Chapter 1: A Framework for Financial Accounting

1. Revenue
● Revenue-​ amounts earned in a normal course of business
● Expenses-​ costs of providing those products or services to customers
● Net Income​- the difference between revenue and expenses
○ Net Income = revenue- expenses
● Net income is the most important number because it shows how a company is financially
performing and how investors and stakeholders judge a company
● Net income is based on a quarterly and yearly basis
● Dividends-​ net income that you give back to the owner/ shareholder; they are not an
expense
○ Young companies usually don’t give dividends because they want to keep the
money to grow the business but companies such as Walmart give dividends
since they don’t necessarily need the money for new products
2. Accounting Equation
● Assets-​ the resources of a company has to generate revenue
○ Assets = Liabilities + Equity
○ Employees do not count as assets from an accounting perspective
○ Land is only an asset if you own it not rent or lease it
● Accounts Receivable-​ Money owed to a company by it debtors; the service has been
performed
● Notes Payable​- a long term liability Ex. a loan
● Accounts Payable​- Money owed by a company to a creditor for a short term Ex. a bill
● Liabilities-​ amounts owed to creditors; money borrowed from a bank so debt is a liability
Ex. if you owe someone $20 for washing a car
● Stockholder’s Equity​- represents the investors “stake” in the business; investors or
owners own all the resources not owed to creditors
3. Economic Entity
● Transactions associated with a business must be separately recorded from those of its
owner or other businesses
● Separate accounting records
● Sets boundary around the business
● Methods to Organize a Business
○ Sole Proprietorship- one single owner
■ Ends at owners death
■ Owner is personally liable
■ Owner pays tax on proprietor’s earnings
○ Partnership- two or more owners
■ Partners are personally liable
■ Terminates at partner’s choice of death
■ Not taxed; partners pay taxes on their share of earnings
○ Corporation- a separate legal entity with 1 or more stockholders
 ■ Life of the entity is indefinite
■ Stockholders are not liable
■ Separate taxable entity; corporation pays tax
○ LLC- 1 or more partners but each is responsible for own actions
■ Life of the entity is indefinite
■ Members are not liable
■ Not taxed; partners pay tax on their share of earnings
4. Purposes of Accounting
● 2 primary functions
○ Measure the activities of a company
■ Record different business activities as journal entries using debts and
credits
■ Follow the rule of GAAP
○ Communicate these measures
■ Recorded business events are summarized in 4 financial statements
■ Financial statements are published for people or stakeholders
5. Who Consumes Financial Information
● The company itself- management and employees
● Investment analysis
● Creditors
● Suppliers
● Stockholder’s and board of directors
● Customers and other strategic partners
● Regulators and tax authorities
● Voters and government
6. Communicating through the 4 Financial Statements- Financial statement are periodic reports
published by the company for the purpose of providing information to external users
1. Income Sheet
a. Reports a company’s revenues and expenses​ over a period of time
b. Was the company able to generate enough revenue to cover the expenses of
running the business
c. Net Income= revenue- expenses
d. Based on the key concept of profitability
e. Profit, income, earning are also synonymous for net income
2. Balance Sheet
a. Reports a company’s financial position ​at a point in time
b. Reports what resources (assets) a company has and how those assets were
sourced (liabilities) and (equity)
c. Based on the key concept of the accounting equation
d. Assets (cash, accounts receivable, supplies, inventory, equipment, land) =
Liabilities (notes payable, salaries payable, utilities payable) + Equity
(common stock, retained earnings)
e. Notes payable - people you owe money
 f. It is called a balance sheet because the assets is on one side and liabilities and
shareholder’s equity is on the other side
g.
3. Statement of Stockholder’s Equity- a detailing of how stockholder’s equity accounts
changed over the year
a. Contributed Capital​ - represents the stockholder’s net contributions to the
company typically in these accounts
i. Common stock
ii. Preferred stock
iii. Treasury stock
iv. Additional paid in capital
b. Retained Earnings​- the net income generated over the life of a company that
wasn’t distributed as dividends to shareholders; what is left over
i. The link between the income statement and balance sheet
ii. Net income flows into retained earnings via the retained earnings
calculation
iii. Ending retained Earnings = Beginning retained earnings + net income -
dividends
iv. The key to the linkage
4. Statement of Cash Flows- provides more insight into the Shareholder’s Equity portion of
the balance sheet
a. Provides detail over how cash was increased and decreased over the period
b. All cash flows fall into one of 3 categories
i. Operating activities​- cash flows from day to day operations of the
business Ex.cash generated from selling coffee
ii. Investing activities-​ cash flows related to the purchase and sale of
investments and long term assets Ex. cash made from equipment
investments such as a bean grinding machine
iii. Financing Activities​- cash flows form transactions with lenders
(borrowing and repaying) and stockholders (issuing stock and paying
dividends). Ex. cash made from investments
c. We want to know how much cash was generated during the period and how
● 1,3,4 are measured over a period of time; they are flow documents
● These four statements are linked together
● On the balance sheet the categories of Cash, Retained Earnings, and Total
Stockholder’s Equity all have subcategories
● Net income - retained earnings = dividends

Chapter 2: The Accounting Cycle

● Assets (resources) = Liabilities + Stockholders’ Equity
● Equation must balance
● If an event increases on one side it must increase on the other side
 ● Pre-paid rent is an asset
Revenue Recognition Principle
● Receiving cash in advance for future golf lessons does not cause revenue to increase
because the service has not been performed
○ Cash would increase and so would liabilities since we owe them a service
The Accounting Cycle- Big Picture
● Analyze the transaction and record it in debit/credit format
○ Chronological list of journal entries
● Post the debits and credits to a T account
○ Each account has one T-account that summarizes the activity in that account and
has a total final balance
● Prepare a trial balance
○ A report that lists each account one time with it’s final balance and ensures total
debts= total credits
● Prepare financial statements
○ Use the balances to create the Balance Sheet, Income Statement, Statement of
SE, and the Cash Flow Statement
Debits and Credits- How They Work
● When you want to increase an asset account you debit the account
○ When you want to decrease an asset you credit the account
● When you want to increase a liability or stockholder equity account you credit the
account
○ When you want to decrease a liability or stockholder equity you debit the account
● DEALOR
○ Dividends, Expenses, Assets
■ As the account increases, you debit the account and as the account
decrease you debit the account
○ Liabilities, Owner’s Equity, Revenues
■ As the account increases, you credit the account and as the account
decreases you credit the account
● Debits always equal credits
● Posting- the process of transferring the debit and credit information from the journal to
individual accounts in the general ledger
● Trial Balance- a list of all accounts and their balances at a particular date
○ Its purpose is to show that total debits = total credits
○ It also helps adjusting (internal) entries as we learn in Chapter 3
○ It is not a required and published statement- it is used for internal purpose only
● deferred revenue is a liability
● Dividends decrease retained earnings
● Financial statements do not happen in a vacuum- they are all related
 Type of Account (Asset, Normal Balance (Debit or
Liability, Revenue, Expense, Credit)
Dividend)

2. Common Stock Equity Credit

3. Prepaid Rent Asset Debit

4. Buildings Asset Debit

5. Utilities Expense Expense Debit

6. Equipment Asset Debit

7. Rent Expense Liability Credit

8. Notes Payable Liability Credit

9. Salaries Expense Expense Debit

10. Insurance Expense Expense Debit

11. Cash Asset Debit

12. Service Revenue Revenue Credit

Practice Problems
● Accounts receivable is when you do something on account
● Supplies vs supplies expense
○ Supplies expense is an expense
○ Supplies is an asset
● Pay employee salaries of $2,800 for the current month is a salaries expense of
$2800 and cash credit of $2800
● Pay office rent of $4,000 for the current month.
○ Rent Expense of $4,000
○ Cash of $4,000
● Receive cash of $4,600 in advance from a customer who plans to have his house
painted in the following month.
○ Cash of $4600
○ Deferred Revenue $4,600
● Sum​mer Leasing received $11,400 from a customer to cover 24 months of rent in
advance.
○ Debit Cash;
○ credit Deferred Revenue
● Clement Company paid an account payable related to a previous utility bill of $1,050.
○ Debit Accounts Payable $1,050,
○ credit Cash $1,050.
 ● Olivia decides that she will need insurance for a one-day special event at the end of the
month and pays Eli $300 in advance.
○ Cash
○ Deferred Revenue
● Pay employees $900 for work performed.
○ Salaries expense
○ Cash

Chapter 3: The Accounting Cycle- End of Cycle

● Revenue Recognition Principle- we should recognize (record) revenue in the accounting
period which we ​EARN​ it, not necessarily in the period in which we receive cash
○ If you book a cruise in 2015 and pay for it but the cruise is not until April 2016,
the cruise agency reports in after the cruise has taken place
● The Matching Principle- a primary goal of accrual accounting is to appropriately match
expenses with the revenues they generate
○ March- cash outflow for purchase of supplies (expense is not recognized)
○ April - cash outflow for purchase and use of fuel (expense because it is used
within the same month)
○ May- cash outflow for payment of salaries
● Cash flows do not equal expense revenues
● Revenue is recognized once a service is performed
Practice
● Receive $1200 for services that will be provided next month (there is no revenue
because the service has yet to be performed)
○ Debit Cash $1200
○ Credit Deferred Revenue $1200
● Perform $900 of services during the month and bill customers who will pay next month
(revenue because the service has been performed)
○ Debit Accounts Receivable $900
○ Credit Services
● Perform $2300 of services during the month and receive full cash payment (revenue)
○ Debit Cash $2300
○ Credit Revenue
● Pay $600 cash to employees for work performed during June (expense)
○ Debit Salaries Expense $600
○ Credit Cash $600
● Receive a $200 telephone bill ​for (tell us the $200 relates to June)​ the month of June,
but Bronco does not plan to pay the bill until early next month.
○ Debit Utilities Expense
○ Credit Accounts Payable
● Pay $500 on account for supplies purchased last month. All supplies were used last
month.
 ○ Debit Accounts Payable $500
○ Credit Cash $500
Why do We Need Adjusting Entries?
● Adjustments are required to more accurately report a company’s financial performance
● Accountant Often Categorize Adjustments into 4 categories:
○ Cash is paid or received before expenses or revenues are recognized
■ Prepaid Expenses (Prepaid Rent, Prepaid Insurance)
■ Unearned Revenues (Deferred Revenues)
○ Cash is paid or received after expenses or revenue is recognized
■ Accrued Expenses (Accounts Payable)
■ Accrued Revenues
● An internal transaction is recorded to recognize the rent expense incurred and reducing
the asset of prepaid rent
● This is a debit to the expense and a credit to the asset
● If Eagle paid for rent for 12 months the journal would look like
○ Debit Rent Expense (+E, -SE) $500
○ Credit Prepaid Rent (-A) $500
● Supplies Expense
○ When supplies are purchased they are an asset; when they are used, they are
expensed
○ An internal transaction is recorded to recognize the supplies used/expensed
○ This is a debit to the expense and a credit to the asset
■ Debit Supplies expenses (+E, -SE) $1000
■ Credit Supplies (-A) $1000
● Depreciation- as an asset is “used up” the original cost of that equipment must be
allocated. It allocates the cost of that asset over it’s useful life
○ Equipment is assumed to be used over the the next 5 years (60 months) so $400
is allocated to each month
● An internal transaction is recorded to recognize the cost of “using up” some of that asset
● The is a debit to the expense and a credit to a new “contra asset” account called
Accumulated Depreciation
○ Debit Depreciation Expense (+E,-SE) $400
○ Credit Accumulated Depreciation (-A) $400
● Deferrals/Prepayments- cash happens first
○ Prepaid expenses- we paid cash before we incurred the expense (example is
prepaid rent, supplies or depreciation)
○ Unearned revenues- we received cash before we earned the revenue (example
is unearned revenue)
○ Depreciation- we have “used up” some of the value of our equipment.
● Accruals- cash happens later
○ Accrued Expenses (Payables):​ We incur the expense and record the liability
before we pay the cash (example is accounts payable)
 ○ Accrued Revenues (Receivables):​ We recognize the revenue and record an
asset but receive the cash later (example is accounts receivable)
● Accrued Expense
○ A liability account used to record our purchase of goods or services on account.
It represents cash “we owe to another party”. Examples include salaries, interest,
utilities
○ This is a 2 Step Process
■ 1. Expense is incurred and Accounts Payable is recorded
■ 2. Cash is spent and Accounts Payable is decreased
● Accrued Revenue
○ An asset account used to record the sale of goods or services on account. It
represents cash “owed to us”.
○ This is a 2 Step Process
■ Revenue earned and Accounts Receivable recorded
■ Cash received and Accounts Receivable decreased
● Prepare Closing Entries
○ Transfer “temporary” accounts (Revenues, Expenses and Dividends) to retained
earnings •
○ Increase the retained earnings account by the amount of revenues and decrease
retained earnings by the amount of expenses and dividends.
○ The balance of each revenue, expense, and dividend account equals zero after
closing entries.
○ Closing entries do not affect the balances of permanent accounts other than
retained earnings.
○ Closing entries/temporary accounts show a company did this year rather than
since the company began
● 6 step Process:
○ record the transactions during the accounting period
○ Write down the initial trial balance
○ Do adjusting entries
○ Do adjusting trial balance- put all impacted accounts into trial balance
○ Do closing entries
○ Post-closing trial balance

Chapter 4: Cash & Internal Controls

● The Association of Certified Fraud Examiners estimate that companies lost 7% of
revenues to employee fraud
● 2 types of fraud
○ Missing Resources (lower-level employees)
○ Financial Statement Manipulation (management
● To minimize fraud and errors we need internal controls
● Internal Controls​ – Procedures, policies, activities that the company follows to:
 ○ Safeguard the company’s assets
○ Improve the accuracy and reliability of accounting information
● Examples of controls include locks on doors, passwords, and
● Preventative Controls
○ Separation of Duties​ – authorizing, recording and maintaining control of
accounting transactions should be separated. If you have physical control over
the assets you should not have access to the accounting records
○ Physical Controls ​– Assets and accounting records should be secured
○ Proper Authorization​ – Who is authorized to make purchases, etc..
○ Employee Management​ – Having appropriate guidance
● Detective Controls
○ Reconciliations​ – Do the physical assets (cash, inventory etc.) match the
accounting records?
○ Performance Reviews and Checks​ – Actual performance
● Internal controls can be circumvented by collusion among employees.
● Collusion-​ Two or more employees working together can hide embezzlement by
covering for each other. No system can completely prevent fraud.
● Sarbanes Oxley Act of 2002 - a U.S. federal law that aims to protect investors by making
corporate disclosures more reliable and accurate. The Act was spurred by major
accounting scandals, Billions of dollars were lost as a result of these financial disasters.
○ Section 404 mandates an internal audit framework and requires public
companies' annual reports to include the company's own assessment of internal
control over financial reporting, and an auditor's attestation
● We need strict controls because it is really easy to steal and manipulate
● Cash is comprised of multiple things:
○ Bills and coins
○ Balances in accounts
○ Checks from customers
○ Any short term securities that can be converted to cash within 3 months (lending
money to the bank and getting it back with interest at a later date to grow money)
● Controls for Cash Coming INTO the Business
○ Record all cash receipts ASAP
○ Open mail each day and make a list of all checks received
○ Split the duties (separation of duties) of:
■ who receives the cash/checks and
■ who deposits cash/checks to the bank and
■ who records the deposit in the accounting records
○ Verify deposit slips against accounting records
○ Accept credit and debit cards – less cash to worry about
● Controls for Cash Going OUT of the Business
○ Make as many disbursements as possible with checks or credit/debit cards
providing a permanent record
○ Use numbered checks
 ○ Require authorization for expenditures and require multiple signatures on higher
amount checks
○ Periodically check debit/credit card statements against purchase receipts
○ Separate (separation of duties) the tasks of:
■ approving disbursements
■ writing the check
■ recording the transaction.
● Reconciling the bank statement is one of the most important “cash” controls
● Matches company’s records (book) with bank’s records (bank)
● Differences due to:
○ Timing = company records transactions either before or after bank.
■ Example 1: company pays supplier with a check.
■ Example 2: company sells tickets for cash
■ Example 3: bank fees (service fees)
■ Example 4: electronic funds transfer
○ Errors = accidental (company or bank) or intentional (probably company only)
Reconciliation Process
● The Process​ - obtain bank statement and cash receipts and disbursements (companies
records)
1. Reconcile the BANK cash balance = look at bank statement and determine which cash
transactions have been recorded by company and NOT bank.
a. Write down ending bank cash balance
b. Deposits outstanding: Add company cash receipts not in bank statement
c. Checks outstanding: Subtract company cash disbursements not in bank
statement (hint: look at check numbers)
d. Adjust for Errors
e. Total = Bank Balance per reconciliation
2. Reconcile the COMPANY cash balance = look at company ledger and determine which
cash transactions have been recorded by bank and NOT company.
a. Write down company ending cash balance (aka ledger)
b. Add bank cash receipts not in company ledger
c. Subtract bank disbursements not in company ledger (hint: look at check
numbers)
d. Adjust for Errors
e. Total = Company balance per reconciliation
3. Compare RECONCILED amounts (should be the same)
4. Update Cash (make JEs) = reflect in company cash account all items from #2

Chapter 5: Receivables and Sales

● Net Sales
○ Trade Discounts
 ○ Sales Discounts
○ Sales Allowances
○ Sales Returns
● Net Realizable Value for Accounts Receivable
● Trade Discount-​ A reduction in normal listed price…just putting something on sale. If a
customer takes them up on the offer, the trade discount is considered directly in the
revenue calculation.
○ Debit Accounts Receivable
○ Credit Service Revenue
● Sales Discount​- Reduces the amount to be paid by a credit customer if they make the
payment in a specified period of time.
○ Debit cash and Sales Discount and credit Accounts Receivable
● Sales Allowance​- – Customer is unsatisfied with product or service and the seller
reduces the customer’s balance owed.
○ Let’s assume something went wrong during the event. The customer complains
and we agree to a $100 reduction in price. This can be directly applied to their
accounts receivable balance.
○ Debit sales allowance
○ Credit accounts receivable
● Sales Return​ – Customer is unsatisfied and returns the product •
○ We reduce the AR balance if it was on account
○ We issue a cash refund if the sale was for cash
○ Debit Sales Return
○ Credit Cash/Accounts Receivable
● Net Sales Revenue = Total Sales Revenues- Discounts - Allowances
○ These accounts are called contra-revenue accounts and reduce overall revenue
● It is not very likely that a company collects all of its accounts receivable (aka customers
pay the bill)
● “Net Realizable Value” ​– this represents the amount of cash we expect to collect and
is a way we account for that fact that not everyone is going to pay their bills
● Net Realizable Value = Accounts Receivable- Allowance for Uncollectible Accounts
● 2 Methods for Reporting at Net Realizable Value
○ Allowance Method​- Companies “estimate” future uncollectible accounts and
record those estimates now – recognize the expense of non payment NOW •
○ Direct Write Off Method-​ Leave it on the books until we know for sure we won’t
collect and then recognize the expense
● The Allowance Method – 3 Types of Entries
○ Entry 1) Year End Adjusting Entry
■ This is the only entry in the process that recognizes an actual expense
■ This is based on an estimate
○ Entry 2) Write Off an account when it is determined uncollectible
■ This entry “uses up” some of the Allowance set up in entry 1
■ It is not an additional expense
 ○ Entry 3) Collection of an account previously written off
■ This entry is a two step process a) reinstate account then b) show
collection of cash
● Bad debt expense causes income to decrease
● Allowance for Uncollectible Account decreases assets on the balance sheet because it
is a contra asset
● Notes Receivable – similar to accounts receivable but more formal credit agreements
○ Can be current or long term – depending on expected collection date

Chapter 6: Inventory and Cash Sales

● Inventory-​ products a company intends to sell to customers in the ordinary course of
business
○ A current asset on the balance sheet
○ Also includes items that are not yet finished products
○ Merchandise Company
■ Wholesaler
■ Retailer
○ Manufacturing Company
■ Raw Materials
■ Work in Progress
■ Finished goods
● The way accounting rules are written assume you are a manufacturing company
because it is based around owning tangible items
● Recording Inventory Entries: Record the purchase of the inventory
○ Debit Inventory
○ Credit Cash
● Record the Sale to Customers
○ Debit Cash
○ Credit Revenue
○ Debit Cost of Goods Sold
○ Credit Inventory
● Gross Profit = sales - cost of goods sold
● Gross Profit Percentage = gross profit/sales
● 4 Inventory Cost Flow Methods
○ First In-First Out (FIFO)- the first item in is the first one purchased by the
customer Ex. sell the older milk first
○ Last In- First Out (LIFO)- the newest items are the first ones purchased by the
customer Ex. a mountain of coal where the newest coal is delivered
○ Weighted Average
○ Specific Identification
■ Physical inventory flow is exactly matched to cost flow
■ Used for expensive products, low sales volume,
 ■ Usually too expensive and time consuming

Chapter 7: Long-Term Assets

● Recording Long Term Assets- Property, Plant, & Equipment (PP&E)
○ Cost + expenditures necessary to get the asset ready for use
○ Would be found under the notes section
● We use the term “capitalize” to describe recording the expenditure as an asset
● This category (PP&E) consists of land, land improvements, buildings, equipment and
natural resources.
● Capitalize or Expense
○ Capitalizing is trying to renovate something and is an asset whereas repairing
something is maintenance and therefore an expense
○ Expense: Expenditures related to our assets will come up (repairs, maintenance,
litigation, etc..)
○ Capitalize (debit the asset account) if the spend increases future benefits
■ Addition to the asset (capitalize)
■ Replacement of part of the asset (capitalize)
○ Expense (debit an expense account) if the spend only benefits the current period
■ Research and Development (expense)
■ Oil change
● Accumulated Depreciation
○ Part of the adjusting entry process
○ A contra-asset account so normal balance would be a credit
○ Accumulates each year
● Historical Cost – the original cost assigned to the asset when it was purchased
● Book Value – Historical cost minus accumulated depreciation
● Service Life – How long does the company expect to use the asset before disposing of it
● Residual Value – What will the asset be worth at the end of it’s life?
○ An example would be a forklift you use for 10 years
● Depreciable Cost – Historical cost minus Residual Value – this represents the total
amount of depreciation you expect over the life of the asset
● 3 Primary Methods to Calculate Depreciation:
○ Straight-line
○ Double-declining Balance
○ Activity Based
● Straight Line Depreciation- An equal amount of depreciable cost is allocated to each
year of the asset’s service life.
Depreciable Cost
○ Depreciation Expense = Asset′s Cost− Residual V alue
Service Lif e = Service Lif e
● Double Declining Balance- Accelerated depreciation method – more depreciation in the
earlier years but lower in the later years Ex. buying a new car
○ Figure out SL rate: 1 / 5 years = 20%
○ Calculate DDB rate: 2 x SL rate or 2 x 20% = 40%
 ○ Book Value x DDB rate: Year 1: $40,000 x .40 = $16,000
○ Year 2: $24,000 x .40 = $9,600
○ Book Value = Cost – Accumulated Depreciation to date
● Activity Based Depreciation- Allocate the asset’s cost based on it’s use
Depreciable Cost (Cost−Residual V alue)
○ Compute the rate per unit: = ​ T otal U nites Expected to be P roduced
○ Multiply this per unit rate x # of units each period = Depreciation each year
○ Book value= cost - depreciated cost
● Partial Year
○ $7000 x 2/12 = $1167. So year 1 depreciation is $1167.
● Change in Estimates- Estimates of residual value and service life can change. If this
happens, you always make the change for future periods, not in prior periods
● Sale of an Asset
○ Gains and losses are on the income statement
○ Gain- when an asset is sold above the book value; it is a credit like a revenue
○ Loss- when an asset is sold below the book value; it is a debit like an expense
○ Gain or Loss = Sales Amount - Book Value
○ Debit Cash and Accumulated Depreciation
○ Credit Equipment and Gain
○ This is not a core operation; it is a side project
● Granite Stone Creamery sold ice cream equipment for $12,000. Granite Stone originally
purchased the equipment for $80,000 and depreciation through the date of sale totaled
$66,000. What is the gain or loss on the sale of the equipment?
○ Gain or Loss = Sales Amount - Book Value
○ $12,000- $14,000= ($2000)
● Intangibles- Assets with no tangible, physical substance but they are often very valuable
○ Patents, Copyrights, Trademarks, Franchises and Goodwill
● Patents​- Exclusive right to manufacture a product or use a process. Granted for a 20
year period.
○ Record at cost to purchase + legal fees
○ Research and Developments costs are expensed (not included in the asset)
● Copyrights-​ Exclusive right of protection for a published work such as a song, film,
painting, software. Good for the life of the creator + 70 years.
○ Record at cost to purchase + legal fees
● Trademarks​- A word slogan or symbol that distinctively identifies a company, product, or
service. Good for 10 years plus renewals.
○ Difficult to grow internally…advertising is an expense
○ Can include attorney fees, successful legal defense
● None of this shows up on the balance sheet unless we buy it
○ This is because we cannot accurately assess what the value of say a drug is
● If a company buys something say a drug from another company
○ Debit patent
○ Credit cash
 ● Goodwill- Represents the value of company as a whole, over and above the value of its
identifiable assets; if you buy a company for more than its assets
○ Only obtain Goodwill from buying another company
○ Example: Amazon buys Whole Foods. They paid $13 billion. The fair value of
Amazons assets (less liabilities) was $4 billion.
○ The $9 billion difference is Goodwill.
○ Fair Value of net assets (assets - liabilities) is $4 billion
● The balance sheet contains goodwill
● Goodwill is only recorded when we buy a company
● You cannot “build up” goodwill
● Depreciation​ – allocating the cost of property plant and equipment to an expense
● Depletion​ – allocating the cost of natural resources to an expense
● Amortization-​ allocating the cost of intangible assets to an expense
○ Usually straight-line
○ Land and intangible assets with indefinite useful lives are not subjected to
amortization
○ Goodwill is not amortized but can be “impaired”.

Chapter 8: Current Liabilities

● Liability
○ A present responsibility to another entity
○ Represents a probable, future sacrifice of economic benefits
○ It results from past transactions or events
● Current Vs. Long-Term Liabilities
○ Current- Payable within one year
○ Long-Term- Payable more than one year
○ You would rather classify your liability as a long term
● Current Portion of Long-Term Debt​- • Current portion of long term debt is the amount
of a long term loan that must be repaid within the next year
● Notes Payable-​ Now we are borrowing the money… this means a Note Payable
in our liabilities and interest expense
○ Montrose Corp borrows $400,000 on Oct 1, 2014 signing a 3%, 6 month note to
be paid six months later on April 1 2015.
○ 1-Oct
■ Debit Cash 400,000
■ Credit Notes Payable 400,000
○ 31- Dec
■ Debit Interest Expense 3000 (0.3*(3/12))
■ Credit Interest Payable 3,000
○ 1-Apr
■ Debit Interest Expense 3,000
■ Credit Cash 3,000
 ■ Debit Interest Payable 3,000
■ Credit Cash 3,000
■ Debit Interest Payable 400,000
■ Credit Cash 400,000
● Deferred Revenue
○ Applies to gift cards, magazine subscriptions, airline or other travel, season
tickets to a sports team
● Sales Tax Payable-​ If you are a company selling a product subject to sales tax, it is your
responsibility to collect that sales tax on behalf of the customer and remit it to the
government.
● Let’s say I go to the DU bookstore and buy a new sweatshirt for $42. The sales tax is
7.65%.
○ Debit Cash $45.21
○ Credit Sales Revenue $42
○ Credit Tax Payable $3.21
○ Debit Sales Tax Payable $3.21
○ Credit Cash $3.21
● Contingent Loss and Contingent Gain
○ Debit Loss
○ Credit Contingent Liability
● If you are sued and may have a gain from the litigation do not record until it is certain
○ With a gain contingency perspective you just disclose; conservatism principle at
work!
● Working Capital​ – “after paying our obligations how much will we have to work with?”
○ Working Capital = Current Assets - Current Liabilities
● Current Ratio​ – a current ratio > 1 indicates that there are more current assets than
current liabilities
Current Assets
○ Current Ratio = Current Liabilities
○ A current ratio of 1.3 says “for every $1 of current liabilities the company has
$1.30 of current assets”
● Liquidity​ - Refers to a company’s ability to pay it’s current liabilities
● Solvency​ – Refers to a company’s ability to pay it’s long term liabilities as well

Notes Payable and Interest Journal Entries

On November 1, 2016, Marketing Research Inc. borrows $80,000 cash from GBC Bank. Marketing
Research Inc signs a six-month, 6% note payable. Interest is payable at maturity. Marketing Research
Inc.’s s year-end is December 31.

1) Record the issuance of the note on November 1, 2016.

● Debit cash $80,000
● Credit Notes Payable $80,000
 2) Record the adjusting entry made by Marketing Research on December 31, 2016.
● Debit Interest Expense $800
● Credit Interest Payable $800
3) Record the payment of the note at maturity.
● Debit Interest Expense $1,600
● Credit Cash $1,600
● Debit Interest Payable $800
● Credit Cash $800
● Debit Note Payable $80,000
● Credit Cash $82,400

Contingencies

Pacific Cruise Lines is a defendant in litigation involving a swimming accident on one of its three cruise
ships. For each of the following scenarios, determine the appropriate way to report the situation.
Explain your reasoning and record any necessary entry.

1. The likelihood of a payment occurring is probable, and the estimated amount is $1.2 million.
● Debit loss
● Credit contingent liability
2. The likelihood of a payment occurring is probable, and the amount is estimated to be in the
range of $1 to $1.5 million.
● When there is a range take the low end of the range
● Debit loss
● Credit Contingent Liability
● Credit Disclosure
3. The likelihood of a payment occurring is reasonably possible, and the estimated amount is
$1.2 million.
● Disclose it in the footnotes only
4. The likelihood of a payment occurring is remote, while the estimated potential amount is
$1.2 million.
● Leave it off

Chapter 9: Long-Term Debt

● Assets = Liabilities + Stockholders’ Equity
● 2 primary sources of external financing
○ Debt Financing - borrowing money “liabilities”
○ Equity Financing- obtaining additional investment from stockholder “Stickholder’s
Equity
● Capital structure​- the mix of debt and equity
● A common method to measure a company’s risk, is the debt to equity ratio.
 ○ Total Liabilities/ Total Stockholders Equity
● In general – the higher a debt to equity ratio, the higher the risk
● Bond-​ is a fixed income instrument that represents a loan made by an investor to a
borrower (typically corporate or governmental).
● Most common form of corporate debt is bonds
● 2 Parts to a Bond
○ Obligation to pay the principal or “face value” at the maturity date
○ Cash interest payments usually 2 x a year
● Why a Bond and not Notes Payable
○ More lenders
○ Usually longer term (10 year; 20 year)
○ Lower rates
○ Bond issuance costs can be high – underwriter fees, SEC filings, etc. but usually
if the amount is over 20 million it is more favorable to issue a bond than borrow
from the bank.
● Issue Price or “Price” of a bond ​– How much cash you got from investors for the bond.
● Face Value ​– The stated amount on the bond contract to be paid back at maturity.
● Stated Rate​: This is the rate quoted in the bond contract and it is used to calculate the
cash payments for interest
● Market Rate​: This is the true interest rate available “today” for this type of bond
● Example:
○ At Face: Bond issued at $100,000. To be paid back to investors at face value of
$100,000
○ At Discount: Bond issued at $95,000. To be paid back to investors at face value
of $100,000
○ At Premium: Bond issued at $105,000. To be paid back to investors at face value
of $100,000
● Why Do We need Discounts and Premiums
○ Because Stated Rate may not equal market rate
○ Stated Rate – Amount written on bond certificate
○ Market Rate – Prevailing market rate of similar bond at a point in time…if I were
to create this bond certificate today what is the current bond market rate?
● Bond Pricing
○ Issue Price of the BondPresent Value of the Face Amount + Present Value of the
Periodic Interest Payments
● Recording Bond Journal Entries –At Face
● Same example - $100,000 face; 10 years; 7% stated rate. Market rate is 7%. Find the
cash proceeds.
○ 1) Find PV of $1 (Note: with Semiannual payments: n = 20; r = 3.5%
■ 1) .50257 x 100,000 = 50,257
○ 2) Find PV of Ord. Annuity of $1
■ 2) 14.21240 x 3,500 (100,000 x .07 x .5) = 49,743.40
○ 3) Add 1+2 = Cash Proceeds
 ■ 3) 50,257 + 49,743 = $100,000
● Recording Bond Journal Entries - at Face
○ At date of issuance
■ Debit Cash
■ Credit Bonds Payable
○ At first Interest Payment
■ Debit Interest Expense
■ Credit Cash
● Recording Bond Journal Entries – At a Discount
○ Same example - $100,000 face; 10 years; 7% stated rate. Market rate is 8%.
Find the cash proceeds
○ 1) Find PV of $1 (Note: with Semiannual payments: n = 20; r = 4%
■ 1) .45639 x 100,000 = 45,639
○ 2) Find PV of Ord. Annuity of $1
■ 2) 13.59033 x 3,500 (100,000 x .07 x .5) = 47,566.16
○ 3) Add 1+2 = Cash Proceeds
■ 3) 45,639 + 47,566.16 = $93,205.16

Chapter 10: Capital Structure- Stockholders Equity

● Advantages of a Corporation
○ Limited Liability
○ Ability to Raise Capital
● Disadvantages of a Corporation
○ Additional taxes
○ More Paperwork
● Accounting Equation
○ Assets = Liabilities + Stockholders’ Equity
● 2 Primary Sources of External Financing
○ Debt Financing - borrowing money “liabilities”
○ Equity Financing - obtain additional investment from stockholders “Stockholder’s
Equity”
● Capital Structure-​ the mix of debt and equity
● 3 Primary Sections of Stockholder’s Equity
○ Contributed Capital-​ amount stockholders have invested in the corporation
(Common stock, Preferred Stock, APIC)
○ Retained Earnings-​ amount of earnings the corporation has retained
○ Treasury Stock- corporations own stock that it has reacquired
● Stockhoder’s RIghts
○ Right to vote in electing board of directors
○ Right to receive dividends
○ Right to share in distribution of assets
○ Do not manage day to day operations
● Common Stock-​ Basic form of stock ownership (includes rights above)
● Preferred Stock: 2 special rights
○ First rights to a specified amount of dividends;
○ Receive preference over common stock holders in the event the corporation is
dissolved.
● Preferred stock are always paid first
● Authorized Stock-​ The maximum number of shares of stock a company is legally
permitted to issue
● Issued Stock-​ Authorized stock that has been sold to the public
● Treasury Stock-​ Stock the company has repurchased back into the corporation
● Outstanding Stock​- Stock owned by investors outside of the corporation
● Par Value-​ is an arbitrary amount assigned to each share of stock when it is authorized.
● Market Price- ​is the amount that each share of stock will sell for in the market.
● No Par Value Journal Entry
○ Debit Cash (price x # of shares)
○ Credit Common Stock
● With Par Value
○ Debit Cash (price x # of shares)
○ Credit Common Stock (price x # of shares)
○ Credit Additional Paid-in Capital (difference)
● Preferred Stock Journal Entry
○ Debit Cash (# of shares x price)
○ Credit Preferred Stock (# of shares x price)
○ Additional Paid-in Capital (difference)
● Why corporations repurchase their stock
○ To boost under-priced stock.
○ To distribute surplus cash without paying dividends.
○ To boost earnings per share.
○ To offset issuance of shares under stockbased compensation plans.
● When we buy back our own stock (treasury stock) we don’t directly reduce our stock
accounts – instead we use a contra equity account called Treasury Stock
● Treasury stock buy back is not an asset because you cannot own shares of your own
company
● Treasury stock buy back reduces total equity account
● If equity accounts such as Common Stock normally have credit balances, what is the
normal balance of a contra-equity account such as Treasury Stock?
● Treasury Buy Back Journal
○ Debit Treasury Stock (shares x price)
○ Credit Cash
● Dividends-​ Distributions paid to stockholders – NOT an expense
● Declaration date ​– the day the board of directors declares a dividend to be paid March
15
○ Debit Dividends
 ○ Credit Dividends Payable
● Record date​ - shareholders of record on a given date March 31
● Payment date ​– date the dividend will be paid April 15
○ Debits Dividends Payable
○ Credit Cash
● Factors to Consider:
○ Interest payments tax deductible; dividends are not
○ Bankruptcy risks
○ Ownership control

Chapter 11: Cash Flow Statement

● The purpose of the cash flow statement is to give more detail to the cash section of the
assets on the balance sheet
● Operating Activities-​ Routine; Cash receipts from revenue Cash payments for
expenses such as paying employees, buying inventory, etc..
● Investment Activities- Cash receipts from selling long term assets or collecting note
receivable
○ Cash payments for buying long term assets or lending long term loans
● Financing Activities​- Cash receipts from borrowing $ or issuing stock
○ Cash payments to repay debt, buy treasury stock, pay dividends
● Indirect Method-​ What is used in practice most commonly
○ Presentation starts with Net Income and goes to the Cash #
● Direct Method-​ FASB is “pushing” this because it is easier for investors to understand
○ Presentation is “Cash Inflows” and “Cash Outflows”
○ Very few companies do direct method
● The net increase on the statement of cash flows should be the same as on the balance
sheet
● Indirect Method Formula:
○ Rule 1: Add non cash expenses (depreciation & amortization)
○ Rule 2: Add losses ; subtract gains (from when you sold equipment)
○ Rule 3: Current Assets; add decreases; subtract increases
○ Rule 4: Current Liabilities; add increases; subtract decreases
○ = Net Cash Flow from Operating Activities
● Cash Flows from Investing Activities
○ Inflows (receipts)
■ lSelling property, plant, and equipment
■ Selling investment securities
■ Collecting loans
○ Outflows (Payments)
■ Purchasing property, plant, and equipment
■ Purchasing investment securities
■ Lending to others
●