The document discusses several key accounting concepts related to financial statements including: 1) The revenue recognition principle which states revenue is recognized when earned through a four step process, not necessarily when cash is collected. 2) Basic inventory valuation methods including specific identification, FIFO, LIFO, and weighted average and how they affect ending inventory and cost of goods sold. 3) Calculation of earnings per share and how transactions like treasury stock purchases or stock splits can impact the number of shares outstanding and EPS.

1. SPECIALTOPICS
Analysis and Interpretation of Financial Statements

2. Explain the Revenue Recognition Principle and How It
Relates to Current and Future Sales and PurchaseTransactions
Revenue recognition principle: states that companies must recognize revenue in the period in
which it is earned, i.e., when a four-step process is completed. Remember, this may not necessarily
be when cash is collected.
1. There is credible evidence that an arrangement exists.
2. Goods have been delivered or services have been performed.
3. The selling price or fee to the buyer is fixed or can be reasonably determined.
4. There is reasonable assurance that the amount owed to the seller is collectible.
Accrual accounting also incorporates the matching principle (otherwise known as the expense
recognition principle), which instructs companies to record expenses related to revenue generation
in the period in which they are incurred.

3. Billie’s WatercraftWarehouse (BWW) sells various watercraft vehicles.They
extend a credit line to customers purchasing vehicles in bulk. A customer bought
10 Jet Skis on credit at a sales price of $100,000.The cost of the sale to BWW is
$70,000.
When the customer pays the amount owed, the following journal entry occurs.
Sales on Account

4. A customer of BWW purchases a canoe for $300, using aVisa credit card.The cost
to BWW for the canoe is $150.Visa charges BWW a service fee equal to 5% of the
sales price. At the time of sale, the following journal entries are recorded.
WhenVisa pays the amount owed to BWW, the following entry occurs in BWW’s
records.
Credit Card Sales

5. Alternatively, BWW could record the following at the time of a credit card sale.

6. Describe and Demonstrate the Basic InventoryValuation
Methods andTheir Cost Flow Assumptions
Accounting for inventory is a critical function of management. Inventory accounting is significantly
complicated by the fact that it is an ongoing process of constant change, in part because
(1) most companies offer a large variety of products for sale
(2) product purchases occur at irregular times
(3) products are acquired for differing prices
(4) inventory acquisitions are based on sales projections, which are always uncertain and often
sporadic

7. Remember how inventory affects the balance sheet and the income statement:
Financial Statement Effects of InventoryTransactions. (attribution: Copyright Rice University, OpenStax, under CC BY-NC-
SA 4.0 license)

8. Relationship between inventory purchases, goods available for sale, and cost of goods sold:
Fundamentals of Inventory Accounting. (attribution: Copyright Rice University, OpenStax, under CC BY-NC-SA 4.0 license)

9. Four Methods ofTracking Inventory Costs
For determining ending inventory account balance and COGS:
■ Specific identification: tracks the actual cost of the specific item being sold
– Generally used only on expensive items that are highly customized, such as cars or unique
gems.
■ First-in, first-out (FIFO): records costs relating to a sale as if the earliest purchased item would
be sold first. However, the physical flow of the units sold under both the periodic and perpetual
methods would be the same.
■ Last-in, first-out (LIFO): records costs relating to a sale as if the latest purchased item would
be sold first
■ Weighted average: requires a calculation of the average cost of all units of each particular
inventory item and records inventory costs based on that average

10. Calculate ending inventory in units and dollars and cost of goods sold under each of the four inventory
valuation methods (specific identification, FIFO, LIFO, and weighted average) using the perpetual
method of inventory tracking.
Company: Spy Who LovesYou Corporation
Product: Global Positioning System (GPS)Tracking Device
Information about purchases and sales are:

11. Assume that the company sold one specific identifiable unit, which was purchased in the second lot
of products, at a cost of $27.
First, notice that three separate lots of goods are purchased:
Specific Identification
Modified for PPT.
One of these units was sold.

12. If one unit is sold, then it will come from the first purchases, which are the oldest items.
One of these units is
assumed to be sold.
First-in, First-out (FIFO)
Modified for PPT.

13. If one unit is sold, then it will come from the last purchases, which are the newest items.
One of these units is
assumed to be sold.
Last-in, First-out (LIFO)
Modified for PPT.

14. Ending inventory value and cost of goods sold will be based on the average inventory value.
585Total Units
Weighted Average Method
Modified for PPT.

15. Compare the four inventory valuation methods.
Comparison of the Four Costing Methods. One unit sold for $36. (attribution: Copyright Rice University, OpenStax, under CC
BY-NC-SA 4.0 license)

16. Discuss the Applicability of Earnings per Share as a
Method to Measure Performance
Earnings per share
■ Earnings per share (EPS) measures the portion of a corporation’s profit allocated to each
outstanding share of common stock.
– Many financial analysts believe that EPS is the single most important tool in assessing a
stock’s market price.
■ A high or increasing earnings per share can drive up a stock price.
■ A falling earnings per share can lower a stock’s market price.
– EPS is also a component in calculating the price-to-earnings ratio (the market price of the
stock divided by its earnings per share), which many investors find to be a key indicator of the
value of a company’s stock.

17. Earnings per share is the profit a company earns for each of its outstanding common shares.
The denominator can fluctuate throughout the year as a company issues and buys back shares of
its own stock.The weighted average number of shares is used on the denominator because of this
fluctuation.

18. To illustrate the weighted average shares outstanding calculation, assume that a corporation
began the year with 600 shares of common stock outstanding and then onApril 1 issued 1,000
more shares. During the period January 1 to March 31, the company had the original 600 shares
outstanding. Once the new shares were issued, the company had the original 600 plus the new
1,000 shares, for a total of 1,600 shares for each of the next nine months—fromApril 1 to
December 31.To determine the weighted average shares, apply these fractional weights to both of
the stock amounts.
Weighted Shares. (attribution: Copyright Rice University, OpenStax, under CC BY-NC-SA 4.0 license)

19. Assume SanaronCompany earns $50,000 in net income during 2020. During the year, the company
also declared a $10,000 dividend on preferred stock and a $14,000 dividend on common stock.The
company had 5,000 common shares outstanding the entire year along with 2,000 preferred shares.
Sanaron has generated $8 of earnings ($50,000 less the $10,000 of preferred dividends) for each of
the 5,000 common shares of stock it has outstanding.
EPS Example
$50,000 $10,000
Earnings per share = = $8.00 per share
5,000


20. Assume that Ranadune Enterprises generated net income of $15,000 in 2020. In addition, 20,000
shares of common stock and no preferred stock were outstanding throughout 2020. On January 1,
2020, the company buys back 2,500 shares of its common stock and holds them as treasury shares.
Net income for 2020 stayed static at $15,000. Just before the repurchasing of the stock, the
company’s EPS is $0.75 per share:
The purchase of treasury stock in 2020 reduces the common shares outstanding to 17,500 because
treasury shares are considered issued but not outstanding (20,000 − 2,500). EPS for 2020 is now
$0.86 per share even though earnings remains the same.
Effect ofTreasury Stock Purchase on EPS
$15,000
Earnings per share = = $0.75 per share
20,000 shares
$15,000
Earnings per share = = $0.86 per share
17,500 shares

21. Actual Company Presentation of EPS on Income
Statement
Consolidated Statements of Income for Cracker Barrel. (attribution: Copyright Rice University, OpenStax, under CC BY-NC-
SA 4.0 license)

22. Treasury Stock
Sometimes a corporation decides to purchase its own stock in the market.These shares are
referred to as treasury stock.
Acquiring treasury stock:
■ Assume Duratech’s net income for the first year was $3,100,000, and that the company has
12,500 shares of common stock issued. During May, the company’s board of directors
authorizes the repurchase of 800 shares of the company’s own common stock as treasury
stock. Each share of the company’s common stock is selling for $25 on the open market on May
1, the date that Duratech purchases the stock. Duratech will pay the market price of the stock
at $25 per share times the 800 shares it purchased, for a total cost of $20,000.The following
journal entry is recorded for the purchase of the treasury stock under the cost method.

23. How treasury stock appears in the stockholders’ equity section.
Partial Stockholders’ Equity Section of the Balance Sheet for Duratech. After the purchase of treasury stock, the
stockholders’ equity section of the balance sheet is shown as a deduction from total stockholders’ equity. (attribution:
Copyright Rice University, OpenStax, under CC BY-NC-SA 4.0 license)

24. Stock Splits
■ A traditional stock split occurs when a company’s board of directors issue new shares to
existing shareholders in place of the old shares by increasing the number of shares and
reducing the par value of each share.
– For example, in a 2-for-1 stock split, two shares of stock are distributed for each share held by
a shareholder.
■ When a split occurs, the market value per share is reduced to balance the increase in the
number of outstanding shares.Although the number of outstanding shares and the price
change, the total market value remains constant.
■ A stock split is much like a large stock dividend in that both are large enough to cause a change
in the market price of the stock.
■ No journal entry is recorded for a stock split. Instead, the company prepares a memo entry in
its journal that indicates the nature of the stock split and the new par value.

25. Duratech’s board of directors declares a 4-for-1 common stock split on its $0.50 par value stock.
Just before the split, the company has 60,000 shares of common stock outstanding, and its stock
was selling at $24 per share.The split causes the number of shares outstanding to increase by four
times to 240,000 shares (4 × 60,000), and the par value to decline to one-fourth of its original value,
to $0.125 per share ($0.50 ÷ 4). No change occurs to the dollar amount of any general ledger
account.

26. The stockholders’ equity section of Duratech before and after the stock split:

27. Earnings Management
■ Earnings management works within GAAP constraints to improve stakeholders’ views of the
company’s financial position.
■ Earnings manipulation is noticeably different in that it typically ignores GAAP rules to alter
earnings significantly.Carried to an extreme, manipulation can lead to fraudulent behavior by a
company.