Ihe 304

Course code: HE-304
Accounting & Finance

Accounting
• Accounting involves the entire process of identifying, recording and
communicating economic events.
• “Accounting" is the process of measuring, processing, and sharing financial
and other information about businesses and corporations.
• The system of recording and summarizing business and financial
transactions and analyzing, verifying, and reporting the results.
• Accounting is the recording of financial transactions along with storing,
sorting, retrieving, summarizing, and presenting the results in various
reports and analyses.
• Accounting, also known as accountancy, is the measurement, processing,
and communication of financial and non financial information
about economic entities such as businesses and corporations. Accounting,
which has been called the "language of business", measures the results of
an organization's economic activities and conveys this information to a
variety of stakeholders,
[
including investors, creditors, management,
and regulators.
Who uses accounting data?
• Internal user: e.g. marketing managers, production supervisors,
finance directors and other company officers.
• External user: e.g. investors, creditors, regulatory agencies,
customers, labor unions etc.
• Accounting is thousands of years old and can be traced to ancient civilizations. The
early development of accounting dates back to ancient Mesopotamia, and is
closely related to developments in writing, counting and money. Accounting has
existed in various forms and levels of sophistication throughout human history.
The double-entry accounting system in use today was developed in medieval
Europe, particularly in Venice, and is usually attributed to the Italian
mathematician and Franciscan friar Luca Pacioli. The first published work on
a double-entry bookkeeping system was the book, ’Summa de arithmetica,
geometria, Proportioni et proportionalita’ published in Italy in 1494 (by Luca
Pacioli also called the "Father of Accounting"). Accounting began to transition into
an organized profession in the nineteenth century, with local professional
bodies in England merging to form the Institute of Chartered Accountants in
England and Wales in 1880. Today, accounting is facilitated by accounting
organizations such as standard-setters, accounting firms and professional bodies.
Financial statements are usually audited by accounting firms, and are prepared in
accordance with generally accepted accounting principles (GAAP). GAAP is set by
various standard-setting organizations such as the Financial Accounting Standards
Board (FASB) in the United States and the Financial Reporting Council in
the United Kingdom.
• The double-entry system of accounting or bookkeeping means that
for every business transaction, amounts must be recorded in a
minimum of two accounts. The double-entry system also requires
that for all transactions, the amounts entered as debits must be equal
to the amounts entered as credits.
• The Double-entry system is a system of bookkeeping where every
financial transaction is recorded in at least 2 different accounts, with
equal and opposite effects on the respective accounts.
• These rules are needed to ensure that a business always keeps its
accounting equation properly balanced.
The Building Blocks of Accounting
• The Basic Accounting Equation:
Assets are resources a business owns. The business uses its assets in carrying out such
activities as production and sales. The common characteristic possessed by all assets is
the capacity to provide future services or benefits. In a business, that service potential or
future economic benefit eventually results in cash inflows (receipts).
Liabilities are claims against assets—that is, existing debts and obligations. Businesses of
all sizes usually borrow money and purchase merchandise on credit. These economic
activities result in payables of various types.
The ownership claim on total assets is owner’s equity. It is equal to total assets minus
total liabilities. Since the claims of creditors must be paid before ownership claims,
owner’s equity is often referred to as residual equity.
• Transactions (business transactions) are a business’s economic events
recorded by accountants.
• A transaction is a business event that has a monetary impact on an
entity's financial statements, and is recorded as an entry in its
accounting records
• Transactions may be external or internal. External transactions involve
economic events between the company and some outside enterprise.
Internal transactions are economic events that occur entirely within one
company. Companies carry on many activities that do not represent
business transactions. Examples are hiring employees, answering the
telephone, talking with customers, and placing merchandise orders. Some
of these activities may lead to business transactions: Employees will earn
wages, and suppliers will deliver ordered merchandise. The company must
analyze each event to find out if it affects the components of the
accounting equation. If it does, the company will record the transaction.
Transaction Analysis
• Each transaction must have a dual effect on the accounting equation. For
example, if an asset is increased, there must be a corresponding: (1)
decrease in another asset, or (2) increase in a specific liability, or (3)
increase in owner’s equity. Two or more items could be affected.
Transactions:
• Rayan decides to open a computer programming service which he names
Softbyte. On September 1, 2021, he invests Tk.150000 cash in the business.
• Softbyte purchases computer equipment for Tk.70000 cash.
• Softbyte purchases for Tk.16000 from Acme Supply Company, computer
paper and other supplies expected to last several months. Acme agrees to
allow Softbyte to pay this bill in October.
• Softbyte receives Tk.12000 cash from customers for programming services
it has provided.
• Softbyte receives a bill for Tk.2500 from the Daily Ittefaq newspaper for
advertising but postpones payment until a later date.
• Softbyte provides Tk.35000 of programming services for customers.
The company receives cash of Tk.15000 from customers, and it bills
the balance of Tk.20000 on account.
• Softbyte pays the following expenses in cash for September: store
rent Tk.6000, salaries and wages of employees Tk.9000, and utilities
Tk.2000.
• Softbyte pays its Tk.2500 newspaper bill in cash.
• Softbyte receives Tk.6000 in cash from customers who had been
billed for services previously.
• Rayan withdraws Tk.13000 in cash from the business for his personal
use.
Generally Accepted Accounting Principles
• The accounting profession has developed standards that are generally
accepted and universally practiced. This common set of standards is
called generally accepted accounting principles (GAAP). These
standards indicate how to report economic events. Because business
is increasingly conducted across national borders, companies must be
able to use their financial statements to communicate with external
users all over the world. As a result, divergent national accounting
practices are converging to an overall global standard.
A Conceptual Framework of Accounting
• A strong theoretical foundation is essential if accounting practice is to keep
pace with a changing business environment. Accountants are continually
faced with new situations, technological advances, and business
innovations that present new accounting and reporting problems. These
problems must be dealt with in an organized and consistent manner.
• The conceptual framework allows for the systematic adaptation of
accounting standards to a changing business environment. The conceptual
framework outlines the objectives of financial reporting and the qualities of
good accounting information, precisely defines commonly used terms such
as asset and revenue, and provides guidance about appropriate
recognition, measurement, and reporting.
Nature and Components of the FASB’s Conceptual
Framework
• Four major areas:
• 1. Objectives: What are the purposes of financial reporting?
• 2. Qualitative characteristics: What are the qualities of useful financial
information?
• 3. Elements: What is an asset? a liability? a revenue? an expense?
• 4. Recognition, measurement, and reporting: How should the objectives,
qualities, and elements definitions be implemented?
Objectives of Financial Reporting
The key financial reporting objectives outlined in the conceptual framework are as follows:
• Usefulness - Financial reporting should provide information that is useful to present and
potential investors and creditors and other users in making rational investment, credit,
and similar decisions
• Understandability - the information should be comprehensible to user (who has a
reasonable understanding of accounting and business and who is willing to study and
analyze the information presented) of financial reports.
• Target audience: investors and creditors - Although there are many potential users of
financial reports, the objectives are directed primarily toward investors and creditors.
• Assessing future cash flows - Financial reporting should provide information that is useful
in assessing amounts, timing, and uncertainty (risk) of prospective cash flows.
• Evaluating economic resources - Financial reporting should also provide information about
a company’s assets, liabilities, and owners’ equity to help investors, creditors, and others
evaluate the financial strengths and weaknesses of the enterprise and its liquidity and
solvency.
• Primary focus on earnings - The primary focus of financial reporting is information about a
company’s performance provided by measures of earnings and its components.
Qualitative Characteristics of Accounting
Information
• the conceptual framework identifies the qualitative characteristics of

useful accounting information.
• Benefits greater than cost
• Relevance
• Reliability
• Comparability
• Materiality
Elements of Financial Statements
Recognition, Measurement, and Reporting
• Recognition criteria - For an item to be formally recognized, it must meet
one of the definitions of the elements of financial statements.
• Measurement –
• Historical cost is the cash equivalent price exchanged for goods or services at the
date of acquisition.
• Current replacement cost is the cash equivalent price that would be exchanged
currently to purchase or replace equivalent goods or services.
• Current market value is the cash equivalent price that could be obtained by selling
an asset in an orderly liquidation.
• Net realizable value is the amount of cash expected to be received from the
conversion of assets in the normal course of business.
• Present (or discounted) value is the amount of net future cash inflows or outflows
discounted to their present value at an appropriate rate of interest.
• Reporting - The conceptual framework indicates that a “full set of financial
statements” is necessary to meet the objectives of financial reporting.
Assumptions/(principles/constraints) of the Accounting
Model
• Economic entity - The economic entity assumption requires that the activities of the entity be kept separate and distinct
from the activities of its owner and all other economic entities.
• Going concern - In the absence of evidence to the contrary, the entity is viewed as a going concern.
• Accounting period - Because accounting information is needed on a timely basis, the life of a business entity is divided into
specific accounting periods
• Monetary unit - The monetary unit assumption requires that companies include in the accounting records only transaction
data that can be expressed in money terms.
• Historical cost - The cost principle (or historical cost principle) dictates that companies record assets at their cost.
• Revenue recognition - revenue is recognized after the performance obligations are considered fulfilled, and the
amount is easily measurable to the company.
• Matching - The matching principle is an accounting concept that dictates that companies report expenses at the
same time as the revenues they are related to.
• Full disclosure - For financial reporting to be most effective, all relevant information should be presented in an
unbiased, understandable, and timely manner.
• Conservatism - Accounting conservatism is a principle that requires company accounts to be prepared with
caution and high degrees of verification. All probable losses are recorded when they are discovered, while gains can
only be registered when they are fully realized.
• Materiality - the concept that all the material items (all items that are reasonably likely to impact investors'
decision-making) should be reported properly in the financial statements.
The Recording Process
• The Account: An account is an individual accounting record of increases
and decreases in a specific asset, liability, or owner’s equity item. In its
simplest form, an account consists of three parts: (1) a title, (2) a left or
debit side, and (3) a right or credit side.
• Debits and Credits: The term debit indicates the left side of an account, and
credit indicates the right side. They are commonly abbreviated as Dr. for
debit and Cr. for credit. The terms debit and credit use to describe where
entries are made in accounts. For example, the act of entering an amount
on the left side of an account is called debiting the account. Making an
entry on the right side is crediting the account.
• When comparing the totals of the two sides, an account shows a debit
balance if the total of the debit amounts exceeds the credits. An account
shows a credit balance if the credit amounts exceed the debits.
• Under the double-entry system, the dual (two-sided) effect of each
transaction is recorded in appropriate accounts. This system provides
a logical method for recording transactions
• Each transaction must affect two or more accounts to keep the basic
accounting equation in balance. In other words, for each transaction,
debits must equal credits. The equality of debits and credits provides
the basis for the double-entry system of recording transactions. If
every transaction is recorded with equal debits and credits, the sum
of all the debits to the accounts must equal the sum of all the credits.
Steps in the Recording Process
• Practically every business uses three basic steps in the recording
process:
• 1. Analyze each transaction for its effects on the accounts.
• 2. Enter the transaction information in a journal.
• 3. Transfer the journal information to the appropriate accounts in the ledger.
• The recording process begins with the transaction. Business
documents, such as a sales slip, a check, a bill, or a cash register tape,
provide evidence of the transaction. The company analyzes this
evidence to determine the transaction’s effects on specific accounts.
The Journal
• Companies initially record transactions in chronological order (the order in
which they occur). Thus, the journal is referred to as the book of original
entry. For each transaction the journal shows the debit and credit effects
on specific accounts.
• Companies may use various kinds of journals, but every company has the
most basic form of journal, a general journal. Typically, a general journal has
spaces for dates, account titles and explanations, references, and two
amount columns. Entering transaction data in the journal is known as
journalizing.
• The journal makes several significant contributions to the recording
process:
• 1. It discloses in one place the complete effects of a transaction.
• 2. It provides a chronological record of transactions.
• 3. It helps to prevent or locate errors because the debit and credit amounts for each
entry can be easily compared.
The Ledger
• The entire group of accounts maintained by a company is the ledger.
The ledger keeps in one place all the information about changes in
specific account balances. Companies may use various kinds of
ledgers, but every company has a general ledger. A general ledger
contains all the asset, liability, and owner’s equity accounts.
Transferring journal entries to the ledger accounts is called posting. This phase of the
recording process accumulates the effects of journalized transactions into the individual
accounts.
• Posting should be performed in chronological order. That is, the
company should post all the debits and credits of one journal entry
before proceeding to the next journal entry. Postings should be made
on a timely basis to ensure that the ledger is up to date.
• CHART OF ACCOUNTS: Most companies have a chart of accounts. This
chart lists the accounts and the account numbers that identify their
location in the ledger. The numbering system that identifies the
accounts usually starts with the balance sheet accounts and follows
with the income statement accounts.
The Trial Balance
• A trial balance is a list of accounts and their balances at a given time.
Customarily, companies prepare a trial balance at the end of an
accounting period. They list accounts in the order in which they
appear in the ledger. Debit balances appear in the left column and
credit balances in the right column.
• The trial balance proves the mathematical equality of debits and
credits after posting. Under the double-entry system, this equality
occurs when the sum of the debit account balances equals the sum of
the credit account balances. A trial balance may also uncover errors in
journalizing and posting. In addition, a trial balance is useful in the
preparation of financial statements.
PN
2021
Limitations of a Trial Balance
• A trial balance does not guarantee freedom from recording errors,
however. Numerous errors may exist even though the trial balance
columns agree. For example, the trial balance may balance even
when:
• 1. a transaction is not journalized,
• 2. a correct journal entry is not posted,
• 3. a journal entry is posted twice,
• 4. incorrect accounts are used in journalizing or posting, or
• 5. offsetting errors are made in recording the amount of a transaction.
• The trial balance does not prove that the company has recorded all
transactions or that the ledger is correct.
Adjusting the Accounts
• Accountants divide the economic life of a business into artificial time
periods. This convenient assumption is referred to as the time period
assumption. Many business transactions affect more than one of these
arbitrary time periods.
• Under the accrual basis, companies record transactions that change a
company’s financial statements in the periods in which the events occur.
For example, using the accrual basis to determine net income means
companies recognize revenues when earned (rather than when they
receive cash). It also means recognizing expenses when incurred (rather
than when paid).
• An alternative to the accrual basis is the cash basis. Under cash-basis accounting,
companies record revenue when they receive cash. They record an expense when they
pay out cash. The cash basis seems appealing due to its simplicity, but it often produces
misleading financial statements. It fails to record revenue that a company has earned
but for which it has not received the cash. Also, it does not match expenses with earned
revenues. Cash-basis accounting is not in accordance with generally accepted
accounting principles (GAAP).
The Basics of Adjusting Entries
• In order for revenues to be recorded in the period in which they are
earned, and for expenses to be recognized in the period in which they
are incurred, companies make adjusting entries. Adjusting entries
ensure that the revenue recognition and expense recognition
principles are followed. Adjusting entries are required every time a
company prepares financial statements.
• Types of Adjusting Entries: Adjusting entries are classified as either deferrals or
accruals.
Adjusting Entries For Deferrals
• To defer means to postpone or delay. Deferrals are costs or revenues
that are recognized at a date later than the point when cash was
originally exchanged. Companies make adjusting entries for deferrals
to record the portion of the deferred item that was incurred as an
expense or earned as revenue during the current accounting period.
The two types of deferrals are prepaid expenses and unearned
revenues.
• Prepaid expenses: record payments of expenses that will benefit more than
one accounting period as assets. Examples of common prepayments are
insurance, supplies, advertising, and rent. Prepaid expenses are costs that
expire either with the passage of time (e.g., rent and insurance) or through
use (e.g., supplies).
• Unearned revenue: record cash received before revenue is earned by
increasing (crediting) a liability account called unearned revenues. Items like
rent, magazine subscriptions, and customer deposits for future service may
result in unearned revenues. Unearned revenues are the opposite of prepaid
expenses. When a company receives payment for services to be provided in a
future accounting period, it increases (credits) an unearned revenue (a
liability) account to recognize the liability that exists. The company
subsequently earns revenues by providing service.
Adjusting Entries for Accruals
• The second category of adjusting entries is accruals. Prior to an
accrual adjustment, the revenue account (and the related asset
account) or the expense account (and the related liability account) are
understated.
• Accrued revenue: Revenues earned but not yet recorded at the statement
date are accrued revenues. An adjusting entry records the receivable that
exists at the balance sheet date and the revenue earned during the period.
• Accrued expense: Expenses incurred but not yet paid or recorded at the
statement date are called accrued expenses. Interest, taxes, and salaries are
common examples of accrued expenses. Companies make adjustments for
accrued expenses to record the obligations that exist at the balance sheet
date and to recognize the expenses that apply to the current accounting
period. Prior to adjustment, both liabilities and expenses are understated.
Summary of adjusting entries
Preparing the Adjusted Trial Balance
• After a company has journalized and posted all adjusting entries, it

prepares another trial balance from the ledger accounts. This trial
balance is called an adjusted trial balance. It shows the balances of all
accounts, including those adjusted, at the end of the accounting
period. The purpose of an adjusted trial balance is to prove the
equality of the total debit balances and the total credit balances in
the ledger after all adjustments. Because the accounts contain all data
needed for financial statements, the adjusted trial balance is the
primary basis for the preparation of financial statements.
Preparing Financial Statements
• Companies can prepare financial statements directly from the

adjusted trial balance.
• Income Statement – to know the profit or loss (business performance)
• Owner’s Equity Statement – to know the owner’s claim
• Balance Sheet – to know the financial condition (financial position) of the
business
• Cashflow Statement – to know the cash balances (cash inflow and outflow)
Worksheet
• A worksheet is a multiple-column form used in the adjustment
process and in preparing financial statements. As its name suggests,
the worksheet is a working tool. It is not a permanent accounting
record; it is neither a journal nor a part of the general ledger. The
worksheet is merely a device used in preparing adjusting entries and
the financial statements
• The use of a worksheet is optional
Steps in Preparing a Worksheet
Illustration 4-1
Steps in Preparing a Worksheet Illustration 4-2
STEP 1: PREPARE A TRIAL BALANCE ON THE WORKSHEET
Trial balance amounts come

directly from ledger accounts.
Include all accounts
with balances.
LO 1
Adjustments
• On 31st October Supplies on hand Tk. 10000.

• On October 4, PN Agency paid Tk. 6000 for a one year fire insurance policy.
• Company charge depreciation on office equipment Tk. 400 for the month.
• PN Advertising Agency earned Tk.4000 service revenue that was received
previously.
• In October PN Agency earned Tk. 2000 for advertising service that were not billed
to client.
• PN Agency signed a 3-month, 12% note payable in the amount Tk.50000 on
October 1.
• At 31st October salaries were accrued Tk. 12000.
STEP 2: ENTER THE ADJUSTMENTS IN THE ADJUSTMENTS COLUMNS
(a)
(b)
Adjustments Key:
(a) Supplies Used.
(d) (b) Insurance Expired.
(c) Depreciation Expensed.
(d) (d) Service Revenue Recognized.
(e)
(g) (e) Service Revenue Accrued.
(f) Interest Accrued.
(a) (g) Salaries Accrued.
(b)
(c)
(c)
(e)
(f)
Enter adjustment amounts, total
(f) adjustments columns,
(g) and check for equality.
Add additional accounts as needed.

LO 1
STEP 3: COMPLETE THE ADJUSTED TRIAL BALANCE COLUMNS
(a)
(b)
(d)
(d)
(e)
(g)
(a)
(b)
(c)
(c)
(e)
(f)
(f)
(g)
Total the adjusted trial balance

columns and check for equality.
LO 1
STEP 4: EXTEND AMOUNTS TO FINANCIAL STATEMENT COLUMNS
(a)
(b)
(d)
(d)
(e)
(g)
(a)
(b)
(c)
(c)
(e)
(f)
(f)
(g)
Extend adjusted trial balance amounts to

appropriate financial statement columns.
LO 1
STEP 5: TOTAL COLUMNS, COMPUTE NET INCOME (LOSS)
(a)
(b)
(d)
(d)
(e)
(g)
(a)
(b)
(c)
(c)
(e)
(f)
(f)
(g)
Compute Net Income or Net Loss.

LO 1
Preparing Financial Statements from a
Worksheet
◆ Income statement is prepared from the income statement

columns.
◆ Balance sheet and owner’s equity statement are
prepared from the balance sheet columns.
◆ Companies can prepare financial statements before they
journalize and post adjusting entries.
LO 1
Other data:
1. Insurance expires at the rate of $200 per month.
2. $1,000 of supplies are on hand at August 31.
3. Monthly depreciation on the equipment is $900.
4. Interest of $500 on the notes payable has accrued during August.
Prepare closing entries and a post-closing trial balance.
At the end of the accounting period, the company makes

the accounts ready for the next period.
Illustration 4-8
Temporary versus permanent accounts
LO 2
Preparing Closing Entries
Closing entries formally recognize in the ledger the transfer of

◆ net income (or net loss) and
◆ owner’s drawings
to owner’s capital.
Companies generally journalize and post closing entries only at

the end of the annual accounting period.
Closing entries produce a zero balance in each temporary
account.
LO 2
Preparing Closing Entries
Illustration 4-9
Diagram of closing
process—proprietorship
Owner’s Capital is a
permanent account. All
other accounts are
temporary accounts.
LO 2
Preparing a Post-Closing Trial Balance
Purpose is to prove the equality of the permanent account balances

carried forward into the next accounting period.
LO 2
Explain the steps in the accounting cycle
and how to prepare correcting entries.
1. Analyze business transactions
9. Prepare a post-closing 2. Journalize the

trial balance transactions
8. Journalize and post

3. Post to ledger accounts
closing entries
7. Prepare financial
4. Prepare a trial balance
statements
6. Prepare an adjusted trial 5. Journalize and post

balance adjusting entries
LO 3
Correcting Entries—An Avoidable Step
◆ Unnecessary if accounting records are free of errors.
◆ Made whenever an error is discovered.
◆ Must be posted before closing entries.
Instead of preparing a correcting entry, it is possible to

reverse the incorrect entry and then prepare the correct
entry.
LO 3
CASE 1: On May 10, Mercato Co. journalized and posted a Tk.50 cash
collection on account from a customer as a debit to Cash Tk.50 and a
credit to Service Revenue Tk.50. The company discovered the error on
May 20, when the customer paid the remaining balance in full.
Incorrect Cash 50
entry
Service Revenue 50
Correct Cash 50
entry
Accounts Receivable 50
Correcting Service Revenue 50
entry Accounts Receivable 50
LO 3
CASE 2: On May 18, Mercato purchased on account equipment
costing Tk.450. The transaction was journalized and posted as a debit
to Equipment Tk.45 and a credit to Accounts Payable Tk.45. The error
was discovered on June 3.
Incorrect Equipment 45
entry
Accounts Payable 45
Correct Equipment 450
entry
Accounts Payable 450
Correcting Equipment 405
entry Accounts Payable 405
LO 3
DO IT! Correcting Entries
Sanchez Company discovered the following errors made in
January 2018 .
1. A payment of Salaries and Wages Expense of Tk.600 was

debited to Supplies and credited to Cash, both for Tk.600.
2. A collection of Tk.3,000 from a client on account was

debited to Cash Tk.200 and credited to Service Revenue
Tk.200.
3. The purchase of supplies on account for Tk.860 was
debited to Supplies Tk.680 and credited to Accounts
Payable Tk.680.
Correct the errors without reversing the incorrect entry.

LO 3
Identify the sections of a classified
balance sheet.
◆ Presents a snapshot at a point in time.

◆ To improve understanding, companies group similar
assets and similar liabilities together.
Standard Classifications Illustration 4-20
Assets Liabilities and Owner’s Equity

Current assets Current liabilities
Long-term investments Long-term liabilities
Property, plant, and equipment Owner’s (Stockholders’) equity
Intangible assets
LO 4
The Classified Balance Sheet
Illustration 4-21
LO 4
The Classified Balance Sheet
Illustration 4-21
LO 4
Chapter
5 Accounting for
Merchandising Operations
Describe merchandising operations and
inventory systems.
Merchandising Companies
Buy and Sell Goods
Retailer
Wholesaler Consumer
The primary source of revenues is referred to as

sales revenue or sales.
Operating Cycles
Illustration 5-2
The operating
cycle of a
merchandising
company
ordinarily is longer
than that of a
service
company.
Merchandising Operations
Income Measurement
Not used in a
Sales Less
Illustration 5-1
Service business.
Revenue Income measurement process for a
merchandising company
Cost of Equals
Gross Less
Goods
Profit
Sold
Operating Equals Net

Cost of goods sold is the total Income
Expenses
cost of merchandise sold during (Loss)
the period.
Flow of Costs
Illustration 5-4
Companies use either a perpetual inventory system or a periodic

inventory system to account for inventory.
Flow of Costs
PERPETUAL SYSTEM
◆ Maintain detailed records of the cost of each inventory
purchase and sale.
◆ Records continuously show inventory that should be on

hand for every item.
◆ Company determines cost of goods sold each time a

sale occurs.
Flow of Costs
PERIODIC SYSTEM
◆ Do not keep detailed records of the goods on hand.
◆ Cost of goods sold determined by count at the end of

the accounting period.
◆ Calculation of Cost of Goods Sold:
Beginning inventory Tk. 100,000

Add: Purchases, net 800,000
Goods available for sale 900,000
Less: Ending inventory 125,000
Cost of goods sold Tk. 775,000
Flow of Costs
ADVANTAGES OF THE PERPETUAL SYSTEM

◆ Traditionally used for merchandise with high unit
values.
◆ Shows the quantity and cost of the inventory that

should be on hand at any time.
◆ Provides better control over inventories than a periodic

system.
Record purchases under a perpetual
inventory system.
◆ Made using cash or credit (on account).
◆ Normally record when

goods are received from
the seller.
◆ Purchase invoice should

support each credit
purchase.
Illustration 5-6
Sales invoice used as purchase
invoice by Sauk Stereo
Recording Purchases of Merchandise
Illustration 5-6
Illustration: Sauk Stereo (the
buyer) uses as a purchase
invoice the sales invoice
prepared by PW Audio Supply,
Inc. (the seller). Prepare the
journal entry for Sauk Stereo for
the invoice from PW Audio
Supply.
May 4 Inventory 3,800

Accounts Payable 3,800
Freight Costs
Ownership of the goods

passes to the buyer when the
public carrier accepts the
goods from the seller.

remains with the seller until
the goods reach the buyer.
Illustration 5-7
Shipping terms
Freight costs incurred by the seller are an
operating expense.
Freight Costs
Illustration: Assume upon delivery of the goods on May 6, Sauk

Stereo pays Public Freight Company $150 for freight charges,
the entry on Sauk Stereo’s books is:
May 6 Inventory 150

Cash 150
Assume the freight terms on the invoice in Illustration 5-6 had

required PW Audio Supply to pay the freight charges, the entry
by PW Audio Supply would have been:
May 4 Freight-Out150
Cash 150
Purchase Returns and Allowances
Purchaser may be dissatisfied because goods are damaged

or defective, of inferior quality, or do not meet specifications.
Purchase Return Purchase Allowance

Return goods for credit if the May choose to keep the
sale was made on credit, or merchandise if the seller will
for a cash refund if the grant a reduction of the
purchase was for cash. purchase price.
Purchase Returns and Allowances
Illustration: Assume Sauk Stereo returned goods costing

$300 to PW Audio Supply on May 8.
May 8 Accounts Payable 300

Inventory 300
Purchase Discounts
Credit terms may permit buyer to claim a cash discount

for prompt payment.
Advantages: Example: Credit terms

may read 2/10, n/30.
◆ Purchaser saves money.
◆ Seller shortens the operating cycle by converting the

accounts receivable into cash earlier.
Purchase Discounts
2/10, n/30 1/10 EOM n/10 EOM
2% discount if 1% discount if Net amount due

paid within 10 paid within first 10 within the first 10
days, otherwise days of next days of the next
net amount due month. month.
within 30 days.
Purchase Discounts
Illustration: Assume Sauk Stereo pays the balance due of

$3,500 (gross invoice price of $3,800 less purchase returns
and allowances of $300) on May 14, the last day of the
discount period. Prepare the journal entry Sauk Stereo
makes on May 14 to record the payment.
May 14 Accounts Payable 3,500

Inventory 70
Cash 3,430
(Discount = $3,500 x 2% = $70)

Purchase Discounts
Illustration: If Sauk Stereo failed to take the discount, and

instead made full payment of $3,500 on June 3, the journal
entry would be:
June 3 Accounts Payable 3,500

Cash 3,500
Purchase Discounts
Should discounts be taken when offered?

Summary of Purchasing Transactions
4th - Purchase 3,800 300 8th - Return

6th – Freight-in 150 70 14th - Discount
Balance 3,580
Record sales under a perpetual
inventory system.
◆ Made using cash or credit (on account).

Illustration 5-6
◆ Sales revenue, like service

revenue, is recorded when
the performance obligation
is satisfied.
◆ Performance obligation is
satisfied when the goods
are transferred from the
seller to the buyer.
◆ Sales invoice should
support each credit sale.
Recording Sales of Merchandise
Journal Entries to Record a Sale
#1 Cash or Accounts receivable XXX Selling

Sales revenue XXX Price
#2 Cost of goods sold XXX

Cost
Inventory XXX
Illustration: PW Audio Supply records the sale of $3,800

on May 4 to Sauk Stereo on account (Illustration 5-6) as
follows (assume the merchandise cost PW Audio Supply
$2,400).
May 4 Accounts Receivable 3,800

Sales Revenue 3,800
4 Cost of Goods Sold 2,400

Inventory 2,400
Sales Returns and Allowances
◆ “Flip side” of purchase returns and allowances.
◆ Contra-revenue account to Sales Revenue (debit).
◆ Sales not reduced (debited) because:
► Would obscure importance of sales returns and

allowances as a percentage of sales.
► Could distort comparisons.

Illustration: Prepare the entry PW Audio Supply would make

to record the credit for returned goods that had a $300 selling
price (assume a $140 cost). Assume the goods were not
defective.
May 8 Sales Returns and Allowances 300

8 Inventory 140
Cost of Goods Sold 140
Illustration: Assume the returned goods were defective

and had a scrap value of $50, PW Audio would make the
following entries:

8 Inventory 50
Sales Discount
◆ Offered to customers to promote prompt payment of

the balance due.
◆ Contra-revenue account (debit) to Sales Revenue.

Sales Discount
Illustration: Assume Sauk Stereo pays the balance due of

$3,500 (gross invoice price of $3,800 less purchase returns
and allowances of $300) on May 14, the last day of the
discount period. Prepare the journal entry PW Audio Supply
makes to record the receipt on May 14.
May 14 Cash 3,430

Sales Discounts 70 *
Accounts Receivable 3,500
* [($3,800 – $300) X 2%]

Apply the steps in the accounting cycle
to a merchandising company.
Adjusting Entries
◆ Generally the same as a service company.
◆ One additional adjustment to make the records agree with

the actual inventory on hand.
◆ Involves adjusting Inventory and Cost of Goods Sold.

Adjusting Entries
Illustration: Suppose that PW Audio Supply has an unadjusted

balance of $40,500 in Merchandise Inventory. Through a physical
count, PW Audio determines that its actual merchandise inventory
at year-end is $40,000. The company would make an adjusting
entry as follows.

Inventory 500
Closing Entries
Closing Entries
Compare a multiple-step with a
single-step income statement.
Multiple-Step Income Statement

◆ Shows several steps in determining net income.
◆ Two steps relate to principal operating activities.
◆ Distinguishes between operating and non-operating

activities.
Illustration 5-14
Multiple-
Step
Key Items:
◆ Net sales
Illustration 5-14
Illustration 5-14
Multiple-
Step
Key Items:
◆ Net sales
◆ Gross profit
Illustration 5-14
Illustration 5-14
Multiple-
Step
Key Items:
◆ Net sales
◆ Gross profit
◆ Operating
expenses
Illustration 5-14
Multiple-
Step
Key Items:
◆ Net sales
◆ Gross profit
◆ Operating
expenses
◆ Nonoperating
activities
Illustration 5-14
Multiple-
Step
Key Items:
◆ Net sales
◆ Gross profit
◆ Operating
expenses
◆ Nonoperating
activities
Illustration 5-14
Multiple-
Step
Key Items:
◆ Net sales
◆ Gross profit
◆ Operating
expenses
◆ Nonoperating
activities
◆ Net income
Illustration 5-14
Single-Step Income Statement
◆ Subtract total expenses from total revenues
◆ Two reasons for using the single-step format:
1. Company does not realize any profit until total

revenues exceed total expenses.
2. Format is simpler and easier to read.

Single-Step Income Statement
Illustration 5-15
APPENDIX 5A: Prepare a worksheet for
a merchandising company.
Using a Worksheet
As indicated in Chapter 4, a worksheet enables companies to
prepare financial statements before they journalize and post
adjusting entries. The steps in preparing a worksheet for a
merchandising company are the same as for a service
company. Illustration 5A-1 shows the worksheet for PW Audio
Supply, Inc. (excluding nonoperating items). The unique
accounts for a merchandiser using a perpetual inventory
system are in red.
Illustration 5A-1
Determining Cost of Goods Sold Under a
Periodic System
◆ No running account of changes in inventory.
◆ Ending inventory determined by physical count.
◆ Cost of goods sold not determined until the end of the

period.
Determining Cost of Goods Sold
Under a Periodic System Illustration 5B-2
Cost of goods sold for a
merchandiser using a periodic
inventory system
Illustration 5B-2
Recording Merchandise Transactions
◆ Record revenues when sales are made.

◆ Do not record cost of merchandise sold on the date of
sale.
◆ Physical inventory count determines:
► Cost of merchandise on hand and
► Cost of merchandise sold during the period.
◆ Record purchases in Purchases account.
◆ Purchase returns and allowances, Purchase discounts,
and Freight costs are recorded in separate accounts.
Illustration: On the basis of the sales invoice (Illustration 5-6)

and receipt of the merchandise ordered from PW Audio Supply,
Sauk Stereo records the $3,800 purchase as follows.
May 4 Purchases 3,800

Accounts Payable 3,800
FREIGHT COSTS
Illustration: If Sauk pays Public Freight Company $150
for freight charges on its purchase from PW Audio Supply on
May 6, the entry on Sauk’s books is:
May 6 Freight-In (Transportation-In) 150

Cash 150
PURCHASE RETURNS AND ALLOWANCES

Illustration: Sauk Stereo returns $300 of goods to PW Audio
Supply and prepares the following entry to recognize the
return.
May 8 Accounts payable 300

Purchase Returns and Allowances 300
PURCHASE DISCOUNTS
Illustration: On May 14 Sauk Stereo pays the balance due
on account to PW Audio Supply, taking the 2% cash discount
allowed by PW Audio for payment within 10 days. Sauk
Stereo records the payment and discount as follows.
May 14 Accounts Payable 3,500

Purchase Discounts 70
Cash 3,430
Illustration: PW Audio Supply, records the sale of $3,800 of

merchandise to Sauk Stereo on May 4 (sales invoice No. 731,
Illustration 5-6) as follows.
May 4 Accounts Receivable 3,800

Sales Revenue 3,800
No entry is recorded for cost of goods sold at the time of the

sale under a periodic system.
SALES RETURNS AND ALLOWANCES

Illustration: To record the returned goods received from Sauk
Stereo on May 8, PW Audio Supply records the $300 sales
return as follows.

SALES DISCOUNTS
Illustration: On May 14, PW Audio Supply receives payment
of $3,430 on account from Sauk Stereo. PW Audio honors the
2% cash discount and records the payment of Sauk’s account
receivable in full as follows.
May 14 Cash 3,430

Sales Discounts 70
Accounts Receivable 3,500
COMPARISON OF ENTRIES
Illustration 5B-3
COMPARISON OF ENTRIES
Illustration 5B-3
Journalize the transactions for the month of July for O’Quinn using a perpetual inventory
system.
• P5-1A O’Quinn Co. distributes suitcases to retail stores and extends credit terms of 1/10, n/30 to all of its
customers. At the end of June, O’Quinn’s inventory consisted of suitcases costing $1,200. During the month of
July, the following merchandising transactions occurred.
• July 1 Purchased suitcases on account for $1,800 from Emerson Manufacturers, FOB destination, terms 2/10,
n/30. The appropriate party also made a cash payment of $100 for freight on this date.
3 Sold suitcases on account to Straume Satchels for $2,000. The cost of suitcases sold is $1,200.
9 Paid Emerson Manufacturers in full.
12 Received payment in full from Straume Satchels.
17 Sold suitcases on account to The Going Concern for $1,800. The cost of the suitcases sold was $1,080.
18 Purchased suitcases on account for $1,900 from Hume Manufacturers, FOB shipping point, terms 1/10,
n/30. The appropriate party also made a cash payment of $125 for freight on this date.
20 Received $300 credit for suitcases returned to Hume Manufacturers.
21 Received payment in full from The Going Concern.
22 Sold suitcases on account to Desmond’s for $2,250. The cost of suitcases sold was $1,350.
30 Paid Hume Manufacturers in full.
31 Granted Desmond’s $200 credit for suitcases returned costing $120.
Chapter
6
Inventories
Classifying Inventory
Merchandising Manufacturing
Company Company
One Classification: Three Classifications:
◆ Inventory ◆ Raw Materials

These items have two common ◆ Work in Process
characteristics: (1) They are owned by
the company, and (2) they are in a form
ready for sale to customers in the ◆ Finished Goods
ordinary course of business. Thus,
merchandisers need only one inventory
classifi - cation, merchandise inventory,
to describe the many different items
that make up the total inventory
6-120
Determining Inventory Quantities
Physical Inventory taken for two reasons: No matter whether

company using a periodic or perpetual inventory system, all
companies need to determine inventory quantities at the end of
the accounting period.
Perpetual System
1. Check accuracy of inventory records.
2. Determine amount of inventory lost due to wasted raw
materials, shoplifting, or employee theft.
Periodic System
3. Determine the inventory on hand.
4. Determine the cost of goods sold for the period.
6-121
TAKING A PHYSICAL INVENTORY

Involves counting, weighing, or measuring each kind of
inventory on hand.
Companies often “take inventory”
◆ when the business is closed or
business is slow.
◆ at the end of the accounting period.
6-122
DETERMINING OWNERSHIP OF GOODS

GOODS IN TRANSIT
◆ Purchased goods not yet received.
◆ Sold goods not yet delivered.
Goods in transit should be included in the inventory of the

company that has legal title to the goods. Legal title is
determined by the terms of sale.
6-123
Determining Ownership of Goods
GOODS IN TRANSIT Illustration 6-2

Terms of sale
Ownership of the goods passes

to the buyer when the public
carrier accepts the goods from
the seller.

remains with the seller until the
goods reach the buyer.
6-124
Determining Ownership of Goods
CONSIGNED GOODS
To hold the goods of other parties and try to sell the goods for
them for a fee, but without taking ownership of the goods.
Many car, boat, and antique dealers sell goods on consignment,
why?
>to keep their inventory costs down and to avoid the

risk of purchasing an item that they won’t be able to
sell.
6-125
Inventory Costing
Inventory is accounted for at cost.
◆ Cost includes all expenditures necessary to acquire goods
and place them in a condition ready for sale.
◆ Unit costs are applied to quantities to compute the total cost
of the inventory and the cost of goods sold using the
following costing methods:
► Specific identification
► First-in, first-out (FIFO)
► Last-in, first-out (LIFO) Cost Flow
Assumptions
► Average-cost
6-126
Inventory Costing
Illustration: Crivitz TV Company purchases three identical

50-inch TVs on different dates at costs of $700, $750, and
$800. During the year Crivitz sold two sets at $1,200 each.
These facts are summarized below. Illustration 6-3
Data for inventory
costing example
6-127
Specific Identification
If Crivitz sold the TVs it purchased on February 3 and May 22,

then its cost of goods sold is $1,500 ($700 + $800), and its
ending inventory is $750.
Illustration 6-4
6-128
Specific Identification
Actual physical flow costing method in which items still in

inventory are specifically costed to arrive at the total cost of
the ending inventory.
◆ Practice is relatively rare.
◆ Most companies make

assumptions (cost flow
assumptions) about which units
were sold.
6-129
Cost Flow Assumptions
Cost flow assumptions DO NOT need to be consistent

with the physical movement of the goods
6-130
Illustration: Data for Houston Electronics’ Astro condensers.

Illustration 6-5
(Beginning Inventory + Purchases) - Ending Inventory = Cost of Goods Sold
6-131
FIRST-IN, FIRST-OUT (FIFO)

◆ Costs of the earliest goods purchased are the first to
be recognized in determining cost of goods sold.
◆ Often parallels actual physical flow of merchandise.
◆ Companies determine the cost of the ending inventory

by taking the unit cost of the most recent purchase and
working backward until all units of inventory have been
costed.
6-132
FIRST-IN, FIRST-OUT (FIFO)
Illustration 6-6
6-133
LAST-IN, FIRST-OUT (LIFO)
◆ Costs of the latest goods purchased are the first to be

recognized in determining cost of goods sold.
◆ Seldom coincides with actual physical flow of

merchandise.
◆ Exceptions include goods stored in piles, such as coal or

hay.
6-134
LAST-IN, FIRST-OUT (LIFO)
Illustration 6-8
6-135
AVERAGE-COST
◆ Allocates cost of goods available for sale on the basis of
weighted-average unit cost incurred.
◆ Applies weighted-average unit cost to the units on

hand to determine cost of the ending inventory.
6-136
AVERAGE-COST
Illustration 6-11
6-137
Financial Statement and Tax Effects
Illustration 6-13
INCOME STATEMENT EFFECTS Comparative effects of
cost flow methods
6-138
BALANCE SHEET EFFECTS

◆ A major advantage of the FIFO method is that in a period
of inflation, the costs allocated to ending inventory will
approximate their current cost.
◆ A major shortcoming of the LIFO method is that in a

period of inflation, the costs allocated to ending inventory
may be significantly understated in terms of current cost.
6-139
TAX EFFECTS
◆ Both inventory and net income are higher when companies
use FIFO in a period of inflation.
◆ LIFO results in the lowest income taxes (because of lower

net income) during times of rising prices.
6-140
Inventory Costing
Using Cost Flow Methods Consistently

◆ Method should be used consistently, enhances
comparability.
◆ Although consistency is preferred, a company may change
its inventory costing method.
6-141
Cost Flow Methods
6-142
Indicate the effects of inventory errors on
the financial statements.
Common Cause:
◆ Failure to count or price inventory correctly.
◆ Not properly recognizing the transfer of legal title to goods

in transit.
◆ Errors affect both the income statement and balance sheet.

Income Statement Effects
Inventory errors affect the computation of cost of goods sold

and net income in two periods.
Illustration 6-15
Illustration 6-16
Income Statement Effects
Inventory errors affect the computation of cost of goods

sold and net income in two periods.
◆ An error in ending inventory of the current period will have
a reverse effect on net income of the next accounting
period.
◆ Over the two years, the total net income is correct

because the errors offset each other.
◆ Ending inventory depends entirely on the accuracy of

taking and costing the inventory.
Income Statement Effects Illustration 6-17
Effects of inventory errors on
two years’ income statements
($3,000) $3,000
Combined income for Net Income
Net Income
2-year period is correct. understated overstated
Balance Sheet Effects
Effect of inventory errors on the balance sheet is determined

by using the basic accounting equation: Assets = Liabilities +
Stockholders’ Equity.
Errors in the ending inventory have the following effects.
Illustration 6-18
Effects of ending inventory
errors on balance sheet
Lower-of-Cost-or-Net Realizable Value
When the value of inventory is lower than its cost

◆ Companies must “write down” the inventory to its net
realizable value.
◆ Net realizable value: Amount that a company expects to

realize (receive from the sale of inventory).
◆ Example of conservatism.
6-148
Lower-of-Cost-or-Net Realizable Value
Illustration: Assume that Ken Tuckie TV has the following

lines of merchandise with costs and market values as
indicated.
Illustration 6-20
Computation of
lower-of-cost-or-net
realizable value
6-149
APPENDIX 6A: Apply the inventory cost flow
methods to perpetual inventory records.
Illustration Illustration 6A-1

Inventoriable units and costs
Assuming the Perpetual Inventory System, compute Cost of Goods Sold

and Ending Inventory under FIFO, LIFO, and average-cost.
6-150
APPENDIX 6B: Describe the two methods of
estimating inventories.
Gross Profit Method

A method of estimating the cost of ending inventory by applying a
gross profit rate to net sales.
A company needs to know its net sales, cost of goods available for
sale, and gross profit rate.
Illustration 6B-1
Gross profit method formulas
6-151
Gross Profit Method
Illustration: Kishwaukee Company records show net sales of

$200,000, beginning inventory $40,000, and cost of goods purchased
$120,000. In the preceding year, the company realized a 30% gross
profit rate. It expects to earn the same rate this year. Compute the
estimated cost of the ending inventory at January 31 under the gross
profit method.
Illustration 6B-1
Illustration 6B-2
Example of gross
profit method
6-152
Retail Inventory Method
► Retail companies establish a relationship between cost and

sales price.
► Company applies cost-to-retail percentage to ending
inventory at retail prices to determine inventory at cost.
Illustration 6B-3
6-153 Retail inventory method formulas
Retail Inventory Method
Illustration: It is not necessary to take a physical inventory to

determine the estimated cost of goods on hand at any given time.
Illustration 6B-4
The major disadvantage of the retail method is that it is an averaging technique.

It may produce an incorrect inventory valuation if the mix of the ending inventory
is not representative of the mix in the goods available for sale.
6-154
• Inventory is classified in the balance sheet as a current asset. In a
multiple-step income statement, cost of goods sold is subtracted from
sales. There also should be disclosure of (1) the major inventory
classifications, (2) the basis of accounting (cost, or
lower-of-cost-or-market), and (3) the cost method (FIFO, LIFO, or
average).
• The amount of inventory carried by a company has significant
economic consequences. And inventory management is a
double-edged sword that requires constant attention. On the one
hand, management wants to have a great variety and quantity on
hand so that customers have a wide selection and items are always in
stock. But such a policy may incur high carrying costs (e.g.,
investment, storage, insurance, obsolescence, and damage). On the
other hand, low inventory levels lead to stockouts and lost sales.
Common ratios used to manage and evaluate inventory levels are
inventory turnover and a related measure, days in inventory.
• Inventory turnover measures the number of times on average the
inventory is sold during the period. Its purpose is to measure the
liquidity of the inventory. The inventory turnover is computed by
dividing cost of goods sold by the average inventory during the
period. Unless seasonal factors are significant, average inventory can
be computed from the beginning and ending inventory balances.
• A variant of the inventory turnover ratio is days in inventory. This
measures the average number of days inventory is held. It is
calculated as 365 divided by the inventory turnover ratio.
Chapter
17
Statement of
Cash Flows
Discuss the usefulness and format of
the statement of cash flows.
Usefulness of the Statement of Cash Flows

Provides information to help assess:
1. Entity’s ability to generate future cash flows.
2. Entity’s ability to pay dividends and meet obligations.
3. Reasons for difference between net income and net cash

provided (used) by operating activities.
4. Cash investing and financing transactions during the period.

Classification of Cash Flows
Operating Investing Financing

Activities Activities Activities
Income Changes in Changes in

Statement Items Investments Long-Term
and Long-Term Liabilities and
Asset Items Stockholders’
Equity Items
Operating activities—Income statement items

Cash inflows: Illustration 17-1
Typical receipt and payment
classifications
From sale of goods or services.
From interest received and dividends received.
Cash outflows:
To suppliers for inventory.
To employees for wages.
To government for taxes.
To lenders for interest.
To others for expenses.
Investing activities—Changes in investments and long-term

assets Illustration 17-1
Cash inflows: classifications
From sale of property, plant, and equipment.

From sale of investments in debt or equity securities of
other entities.
From collection of principal on loans to other entities.
Cash outflows:
To purchase property, plant, and equipment.
To purchase investments in debt or equity securities of
other entities.
To make loans to other entities.
Financing activities—Changes in long-term liabilities and

stockholders’ equity Illustration 17-1
Cash inflows: classifications
From sale of common stock.

From issuance of debt (bonds and notes).
Cash outflows:
To stockholders as dividends.
To redeem long-term debt or reacquire
capital stock (treasury stock).
Significant Noncash Activities
1. Direct issuance of common stock to purchase assets.

2. Conversion of bonds into common stock.
3. Issuance of debt to purchase assets.
4. Exchanges of plant assets.
Companies report noncash activities in either a

◆ separate schedule (bottom of the statement) or
◆ separate note to the financial statements.
Format of the Statement of Cash Flows
Order of Presentation:
Direct Method
1. Operating activities.
2. Investing activities. Indirect Method
3. Financing activities.
Illustration 17-2
Format of statement of cash flows
Prepare a statement of cash flows
using the indirect method.
Three sources of information:

1. Comparative balance sheets
2. Current income statement
3. Additional information
Preparing the Statement of Cash Flows
Three Major Steps:

Illustration 17-3
Three Major Steps:

Illustration 17-3
Three Major Steps:

Illustration 17-3
Indirect and Direct Methods
Companies favor the indirect method for two reasons:

1. Easier and less costly to prepare.
2. Focuses on differences between net income and net
cash flow from operating activities.
Indirect Method
COMPUTER SERVICES COMPANY

Income Statement
For the Month Ended December 31, 2017
Illustration 17-4
Indirect Method
Illustration 17-4
2017 2016
Indirect Method
Illustration 17-4
Additional information for 2017:

1. Depreciation expense was comprised of $6,000 for building and $3,000 for equipment.
2. The company sold equipment with a book value of $7,000 (cost $8,000, less accumulated
depreciation $1,000) for $4,000 cash.
3. Issued $110,000 of long-term bonds in direct exchange for land.
4. A building costing $120,000 was purchased for cash. Equipment costing $25,000 was also
purchased for cash.
5. Issued common stock for $20,000 cash.
6. The company declared and paid a $29,000 cash dividend.
Indirect Method
Illustration 17-4
2017 2016
Indirect Method
Illustration 17-4

purchased for cash.
Step 1: Operating Activities
DETERMINE NET CASH PROVIDED/USED BY

OPERATING ACTIVITIES BY CONVERTING NET
INCOME FROM ACCRUAL BASIS TO CASH
BASIS.
Common adjustments to Net Income (Loss):
◆ Add back non-cash expenses (depreciation,
amortization, or depletion expense).
◆ Deduct gains and add losses.
◆ Analyze changes in noncash current asset and current

liability accounts.
DEPRECIATION EXPENSE
Although depreciation expense reduces net income, it does
not reduce cash. The company must add it back to net
income.
Illustration 17-6
LOSS ON DISPOSAL OF EQUIPMENT

Companies report as a source of cash in the investing
activities section the actual amount of cash received from
the sale.
◆ Any loss on disposal is added to net income in the
operating section.
◆ Any gain on disposal is deducted from net income in the

operating section.
CHANGES TO NONCASH CURRENT ASSET

When the Accounts Receivable balance decreases, cash
receipts are higher than revenue earned under the accrual basis.
Illustration 17-8
Accounts Receivable
1/1/017 Balance 30,000 Receipts from customers

Sales Revenue 507,000 517,000
12/31/17 Balance 20,000
Company adds to net income the amount of the decrease in

accounts receivable.

When the Inventory balance increases, the cost of
merchandise purchased exceeds the cost of goods sold.
Inventory
1/1/17 Balance 10,000 Cost of goods sold 150,000
Purchases 155,000
12/31/17 Balance 15,000
Cost of goods sold does not reflect cash payments made for
merchandise. The company deducts from net income this
inventory increase.

When the Prepaid Expense balance increases, cash paid for
expenses is higher than expenses reported on an accrual basis.
The company deducts the decrease from net income to arrive
at net cash provided by operating activities.
If prepaid expenses decrease, reported expenses are higher

than the expenses paid.
CHANGES IN CURRENT LIABILITIES

When Accounts Payable increases, the company received
more in goods than it actually paid for. The increase is added
to net income to determine net cash provided by operating
activities.
When Income Tax Payable decreases, the income tax

expense reported on the income statement was less than the
amount of taxes paid during the period. The decrease is
subtracted from net income to determine net cash provided by
operating activities.
Summary of Conversion to Net Cash Provided

by Operating Activities—Indirect Method
Illustration 17-11
Step 2: Investing and Financing Activities
Company purchased land of $110,000 by issuing long-term

bonds. This is a significant noncash investing and financing
activity that merits disclosure in a separate schedule.
Land
1/1/17 Balance 20,000
Issued bonds 110,000
12/31/17 Balance 130,000
Bonds Payable
1/1/17 Balance 20,000
For land 110,000
12/31/17 Balance 130,000
The additional information explains that the equipment increase

resulted from two transactions: (1) a purchase of equipment of
$25,000, and (2) the sale for $4,000 of equipment costing $8,000.
Illustration 17-12
Equipment
1/1/17 Balance 10,000 Equipment sold 8,000
Purchase 25,000
12/31/17 Balance 27,000
Cash 4,000
Journal
Accumulated Depreciation 1,000
Entry
Loss on Disposal of Equipment 3,000
Equipment 8,000
Retained earnings increased $116,000 during the year. This

increase can be explained by two factors: (1) Net income of
$145,000 increased retained earnings, and (2) Dividends of
$29,000 decreased retained earnings.
Retained Earnings
1/1/17 Balance 48,000
Dividends 29,000 Net income 145,000
12/31/17 Balance 164,000

Illustration 17-13
Statement
of Cash
Flows
Indirect
Method
APPENDIX 17A: Statement of Cash
Flows Using the Direct Method.
1. Compute net cash provided by operating activities by

adjusting each item in the income statement from the
accrual basis to the cash basis.
2. Companies report only major classes of operating

cash receipts and cash payments.
3. For these major classes, the difference between

cash receipts and cash payments is the net cash
provided by operating activities.
Step 1: Operating Activities Illustration 17A-2
Major classes of cash
receipts and payments
Direct Method
COMPUTER SERVICES COMPANY

Income Statement
For the Month Ended December 31, 2017
Illustration 17-4
Direct Method
Illustration 17-4
2017 2016
Direct Method
Illustration 17-4

purchased for cash.
Cash Receipts from Customers

For Computer Services, accounts receivable decreased $10,000.
Illustration 17A-4
Accounts Receivable
1/1/017 Balance 30,000 Receipts from customers 517,000
Sales revenue 507,000
12/31/17 Balance 20,000
Illustration 17A-5
Cash Payments to Suppliers

In 2017, Computer Services Company’s inventory increased $5,000
and cash payments to suppliers were $139,000.
Inventory
1/1/17 Balance 10,000 Cost of goods sold 150,000
Purchases 155,000
12/31/17 Balance 15,000
Illustration 17A-8
Accounts Payable
Payment to suppliers 139,000 1/1/17 Balance 12,000
Purchases 155,000
12/31/17 Balance 28,000

Cash Payments to Suppliers

In 2017, Computer Services Company’s inventory increased $5,000
and cash payments to suppliers were $139,000.
Illustration 17A-10
Formula to compute cash payments
to suppliers—direct method
Cash Payments for Operating Expenses

Cash payments for operating expenses were $115,000.
Illustration 17A-11
Illustration 17A-12
Cash Payments for Interest

In 2017, Computer Services’ had interest expense of $42,000.
Interest Payable
Cash paid for interest 42,000 1/1/17 Balance 0
Interest expense 42,000
12/31/17 Balance 0
Cash Payments for Income Taxes

Cash payments for income taxes were $49,000.
Income Tax Payable

Cash paid for taxes 49,000 1/1/17 Balance 8,000
Income tax expense 47,000
12/31/17 Balance 6,000
Illustration 17A-15
Illustration 17A-16
Operating activities section
of the statement of cash flows
Increase in Land. Land increased Significant noncash

$110,000. The company purchased land investing and
of $110,000 by issuing bonds. financing transaction.
Increase in Building. Acquired building

Investing transaction.
for $120,000 cash.
Increase in Bonds Payable. Bonds

Significant noncash
Payable increased $110,000. The
investing and
company acquired land by exchanging financing transaction.
bonds for land.
Increase in Common Stock. Increase

in Common Stock of $20,000. Increase Financing
resulted from the issuance of new transaction.
shares of stock.
Increase in Retained Earnings. The

$116,000 net increase in Retained Financing
Earnings resulted from net income of transaction
$145,000 and the declaration and (cash dividend)
payment of a cash dividend
of $29,000.
Illustration 17A-18
Statement of cash flows,
2017—direct method
Analyze the statement of cash flows.
Free Cash Flow

Illustration 17-14
Free cash flow describes the cash remaining from

operations after adjustment for capital expenditures and
dividends.
Free Cash Flow Illustration 17-15
Microsoft’s cash flow
information ($ in millions)
Required:
Calculate
Microsoft’s
free cash
flow.
Cash provided by operating activities $21,863

Less: Expenditures on property, plant, and equipment 4,257
Dividends paid 7,455
Free cash flow $10,151
Cost and Managerial Accounting
DEFINITION OF ACCOUNTING
► Accounting is the process of identifying, measuring and

communicating economic information about an entity to permit
informed judgments and decisions by users of the information
(Anthony et al, 1995)
economic information
users of the information
Branches of Accounting
• Financial Accounting
• Cost Accounting
• Management Accounting
Accounting:
► Financial Accounting: (Stewardship Accounting)

► limits its activities in recording business transaction and
determining financial results and position.
► Cost Accounting: (Control Accounting)
► takes the responsibility of determining cost of products
and services and controlling costs with a view to
maximizing profit.
► Management Accounting: (Decision making
Accounting)
► takes the duty of helping management in planning and
decision making.
Relationship of Financial, Management, and Cost
Accounting
Product
Costs
FINANCIAL COST MANAGEMENT

ACCOUNTING ACCOUNTIN ACCOUNTING
G
What is Managerial Accounting?
● It is the process of identifying, measuring, accumulating, analyzing, preparing,
interpreting, and communicating information that managers use to fulfill organizational
objectives.
● The branch of accounting that produces information for managers within an
organization is termed as Managerial Accounting.
● The term Managerial accounting refers to accounting for the management, i.e.,
accounting which provides necessary information to the management for discharging
its functions. The functions of the management are planning, organizing, directing and
controlling.
● Thus, Managerial accounting provides information to management so that planning,
organizing, directing and controlling g of business operation can be done in an orderly
manner. 212
1959- Committee of Mgt Acc. of the AAA
► “ The application of appropriate techniques & concepts in
processing the historical & projected income data of an
entity to assist management in establishing plans for
reasonable economic objectives & in the making of rational
decisions with a view toward achieving these objectives. It
includes the method & concepts necessary for effective
planning, for choosing among alternatives business actions
& for control through the evaluation & interpretation of
performance. Its study involves consideration of ways in
which accounting information may be accumulated,
synthesized, analyzed & presented in relation to specific
problems, decisions & day to day task of business
management.”
1-214
Comparison of Financial and Managerial

Accounting
Distinction between Cost Accounting
and Managerial Accounting
Cost Accounting:
Cost Accounting is the process of a accounting for costs which begins with recording
of income and expenditure or the bases on which they are calculated and ends with
the preparation of statistical data.
Managerial Accounting:
It is the process of identifying, measuring, accumulating, analyzing, preparing,
interpreting, and communicating information that managers use to fulfill organizational
objectives
Difference Between Cost Accounting and Managerial Accounting
Base Cost Accounting Managerial Accounting
Meaning Cost Accounting is a process of Managerial accounting is one which enables

ascertaining the cost management in doing its functions efficiently.
Objects The primary object of Cost accounting is Managerial accounting is aims at representation of
cost data or accounting information for
to determine the records, cost of products
management use.
and services.
Scope The scope of Cost accounting is not wide, Managerial accounting has wider scope. It includes
it is apart of Managerial accounting Financial accounting, Cost accounting an
statistics etc.
Principles Under this system of cost accounting No principles is followed under the system of
certain principles are followed. managerial accounting.
Parties Both parties, internal and external have Managerial accounting is specially designed for
interested in costing management or internal use.
Principles Cost accountancy have some established it is not so in the case of the management
and formats and set accounting principles and formats accounting
Cost Accounting
► “Cost Accounting is the identification, accumulation,
assignment and analysis of production and activity cost
data to provide information for external reporting, internal
planning and control of ongoing operations and special
decisions.”
► Cost accounting is concerned with providing information
for financial accounting and management accounting
purposes. Cost accounting provides the product cost data
needed for inventory valuation in the statement of financial
position and for income determination in the Income
Statement. It also provides the cost data needed for
budgeting, the control of operation and special decisions
e.g. pricing decision.
Cost
► Cost can be defined as the value of the sacrifice made to
acquire goods or services, measured in monetary units by
the reduction of assets or incurrence of liabilities at the
time the benefits are acquired. At the time of acquisition
the cost incurred for present or future benefits. When
these benefits are utilized, the cost becomes expense.
► An expense is defined as a cost that has given a benefit and
is now expired. Unexpired costs that can give future
benefits are classified as assets.
► When assets are given up for nothing in return in those
cases the value of the assets given up becomes a loss.
Classification of costs:
The achievement of the objective of cost accounting requires
that cost should be ascertain, analyzed and classified.
Classifications are based on the relationship of costs to:
► The product
► Volume of production/cost behavior pattern.
► Ability to trace.
► Departments where incurred.
► Functional areas.
► Timing of charges against revenue.
► Time when computed
► Relationship with accounting period.
► Relationship to planning, controlling and decision making.
1-220
Manufacturing Costs
Manufacturin
Direct Direct
g
Materials Labor
Overhead
The Product
1-221
Direct Materials
Raw materials that become an integral part of
the product and that can be conveniently traced
directly to it.
1-222
Direct Labor
Those labor costs that can be easily

traced to individual units of product.
1-223
Manufacturing Overhead
Manufacturing costs cannot be traced directly to
specific units produced.
Examples: Indirect materials and indirect labor
Materials used to support Wages paid to employees

the production process. who are not directly
involved in production
Examples: Lubricants and work.
cleaning supplies used in the Examples: Maintenance
automobile assembly plant. workers, janitors and
security guards.
1-224
Classifications of Nonmanufacturing
Costs
Administrative
Selling Costs
Costs
Costs necessary to get All executive,

the order and deliver organizational, and
the product. clerical costs.
► The product
Volume of Production:
► Fixed cost: are those in which total fixed cost remain
constant over a relevant range of output, while the fixed
cost per unit varies with the output. Beyond the
relevant range of output, fixed cost will vary.
► The relevant range refers to that range of activities in
which management expects the firm to be operative in
the next planning period.
► Variable cost: are those that in total will change
proportionately as levels of activities are changed. A
variable cost can be viewed as a cost that is constant as
per unit.
► Mixed cost: contain both fixed and variable
characteristics over relevant ranges of operation. Mainly
two types:
► Step cost
► Semi-variable cost
• Relationship between cost & volume within the
relevant range:
• Total variable cost change in proportion to change in
volume.
• Per unit variable cost remain constant when volume
changes.
• Total fixed cost remain constant when volume changes.
• Per unit fixed cost increase/decrease when volume
decrease/increase.
1-228
Cost Classifications for Predicting Cost

Behavior
► The product
Ability to trace:
• Direct cost: cost that management is capable of

tracing to specific items or areas. e.g. direct
material, direct labor etc.
• Indirect cost: cost that are common to many
items and are not therefore directly traceable to
any one item or area. Indirect costs are usually
charged to items or areas on the basis of
allocation techniques.
► The product
Departments where incurred:
► Production dept.: These contribute directly to
the production of the item and include
departments in which conversion and
production processes take place. They include
manual and machine operations directly
performed on the product manufactured.
► Service dept.: These are departments which are
not directly related to the production of an
item. Their function is to provide services for
other depts. The cost of service depts. are
usually allocated to production depts. since the
benefit from the service provided.
► The product
Functional areas:
► Manufacturing cost: they are related to the production
of an item. They are the sum of direct material cost,
direct labor cost, other direct expenses and factory
overhead.
► Administrative cost: these are incurred for the overall
management of the enterprise which cannot be readily
identified with one of the major functional areas. It
includes all expenses necessary for the maintenance of
an efficient management administration.
► Selling & Distribution cost: are cost that incurred after
the manufacturing process. It includes all expenditure
necessary for the transition of the product from the
manufacturing to the immediate buyer.
► The product
Period charges to income:
► Product cost: relates to the product on hand,
either unsold finished goods or semi-finished
goods. They are inventoried and carried forward
as assets until the goods to which they relate
are sold, then they are matched against sales.
► Period cost: are cost that are associated with
the revenues of the current period. They are not
assigned directly to the products on hand
because they do not represent value added to
any specific product.
1-237
Product Costs Versus

Period Costs
Product costs include Period costs are not
direct materials, direct included in product
labor, and costs. They are
manufacturing expensed on the
overhead. income statement.
Cost of
Inventory Goods Sold Expense
Sale
Balance Income Income

Sheet Statement Statement
► The product
Time when computed:
► Historical cost: are past cost valued at the

acquisition cost of the asset. It has the basic
advantage of confirming to GAAP and so are
assumed to be objective , verifiable and free
from bias.
► Standard/ Predetermine cost: express the
future trend of the historical cost and result
from prediction model. It is useful for planning
& control. Standard cost set yardstick for future
performance.
► The product
Relationship with Accounting
period:
• Capital expenditure: provides benefits to future
period and is classified as an asset.
• Revenue expenditure: is assumed to the
current period and is classified as an expense.
• A capital expenditure will flow into the cost
stream as an expense when the asset is used
up or written off.
► The product
Relationship with Planning, Controlling & Decision making
purposes:
► Committed fixed cost: are those fixed unavoidable costs

necessary for maintaining a basic organization and a
production capacity. Their incurrence continues even if the
volume of activity is zero.
► Discretionary fixed cost: arises from yearly appropriation.
Decision for repairs and maintenance costs, advertising
costs, executive training cost etc.
► Controllable cost: are those which may be directly
influenced by unit managers in a given time period.
► Non-controllable cost: are those which are not directly
administered at a given level of management authority.
• Relevant cost: are expected future cost that differ among alternative
courses of action
• Irrelevant cost: are unaffected by management’s actions.
• Differential cost: a differential cost is the difference between the cost
of alternative courses of action on an item by item basis. If the cost is
increasing from one alternative to another it is called an incremental
cost and if the cost is decreasing from one alternative to another it is
called decremental cost.
• Opportunity cost: it is the cost of next best alternative forgone. Where
a decision to persue one alternative is made, the benefits of other
options are forgone. Benefits lost from rejecting the next best
alternative are the opportunity cost of the chosen action. Since
opportunity costs are not actually incurred they are not recorded in the
accounting records. They are however relevant cost fop decision
making purposes and must be considered in evaluating a proposed
alternative.
► Sunk cost: irrevocable costs are called sunk cost. Sunk cost
referred to those cost that result from expenditure made in
the past and can’t be changed by present or future
decisions.
► Imputed cost: are costs not actually incurred in some
transactions but which are relevant to the decision as they
pertain to a particular situation. This cost do not enter into
traditional accounting system but they are being related
with economic reality help in making better decision.
► Out of pocket cost: refers to cash outlay immediately or at
some future date. These costs are relevant cost. Sometime
this cost is termed as direct or variable cost. This cost
concept is useful for management decision making.
► Avoidable cost: are those cost which may not have been
incurred under expected condition. e.g. abnormal loss.
► Joint cost: is the cost of two or more products that are
produced simultaneously by a single process and are not
identifiable as individual types of products until a certain
stage of production known as the split off point is reached.
In other words, it is the total cost incurred up to the point
of separation.
► Common cost: are those cost which are incurred for more
than one product, job, territory or any other specific
costing object. It is not easily identifiable with individual
product and therefore generally apportioned.
• Indicate whether each of the following items is a variable (V), fixed
(F), or mixed (M) cost and whether it is a product/ service (PT) or
period (PD) cost. If some items have alternative answers, indicate the
alternatives and the reasons for them.
Finance
Introduction
What is Finance?
• Finance – area of business responsible for finding the best

sources of funds and the best way to use them.
• Business finance is the activity concerned with planning,
raising, controlling, administering of the funds used in the
business.
• The study of how a present known amount of cash is
converted into a future perhaps unknown amount of cash
(S.M.Archer; G.M. Choate; G.A. Racette)
Finance
To raise money by sell of stocks, bonds or notes (J.M.
Rosenberg-Investor Dictionary)
Finance is the study of how people and businesses
evaluate investments and raise capital to fund them.
Finance is the accumulation of fund and proper
utilization of the accumulated fund to achieve
organizational goal of shareholder’s wealth
maximization.
Finance
• Finance is a body of facts, principles and theories
dealing with the raising and using of money by
individual, business and government
• According to Paul G. Hasings, "finance" is the
management of the monetary affairs of a company.
It includes determining what has to be paid for and
when, raising the money on the best terms available,
and devoting the available funds to the best uses.
Why Study Finance?
• Knowledge of financial tools is critical to making good decisions in both
professional world and personal lives.
• Finance is an integral part of corporate world. Some important questions that
are answered using finance:
• What long-term investments should the firm take on?
• Where will we get the long-term financing to pay for the investments?
• How will we manage the everyday financial activities of the firm?
Finance is all about
decision making
Investment Decision
The investment decision is the most important of the three
major decisions when it comes to value creation. It begins
with a determination of the total amount of assets needed
to be held by the firm. A firm’s investment decision
involve capital expenditures. They are, therefore, referred
as capital budgeting decisions. Two important aspects of
investment decisions are: a) the evaluation of the
prospective profitability of new investments and b) the
measurement of a cut-off rate against that the prospective
return of new investments could be compared.
Financing Decision
Financing decision is the second important function to be
performed by the financial manager. Broadly, he or she must
decide when, where from and how to acquire funds to meet
the firm’s investment needs. The central issue before him or
her is to determine the appropriate proportion of debt and
equity. The mix of debt and equity is known as the firm’s
capital structure. The financial manager must strive to obtain
the best financing mix or the optimum capital structure for his
or her firm. The firm’s capital structure is considered optimum
when the market value of share is maximized. In addition,
dividend policy must be viewed as an integral part of the firms
financing decisions.
Asset Management Decisions
The third important decision of the firm is the asset management
decision. Once assets have been acquired and appropriate
financing provided, these assets must still be managed
efficiently. The financial manager is charged with varying
degree of operating responsibility over existing assets. These
responsibilities require that the financial manager be more
concerned with the management of current assets than with
that of fixed assets. Current assets should be managed
efficiently for safeguarding the firm against the risk illiquidity or
lack of liquidity which in extreme situations can lead to the
firm’s insolvency.
Functions of Financial
Managers
• The term financial manager refer to any person
responsible for a significant corporate investment
or financing decisions (Brealey & Myres)
• Executive Finance Functions

• Incidental Finance Functions
Executive finance functions
Analysing, forecasting & planning
Determining the sources of funds
Determining feasible project to invest the fund
Coordination & control
Interaction with capital markets
Negotiation with outside financer
Establishing asset-management policies
Determination of the allocation of the net profit
Estimating the cash flow requirements & the control
of cash flow
Incidental finance functions
• Supervision of cash transaction & safeguarding of cash
• Custody & safeguarding of valuable papers
• Taking care of mechanical details of outside financing
• Record keeping & reporting
Objectives of financial management
Efficient financial management requires the existence of
some objectives or goals, because judgment as to whether
or not a financial decision is efficient must be made in
light of some standard. It is generally agreed in theory that
the financial goal of the firm should be shareholder’s
wealth maximization, as represented by the market price
per share of the firm’s common stock, which, in turn is a
reflection of the firm’s investment, financing and asset
management decisions.
Profit maximization
Actions that increase profits should be undertaken and
those that decrease profits are to be avoided
Wealth maximization
When operating under a shareholder wealth maximization
objective, management has to coordinate its profit-plan so
that shareholders receive the highest combination of
dividends and increase in share value or price of any given
period.
Favourable arguments of profit maximization
• Economic efficiency
• Social economic welfare
• Monopoly right over market
• Long term survivability
• Increase management confidence
• Expansion of business
Criticism of profit maximization
• Not suitable for perfect competitive market

• Managers have some social responsibility
• It fails to provide an operationally feasible measure for ranking
alternative courses of actions in terms of their economic
efficiency
• Conceptual ambiguity
• Ignores timing of return
• It ignores risks
• It emphasis a short time outlook
• Profit has no earning capacity
Focus of Wealth Maximization
• Focus on shareholders rather than the firm

• Emphasis on future events
• Introduce the idea that capital market evaluates the
activities of the firms and establishes the share prices
• Emphasis cash payments to shareholders
• Consider risk and uncertainty
How Does Finance Fit into the Firm’s
Organizational Structure?
• In a corporation, the Chief Financial Officer (CFO) is
responsible for managing the firm’s financial affairs.
• Figure 1-2 shows how the finance function fits into a firm’s organizational
chart.
Basic Principles of Finance
PRINCIPLE 1: Money Has a Time
Value.
• A money received today is more valuable than a money
received in the future.
• We can invest the money received today to earn
interest. Thus, in the future, we will have more money,
as we will receive the interest on our investment plus
our initial invested amount.
PRINCIPLE 2: There is a Risk-Return
Trade-off.
• We only take risk when we expect to be compensated for
the extra risk with additional return.
• Higher the risk, higher will be the expected return.

PRINCIPLE 3: Cash Flows Are The Source of Value.
• Profit is an accounting concept designed to measure a business’s performance over an
interval of time.
• Cash flow is the amount of cash that can actually be taken out of the business over this
same interval.
• It is possible for a firm to report profits but have no cash.

For example, if all sales are on credit, the firm may report profits even though no cash is
being generated.
Financial decisions in a firm should consider “incremental cash flow” i.e. the difference
between the cash flows the company will produce with the potential new investment it’s
thinking about making and what it would make without the investment.
PRINCIPLE 4: Market Prices Reflect
Information.
Investors respond to new information by buying
and selling their investments.
The speed with which investors act and the way

that prices respond to new information
determines the efficiency of the market. In
efficient markets, this process occurs very quickly.
As a result, it is hard to profit from trading
investments on publicly released information.
• Investors in capital markets will tend to react positively to
good decisions made by the firm resulting in higher stock
prices.
• Stock prices will tend to decrease when there is bad

information released on the firm in the capital market.
The Financial Environment
Financial system of a country is consists of a
number of institutions and markets serving
business firms, individuals and governments.
When a firm invests temporarily idle funds in
marketable securities, it has direct contact with
financial markets. Most firms use financial
markets to help finance their investment in assets.
In the final analysis, the market price of a
company’s securities is the test whether the
company is a success or a failure.
Market – Financial market
• The place where purchaser and sellers gather to publicly trade called
market (J.M. Rosenberg)
• Transactions in which the creation and transfer of financial assets
and financial liabilities take place (Weston & Brigham)
• A financial asset is a liquid asset that gets its value from a

contractual right or ownership claim. Cash, stocks, bonds, mutual
funds, and bank deposits…
• The financial liabilities are contractual obligations of a business
organization to deliver cash or financial assets to the party involved.
The Purpose of Financial Markets
The purpose of financial markets in an economy is
to allocate savings efficiently to ultimate users. If
those economic units that saved were the same as
those that engaged in capital formation, an
economy could have prosper without financial
markets. In modern economies, however, most
nonfinancial corporations use more that their
savings for investing in real assets. Most
households, on the other hand have total savings
in excess of the total investment.
Types of Financial Markets
There are different types of markets in developed and
developing countries and each market deals with a
somewhat different types of instruments in terms of the
instruments maturity and the assets backing it. Also,
different markets serve different types of customers, or
operate in different parts of the country.
Spot vs. Future markets
Spot markets are markets in which assets are
bought or sold on-the-spot delivery. Futures
markets are markets in which participants agree
today to buy or sell an asset at some future date.
For example, a farmer may enter into a future
contract in which he agrees today to sell 5,000
barrel of soybeans six months from now at a price
of Tk500 per barrel.
Money Market vs. Capital Market
Financial markets can be broken down into two
basic classes-the money market and the capital
market. The money market is concerned with the
buying and selling of short-term (less than one
year original maturity) government and corporate
debt securities. The capital market, on the other
hand, deals with relatively long-term (greater than
one year original maturity) debt and equity
instruments (e.g., bonds and stocks).
Primary Market vs. Secondary Market
Within money and capital markets there exists

both primary and secondary markets. A primary
market is a “new issues” market. The corporations
selling the newly created stock receives the
proceeds from the sale in a primary market
transaction. Secondary markets are markets in
which existing, already outstanding, securities are
traded among investors. Transactions in these
already existing securities do not provide
additional funds to finance capital investment.
Private vs. Public Markets
Private markets are markets where transactions
are worked out directly between two parties. On
the other hand, in public markets standardized
contracts are traded on organized exchanges.
Public securities must have fairly standardized
contractual features, both to appeal to a broad
range investors and also because public investors
cannot afford the time to study unique,
non-standardized contracts.
Financial Intermediaries
Financial Intermediaries consist of financial
institutions, such as commercial banks, savings
institutions, insurance companies, pension funds,
finance companies and mutual funds. Financial
intermediaries purchase direct (or primary)
securities and, in turn, issue their own indirect (or
secondary) securities to the public.
Flow of funds used in the Economy
Investment Sector
Business
Government
Household
Financial Intermediaries
Commercial Banks
Financial Brokers
Savings Institutions
-Investment Bankers Insurance Companies
-Mortgage Bankers Pension Funds
Finance Companies
Secondary Market Mutual Funds
Security Exchanges
OTC Market
Savings Sector
Household
Businesses
Government

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Accounting & Finance

• the conceptual framework identifies the qualitative characteristics of

• After a company has journalized and posted all adjusting entries, it

• Companies can prepare financial statements directly from the

STEP 1: PREPARE A TRIAL BALANCE ON THE WORKSHEET

Trial balance amounts come

• On 31st October Supplies on hand Tk. 10000.

STEP 2: ENTER THE ADJUSTMENTS IN THE ADJUSTMENTS COLUMNS

Add additional accounts as needed.

STEP 3: COMPLETE THE ADJUSTED TRIAL BALANCE COLUMNS

Total the adjusted trial balance

STEP 4: EXTEND AMOUNTS TO FINANCIAL STATEMENT COLUMNS

Extend adjusted trial balance amounts to

STEP 5: TOTAL COLUMNS, COMPUTE NET INCOME (LOSS)

Compute Net Income or Net Loss.

◆ Income statement is prepared from the income statement

At the end of the accounting period, the company makes

Closing entries formally recognize in the ledger the transfer of

Companies generally journalize and post closing entries only at

Purpose is to prove the equality of the permanent account balances

1. Analyze business transactions

9. Prepare a post-closing 2. Journalize the

8. Journalize and post

6. Prepare an adjusted trial 5. Journalize and post

◆ Unnecessary if accounting records are free of errors.

◆ Made whenever an error is discovered.

◆ Must be posted before closing entries.

Instead of preparing a correcting entry, it is possible to

1. A payment of Salaries and Wages Expense of Tk.600 was

2. A collection of Tk.3,000 from a client on account was

Correct the errors without reversing the incorrect entry.

◆ Presents a snapshot at a point in time.

Standard Classifications Illustration 4-20

Assets Liabilities and Owner’s Equity

The primary source of revenues is referred to as

Operating Equals Net

Companies use either a perpetual inventory system or a periodic

◆ Records continuously show inventory that should be on

◆ Company determines cost of goods sold each time a

◆ Cost of goods sold determined by count at the end of

◆ Calculation of Cost of Goods Sold:

Beginning inventory Tk. 100,000

ADVANTAGES OF THE PERPETUAL SYSTEM

◆ Shows the quantity and cost of the inventory that

◆ Provides better control over inventories than a periodic

◆ Made using cash or credit (on account).

◆ Normally record when

◆ Purchase invoice should

May 4 Inventory 3,800

Ownership of the goods

Ownership of the goods

Illustration: Assume upon delivery of the goods on May 6, Sauk

May 6 Inventory 150

Assume the freight terms on the invoice in Illustration 5-6 had

Purchaser may be dissatisfied because goods are damaged

Purchase Return Purchase Allowance

Illustration: Assume Sauk Stereo returned goods costing

May 8 Accounts Payable 300

Credit terms may permit buyer to claim a cash discount

Advantages: Example: Credit terms

◆ Seller shortens the operating cycle by converting the