anthony ppt.ppt

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999
© The McGraw-Hill Companies, Inc., 1999
Anthony, Hawkins, and Merchant
Tenth Edition
These electronic slides are intended for the exclusive use by
adopters of Irwin/McGraw-Hill accounting textbooks only.
Any other use of these presentations without express written
permission of Irwin/McGraw-Hill is strictly prohibited.
ACCOUNTING:
TEXT AND CASES

Task Force Clip Art included
in this electronic presentation
is used with the permission of
New Vision Technology of
Nepean Ontario, Canada

The Nature
and Purpose
of Accounting
Part One: Financial Accounting

….
Planning is the
process of
deciding what
actions should be
taken in the
future.
Planning Slide 1-1

 recognizing that a problem or an opportunity
exists
 specifying and ranking the criteria to be used to
determine the best solution
 identifying alternative ways of addressing the
problem or opportunity
 analyzing the consequences of each alternative
 comparing these consequences to each other and
the criteria so as to decide which is best
Planning Slide 1-2
Planning involves making decisions. Decisions are
arrived at by--

Information
The Nature and Purpose of Accounting
Nonquantitative
information
Quantitative
information
Accounting
information
Nonaccounting
information
Consists of
Operating
information
Financial
accounting
Management
accounting
Tax
accounting
Consists of
Slide 1-3

Relationship of Management Functions Slide 1-4
Planning

Planning Implementation

Planning Implementation Control

Planning Implementation Control
Appropriate action
Feedback
Plan revision

The Balance Sheet Slide 1-8
HOLDEN COMPANY
Balance Sheet
As of December 31, 1999
(000 omitted)
Assets Liabilities and Owners’ Equity
Current assets: Current liabilities:
Cash $ 1,449 Accounts payable $ 5,602
Marketable securities 246 Bank loan payable 1,000
Accounts receivable, net 9,944 Accrued liabilities 876
Inventories 10,623 Estimated tax liability 1,541
Prepaid expenses 389 Current portion of long-
term debt 500
Total current assets $22,651 Total current liabilities $ 9,519
Current Section

The Balance Sheet Slide 1-9
Noncurrent assets: Noncurrent liabilities:
Property, plant, equipment Long-term debt, less
at cost $26,946 current portion $ 2,000
Less: Accumulated Deferred income taxes 824
Depreciation 13,534 Total liabilities 12,343
Property, plant, equipment
net 13,412 Owners’ equity:
Investments 1,110 Common stock 1,000
Patents and trademarks 403 Additional paid-in capital 11,256
Goodwill 663 Total paid-in capital 12,256
Retained earnings 13,640
Total owners’ equity 25,896
Total liabilities and owners’
Total assets $38,239 and owners’ equity $38,239
Noncurrent Section

Assets are economic resources
which are owned by a business
and are expected to benefit
future operations.
The Accounting Equation Slide 1-10
Assets = Liabilities + Owners’ Equity

The Accounting Equation
Liabilities are obligations
of the entity to outside
parties who have
furnished resources
Slide 1-11

Sales revenue $75,478
Less cost of sales 52,227
Gross margin 23,251
Less operating expenses 10,785
Income before taxes 12,466
Provision for income taxes 6,344
Net income $ 6,122
Income Statement
HOLDEN COMPANY
Income Statement
For the Year 1999
(000 omitted)
Slide 1-12

 Useful to present and potential investors and creditors in
making rational investment and credit decisions
 Comprehensible to those who have a reasonable
understanding of business and economic activities and are
willing to study the information with reasonable diligence
 About the economic resources of an enterprise, the claims
to those resources, and the effects of transactions and
events that change resources and claims to those resources
 About an enterprise’s financial performance during a
period
Financial Statement Objectives
Financial reporting should provide information:
Slide 1-13

A “Package” of Accounting Reports Slide 1-14
Condensed Balance Sheet
Assets
Current assets $22,651
Building and equip. 13,412
Other assets 2,176
Total assets $38,239
Liabilities and Owners’ Equity
Liabilities $12,343
Owners’ Equity
Paid-in capital 12,256
Total liabilities and
owners’ equity $38,239

Income Statement
For the Year 1999
Gross margin 23,351
Less operating exp. 10,785
Provision for taxes 6,344
Net income, 1999 $ 6,122
Assets
Other assets 2,176
Liabilities $12,343
Owners’ Equity

Income Statement
For the Year 1999
Gross margin 23,351
Net income, 1999 $ 6,122
Statement of Retained Earnings
Retained earnings $13,640
Add net income 6,122
19,762
Less dividends 4,390
Assets
Other assets 2,176
Liabilities $12,343
Owners’ Equity

Income Statement
For the Year 1999
Gross margin 23,351
Net income, 1999 $ 6,122
19,762
Assets
Other assets 2,176
Liabilities $12,343
Owners’ Equity

19,762
Other assets 3,207
Liabilities $14,622
Owners’ Equity
Assets

 Operating information, which has to do with the
details of operations
 Management accounting information, which is
used internally for planning, implementation, and
control
 Financial accounting information, which is used
both by management and external parties
 Tax accounting information, which is used to file
tax returns with taxing authorities
Summary Slide 1-20
An organization has four types of accounting
information:

Basic Accounting
Concepts: The
Balance Sheet

• Accounting
period
• Conservatism
• Realization
• Matching
• Consistency
• Materiality
Basic Concepts
• Money
measurement
• Entity
• Going concern
• Cost
• Dual aspect
Slide 2-1

Owner
The Entity Concept
The owner of a clothing store removes $100 from the store’s
cash register for personal use. Should the store’s accounting
records show that the owner took this cash?
Slide 2-2

The Entity Concept
Yes, because of the entity concept. This concept
requires that the accounting records of the
clothing store show that the business has less
cash than it had previously.
Slide 2-3

The Going -Concern Concept
A thriving blue jeans manufacturing firm
has jeans in various stages of production.
If the firm had to cease operations and
liquidate today, the jeans would have little,
if any, value. If today is the last day of the
accounting period, should the jeans be
shown at liquidation value?
Slide 2-4

The Going -Concern Concept
Because of the going-concern
concept, the firm would not value
the jeans at what they are currently
worth--the liquidation value.
Slide 2-5

The Cost Concept--Nonmonetary Assets
Land purchased last year for $250,000 has a current market
value of $270,000. What amount should be shown in the
accounting records to reflect ownership of this land?
Slide 2-6

The Cost Concept--Nonmonetary Assets
The land should be shown at the original purchase price of
$250,000 because of the cost concept.
Slide 2-7

The Cost Concept--Monetary Assets
A company invested surplus cash in 100,000 shares of the
common stock of General Electric. The cost of per share was
$60; therefore, the firm spent $6,000,000. By the end of the
fiscal period, the stock had a fair market value of $65 per share.
What amount should be shown on the balance sheet?
Slide 2-8

The Cost Concept--Monetary Assets
The fair value of the stocks is $6,500,000.
This is the amount that should be shown for this monetary asset.
Slide 2-9

The Dual-Aspect Concept Slide 2-10
Ms. Jones opens a bank account for
the business by depositing $40,000.
Assets = Liabilities + Owners’ equity
Assets = Equities
+ $40,000 + $40,000
=

The business borrows
$15,000 from the bank.
+ $40,000 = $40,000
+ 15,000 + 15,000

Assets = Equities
+ $40,000 = $40,000
+ 15,000 + 15,000
$55,000 $15,000 $40,000

Name of entity
Name of statement
Moment of time
GARSDEN CORPORATION
Balance Sheet
The Balance Sheet--The Heading Slide 2-13

Current assets:
Cash $ 3,448,891
Marketable securities 246,221
Accounts receivable 5,954,588
Inventories 12,623,412
Prepaid expenses 377,960
Total current assets $22,651,072
Property, plant, and equipment:
Land 642,367
Building and equipment, at cost 26,303,481
Less: accumulated depreciation 13,534,069 12,769,412
Other assets:
Investments 110,000
Intangible assets 63,214 173,214
Total assets $36,236,065
The Balance Sheet--Assets Slide 2-14

Slide 2-15
The Balance Sheet--Liabilities
and Shareholders’Equity
Current liabilities:
Accounts payable $ 6,301,442
Taxes payable 1,672,000
Accrued expenses 640,407
Deferred revenues 205,240
Current portion of long-term debt 300,000
Total current liabilities $ 9,119,089
Long-term debt 3,000,000
Total liabilities 12,119,089
Shareholders’equity:
Paid-in capital 5,000,000
Retained earnings 19,116,976
Total shareholders’ equity 24,116,976
Total liabilities and shareholders’ equity $36,236,065

 Cash
Funds that are readily available for
distribution
 Marketable securities
Investments that are both readily marketable
and expected to be converted into cash
withinone year
 Accounts receivable
Amounts owed to the entity by its customers
Account Categories--Current Assets Slide 2-16

Inventories
Aggregate of items either held for sale
in the ordinary course of the business, in
process of production for such sale, or
soon to be consumed in production
Prepaid expenses
Assets, usually of an intangible nature,
whose usefulness will expire in the near
future
Slide 2-17
Account Categories--Current Assets

Accounts payable
Claims of suppliers arising from their
furnishing goods or services to the
entity for which they have not been paid
Taxes payable
Amount the entity owes governmental
agencies
Account Categories--Current Liabilities Slide 2-18

Accrued expenses
Amounts earned by outside parties but
have not been paid by the entity
Deferred revenues
Liabilities that arise because the entity
receives advanced payments for services
the entity has agreed to render in the
future
Current portion of long-term debt
Account Categories--Current Liabilities Slide 2-19

Music Mart Slide 2-20
On January 1, John Smith starts an incorporated CD and tape
store called Music Mart, Inc. He deposits $25,000 of his
own funds in a bank account that he opened in the name of
the entity. In return, he takes $25,000 of stock certificates.

On January 1, John Smith starts an incorporated CD and tape
store called Music Mart, Inc. He deposits $25,000 of his
own funds in a bank account that he opened in the name of
the entity. In return, he takes $25,000 of stock certificates.
MUSIC MART
Balance Sheet
As of January 1
Assets Liabilities and Owners’Equity
Cash $25,000 Paid-in capital $25,000

On January 2, Music Mart borrows $12,500 from a bank; the
loan is evidence by a legal document called a note.
MUSIC MART
Balance Sheet
As of January 1
Cash $25,000 Paid-in capital $25,000

Cash $37,500 Notes payable $12,500
Total $37,500 Total $37,500
On January 2, Music Mart borrows $12,500 from a bank; the
loan is evidence by a legal document called a note.
MUSIC MART
Balance Sheet
As of January 1

Inventory 5,000 Paid-in capital 25,000
Total $37,500 Total $37,500
On January 3, the business buys inventory in the amount of
$5,000, paying cash.
MUSIC MART
Balance Sheet
As of January 1

Inventory 4,500 Paid-in capital 25,000
Retained earnings 250
Total $37,750 Total $37,750
On January 4, the business sells merchandise that cost $500
for $750. Cash was received.
MUSIC MART
Balance Sheet
As of January 1

Basic Accounting
Concepts: The
Income Statement

Basic Business Financial Flows
Cash
Accounts
receivable
Inventories
Collection
activities
Purchasing or
production
activities
Earnings
activities
Slide 3-1

• Accounting
period
• Conservatism
• Realization
• Matching
• Consistency
• Materiality
• Money
measurement
• Entity
• Going concern
• Cost
• Dual aspect
Basic Concepts Slide 3-2

Revenues $122,400
Less expenses:
Food $42,756
Wages 46,935
Rental 12,000
Other costs 5,472
Total exp. 107,163
Net income $ 15,237
Basic Concepts
Let’s take a look at
our summer camps
income statement for a
few summer months.
Accounting Period Concept
Slide 3-3

Revenues $122,400
Less expenses:
Food $42,756
Wages 46,935
Rental 12,000
Other costs 5,472
Total exp. 107,163
Net income $ 15,237
Basic Concepts
The accounting period
concept allows us to find
out how we did for a specific
period of time.
Accounting Period Concept
Slide 3-4

• Accounting
period
• Conservatism
• Realization
• Matching
• Consistency
• Materiality
• Money
measurement
• Entity
• Going concern
• Cost
• Dual aspect

 Recognize revenues (increases in retained
earnings) only when they are reasonably
certain.
 Recognize expenses (decreases in retained
earnings) as soon as they are reasonably
possible.
Basic Concepts
Aspects of the conservatism concept:
Slide 3-6

When should the
revenue be
recognized?
Basic Concepts
In December, customers
pay for a year’s
subscription to a
magazine that they will
begin receiving in
January.
Conservatism Concept
Slide 3-7

Revenue is
recognized when
the service is
performed--thus
in the year the
magazine service
is provided.
Basic Concepts
In December, customers
pay for a year’s
subscription to a
magazine that they will
begin receiving in
January.
Conservatism Concept
Slide 3-8

• Accounting
period
• Conservatism
• Realization
• Matching
• Consistency
• Materiality
• Money
measurement
• Entity
• Going concern
• Cost
• Dual aspect

Basic Concepts
Realization Concept
Joe makes credit sales of merchandise
amounting to $100,000.
Slide 3-10

Basic Concepts
If experience indicates that 3 percent of credit
sales will eventually become bad debts, then
revenue for the period is $97,000.
Realization Concept
Sorry Joe,
I can’t pay.
Slide 3-11

Basic Concepts
• Accounting
period
• Conservatism
• Realization
• Matching
• Consistency
• Materiality
• Money
measurement
• Entity
• Going concern
• Cost
• Dual aspect
Slide 3-12

Basic Concepts
Matching Concept
Today is
March
19
On March 19, an
item of inventory
costing $1,000 is
received.
Slide 3-13

Basic Concepts
Matching Concept
Today is
April
16
On April 16, the
vendor is paid in full.
Slide 3-14

When should the
merchandise be an
expense to the firm?
Basic Concepts
Matching Concept
Today is
May
9
On May 9, the item of
merchandise is sold
for $1,500.
Slide 3-15

In May, when the
merchandise is sold.
Basic Concepts
Matching Concept
Today is
May
9
On May 9, the item of
merchandise is sold
for $1,500.
Slide 3-16

 Expenditures that are also expenses
 Beginning assets that become expenses
 Expenditures that are not yet expenses
 Expenses not yet paid
Basic Concepts
Types of transactions that need to be considered in
distinguishing between amounts that are properly
considered as expenses of a given accounting period
and the expenditures made in connection with the
item.
Slide 3-17

Basic Concepts
• Accounting
period
• Conservatism
• Realization
• Matching
• Consistency
• Materiality
• Money
measurement
• Entity
• Going concern
• Cost
• Dual aspect
Slide 3-18

Basic Concepts
The consistency concept:
Once an entity has decided
on one accounting
method, it should use the
same method for all
subsequent events of the
same character (unless it
has a sound reason to
change methods).
LIFO
Slide 3-19

Basic Concepts
• Accounting
period
• Conservatism
• Realization
• Matching
• Consistency
• Materiality
• Money
measurement
• Entity
• Going concern
• Cost
• Dual aspect
Slide 3-20

Materiality
A dozen pencils were purchased
for the office secretary. These
pencils are assets to the firm
and technically should be
expensed each time one is used.
Materiality allows the firm to
expense the pencil either at the
time of purchase or when an
inventory is taken of office
supplies at period-end.

Income Statement Slide 3-22
GARDEN CORPORATION
Income Statement
For the Year Ended December 31, 1998
Net sales $75,478,221
Cost of sales 52,227,004
Gross margin 23,251,217
Research and development expense 2,158,677
Selling, genera, and administrative expenses 8,726,696
Operating income 12,356,844
Other revenues (expenses):
Interest expense (363,000
Interest and dividend revenues 43,533
Royalty revenues 420,010
Income before income taxes 12,466,387
Provision for income taxes 4,986,555
Net income $ 7,479,832
)

Statement of Retained Earnings Slide 3-23
Retained earnings at the beginning of year $16,027,144
Add: Net income 7,479,832
Deduct: Dividends ($4 per common share) (4,390,000
Retained earnings at end of year $19,116,976

Accounting
Records and
Systems

New balance 5,450
(decrease)
750
7,200
4,800
3,000
15,750
The Account Slide 4-1
(increase)
Beginning balance -0-
5,000
4,000
200
12,000
21,200
Cash

Debits and Credits Slide 4-2
Assets Liabilities Owners’ Equity
Debit Credit Debit Credit Debit Credit
+ - + - + -

The Accounting Process Slide 4-3
3. Post journal entries to ledger
4. Identify, journalize, and post
adjusting entries
5. Journalize and post closing
entries
6. Prepare financial statements
2. Journalize original entries
1. Analyze transactions

Transaction Analysis Slide 4-4
On August 1, Snelson invested $5,000 in the
business as owner.
Cash Paid-in Capital
5,000 5,000

On August 1, the firm paid $750 rent for the
month of August.
Cash Prepaid Expenses
5,000 750
750

The firm borrowed $4,000 from a bank on a 9 percent
note payable, with interest payable quarterly and the
principal due in full at the end of two years.
4,000
Cash Notes Payable
5,000 750 4,000

Equipment costing $7,200 was purchased for cash. The
expected life of the equipment was 10 years.
4,000
Cash Equipment, at Cost
5,000 750 7,200
7,200
Refer to pages 94 through 96 for the
remaining entries for the month of August.

Balance 5,450
Balancing an Account Slide 4-8
Balance -0- 750
5,000 7,200
4,000 4,800
200 3,000
12,000 To Balance
5,450
21,200 21,200
Cash

The Trial Balance Slide 4-9
CAMPUS PIZZERIA, INC.
Trial Balance
As of August 31
Cash……………………………………………………. $ 5,450
Accounts receivable……………………………………. -0-
Inventory……………………………………………….. 550
Prepaid expenses……………………………………….. 750
Equipment, at cost……………………………………… 7,200
Accounts payable………………………………………. $ 2,200
Notes payable………………………………………….. 4,000
Paid-in capital………………………………………….. 5,000
Sales revenue…………………………………………... 12,200
Cost of sales……………………………………………. 6,000
Wage expense………………………………………….. 3,000
Utilities expense……………………………………….. 450
Totals……………………………………………….. $23,400 $23,400
Balance
Debit Credit

Adjusting Entries Slide 4-10
Fuel oil was purchased for $1,000.
Fuel Oil Inventory Accounts Payable
1,000 1,000

By the end of the accounting period,
$600 of the fuel had been consumed.
Fuel Oil Inventory Fuel Expense
1,000 600
600

Paid an insurance premium on
company car, $1,200.
Prepaid Insurance Cash
1,200 1,200

Prepaid Insurance Insurance Expense
1,200
At year-end, $800 of this is an expense.
800
800

Employees earned $150 of wages during the
period. These wages have not been paid.
Wages Expense Accrued Wages
150 150

Annual depreciation on
equipment totaled $2,000.
Depreciation Accumulated
Expense Depreciation
2,000 2,000
Additional adjusting entries are explained on
pages 99 through 101 of the textbook.

12,200
200
Closing Entries Slide 4-16
Closing the Sales Revenues account
Sales Income
Revenues Summary
12,400 12,400

6,000 12,400
6,000 6,000
Closing the Cost of Sales account
Cost of Income
Sales Summary

Closing the Income Summary account
(17) 382
Income Summary
(B) 6,000
(C) 3,000
(D) 450
(E) 750
(F) 60
(G) 30
10,290
(A) 12,400
Credit
Income Tax
Liability
(H) 1,528

Financial Statements Slide 4-19
Balance Sheet
As of August 31
Cash $ 5,450 Accounts payable $ 2,200
Accounts receivable 200 Notes payable 4,000
Inventory 550 Accrued expenses 30
Prepaid expenses 0 Income tax liability 382
Total current assets 6,200 Total liabilities 6,612
Equipment, at cost 7,200 Paid-in capital 5,000
Less: Accum. Depr. 60 Retained earnings 1,728
Equipment, net 7,140 Total owners’ equity 6,728
Total assets $13,340 Total liab. and own. eq. $13,340

Sales revenues $12,400
Cost of sales 6,000
Gross margin 6,400
Operating expenses:
Wages $3,000
Rent 750
Utilities 450
Depreciation 60
Interest 30 4,290
Income before income taxes 2,110
Income tax expense 382
Net income $ 1,728
Financial Statements Slide 4-20
Income Statement
For the Month of August

Revenue and
Monetary
Assets

The Business Operating Cycle Slide 5-1
Purchase materials
Convert materials
into a finished
product
Inspect the product
Receive an order
for the product
from a customer
Ship the product
and send the
customer an
invoice
Customer
acknowledges
receipt of the item
Store the product in
a warehouse
Collect cash from
the customer

1. Sales order received no none
2. Deposit or advance no none
payment received
3. Goods being produced For certain long- percentage of
term contracts completion
4. Production completed; For precious metals production
goods stored and certain agri-
cultural products
5. Goods shipped or usually delivery
6. Customer pays account collection is installment
receivable uncertain
Timing of Revenue Recognition Slide 5-2
Typical
Revenue Recognition Revenue Recognition
Event at This Time Method

dr. Inventory on consignment 1,000
cr. Merchandise inventory 1,000
Consignment Shipments Slide 5-3
Goods costing $1,000 were
shipped out on consignment.

dr. Cost of goods sold 1,000
cr. Inventory on consignment 1,000
dr. Accounts receivable 1,400
cr. Sales revenue 1,400
Consignment Shipments Slide 5-4
These goods are sold by the
consignee for $1,400.

Customer Project Year-End
Payments Costs Percent
Year Received Incurred Complete Revenues Expenses Income
1 $120,000 $160,000 20 $ 0 $ 0 $ 0
2 410,000 400,000 70 0 0 0
3 370,000 240,000 100 900,000 800,000 100,000
Total $900,000 $800,000 $900,000 $800,000 $100,000
Completed-Contract Method Slide 5-5
If the amount of income to be earned on the
contract cannot be reliably estimated, then
revenue is to be recognized only when the project
has been completed.

1 $120,000 $160,000 20 $180,000 $160,000 $ 20,000
2 410,000 400,000 70 450,000 400,000 50,000
3 370,000 240,000 100 270,000 240,000 30,000
Total $900,000 $800,000 $900,000 $800,000 $100,000
Customer Project Year-End
Payments Costs Percent
Year Received Incurred Complete Revenues Expenses Income
Percentage-of-Completion Method Slide 5-6
GAAP assumes that the percentage-of-
completion method will be used to account for
long-term contracts.

Bad Debts Slide 5-7
Check out the aging
schedule in
Illustration 5-4.
The firm expects
bad debts of
$7,132 .

The accounts receivable section of the December 31,
1997 balance sheet would appear as follows:
Accounts receivable $262,250
less: allowance for doubtful accounts 7,132
accounts receivable, net $255,118
dr. Bad Debts Expense 7,132
cr. Allowance for Doubtful 7,132
Bad Debts Slide 5-8
The adjusting entry would be:

Bad Debts Slide 5-9
If sometime in 1998 the Essel Company decided that
James Johnson was never going to pay his bill of
$250, the following entry would be made:
dr. Allowance for Doubtful Accounts 250
cr. Accounts Receivable 250
The accounts receivable section of the balance sheet
immediately after the write-off entry would show--
Accounts receivable $262,000
less: allowance for doubtful accounts 6,882
accounts receivable, net $255,118
Note the the net
amount of accounts
receivable is unchanged.

Sales Discounts Slide 5-10
Sold $1,000 of merchandise on credit terms of 2/10,
net/30.

Sold $1,000 of merchandise on credit terms of 2/10,
net/30.
dr. Accounts Receivable 980
cr. Sales Revenue 980
If payment is made within the discount period:
dr. Cash 980
cr. Accounts Receivable 980

If payment is made after the discount period:
dr. Cash 1,000
cr. Discounts Not Taken 20
Accounts Receivable 980
The 2 percent discount
really amounts to an
annual rate of 32 percent.

Credit Card Sales Slide 5-12
Bank plan (MasterCard and Visa)
dr. Cash 970
Sales Discounts (Credit Cards) 30
cr. Sales Revenue 1,000
Other plans (American Express and Discover)
dr. Accounts Receivable 970
Sales Discounts (Credit Cards) 30
cr. Sales Revenue 1,000

Interest Revenue Slide 5-13
On September 1, 1997, a bank loaned $10,000 for
one year at 9 percent interest, the interest and
principal to be paid on August 31, 1998. The bank’s
entry on September 1, 1997 is:
dr. Loan Receivable 10,000
cr. Cash 10,000
On December 31, 1997, an adjusting entry is made
to record the fact that interest for one-third of a year,
$300, was earned in 1997:
dr. Loan Receivable 300
cr. Interest Revenue 300

On September 1, 1997, a bank loaned $10,000 for
one year at 9 percent discounted.
dr. Loan Receivable 10,000
cr. Cash 9,100
Unearned Interest Revenue 900
On December 31, 1997, an adjusting entry is made
to record the fact that $300 of interest was earned in
1997.
dr. Unearned Interest Revenue 300

On August 31, 1998, when the loan is repaid, the
entry is:
dr. Cash 10,000
cr. Loans Receivable 10,000
After repayment by the borrower, an adjusting entry
is also made by the bank to record the fact that $600
interest was earned in 1998.
dr. Unearned Interest Revenue 600

Current Ratio Slide 5-16
Current assets
Current liabilities
Current Ratio =
$1,245.1
$1,214.6
Current Ratio =
1.03
Current Ratio =

Slide 5-17
Acid-Test Ratio
Cash,
temporary
investments,
and accounts
receivable
(net)
Monetary Current assets
Current liabilities
Acid-Test Ratio
=
$634.9
$1,214.6
Acid-Test Ratio
=
0.52
Acid-Test Ratio
=

Slide 5-18
Cash Cost Per Day
Expenses (net of depreciation)
365
Cash Cost
Per Day =
$5,348.0
365
Cash Cost
Per Day =
$14.65 per day
Cash Cost
Per Day =

Slide 5-20
Days’ Cash
Cash
Cash costs per day
Days’ Cash =
$98.1
$14.65
Days’ Cash =
7 days
Days’ Cash =

Cost of Sales
and
Inventories

Merchandise Inventory and Flows Slide 6-1
Available
for sale
$11,400
Purchases
$7,400
Ending
inventory
Beginning
inventory
$?
Cost of
goods sold
$?
Inventory reservoir
$4,000

Slide 6-2
Periodic Inventory Method
Beginning inventory $ 4,000
Plus: Purchases 7,400
Equals: Goods available for sale 11,400
Less: Ending inventory 2,000
Cost of goods sold $ 9,400
In the periodic inventory method a physical count is
made of merchandise in the ending inventory.

Beginning inventory $ 4,000
Plus Purchases, gross $7,000
Freight-in 600
7,600
Less: Purchase returns 200
Net purchases 7,400
Goods available for sale 11,400
Less: Ending inventory 2,000
Cost of goods sold $ 9,400
Slide 6-3

Slide 6-4
First, close the beginning inventory amount:
Cost of Goods Sold 4,000
Merchandise Inventory 4,000
Next, close Purchases, Purchases Returns, and Freight-In
accounts.
Purchase Return 200
Purchases 7,000
Freight-In 600
Entries

Slide 6-5
Entries
The new balance from the physical inventory is entered:
Finally, Cost of Goods Sold is closed:
Income Summary 9,400

Slide 6-6
Perpetual Inventory Method
Entries
For purchases:
For shipment to customers:
For purchase returns:
Accounts Payable 200
Merchandise Inventory 200

Slide 6-7
Perpetual Inventory Method
Item: Cassette Deck, Model S150 Unit: Each
Date Receipts Shipments Balance
Unit Unit Unit
Units Cost Total Units Cost Total Units Cost Total
Jan. 2 40 100 100 4,000
12 32 100 3,200 8 100 800
14 10 100 1,000 18 100 1,800
25 4 100 400 22 100 2,200
31 2 100 200 20 100 2,000

Beginning inventory $ 4,000 $ 6,000
Purchases 7,000 10,000
Goods available for sale $11,000 $16,000
Slide 6-8
Retail Method
At Cost At Retail
$11,000/$16,000 =69%

Sales 13,000
Ending inventory at retail $ 3,000
Ending inventory at cost
Beginning inventory $ 4,000 $ 6,000
Purchases 7,000 10,000
Goods available for sale $11,000 $16,000
Slide 6-9
Retail Method
At Cost At Retail
$ 2,070
$3,000 x .69
Cost of goods sold: $13,000 x .69 = $8,970

Slide 6-10
Flow of Cost Through Inventories
Materials Inventory
Balance, Jan 1 154
Purchases 273
Work in Process Inventory
Balance, Jan 1 19
Finished Goods Inventory
Balance, Jan 1 69

Slide 6-11
Balance, Jan 1 154
Purchases 273
Balance, Jan 1 19
Materials used 264
264
Conversion cost 330
Materials Inventory
Balance, Jan 1 69

Slide 6-12
Balance, Jan 1 154
Purchases 273
Balance, Jan 1 19
Materials used 264
264
Conversion cost 330
570
Materials Inventory
Balance, Jan 1 69
Goods manufactured 570
573 Cost of Goods Sold

Slide 6-13
Inventory Costing Methods

Slide 6-14
Basic Data
Units Unit Cost Total Cost
Inventory, January 1 100 $8 $ 800
Purchased June 1 60 9 540
Purchased October 1 80 10 800
Goods available for sale 240 $2,140
Goods sold 150
Ending inventory 90

Slide 6-15
Specific Identification Method
Goods sold 150
Ending inventory 90
SOLD 100
SOLD 50

Slide 6-16
Specific Identification Method
Purchased June 1 10 $ 9 $ 90
Ending inventory 90 $890
Cost of goods sold = (100 x $8) + (50 x $9) = $1,250

Slide 6-17
Average Cost Method
Goods available for sale 240 $8.917 $2,140
$2,140
240
Ending inventory: 90 x $8.917 = $802
Cost of goods sold: 150 x $8.917 = $1,338

Goods sold 150
Ending inventory 90
Slide 6-18
FIFO
Sold 100
Sold 50

Slide 6-19
FIFO
Ending inventory 90 $890
Cost of goods sold: (100 x $8) + (50 x $9) = $1,250

Goods sold 150
Ending inventory 90
Slide 6-20
LIFO
Sold 80
Sold 60
Sold 10

Inventory, January 1 90 $8 $720
Slide 6-21
LIFO
Ending
inventory
Cost of goods sold: (80 x $10) + (60 x $9) + (10 x $8)
= $1,420

FIFO $1,250 $890 $2,140
Average cost 1,338 802 2,140
LIFO 1,420 720 2,140
Slide 6-22
Comparison of Method
Cost of Ending
Goods Sold Inventory Total

Long-Lived
Nonmonetary
Assets and Their
Amortization

Tangible assets:
Land not amortized
Plant and equipment depreciation
Natural resources depletion
Intangible assets:
Goodwill amortization
Patents, copyrights, etc. amortization
Leasehold improvements amortization
Deferred charges amortization
Research and development costs not capitalized
Types of Long-Lived Assets Slide 7-1
Type of Asset
Method of Converting
to Expense

 Purchase price
 Sales tax
 Transportation costs
 Installation cost
Items Included in Cost Slide 7-2

Straight-Line Method Slide 7-3
Depreciation Expense =
Original cost - Residual value
Service life (years)
The number of
accounting periods over
which the asset will be
useful to the entity.
The expected amount to
be recovered at the end
of the service life.

Straight-Line Method Slide 7-4
Service life (years)
$10,000 - $1,000
5 years
Depreciation Expense = $1,800

$10,000
Year 1: $10,000 x .40 = $4,000 6,000
Year 2: $6,000 x .40 = 2,400 3,600
Year 3: $3,600 x. 40 = 1,440 2,160
Year 4: $2,160 x .40 = 864 1,296
Year 5: $1,296 - $1,000 = 296 1,000
Declining-Balance Method Slide 7-5
Note that this amount reduces the
book value to the salvage value.
Depreciation
Expense
Book
Value

$10,000
Year 1: 5/15 x ($10,000 - $1,000) $3,000 7,000
Year 2: 4/15 x ($10,000 - $1,000) 2,400 4,600
Year 3: 3/15 x ($10,000 - $1,000) 1,800 2,800
Year 4: 2/15 x ($10,000 - $1,000) 1,200 1,600
Year 5: 1/15 x ($10,000 - $1,000) 600 1,000
n + 1
2
Years’-Digits Method Slide 7-6
First, determine the sum by using the following equation:
n =
5 + 1
2
5 = 15
Next, build a table:
Annual
Depreciation
Book
Value

Units-of-Production Method Slide 7-7
Service life (units)
$10,000 - $1,000
90,000 miles
Depreciation Expense = $.10 per mile

Accounting for Depreciation Slide 7-8
Building, at net $1,000,000
Less: Accumulated depreciation 25,000
Building, net $975,000
December 31, 1996
Less: Accumulated depreciation 50,000
Building, net $950,000
December 31, 1997

Accounting for Depreciation Slide 7-9
The annual journal entry to record depreciation is:
Depreciation Expense 25,000
Accumulated Depreciation 25,000
A fully depreciated building still in use (assume no
salvage value) would appear on the balance sheet as
follows:
Less: Accumulated depreciation 1,000,000
Building, net $0

Disposal of Plant and Equipment Slide 7-10
A building is sold for its book value of $750,000:
Cash 750,000
Building 1,000,000
Assume instead that the building was sold for
$650,000:
Cash 650,000
Loss on Sale of Building 100,000
Building 1,000,000

Exchanges and Trade-Ins Slide 7-11
Assume a company trades in two automobiles, each of which
originally cost $20,000 and each has a book value of $5,000.
Each car has a market value of $7,000.
The first car is traded for another car with a list price of $30,000,
and $18,000 cash is given to the dealer in addition to the trade-in.
Automobile (New) 23,000
Accumulated Depreciation (Automobile) 15,000
Cash 18,000
Automobile (Old) 20,000
$18,000 + $7,000 -
“gain” of $2,000

Exchanges and Trade-Ins Slide 7-12
Assume a company trades in two automobiles, each of which
originally cost $20,000 and each has a book value of $5,000.
Each car has a market value of $7,000.
The second automobile is traded for a piece of equipment
that also has a list price of $30,000 and $18,000 cash
is given in addition to the trade-in.
Equipment (New) 25,000
Accumulated Depreciation (Automobile) 15,000
Cash 18,000
Automobile (Old) 20,000
Gain on Disposal of Automobile 2,000
$18,000
+
$7,000

Group Depreciation Slide 7-13
Group depreciation treats all similar assets (such as
automobile or office chairs) as a “pool” or group rather
than making the calculation for each one separately.
A used microcomputer which originally cost $3,000 is
disposed of for $400 cash.
Cash 400
Accumulated Depreciation, Microcomputers 2,600
Microcomputers 3,000

A method provided by the tax code
Designed as an incentive to invest in capital
assets
Shortened assets’ lives for tax purposes
Most classes of property acquired or
disposed of at any point during the year are
assumed to have been acquired or disposed
of at the midpoint of the year
MACRS Slide 7-14

19x1 $ 20,000 1/2 * 40% * $100,000
19x2 32,000 40% * ($100,000 - $20,000)
19x3 19,200 40% * ($80,000 - $32,000)
19x4 11,520 40% * ($48,000 - $19,200)
19x5 11,520 change to straight-line
19x6 5,760 1/2 * 19x5 amount
Total $100,000
MACRS Slide 7-15
Assume that a machine in the five-year class is
acquired at some point in 19x1 for $100,000.
Cost Recovery
Year Deduction Computation

Investment Tax Credit Slide 7-16
In late December 19x1 a company purchased a $200,000
machine that qualified for a $20,000 investment tax credit.
Income Tax Liability 20,000
Income Tax Expense 20,000
This is the
flow-through
method.

An alternative approach is to record the investment tax credit
as a deferred credit--which is analogous to unearned revenue.
Income Tax Liability 20,000
Deferred Investment Tax Credits 20,000
This approach is
called the
deferred method.

In 19x2 and the subsequent nine years, Income
Tax Expense would be decrease by $2,000.
Deferred Investment Tax Credits 2,000
This method has the
effect of increasing net
income each year
the entry is made.

Depletion Expense Slide 7-19
An oil property cost $250 million and is
estimated to contain 50 million barrels of oil.
Depletion Expense =
Total barrels of oil
Depletion Expense =
$250 million - $0
50 million
Depletion Expense = $5 per barrel

• Goodwill
• Patent
• Copyrights
• Franchise rights
• Leasehold improvements
• Deferred charges
• Research and development costs
Intangible Assets Slide 7-20

Sources of
Capital:
Debt

Loss Contingency Slide 8-1
1. Information available prior to issuance of
the financial statements indicates that it is
probable that an asset has been impaired
or a liability has incurred.
2. The amount of loss can be reasonable
estimated.
A loss contingency is recorded as a liability if both of the
following conditions are met:

• a specified sum of money at a stated date,
called the maturity date
• interest at a stated rate until the maturity
date
Bonds Slide 8-2
A bond is a certificate promising to pay its holder--

 Mortgage bond
 Secured bond
 Debenture bond
 Sinking fund bond
 Serial bonds
 Callable bonds
 Zero-coupon bonds
 Convertible bonds
 Subordinated bonds
Types and Features of Bonds Slide 8-3
A bond can have a
combination of
these features.

Recording a Bond Issue Slide 8-4
Mason Corporation’s 10% bonds, for which investors paid $851
each, also had issue costs to Mason averaging $21 per bond,
resulting in a net cash inflow to Mason of $830 per bond.
Cash 83,000
Bond Discount 14,900
Deferred Charges 2,100
Bonds Payable 100,000

Recording a Bond Issue Slide 8-5
By contrast, if prevailing rates for similar bonds
had been 9 percent, the bonds would have been
issued at a premium of $91 per bond.
Cash 107,000
Deferred Charges 2,100
Bond Premium 9,100

Balance Sheet Presentation Slide 8-6
If a Discount:
Bonds payable:
Face value $100,000
Less: Unamortized discount 14,900
$ 85,100
If a Premium
Bonds payable:
Face value $100,000
Plus: Unamortized premium 9,100
$109,100

Slide 8-7
Bond Interest Expense
The first year’s interest expense for the 10
percent Mason Corporation bonds (issued at a
discount; effective rate is 12 percent).
Bond Interest Expense 10,212
Bond Discount 212
Cash 10,000
$85,100 x .12
$100,000 x .10

The bonds were issued on October 1. The interest date is
September 30, and the fiscal year ends on December 31. The
adjusting entry at December 31 would be--
Bond Discount 53
Accrued Interest Payable 2,500
$85,100 x .12 x 3/12
$100,000 x .10 x 3/12

Interest Payment Entry Slide 8-9
Payment of interest is made to bondholders on September 30.
Accrued Interest Payable 2,500
Bond Discount 159
Cash 10,000
$85,100 x .12 x 9/12
$100,000 x .10

Refunding a Bond Issue Slide 8-10
One hundred Mason Corporation bonds are called at the
end of five years at a price of $1,050 per bond.
Miscellaneous refunding costs amount to $1,000.
Reacquisition price ($105,000 + $1,000) $106,000
Net carrying amount:
Face value $100,000
Less: Unamortized discount (13,553)
Less: Unamortized issuance cost (1,575) 84,872
Loss on retirement of bond $ 21,128

Refunding a Bond Issue Slide 8-10
One hundred Mason Corporation bonds are called at the
end of five years at a price of $1,050 per bond.
Miscellaneous refunding costs amount to $1,000.
Loss on Retirement of Bonds 21,128
Cash 106,000
Bond Discount 13,553
Deferred Charges (Issuance Costs) 1,575

• Ownership is transferred to the the lessee at the
end of the term of the lease
• The lessee has an option to purchase the asset at a
“bargain” price
• The term of the lease is 75 percent or more of the
economic life of the asset
• The present value of the lease payments is 90
percent or more of the fair value of the property
Capital Leases Slide 8-11
The Financial Accounting Standards Board has ruled that a
lease is a capital lease if one or more of the following criteria
are met:

Slide 8-12
A company leases equipment whose useful life is 10 years.
Lease payments are $1,558 per year payable at the end of each
of the next 10 years. The fair value of the equipment is $10,000.
Capital Leases
Equipment 10,000
Capital Lease Obligations 10,000
What is the journal entry to record acquiring the equipment?.

Slide 8-13
The first annual lease payment consists of $900 of interest
expense and $658 to reduce the liability.
Capital Leases
Interest Expense 900
Capita Lease Obligations 658
Cash 1,558
Assuming straight-line depreciation, the following adjusting
entry is made to record annual depreciation.

Debt/Equity Ratio
Total liabilities
Shareholders’ equity
Debt/Equity
Ratio
=
$3,400
$3,600
Debt/Equity
Ratio
=
Debt/Equity
Ratio
= 94 percent
Excluding current liabilities, the
ratio changes to 50 percent
Slide 8-14

Times Interest Earned Slide 8-15
Pre-tax income before interest
Interest expense
Times Interest Earned =
$1,000
$200
5.0 times

Future Value--Compound Interest Slide 8-16
FV = p(1 + i)
n
where:
p = Principal (initial investment)
i = Interest rate
n = Number of periods
The future value of $1,000 invested at 5
percent for 10 years is given by:
FV = $1,000(1 + 0.05) = $1,628.89
10

Present Value of a Future Amount Slide 8-17
PV =
p
(1 + i)
n
What is the present value of $400 to be received 10 years
hence, discounted at a rate of 8 percent?
PV =
p
(1 + i)
n
Amount to be
received in future
From Table A, we
find the 10 year/8%
factor to be 0.463.
$185.20 = $400 x 0.463

1 $1,750 0.909 $1,591
2 1,750 0.826 1,446
3 1,750 0.751 1,314
4 1,750 0.683 1,195
Present value of series $5,546
Present Value of a Series of Payments Slide 8-18
What would be the present value of a series of equal payments
of $1,750 for 10 years (assume 10 percent)?
Year Payment (Table A) Value
Present

Present Values and Liabilities Slide 8-19
Kinnear Company borrowed $25,000, with interest at 10
percent to be paid annually and the principal to be repaid in one
lump sum at the end of ten years. What balance sheet liability
would be reported at the inception of the debt?
Interest, $2,500*3.791 (Table B) $ 9,478
Principal, $25,000*0.621 (Table A) 15,575
Total present value $25,003*
*Does not add exactly to $25,000 due to rounding

Present Values and Liabilities Slide 8-20
Kinnear Company borrowed $25,000, with interest at 10
percent to be repaid in equal annual amounts at the end of each
of the next five years. How much is each equal annual
payment?
PV of the annuity = Table B Value x Annual
for 10 percent/5 payment
year factor
$25,000 = 3.791 x ?
$25,000 = 3.791 x $6,595

Sources of
Capital:
Owners’ Equity

Forms of Business Organizations Slide 9-1
Owned by an individual
No incorporation fees
No special reports
Profits taxed at proprietor’s
personal tax rate
Personally responsible for the
entity’s debts
Borrow money as an individual
Sole Proprietorship

Owned by two or more persons
Each partner is personally liable
for all debts incurred by firm
Each partner is responsible for
business actions of other
partners
Taxed as individuals
Partnership

Legal entity with essentially
perpetual existence
Granted a charter to operate
Taxed as an entity
Limited liability to owners
Ownership of an individual is
easily added or liquidated
Corporation

 There may be significant legal and other fees
involved in formation.
 The corporation’s activities are limited to those
specifically granted in its charter.
 It is subject to numerous regulations and
requirements.
 It must secure permission from each state in
which it wishes to operate.
 Its income is subject to double taxation.
Disadvantages of the Corporation Form Slide 9-4

Salary $60,000 $20,000 $40,000
Interest on capital 8,000 2,400 5,600
Remainder 12,000 6,000 6,000
Total $80,000 $28,400 $51,600
Partnership Equity Slide 9-5
The partnership agreement of Jackson and Curtin provided that
Jackson would receive a salary of $20,000 and Curtin a salary of
$40,000; that each would receive 8 percent interest on their
invested capital; and they they would share any remainder equally.
The partnership’s net income for the year is $80,000.
Total Jackson Curtin

Salary $60,000 $20,000 $40,000
Interest on capital 8,000 2,400 5,600
Remainder 12,000 6,000 6,000
Total $80,000 $28,400 $51,600
Partnership Equity Slide 9-6
If the partnership agreement is silent
concerning the remainder, then it is
divided equally.
Total Jackson Curtin

Recording a Common Stock Issue Slide 9-7
Kuick Corporation is authorized to issue 200,000
shares of $1 par value common stock. Of these,
100,000 shares were issued at $7 per share.
Cash 700,000
Common Stock at Par 100,000
Additional Paid-In Capital 600,000
100,000 x $1

Cash Dividend Slide 9-8
Kuick Corporation declares a $6,000 dividend on
December 15 to be paid on January 15 to holders
of record as of January 1.
December 15
Retained Earnings 6,000
Dividends Payable 6,000
January 1 (no entry)
January 15
Dividends Payable 6,000
Cash 6,000

Stock Dividend Slide 9-9
Kuick Corporation declares and issues a 5 percent
stock dividend to the holders of its 100,000
outstanding shares (par value of $1) when the
market price of a share is $10.50.
Retained Earnings 52,500
Common Stock at Par 5,000
Additional Paid-In Capital 47,500
5,000 x
$10.50 5,000 x
$1

Common stock, $25 per share $ 77.6 $ 77.5
Capital in excess of par 72.0 60.2
Retained earnings 3.409.4 3.033.9
Treasury stock, at cost (1,653.1) (1,105.0)
Total stockholders’ equity $1,905.9 $2,075.6
Balance Sheet Presentation Slide 9-10
PRESTON COMPANY AND SUBSIDIARIES
Consolidated Balance Sheet
At December 31
(millions)
1998 1997

Basic Earnings Per Share Slide 9-11
Basic earnings per share is a measurement
of the corporation’s per share performance
over a period of time.
Earnings per share =
Net income
Number of shares of common
stock outstanding
$7,000,000
1,000,000 shares = $7
Assume Nugent Corporation had net income
of $7 million and 1 million shares of
common stock outstanding.

= $6.20
Now, assume that Nugent Corporation also
has 100,000 shares of $8 convertible
preferred stock.
Basic Earnings Per Share Slide 9-12
Net income - Preferred dividends
stock outstanding
$7,000,000 - $800,000
1,000,000 shares

= $5.83
For diluted earnings per share, we assume that
the 100,000 convertible preferred shares are
exchanged for 200,000 shares of common stock.
Earnings Per Share Slide 9-13
stock outstanding
$7,000,000
1,200,000 shares

= $5.83
For diluted earnings per share, we assume that
the 100,000 convertible preferred shares are
exchanged for 200,000 shares of common stock.
Slide 9-14
stock outstanding
$7,000,000
1,200,000 shares
Note that all the preferred
stock is assumed converted, so
there would be no dividends.
1,000,000 shares of common stock
plus the 200,000 shares assumed
from converting preferred stock
Earnings Per Share

1,000,000 x 12/12 = 1,000,000
500,000 x 6/12 = 250,000
Denominator amount 1,250,000
Slide 9-15
Weighted-Average Number of Shares
Optel Corporation had 1 million shares of
common stock outstanding on January 1. On July
1 it issued an additional 500,000 shares. How
many weighted-average shares would be used for
calculating earnings per share?

Slide 9-16
Zero-Coupon Bonds
Bonds with a total par of $100,000 and carrying
zero interest are issued when the current yield is
14 percent. How much should the investor pay
for each $1,000 bond?
$1,000 x .519 = $519 per $1,000 bond
No cash is paid by the borrower
until these bonds mature.

Slide 9-17
Debt With Warrants
Some corporations issue warrants in
conjunction with the issuance of bonds,
putting an exercise price on the warrants of
about 15 to 20 percent above the current
market price of the common stock.
If detachable, the warrants
can be removed from the
debt and used to purchase
the issuer’s stock or sold
to a third party.

Slide 9-18
Debt With Warrants
If nondetachable, the debt
is accounted for as if it
were a convertible debt
security--no recognition is
given to the equity
character of the debt.
Some corporations issue warrants in
conjunction with the issuance of bonds,
putting an exercise price on the warrants of
about 15 to 20 percent above the current
market price of the common stock.

Slide 9-19
Redeemable Preferred Stock
Redeemable preferred stock not only pays
dividends, it may also be redeemed by the
investor on or after a certain date.
The SEC requires that redeemable preferred
stock be listed as a separate item on the balance
sheet at it’s redemption price. This item must be
listed between the liability and owners’ equity
section and not included in the total of either
liabilities or owner’s equity.

Slide 9-20
Redeemable Preferred Stock
Redeemable preferred stock $ 8,000,000
Stockholders’ equity:
Common stock @ $1 par 20,000,000
Additional paid-in capital 75,000,000
Total paid-in capital 95,000,000
Retained earnings 60,000,000
Total stockholders’ equity $155,000,000
The $8 million for
redeemable preferred
stock is not included.

Other
Nonowner
Items that
Affect
Owners’ Equity

Detailed Condensed Statement (Top) Slide 10-1
BASEL CORPORATION
Condensed Statement of Income and Retained Earnings
Year Ended December 31, 1998
(in thousands)
Net sales and other revenue $60,281
Expenses 46,157
Income from continuing operations before
income taxes 14,124
Provision for income taxes 5,650
Income from continuing operations 8,474
Discontinued operations (Note A):
Loss from operations of Division X (less
applicable income taxes of $320) $480
Loss on disposal of Division X (less applicable
income taxes of $640 960 (1,440)

Extraordinary loss (less applicable income taxes
of $400)(Note B) (600)
Cumulative effect of changes in accounting principles
(less applicable income taxes of $125)(Note C) (400)
Net income $ 6,034
Retained earnings at beginning of year:
As previously reported $41,400
Adjustments (Note D) (1,200)
As restated 40,200
Deduct dividends (2,000)
Retained earnings at end of year $44,234
Detailed Condensed Statement (Bottom) Slide 10-2

 The event must be unusual; it should be
highly abnormal and unrelated to, or only
incidentally related to, the ordinary
activities of the entity.
 The event must occur infrequently; it
should be of a type that would not
reasonably be expected to recur in the
foreseeable future.
Extraordinary Items Slide 10-3
In order to qualify as an extraordinary item, an event
must satisfy two criteria:

 Write-down or write-off of accounts receivable,
inventory, or intangible assets
 Gains or losses from changes in the value of
foreign currency
 Gains or losses on disposal of a segment of a
business
 Gains or losses from the disposal of fixed assets
 Effects of a strike
Extraordinary Items Slide 10-4
The following gains and losses are specifically not
extraordinary:

• The transaction must
involved a whole
business
• Discontinuance may
occur by abandoning
the segment and
selling off the assets
• Discontinuance may
occur by selling the
whole segment as a
unit to some other
company
Discontinued Operations Slide 10-5
Chair
Division
ABC
Furniture
Mfg.
Company

1. The net income or loss attributed to the
operations of the segment until it is sold
2. The estimated net gain or loss on disposal after
taking account of all aspects of the sale,
including the amount received and the write-off
of assets that are not sold
Discontinued Operations Slide 10-6
Two amounts are reported on the income
statement after their income tax effect has
been taken into account:

Change in Accounting Principles Slide 10-7
Sometimes a change is
required by a new
FASB Statement.
The consistency concept
requires that a company
use the same accounting
principle from one year
to the next.
If a company has a sound
reason for doing so, it
may occasionally shift
from one GAAP to
another one.
The cumulative effect of the
change is reported as one of the
nonrecurring items on the
income statement in the year
the changed is made.

Adjustments to Retained Earnings Slide 10-8
Only correction of
past periods errors is
allowed as an adjustment
to Retained Earnings.

• Mathematical mistakes
• Mistakes in the
application of
accounting principles
• An oversight or
misuse of facts
Adjustments to Retained Earnings Slide 10-8
So, what is
an error?

• An amount representing the
employee’s FICA contribution
and medicare coverage
• An amount withheld from gross
earnings to apply toward the
employee’s personal state and
federal income taxes
• Deductions for charitable
contributions, savings plans, union
dues, and a variety of other items
Personnel Costs Slide 10-9
Deductions from an employee’s paychecks:

If an employee with three dependents earned $600 for work
in a certain week in 1998, $45.90 for FICA and $63.00 for
withholding tax would be deducted from this $600. The
employer incurs a matching expense of $45.90 for FICA plus
$54 for federal and state unemployment insurance taxes.
When wages are earned:
Wages Cost 600.00
Wages Payable 600.00
Employment Tax Cost 99.90
FICA Taxes Payable 45.90
Unemployment Taxes Payable 54.00

When wages are paid:
Wages Payable 600.00
Cash 491.10
Withholding Taxes Payable 63.00
When the government is paid:
Unemployment Taxes Payable 54.00
Withholding Taxes Payable 63.00
Cash 208.80
$45.90 +
$45.90

• The year’s service cost element
• The year’s interest cost element
• The actual return on plan assets element
• The amortization of several other pension-related
items
Pensions Slide 10-12
A company’s pension cost is the sum of four
elements.

Pensions Slide 10-13
The net pension cost using a defined
benefit plan are $500,000
Net Pension Cost 500,000
Unfunded Accrued Pension Cost 500,000
A liability
A subsequent contribution of
$450,000 is made to the plan by the
employer.
Unfunded Accrued Pension Cost 450,000
Cash 450,000

Income Taxes Slide 10-14
A company buys personal computers costing over
$15,000 each. For tax purposes it elects to use an
accelerated depreciation method. For financial
reporting purposes it decides to use the straight-
line method.
In the first year the
depreciation charge for
tax purposes will be
higher than the
depreciation for
financial reporting
purposes.
If all other items are
accounted for in the
same way, the
company’s taxable
income for the year will
be lower than its book
pre-tax income.
At the end of the year the net carrying
amount of the computers on the company’s
tax books will be lower than their net carry
amount on the company’s financial
reporting books.

Deferred Income Taxes Slide 10-15
Because of temporary differences, in 1998 a
corporation reported $1 million pre-tax income to
its shareholders and $800,000 taxable income to
the IRS (resulting in an income tax expense of
$340,000 and a tax liability of only $272,000).
- $272,000 Retained Earnings - $340,000
Reflecting
actual tax bill
paid
Reflecting tax expense
used to measure book
income

Deferred Income Taxes Slide 10-16
Because of temporary differences, in 1998 a
corporation reported $1 million pre-tax income to
its shareholders and $800,000 taxable income to
the IRS (resulting in an income tax expense of
$340,000 and a tax liability of only $272,000).
Income Tax Expense--Current 272,000
Income Tax Expense--Deferred 68,000
Cash 272,000
Deferred Income Taxes Liability 68,000

Deferred Tax Measurement Slide 10-17
1998 $1,000.0 $ 333.3 $ 666.7 $ 266.7
1999 1,000.0 266.7 733.3 293.3
2000 1,000.0 200.0 800.0 320.0
2001 1,000.0 133.3 866.7 346.7
2002 1,000.0 66.7 933.3 373.3
$5,000.0 $1,000.0 $4,000.0 $1,600.0
Income before Depreciation Taxable Taxes Due
Year Depreciation and Taxes Charge Income (at 40 percent rate)
Calculation of Taxes Due
(thousands of dollars)

1998 $1,000.0 $333.3 $333.3 $666.7
1999 1,000.0 266.7 600.0 400.0
2000 1,000.0 200.0 800.0 200.0
2001 1,000.0 133.3 933.3 66.7
2002 1,000.0 66.7 1,000.0 -0-
Original Annual Cumulative
Year Depreciable Cost Tax Depreciation Tax Depreciation Tax Basis
Tax Basis Calculation

1998 $1,000.0 $200.0 $200.0 $800.0
1999 1,000.0 200.0 400.0 600.0
2000 1,000.0 200.0 600.0 400.0
2001 1,000.0 200.0 800.0 200.0
2002 1,000.0 200.0 1,000.0 -0-
Original Annual Book Cumulative Book Net Book
Year Book Cost Depreciation Depreciation Value
Net Book Value Calculation

When the taxes are paid:
Income Tax Payable 266,700
Cash 266,700
Combining all three 1998 entries:
Cash 266,700
Deferred Income Taxes Liability 53,300

The
Statement
of Cash
Flows

• Operations
• New borrowings
• New stock issues
• Sale of property, plant,
and equipment
• Sale of other noncurrent
assets
Sources of Cash Slide 11-1

• Cash dividends
• Repayment of
borrowings
• Repurchase of stock
• Purchase of property,
plant, and equipment
• Purchase of other
noncurrent assets
Uses of Cash Slide 11-2

• How much cash was provided by the normal, ongoing
operations of the company?
• In what other ways were significant amounts of cash
raised?
• Is the company investing enough in new plant and
equipment to maintain or increase capacity and to
replace old facilities with more efficient ones?
• Is the company reinvesting excess cash in productive
assets, or is it using the cash to retire stock?
Typical Questions Answered by the SCF Slide 11-3

Operating activities:
Transactions associated with sales revenues and
cash outflows associated with the operating
expenses
Investing activities:
Transactions involving acquiring and disinvesting in
long-lived assets
Financing activities:
Transactions involving borrowing of cash through
noncurrent instruments and the issuance of equity
securities
Major Categories on the SCF Slide 11-4

Cash flows from investing activities:
Acquisition of plant and equipment (500)
Proceeds from disposals of plant and equipment 20
Purchase of investment securities (25)
Proceeds from sales of investment securities 75
Net cash used by investing activities (430)
Investing Activities Section of SCF Slide 11-5
Equipment costing $500,000 was purchased for cash
during the year.
Equipment that originally cost $150,000 was sold for
$20,000, resulting in an inflow of cash .
The net result of these two transaction on the balance
sheet is an increase in plant and equipment of $350,000.

Investing Activities Section of SCF Slide 11-6
Investment securities decreased $50,000 ($450,000 to
$400,000) during the year.
The firm purchased $25,000 of new securities (an inflow
of cash) and and sold $75,000 of old securities (and
outflow of cash)

Financing Activities Section of SCF Slide 11-7
Short-term borrowing decreased $21,000
(from $147,000 to $126,000).
Cash flows from financing activities:
Proceeds from short-term debt 15
Payments to settle short-term debt (36)
Proceeds from long-term debt 375
Payments on long-term debt (40)
Proceeds from issuing common stock 44
Dividends paid (160)
Net cash provided by financing activities 326
Dividends paid (60)
The firm borrowed $15,000 using short-term
debt and paid $36,000 on old borrowings.

Dividends paid (60)
Long-term debt increased $335,000 (from
$500,000 in 1997 to $835,000 in 1998).
The firm borrowed $375,000 using long-term
debt and paid $40,000 on old long-term debt.

Dividends paid (60)
On the balance sheet, common stock increased
$10,000 and paid-in capital increased by
$34,000 between 1997 and 1998.
During 1998, Fairway issued 10,000 additional
shares of $1 par value common stock resulting in
cash proceeds of $44,000.

Dividends paid (60)
During 1998, cash dividends
amounted to $60,000.

Net cash flow from operating activities:
Cash received from customers $3,103
Dividends and interest received 19
Cash provided by operating activities 3,122
Cash paid to suppliers and employers 2,729
Interest paid 67
Income taxes paid 98
Cash disbursed for operating activities 2,894
Net cash flow from operating activities 228
Operating Activities Section of SCF Slide 11-11
Direct Method
FASB 95
encourages
use of the
direct method.

Net income $200
Noncash expenses, revenues, and losses included
in income:
Depreciation 120
Deferred taxes 5
Increase in accounts receivable (87)
Increase in inventories (47)
Increase in accounts payable 56
Increase in taxes payable 1
Gain on sale of equipment (20)
Cash flow from operating activities 228
Indirect Method
Net income $200
in income:
Depreciation 120
Deferred taxes 5

Accumulation Depreciation 120,000
The actual adjusting entry made:
Depreciation expense reduces net
income, but has no effect on cash.
Let’s restate the entry
by replacing depreciation.

Cash provided by operations 120,000
Accumulation Depreciation 120,000
The restated entry:
Examine Illustration 11-6 closely. Notice that entry (3)
matches the restated entry above.

Net income $200
in income:
Depreciation 120
Deferred taxes 5
Indirect Method
Net income $200
in income:
Depreciation 120
Deferred taxes 5

Inventories
Beginning balance 610,000
Purchases 2,337,000
Cost of sales 2,290,000
Ending balance 657,000
Beginning balance
in next period 657,000
Purchases = Cost of sales + (Ending
Balance - Beginning Balance)
Actual cash payments (assume all
purchases were cash purchases) $2,337,000
Cost of sales (based on units sold) 2,290,000
Excess of cash spent over amount recorded
as a cost on the income statement $ 47,000

Net income $200
in income:
Depreciation 120
Deferred taxes 5
Indirect Method
Net income $200
in income:
Depreciation 120
Deferred taxes 5

Cash 20,000
Equipment, at Cost 150,000
Gain on Disposal of Equipment 20,000
The journal entry made was:
Freeway Corporation sold equipment that originally cost
$150,000 for $20,000. The asset was fully depreciated at
the time of sale.
This gain increased
net income by $20,000.

Cash provided by investing
activities 20,000
Cash provided by operating
activities 20,000
The restated entry is:
The actual cash inflow should be treated as cash provided by
investing activities and the gain on disposal subtracted from
net income through reducing cash provided by operations (see
entry 6 in Illustration 11-6).

Suppose the equipment had a book value of $10,000 at the
time of sale, and the cash proceeds totaled $15,000.
Cash 15,000
Gain on Disposal of Equipment 5,000
The journal entry made was:

Suppose the equipment had a book value of $10,000 at the
time of sale, and the cash proceeds totaled $15,000.
Cash provided by investing
activities 15,000
Cash provided by operating
activities 5,000
The entry restated is:
Cash provided by investing activities increased $15,000 and
cash provided by operating activities decreased $5,000.

Acquisitions
and
Consolidated
Statements

Slide 12-1
If an investor company owns less than 20 percent of
an investee company’s common stock, and the stock’s
fair value is readily determinable, the investment is
reported using the fair value method.
Fair-Value Method

Fair-Value Method Slide 12-2
When a dividend is
received, the entire
amount is credited to
Dividend Revenues.
Cash 50,000
Dividend Revenues 50,000

Cost Method Slide 12-3
If an investor company owns less than 20 percent of
an investee company’s common stock, and the stock’s
fair value is not readily determinable, the investment
is reported at its cost.

Equity Method Slide 12-4
If the investing company owns less than
50 percent of the voting stock, but can
significantly influence the actions of the
investee, the investment is accounted for
by the equity method.

Merkle Company acquired 25 percent of the common stock of
Pentel Company on January 2, 1998, for $250,000.
Investments 250,000
Cash 250,000
Pentel’s net income for 1998 was $100,000.
Investments 25,000
Investment Revenue 25,000
25% of $100,000
Assume that
Merkle Company has
significant influence

During 1998, Merkle Company received $10,000 in dividends
from Pentel Company.
Cash 10,000
Investments 10,000
Note that the
dividend reduces
the Investments
account.

Over 50% consolidated statements
20-50% equity method
Less than 20% fair-value method
Consolidated Basis Slide 12-7
Amount of Ownership Method of Reporting
Corporation B

• The acquiring corporation issues only common stock
with rights identical to the majority of its outstanding
voting common stock in exchange for substantially all
of the voting common stock of the acquired company.
• Each combining company is autonomous and has not
been a subsidiary or division of another corporation
within the previous two years.
• The combination is effected in a single transaction or
is completed according to a specific plan within on
year.
Pooling Slide 12-8
If all of the following are met, pooling is required:
Keep going! There are
two more requirements.

• Following the combination the acquiring corporation
does not reacquire its voting common stock for a six-
month period other than for normal business purposes,
such as the issuance of shares under stock option
programs.
• The combined corporation does not intend to dispose
of a significant part of the assets of the combining
companies within two years after the combination.
Pooling Slide 12-9
If all of the following are met, pooling is required:

Pro-Forma Consolidated Balance Sheet Slide 12-
10
Pooling Purchase
Assets
Cash and marketable securities $ 7,000 $ 7,000
Accounts receivable 6,400 6,400
Inventories 8,200 8,200
Total current assets 21,600 21,600
Goodwill --- 1,500
Plant and equipment, net 13,400 14,500
Total assets $35,000 $37,600
Assets Section

Pro-Forma Consolidated Balance Sheet Slide 12-
11
Pooling Purchase
Liabilities and Shareholders’Equity
Accounts payable $ 7,700 $ 7,700
Other current liabilities 1,800 1,800
Total current liabilities 9,500 9,500
Long-term debt 9,800 9,800
Total liabilities 19,300 19,300
Common stock (par plus paid-in capital) 3,200 8,500
Retained earnings 12,500 9,800
Total shareholders’ equity 15,700 18,300
Total liabilities and shareholders’ equity $35,000 $37,600
Liabilities and Shareholders’ Equity Section

Accounting as a Pooling Slide 12-
12
There is a “marriage”
of the two entities.
The two balance
sheets simply are
added together at
book value to arrive
at a consolidated
balance sheet for the
surviving entity.

Accounting as a Purchase Slide 12-
13
First, B’s identifiable net assets
are revalued to their fair value.
Plant and equipment had a book value of $2.8
million, but a fair value of $3.9 million.
The consolidated plant and
equipment account shows
$14.5 million.

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