Ending Inventory?(different purchases are stored together / get mixed up)
Different inventory valuation methods (FIFO, LIFO, HIFO)
INVENTORY Perpetual Inventory System
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INVENTORY Perpetual Inventory System
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INVENTORY Perpetual Inventory System
Scanners scan the products and automatically update
the sales and inventory records
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INVENTORY Perpetual Inventory System
PERPETUAL vs. PERIODICAL INVENTORY
Which dealer would you rather deal with ?
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Which dealer would you rather deal with ?
The one who can call it up on their computer and determine
immediately if they have any and give you the price or the
dealer that puts you on hold and has to look around his storeand try to physically locate the item and determine the price?
BUT: Also Perpetual Inventory Systems need to have a
physical count WHY?
Perpetual Inventory Systems are only as good as the people
who maintain it - verify that they actually do have the part
INVENTORY Perpetual Inventory System
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INVENTORY Perpetual vs. Periodic
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INVENTORY
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Quick Test Inventory Methods
INVENTORY Inventory Valuation
First-In, First-Out(FIFO)
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Valuation method in which the assets acquired first
are sold first.
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INVENTORY Inventory Valuation
Average Cost Method
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values inventory costs as the average unitcost between the assets in the beginning inventoryand the newly acquired assets.
INVENTORY Cost of Goods sold
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An inventory count on October 30 showed 500 units in the warehouse.
1) What is the cost of goods sold for October under the FIFO method?
2) What is the cost of goods sold for October under the LIFO method?
3) What is the cost of goods sold for October under the weighted average method?
INVENTORY
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Quick Test Costing Methods
INVENTORY - RATIOS
Inventory Turnover Ratio
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Shows how many times a company's inventory is sold and replaced
over a period.
A low turnover implies poor sales and, therefore, excess inventory.
A high ratio implies either strong sales or ineffective buying.
FMCG vs. CAR DEALER
Days in Inventory = 365 / Inventory Turnover Ratio Measures the average number of days the company holds its
inventory before selling it.
INVENTORY - RATIOS
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Overview Day 3
Classified Balance Sheets
Current Assets
Inventory
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y Accounts Receivable
Fixed Assets
Depreciation Methods
Intangibles & Goodwill
Current Liabilites Accounts Payable
Ratio Analysis
Compliance
Internal Controls
VAT What to expect in an Audit
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Current Assets Accounts ReceivableA typical invoice contains:
Invoice Requirements:
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The word INVOICE
Unique identification number
Company Name, Adress
Product Description Date
Amount
Currency
VAT amount (if applicable)
Rate of VAT per Item (if applicable)
VAT registration number (if applicable)
Current Assets Accounts Receivableec.europa.eu/taxation_customs/vies/vieshome.do
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Current Assets Accounts Receivable
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Current Assets Accounts Receivable
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Current Assets Accounts Receivable
How to improve Cash
Flow?
The sooner a seller receives the
cash, the earlier he can put the
money back into the business to
buy more supplies and/or growthe company further.
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Flow? Factoring
= financial transaction whereby a
business sells its accounts receivable
(i.e., invoices) to a third party (calleda factor at a discount in exchange for
immediate money
Invoice discounting= borrowing where the receivable is
used as collateral
Cash discounts
the company further.
Current Assets Accounts Receivable
How do you estimate the amount of uncollectible accounts
receivable?
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Aging Analysis, Percentage of Credit Sales based on
experience
Prudence Principle: Create Allowance for Doubtful Debt
Current Assets Accounts Receivable
Bad Debt
is an amount that is written off by the business as a loss to the businessd l ifi d b th d bt d t th b i i
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and classified as an expense because the debt owed to the business isunable to be collected, and all reasonable efforts have been exhausted tocollect the amount owed. This usually occurs when the debtor hasdeclared bankruptcy or the cost of pursuing further action in an attemptto collect the debt exceeds the debt itself
Doubtful Debt
Doubtful debts are those debts which a business or individual is unlikely tobe able to collect. The reasons for potential non payment can include
disputes over supply, delivery, and conditions of goods, the appearance offinancial stress within customers operation. When such a dispute occurs itis prudent s add this debt or portion thereof to the doubtful debt reserveWhen there is no longer any doubt that a debt in uncollectable the debtbecomes bad.
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Allowance for Doubtful AccountsJournal Postings
1. The allowance for doubtful accounts is normally recorded at the beginning of
the companys fiscal year after the estimated calculation is made. The
following is the general journal entry at the beginning of the fiscal year.Bad Debts E pense Debit (e pense increase)
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- Bad Debts Expense Debit (expense increase)
- Allowance for Doubtful Accounts Credit (asset decrease)
2. Once an account becomes delinquent (bad), a journal entry needs to be made
to decrease accounts receivable for that specific customer = WRITE OFF
- Allowance for Doubtful Accounts - Debit (asset increase)
- Accounts Receivable Credit (asset decrease)
Current Assets Accounts Receivable
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Overview Day 3
Classified Balance Sheets
Current Assets
InventoryA t R i bl
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Accounts Receivable
Fixed Assets
Depreciation Methods
Intangibles & Goodwill
Current Liabilites Accounts Payable
Ratio Analysis
Compliance
Internal Controls
VAT What to expect in an Audit
Balance Sheet Details: Fixed Assets
Assets intended to be in use for period
longer than one year
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Property, Plant & EquipmentLand, buildings, cars, furniture, computers, etc...
Characteristics? Cannot easily be converted into cash
Are not directly sold to a firm's consumers
Balance Sheet Details: Fixed Assets
How to determine the cost of asset?:
The cost of property, plant, and equipment includesthe purchase price of the asset and all
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the purchase price of the asset and all
expenditures necessary to prepare the asset for its
intended use.
Example COST OF LAND:
Land purchases often involve real estate commissions,
legal fees, bank fees, title search fees, and similar
expenses. To be prepared for use, land may need to be
cleared of trees, drained and filled, graded to remove
small hills and depressions, and landscaped. In addition,old buildings may need to be demolished before the
company can use the land. Such demolition expenses are
considered part of the land's cost.
Balance Sheet Details: Fixed Assets
Example:
Cost of land:
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Cost of land :
Land is not depreciated because
it does not have an expected
useful life
Land improvement:
Separate asset on the balance
sheet, with definite liveExample: Parking lot
Balance Sheet Details: Fixed Assets
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Balance Sheet Details: Fixed AssetsRepetition: Capitalization vs. Expense
CAPEX (Capital Expenditure)
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are expenditures creating future benefits. A capitalexpenditure is incurred when a business spends money eitherto buy fixed assets or to add to the value of an existing fixed
asset with a useful life that extends beyond the taxable year.In accounting, a capital expenditure is added to an ASSETaccount (CAPITALIZED")
For tax purposes, capital expenditures are costs that cannotbe deducted in the year in which they are paid or incurredand must be capitalized (= recorded as an asset).
Depreciation is then periodically booked as an expense
Balance Sheet Details: Fixed AssetsRepetition: Capitalization vs. Expense
OPEX (Operational Expenditure)
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is an ongoing cost for running a product, business, or
system.
are immediately treated as an EXPENSE
Example:
The purchase of a photocopier is the CAPEX, and the annualpaper, toner, power and maintenance cost is the OPEX.
Balance Sheet Details: Fixed AssetsSteps to follow when Capitalizing an Asset
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1. Estimate Useful Life
2. Chose Rate of Depreciation
Overview Day 3
Classified Balance Sheets
Current Assets
Inventory Accounts Receivable
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Accounts Receivable
Fixed Assets
Depreciation Methods
Intangibles & Goodwill
Current Liabilites Accounts Payable
Ratio Analysis
Compliance
Internal Controls
VAT What to expect in an Audit
Fixed Assets - Depreciation Methods
Example EXCEL
When a company buys a large asset such as a piece of
machinery, accounting rules specify how the asset shouldbe expensed each year. This is called depreciation.
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p y p
EXCEL offers four common methods for calculating
depreciation:
Straight-line (SLN)
Declining-balance (DB)
Double-declining-balance (DDB) Sum-of-years-digits (SYD)
Fixed Assets - Depreciation Methods
By selecting the depreciation time, method,
companies can manage the effects on profiti i f i
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over time most companies prefer to write
off as fast as possible:
Reason:
Less profits now = less taxes now
More profits later = more taxes later
Fixed Assets - Depreciation MethodsCzech Republic Depreciation on Fixed Assets
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Fixed Assets - Depreciation Methods
Depreciation as a Policy Instrument
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Fixed Assets - Depreciation Methods
Depreciation as a Policy Instrument
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Fixed Assets - Depreciation Methods
Cost = This is the initial cost of the asset. For example the
machinery might cost $120.000
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Useful life = This is how long you expect to use the asset. If
you think the machinery will be used for 10 years before
being replaced, the useful life is 10 years
Salvage value = This is the value of the asset at the end of
the useful life. Perhaps after 10 years you can sell the
machine to a scrap dealer for $1.000. This is the salvagevalue.
Fixed Assets - Depreciation Methods
Accumulated Depreciation = CONTRA ASSET ACCOUNT
An asset account which is expected to have a credit balance (which is contrary
to the normal debit balance of an asset account). The contra asset account isrelated to another asset account. For example, the contra asset accountAllowance for Doubtful Accounts is related to Accounts Receivable The contra
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Allowance for Doubtful Accounts is related to Accounts Receivable. The contraasset account Accumulated Depreciation is related to a constructed asset(s)
Journal Posting
The net of the asset and its related contra asset account is referred to as theasset's book value or carrying value.
Balance Sheet View
Reason: You dont want to lose the information for how much the asset waspurchased in the first place
Fixed Assets Fixed Asset Schedule
Because businesses usually have several fixed assets
purchased at different times, with different useful lives anddifferent depreciation methods, it is necessary to keep a
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separate schedule of these assets called a fixed asset
schedule.
An example of a portion of a fixed asset schedule is:
Fixed Assets - Depreciation Methods
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Exkurs: Present Value
If you received $100 today and deposited it into a savings
account, it would grow over time to be worth more than
$100. This fact of financial life is a result of the time valueof money a concept which says it's more valuable to
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of money, a concept which says it s more valuable to
receive $100 now rather than a year from now. To put it
another way, the present value of receiving $100 one year
from now is less than $100.
DISCOUNTED CASH FLOW ANALYSIS Standard method to
analyze long-term projects
Example: You invest in 2010 in a project that returns from 2011 to
2016 every year 200 EUR. Discount rate = 10%. How much would
you spend to invest in this project?
Overview Day 3
Classified Balance Sheets
Current Assets
Inventory Accounts Receivable
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Fixed Assets
Depreciation Methods
Intangibles & Goodwill
Current Liabilites Accounts Payable
Ratio Analysis
Compliance
Internal Controls
VAT
What to expect in an Audit
Balance Sheet Details: Intangibles and Goodwill
Assets that cannot be seen,
touched, nor physically measured
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Intangible assets
Patents, Copyright, Trademark etc.
The process of expense recognition for this category of assets iscalled amortization.
Goodwill
T
he difference between the acquisition price and book asset valueof purchased business entity
Premium" for buying a business
Balance Sheet Details: Intangibles and Goodwill
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What are Patents, Trademarks and Copyrights?
Example: You invent a time machine
You would have a PATENT on the technique
You would have a COPYRIGHT on the design
If you call it TIMINATORyou would have a
TRADEMARK on the name
Licenses are the contractual rights to use another's property, whether it be a
patent, trademark or copyright
Balance Sheet Details: Intangibles and Goodwill
Patents
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Has to be registerd - gets checked
The right to exclude others from making, using, offering for sale, selling or
importing an invention
Granted for a limited period of time in exchange for a public disclosure ofan invention
Question:WHY?
Balance Sheet Details: Intangibles and Goodwill
Trademarks
A Trademark is the means by which a business makes itself visible in the
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A Trademark is the means by which a business makes itself visible in the
marketplace.
The essential function of a trademark is to exclusively identify the
commercial source or origin of products or services
A trademark is typically a name, word, phrase, logo, symbol, design,
image, or a combination of these elements
Trademark rights may be used to prevent others from using a confusinglysimilar mark, but not to prevent others from making the same goods or
from selling the same goods or services under a clearly different mark.
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