Credits are the source; they represent the flow of economic benefit from a source.

(Increase when debited, decrease when credited)

Debits are the destination; they represent the flow of economic benefit to a destination.
(Increase when credited, decrease when debited)

Dividends + Expenses + Assets = Liabilities + Owners Equity + Revenue

Debits Credits

FOB shipping point:

- Buyer pays shipping costs called ‘’freight-in’’
- No entry for seller

FOB destination:
- Seller pays shipping costs called ‘’freight-out’’
- No entry for buyer

When the periodic inventory system is used, the costs of goods sold section in the income statement
must include the following elements:

Purchases – Purchases returns and allowances + freight in = Net cost of purchases

Beginning merchandise inventory + net cost of purchases = cost of goods available for sale

Cost of goods available for sale – ending merchandise inventory = cost of goods sold

Depreciation key concepts:

1. Cost
2. Residual value
3. Depreciable cost: cost – residual value
4. Estimated useful life
The multistep income statement goes through a series of steps to arrive at net income.

1. Net sales: the gross proceeds from sales – sales returns and allowances
a. Returns & Allowances?
b. Sales discounts?
2. Cost of goods sold: the amount a merchandiser paid for the merchandise it sold during an
accounting period.
a. Freight in!
3. Gross margin: net sales – cost of goods sold
4. Operating expenses: expenses incurred in running a business other than the cost of goods
sold.
5. Income from operations: gross margin – operating expenses
6. Other revenues and expenses
7. Income taxes: expense for federal, state, and local taxes on corporate income.
8. Net income: What remains

Closing entries set the stage for the next accounting period, they summarize a periods revenues and
expenses. Only temporary accounts need closing entries.
Closing entries summarize a periods revenues and expenses by transferring this to the
income summary account.
Example of closing journal entry with respect to sales from the same case:
Steps involved making closing entries:
1. Close the credit balance on the income statement accounts to the income summary account
2. Close the debit balance on the income statement accounts to the income summary account
3. Close the income summary account balance to the owner’s capital account
4. Close the withdrawals account balance to the owners capital account.

The cashflow statement focuses on liquidity, cash flows are the inflows and outflows of cash into
and out of a business. Net cashflows are the difference between the inflows and outflows.
The statement of cash flows explains the change in cash in terms of operating, investing, and
financing activities over an accounting period.
There are three major business activities:
1. Cash flows from operating activities: shows the cash produced by business operations.
2. Cash flows from investing activities:
3. Cash flows from financing activities
When the bond price is lower than the face value, the bond sells at discount.
When the bond price is higher than the face value, the bond sells at premium.

Face rate > market rate  premium

Face rate < market rate  discount

Example bond Discount:

2000 bonds with face value €100, a face rate of 9%. The market interest rate is 12%. Bram will
receive €189605, but we have to pay our investors €200000.
The difference between is the bond discount: 200000 – 189605 = €10395

Cash 189605
Unamortized bond discount 10395
@Bonds payable 200000

Straight-line method
Recall: two year life, semi-annual.
- 10395/4 Is therefore the amount unamortized bond discount is credited each period.
- The interest payment is 9% * 200000 /2 = €9000
- The interest expense = interest payment + unamortized bond discount

Bond interest expense 11599

@Cash 9000
@Unamortized bond discount 2599

Effective interest method

A constant interest rate, the effective rate (market rate) is applied to the carrying value.
Recall: discount = €10395 and the market interest rate is 12%
Carrying value in first period = 200000 – 10395 = €189605

Interest expense 1st period = 0.12 * 189605/2 = €11376

Interest payments remain the same, €9000

The amortization in the 1st period is equal to 11376 – 9000 = €2376

Bond interest expense 11376

@Cash 9000
@Unamortized bond discount 2376

For the 2th period: the carrying value = €189605 + €2376 = €191981
Therefore the interest expense = 0.12 * €191981

Bonds discount – effective rate method

Carrying value = face value – unamortized bond discount
Interest expense = carrying value x market rate x time
Interest payment (cash) = face value x face rate x time
Example bond premium
Company Sun Power produces solar panels. Sun Power decided to a convertible bond issue. On April
1, 2021 Sun Power issued eight-year term, unsecured, convertible bonds with a face value of €
30,000,000. In total 60,000 bonds of € 500 were issued. The face interest rate is 5 per cent per year.
Interest is payable semiannually on March 31 and September 30. The bonds were issued for €
32,029,500 implying a market interest rate of 4 per cent. The effective interest method is used to
amortize the premium at which the bonds were issued. Sun Power’s accounting year ends on
December 31.

Prepare the journal entries to record:

1. The issue of the bond on April 1, 2021.
2. The first payment of the interest and the amortization of the premium on September
30, 2021.
3. The accrual of interest and the amortization of the premium on December 31, 2021.
4. The second payment of the interest and the amortization of the premium on March
31, 2022

Bonds premium – effective rate method

Carrying value = face value + unamortized bond premium
Interest payments (cash) = face value x face rate x time
Interest expense = Carrying value x market rate x time
Bond converting
On April 1, 2022 the bondholders present all the bonds for conversion into common shares. The
common shares have a par value of € 100 each. Each set of 10 bonds, each with a face value of € 500,
can be converted into 7 shares.

Additional Paid-In Capital, Common stock = All that is left over.

Lease
Interest expense = interest x present value
Capital lease obligation = annual payment – interest expense

2th period:
New present value = old present value – capital lease obligation
New interest expense = interest expense x new present value

Interest expense = rate * capital lease obligation

Example stocks
Inspired by the holiday season, ROY has started a company in 2014 called Angry Snowman Inc. The
company specializes in making snowmen that people can put in their front yard to show that they are
not in a festive mood and want to be left alone

Suppose that ROY has been authorized to issue 5 million shares of common stock with a par value of
$1 and issues 1 million shares on December 1, 2014
ROY’s shares are issued at a price of €50

Cash 50000000
@Common stock 1000000
@Additional paid in capital 49000000

Assume that ROY decides to buy back 20% of his own outstanding shares (= 200,000 shares)
on December 15, 2014
› Since the issue of the shares, ROY’s share price has risen from $50 to $55
› As a result, ROY has to pay shareholders 200,000 * $55 = $11,000,000 to get his shares
back

Treasury stock, common 11000000

@Cash 11000000
 - For 2014, ROY’s retained earnings equals €100 million (given).
- On December 31, 2014, the stockholders’ equity section of ROY’s balance sheet looks like this:

Treasury stock is treated as a reduction is stockholders equity.

- Two moths later, ROY decides to put half of his treasury stock (100000 shares) back on the
market.
- In the mean time, the share price has risen to €60.
- As a result he receives 10000 * €60 = €6000000

Cash 6000000
@Treasury stock, common 5500000
@Paid-in capital, treasury stock 500000

Now, the stockholders’ equity section of ROYs balance sheet looks like this:
Suppose that ROY wants to reward his stockholders by declaring a 11.11% stock dividend on March
1, 2015
› Recall that there are 900,000 shares outstanding with a par value of $1
› Furthermore, assume that the market price of VLAD’s stock is still $60

› The size of Stock dividends is equal to 900,000 shares * 11.11% = 100,000 shares
› The corresponding market value is $6,000,000 (100,000 shares * $60)

Stock dividends 6000000

@common stock distributable 100000
@Additional paid-in capital 5900000

› On March 31, 2015, ROY has to pay the stock dividends

Common stock distributable 100000
@Common stock 100000

› We also need a closing entry for Stock dividends!

Retained earnings 6000000
@Stock dividends 6000000

Before the stock dividend

After the stock dividend

Example practical

‘’Issued 10000 shares of common stock for a building valued at €88000’’

‘’Sold 4000 shares of treasury stock for €36000’’

This means that they are €9 per share, they were bought for €10 per share.
‘’Declared a cash dividend of €4 per share on preferred stock and €0.40 per share on
common stock outstanding’’

‘’Declared a 5 per cent common stock dividend. The market value on the date of declaration
was €36 per share. The stock dividend was distributed in 2023.

Example in making cash flow statement

› On New Year’s day, 2021, James started his company Resolutions Inc. The company uses
personal trainers to aggressively remind clients of their New Year’s resolutions
› Information for Resolutions Inc. for the year 2021:
The beginning balance of Cash is $42,600
1. Net income is equal to $17,900
2. Depreciation equals $19,300
3. Office equipment that cost $27,000 - with accumulated depreciation of $15,300 - was
sold for $10,700 -> a loss of $1,000!
4. James repaid a note in the amount of $20,000
5. James issued $25,000 of common stock at par value
6. Dividends of $4,300 were also paid

› The following information is available regarding changes in current assets between 2021
and 2022:
7. Accounts receivable decreased by $5,000 -> more cash was collected than sales were
made, so added to net income
8. Inventory decreased by $5,000 -> we used up existing inventory and did not have to
pay for new inventory, so added to net income
9. Prepaid expenses increased by $600 -> we spent additional cash on prepaying
expenses, so deducted from net income

› The following information is available regarding changes in current liabilities between 2021
and 2022:
10. Accounts payable decreased by $1,000 -> we paid more to creditors than our cost of
goods sold indicated, so deducted from net income
11. Income taxes payable decreased by $600 -> we paid more in income taxes than this
year’s income taxes, so deducted from net income
Starting point: Cashflow from operations
› What do we include here?
- 1. Net income ( = $17,900)
- 2. Depreciation ( = $19,300)
- 3. Loss on sale of office equipment ( = $1,000: added back!)
- 7. – 11. Changes in current assets and current liabilities

› Next, we look at cash flows from investing activities › This is where we include the full cash
amount of the sale of our office equipment ($10,700)

› Finally, we look at cash flows from financing activities › This includes the repayment of
notes, issue of common stock, and dividends
Closing entry with respect to sales example:

Interest paid over bonds = authorized number of shares * value * interest rate

Dividends paid = issued number of shares * dividend per share

Costs of goods sold = Purchases + old merchandise inventory – new merchandise inventory

‘’Declared dividend’’  entry!

‘’Date of record dividend’’  no entry!

For a stock dividend, the entry for ‘’Declared dividend’’