Chapter 1&2: Accounting Cycle & Financial Statements

Bookkeeping: Preservation of a systematic, quantitative record of an activity.

Accounting System: Procedures & processes used by a business to analyse transactions, handle routine bookkeeping
tasks, and structure information so it can be used for evaluation.

Nonprofit Organization: An entity oriented towards providing services efficiently and effectively without a profit
objective.

Resources (capital) is usually provided by:

1. Investors (owners).
2. Creditors (lenders).
3. Business’ retained earnings.
When product is sold, additional monetary resources are generated (revenue).

Users & Uses

Investors
Value firm, Assess Risk
- Wants to estimate how much they can expect to receive in the
future.
Lenders (creditors)
Value firm, Assess Risk, Set early warning trip wires – Covenants.
- Interested in being repaid with interest.
Board of Directors
Set compensation of managers (C-Suite: CEO, CFO, COO, CTO, CIO)
Suppliers
Assess future viability of customers business
Labor Unions
Negotiate compensation with Managers
Regulators
Assess whether firms follow financial accounting standards

Pooling Equilibrium: Investors cannot differentiate between two entities (Inefficient).

Separating Equilibrium: Investors can differentiate between two entities.
Generally Accepted Accounting Principles (GAAP): Guidelines that define accounting practice at a particular time.

Managers of the Firm Who Mitigates Earnings Management

• Voluntary disclosure of information: • Auditors
press releases, conference calls. • Corporate governance bodies
• Analysts
• Incentives to manipulate the • Fund Managers
earnings up/down. • Lenders
• Regulators

Balance Sheets
Primary Financial Statements: Statements used by external groups to assess a company’s economic standing.
(aka General-purpose Financial Statements).
- Balance Sheet: Reports assets, liabilities and equity (assets – liabilities) all at a point in time.
- Statement of Comprehensive Income: Provides information on revenues, expenses, net income, and other
comprehensive income (OCI). OCI arises primarily from unrealized valuation gains/losses for certain assets of
foreign currency translation adjustment.
- Statement of Changes in Equity: Details changes in the elements of equity during a period.
- Statement of Cash Flows: Reports amount of cash collected and paid out by a company during a period.

Assets, Liabilities & Equity

Asset: Resource controlled by the entity as a result of past events and from which future economic benefits are
expected to flow to the entity.
- Revenue is an equity, NOT an asset.

(property & plants count under buildings, prepaid insurance is an asset)

Liability: Present obligation of the entity arising from past events, the settlement of which is expected to result in an
outflow from the entity of resources embodying economic benefits.

Anything “payable” is a liability (owed).

Equity: Residual interest in the assets of the entity after deducting all its liabilities.
Net Assets/Worth: The equity of a business; Total Assets – Total Liabilities = Equity.
Stockholders/Shareholders: The owners of a corporation (usually the one with the highest % of shares).
- Stockholders' Equity (Net Worth): The equity section of a corporate balance sheet.
o Includes: Contributed capital, retained earnings & share repurchases/treasury shares.
Dividends: Distributions to the shareholders of a corporation (reduces equity).
- On declaration date, company is legally obliged to pay dividend.
On date of record, corporation identifies stockholders to pay.
Dividend payment date is self-explanatory.
- Not considered in Net Income.
- Dividends Paid = Net Income – Increase in Equity

Retained Earnings: The amount of accumulated earnings of the business that have not been distributed to owners.
Capital Stock: The portion of equity that represents investment by owners in exchange for shares of stock; also
referred to as paid-in capital.
Accounting Equation: An algebraic equation that expresses the relationship between assets, liabilities, and equity
(residual interest): Total Assets – Total Liabilities = Equity (Net Assets)

Classified & Comparative Sheets

Classified Balance Sheet: Assets and liabilities are subdivided into current and non-current categories.
Liquidity: The ability of a company to pay its debts in the short run.
- Assets are listed in decreasing order of liquidity (cash is first).
Current Assets: Non-current (long-term) Assets:
Cash and other assets that can be easily converted Assets that a company needs in order to operate its
to cash/consumed within a year. business over an extended period of time.

Current Liabilities: Non-current (long-term) Liabilities:

Liabilities expected to be satisfied within a year/the Liabilities that are not expected to be satisfied
current operating cycle, whichever is longer. within a year.

Comparative Financial Statements: Statements in which data for two or more years are shown together side-by-side

Market Value: Current value of a business = No. of shares of stock outstanding x Current Market Price of Stock.
- Balance sheets do not usually reflect the current worth of a company.
Book Value: The value of a company as measured by the amount of equity (assets – liabilities).
- Usually less than the market value.

Statement of Comprehensive Income

Statement of Comprehensive Income: Shows the result of a company's operations for a period of time & summarizes
revenues generated and costs incurred to generate them.
- Measures results of operations.
 - Only the amount incurred, not the accumulated amount.
Categories in income statement:
• Sales
• Operating Expenses & non-operating items
• Gains/Losses
• Income tax expense

Revenue: Increase in a company's assets from the sale of goods or services part of the firm’s operations.
- Where assets come from (revenue is NOT an asset, it’s just a label for its source).
- One payment can have multiple revenues: e.g. profit from sales & profit from labour.
- Not tied to any liabilities.
Expenses: Costs incurred in the normal course of business to generate revenues.
- Sometimes divided into operating (earn revenue) and non-operating (no connection with nature of the
business).
Net Income/Loss (Profit): Overall measure of the performance of a company = Revenue - Expenses for the period.
When Revenue ↑, Net Income ↑ (Retained Earnings & Shareholder’s Equity ↑) & vice versa with expenses.

Gains/Losses: From non-operating activities

o E.g. Selling fixed assets.
Sales – Expenses (incl. tax) = Profit after tax

Revenue – “gross”
Income/Loss – “net”

Other Comprehensive Income (OCI): Unrealized gains and losses due to the changes in value of some categories of
securities. Since it is equity, its balance will be carried forward to the next period.
- Not included in the net income (revenues, expenses, gains, and losses).
Comprehensive Income: A measure of the overall change in a company's wealth during a period.
Net income + OCI that results from changes in investment value and exchange rates.

Gross Profit/Margin: The excess of net sales revenue over the cost of goods sold.
Sales – Cost of Goods Sold = Gross Profit
Gains: Money made on activities outside the normal operation of a company.
Losses: Money lost on activities outside the normal operation of a company.
Earnings/Loss per Share (EPS): The amount of net income (earnings) related to each share of stock.
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
𝐸𝑃𝑆 =
𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 𝑛𝑜. 𝑜𝑓 𝑆ℎ𝑎𝑟𝑒𝑠 𝑜𝑓 𝑆𝑡𝑜𝑐𝑘

Statement of Retained Earnings: Shows the changes in retained earnings during a period of time.

Fundamental Concepts & Assumptions

*Note: I’m leaving out a few from the textbook cos I think it’s common sense.
Separate Entity Concept: Activities of an entity are to be separated from those of the individual owners.
Time-period Assumption: The idea used to report the results of activities over a standard time period (usually
monthly, quarterly, or annually).
Arm's-length Transactions: Business dealings between independent and rational parties who are looking out for their
own interests.
Historical Cost: The dollar amount originally exchanged in an arm's-length transaction. Assumed to reflect the fair
market value of an item at the transaction date.
Cost Principle: Transactions are recorded at their historical costs or exchange prices at the transaction date.
Fair Value Principle: Assets and liabilities should be measured at fair value to increase the relevance of accounting
information.
Monetary Measurement: Money is the accounting unit of measurement and that only economic activities
measurable in monetary terms are included in the accounting model.
Going Concern Assumption: The idea that an accounting entity will have a continuing existence for the foreseeable
future.

Accounting Equations
• A – Assets • L – Liabilities
• SE – Shareholders equity
• CC – Contributed capital • RE – Retained earnings
(end of the year)
• NIyear – Net income earned during the year (consolidated income statement).
• DD – Dividend declared during the year (debit)
• Reserves – Cumulative profit put aside for later use.

Average Total Assets (ATO):

𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡 (𝑖) + 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡(𝑒)
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡 (𝐴𝑇𝑂) =
2
FATO:
𝑆𝑎𝑙𝑒𝑠 𝑆𝑎𝑙𝑒𝑠
𝐹𝐴𝑇𝑂 = =
𝐴𝑣𝑔. 𝑁𝑒𝑡 𝑃𝑃𝐸 (𝐵𝑒𝑔. +𝐸𝑛𝑑. 𝑃𝑃𝐸 )
2
Sales/Avg. Net PPE (beg + end /2)

Chapter 3: Mechanics of Accounting

Business documents are important because they:
- Confirm a transaction has occurred.
- Establish the amounts to be recorded.
- Facilitate the analysis of business events.
Analyse transactions > Record effects of transactions > Summarise effects of transactions > Prepare report.

𝐴𝑠𝑠𝑒𝑡𝑠 = 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 + 𝐸𝑞𝑢𝑖𝑡𝑦

1. Borrowing money = Assets ↑ (cash) Liabilities ↑ (notes payable)
2. Purchasing on credit = Assets ↑ (supplies) Liabilities ↑ (accounts payable)
3. Purchasing equipment = Assets ↑ (Equipment) Assets ↓ (cash)
4. Investment = Assets ↑ (cash) Equity ↑ (capital stock)
In the last sentence, all 3 must be balanced.
Account: A record where the results of transactions are accumulated (increase/decrease/balance).
- Asset accounts (cash, supplies etc), liability accounts (payable) & equity accounts (stock & RE).
T-Account: Separates each account column into Debit/Dr. (left) and Credit/Cr. (right), looks like a T.

Debits should balance with Credits.

Supplies bought for customers (e.g. merchandise) should be classified under Equity – Expense.

Including Revenue, Expenses & Dividends

Revenue & expenses can be considered as temporary equity.
- Revenue increases equity (credit), expenses decrease equity (debit).
- Expenses are NOT Liabilities; Expense is an equity, and will increase/decrease when assets/liability
decreases/increases.
o E.g. Wage = Expense, Accounts Payable = Liability.

Journal Entries
Journal: A record where transactions are first entered; a chronological record of all business activities.
- Debit is listed first (left side), followed by credit (right). *the same amount
- Compound journal: more than one debit/credit.

An entry follows the same 3-step process:

1. Identify which accounts are involved (asset/liability/equity).
2. For each account, determine if it is increased or decreased (debited/credited).
3. Determine by how much did it increase/decrease.
o E.g. Borrowing $25k from a bank. Accounts: Cash + Notes Payable.
Cash ↑, since it is an asset, then cash must be debited for $25k.
Notes Payable ↑, since it is a liability, then notes payable must be credited for $25k
[See pg. 118/865 for a more in-depth example.]
- Asset ↑ and Asset ↓ can appear in the same journal entry.
o E.g. Supplies ↑ for Cash ↓.
- Asset = Liability + Equity must be balanced.

Transactions fit into 4 general categories:

• Acquiring cash
• Acquiring not-cash
• Providing services
• Collecting cash & paying obligations

When you make a sale with inventory sold, it will appear in the journal as 2 entries.
 (this will appear as 90 – 75 in the accounting equation)
When agreeing for payment at a later date, it becomes “Accounts Receivable/Payable” on the date the payment is
agreed to occur on.
When payment is made, buyer increases (Dr) Accounts Payable + decreases (Cr) Cash, and seller increases Accounts
Receivable (Dr) + decreases Cash (Cr).

Posting Journal Entries & Trial Balances

Posting: Process of transferring amounts from journal to ledger; sorts entry amounts by account type.
Ledger: A book of accounts in which data from transactions recorded in journals are posted & summarized.

Note: Because the account used here is Cash (Asset), Increase is under Debit and Decrease is under Credit.
Debit Balances (usually) Credit Balances (usually)
Asset Liability
Expense Equity
Dividend Revenue
The balance is on the side that increases the account.
The Trial balance will then be condensed into a statement of comprehensive income + balance sheet + statement of
cash flows.
[See pg. 126/865 for a more detailed example].

Ratios to Assess [Chapter 15]

Liquidity: ability to pay short term debt
Solvency: ability to meet long term debt
Efficiency: whether the firm is efficiently using its assets to generate revenue/profits
Profitability: is the firm profitable, what are the sources of profitability?

Return on Assets (ROA): How much return (profit) do the assets generate.
𝑃𝑟𝑜𝑓𝑖𝑡 𝐴𝑓𝑡𝑒𝑟 𝑇𝑎𝑥
𝑅𝑂𝐴 =
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠

Debt to assets: How much of the assets are financed by interest bearing debt.
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑏𝑒𝑎𝑟𝑖𝑛𝑔 𝑑𝑒𝑏𝑡
𝐷𝑒𝑏𝑡 𝑅𝑎𝑡𝑖𝑜 =
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
Higher the risk, higher is the chance of bankruptcy.
- This ratio is also known as financial leverage ratio.

Asset Efficiency Ratio: Measures how much sales assets generate.

- The returns the firm earns from assets depends on sales the firm generates and the margin on those sales.

Chapter 4: The Accounting Cycle

Time-Period Assumption: Idea that life of a business is divided into distinct and relatively short time periods so
accounting is timely.
Fiscal Year: A 12-month period starting from any time of the year.
Calendar Year: A year from Jan 1st to Dec 31st.

*Accrual-Basis Accounting: Revenues are recognised when certain criteria are satisfied & expenses are recorded as
they are incurred (not necessarily when cash is exchanged).
 - Basically, money increase/deduction is recorded down like it’s already received (includes
receivables/payables).
- “revenues earned”/”expenses incurred”.
Matching Principle: All costs and expenses incurred in generating revenues must be recognised in the same reporting
period as the related revenues.
Cash-Basis Accounting: Transactions are recorded & revenues and expenses are recognised only when cash is
received/paid (ignores payables/receivables).
- “Cash receipts”/”cash disbursements”.

Adjusting Entries
Adjusting Entries: Entries required at the end of each accounting period to recognise (accrual-basis) revenues &
expenses for the period and report proper assets, liabilities, equity, revenue & expense amounts.
- Basically fixing any errors in the balance sheet & statement of comprehensive income.
- Recorded based on the circumstances at the close of each accounting period, same as the regular journal.

Unrecorded Receivables
Revenue earned during a period that have not been recorded by the end of the period (receivables).
- Interest expense (E ↓) Interest payable (L ↑).

Unrecorded Liabilities
Expenses incurred during a period that have not been recorded by the end of that period.
- Expense is recorded first (debit↑), then liability (credit↑).
o E.g. Wages Expense & Wages Payable for rollover period.

Prepaid Expenses
Payments made in advance for items normally charged to expense.
- Written as “prepaid _____” in journal.
- Only assets that offer future benefits should be recorded on the year-end balance sheet.
o E.g. For 4 months of 6-month insurance:

(Same for other usable materials like supplies).

Unearned Revenues
Cash amounts received before its corresponding revenue can be recognised (a liability).
- Arises when customers pay in advance of receiving goods/services.
- Recorded as “unearned revenue” in journal (credit).
o E.g. For 1 month of 3-month pre-paid:
*Note: Adjusting entries made at the end of the accounting period do not involve cash.

Preparing Financial Statements

*Note: Notes are also added to the financial statements to clarify and explain (assumptions, methods etc.)

Closing the Book

The last step.
Real Accounts: Accounts not closed to a zero balance at the end of each accounting period; permanent accounts
appearing on the balance sheet.
- Assets, liabilities & equity.
Nominal Accounts: Accounts closed to a zero balance at the end of each accounting period; primarily includes
revenue and expense accounts (temporary).
- Purposely reduced to zero balance, everything leftover is transferred to Retained Earnings.
- Revenue accs have credit balances and are closed by being debited; vice versa for expense accs.

Closing Entries: Entries that reduce all nominal accounts to zero balance, transferring their pre-closing balances to a
permanent balance sheet account.

(e.g. of a closing journal entry)

Dividends are not expenses and will not be reported on the Statement of Comprehensive Income.
- Dividends reduce Retained Earnings.
Post-Closing Trial Balance: A list of all real account balances after closing process has been completed; tests whether
debits = credits for all real accounts prior to the new accounting cycle.

Chapter 7: Receivables
Receivable: A claim for money, goods, or services – not revenue.
- Most commonly created by selling things on credit & lending money.
Accounts Receivable: Money due for services/merchandise sold on credit.
Notes Receivable: A contract written by the customer received by the firm as a result of selling things on credit &
lending money.
- Stronger legal claim

Revenue Recognition: Incorporating an item that meets the definition of revenue into the net income when it meets
all conditions.
- Seller has a performance obligation and buyer agrees to pay an amount of consideration – the dollar value of
the transaction.
- Happens in 5 steps:
1. Identify the contract with customer.
2. Identify separate performance obligations in contract.
3. Determine transaction price.
4. Allocate transaction price to the separate performance obligations.
5. Determine when the performance obligation is satisfied, and revenue can be recognised.

Valuing & Reporting Receivables

Bad Debts: Uncollectable account receivables.
- Non-paying customers.
- There are internal (e.g. history of customer) and external factors (e.g. economy) affecting the dates.
Direct Write-off Method: Recording of actual losses from uncollectables as expenses during the period in which
accounts receivable are actually determined to be uncollectable.
- Not the preferred method as account could have been manipulated to not be paid.

Allowance Method: Recording of impairment of accounts receivable before they actually cannot be collected.
- Debiting Expected Credit Loss (↓), Crediting Loss Allowance (↑).

Expected Credit Loss: Estimated expense associated with reduction in the carrying amount of accounts receivable.
- Expense, appears on Statement of Comprehensive Income (Debit).

Allowance for Expected Credit Loss (Loss Allowance): A contra account, deducted from Accounts Receivable, that
shows the impairment of accounts receivable that is estimated to be uncollectable.
- Follows Accounts Receivable, appears on Balance Sheet.

- Doesn’t affect net income.

 - 1500 was thrown to Accounts Receivable (credit), Loss Allowance is debited as the bad account has been
identified and eliminated.

Net Realisable Value of Accounts Receivable (NRVAR): Net amount that would be received if all collectable receivables
were collected.
- NRVAR = Total Accounts Receivable – Loss Allowance

- If an amount written off as uncollectable is paid back, the write-off entry is reversed.

Aging Account Receivable: Categorising each Account Receivable by the number of days outstanding.
- Each total by dates is multiplied by an appropriate uncollectable %.
o The older the receivable, the less likely to return.

Monitoring Level of Receivables:

Accounts Receivable Turnover: Indicates how fast a company collected its receivables.
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠 𝑅𝑒𝑣𝑒𝑛𝑢𝑒
- 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑁𝑒𝑡 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒
Average Collection Period: Average number of days it takes to collected a credit sale.
365
- 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐶𝑜𝑙𝑙𝑒𝑐𝑡𝑖𝑜𝑛 𝑃𝑒𝑟𝑖𝑜𝑑 = 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟

Notes Receivable & Foreign Currencies

Is written.
o Fixed Deposit
 - Dishonoured (unfulfilled) notes receivable still have to be paid back.

Foreign Currency Transaction: Price is denominated in a currency other than the currency of the company’s home
country.
- Written as “Foreign Exchange Loss/Gain”

Chapter 5&6: Financial Statement Integrity & Operating Activities: Cash

Error: a mistake
Disagreement: when people arrive at different conclusions due to different judgements
o E.g. Determining how much of a job has been completed.
Fraud: intentional error
- Results in stolen assets (creating false journal entries).

Internal Control Structure

Internal Control Structure: Policies & procedures established to provide management with reasonable assurance that
objectives will be achieved.
- Can be divided into: control environment, risk assessment, control activities, info & comms & monitoring.
A good control environment has:
An audit committee: Independent directors who are responsible for dealing with external & internal auditors.
Control Activities:

Income Smoothing: Carefully timing the recognition of revenue & expense to even out reported earnings.
Business Activities

Recording Discounts:

Debit to Accounts Payable (liability decrease), credit Cash & Inventory (asset increase).

Petty Cash Fund: Special cash fund used to pay relatively small amounts.

Why’s its own account? The fuck I know why.

- There’s even a petty cash custodian.

Bank Reconciliation: Process of systematically comparing the cash balance as reported by the bank with the cash
balance on the company’s books & explaining differences.
NSF: Non-sufficient funds – will have a penalty.

Chapter 8: Inventory & Cost of Sales

Inventory: Goods held for resale in the normal course of business.
- Consists of all costs involved in buying inventory & preparing it for sale.
- Sale effort costs are operating expenses.
Cost of Goods Sold (COGS): Costs incurred to purchase/manufacture merchandise sold during a period.
Cost of Goods Available for Sale: Cost of all merch available for sale during a period.
𝐶𝑜𝑠𝑡 𝑜𝑓 𝐺𝑜𝑜𝑑𝑠 𝐴𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 = 𝐵𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 + 𝑁𝑒𝑡 𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠

Raw Materials: Materials purchased for manufacturing products.

Work in Progress & Finished Goods: I don’t need to explain this do I.

Who Owns the Inventory During Transit?

Free-On-Board (FOB) Destination: Seller of merch bears shipping cost and has ownership until buyer receives the
merch.
Free-On-Board (FOB) Shipping Point: Buyer of merch bears shipping cost and has ownership at the point of shipment.
Consignment: Arrangement whereby merch owned by the consignor is sold by the consignee, usually on commission
basis.
- Goods held on consignment are not included in inventory of the firm (consignee) holding them.
Same for the supplier (consignor) to include them in their records.

Perpetual & Periodic Systems

Perpetual Inventory System:
Detailed records of the number of units and the
cost of each purchase & sales transaction are
prepared throughout the accounting period.
- Record whenever a purchase is made – best
for high value individual items/high costs to
running out.
Periodic Inventory System:
Cost of goods sold is determined & inventory is
adjusted at the end of the accounting period.
- Best when inventory is large and
diverse/with low value.

All purchases are added (debited) to Inventory.
Inventory is only updated using an inventory count
at period end.
- Purchases are recorded in temp. account
“Purchases”, which is closed to Inventory.
This is about the same for every new thing.

Transportation Costs

Purchase Returns

Purchase Discounts
 Sales

With a periodic system, no attempt is made to recognise cost of goods sold on a transactional basis, only total sales.
- Perpetual sales also has a more divided T-accounts for the larger number of journal entries.
Once ending Inventory is known, two entries are made:
1. Transfer all temporary accounts to Inventory.
2. Reduce Inventory by amount of Cost of Goods Sold.

Net Purchases: Net cost of inventory purchased during a period after adding cost of freight & subtracting returns and
discounts.
𝑁𝑒𝑡 𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠 = 𝑁𝑒𝑡 𝐶𝑜𝑠𝑡 𝑜𝑓 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 + 𝐶𝑜𝑠𝑡 𝑜𝑓 𝐹𝑟𝑒𝑖𝑔ℎ𝑡 − 𝑅𝑒𝑡𝑢𝑟𝑛𝑠 − 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡𝑠

Counting & Calculations

Physical count of inventory has 2 steps:
1. Quantity Count
2. Inventory Costing – Value of each item

Inventory Shrinkage: Inventory lost/stolen/spoilt during a period; determined by comparing perpetual inventory
records to physical inventory count.

- For perpetual inventory:

- For periodic inventory, no journal entry for shrinkage is made, so it is reflected as change in physical count.

Errors in inventory correct themselves after 2 years if the physical count at the end of 2nd year is correct.

Correct by detracting from the wrong one and adding it to the right one.
Calculating Income
First-in-first-out (FIFO): First goods purchased are assumed to be the first goods sold; ending inventory consists of
most recent purchased goods.
Last-in-first-out (LIFO): Last goods purchased are assumed to be the first goods sold; ending inventory consists of first
goods purchased.
Weighted Average Cost: COGS and cost of ending inventory determined by average of all merch available during the
period.
- Average of FIFO and LIFO.
𝐶𝑂𝐺𝑆 = 𝑁𝑜. 𝑜𝑓 𝑈𝑛𝑖𝑡𝑠 𝑆𝑜𝑙𝑑 × 𝑊𝑒𝑖𝑔ℎ𝑡𝑒𝑑 𝐴𝑣𝑔. 𝐶𝑜𝑠𝑡 𝑝𝑒𝑟 𝑈𝑛𝑖𝑡

IFRS doesn’t allow LIFO & companies tend to prefer FIFO (looks better).

Specific Identification: Valuing inventory and determining cost of goods sold, whereby the actual costs of specific
inventory items are assigned to them.
- Often used for limited items with high price (e.g. cars).
- Requires the individual costs of actual units sold be charged against revenue as COGS.

FIFO vs. Weighted Average

Weighted Average cost must be computed for all inventory available during the period.

Credit Terms
E.g.
Credit terms are usually written as: 1/5, n/30 (“one-five, net 30)
1/5: if the customer pays within 5 days of the date of the invoice, the customer gets a 1% discount on the
invoice value
n/30: if the customer pays within 30 days of the date of the invoice, there is no interest charged for late
payment
Net: net of returns by the customer
30 days: Some firms charge customers interest if they have not paid by the due date (30 days).

Valuing & Assessing Inventory

Lower of Cost (Net Realisable Value): Inventory should be reported on the balance sheet at the value that is lower of
cost/net realisable value.
 - Sometimes items can be damaged or made obsolete.

Net Realisable Value: Selling price of an item minus any selling cost.

Journal Entry:
Debit – Cost of Goods Sold
Credit - Loss becomes “Allowance for Inventory Write-down”.
Allowance for Inventory Write-down is a contra-account to Inventory, and should be presented on the balance sheet
as a deduction from Inventory.

Level of Inventory
Inventory Turnover: Measure of the efficiency of how inventory is managed.
- The average of beginning and ending inventory.
𝐶𝑜𝑠𝑡 𝑜𝑓 𝐺𝑜𝑜𝑑𝑠 𝑆𝑜𝑙𝑑
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 =
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑓𝑜𝑟 𝑎 𝑃𝑒𝑟𝑖𝑜𝑑
Number of Days’ Sales in Inventory: Alternative measure of how well Inventory is being managed.
- Average no. of days between each turnover.
365
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝐷𝑎𝑦𝑠 ′ 𝑆𝑎𝑙𝑒𝑠 𝑖𝑛 𝐼𝑛𝑣𝑒𝑛 =
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟
Number of Days’ Sales in Inven + Average Collection Period Ratio = Length of Operating Cycle
- Average amount of time between point of inven purchase to when cash is collected from customer.

Number of Days’ Purchases in Accounts Payable: Measure of how well operating cash flow is managed.
365
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝐷𝑎𝑦𝑠’ 𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠 𝑖𝑛 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑃𝑎𝑦𝑎𝑏𝑙𝑒 =
𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑃𝑎𝑦𝑎𝑏𝑙𝑒

Chapter 9: Provisions & Contingent Liabilities

Sometimes shit takes years to happen (e.g. litigation), and it can’t be recorded last minute right?

Provision: A present obligation as a result of a past event, for which it is probable that an outflow of resources is
required for settlement & the amount can be reliably estimated
- A recognised liability.
- Recognised if:
o An entity has a present obligation.
o It is probable that an outflow of resources embodying economic benefits will be required to settle.
o A reliable estimate can be made of the amount of the obligation.
- Debit Loss account, Credit Provision account.
o E.g. Warrant Liabilities, Lawsuits

Contingent Liabilities: A present obligation as a result of a past event, for which it is possible that an outflow of
resources will be required for settlement/the amount cannot be reliably measured.
- Should not be recognised BUT should be disclosed in financial statement notes.
 o Existence will be confirmed only be the occurrence/non-occurrence of 1 or more uncertain future
events not wholly within the control of the entity.
o A present obligation but is not recognised because:
▪ It is not probable that an outflow of resources embodying economic benefits will be required
to settle.
▪ OR a reliable estimate cannot be made of the amount of the obligation.

Categorising Capital (Asset) vs. Expense

Capitalize: Write the expenditure as an asset in the balance sheet rather than as an expense in the income
statement.

Research & Development – Due to the uncertainty of its future economic benefit, it is considered an expense.
Advertising - Due to the uncertainty of its future economic benefit, it is considered an expense.
- If select cases are more certain of benefits, it is considered a capital.

Chapter 10: Investments

Property, plant & equipment (PPE) are considered tangible, long-lived assets.
o E.g. Land, buildings, machinery, equipment & furniture.
Intangible Assets: Long-lived assets without physical substance.
o E.g. Licences, patents, franchises & goodwill (competitive advantages).
Amortization: Process of cost allocation that assigns original cost of an intangible asset to the periods benefitted.
- Some intangibles have unlimited life and are not amortized, but is tested for impairment annually.

Cost of an Asset: Includes the purchase price, any other costs incurred necessary in acquiring the asset & getting it
ready for use.
- Assets are usually acquired by purchase.
Basket Purchase: Buying 2 or more assets together at a single price.

Depreciation
Written on Statement of Comprehensive Income, determinant of Net Income.
Straight-Line Depreciation: Cost of an Asset is allocated equally over the periods of an asset’s estimated useful life.

𝐺𝑟𝑜𝑠𝑠 𝐶𝑜𝑠𝑡 − 𝑆𝑎𝑙𝑣𝑎𝑔𝑒 𝑉𝑎𝑙𝑢𝑒

𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 =
𝑈𝑠𝑒𝑓𝑢𝑙 𝐿𝑖𝑓𝑒
Written as: “Accumulated depreciation ↑” (asset ↓) and “Depreciation Expense ↑” (Equity ↓)
In the balance sheet:
Gross cost of Cash Register 100,000
Less Accumulated Depreciation (750)
Net Book Value of Cash Register 99,250 – salvage value not shown

𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑏𝑙𝑒 𝐴𝑚𝑜𝑢𝑛𝑡 = 𝐴𝑠𝑠𝑒𝑡 𝐶𝑜𝑠𝑡 − 𝑆𝑎𝑙𝑣𝑎𝑔𝑒 𝑉𝑎𝑙𝑢𝑒

𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑏𝑙𝑒 𝐴𝑚𝑜𝑢𝑛𝑡
𝐴𝑛𝑛𝑢𝑎𝑙 𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝐸𝑥𝑝𝑒𝑛𝑠𝑒 =
𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝐿𝑖𝑓𝑒 (𝑌𝑒𝑎𝑟𝑠)
Units-of-Production Depreciation: Cost of an Asset is allocated to each period on the basis of the productive output
or use of the asset during the period.
- Usually used for natural resources (e.g. coal).
𝐶𝑜𝑠𝑡 − 𝑆𝑎𝑙𝑣𝑎𝑔𝑒 𝑉𝑎𝑙𝑢𝑒
𝑈𝑜𝑃 𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 = × 𝑁𝑜. 𝑜𝑓 𝑈𝑛𝑖𝑡𝑠 𝑃𝑟𝑜𝑑𝑢𝑐𝑒𝑑/𝐻𝑜𝑢𝑟𝑠 𝑈𝑠𝑒𝑑 𝑒𝑡𝑐.
𝑇𝑜𝑡𝑎𝑙 𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝐿𝑖𝑓𝑒
Total Estimated Life and No. of Usages use the same units.
o E.g. Miles, Hours, Products Produced.

Depletion: Cost Allocation that assigns the original cost of a natural resource to the periods benefitted.

Double-Declining Balance Depreciation (DDB): Specifies a fixed depreciation rate equal to twice the straight-line rate.
1
𝐷𝐷𝐵 𝑅𝑎𝑡𝑒 = ×2
𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝐿𝑖𝑓𝑒 (𝑦𝑒𝑎𝑟𝑠)

𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝐸𝑥𝑝𝑒𝑛𝑠𝑒 = 2(𝑆𝑡𝑟𝑎𝑖𝑔ℎ𝑡𝑙𝑖𝑛𝑒 𝑟𝑎𝑡𝑒)(𝐶𝑜𝑠𝑡 − 𝐴𝑐𝑐𝑢𝑚𝑢𝑙𝑎𝑡𝑒𝑑 𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛)

Partial Year Depreciation & Changes in Estimate

Often times assets are purchased at different times during the year.
Depreciation is calculated from the date the asset is ready for use/bought till the reporting period end.
- The next year is calculated as usual.
- If the asset is not fully depreciated and no scrap value is received then the book value of the fixed asset is
treated as a non-operating loss.

Change in estimated useful life/salvage value does not require modifying depreciation expense already taken.
- New info only affects future years’ depreciation.
- Disclose that the estimates have been changed in the footnotes.

Expenditures & Impairments

Revenue Expenditures: Expenditures on long-term operating assets, such as ordinary repairs and maintenance that
typically only benefit the year they are made.
- Expenses of the year.
- Written in journal with “-Expense” suffix.

Capital Expenditures: Expenditures on long-term operating assets that are significant in amount, can benefit over
several years & can increase the productive life/capacity of the assets.
- Added to the cost of the asset (capitalised).

Impairment: Decline in the value of a long-term operating asset.

Recoverable Amount: Value of an Asset, that which is the higher one of net fair value/value in use of the asset.
Net Fair Value: Fair value of an asset after subtracting disposable cost.
Value in Use: Value of an asset that is present value of the expected future cash flows generated by the asset.

Accumulated Impairment Loss: Contra account of property, plant & equipment to reduce its value to the recoverable
amount.
Impairment Loss: Non-operating expense for recognizing decrease in value of property, plant and equipment.
- Results in decrease of net income.

Disposal

- Same for selling assets.

Chapter 12: Financing Equity

Proprietorship: A business owned by one person.
Partnership: An association of 2 or more individuals/organizations to carry on economic activity.
- Both ownerships have unlimited liability (will take all the Ls if the business becomes bankrupt).

Corporation: A legal entity chartered by a state; ownership represented by transferable shares of stock.
- Characterised by limited liability (only Ls is the money they invested), easy ownership transferral, ability to
raise capital, separate/independent taxation & government regulation.
I think all this is in BSP1702 notes.

Prospectus: A report provided to potential investors that represents a company’s financial statements and explains its
business plans, sources of financing & significant risks.
Stocks
Considered as equity accounts.
Common Stock/Share – Share Capital Preferred Stock/Share
Typically provides voting right, is secondary to preferred Provides dividends and liquidation preferences over
stock in dividend and liquidation rights. common stock.
Most frequently issued class of stock. - Not allowed to vote & only received a fixed-
cash dividend.
- Preferred shareholders have a right to dividend
before common shareholders.

Convertible Preferred Stock

Preferred stock that can be converted to common stock
at a specified conversion rate.

Par Value: Nominal value assigned to & printed on the face of each share of a corporation’s stock.
- When stock sells for a price above par, it is sold at premium (discounted = below par).
- Kinda historical.
 Same for selling preferred stock
Common Stock: “Share Capital-Ordinary”
Paid-in Capital in Excess of Par, Common Stock: “Share Premium-Ordinary”, “Capital Surplus”

Only 1 credit entry for no-par stock.

When noncash items are considered, assets/services received is recorded at the fair value. If that cannot be
determined, fair market value of the stock issued is used as basis for recording transaction.

Treasury Stock: Issued stock that has subsequently been reacquired by the corporation.
- Accounted for on a cost basis (stock is debited at its cost on the date of its repurchase).
- When reissuance price > repurchase cost, no gain can be recognised as part of net income. A company
cannot earn profits from selling (issuing) its own stock.
o Buying back stock.

When reissuance price of treasury stock < cost, an additional debit is required.
- If there is a balance from before, debit to Paid-in Capital, Treasury Stock.
- If above account is empty, debit to Retained Earnings.

Dividends
There are two types of stock dividend.
• Small stock dividend (< 25% of shares outstanding)
• Large stock dividend (> 25% of shares outstanding)

Basis for recording stock dividend:

• Small stock dividend – Fair value of stock (e.g. market price of stock)
• Large stock dividend – Par value of stock

Corporations sometimes split their shares, especially when the share price has gone up a lot.
 - Split allows the stock to get back into a trading range where individual investors can trade in the stock.
o Stock split 2:1 = one share becomes two shares.
The par value becomes half & share price in the market also becomes close to half.

Earnings per Share (EPS): Measures profitability of firm.

- Account for any new capital issued or capital reduced via repurchase calculate weighted average.
𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡 𝑎𝑓𝑡𝑒𝑟 𝑇𝑎𝑥 − 𝑃𝑟𝑒𝑓𝑒𝑟𝑟𝑒𝑑 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑
𝐸𝑃𝑆 =
𝑊𝑒𝑖𝑔ℎ𝑒𝑑 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑆ℎ𝑎𝑟𝑒𝑠 𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔

Price to Earnings Ratio (PE): Describes stock price as a multiple on earnings - How much is the market willing to pay
for the earnings.
- High growth firms have high PE ratios, value firms have low PE ratios.

Dividend Payout Ratio (DivPayout): The ratio of dividends paid to net income.
- High dividend payout ratio firms are stable (high earnings) with stable future earnings.
𝐶𝑎𝑠ℎ 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑
𝐷𝑖𝑣𝑃𝑎𝑦𝑜𝑢𝑡 =
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 𝐴𝑓𝑡𝑒𝑟 𝑇𝑎𝑥

Chapter 14: Statement of Cash Flow

Financial statement that shows cash inflow (receipts) and outflows (payments) during a period.
- Provides details on how Cash account changes during a period.
Cash Equivalents: Short-term, highly liquid investments that can be easily converted into cash.

Major Classifications of Cash Flow:

Operating Activities (CFO): Activities part of the day-to-day business of a company – transactions & events.
Investing Activities (CFI): Activities associated with buying and selling long-term & non-operating assets.
o (securities, PPE, assets not held for resale) & (stocks & loans from other companies).
Financing Activities (CFF): Activities whereby cash is obtained from or repaid to owners and creditors.
o sale of stock, bonds, loans, Cash paid for repayments of debt & dividends declared.

Interest paid, interest received, and dividend received are CFO.

Dividend paid is CFF.
 Δ Cash = Δ Liabilities + Δ Shareholders equity – Δ Non-cash assets
Δ Cash = Δ Liabilities + Issues – Repurchases + NI - Dividend Declared – Δ Non-cash assets
𝐶𝑎𝑠ℎ 𝐹𝑙𝑜𝑤 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛𝑠
Quality of Net Income Ratio =
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
Low quality of net income ratio = accounting net income has low quality.

Investing & Financing Activities

Acquisition and proceeds from property (land), plants, and equipment.

Issuing stocks/shares will result in an increase (debit) to Cash.

Direct Method of Reporting Cash Flow

1. Eliminate expenses not involving cash.
2. Eliminate effects of non-operating activities.
3. Adjust remaining figures from accrual-basis to cash-basis.

Remove depreciation expense, gain on sale of equipment (investing).

- When depreciation is removed to get net income, add the depreciation back as no cash flowed out relating
to depreciation.
Statement of Cash Flow should reflect cash paid for inventory.
- Adjust COGS to reflect inventory used in the current period purchased in the last period & inventory
purchased last period and paid in the current period.
Chapter 15: Financial Statement Analysis
Refer to Week 12 slides for graphs and clearer examples.
Financial Statement Analysis: The examination of both the relationships amongst financial statement numbers and
the trends in those numbers over time.
Financial Ratios: Relationships between financial statement amounts.

Vertical Analysis (Common-size Financial Statement): Divides all financial statement numbers by total sales/total
assets for the period/at period end.
- Shows all amounts for a given period as a % of sales/total assets for that period.
- Income statement (ratio of net sales) & Balance sheet (ratio of total assets).

Horizontal Analysis: Examines changes over time.

- Uses a bunch of graphs.
- Year on year change: % change between year T and year T-1.
(𝐼𝑡𝑒𝑚 𝑇 − 𝐼𝑡𝑒𝑚 𝑇−1 )
𝑌𝑒𝑎𝑟 𝑂𝑛 𝑌𝑒𝑎𝑟 (𝑌𝑂𝑌) 𝐶ℎ𝑎𝑛𝑔𝑒 =
𝐼𝑡𝑒𝑚 𝑇−1
- Overtime change: % change between year T and base year.
𝐼𝑡𝑒𝑚 𝑇
𝐶ℎ𝑎𝑛𝑔𝑒 𝐵𝑎𝑠𝑒 𝑌𝑒𝑎𝑟 =
𝐼𝑡𝑒𝑚𝐵𝑎𝑠𝑒 𝑌𝑒𝑎𝑟
I think it’s more or less graph analysis – gradients, rising/falling, etc.

Financial Ratios

Acid-test (quick) ratio, Accounts Receivable Turnover, Inventory Turnover, Fixed Asset Turnover (PP&E)
Current Ratio: Liquidity of a business; current assets divided by current liabilities.
- Usually an amount > 1 is considered appropriate.
Return on Equity (ROE): Return to equity shareholders.
𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡 𝐴𝑓𝑡𝑒𝑟 𝑇𝑎𝑥 − 𝑃𝑟𝑒𝑓𝑒𝑟𝑟𝑒𝑑 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 − 𝑃𝑒𝑟𝑝𝑒𝑡𝑢𝑎𝑙𝑠 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑
𝑅𝑂𝐸 =
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑇𝑜𝑡𝑎𝑙 𝑂𝑟𝑑𝑖𝑛𝑎𝑟𝑦 𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟 ′ 𝑠 𝐸𝑞𝑢𝑖𝑡𝑦

Debt to Equity Ratio: Reflects mix of sources of financing for a company - Total Liabilities divided by Total Equity.
- The higher the ratio, the more debt the company has.

Total Liabilities Ratio: How much of the assets are financed by liabilities and not equity – Total Liabilities/Total Assets
- Whether there are enough assets to cover all liabilities.
 Profit Margin, Return on Assets, Asset Turnover, Return on Equity, Earnings per share, Price-earnings (PE) ratio.
Accounts Payable Turnover (APTO): Check how fast is the firm paying suppliers - Purchases/Average Accounts Payable
- Assume that COGS is all cash.
o E.g. non-cash item in COGS that we can adjust – Depreciation expense
• BB inventory + purchases – EB inventory = COGS

Dupont Analysis
Breaks down return on equity for to 3 ratios:
1. Return on Sales
2. Asset Turnover
3. Assets-to-Equity Ratio

ROA = ATO * Net Margin Ratio

- Returns the firm earns from its assets depends on how much sales the firm generates and the margin on
those sales.

𝑅𝑂𝐸 = 𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝑆𝑎𝑙𝑒𝑠 (𝑃𝑟𝑜𝑓𝑖𝑡𝑎𝑏𝑖𝑙𝑖𝑡𝑦)𝑥 𝐴𝑠𝑠𝑒𝑡 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 (𝐸𝑓𝑓𝑖𝑐𝑖𝑒𝑛𝑐𝑦)𝑥 𝐴𝑠𝑠𝑒𝑡𝑠: 𝐸𝑞𝑢𝑖𝑡𝑦 𝑅𝑎𝑡𝑖𝑜 (𝐿𝑒𝑣𝑒𝑟𝑎𝑔𝑒)
- The higher the ROE, the better the result.