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Assignment Question(s):
30)
(Marks
Q1. How are the direct write-off method and the allowance method applied in
accounting
for
uncollectible
accounts
receivables? Explain
with
examples
(4 Marks)
Q2. Explain what is meant by depreciation
Describe the methods of depreciation and give a numerical example for each method
(7 Marks)
Q3 The following information is related to PQR company and XYZ company for the
year 2013:
Cash dividend declared and paid during the
year
Common stock
Number of shares of common stock
outstanding
Par value of a share
Market value of a share
PQR
Company
XYZ
Company
750,000
124,800
25,000,000
12,000,000
50,000
24,000
50
60
50
52
Both the companies belong to same industry. PQR is an old and well-established
company where as XYZ is a new company. The historical data shows that the
PQR has a stable annual dividend distribution to stockholders.
Required:
Calculate dividend yield ratio of both the companies. Which company would you
recommend for investment in shares? Explain with reasons.
(5 Marks)
Q4. A company’s income statement for 2021 showed the following:
Net income, SR150, 000;
depreciation expense, SR20,000

Changes in current assets and current liabilities:
Accounts receivable decreased SR20, 000
merchandise inventory increased 8,000
accounts payable increased 3,000.
Required: Prepare the operating activity section of the statement of cash flow
using the indirect method.
(5 Marks)
Q5. Why does the management of any companies analyze financial statements?
Explain by using the different tools in analyzing financial statement with proper
numerical example?
(5 Marks)
Q6. a) Explain the methods that can estimate bad debt expenses in business. (Give
numerical examples)
(1 Mark)
b.) Differentiate between Accounts receivable and Notes receivable.
(1 Mark)
c) On 1st of October 2019, XYZ Inc. has sold an equipment for SAR 25,000 to ABC
Ltd.by issuing an 8% note receivable for 90 days. Calculate the interest on the note
and on what would be the maturity date. Pass Journal entry in the books of the
company to record these transactions. (2 Marks)
Financial Accounting
John J. Wild
Sixth Edition
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 01
Introducing Accounting in
Business
Conceptual Chapter Objectives
C1: Explain the purpose and importance of
accounting.
C2: Identify users and uses of accounting.
C3: Explain why ethics are crucial to
accounting.
C4: Explain generally accepted accounting
principles and define and apply
several accounting principles.
C5: Appendix 1B – Identify and describe the
three major activities of organizations.
1-3
Analytical Chapter Objectives
A1: Define and interpret the accounting
equation and each of its components.
A2: Compute and interpret return on assets.
A3: Appendix 1A – Explain the relation
between return and risk.
1-4
Procedural Chapter Objectives
P1: Analyze business transactions using
the accounting equation.
P2: Identify and prepare basic financial
statements and explain how they
interrelate.
1-5
C1
Importance of Accounting
is a
Accounting
system that
Identifies
Records
information
Relevant
that is
Communicates
Reliable
Comparable
about an
organization’s
business activities.
1-6
C1
Accounting Activities
 Identifying
Business
Activities
 Recording
Business
Activities
ï‚Ž
Communicating
Business
Activities
1-7
Users of Accounting
Information
C2
Internal Users
External Users
•Lenders
•Consumer Groups
•Managers
•Sales Staff
•Shareholders •External Auditors
•Officers
•Budget Officers
•Governments •Customers
•Internal Auditors •Controllers
1-8
C2
Users of Accounting
Information
External Users
Internal Users
Financial accounting provides
external users (shareholders,
lenders, etc.) with financial
statements.
Managerial accounting provides
information needs for internal
decision makers (officers,
managers, etc.).
1-9
C2
Opportunities in Accounting
Financial
•Preparation
•Analysis
•Auditing
•Regulatory
•Consulting
•Planning
•Criminal
investigation
Accountingrelated
Managerial
Taxation
•General accounting
•Cost accounting
•Budgeting
•Internal auditing
•Consulting
•Controller
•Treasurer
•Strategy
•Preparation
•Planning
•Regulatory
•Investigations
•Consulting
•Enforcement
•Legal services
•Estate plans
•Lenders
•Consultants
•Analysts
•Traders
•Directors
•Underwriters
•Planners
•Appraisers
•FBI investigators
•Market researchers
•Systems designers
•Merger services
•Business valuation
•Forensic accountant
•Litigation support
•Entrepreneurs
1-10
C2
Accounting Jobs by Area
Private
accounting
60%
Public
accounting
24%
Government,
not-for-profit,
& education
16%
1-11
C3
Ethics—A Key Concept
Ethics
Beliefs that
distinguish
right from
wrong
Accepted
standards of
good and bad
behavior
1-12
C3
Guidelines for Ethical Decisions
 Identify
ethical concerns
 Analyze
options
Use personal Consider all good
ethics to
and bad
recognize an
consequences.
ethical concern.
ï‚Ž Make ethical
decision
Choose best
option after
weighing all
consequences.
1-13
C4
Generally Accepted Accounting
Principles
Financial accounting practice is governed by
concepts and rules known as generally accepted
accounting principles (GAAP).
Relevant
Information
Affects the decision of
its users.
Reliable Information
Is trusted by
users.
Comparable
Information
Used in comparisons
across years & companies.
1-14
C4
Setting Accounting Principles
In the United States, the Securities and Exchange
Commission, a government agency, has the legal authority
to establish reporting requirements and set GAAP for
companies that issue stock to the public.
The Financial Accounting
Standards Board is the private
group that sets both broad and
specific principles.
The International Accounting Standards Board (IASB) issues international standards that identify preferred accounting practices
in other countries. More than 100 countries now require or permit
companies to prepare financial reports following IFRS.
1-15
C4
Principles and Assumptions
of Accounting
Measurement principle (also called
cost principle) means that accounting
information is based on actual cost.
Going-concern assumption means
that accounting information reflects a
presumption the business will
continue operating.
Revenue recognition principle
provides guidance on when a
company must recognize revenue.
Monetary unit assumption means we
can express transactions in money.
Matching principle (expense
recognition) prescribes that a
company must record its expenses
incurred to generate the revenue.
Time period assumption presumes
that the life of a company can be
divided into time periods, such as
months and years.
Full disclosure principle requires a
company to report the details behind
financial statements that would impact
users’ decisions.
Business entity assumption means
that a business is accounted for
separately from its owner or other
business entities.
1-16
C4
Business Entity Forms
Sole
Proprietorship
Partnership
Corporation
1-17
C4
Sarbanes-Oxley Act
In response to a number of publicized accounting
scandals (Enron, WorldCom, Tyco, ImClone),
Congress passed the Sarbanes-Oxley Act (also
called SOX) in 2002 to help curb financial abuses
at companies that issue their stock to the public.
The act requires that public companies apply
both accounting oversight and stringent internal
controls. The desired results include more
transparency, accountability, and truthfulness in
reporting transactions.
1-18
A1
Accounting Equation
Assets
=
Liabilities
Assets
+
Equity
Liabilities
+ Equity
1-19
Assets
A1
Cash
Accounts
Receivable
Vehicles
Store
Supplies
Resources
owned or
controlled
by a
company
Notes
Receivable
Land
Buildings
Equipment
1-20
A1
Liabilities
Accounts
Payable
Notes
Payable
Creditors’
claims on
assets
Taxes
Payable
Wages
Payable
1-21
A1
Equity
Retained
Earnings
Contributed
Capital
Owner’s
claim on
assets
Dividends
1-22
A1
Expanded Accounting Equation
Assets
Assets
Contributed
Capital
=
=
_
Liabilities
Liabilities
Dividends
+
+
+
Equity
Equity
_
Revenues
Expenses
Retained Earnings
1-23
P1
Transaction Analysis
Business activities can be described in terms of
transactions and events. External transactions
are exchanges of value between two entities,
which yield changes in the accounting equation.
Internal transactions are exchanges within any
entity; they can also affect the accounting
equation. Events refer to happenings that affect
an entity’s accounting equation and can be
reliably measured. Transaction analysis is
defined as the process used to analyze
transactions and events.
1-24
P1
Transaction Analysis
J. Scott invests $20,000 cash to start the
business in return for stock.
Assets
=
Cash
Supplies Equipment
(1) $ 20,000
$ 20,000 $

$ 20,000
$

Liabilities
Accounts
Notes
Payable Payable
$
=

$

$
20,000
+
Equity
Common
Stock
$ 20,000
$ 20,000
1-25
P1
Transaction Analysis
Purchased supplies paying $1,000 cash.
Assets
=
Cash
Supplies Equipment
(1) $ 20,000
(2)
(1,000) $ 1,000
$ 19,000 $ 1,000 $
$ 20,000

Liabilities
Accounts
Notes
Payable Payable
$
=

$

$
20,000
+
Equity
Common
Stock
$ 20,000
$ 20,000
1-26
P1
Transaction Analysis
Purchased equipment for $15,000 cash.
Assets
=
Cash
Supplies Equipment
(1) $ 20,000
(2)
(1,000) $ 1,000
(3)
(15,000)
$ 15,000
$
4,000 $ 1,000 $
$ 20,000
15,000
Liabilities
Accounts
Notes
Payable Payable
$
=

$

$
20,000
+
Equity
Common
Stock
$ 20,000
$ 20,000
1-27
P1
Transaction Analysis
Purchased Supplies of $200 and
Equipment of $1,000 on account.
Assets
(1)
(2)
(3)
(4)
=
Cash
Supplies Equipment
$ 20,000
(1,000) $ 1,000
(15,000)
$ 15,000
200
1,000
$
4,000 $ 1,200 $
$ 21,200
Liabilities
Accounts
Notes
Payable Payable
+
Equity
Common
Stock
$ 20,000
$ 1,200
16,000
$ 1,200 $
=
$

$ 20,000
21,200
1-28
P1
Transaction Analysis
Borrowed $4,000 from 1st American Bank.
Assets
(1)
(2)
(3)
(4)
(5)
=
Cash
Supplies Equipment
$ 20,000
(1,000) $ 1,000
(15,000)
$ 15,000
200
1,000
4,000
$ 8,000 $ 1,200 $ 16,000
$ 25,200
Liabilities
Accounts
Notes
Payable Payable
+
Equity
Common
Stock
$ 20,000
$ 1,200
=
$
$ 1,200 $
4,000
4,000
$
25,200
$ 20,000
1-29
P1
Transaction Analysis
The balances so far appear below. Note that the
Balance Sheet Equation is still in balance.
Assets
=
Cash
Supplies Equipment
Bal. $ 8,000 $ 1,200 $ 16,000
$ 8,000 $
1,200 $
$ 25,200
16,000
=
Liabilities
+
Equity
Accounts Notes
Payable Payable
$ 1,200 $ 4,000
Common
Stock
$ 20,000
$
$ 20,000
1,200 $
4,000
$ 25,200
1-30
P1
Transaction Analysis
Now, let’s look at transactions
involving revenue, expenses, and
dividends.
1-31
P1
Transaction Analysis
Provided consulting services receiving
$3,000 cash.
Assets
=
Cash
Supplies Equipment
Bal. $ 8,000 $ 1,200 $ 16,000
(6)
3,000
$ 11,000 $
1,200 $
$ 28,200
16,000
=
Liabilities
+
Equity
Accounts Notes
Payable Payable
$ 1,200 $ 4,000
Common
Stock
Revenue
$ 20,000
$ 3,000
$ 1,200 $ 4,000
$ 20,000 $ 3,000
$ 28,200
1-32
P1
Transaction Analysis
Paid salaries of $800 to employees.
Assets
=
Cash
Supplies Equipment
Bal. $ 8,000 $ 1,200 $ 16,000
(6)
3,000
(7)
(800)
$ 10,200 $
1,200 $
$ 27,400
16,000
=
Liabilities
+
Equity
Accounts Notes
Payable Payable
$ 1,200 $ 4,000
Common
Stock
Revenue Expenses
$ 20,000
$ 3,000
$
(800)
$ 1,200 $
$ 20,000 $ 3,000 $
4,000
(800)
$ 27,400
Remember that expenses decrease equity.
1-33
P1
Transaction Analysis
Dividends of $500 are paid to shareholders.
Assets
=
Accounts Notes
Payable Payable
$ 1,200 $ 4,000
Cash
Supplies Equipment
Bal. $ 8,000 $ 1,200 $ 16,000
(6)
3,000
(7)
(800)
(8)
(500)
$ 9,700 $ 1,200 $ 16,000
$ 26,900
Liabilities
$ 1,200 $
=
4,000
+
Equity
Common
Stock
Dividends Revenue Expenses
$ 20,000
$ 3,000
$
(800)
$
(500)
$ 20,000 $
(500) $ 3,000 $
(800)
$ 26,900
Remember that dividends decrease equity.
1-34
P2
Financial Statements
Let’s prepare the Financial Statements
reflecting the transactions we have
recorded.
1. Income Statement
2. Statement of Retained Earnings
3. Balance Sheet
4. Statement of Cash Flows
1-35
P2
Income Statement
SCOTT COMPANY
Income Statement
For Month Ended December 31, 2011
Revenues:
Consulting revenue
Expenses:
Salaries expense
Net income
$
3,000
$
800
2,200
Net income is the
difference
between
Revenues and
Expenses.
The income statement describes a
company’s revenues and expenses along
with the resulting net income or loss over a
period of time due to earnings activities.
1-36
P2
Statement of Retained Earnings
SCOTT COMPANY
Income Statement
For Month Ended December 31, 2011
Revenues:
Consulting revenue
Expenses:
Salaries expense
Net income
$
3,000
$
800
2,200
The net income of
$2,200 increases
Retained Earnings by
$2,200.
SCOTT COMPANY
Statement of Retained Earnings
For Month Ended December 31, 2011
Retained Earnings, Dec. 1, 2011 $
Plus: Net income
Less: Dividends
Retained Earnings, Dec. 31, 2011 $
2,200
500
1,700
1-37
P2
Balance Sheet
The Balance Sheet describes
a company’s financial position
at a point in time.
SCOTT COMPANY
Statement of Retained Earnings
For Month Ended December 31, 2011
Retained Earnings, Dec. 1, 2011
Plus: Net income
Less: Dividends
SCOTT COMPANY
Retained Earnings, Dec. 31, 2011
Balance Sheet
December 31, 2011
Assets
$
Cash
Supplies
Equipment
Total assets
$
9,700
1,200
16,000
26,900
Liabilities
Accounts payable
Notes payable
Total liabilities
Equity
Common stock
Retained earnings
Total liabilities and equity
$
$
$
2,200
500
1,700
1,200
4,000
5,200
20,000
1,700
$
26,900
1-38
P2
Statement of Cash Flows
SCOTT COMPANY
Statement of Cash Flows
For Month Ended December 31, 2011
Cash flows from operating activities:
Cash received from clients
$ 3,000
Purchase of supplies
(1,000)
Cash paid to employees
(800)
Net cash provided by operating activities
Cash flows from investing activities:
Purchase of equipment
(15,000)
Net cash used in investing activities
Cash flows from financing activities:
Investment by Shareholders
20,000
Borrowed at bank
4,000
Dividends Paid
(500)
Net cash provided by financing activities
Net increase in cash
Cash balance, December 1, 2011
Cash balance, December 31, 2011
$
1,200
(15,000)
$
$
23,500
9,700
9,700
1-39
A2
Return on Assets (ROA)
Return
on
assets
Net income
=
Average total assets
ROA is a profitability
measure.
1-40
End of Chapter 01
1-41
Financial Accounting
John J. Wild
Sixth Edition
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 02
Analyzing and Recording
Transactions
Conceptual Learning Objectives
C1: Explain the steps in processing
transactions.
C2: Describe an account and its use in
recording transactions.
C3: Describe a ledger and a chart of accounts.
C4: Define debits and credits and explain
double-entry accounting.
2-3
Analytical Learning Objectives
A1: Analyze the impact of transactions
on accounts and financial statements.
A2: Compute the debt ratio and describe
its use in analyzing financial
condition.
2-4
Procedural Learning Objectives
P1: Record transactions in a journal and
post entries to a ledger.
P2: Prepare and explain the use of a trial
balance.
P3: Prepare financial statements from
business transactions.
2-5
C1
Analyzing and Recording
Process
Exchanges of economic consideration
between two parties.
External Transactions
occur between the
organization and an
outside party.
Internal Transactions
occur within the
organization.
2-6
C1
Analyzing and Recording
Process
Analyze each transaction and
event from source documents
Prepare and analyze
the trial balance
Record relevant transactions
and events in a journal
Post journal
information
to ledger
accounts
2-7
C1
Source Documents
Checks
Employee
Earnings
Records
Bills from
Suppliers
Purchase
Orders
Bank
Statements
Sales
Tickets
2-8
C2
The Account and its Analysis
An account is a
record of
increases and
decreases in a
specific asset,
liability, equity,
revenue, or
expense item.
The general
ledger is a record
containing all
accounts used by
the company.
2-9
C2
The Account and Its Analysis
Assets
Assets
Asset
Accounts
Accounts
Accounts
=
Liability
Liability
Liability
Accounts
Accounts
Accounts
+
Equity
Equity
Equity
Accounts
Accounts
Accounts
2-10
C3
Asset Accounts
Cash
Land
Buildings
Asset
Accounts
Accounts
Receivable
Notes
Receivable
Prepaid
Accounts
Equipment
Supplies
2-11
C3
Liability Accounts
Accounts
Payable
Notes
Payable
Liability
Accounts
Accrued
Liabilities
Unearned
Revenue
2-12
C3
Equity Accounts
Retained
Earnings
Common
Stock
Dividends
Equity
Accounts
Revenues
Expenses
2-13
C3
The Account and Its Analysis
Assets
+
Common
Stock
=
Liabilities
+
Equity
–
+
–
Dividends
Revenues
Expenses
2-14
C3
Ledger and Chart of Accounts
The ledger is a collection of all accounts for
an information system. A company’s size and
diversity of operations affect the number
of accounts needed.
The chart of accounts is a list of all accounts and
includes an identifying number for each account.
101
106
126
128
167
201
236
307
318
Cash
Accounts receivable
Supplies
Prepaid insurance
Equipment
Accounts payable
Unearned revenue
Common stock
Retained earnings
319
403
406
622
637
640
652
690
Dividends
Consulting revenues
Rental revenue
Salaries expense
Insurance expense
Rent expense
Supplies expense
Utilities expense
2-15
C4
Debits and Credits
A T-account represents a ledger account
and is a tool used to understand the effects
of one or more transactions.
T- Account
(Left side)
(Right side)
Debit
Credit
2-16
C4
Double-Entry Accounting
Assets
ASSETS
Debit
+
Credit

= Liabilities +
Equity
LIABILITIES
EQUITIES
Debit

Credit
+
Debit

Credit
+
2-17
Double-Entry Accounting
C4
Equity
Common
Stock
_
Dividends
+
_
Revenues
Expenses
Stock
Dividends
Revenues
Expenses
Debit Credit
Debit Credit
Debit Credit
Debit Credit

+
+


+
+

2-18
C4
Double-Entry Accounting
An account balance is the difference between the
increases and decreases in an account.
Notice the T-Account
Cash
Investment by owner for stock
Consulting services revenues earned
Collection of accounts receivable
Total increases
Balance
30,000 Purchase of supplies
4,200 Purchase of equipment
1,900 Payment of rent
Payment of salary
Payment of accounts payable
Payment of cash dividend
36,100 Total decreases
4,800
2,500
26,000
1,000
700
900
200
31,300
2-19
Journalizing and
Posting Transactions
P1
Assets
= Liabilities +
Equity
T- Account
(Left side)
(Right side)
Debit
Credit
Step 1: Analyze
transactions and source
documents.
ACCOUNT NAME:
Date
Step 2: Apply doubleentry accounting
GENERAL JOURNAL
ACCOUNT No.
Description
PR
Debit
Credit
Balance
Step 4: Post entry to ledger
Date
Description
Post.
Ref.
Page
123
Debit
Credit
Step 3: Record journal entry
2-20
P1
Journalizing Transactions
ï‚ŒTransaction
Date
Titles of Affected
Accounts
GENERAL JOURNAL
Date
Account Titles and Explanations PR
2011
Dec. 1 Cash
Common stock
Investment by shareholders
Dec. 2 Transaction
Supplies
explanation
Cash
Page 1
Debit
Credit
30,000
30,000
ï‚ŽDollar amount of debits
2,500
and credits
2,500
2-21
P1
Balance Column Account
T-accounts are useful illustrations, but
balance column accounts are used in
practice.
CASH
Date
ACCOUNT No. 101
Explanation
PR
Debit
Credit
Balance
2,500
26,000
30,000
27,500
1,500
5,700
2011
Dec. 1
Dec. 2
Dec. 3
Dec. 10
Initial investment
Purchased supplies
Purchased equipment
Collection from customer
30,000
4,200
2-22
P1
Posting Journal Entries
GENERAL JOURNAL
Date
Account Titles and Explanation
2011
Dec. 1 Cash
Common stock
Investment by shareholders
Page 1
PR
30,000
CASH
Explanation
PR
Credit
30,000
Dec. 2 Supplies
Cash
1 Identify the
debit account in ledger.
Purchased store supplies
for cash
Date
Debit
Debit
2,500
2,500
ACCOUNT No.
Credit
101
Balance
2011
Dec. 3
Purchased equipment
G1
20,000.00
######## 2-23
P1
Posting Journal Entries
GENERAL JOURNAL
Date
Account Titles and Explanation
2011
Dec. 1 Cash
Common stock
Investment by shareholders
Page 1
PR
Explanation
Credit
30,000
30,000
Dec. 2 Supplies
2
Enter
the date.
Cash
Purchased store supplies
CASH for cash
Date
Debit
2,500
2,500
ACCOUNT No.
PR
Debit
Credit
101
Balance
2011
Dec. 1
Dec. 3
Purchased equipment
G1
20,000.00
######## 2-24
P1
Posting Journal Entries
GENERAL JOURNAL
Page 1
Date
Account Titles & Elxplanations
PR
2011
Dec. 1 Cash
Common stock
Investment by shareholders
Dec. 2 Supplies
3 Enter the
amount and description.
Cash
Purchased store supplies
CASH for cash
Date
Explanation
PR
Debit
Credit
30,000
30,000
2,500
2,500
ACCOUNT No.
Debit
101
Credit
Balance
20,000
(20,000) 2-25
2011
30,000
Dec. 1
Dec. 3
Purchased equipment
G1
P1
Posting Journal Entries
GENERAL JOURNAL
Page 1
Date
Account Titles and Explanation
PR
2011
Dec. 1 Cash
Common stock
Investment by shareholders
Dec.
2 Supplies
the journal reference.
4 Enter
Cash
Purchased store supplies
CASH for cash
Date
Explanation
Debit
Credit
30,000
30,000
2,500
2,500
ACCOUNT No.
PR
Debit
G1
30,000
Credit
101
Balance
2011
Dec. 1
2-26
P1
Posting Journal Entries
GENERAL JOURNAL
Date
Account Titles & Elxplanations
2011
Dec. 1 Cash
Common stock
Investment by shareholders
Page 1
PR
Debit
30,000
30,000
Dec.
2 Supplies
Compute the balance.
Cash
Purchased store supplies
CASH for cash
2,500
5
Date
Explanation
Credit
2,500
ACCOUNT No.
PR
Debit
G1
30,000
Credit
101
Balance
2011
Dec. 1
Dec. 3
Purchased equipment
G1
30,000
20,000
(20,000) 2-27
P1
Posting Journal Entries
GENERAL JOURNAL
Date
Account Titles and Explanation
2011
Dec. 1 Cash
Common stock
Investment by shareholders
Page 1
PR
Debit
101
2 Supplies
Enter Cash
the ledger reference.
Purchased store supplies
CASH for cash
2,500
6
Explanation
30,000
30,000
Dec.
Date
Credit
2,500
ACCOUNT No.
PR
Debit
G1
30,000
Credit
101
Balance
2011
Dec. 1
Dec. 3
Purchased equipment
G1
30,000
20,000
(20,000) 2-28
A1
Analyzing Transactions
Shareholder invested $30,000 in FastForward on Dec.
1.
Transaction:
Analysis:
Assets
=
Liabilities
Cash
30,000
+
Equity
Common
Stock
30,000
Double entry:
(1)
Cash
101
301
Common stock
30,000
30,000
Posting:
(1)
Cash
30,000
101
Common Stock
(1)
301
30,000
2-29
A1
Analyzing Transactions
Transaction:
FastForward purchases supplies by paying $2,500
cash.
Analysis:
Cash
Assets
Supplies
(2,500)
2,500
=
Liabilities
+
Equity
Common
Stock
Double entry:
(2)
Supplies
Cash
126
101
2,500
2,500
Posting:
(2)
Supplies
2,500
126
(1)
Cash
30,000
101
(2)
2,500
2-30
Analyzing Transactions
A1
Transaction:
FastForward purchases equipment by paying $26,000
cash.
Analysis:
Assets
Cash Equipment
(26,000)
=
Liabilities
+
Equity
Common
Stock
26,000
Double entry:
(3)
Equipment
Cash
167
101
26,000
26,000
Posting:
(3)
Equipment
26,000
167
(1)
Cash
30,000
101
(2)
(3)
2,500
26,000
2-31
A1
Analyzing Transactions
Transaction:
FastForward purchases $7,100 of supplies on credit.
Analysis:
Assets
=
Supplies
Liabilities
Accounts Payable
7,100
7,100
+
Equity
Common
Stock
Double entry:
(4)
Supplies
Accounts payable
126
201
7,100
7,100
Posting:
(2)
(4)
Supplies
26,000
7,100
126
Accounts Payable
(4)
201
7,100
2-32
A1
Analyzing Transactions
Transaction:
FastForward provides consulting services and
immediately collects $4,200 cash.
Analysis:
Assets
=
+
Liabilities
Cash
4,200
Equity
Revenue
4,200
Double entry:
(5)
Cash
101
403
Consulting Revenue
4,200
4,200
Posting:
403
Consulting Revenue
(5)
4,200
(1)
(5)
Cash
30,000
4,200
101
(2)
(3)
2,500
26,000
2-33
P2
Trial Balance
FastFoward
Trial Balance
December 31, 2011
Cash
Accounts receivable
Supplies
Prepaid Insurance
Equipment
Accounts payable
Unearned consulting revenue
Common stock
Dividends
Consulting revenue
Rental revenue
Salaries expense
Rent expense
Utilities expense
Total
Debits
$ 4,350
9,720
2,400
26,000
Credits
$
6,200
3,000
30,000
200
5,800
300
1,400
1,000
230
$ 45,300 $ 45,300
After processing its
remaining transactions
for December,
FastForward’s trial
balance is prepared.
The trial balance lists
all account balances in
the general ledger. If
the books are in
balance, the total
debits will equal the
total credits.
2-34
P2
Six Steps for Searching for
and Correcting Errors
If the trial balance does not balance, the
error(s) must be found and corrected.
ï‚ŒVerify that the trial balance
columns are correctly added.
Recompute each account
balance in the ledger.
Verify that account balances
are correctly entered from the
ledger.
Verify that each journal
entry is properly posted.
ï‚ŽSee whether a debit (or
credit) balance is mistakenly
listed as a credit (or debit).
ï‚‘Verify that each original
journal entry has equal
debits and credits.
2-35
P3
Using a Trial Balance to
Prepare Financial Statements
Point in
Time
Period of Time
Point in
Time
Income Statement
Statement of Retained Earnings
Beginning
Balance
Sheet
Statement of Cash
Flows
Ending
Balance
Sheet
2-36
P3
Income Statement
FASTFORWARD
Income Statement
For the Month Ended December 31, 2011
Revenues:
Consulting revenue
$ 5,800
Rental revenue
300
Total revenues
$ 6,100
Expenses:
Salaries expense
1,400
Rent expense
1,000
Utilities expense
230
Total expenses
2,630
Net income
$ 3,470
2-37
P3
Statement of Retained Earnings
FASTFORWARD
Statement of Retained Earnings
For the Month Ended December 31, 2011
Balance, 12/1/11
$
Net income for December
3,470
3,470
Less: Dividends
(200)
Balance, 12/31/11
$
3,270
FASTFORWARD
Income Statement
For the Month Ended December 31, 2011
Revenues:
Consulting revenue
$
5,800
Rental revenue
300
Total revenues
$
6,100
Expenses:
Rent expense
1,000
Salaries expense
1,400
Utilities expense
230
Total expenses
2,630
Net income
$
3,470
2-38
P3
Balance Sheet
FASTFORWARD
Statement of Retained Earnings
For the Month Ended December 31, 2011
Balance, 12/1/11
$
Net income for December
3,470
3,470
Less: Dividends
200
Balance, 12/31/11
$
3,270
FASTFORWARD
Balance Sheet
December 31, 2011
Assets
Cash
Supplies
Prepaid insurance
Equipment
Total assets
Liabilities
Accounts payable
Unearned revenue
Total liabilities
Equity
Common stock
Retained earnings
Total equity
Total liabilities and equity
$ 4,350
9,720
2,400
26,000
$ 42,470
$ 6,200
3,000
9,200
30,000
3,270
33,270
$ 42,470
2-39
A2
Debt Ratio
o
Describes the relationship between the
amounts of the company’s liabilities
and assets.
Total Liabilities
Debt Ratio =
Total Assets
o
Helps to assess the risk that a
company will fail to pay its debts.
2-40
End of Chapter 02
2-41
Financial Accounting
John J. Wild
Sixth Edition
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 03
Adjusting Accounts and Preparing
Financial Statements
Conceptual Chapter Objectives
C1: Explain the importance of periodic
reporting and the time period
assumption.
C2: Explain accrual accounting and how
it improves financial statements.
C3: Identify steps in the accounting cycle.
C4: Explain and prepare a classified
balance sheet.
3-3
Analytical Chapter Objectives
A1: Explain how accounting adjustments
link to financial statements.
A2: Compute profit margin and describe
its use in analyzing company
performance.
A3: Compute the current ratio and
describe what it reveals about a
company’s financial condition.
3-4
Procedural Chapter Objectives
P1: Prepare and explain adjusting
entries.
P2: Explain and prepare an adjusted trial
balance.
P3: Prepare financial statements from an
adjusted trial balance.
P4: Describe and prepare closing entries.
P5: Explain and prepare a post-closing
trial balance.
3-5
Procedural Chapter Objectives
(Continued)
P6: Appendix 3A – Explain the
alternatives in accounting for
prepaids (see text for details).
P7: Appendix 3B – Prepare a work sheet
and explain its usefulness (see text
for details).
P8: Appendix 3C – Prepare reversing
entries and explain their purpose
(see text for details).
3-6
C1
The Accounting Period
Annually
1
2
Semiannually
1
2
3
4
Quarterly
1
2
3
4
Jan
Feb
Mar
Apr
5
6
7
May Jun Jul
8
9
10
Aug Sep Oct
11
12
Nov Dec
Monthly
3-7
C1
Accrual Basis vs. Cash Basis
Accrual Basis
Cash Basis
Revenues are
recognized when
earned and expenses
are recognized when
incurred.
Revenues are
recognized when
cash is received and
expenses recorded
when cash is paid.
Not GAAP
Accounting
3-8
Accrual Basis vs. Cash Basis
C1
Example:
FastForward paid $2,400 for a 24-month insurance
policy beginning December 1, 2011.
On the cash basis the
entire $2,400 would be
recognized as insurance
expense in 2011. No
insurance expense from
this policy would be
recognized in 2012 or
2013, periods covered by
the policy.
Insurance Expense 2011
Jan
Feb
Mar
Apr
$
May
$
Jun
$
Jul
$
Aug
$
Sep
$
Oct
$
Nov
$
Dec
$

$

$

$ 2,400
3-9
Accrual Basis vs. Cash Basis
C2
Jan
Insurance Expense 2011
Feb
Mar
Apr
$
May
$
Jun
$
Jul
$
Aug
$
Sep
$
Oct
$
Nov
$
Dec
$

$

$

$
100
Insurance Expense 2012
Jan
Feb
Mar
Apr
$
100
May
$
100
Jun
$
100
Jul
$
100
Aug
$
100
Sep
$
100
Oct
$
100
Nov
$
100
Dec
$
100
$
100
$
100
$
100
Insurance Expense 2013
Jan
Feb
Mar
Apr
$
100
May
$
100
Jun
$
100
Jul
$
100
Aug
$
100
Sep
$
100
Oct
$
100
Nov
$
100
Dec
$
100
$
100
$
100
$

On the accrual basis
$100 of insurance
expense is recognized in
2011, $1,200 in 2012,
and $1,100 in 2013. The
expense is matched with
the periods benefited by
the insurance coverage.
3-10
C2, P1
Adjusting Accounts
An adjusting entry is recorded to bring an asset or
liability account balance to its proper amount.
Framework for Adjustments
Adjustments
Paid (or received) cash before
expense (or revenue) recognized
Prepaid
(Deferred)
expenses*
Unearned
(Deferred)
revenues
Paid (or received) cash after
expense (or revenue) recognized
Accrued
expenses
Accrued
revenues
*including depreciation
3-11
P1
Prepaid (Deferred) Expenses
Resources paid
for prior to
receiving the
actual benefits.
Asset
Unadjusted
Balance
Credit
Adjustment
Here is the check
for my first
6 months’ insurance.
Expense
Debit
Adjustment
3-12
P1
Supplies
During 2011, Scott Company purchased $15,500
of supplies. Scott recorded the expenditures as
Supplies. On December 31, a count of the supplies
indicated $2,655 on hand.
What adjustment is required?
Dec. 31 Supplies Expense
Supplies
12,845
12,845
To record supplies used during 2011
126
Supplies
Bought 15,500 Dec. 31 12,845
Bal.
2,655
Supplies Expense
Dec. 31 12,845
652
3-13
P1
Depreciation
Depreciation is the process of allocating
the costs of plant assets over their
expected useful lives.
Straight-Line
Asset Cost – Salvage Value
Depreciation =
Useful Life
Expense
3-14
P1
Depreciation
On January 1, 2011, Barton, Inc. purchased
equipment for $62,000 cash. The equipment has
an estimated useful life of 5 years and Barton
expects to sell the equipment at the end of its life
for $2,000 cash.
Let’s record depreciation expense for the year
ended December 31, 2011.
2011
$62,000 – $2,000
Depreciation =
=
Expense
5
$12,000
3-15
P1
Depreciation
On January 1, 2011, Barton, Inc. purchased
equipment for $62,000 cash. The equipment has
an estimated useful life of 5 years and Barton
expects to sell the equipment at the end of its life
for $2,000 cash.
Let’s record depreciation expense for the year
ended December 31, 2011.
Dec. 31 Depreciation Expense
Accumulated Depreciation – Equipment
12,000
12,000
To record equipment depreciation
Accumulated depreciation is
a contra asset account.
3-16
Depreciation
P1
BARTON, INC.
Partial Balance Sheet
At December 31, 2011
$
Assets
Cash
.
Equipment
Less: accumulated deprec.
.
.
Total Assets
$ 62,000
(12,000)
50,000
Equipment is
shown net of
accumulated
depreciation.
This amount is
referred to as
the asset’s book
value.
3-17
P1
Unearned (Deferred) Revenues
Cash received in
advance of
providing
products or
services.
Liability
Debit
Adjustment
Unadjusted
Balance
Buy your season tickets for
all home basketball games NOW!
“Go Big Blue”
Revenue
Credit
Adjustment
3-18
P1
Unearned (Deferred) Revenues
On October 1, 2011, Ox University sold
1,000 season tickets to its 20 home
basketball games for $100 each. Ox
University makes the following entry:
Oct. 1
Cash
100,000
Unearned Revenue
100,000
Basketball revenue received in advance
Unearned Revenue
Oct.1 100,000
3-19
P1
Unearned (Deferred) Revenues
On December 31, Ox University has played
10 of its regular home games, winning 2 and
losing 8.
Dec. 31 Unearned Revenue
50,000
Basketball Revenue
50,000
To recognize 10-games of revenue
Unearned Revenue
Dec. 31 50,000 Oct. 1 100,000
Bal.
50,000
Basketball Revenue
Dec. 31 50,000
3-20
P1
Accrued Expenses
Costs incurred in a
period that are
both unpaid and
unrecorded.
Expense
Debit
Adjustment
We’re about one-half
done with this job and
want to be paid for
our work!
Liability
Credit
Adjustment
3-21
P1
Accrued Expenses
Barton, Inc. pays its employees every Friday. Year-end,
12/31/11, falls on a Thursday. As of 12/31/11, the
employees have earned salaries of $47,250 for Monday
through Thursday.
Last pay
date
12/25/11
12/1/11
Next pay
date
12/31/11
Year-end
Record adjusting
journal entry.
3-22
P1
Accrued Expenses
Barton, Inc. pays its employees every Friday. Year-end,
12/31/11, falls on a Thursday. As of 12/31/11, the
employees have earned salaries of $47,250 for Monday
through Thursday.
Dec. 31 Salaries Expense
Salaries Payable
47,250
47,250
To accrue 4-days’ salary
Salaries Expense
Other salaries
657,500
Dec. 31 47,250
Bal.
704,750
Salaries Payable
Dec. 31 47,250
3-23
P1
Accrued Revenues
Smith & Jones, CPAs, had $31,200 of work
completed but not yet billed to clients. Let’s make
the adjusting entry necessary on December 31, 2011,
the end of the firm’s fiscal year.
Dec. 31 Accounts Receivable
Service Revenue
31,200
31,200
To accrue revenue earned
Accounts Receivable
Other receivables
1,325,268
Dec. 31
31,200
Bal.
1,356,468
Service Revenue
Other revenues
6,589,500
Dec. 31
31,200
Bal .
6,620,700
3-24
A1
Links to Financial Statements
Summary of Adjustments and Financial Statement Links
Before Adjustment
Income
Balance Sheet
Statement
Account
Account
Type
Adjusting Entry
Prepaid
Asset Overstated
Expense
Dr. Expense
Expenses
Equity Overstated
Understated
Cr. Asset
Unearned
Liability Overstated Revenue
Dr. Liability
Revenues
Equity Understated Understated
Cr. Revenue
Accrued
Liability Understated Expense
Dr. Expense
Expenses
Equity Overstated
Understated
Cr. Liability
Accrued
Asset Understated
Revenue
Dr. Asset
Revenues
Equity Understated Understated
Cr. Revenue
3-25
P2
Cash
Accounts receivable
Supplies
Prepaid insurance
Equipment
Accum. depr. – Equip.
Accounts payable
Salaries payable
Unearned revenue
Common Stock
Retained Earnings
Dividends
Consulting revenue
Rental revenue
Depr. expense
Salaries expense
Insurance expense
Rent expense
Supplies expense
Utilities expense
Totals
FastForward – Trial Balance December 31, 2011
Trial Balance
Dr.
Cr.
3,950
9,720
2,400 $
26,000
Adjustments
Dr.
6,200
3,000
30,000
0
600
5,800
300
1,400
1,000
230
45,300
Cr.
Adjusted
Trial Balance
Dr.
Cr.
First, the
initial
unadjusted
amounts are
added to the
work sheet.
45,300
3-26
P2
FastForward – Recording Adjustments
Trial Balance – December 31, 2011
Cash
Accounts receivable
Supplies
Prepaid insurance
Equipment
Accum. depr. – Equip.
Accounts payable
Salaries payable
Unearned revenue
Common Stock
Retained Earnings
Dividends
Consulting revenue
Rental revenue
Depr. expense
Salaries expense
Insurance expense
Rent expense
Supplies expense
Utilities expense
Totals
Unadjusted
Trial Balance
Dr.
Cr.
3,950
9,720
2,400
26,000
Adjustments
Dr.
f
6,200
3,000 d
30,000
0
Adjusted
Trial Balance
Dr.
Cr.
Cr.
1,800
b
a
1,050
100
c
375
e
210
d
f
250
1,800
250
Next,
FastForward’s
adjustments
are added.
600
5,800
300
1,400
1,000
230
$45,300
$45,300
c
e
a
375
210
100
b
1,050
$3,785
$3,785
3-27
P2
FastForward – Computing the Adjusted
Trial Balance – December 31, 2011
Cash
Accounts receivable
Supplies
Prepaid insurance
Equipment
Accum. depr. – Equip.
Accounts payable
Salaries payable
Unearned revenue
Common Stock
Retained Earnings
Dividends
Consulting revenue
Rental revenue
Depr. expense
Salaries expense
Insurance expense
Rent expense
Supplies expense
Utilities expense
Totals
Unadjusted
Trial Balance
Dr.
Cr.
3,950
9,720
2,400
26,000
Adjustments
Dr.
f
6,200
3,000
30,000

d
Cr.
1,800
b
a
1,050
100
c
375
e
210
Adjusted
Trial Balance
Dr.
Cr.
3,950
1,800
8,670
2,300
26,000
250

600
600
5,800
d
f
250
1,800
7,850
300
1,400
1,000
230
$45,300
375
6,200
210
2,750
30,000

$45,300
300
c
e
a
375
210
100
b
1,050
$3,785
Finally, the
totals are
determined.
$3,785
375
1,610
100
1,000
1,050
230
$47,685
$47,685
3-28
P3
1. Prepare Income Statement
Adjusted
Trial Balance
December 31, 2011
Dr.
Cr.
Cash
Accounts receivable
Supplies
Prepaid insurance
Equipment
Accum. depr. – Equip.
Accounts payable
Salaries payable
Unearned revenue
Common Stock
Retained Earnings
Dividends
Consulting revenue
Rental revenue
Depr. expense
Salaries expense
Insurance expense
Rent expense
Supplies expense
Utilities expense
Totals
$
3,950
1,800
8,670
2,300
26,000
$
375
6,200
210
2,750
30,000

600
7,850
300
375
1,610
100
1,000
$
1,050
230
47,685
$
FASTFORWARD
Income Statement
For the Month Ended December 31, 2011
Revenues:
Consulting revenue
$ 7,850
Rental revenue
300
Operating expenses:
Depr. expense – Equip. $
375
Salaries expense
1,610
Insurance expense
100
Rent expense
1,000
Supplies expense
1,050
Utilities expense
230
Total expenses
4,365
Net income
$ 3,785
47,685
3-29
P3
2. Prepare Statement of Retained
Earnings
Note that net income from the Income Statement
carries to the Statement of Retained Earnings.
FASTFORWARD
Income Statement
For the Month Ended December 31, 2011
Revenues:
Consulting revenue
$
7,850
Rental revenue
300
Total Revenues
8,150
Operating expenses:
Depr. expense – Equip. $
375
Salaries expense
1,610
Insurance expense
100
Rent expense
1,000
Supplies expense
1,050
Utilities expense
230
Total expenses
4,365
Net income
$
3,785
FASTFORWARD
Statement of Retained Earnings
For the Month Ended December 31, 2011
Retained earnings, 12/1/11
Add: Net income
Less: Dividends
Retained earnings 12/31/11
$
-03,785
600
$ 3,185
3-30
P3
3. Prepare Balance Sheet
FASTFORWARD
Balance Sheet
December 31, 2011
Adjusted
Trial Balance
Dr.
Cr.
Cash
$
3,950
Accounts receivable
1,800
Supplies
8,670
Prepaid insurance
2,300
Equipment
26,000
Accum. depr. – Equip.
$
375
Accounts payable
6,200
Salaries payable
210
Unearned revenue
2,750
Chuck Taylor, Capital
30,000
FASTFORWARD
Chuck Taylor, Withd’l.
600
Statement
of
Retained
Earnings 7,850
Consulting revenue
Rental
revenue
300
For the
Month Ended December 31, 2011
Depr. expense
375
Salaries expense
1,610
Retained
earnings,
12/1/11
$
-0Insurance expense
100
Add:
income
3,785
Rent Net
expense
1,000
Supplies
expense
1,050
Less:
Dividends
600
Utilities expense
230
Retained
earnings 12/31/11
$$ 3,185
Totals
$
47,685
47,685
Assets
Cash
Accounts receivable
Supplies
Prepaid insurance
Equipment
Less: accum. depr.
Total assets
$
26,000
(375)
3,950
1,800
8,670
2,300
$
25,625
42,345
$
9,160
$
30,000
3,185
42,345
Liabilities
Accounts payable
Salaries payable
Unearned revenue
Total liabilities
$
6,200
210
2,750
Equity
Common stock
Retained earnings
Total liabilities and equity
3-31
C3
The Closing Process:
Temporary and Permanent Accounts
Temporary (nominal) accounts accumulate data related to
one accounting period. They include all income statement
accounts, the dividends account, and the Income Summary
account. These accounts are “closed” at the end of the period
to get ready for the next accounting period.
Permanent (real) accounts report activities related to one or
more future accounting periods. They carry ending balances
to the next accounting period and are not “closed.”
3-32
P4
Recording Closing Entries
1. Close revenue accounts.
2. Close expense accounts.
3. Close income summary account.
4. Close dividends account.
3-33
P4
Recording Closing Entries
Salaries Expenses
$ 18,100
Consulting Revenues
Examine the
accounts
presented.
Income Summary
$ 25,000
Retained Earnings
$ 7,000
3-34
P4
Recording Closing Entries
Salaries Expenses
Consulting Revenues
$ 25,000
$ 18,100
Income Summary
$ 25,000
$ 25,000
Close revenues
with a debit to the
revenue account
and a credit to
Income Summary.
3-35
P4
Recording Closing Entries
Salaries Expenses
$ 18,100
$ 18,100
Income Summary
$ 18,100
$ 25,000
Consulting Revenues
$ 25,000
$ 25,000
Close expense
accounts with a
credit to expenses
and a debit to
Income Summary.
3-36
P4
Recording Closing Entries
Salaries Expenses
$ 18,100
$ 18,100
Income Summary
$ 18,100
$ 25,000
$ 6,900
Consulting Revenues
$ 25,000
$ 25,000
Determine the
balance in the
Income Summary
account.
3-37
P4
Recording Closing Entries
Salaries Expenses
$ 18,100
Close the Income
Summary to
Retained Earnings.
Income Summary
Retained Earnings
$ 25,000
$ 7,000
$ 18,100
$ 18,100
$ 6,900
$ 6,900
$ 6,900
3-38
P4
Recording Closing Entries
The dividends account is closed to
Retained Earnings.
Dividends
$ 2,000
$ 2,000
Retained Earnings
$ 2,000
$ 7,000
6,900
3-39
P4
Recording Closing Entries
The dividends account is closed to
Retained Earnings.
Dividends
$ 2,000
$ 2,000
Retained Earnings
$ 2,000
Determine the
ending balance in
Retained Earnings.
$ 7,000
6,900
$ 11,900
3-40
P5
Post-Closing Trial Balance
Trial balance prepared after the
closing entries have been posted.
â—¼ The purpose is to ensure that all
nominal or temporary accounts have
been closed.
â—¼ The only accounts on this trial balance
should be assets, liabilities, and equity
accounts.
â—¼
3-41
C3
The Accounting Cycle
Start
10. Reverse
(optional)
1. Analyze
transactions
9. Prepare
post-closing
trial balance
8. Close
2. Journalize
3. Post
7. Prepare
statements
4. Prepare
unadjusted
trial balance
6. Prepare
adjusted
trial balance
5. Adjust
3-42
C4
Classified Balance Sheet
Assets
Current assets
Noncurrent assets:
Long-term investments
Plant assets
Intangible assets
Liabilities and Equity
Current liabilities
Noncurrent liabilities
Equity
Current items are those expected to come due
(either collected or owed) within one year or the
company’s operating cycle, whichever is longer.
3-43
C4
Classified Balance Sheet
Plant Assets
Tangible assets that are both long lived and used to
produce or sell products or services. Examples
include equipment, machinery, buildings, and land that
are used to produce or sell products and services.
Intangible Assets
Long-term resources that benefit business operations.
They usually lack physical form and have uncertain
benefits. Examples include patents, trademarks,
copyrights, franchises, and goodwill.
3-44
C4
Liabilities
Current Liabilities
Obligations due to be paid or settled within one
year or the operating cycle, whichever is longer.
Long-Term Liabilities
Obligations not due within one year or the
operating cycle, whichever is longer.
3-45
C4
Classified Balance Sheet
FASTFORWARD
Balance Sheet
Decem ber 31, 2011
Assets
Current Assets
Cash
Accounts receivable
Supplies
Prepaid insurance
Total Current Assets
Plant Assets
Equipm ent
Less: accum . depr.
Total assets
Liabilities
Current Liabilities
Accounts payable
Salaries payable
Unearned revenue
Total liabilities
Equity
Com m on stock
Retained earnings
Total liabilities and equity
$
26,000
(375)
$
3,950
1,800
8,670
2,300
16,720
$
25,625
42,345
$
9,160
$
30,000
3,185
42,345
6,200
210
2,750
3-46
A2
Profit Margin
The profit margin ratio measures the
company’s net income to net sales.
Profit
=
margin
Net income
Net sales
3-47
A3
Current Ratio
This ratio is an important measure of a company’s
ability to pay its short-term obligations.
Current
Current assets
=
ratio
Current liabilities
3-48
End of Chapter 03
3-49
Financial Accounting
John J. Wild
Sixth Edition
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 04
Reporting and Analyzing
Merchandising Operations
Conceptual Learning Objectives
C1: Describe merchandising activities and
identify income components for a
merchandising company.
C2: Identify and explain the inventory asset
and cost flows of a merchandising
company.
4-3
Analytical Learning Objectives
A1: Compute the acid-test ratio and
explain its use to assess liquidity.
A2: Compute the gross margin ratio and
explain its use to assess profitability.
4-4
Procedural Learning Objectives
P1: Analyze and record transactions for
merchandise purchases using a perpetual
system.
P2: Analyze and record transactions for
merchandise sales using a perpetual system.
P3: Prepare adjustments and close accounts for
a merchandising company.
P4: Define and prepare multiple-step and
single-step income statements.
P5: Appendix 4A – Record and compare
merchandising transactions using both
periodic and perpetual inventory systems
(see text for details).
4-5
C1
Merchandising Activities
Service organizations sell time to
earn revenue.
Examples: Accounting firms, law firms,
and plumbing services
Revenues
Minus
Expenses
Equals
Net
income
4-6
C1
Merchandising Activities
Merchandising Companies
Manufacturer
Wholesaler
Retailer
Customer
4-7
Reporting Income for
a Merchandiser
C1
Merchandising companies sell products to earn revenue.
Examples: sporting goods, clothing, and auto parts stores
Net
sales
Minus
Cost of Equals
goods sold
Gross
profit
Minus
Expenses
Equals
Net
income
Merchandising Company
Income Statement
For Year Ended December 31, 2011
Net sales
Cost of goods sold
Gross profit
Operating expenses
Net income
$ 150,000
80,000
$
70,000
46,500
$
23,500
4-8
C2
Operating Cycle for a
Merchandiser
Begins with the purchase of merchandise and ends with
the collection of cash from the sale of merchandise.
Credit Sale
Cash Sale
Purchases
Cash
collection
Purchases
Merchandise
inventory
Accounts
receivable
Cash
sales
Merchandise
inventory
Credit sales
4-9
C3
Inventory Systems
Beginning
inventory
+
Net
purchases
= Merchandise
available for sale
Ending inventory
+
Cost of goods
sold
4-10
P1
Merchandise Purchases
On June 20, Jason, Inc. purchased $14,000 of
Merchandise Inventory paying cash.
Dr.
Jun. 20 Merchandise Inventory
Cr.
14,000
Cash
14,000
Purchase merchandise for cash
4-11
P1
Trade Discounts
Used by manufacturers and wholesalers
to offer better prices for greater
quantities purchased.
Example
Matrix, Inc. offers a 30% trade
discount on orders of 1,000
units or more of their popular
product Racer. Each
Racer has a list price of $5.25.
Quantity sold
Price per unit
Total
Less 30% discount
Invoice price
1,000
$ 5.25
5,250
(1,575)
$ 3,675
4-12
Vendor’s Invoice for
Purchase of Merchandise
P1
ï‚ŒSeller
Invoice date
ï‚ŽPurchaser
Order number
Credit terms
ï‚‘Freight terms
ï‚’Goods
ï‚“Invoice amount
Invoice
Main Source, Inc.
614 Tech Avenue
Nashville, TN 37651
ï‚Ž

S
o
l
d
T
o
P.O. 167
Item
AC417

Sales: 25
Invoice
Date
5/4/12
Number
358-BI
Name: Barbee, Inc.
Attn: Tom Bell
Address: One Willow Plaza
Cookeville, Tennessee
38501

Terms 2/10,n/30
Description
250 Backup System
Ship: FedEx Prepaid
Quanity
Price
500 $ 54.00

ï‚‘
$
Amount
27,000
Sub Total
Ship Chg.
Tax
Total
$
27,000
27,000
ï‚’
We appreciate your business!
ï‚“
4-13
P1
Purchase Discounts
A deduction from the invoice price granted to induce
early payment of the amount due.
Terms
Discount Period
Credit
Period
Time
Due
Date of
Invoice
Due: Invoice
price minus
discount
Due: Full Invoice Price
4-14
P1
Purchase Discounts
2/10,n/30
Discount
Percent
Number of
Days
Discount Is
Available
Otherwise,
Net (or All)
Is Due in 30
Days
Credit
Period
4-15
P1
Purchase Discounts
On May 7, Jason, Inc. purchased $27,000 of
merchandise inventory on account, credit
terms are 2/10, n/30.
Merchandise Inventory
Accounts Payable
Dr.
27,000
Cr.
27,000
Purchase merchandise on account
4-16
P1
Purchase Discounts
On May 15, Jason, Inc. paid the amount due
on the purchase of May 7.
Dr.
27,000
May 15 Accounts Payable
Cash
Merchandise Inventory*
Cr.
26,460
540
Pai d accounts payabl e i n ful l
*$27,000 × 2% = $540 discount
4-17
P1
Purchase Discounts
After we post these entries, the
accounts involved look like this:
Merchandise Inventory
Accounts Payable
5/7
5/15 27,000 5/7 27,000
27,000 5/15
Bal. 26,460
540
Bal.
0
4-18
P1
When Discount Is Not Taken
If we fail to take a 2/10, n/30
discount, is it really expensive?
365 days ÷ 20 days × 2% = 36.5% annual rate
Days
in a
year
Number
of additional
days before
payment
Percent
paid to
keep
money
4-19
P1
Purchase Returns and
Allowances
Purchase returns . . .
refer to merchandise a buyer acquires but then
returns to the seller.
Purchase allowance . . .
is a reduction in the cost of defective or
unacceptable merchandise that a buyer
acquires.
4-20
Purchase Returns and
Allowances
P1
On May 9, Matrix, Inc. purchased $20,000
of merchandise inventory on account,
credit terms are 2/10, n/30.
May 9
Merchandise Inventory
Accounts Payable
20,000
20,000
Purchase merchandise on account
4-21
P1
Purchase Returns and
Allowances
On May 10, Matrix, Inc. returned $500 of
defective merchandise to the supplier.
May 10 Accounts Payable
Merchandise Inventory
Dr.
500
Cr.
500
Returned defective merchandise
4-22
Purchase Returns and
Allowances
P1
On May 18, Matrix, Inc. paid the amount
owed for the purchase of May 9.
May 18
Accounts Payable
Cash
Merchandise Inventory
Dr.
19,500
Cr.
19,110
390
Pa i d a ccount i n ful l
Purchase
Returns
Amount Due
Discount
Cash Paid
$ 20,000
(500)
19,500
(390)
$ 19,110
4-23
P1
Transportation Costs
Buyer
Seller
FOB shipping point
(buyer pays)
Terms
FOB shipping point
FOB destination
Merchandise
FOB destination
(seller pays)
Ownership transfers
to buyer when goods
are passed to
Transportation
costs paid by
Carrier
Buyer
Buyer
Seller
4-24
P1
Transportation Costs
On May 12, Jason, Inc. purchased $8,000 of
merchandise inventory for cash and also
paid $100 transportation costs.
May 12 Merchandise Inventory
Cash
Dr.Dr.
8,100
Cr.
8,100
Paid for merchandise and transportation
4-25
P1
Quick Check 
On July 6, 2011, Seller Co. sold $7,500 of merchandise to
Buyer, Co. on account; terms of 2/10,n/30. The shipping terms
were FOB shipping point. The shipping cost was $100. Which
of the following will be part of Buyer’s July 6 journal entry?
a. Credit Sales $7,500
b. Credit Purchase Discounts $150
c. Debit Merchandise Inventory $7,600
d. Debit Accounts Payable $7,450
FOB shipping point indicates the buyer ultimately
pays the freight. This is recorded with
a debit to Merchandise Inventory.
4-26
P1
Cost of Merchandise Purchased
MATRIX, INC.
Itemized Cost of Merchandise Purchases
For Year Ended May 31, 2011
Invoice cost of merchandise purchases
$ 692,500
Less:
Purchase discounts
(10,388)
Purchase returns and allowances
(4,275)
Add:
Cost of transportation-in
4,895
Total cost of merchandise purchases
$ 682,732
4-27
P2
Accounting for Merchandise Sales
MATRIX, INC.
Computation of Gross Profit
For Year Ended May 31, 2011
Sales
Less:
Sales discounts
Sales returns and allowances
Net sales
Cost of goods sold
Gross profit
$ 2,451,000
$ 29,412
18,500
47,912
$ 2,403,088
(1,928,600)
$
474,488
Sales discounts and returns and allowances are contra revenue accounts.
4-28
P2
Sales of Merchandise
On March 18, Diamond Store sold $25,000 of
merchandise on account. The merchandise was carried
in inventory at a cost of $18,000.
Mar. 18 Accounts Receivable
Sales
Dr.
25,000
Cr.
25,000
Sa l es of mercha ndi se on credi t
Cost of Goods Sold
Merchandise Inventory
18,000
18,000
To record cost of sa l es
4-29
P2
Sales Discounts
On June 8, Barton Co. sold merchandise costing $3,500
for $6,000 on account. Credit terms were 2/10, n/30. Let’s
prepare the journal entries.
Jun. 8
Accounts Receivable
Sales
Dr.
6,000
Cr.
6,000
Sales of merchandise on credit
Cost of Goods Sold
Merchandise Inventory
3,500
3,500
To record cost of sales
4-30
P2
Sales Discounts
On June 17, Barton Co. received a check for $5,880
in full payment of the June 8 sale.
Jun 17
Cash
Sales Discounts
Accounts Receivable
5,880
120
6,000
Received payment less discount
4-31
P2
Sales Returns and Allowances
On June 12, Barton Co. sold merchandise
costing $4,000 for $7,500 on account. The
credit terms were 2/10, n/30.
Jun. 12 Accounts Receivable
Sales
Dr.
7,500
Cr.
7,500
Sales of merchandise on credit
Cost of Goods Sold
Merchandise Inventory
4,000
4,000
To record cost of sales
4-32
P2
Sales Returns and Allowances
On June 14, merchandise with a sales price of $800 and
a cost of $470 was returned to Barton. The return is
related to the June 12 sale.
Jun. 14 Sales Returns and Allowances
Accounts Receivable
Dr.
800
Cr.
800
Customer returned merchandise
Merchandise Inventory
Cost of Goods Sold
470
470
Returned goods placed in inventory
4-33
P2
Sales Returns and Allowances
On June 20, Barton received the amount owed to it from
the sale of June 12.
Jun. 20
Cash
Sales Discount
Accounts Receivable
Dr.
6,566
134
Cr.
6,700
Recei ved payment l ess di scount
Sale
Return
Amount due
Discount
Cash received
$ 7,500
(800)
$ 6,700
(134)
$ 6,566
4-34
Completing the
Accounting Cycle
P3
BARTON COMPANY
Adjusted Trial Balance
December 31, 2011
Cash
Accounts receivable
Merchandise inventory
Supplies
Equipment
Accum. depr.- Equip.
Accounts payable
Salaries payable
Common Stock
Retained Earnings
Dividends
Sales
Sales discounts
Sales returns
Cost of goods sold
Admin. salaries expense
Sales salaries expense
Insurance expense
Rent expense
Supplies expense
Advertising expense
$
7,700
11,200
14,300
1,300
41,200
$
Next, let’s complete
the accounting cycle
by preparing the
7,000
16,400 closing entries for
1,000
Barton Company.
42,400
4,000
323,800
$
4,300
2,000
233,200
18,200
29,600
1,200
8,100
1,000
13,300
390,600
$
390,600
4-35
P3
Step 1: Close Credit Balances in
Temporary Accounts to Income Summary
Dec. 31 Sales
Income Summary
Dr.
323,800
Cr.
323,800
To close credit balances
in temporary accounts
BARTON COMPANY
Adjusted Trial Balance (partial)
December 31, 2011
Salaries payable
Common Stock
Dividends
Sales
Sales discounts
Sales returns
Cost of goods sold
Admin. salaries expense
Sales salaries expense
Insurance expense
Rent expense
Supplies expense
Advertising expense
1,000
42,400
4,000
323,800
4,300
2,000
233,200
18,200
29,600
1,200
8,100
1,000
13,300
Income Summary
323,800
4-36
P3
Step 2: Close Debit Balances in
Temporary Accounts to Income Summary
Dr.
De c. 31
Incom e Sum m ary
Cr.
310,900
Sale s Dis counts
4,300
Sale s Re turns
2,000
Cos t of Goods Sold
233,200
Adm . Salarie s Expe ns e
18,200
Sale s Salarie s Expe ns e
29,600
Ins urance Expe ns e
1,200
Re nt Expe ns e
8,100
Supplie s Expe ns e
1,000
Adve rtis ing Expe ns e
13,300
To cl ose debi t ba l a nces i n tempora ry a ccounts
Income Summary
310,900
323,800
12,900
4-37
P3
Step 3: Close Income Summary to
Retained Earnings
Dec. 31 Income Summary
Retained Earnings
Dr.
12,900
Cr.
12,900
To close Income Summary account
Income S ummary
310,900
323,800
12,900
-04-38
P3
Step 4: Close Dividends to
Retained Earnings
Dec. 31 Retained Earnings
Dividends
Dr.
4,000
Cr.
4,000
To cl ose the di vi dends account
4-39
P4
Multiple-Step Income Statement
BARTON COMPANY
Income Statement
For Year Ended December 31, 2011
Sales
Less: Sales discounts
Sales returns
Net sales
Cost of goods sold
Gross profit
Operating expenses:
Selling expenses:
Salaries expense
$ 29,600
Advertising expense
13,300
General and administrative expenses:
Adm. salaries expense
$ 18,200
Insurance expense
1,200
Rent expense
8,100
Supplies expense
1,000
Total operating expenses
Net income
$ 323,800
$
$
4,300
2,000
6,300
$ 317,500
233,200
$ 84,300
42,900
28,500
71,400
$ 12,900
4-40
P4
Single-Step Income Statement
BARTON COMPANY
Income Statement
For Year Ended December 31, 2011
Net sales
Cost of goods sold
Operating expenses
Total expenses
Net income
$ 317,500
$ 233,200
71,400
304,600
$ 12,900
4-41
P4
Balance Sheet
BARTON COMPANY
Balance Sheet
December 31, 2011
Assets:
Cash
$
7,700
Accounts receivable
11,200
Merchandise inventory
14,300
Supplies
1,300
Equipment
41,200
Accum. depr.- Equip.
(7,000)
Total assets
Liabilities
Accounts payable
Salaries payable
Total liabilities
Equity
Common stock
Retained earnings
Total liabilities
Total liabilities & equity
$
68,700
16,400
1,000
17,400
$
$
42,400
8,900
51,300
68,700
4-42
A1
Acid-Test Ratio
Acid-test
=
ratio
Acid-test
=
ratio
Quick assets
Current liabilities
Cash + S/T investments + receivables
Current liabilities
A common rule of thumb is the acid-test ratio should
have a value of at least 1.0 to conclude a company is
unlikely to face liquidity problems in the near future.
4-43
Gross Margin Ratio
A2
Gross
margin =
ratio
Net sales – Cost of goods sold
Net sales
Percentage of dollar sales available to
cover expenses and provide a profit.
4-44
End of Chapter 04
4-45
Financial Accounting
John J. Wild
Sixth Edition
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 05
Reporting and Analyzing
Inventories
Conceptual Chapter Objectives
C1: Identify the items making up
merchandise inventory.
C2: Identify the costs of merchandise
inventory.
5-3
Analytical Chapter Objectives
A1: Analyze the effects of inventory methods
for both financial and tax reporting.
A2: Analyze the effects of inventory errors on
current and future financial statements.
A3: Assess inventory management using both
inventory turnover and days’ sales in
inventory.
5-4
Procedural Chapter Objectives
P1: Compute inventory in a perpetual system
using the methods of specific identification,
FIFO, LIFO, and weighted average.
P2: Compute the lower of cost or market
amount of inventory.
P3: Appendix 5A – Compute inventory in a
periodic system using the methods of
specific identification, FIFO, LIFO, and
weighted average (see text for details).
P4: Appendix 5B – Apply both the retail
inventory and gross profit methods to
estimate inventory (see text for details).
5-5
C1
Determining Inventory Items
Merchandise inventory includes all goods that
a company owns and holds for sale, regardless
of where the goods are located when inventory
is counted.
Items requiring special attention include:
Goods in
Transit
Goods on
Consignment
Goods
Damaged or
Obsolete
5-6
C1
Goods in Transit
FOB Shipping Point
Public
Carrier
Seller
Buyer
Ownership passes
to the buyer here.
Public
Carrier
Seller
FOB Destination Point
Buyer
5-7
C2
Determining Inventory Costs
Include all expenditures necessary to bring an
item to a salable condition and location.
Minus
Discounts
and
Allowances
Plus Import
Duties
Invoice
Cost
Plus
Freight
Plus
Insurance
Plus
Storage
5-8
C2
Internal Controls and Taking a Physical
Count
➢
Most companies take
a physical count of
inventory at least once
each year.
➢
When the physical
count does not match
the Merchandise
Inventory account, an
adjustment must be
made.
5-9
P1
Inventory Costing Under a Perpetual
System
Accounting for
inventory
requires several
decisions . . .
➢
Costing Method
âš« Specific Identification, FIFO, LIFO,
or Weighted Average
➢
Inventory System
âš« Perpetual or Periodic
5-10
P1
Frequency in Use of Inventory
Methods
FIFO
46%
LIFO
30%
Weighted
Average
20%
Other*
4%
5-11
P1
Inventory Cost Flow Assumptions
First-In, First-Out
(FIFO)
Assumes costs flow in the order
incurred.
Last-In, First-Out
(LIFO)
Assumes costs flow in the
reverse order incurred.
Weighted
Average
Assumes costs flow at an
average of the costs available.
5-12
P1
Inventory Costing Illustration
Cost of Goods Available for Sale
Aug. 1 Beg. Inventory
10 units @
Aug. 3 Purchased
15 units @
Aug. 17 Purchased
20 units @
Aug. 28 Purchased
10 units @
Retail Sales of Goods
Aug. 14 Sales
Aug. 31 Sales
$ 91
$ 106
$ 115
$ 119
=
=
=
=
$
910
$ 1,590
$ 2,300
$ 1,190
20 units @ $ 130 =
23 units @ $ 150 =
$ 2,600
$ 3,450
5-13
P1
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Specific Identification
Purchases
10 @
$
15 @
$ 106 =
91 =
Cost of Goods Sold
$
910
$ 1,590
8 @
20 @
10 @
Inventory
Balance
$
910
$ 2,500
$
91 =
$
728
12 @purchases
$ 106 =
$ were
1,272 $
500
The above
$ 115 = $ 2,300
$ 2,800
made
in
August.
On
August
14,
$ 119 = $ 1,190
$ 3,990
a company
8 bikes
2 @ sold
$
91
=
$
182
@ $ 106 $91
=
$and
31812
originally3 costing
14 @ $ 115 =
$ 1,610
bikes originally
costing
$106.
4 @
$ 119 =
$
476
$ 1,404
5-14
P1
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Specific Identification
Purchases
Cost of Goods Sold
10
@
$ 91
=
$
15
@
$ 106
=
$ 1,590
910
8
@
$ 91
=
$
Inventory
Balance
$
910
$
2,500
728
The cost of goods sold 12
for the
bikes
on $
@ 20
$ 106
= sold
$ 1,272
the August 14 sale is $2,000.
20 @ $ 115 = $ 2,300
$
10 @ $ 119
= $@1,190
$
8 bikes
91 =
$ 728
12 bikes @ 106 =2 @ $1,272
$ 91 =
$ 182
3
@
$ 106
=
$
500
2,800
3,990
318
After this sale, there are five units in inventory
14 @ $ 115 =
$ 1,610
at $500:
2 bikes @ $91 =
$ 182
3 bikes @ $106 =
$ 318
5-15
P1
Specific Identification
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Purchases
Inventory
Balance
$
910
$ 2,500
Cost of Goods Sold
10
@
$ 91
=
$
15
@
$ 106
=
$ 1,590
910
20
@
$ 115
=
$ 2,300
10
@
$ 119
=
$ 1,190
8
@
$ 91
=
$
12
@
$ 106
=
$ 1,272
2
@
$ 91
=
$
728
$
500
$ 2,800
$ 3,990
182
Additional purchases were made
3 @ on$ August
106 = 17$ and
31828.
14 August
@ $ 115
=
$as
1,610
The cost of the 23 items sold on
31 were
follows:
4 @ $ 119 =
$ 476 $ 1,404
2 @ $91
3 @ $106
15 @ $115
3 @ $119
5-16
P1
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Specific Identification
Purchases
Inventory
Balance
$
910
$ 2,500
Cost of Goods Sold
10
@
$
91
=
$
910
15
@
$ 106
=
$ 1,590
20
@
$ 115
=
$ 2,300
10
@
$ 119
=
$ 1,190
8
@
$
91
=
$
728
12
@
$ 106
=
$ 1,272
2
@
$
91
=
$
182
3
@
$ 106
=
$
318
15
@
$ 115
=
$ 1,725
3
@
$ 119
=
$
357
$
500
$ 2,800
$ 3,990
$ 1,408
Cost of goods sold for
August 31 = $2,582
5-17
P1
Specific Identification
Here are the entries to record the purchases and sales. The
numbers in red are determined by the cost flow assumption
used.
All purchases
and sales are
made on
credit.
The selling
price of
inventory was
as follows:
8/14 $130
8/31 150
Aug. 3
Aug. 14
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Aug. 31
Merchandise Inventory
Accounts Payable
Accounts Receivable
Sales
Cost of Goods Sold
Merchandise Inventory
Merchandise Inventory
Accounts Payable
Merchandise Inventory
Accounts Payable
Accounts Receivable
Sales
Cost of Goods Sold
Merchandise inventory
1,590
1,590
2,600
2,600
2,000
2,000
2,300
2,300
1,190
1,190
3,450
3,450
2,582
2,582
5-18
P1
Date
Aug. 1
Aug. 3
First-In, First-Out (FIFO)
Purchases
Inventory
Balance
$
910
$ 2,500
Cost of Goods Sold
10
@
$ 91
=
$
15
@
$ 106
=
$ 1,590
910
Aug. 17 20 @ $ 115 = $ 2,300
The above purchases were
Aug. 28 10 @ $ 119 = $ 1,190
made
Aug.
31 in August.
5 @
18
@
On August 14, the company
sold 20 bikes.
$ 2,300
$ 3,490
$ 106
=
$
$ 115
=
$ 2,070
530
$
890
5-19
P1
Date
Aug. 1
Aug. 3
Aug. 14
First-In, First-Out (FIFO)
Purchases
Inventory
Balance
$
910
$ 2,500
Cost of Goods Sold
10
@
$ 91
=
$
15
@
$ 106
=
$ 1,590
910
10
@
$ 91
=
$
910
$
530
Aug. 17 20 @ $ 115 = $ 2,300
$ 2,830
Aug. 28 The
10 @Cost
$ 119 of
= goods
$ 1,190 sold for the August$ 4,020
Aug. 31
5 @ $ 106 =
$ 530
14 sale is $1,970. 18 @ $ 115 = $ 2,070 $ 1,420
10
@
$ 106
=
$ 1,060
After this sale, there are five units in
inventory at $530: 5 @ $106
5-20
P1
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
First-In, First-Out (FIFO)
Purchases
Inventory
Balance
$
910
$ 2,500
Cost of Goods Sold
10
@
$ 91
=
$
910
15
@
$ 106
=
$ 1,590
20
@
$ 115
=
$ 2,300
10
@
$ 119
=
$ 1,190
10
@
$ 91
=
$
910
10
@
$ 106
=
$ 1,060
5
@
$ 106
=
$
18
@
$ 115
=
$ 2,070
$
530
$ 2,830
$ 4,020
530
$ 1,420
Cost of goods sold for
August 31 = $2,600
5-21
P1
Date
Aug. 1
Aug. 3
Aug. 14
First-In, First-Out (FIFO)
Purchases
Aug. 31
Cost of Goods Sold
10
@
$
91
=
$
15
@
$ 106
=
$ 1,590
Income
Statement
Aug. 17 20
@ $ 115 =
Aug.
28 10
@ $ 119 =
COGS
= $4,570
Inventory
Balance
$
910
$ 2,500
910
10
@
$
91
=
$
910
10
@
$ 106
=
$ 1,060
5
@
$ 106
=
$
18
@
$ 115
=
$ 2,070
$ 2,300
$ 1,190
$
530
$ 2,830
$ 4,020
530
$ 1,420
Balance Sheet
Inventory = $1,420
5-22
P1
First-In, First-Out (FIFO)
Here are the entries to record the purchases and sales
entries. The numbers in red are determined by the cost flow
assumption used.
All purchases
and sales are
made on
credit.
The selling
price of
inventory was
as follows:
8/14 $130
8/31 150
Aug. 3
Aug. 14
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Aug. 31
Merchandise Inventory
Accounts Payable
Accounts Receivable
Sales
Cost of Goods Sold
Merchandise Inventory
Merchandise Inventory
Accounts Payable
Merchandise Inventory
Accounts Payable
Accounts Receivable
Sales
Cost of Goods Sold
Merchandise Inventory
1,590
1,590
2,600
2,600
1,970
1,970
2,300
2,300
1,190
1,190
3,450
3,450
2,600
2,600
5-23
P1
Date
Aug. 1
Aug. 3
Aug. 14
Last-In, First-Out (LIFO)
Purchases
Inventory
Balance
$
910
$ 2,500
Cost of Goods Sold
10
@
$ 91
=
$
15
@
$ 106
=
$ 1,590
910
15
@
$ 106
=
$ 1,590
5
@
$ 91
=
$
Aug.
20 @ $ 115 = $ 2,300
The17above
purchases were
Aug. 28 10 @ $ 119 = $ 1,190
made
Aug.
31 in August.
10 @
$ 119
=
$ 1,190
$ 115
=
$ 1,495
13
@
On August 14, the company
sold 20 bikes.
455
$
455
$ 2,755
$ 3,945
$ 1,260
5-24
P1
Date
Aug. 1
Aug. 3
Aug. 14
Last-In, First-Out (LIFO)
Purchases
Inventory
Balance
$
910
$ 2,500
Cost of Goods Sold
10
@
$ 91
=
$
15
@
$ 106
=
$ 1,590
910
15
@
$ 106
=
$ 1,590
$
455
Aug. 17 20 @ $ 115 = $ 2,300
$ 2,755
sold for the August$ 3,945
Aug. 28 The
10 @Cost
$ 119 of
= goods
$ 1,190
Aug. 31
10 $2,045.
@ $ 119 =
$ 1,190
14 sale is
13 @ $ 115 =
$ 1,495 $ 1,260
5
@
$ 91
=
$
455
After this sale, there are five units in
inventory at $455:
5 @ $91
5-25
P1
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Last-In, First-Out (LIFO)
Purchases
Inventory
Balance
$
910
$ 2,500
Cost of Goods Sold
10
@
$ 91
=
$
15
@
$ 106
=
$ 1,590
910
20
@
$ 115
=
$ 2,300
10
@
$ 119
=
$ 1,190
15
@
$ 106
=
$ 1,590
5
@
$ 91
=
$
10
@
$ 119
=
$ 1,190
13
@
$ 115
=
$ 1,495
455
$
455
$ 2,755
$ 3,945
$ 1,260
Cost of goods sold for
August 31 = $2,685
5-26
P1
Date
Aug. 1
Aug. 3
Aug. 14
Last-In, First-Out (LIFO)
Purchases
Cost of Goods Sold
10
@
$
91
=
$
15
@
$ 106
=
$ 1,590
Aug. 17Income
20 @ $ 115 =
Statement
Aug.
28 10 @COGS
$ 119 =
= $4,730
Aug. 31
Inventory
Balance
$
910
$ 2,500
910
15
@
$ 106
=
$ 1,590
5
@
$
91
=
$
10
@
$ 119
=
$ 1,190
13
@
$ 115
=
$ 1,495
455
$ 2,300
$ 1,190
$
455
$ 2,755
$ 3,945
$ 1,260
Balance Sheet
Inventory = $1,260
5-27
P1
Last-In, First-Out (LIFO)
Here are the entries to record the purchases and sales
entries. The numbers in red are determined by the cost flow
assumption used.
All purchases
and sales are
made on
credit.
The selling
price of
inventory was
as follows:
8/14 $130
8/31 150
Aug. 3
Aug. 14
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Aug. 31
Merchandise Inventory
Accounts Payable
Accounts Receivable
Sales
Cost of Goods Sold
Merchandise Inventory
Merchandise Inventory
Accounts Payable
Merchandise Inventory
Accounts Payable
Accounts Receivable
Sales
Cost of Goods Sold
Merchandise Inventory
1,590
1,590
2,600
2,600
2,045
2,045
2,300
2,300
1,190
1,190
3,450
3,450
2,685
2,685
5-28
P1
Weighted Average
When a unit is sold, the
average cost of each unit
in inventory is assigned to
cost of goods sold.
Cost of goods
Units on hand
available for ÷ on the date of
sale
sale
5-29
P1
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Weighted Average
10
15
20
10
Inventory
Balance
Purchases
Cost of Goods Sold
@ $ 91 = $ 910
$
910
@ $ 106 = $ 1,590
$ 2,500
20 @ $ the
100 weighted
= $ 2,000 $
500
First, we need to compute
@average
$ 115 =cost
$ 2,300
per unit of items in inventory. $ 2,800
@ $ 119 = $ 1,190
$ 3,990
Cost of goods available for sale
$ 2,500
23 @ $ 114 = $ 2,622 $ 1,368
Total units in inventory
25
Weighted average cost per unit
$
÷
100
The cost of goods sold for the August 14
sale is $2,000. After this sale, there are five
units in inventory at $500:
5-30
P1
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Weighted Average
Purchases
Cost of Goods Sold
10 @
$
91 =
$
910
15 @
$ 106 =
$
1,590
20 @
20 @
$ 115 =
$
2,300
10 @
$ 119 =
$
1,190
$ 100 =
$
2,000
Inventory
Balance
$ 910
$ 2,500
$ 500
$ 2,800
$ 3,990
$ 1,368
23 @ $ 114 = $ 2,622
Additional purchases were made
on August 17 and 28.
Twenty-three bikes were sold on August 31.
What is the weighted average cost per unit
of items in inventory?
5-31
P1
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Weighted Average
Purchases
Cost of Goods Sold
10 @
$
91 =
$
910
15 @
$ 106 =
$
1,590
20 @
$ 115 =
$
2,300
10 @
$ 119 =
$
1,190
Units
Inventory 8/14
5
Purchase 8/17
20
Purchase 8/28
10
Units available for sale
35
20 @
$ 100 =
$
2,000
23 @
$ 114 =
$
2,622
Cost of goods available for sale
Total units in inventory
Weighted average cost per unit
Inventory
Balance
$ 910
$ 2,500
$ 500
$ 2,800
$ 3,990
$ 1,368
$
3,990
÷ 35
$
114
5-32
P1
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Weighted Average
Purchases
10
@ $ 91
= $
910
15
@ $ 106
= $ 1,590
20
@ $ 115
= $ 2,300
10
@ $ 119
= $ 1,190
Cost of goods sold for
August 31 = $2,622
Inventory
Balance
Cost of Goods Sold
$
910
$ 2,500
20 @ $ 100 = $ 2,000 $
500
$ 2,800
$ 3,990
23 @ $ 114 = $ 2,622 $ 1,368
Ending inventory is
comprised of 12 units @ an
average cost of $114 each or
$1,368.
5-33
P1
Weighted Average
Date
Purchases
Aug. 1
10 @ $ 91 = $ 910
Aug. 3
15 @ $ 106 = $ 1,590
Aug. 14
Aug. 17 Income
20 @ $ 115 = $ 2,300
Aug.Statement
28 10 @ $COGS
119 = $ 1,190
Aug. 31 = $4,622
Inventory
Balance
Cost of Goods Sold
$
910
$ 2,500
20 @ $ 100 = $ 2,000 $
500
$ 2,800
$ 3,990
23 @ $ 114 = $ 2,622 $ 1,368
Balance Sheet
Inventory = $1,368
5-34
P1
Weighted Average
Here are the entries to record the purchases and sales
entries for Trekking. The numbers in red are determined by
the cost flow assumption used.
All purchases
and sales are
made on
credit.
The selling
price of
inventory was
as follows:
8/14 $130
8/31 150
Aug. 3
Aug. 14
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Aug. 31
Merchandise Inventory
Accounts Payable
Accounts Receivable
Sales
Cost of Goods Sold
Merchandise Inventory
Merchandise Inventory
Accounts Payable
Merchandise Inventory
Accounts Payable
Accounts Receivable
Sales
Cost of Goods Sold
Merchandise Inventory
1,590
1,590
2,600
2,600
2,000
2,000
2,300
2,300
1,190
1,190
3,450
3,450
2,622
2,622
5-35
A1
Financial Statement Effects of Costing
Methods
Because prices change, inventory methods nearly
always assign different cost amounts.
TREKKING COMPANY
For Month Ended August 31
Specific
Identification
Sales
$
6,050
Cost of goods sold
4,582
Gross profit
$
1,468
Operating expenses
450
Income before taxes
$
1,018
Income tax expense (30%)
305
Net income
$
713
Balance sheet inventory
$
1,408
$
FIFO
6,050
4,570
1,480
450
1,030
309
721
$
1,420
$
$
$
$
LIFO
6,050
4,730
1,320
450
870
261
609
$
1,260
$
$
$
Weighted
Average
$
6,050
4,622
$
1,428
450
$
978
293
$
685
$
1,368
5-36
A1
Financial Statement Effects of Costing
Methods
Advantages of Methods
Weighted
Average
First-In,
First-Out
Last-In,
First-Out
Smoothes out
price changes.
Ending inventory
approximates
current
replacement cost.
Better matches
current costs in cost
of goods sold with
revenues.
5-37
A1
Tax Effects of Costing Methods
The Internal Revenue Service (IRS)
identifies several acceptable
methods for inventory costing for
reporting taxable income.
If LIFO is used for tax
purposes, the IRS requires
it be used in financial
statements.
5-38
A1
Consistency in Using Costing
Methods
The consistency concept requires a
company to use the same accounting
methods period after period so that
financial statements are comparable
across periods.
5-39
P2
Lower of Cost or Market
Inventory must be reported at market
value when market is lower than
cost.
Defined as current
replacement cost
(not sales price).
Consistent with
the conservatism
principle.
Can be applied three ways:
(1)
(2)
(3)
separately to each
individual item.
to major categories of
assets.
to the whole inventory.
5-40
P2
Lower of Cost or Market
A motorsports retailer has the following items in
inventory:
Per Unit
Inventory Items
Cycles:
Roadster
Sprint
Category subtotal
Off-Road
Trax-4
Blazer
Category subtotal
Total
Units on
Hand
Cost
20 $ 8,000
10
5,000
8
5
5,000
9,000
Total
Cost
Total
Market
$ 7,000
6,000
$160,000
50,000
210,000
$ 140,000
60,000
200,000
6,500
7,000
40,000
45,000
85,000
$295,000
52,000
35,000
87,000
$ 287,000
Market
5-41
P2
Lower of Cost or Market
Here is how to compute lower of cost or
market for individual inventory items.
LCM Applied to
Units on
Inventory Items Hand
Total Cost
Cycles:
Roadster
20 $ 160,000
Sprint
10
50,000
Category subtotal
$ 210,000
$ 140,000 $ 140,000
60,000
50,000
$ 200,000
Off-Road
Trax-4
Blazer
Category subtotal
Total
$ 52,000
40,000
35,000
35,000
$ 87,000
$ 287,000 $ 265,000
8
5
$ 40,000
45,000
$ 85,000
$ 295,000
Total
Market
Items
Categories
Whole
5-42
A2
Financial Statement Effects of Inventory
Errors
Income Statement Effects
Inventory Error
Understate ending inventory
Understate beginning inventory
Overstate ending inventory
Overstate beginning inventory
Cost of Goods Sold
Overstated
Understated
Understated
Overstated
Net Income
Understated
Overstated
Overstated
Understated
5-43
A2
Financial Statement Effects of Inventory
Errors
Balance Sheet Effects
Inventory Error
Understate ending inventory
Overstate ending inventory
Assets
Equity
Understated Understated
Overstated
Overstated
5-44
A3
Inventory Turnover
Shows how many times a company turns over its
inventory during a period. Indicator of how well
management is controlling the amount of
inventory available.
Inventory
turnover
Average
inventory
=
Cost of goods sold
Average inventory
= (Beg. Inv. + End Inv.) ÷ 2
5-45
A3
Days’ Sales in Inventory
Reveals how much inventory is available in
terms of the number of days’ sales.
Days’ sales in
inventory
=
Ending inventory
365
×
Cost of goods sold
5-46
End of Chapter 05
5-47
Financial Accounting
John J. Wild
Sixth Edition
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 06
Reporting and Analyzing
Cash and Internal Controls
Conceptual Learning Objectives
C1: Define internal control and identify its
purpose and principles.
C2: Define cash and cash equivalents
and explain how to report them.
6-3
Analytical Learning Objectives
A1: Compute the days’ sales uncollected
ratio and use it to assess liquidity.
6-4
Procedural Learning Objectives
P1: Apply internal control to cash receipts
and disbursements.
P2: Explain and record petty cash fund
transactions.
P3: Prepare a bank reconciliation.
P4: Appendix 6A – Describe the use of
documentation and verification to
control cash disbursements (see text for
details).
P5: Appendix 6B – Apply the net method to
control purchase discounts (see text for
details).
6-5
C1
Purpose of Internal Control
Managers use policies and procedures to:
Protect assets.
2. Ensure reliable accounting.
1.
Promote efficient operations.
4. Urge adherence to company
policies.
3.
6-6
C1
The Sarbanes-Oxley Act
The Sarbanes-Oxley Act, also known as SOX, requires
management and auditors of publicly held companies to
adhere to or perform specific requirements, such as:
1. Evaluation of internal controls.
2. Oversight of the Auditor’s work by the Public
Company Accounting Oversight Board (PCAOB).
3. Restriction on consulting services performed by
auditors.
4. Term limits on person leading the audit.
5. Harsh penalties for violators, including prison time
with severe fines.
6-7
Principles of Internal Control
C1
1.
Establish responsibilities.
2.
Maintain adequate records.
3.
Insure assets and bond key employees.
4.
Separate recordkeeping from custody
of assets.
5.
Divide responsibility for related transactions.
6.
Apply technological controls.
7.
Perform regular and independent reviews.
6-8
C1
Technology and Internal Control
Reduced
Processing
Errors
More
Extensive Testing
of Records
Limited
Evidence of
Processing
Crucial
Separation of
Duties
Increased
E-commerce
6-9
C1
Limitations of Internal Control
Human Error
Human Fraud
Negligence
Fatigue
Misjudgment
Confusion
Intent to
defeat internal
controls for
personal gain
6-10
C1
Limitations of Internal Control
The costs of internal controls
must not exceed their benefits.
Benefits
Costs
6-11
C1
Control of Cash
An effective system of internal control that
protects cash and cash equivalents should meet
three basic guidelines:
Handling cash is
separate from
recordkeeping of
cash.
Cash receipts are
promptly deposited
in a bank.
Cash
disbursements are
made by check.
6-12
C2
Cash, Cash Equivalents, and
Liquidity
Cash
Currency, coins, and amounts on deposit in
bank accounts, checking accounts, and
many savings accounts. Also includes items
such as customer checks, cashier checks,
certified checks, and money orders.
Cash Equivalents
Short-term, highly liquid investments that are:
1. Readily convertible to a known cash amount.
2. Close to maturity date and not sensitive to
interest rate changes.
6-13
C2
Cash, Cash Equivalents, and
Liquidity
Liquidity
How easily an asset can be converted into
cash to be used to pay for services or
obligations.
Inventory
Cash
6-14
C2
Cash Management Principles
When companies fail, one of the most
common causes is their inability to
manage cash. The goals of cash
management are twofold:
â—¼ Plan cash receipts to meet cash
payments when due.
â—¼ Keep the minimum level of cash
necessary to operate.
6-15
Control of Cash Receipts
P1
Over-the-Counter
Cash Receipts
â—¼
â—¼
Cash register with
locked-in record of
transactions.
Compare cash
register record with
cash reported.
Cash Receipts By Mail
â—¼
Two people open the
mail.
✓ Money to cashier’s
office.
✓ List to accounting
dept.
✓ Copy of list filed.
6-16
Control of Cash Disbursements
P1
â—¼
â—¼
â—¼
All expenditures should be made by check.
The only exception is for small payments
from petty cash.
Separate authorization for check signing
and recordkeeping duties.
Use a voucher system.
6-17
Voucher System of Control
P1
A voucher system establishes procedures
for:
âš«
Verifying, approving, and recording obligations
for eventual cash disbursements.
âš«
Issuing checks for payment of verified,
approved, and recorded obligations.
6-18
P1
Voucher System of Control
Sender
Cashier
Accounting
Receiving
Supplier (Vendor)
Purchasing
Requesting
Receiver
Check
Invoice Approval
Receiving Report
Invoice
Purchase Order
Purchase Requisition
Supplier (Vendor)
Cashier
Accounting, Requesting
& Purchasing
Accounting
Supplier, Requesting,
Receiving & Accounting
Purchasing and
Accounting
Voucher
6-19
P2
Petty Cash System of Control
Small payments required in most
companies for items such as postage,
courier fees, repairs, and supplies.
6-20
P2
Operating a Petty Cash Fund
Petty Cash
Company
Cashier
Petty
Cashier
May 1
Petty cash
Cash
400
400
Accountant
6-21
P2
Operating a Petty Cash Fund
Petty Cash
Petty
Cashier
6-22
P2
Operating a Petty Cash Fund
A petty cash fund
is used only for
business
expenses.
Petty
Cashier
39¢
Stamps
$45
Courier
$80
6-23
P2
Operating a Petty Cash Fund
Petty cash
receipts with
either no
signature or a
forged signature
usually indicate
misuse of petty
cash.
Receipts
Petty
Cashier
39¢
Stamps
$45
Courier
$80
6-24
P2
Operating a Petty Cash Fund
Receipts
$125
Company
Cashier
To reimburse
petty cash fund
May 31
Use a Cash
Over and Short
account if needed.
Petty
Cashier
Postage expense
Delivery expense
Cash
45
80
125
Accountant
6-25
P2
Petty Cash Example
Tension Co. maintains a petty cash fund of $400.
The following summary information was taken from
petty cash vouchers for July:
Travel Expenses
Customer Business Lunches
Express Mail Postage
Miscellaneous Office Supplies
$79.30
93.42
55.00
32.48
Let’s look at replenishing the fund if the balance on
July 31 was $137.80.
6-26
P2
Petty Cash Example
What amount of cash will be required
to replenish the petty cash fund?
a. $260.20
b. $262.20
c. $139.80
d. $137.80
6-27
Petty Cash Example
P2
What amount of cash will be
required to replenish the petty
cash fund?
a.
b.
c.
d.
$260.20
$262.20
$139.80
$137.80
Desired balance
Actual balance
Amount needed
$ 400.00
137.80
$ 262.20
Let’s prepare the journal entry to replenish the
petty cash fund.
6-28
P2
Petty Cash Example
Journal entry to replenish petty cash fund
Dr.
July 31 Travel Expense
79.30
Entertainment Expense
93.42
Postage Expense
55.00
Office Supplies Expense
32.48
Cash Over and Short
2.00
Cash
Cr.
262.20
6-29
P1
Banking Activities as Controls
Bank Accounts
Signature Cards
Deposit Tickets
Checks
Electronic
Funds
Transfer
Bank
Statements
6-30
Bank Reconciliation
P3
A bank reconciliation is prepared periodically to explain the
difference between cash reported on the bank statement and the
cash balance on company’s books.
Bank Statement
First National Bank
Nashville, TN 37459
May 31, 2011
*
Clothes Mart
Nashville, TN
Why are the
balances different?
Acct No 278609
Previous
Balance
Total Checks
1488.79
5/1
5/2
1,367.09
107
5/4
5/7
5/9
5/12
108
109
110
111
Total
Deposits
2,604.22
55.00
Current
Balance
2,725.92
Account: Cash
GENERAL LEDGER
Acct. No.
1,251.88
279.50
44.75
21.81
37.55
5/15
5/18
5/21
5/27
5/30
112
113
114
175.98
288.31
12.54
5/31
115
451.65
Date
Item
May 31 Balance
PR
Debit
Credit
102
Balance
DR (CR)
2,481.18
825.04
527.30
6-31
P3
Reconciling Items
Bank Statement Balance
âš« Add:
Deposits in transit.
âš« Deduct:
Outstanding
checks
âš« Add or Deduct:
Bank errors.
•
•
•
•
•
Book Balance
Add: Collections
made by the bank.
Add: Interest earned
on checking account.
Deduct:
Nonsufficient funds
check (NSF).
Deduct: Bank
service charge.
Add or Deduct:
Book errors.
6-32
P3
Bank Reconciliation
Two sections:
1. Reconcile bank statement balance to
the adjusted bank balance.
2. Reconcile book balance to the adjusted
book balance.
The adjusted balances should be equal.
6-33
P3
Bank Reconciliation Example
Let’s prepare a July 31 bank reconciliation
statement for the Simmons Company.
â—¼
â—¼
The July 31 bank statement indicated a
balance of $9,610.
The cash general ledger account on that
date shows a balance of $7,430.
Additional information necessary for the
reconciliation is shown on the next screen.
6-34
P3
Bank Reconciliation Example
1.
Outstanding checks totaled $2,417.
2.
A $500 check mailed to the bank for deposit had not
reached the bank at the statement date.
3.
The bank returned a customer’s NSF check for $225
received as payment on account receivable.
4.
The bank statement showed $30 interest earned during
July.
5.
Check No. 781 for supplies expense cleared the bank for
$268 but was erroneously recorded in our books as $240.
6.
A $486 deposit by Acme Company was erroneously
credited to our account by the bank.
6-35
P3
Bank Reconciliation Example
Simmons Company
Bank Reconciliation
July 31, 2011
Bank Balance, July 31
Add: Deposit in Transit
Less: Bank Error
$
486
Outstanding Checks
2,417
Adjusted Balance, July 31
Book Balance, July 31
Add: Interest
Less: Recording Error
NSF Check
Adjusted Balance, July 31
$
(2,903)
$ 7,207
$
$
9,610
500
28
225
$
7,430
30
(253)
7,207
6-36
P3
Adjusting Entries from a
Bank Reconciliation
Only amounts shown on the book portion
of the reconciliation require an adjusting
entry.
Dr.
30
July 31 Cash
Interest revenue
July 31 Supplies expense
Accounts receivable
Cash
Cr.
30
28
225
253
6-37
P3
Adjusting Entries from a
Bank Reconciliation
After posting the reconciling entries the cash account
looks like this:
Account: Cash
GENERAL LEDGER
Acct. No.
Date
Item
July 31 Balance
31 Adjusting entry
31 Adjusting entry
PR
Debit
Credit
30
253
101
Balance
DR (CR)
7,430
7,460
7,207
Adjusted balance on July 31.
6-38
A1
Days’ Sales Uncollected
How much time is likely to pass before
we receive cash receipts from credit sales?
Days’
=
sales
uncollected
Accounts receivable
Net sales
× 365
6-39
End of Chapter 06
6-40
Financial Accounting
John J. Wild
Sixth Edition
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 7
Reporting and Analyzing
Receivables
7-2
Conceptual Learning Objectives
C1: Describe accounts receivable and
how they occur and are recorded.
C2: Describe a note receivable,
computation of its maturity date
and the recording of its existence.
C3: Explain how receivables can be
converted to cash before maturity.
7-3
Analytical Learning Objectives
A1: Compute accounts receivable
turnover and use it to help assess
financial condition.
7-4
Procedural Learning Objectives
P1: Apply the direct write-off method to
account for accounts receivable.
P2: Apply the allowance method and estimate
uncollectibles based on sales and accounts
receivable.
P3: Record the honoring and dishonoring of a
note and adjustments for interest.
7-5
C1
Accounts Receivable
â—¼
â—¼
Amounts due from
customers for credit sales.
Credit sales require:
ï‚¡ Maintaining a separate
account receivable for
each customer.
ï‚¡ Accounting for bad
debts that result from
credit sales.
7-6
C1
Sales on Credit
On July 16, Barton, Co. sells $950 of
merchandise on credit to Webster, Co., and
$1,000 of merchandise on account to Matrix, Inc.
Jul. 16 Accounts Receivable – Webster
Sales
950
950
To record credit sales to Webster Co.
Accounts Receivable – Matrix
Sales
1,000
1,000
To record credit sales to M atrix, Inc.
7-7
C1
Sales on Credit
Accounts Receivable Ledger
Webster, Co.
Date
PR Debit Credit
Jul. 16
950
Balance
950
Matrix, Inc.
Date
PR Debit Credit
Jul. 16
1,000
Balance
1,000
Schedule of
Accounts Receivable
Webster, Co.
$ 950
Matrix, Inc.
1,000
Total
$ 1,950
General Ledger
Accounts Receivable
Date
PR Debit Credit Balance
Jul. 16
1,950
1,950
7-8
C1
Sales on Credit
On July 31, Barton, Co. collects $500 from Webster,
Co., and $800 from Matrix, Inc. on account.
Jul. 31 Cash
500
Accounts Receivable – Webster
500
To record cash collections on account
Cash
Accounts Receivable – Matrix
800
800
To record cash collections on account
7-9
C1
Sales on Credit
Accounts Receivable Ledger
Webster, Co.
Date
PR Debit Credit
Jul. 16
950
Jul. 31
500
Balance
950
450
Matrix, Inc.
Date
PR Debit Credit
Jul. 16
1,000
Jul. 31
800
Balance
1,000
200
Schedule of
Accounts Receivable
Webster, Co.
$ 450
Matrix, Inc.
200
Total
$ 650
General Ledger
Accounts Receivable
Date
PR Debit Credit Balance
Jul. 16
1,950
1,950
Jul. 31
1,300
650
7-10
C1
Credit Card Sales
Advantages of allowing customers to
use credit cards:
Customers’
credit is
evaluated by
the credit
card issuer.
Sales increase by
providing purchase
options to the
customer.
The risks of extending
credit are transferred to
the credit card issuer.
Cash collections
are quicker.
7-11
C1
Credit Card Sales
 With bank credit cards, the seller
deposits the credit card sales receipt
in the bank just like it deposits a
customer’s check.
 The bank increases the balance in the
company’s checking account.
ï‚Ž The company usually pays a fee of 1%
to 5% for the service.
7-12
C1
Credit Card Sales
On July 16, 2011, Barton, Co. has a bank credit
card sale of $500 to a customer. The bank
charges a processing fee of 2%. The cash is
received immediately.
Jul. 16 Cash
Credit Card Expense
Sales
490
10
500
To record credit card sales
and fees
7-13
C1
Credit Card Sales
On July 16, 2011, Barton, Co. has a bank credit card
sale of $500 to a customer. The bank charges a
processing fee of 2%. Barton remits the credit card
sale to the credit card company and waits for the
payment that is received on July 28.
Jul. 16 Accounts Receivable – Credit Card Co.
Credit Card Expense
Sales
DR
490
10
CR
500
To record credit card sales and fees.
Jul. 28 Cash
490
Accounts Receivable – Credit Card Co.
490
To record receipt from credit card company
7-14
C1
Installment Accounts Receivable
Amounts owed by customers from credit sales for
which payment is required in periodic amounts over
an extended time period. The customer is usually
charged interest.
7-15
P1/P2
Valuing Accounts Receivable
Some customers may not pay
their account. Uncollectible
amounts are referred to as bad
debts. There are two methods
of accounting for bad debts:
ï‚¡ Direct write-off method
ï‚¡ Allowance method
7-16
P1
Direct Write-Off Method
On August 4, Barton determines it
cannot collect $350 from Martin, Inc.,
a credit customer.
Aug. 4
Bad Debts Expense
Accounts Receivable – Martin
DR
350
CR
350
To write off uncollectible account
7-17
P1
Direct Write-Off Method
On September 9, Martin decides to pay
$200 that was previously written off.
Sep. 9
Accounts Receivable – Martin
Bad Debts Expense
DR
200
CR
200
To reinstate account previously written-off
Sep. 9
Cash
200
Accounts Receivable – Martin
200
To record payment on account
7-18
P1
Matching vs. Materiality
The matching
principle requires
expenses to be
reported in the same
accounting period as
the sales they help
produce.
The materiality
constraint states that
an amount can be
ignored if its effect
on the financial
statements is
unimportant to
users’ business
decisions.
7-19
P2
Allowance Method
At the end of each period, estimate total bad debts
expected to be realized from that period’s sales.
There are two advantages to the allowance method:
1. It records estimated bad debts expense in the
period when the related sales are recorded.
2. It reports accounts receivable on the balance
sheet at the estimated amount of cash to be
collected.
7-20
P2
Recording Bad Debts Expense
At the end of its first year of operations, Barton Co.
estimates that $3,000 of its accounts receivable will prove
uncollectible. The total accounts receivable balance at
December 31, 2011, is $278,000.
Dec. 31 Bad Debts Expense
Allowance for Doubtful Accounts
DR
3,000
CR
3,000
To record estimated bad debts
Contra-asset account
Bal.
Accounts Receivable
278,000
Allowance for Doubtful Accounts
Dec. 31
3,000
7-21
P2
Recording Bad Debts Expense
At the end of its first year of operations, Barton Co.
estimates that $3,000 of its accounts receivable will prove
uncollectible. The total accounts receivable balance at
December 31, 2011, is $278,000.
Barton, Co.
Partial Balance Sheet
December 31, 2011
Cash
Accounts receivable
Less: Allowance for doubtful accounts
$ 278,000
3,000
$ 275,000
7-22
P2
Estimating Bad Debts Expense
Two Methods
1. Percent of Sales Method; and
2. Accounts Receivable Methods
Percent of Accounts
Receivable Method
Aging of Accounts
Receivable Method.
7-23
P2
Percent of Sales Method
Bad debts expense is computed as follows:
Current Period Sales
× Bad Debt %
= Estimated Bad Debts Expense
Barton has credit sales of $1,400,000 in 2011.
Management estimates 0.5% of credit sales will
eventually prove uncollectible.
What is bad debts expense for 2011?
7-24
P2
Percent of Sales Method
$
×
= $
1,400,000
0.50%
7,000
Barton’s accountant
computes estimated
Bad Debts Expense of
$7,000.
Dec. 31 Bad Debts Expense
Allowance for Doubtful Accounts
DR
7,000
CR
7,000
To record estimated bad debts
7-25
P2
Percent of Accounts Receivable
Method

Compute the estimate of the allowance
for doubtful accounts.
Year-end Accounts Receivable × Bad Debt %

Bad debts expense is computed as:
Estimated Adj. Bal. in Allowance for Doubtful Accounts
– Unadj. Year-End Bal. in Allowance for Doubtful Accounts
= Estimated Bad Debts Expense
7-26
P2
Percent of Accounts Receivable
Barton has $100,000 in
accounts receivable and a $900
credit balance in Allowance for
Doubtful Accounts on
December 31, 2011. Past
experience suggests that 4% of
receivables are uncollectible.
What is Barton’s bad debts
expense for 2011?
7-27
P2
Percent of Accounts Receivable
Desired balance in Allowance for
Doubtful Accounts.
$ 100,000
×
4.00%
= $
4,000
Allowance for
Doubtful Accounts
900
Dec. 31 Bad Debts Expense
Allowance for Doubtful Accounts
3,100
4,000
DR
3,100
CR
3,100
To record estimated bad debts
7-28
P2
Aging of Accounts Receivable
Method
 Each receivable is grouped by
how long it is past its due date.
 Each age group is multiplied
by its estimated bad debts
percentage.
ï‚Ž Estimated bad debts for each
group are totaled.
7-29
P2
Aging of Accounts Receivable
Barton, Co.
Schedule of Accounts Receivable by Age
December 31, 2011
Accounts
Estimated
Receivable
Percent
Uncollectible
Days Past Due
Balance
Uncollectible
Amount


Not Yet Due
1 – 30 Days Past Due
31 – 60 Days Past Due
61 – 90 Days Past Due
Over 90 Days Past Due
ï‚Ž
$
64,500
18,500
10,000
3,900
3,100
$ 100,000
1% $
3%
7%
40%
60%
$
645
555
700
1,560
1,860
5,320
7-30
P2
Aging of Accounts Receivable
Barton’s unadjusted balance
in the allowance account is
$900.
Allowance for
Doubtful Accounts
900
4,420
5,320
We estimated the proper
balance to be $5,320.
DR
Dec. 31 Bad Debts Expense
4,420
Allowance for Doubtful Accounts
CR
4,420
To record estimated bad debts
7-31
P2
Writing Off a Bad Debt
With the allowance method, when an
account is determined to be uncollectible,
the debit goes to Allowance for Doubtful
Accounts.
Barton determines that Martin’s $300
account is uncollectible.
Dec. 31 Allowance for Doubtful Accounts
Accounts Receivable – Martin
DR
300
CR
300
To write-off an uncollectible account
7-32
P2
Recovery of a Bad Debt
Subsequent collections on accounts written
off require that the original write-off entry be
reversed before the cash collection is
recorded.
Feb. 8
Accounts Receivable – Martin
Allowance for Doubtful Accounts
DR
300
CR
300
To reinstate account previously written off
Feb. 8
Cash
300
Accounts Receivable – Martin
300
To record full payment on account
7-33
P2
Summary
% of Sales
% of Receivables
Aging of
Receivables
Emphasis on
Matching
Emphasis on
Realizable Value
Emphasis on
Realizable Value
Accts.
Rec.
Accts.
Rec.
Sales
Bad
Debts
Exp.
Income
Statement
Focus
All. for
Doubtful
Accts.
Balance
Sheet Focus
All. for
Doubtful
Accts.
Balance
Sheet Focus
7-34
C2
Notes Receivable
$1,000.00
Term
Payee
July 10, 2011
Ninety days
after date I promise to pay to
Principal
the order of Barton Company, Los Angeles, CA
One thousand and no/100 ——————————— Dollars
Payable at
First National Bank of Los Angeles, CA
Maker
Interest Rate
12% per annum
Value received with interest at
No.
42
Due Oct. 8, 2011
Julia Browne
Due Date
7-35
C2
Principal
of the
note
Interest Computation
×
Annual
interest
rate
Even for
maturities less
than one year,
the rate is
annualized.
Time
× expressed
in years
=
Interest
If the note is
expressed in
days, base a
year on 360
days.
7-36
C2
Computing Maturity and Interest
On March 1, 2011,
Matrix, Inc. purchased a
copier for $12,000 from
Office Supplies, Inc.
Matrix gave Office
Supplies a 9% note due
in 90 days in payment
for the copier.
What is the maturity
date of the note?
7-37
C2
Computing Maturity and Interest
Days in March
Minus the date of the note
Days remaining in March
Days in April
Days in May to maturity
Period of the note in days
31
1
30
30
30
90
The note is due and payable on May 30, 2011.
How much interest will Matrix pay to Office
Supplies, Inc. on this note?
7-38
C2
Computing Maturity and Interest
Principal
of the
note
×
Annual
interest
rate
$ 12,000
×
9%
Time
× expressed = Interest
in years
×
90/360
=
$
270
Total interest due
at May 30.
7-39
P3
Recognizing Notes Receivable
Here are the entries to record the note on
March 1, and the settlement on May 30, 2011.
Mar. 1
Notes Receivable
Sales
DR
12,000
CR
12,000
Sold goods in exchange for note
DR
12,270
May 30 Cash
Interest Revenue
Notes Receivable
CR
270
12,000
Collected note and interest due
7-40
P3
Recording a Dishonored Note
On May 30, 2011, Matrix informs us that the
company is unable to pay the note or interest.
Accounts Receivable – Matrix
Interest revenue
Notes Receivable
12,270
270
12,000
To charge accounts receivable for dishonored
note
7-41
P3
Recording End-of-Period Interest
Adjustments
On December 1, 2011, Matrix, Inc. purchased a
copier for $12,000 from Office Supplies, Inc. Matrix
issued a 9% note due in 90 days in payment for the
copier. What adjusting entry is required on
December 31, the end of the company’s accounting
period?
$12,000 × 9% × 30/360 = $90
Dec. 31 Interest Receivable
Interest Revenue
DR
90
CR
90
To accrue interest on note
7-42
P3
Recording End-of-Period Interest
Adjustments
Recording collection on note at maturity.
Days in December
Minus the date of the note
Day remaining in December
Days in January
Days in February
Days in March until maturity
Period of the note in days
Mar. 1
31
(1)
30
31
28
1
90
DR
12,270
Cash
Interest Receivable
Interest Revenue
Notes Receivable
CR
90
180
12,000
To record full payment of note
7-43
C3
Disposing of Receivables
Companies sometimes want to convert
receivabl…
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