FINANCIAL ACCOUNTING, Dispense di Contabilità Finanziaria

Scarica FINANCIAL ACCOUNTING e più Dispense in PDF di Contabilità Finanziaria solo su Docsity! FINANCIAL ACCOUNTING: THEORY FOR THE EXAM CLASSIFICATION OF ALL ACCOUNTS FINAL EXAM QUESTIONS WITH SOLUTION PPE They are resources that have 3 main characteristics. They have a physical substance, are used in the operation of a business and are not intended for sale. They are expected to provide service for a company for a number of years. HISTORICAL COST PRINCIPLE Under the historical cost principle, the acquisition cost for a plant asset includes all expenditures necessary to acquire the asset and make it ready for its intended use. For example, the cost of factory machinery includes the purchase price, freight costs paid by the purchaser, insurance costs during transit, and installation costs. Once the cost is established, the company generally uses that amount as the basis of acctg for the plant asset over its useful life. Land The cost of land includes: the cash purchase price, closing title, attorney’s fees, real estate broker’s commissions and accrued property taxes and other liens assumed by the purchaser. When land is acquired the account to be debited is land and credited cash. LAND debit CASH or A\P credit Land Improvements Are structural additions. (driveways, parking lots, fences etc). The cost includes all expenditures necessary to make the improvements ready for their intended use. Land improvement can be depreciated because have limited useful life and eventually they would be replaced. Equipment Are assets used in operations. The cost of equipment includes cost of the cash purchase, sales taxes, freight charges, and insurance during transit. But also expenditures required in assembling, installing and testing the unit. NOT INCLUDES licenses or accidental insurances. Equipments have a limited useful life so they are depreciated EQUIPMENT debit CASH credit Buildings Are facilities used in operations, such as stores offices, factories etc. The cost includes purchase price, closing costs, attorney’s fees, title insurance, and real estate broker’s commissions. But also all the costs to make the building ready for its intended use so: expenditures for remodelling, repairing, replacing etc, architect’s fees, permits and excavation costs. CAPITALISATION OF INTEREST EXPENSE IAS23REV It means not recognising an interest expense but including it into the cost of fixed assets. We do this only for qualified assets (assets that need a long time to be ready for use like buildings). Conditions to capitalise an int. expense: • int. exp. must be incurred (has to be already paid) • The company started to incur costs for assets and the activities needed to prepare such assets in progress DEPRECIATION Is the process of allocating to expense the cost of a plant asset ove its useful life in a rational and systematic manner. I Depreciation is a process of cost allocation, NOT asset valuation. It applies to: land improvements, buildings and equipment. Depreciation starts when the item is available for use. It provides for the proper matching of expenses with revenues.The book value of a plant asset may be quite different from its fair value. The revenue-producing ability of an asset will decline due to wear and tear to obsolescence. Recognizing depreciation on an asset does not result in an accumulation of cash for replacement of the asset. Depreciation expense is reported on the income statement, and accumulated depreciation is reported as a deduction from plant assets on the statement of financial position. NOT LAND. Depreciation does not apply to land because its usefulness and revenue-producing ability generally remain intact over time. COMPUTING DEPRECIATION 1. 2. 3. USEFUL LIFE 4. RESIDUAL VALUE 1. STRAIGHT LINE Companies expense the same amount of depreciation for each year of the asset’s useful life. It is measured solely by the passage of time. Dep. Cost: COST - RESIDUAL VALUE Dep. rate: 100%/YEARS (the amount is in %) Ann. Dep. Exp.: DEP COST * DEP. RATE When book value equals estimated Acc. Dep.: ANN. DEP. EXP. + ANN. DEP. EXP. residual value, the Dep. stops Book Value: INITIAL COST - ACC. DEP DEP. EXP. debited ACC. DEP. Credited 2. UNITS OF ACTIVITY METHOD Useful life is expressed in terms of the total units of production or use expected from the asset, rather than as a time period. Dep. Cost: COST - RESIDUAL VALUE INTERNAL obsolescence or physical damage, change in use of asset, cash outflows for operating or maintaining the assets > budget , cash inflows from the asset < budget CHAPTER 5 ACCOUNTING FOR MERCHANDISING OPERATIONS The operating cycle of a merchandiser differs from that of a service company. The operating cycle of a merchandiser is ordinarily longer. For a merchandiser the primary source of revenue is the sale of inventory. In a periodic inventory system, no detailed inventory records of goods on hand are maintained. In a periodic inventory system the cost of goods sold is determined only at the end of the accounting period. A perpetual inventory system provides better control over inventories than a periodic system. PERPETUAL BUYER In general INVENTORY debit ACC.PAY./CASH credit Freight costs FOB SHIPPING POINT INVENTORY D CASH C Return (Purch. Ret. and all.) ACC PAY D INV. C Credit terms (discount) ACC. PAY D CASH C INV (amount of discount) PERPETUAL SELLER In general ACC REC. SALES REV COGS (EXP) INV. Freight costs FOB DESTINATION FREIGHT OUT (EXP.) CASH C Return (Sales Ret. and all.) SALES RET. (XREV) ACC. REC INV. COGS Credit terms (discount) CASH D SALES DISCOUNT D (amount of discount) ACC. REC C ADJ. PERPETUAL COGS INV PERIODIC BUYER In general PURCH. ACC. P Freight costs FOB SHIPPING POINT FREIGHT IN CASH Return (Purch. Ret. and all.) ACC PAY PURCH RET. AND ALL. Credit terms (discount) ACC. PAY D CASH C PURCH. DISCOUNT C (amount of discount) PERIODIC SELLER In general ACC REC. SALES REV Return (Sales Ret. and all.) SALES RET. (XREV) ACC. REC Credit terms (discount) CASH D SALES DISCOUNT D (amount of discount) ACC. REC C BEGINNING INVENTORY + COG PURCHASED = COG AVAILABLE FOR SALE - ENDING INVENTORY= —————— ——————— ————————————- COGS GROSS PROFIT = NET SALES - COGS GROSS PROFIT RATE = GROSS PROFIT / NET SALES The gross profit rate is generally considered to be more useful than the gross profit amount. The rate expresses a more meaningful (qualitative) relationship between net sales and gross profit. The gross profit rate indicates what portion of each sales dollar goes to gross profit. The trend of the gross profit rate is closely watched by financial statement users, and is compared with rates of competitors and with industry averages. Such comparisons provide information about the effectiveness of a company’s purchasing function and the soundness of its pricing policies. LIABILITIES Liabilities are creditors’ claims on total assets and existing debts and obligations. Companies must settle or pay these claims, debts, and obligations at some time in the future by transferring assets or services. CURRENT LIABILITIES The future data on which they are due or payable is called the maturity date and is a significant feature of liabilities, because if the maturity date is due within one year from the issue date, then we are talking about a current liability. By definition a current liability is a debt that a company expects to pay within one year or the operating cycle, whichever is longer. Debts that do not meet this criterion are non-current liabilities. Payment is usually made by transferring assets or services. A feature of current liabilities is that they are measured at amount payable, it means that interest is not included in the value. Financial statements users need to know whether a company’s obligations are current or non- current. For instance, a company that has more current liabilities than current assets often lacks of liquidity, so it could be usually unable to pay in short-terms. Moreover, they want to know the amount and which types of liabilities companies have. The different types of current liabilities include notes payable, accounts payable, unearned revenues and accrued liabilities such as taxes, salaries and wages, and interest payable. NOTES PAYABLE Companies record obligations in the form of written notes payable. Notes are often used instead of accounts because they give an actual formal proof to the lender of the obligation in case there should be the need for legal remedies to collect the debt. Notes most of the time require the borrower to pay the sum borrowed at the time the note was issued plus interest. Notes payable can actually be classified as non-current liabilities when the maturity date is not set within one year from the issue date. When recording a note payable, at the time the note is issued, the note will be recorded at its value, without interest; interest actually accrues over the life of the note, and the company must periodically record that accrual. ANALYSIS OF CURRENT LIABILITIES Use of current and non-current liabilities makes it possible to analyze a company’s liquidity. Liquidity refers to the ability to pay obligations and to pay unexpected events that require for cash. The relationship of current assets to current liabilities is fundamental for analyzing the liquidity of a company; this relation is called working capital when is expressed as a currency amount, and it is the excess of current assets over current liabilities (ass. - liab.). Another way to explain this relationship is as a ratio, the current ratio, that is calculated as current assets divided by current liabilities. The current ratio permits us to compare liquidity of different sized companies and of a single company at different times. Historically a current ratio of 2:1 was considered standard for a good credit rating, but more recently many healthy companies have maintained ratios well below 2:1 by improving management of their current assets and liabilities. NON-CURRENT LIABILITIES Are liabilities that a company expects to pay beyond a year or the operating cycle, whichever is longer. These liabilities may be bonds, long-term notes, or lease obligations. BONDS Bonds are a type of interest-bearing note payable issued by companies, and they represent a promise to pay. Bonds are sold in small denominations, and as a result they attract many investors. The face value of a bond is the amount of principal the issuing company must pay at the maturity date; the maturity date is the date that the final payment is due. The contractual interest often called stated rate, is the rate used to determine the amount of cash interest the issuing company pays to the lender. When a company issues bonds it is borrowing money; the person who buys the bonds is called bondholder, and he is the one who lends the money, so in the future he will be the one entitled to receive the money back plus interest. Interest payments are usually made semi-annually. Bonds are an alternative way to obtain large amounts of long-term capital without relying to equity financing. Some disadvantages in relation to equity financing is that interest must be paid, and principal of course must be repaid. An advantage is that shareholders’ control is not affected, because bondholders do not have voting rights, so the current owners retain full control of the company. Tax savings could be another advantage because bond interest is deductible for tax purposes; div. on shares are not. Third advantage is that EPS (earnings per share) may be higher; although bond interest expense reduces net income, earnings per share is higher under bond financing because no additional shares are issued. CHARACTERISTICS OF BONDS Secure bonds: a secured bond is a type of investment in debt that is secured by a specific asset owned by the issuer. The asset serves as collateral for the loan. If the issuer defaults on the bond, the title to the asset is transferred to the bondholders. Unsecured bonds: also called debenture bonds, are issued against the general credit of the borrower. Companies with good credit ratings use these bonds extensively. Convertible bonds: are bonds that can be converted into ordinary shares at the bondholders’ will. This ‘conversion’, is generally an attractive feature for individuals that are interested in buying bonds. Callable bonds: are bonds that the issuing company can redeem (buy back) at a stated currency amount prior to maturity. This call feature is frequently included in all bonds issued by companies. ISSUING BONDS The terms and the characteristics of the bond issue are set in a legal document called bond indebenture. This indebenture shows the terms and summarizes the rights that bondholders have and the obligations of the issuing company. The trustee keeps record of each bondholder, maintains custody of the unissued bonds… An issuing company is authorized to issue bonds when the governmental laws grants it and when the BoD and shareholders approve it. In authorizing the bond issue, the BoD and shareholders must stipulate the numbers of the bonds to be issued, total face value and contractual interest rate. BONDS TRANSACTIONS A company records the transaction when it issues the bonds or redeems the bonds. Then the company records transactions when the interest on bonds is payed, and also when bondholders convert bonds into ordinary shares. Transaction will not be recorded when bondholders sell their bonds to other investors. ISSUANCE AT PAR Bonds are not necessary issued at face value. This happens because it takes some time to issue bonds and the prevailing interest rate in the market may change; in conclusion, it will be a coincidence if the market rate and the contractual rate are the same. When companies issue bonds at face value they debit cash for the cash proceeds and they credit bonds payable for the face value of the bonds. ISSUANCE AT DISCOUNT When market value is higher than contractual rate, then the company will issue bonds at discount. The issuance of bonds below face value causes the total cost of borrowing to differ from the bond interest paid, because contractual interest differs from actual interest, so as a consequence the liability differs from face value, and the amount to be paid at maturity is an additional cost of borrowing so it is an additional expense that is the difference between the issuance price and face value, the discount. This is why issuing bonds at discount increases cost of borrowing, and an expense has to be recognized, referred to as an interest expense. To follow the expense recognition principle, companies allocate bond discount to expense in each period in which the bonds are outstanding. This is referred to as amortizing the discount. Amortizing the discount increases the amount of interest expense reported in each period. So after the company amortizes the discount the amount of interest expense it reports in a period will exceed the contractual amount. As the discount is amortised the carrying value of the bonds will increase , anti let maturity the carrying value of the bonds equals their face amount. ISSUANCE AT PREMIUM When market value is lower than bond contractual interest rate, then the company will issue bonds at premium. The sale of the bonds above face value causes the total cost of borrowing to be less than the bond interest paid, because the borrower is not required to pay the bond premium at the maturity date of the bonds. Thus, the bond premium is considered To be a reduction in the cost of borrowing. Therefore, the company credits the bond premium to interest expense over the life of the bonds. Companies allocate bond premium to expense in each. In which the bonds are outstanding. This is referred to as amortizing the premium . Amortizing the premium decreases the amount of interest expense reported in each period. So after the company amortize the premium, the amount of interest expense it reports in a period will be less than the contractual amount. The caring value of the bonds will decrease call mom until at maturity the carrying value of the bonds equals their face amount. EFFECTIVE-INTEREST METHOD There are two ways to amortize bonds the first one is the straight line. The second one is called the effective interest method , that is required by the IFRS. Under the effective interest method of amortization call mom the amortization of bond discount or bond premium results in periodic interest expense equal to a constant percentage of the carrying value of the bonds. The steps required to use the effective interest method ara the computation of the bond interest expense (caring value of the bonds at beginning of period x Effective interest rate given), computation of the bond interest paid (face amount of bonds x contractual interest rate). Bond interest expense minus bond interest paid will result in the amortization amount. REDEEMING BONDS An issuing company retires bonds either when it redeems the bonds so, when it buys back the bonds, or when bond holders exchange convertible bonds for ordinary shares. AT MATURITY regardless of the shooting price, the book value of the bonds at maturity will equal their face value. So when a company redeems bonds at maturity it will debit bonds payable and credit cash for the amount of face value. BEFORE MATURITY A company should redeem debt early only if it has sufficient cash resources. When a company redeems bonds before maturity, it is necessary to eliminate the carrying value of the bonds at the redemption date, record the cash paid , and recognize the gain or the loss on redemption. The carrying value of the of the bonds is the face value of the bonds adjusted for bond discount or bond premium amortized up to the redemption date. LONG-TERM NOTES PAYABLE Another type of the noncurrent liability are long term notes payable. Long term notes payable are similar to short term notes payable except that the term of the notes exceeds one year. A long term note me be secured by a mortgage. A mortgage occurs when an individual pledges his own interests as a security for a loan. Individualism widely used mortgage notes payable to purchase homes, and many smaller and some large companies use them to acquire plant assets. Like other long-term notes payable, do not gauge loan terms may stipulate either a fixed or an adjustable interest rate. The interest rate on a fixed-rate mortgage remains the same over the life of the mortgage. The interest rate to on an adjustable-rate mortgage is adjusted periodically to reflect the changes in the market rate of interest. Companies initially record mortgage notes payable at face value they subsequently make entries for each installment payment. Each payment consists of the interest on the unpaid balance of the loan and a reduction of loan principal. The interest decreases each period, while the portion applied to the loan principle increases. In the statement of financial position, the company reports the reduction in principle for the next year as a current liability, and it classifies the remaining unpaid principal balance is a non- current liability. Retained earnings is net income that a Corporation retains for future use. Net income is recorded in retained earnings by a closing entry that debits income summary and credits retained earnings. STATEMENT OF FINANCIAL POSITION Equity +Share capital-ordinary. +Retained earnings Tot. equity ISSUING SHARES AT PAR VALUE FOR CASH Par value shares (nominal) are ordinary shares to which the charter assigned a value per share (the value determines the legal capital). In the past a par value determined the legal capital per share their company must retain in the business for the protection of corporate directors, nowadays par value does not prevent the Corporation from issuing shares above the value. When the company records the issuance of ordinary shares for cash, it credits the par value of the share to share capital-ordinary. It records in a separate account the portion of the proceeds that is above par value. The separate account is called share premium. When a Corporation issues shares for less than per volume, it debits the account share premium ordinary if a credit balance exists in this account. If a credit balance does not exist, Deborah Corporation debit to retained earnings the amount less than farm. This situation anyway occurs only rarely because most jurisdictions do not permit the sale of ordinary shares below par value because shareholders may be held personally liable for the difference between the price paid upon original sale and par value. ISSUING NO-PAR (STATED VALUE) ORDINARY SHARES FOR CASH When no-par ordinary shares have a stated value, the entries are similar to those illustrated for par value shares. the Corporation credits the stated value to share capital-ordinary. Also when the selling price of no par shares exceeds stated value, the Corporation credits the excess to share premium-ordinary. Sometimes Nope are shares do not have a stated value. in that case, Corporation credits the entire proceeds to share capital-ordinary. ISSUING ORDINARY SHARES FOR SERVICES OR NON-CASH ASSETS Corporations also may issue share for services, so compensation to attorneys or consultants, or for non-cash assets, so land, buildings and equipment. To comply with historical cost principle, in a non-cash transaction cost is the equivalent price. Thus, cost is either the fair value of the consideration given up or the fair value of the consideration received, whichever is more clearly determinable. To record the transaction, we debit an expense account if the shares are issued for services, and we credit share capital- ordinary. If the shares are issued for a non-cash asset, we debit the specific asset account and we credit share capital-ordinary. The par value of the shares is never a factor in determining the cost of the assets received. Even in this case, the portion above par value is recorded in a separate account, (Share premium-ordinary). ACCOUNTING FOR PREFERENCE SHARES To attract more investors, many companies decide to issue a different kind of shares called Preference shares. Preference shares have contractual provisions that confer them a preference or a priority over ordinary shares. So preference shareholders have a priority when it come to distributing earnings (dividends) and assets at the time of liquidation. That’s why in the equity section of the stmt of fin position, companies list preference shares first (because of their dividend and liquidation preference over ordinary shares). However, preference shares do not give shareholders the right to vote. Corporations may issue this type of shares for cash or non-cash assets. The entries are very similar to the ones for ordinary shares, the only difference is that each capital account title has to be specified and has to identify the shares to which it relates. For example when the company records the issuance of preference shares for cash, it debits the account cash, and it credits the par value of the share to share capital-preference. If the cost of shares exceeds par value, it records in a separate account the portion of the proceeds that is above par value. The separate account is called share premium- preference. Preference shares may either have no- par value. ACCOUNTING FOR TREASURY SHARES Treasury shares are a corporation’s own shares that the corporation has issued and subsequently reacquired from shareholders but not retired. Treasury shares do not have dividends rights or voting rights, bur corporations acquire them for different reasons. For instance to reissue the shares to employees under bonus and compensation plans, to enhance shares market price that management believes is underpriced, to have additional shares for the acquisition of other companies, to reduce the number of shares outstanding and increase earnings per share, or to eliminate hostile shareholders by buying them out. All transactions referring to treasury shares are classified as equity transactions. So income statement accounts are not involved. PURCHASE OF TREASURY SHARES Treasury shares are generally accounted by the cost method. Under this method the company debits the account treasury shares for the price paid to reacquire the shares. The same amount is credited to Treasury shares when the company disposes the shares. The account treasury shares, is a contra equity account, so when the company acquires treasury shares it reduces equity. Anyway, the original share capital-ordinary account is not affected, because the number of issued shares dos not change, since shares are reacquired from shareholders, but not retired. So, to reduce equity in the statement of financial position, the company will deduct the amount accounted to treasury shares, form Retained Earnings. In the balance sheet, the difference between the number of shares issued, so share capital, and the number of treasury shares, is the number of Outstanding Shares. The term Out. Shares, means the number of issued shares that are being held by shareholders. So, in conclusion, treasury shares reduce shareholder’s claims on corporate assets. This effect is correctly shown by reporting treasury shares as a deduction from equity. DISPOSAL OF TRASURY SHARES Treasury shares are usually sold or retired. When the company disposes treasury shares, if the selling price of the shares is equal to their cost, the company records the sale of the shares by a debit to cash and a credit to treasury shares, under the cost method. Since treasury shares is a contra equity account, the sale of treasury shares increase equity but also increases total asset. Like from the purchase, share capital-ordinary is not affected… The accounting for their sale differs when treasury shares are sold above cost than when they are sold below cost. SALE OF TREASURY SHARES ABOVE COST When the selling price of the shares is greater than their cost, the company credits the difference to Share Premium-Treasury. The company does not record a gain on sale of treasury shares because gains on sales occur when assets are sold, and treasury shares are not assets. Second reason is because a corporation does not realize gain or suffer a loss from share transactions with its shareholders. Thus, companies should not include in net income any capital arising from the sale of treasury shares; instead, they report Share Premium-Treasury separately on the statement of financial position, as a part of equity. SALE OF TREASURY SHARES BELOW COST When a company sells the Treasury shares below cost, it usually debits to share premiumTreasury the excess of cost over selling price. When a company fully depletes the credit balance in share premium-Treasury , it debits to retained earnings any additional excess of cost over selling price. DIVIDENDS AND SPLITS A dividend is a corporation’s distribution of cash or shares to its shareholders on a pro rata basis, it means that the amount of distribution of cash or shares it’s proportional to ownership. So, for example, if you own 10% of the ordinary shares of a company you will be entitled to receive 10% of the dividends. Dividends can be given in the form of shares, cash, property or scrip (a promissory note to pay cash). The forms that predominate are cash and share dividends. Cash dividends are not paid on treasury shares. Dividends are generally reported quarterly as a currency amount per share, but in some cases are reported annually. CASH DIVIDENDS For a corporation to pay cash dividends, it must have first of all Retained Earnings. Payment of cash dividends from retained earnings is legal in all jurisdictions. This is because payment of cash dividends from the legal capital, Share Capital, is illegal. A dividend declared out of share capital or share premium is called a liquidating dividend. Such dividend reduces or ‘liquidates’ the amount originally paid in by shareholders. Secondly, a company that wants to declare dividends has to have adequate cash. Before declaring a cash dividend a company has to consider current and future demands on the company’s resources. In some cases the amount current liabilities will make it inappropriate to declare dividends. Thirdly, the BoD decides when to declare dividends, and it has also the full authority to determine the amount of income to distribute in the form of dividends. Dividends do not accrue like interest on a note payable so and they are not a liability until declared. The amount and timing of a dividend are important issues for management to consider. The payment of our large cash dividend could lead to liquidity problems for the company. On the other end, a small dividend or a missed dividend may cause unhappiness among shareholders. Many shareholders expect to receive a reasonable cash payment from the company on a periodic basis. Many companies declare and pay cash dividends quarterly. On the other hand, a number of high-growth companies pay no dividends, preferring to conserve cash to finance future capital expenditures. equity. However, the number of shares outstanding increases, and part value per share decreases. Since share splits do not affect the balances in any equity accounts, a company is not required to journalize them. ANALYZING EQUITY RETAINED EARNINGS Retained earnings is net income that a company retaines in the business. the balance in retained earnings it's part of the shareholders claim on total assets of the Corporation. However, it does not represent a claim on any specific asset and the amount of retained earnings cannot be associated with the balance of any asset account; for instance if a company has $1,000,000 of balance in retained earnings it does not mean that there should be $1,000,000 in cash. the reason is that the company may have used the cash resulting from the excess of revenues over expenses to purchase buildings , equipment, and other assets. When a company has net income, it closes net income to retained earnings . The closing entry is a debit to income summary and a credit to retained earnings. When a company has a net loss (so when expenses exceed revenues) it also closes this amount to retained earnings; the closing entry is a debit retained earnings and a credit to income summary. Companies do not debit net losses to share capital or share premium. If cumulative losses exceed the cumulative income over a company's life, a debit balance in retained earnings results. A debit balance in retained earnings is identified as a deficit. A company reports at deficit as a deduction in the equity section. The balance in retained earnings is generally available for dividend declarations. In some cases however there may be retained earnings restrictions. This make a portion of the retained earnings balance currently unavailable for dividends . Companies generally disclose the retained earnings restrictions in the notes to the financial statements. STATEMENT OF FINANCIAL POSITION Under IFRS, companies often used the term ‘reserves’ 4 forms of equity other than contributed by shareholders. Reserves sometimes includes retained earnings. More common link, this line item is used to report the equity impact of comprehensive income items, such as the revaluation surplus that resulted from the revaluation of property , plant, and equipment. STATEMENT OF FIN POSITION EQUITY Share capital-preference Share Capital-ordinary +Ordinary share dividends distributable (added to share capital-ord.) Share premium-preference Share premium-ordinary Retained earnings -treasury shares Tot equity STATEMENT OF CHANGES IN EQUITY Instead of presenting a detailed equity section in the statement of financial position and a retained earning statement, Many companies prepare a statement of changes in equity . This statement shows the changes in each equity account and in total that occurred during the year. When statements of financial position and income statements are presented by a Corporation, changes in the separate accounts comprising equity should also be disclosed. Disclosure of such changes is necessary to make the financial statement sufficiently informative for users. The disclosures add made in an additional statement called the statement of changes in equity. This statement shows the changes in each equity account and in total equity during the year. The statement is prepared in a columnar form. it contains columns for each account and for total equity. The transaction are then identified and their effects are shown in appropriate columns. When a statement of changes in equity is presented, a retained earnings statement is not necessary call mom because the retained earnings column explains the changes in the account. WHY DO COMPANIES INVEST? Companies invest generally for three main reasons. First, a company may have excess cash that it does not need immediately, so it decides to use that money to invest; for instance, many companies experience seasonal fluctuations in sales. So, what happens is that in some seasons of the year, the company has more sales, but the same company has an excess of cash in the other seasons until the start of another operating cycle. Excess cash my also result from economic cycles. When investing excess cash for short periods of time, companies invest in low-risk highly liquid securities (Most often short term government securities). It is generally not wise to invest short- term excess cash in ordinary shares because the shared investments can experience rapid price changes. If a company did actually invest short-term excess cash In shares and the price of the shares declined significantly just before the company needed cash again, then the company would be forced to sell investment at loss. A second reason some companies purchase investments is to generate earnings from investment income. For example, banks make most of their earnings by lending money, but they also generate earnings by investing primarily in debt securities. Third, companies also invest for strategic reasons. A company can exercise some influence over a customer or supplier by purchasing a significant, but non-controlling, interest in that company. Or a company may purchase a non-controlling interest in another company in a related industry in which it wishes to establish a presence. A company may also choose to purchase a controlling interest in another company. DEBT INVESTMENTS (hold-to collect) Debt investments are investments in government and company bonds. Hold-to-collect securities, are debt investments that a company intends to hold, to collect the contractual cashflows. At the financial reporting date, these securities are reported at amortized cost. Amortized cost is the initial cost of the investment, minus any repayments received, and plus or minus cumulative amortization of discounts or premiums. (chapter 11) In accounting for debt investments, companies make entries to record the acquisition, the interest revenue, end the sale. At acquisition, investments are recorded at cost. The company will record a debit in the account Debt Investments, and a credit in Cash. To record the interest revenue accrued, the company will journalize an adjusting entry at the end of the accounting year, in which it will debit the account Interest receivable, and credit the account Interest Revenue for the amount stipulated in the contract. The company will report interest receivable as a current asset in the statement of financial position. It will report interest revenue under ‘other income and expenses’ in the income statement. At the beginning of the new accounting period, the company will report a debit in cash and a credit in interest receivable, to record the receipt of accrued interest. A credit to interest revenue at this time is incorrect because the company earned and accrued interest revenue in the preceding accounting period. When the company will sell the bonds, it will debit cash, and it will credit the investment account for the cost of the bonds Then the company will record as a gain or loss any difference between the net proceeds from the sale and the cost of the bonds. If it is a gain, the account to be recorded is ‘gain or sale on debt investments’; if it is a loss, the account to be recorded is ‘Loss on sale of debt investments. The company will report any gain or losses on the sale of debt investments under ‘other income and expense’ in the income statement. SHARE INVESTMENTS Share investments are investments in the shares of other companies. When a company holds shares of several different companies, the group of securities is identified as an investment portfolio. *The accounting for investments in shares depends on the extent of the investor's influence over the operating and financial affairs of the issuing company.* Share investments do not have fixed interest or principal payment schedules and therefore they are not classified as held-for-collection securities. But they are classified into trading securities and non-trading securities. TRADING SECURITIES Trading securities are bought and held by companies with intention of being sold in a short period of time, in fact trading means frequent buying and selling. The fact that trading securities are short-term investments increases the likelihood that they will be sold at fair value. Fair value is the amount for which a security could be sold in a normal market. Companies classify trading securities as current assets. *The accounting for investments in shares depends on the extent of the investor's influence over the operating and financial affairs of the issuing company.* HOLDINGS OF LESS THAN 20% When investor’s ownership interest in investee’s ordinary shares Is less than 20% companies use the cost method with adjustment to fair value. Under the cost method, companies recorded investment that cost, and recognize revenue only when cash dividends are received. At liabilities controlled by the parent company. They also present the total revenues and expenses of the subsidiary companies. Companies prepare consolidated statements in addition to the financial statements for the parent and individual subsidiary companies. Consolidated statements are useful to the shareholders board of directors and managers of the parent company these statements indicate the magnitude and scope of operations of the companies under common control. CONSOLIDATED STMT OF FIN POSITION Companies prepare consolidated statements of financial position from the individual statements of their affiliated companies. They do not prepare consolidated statements from ledger accounts kept by the consolidated entity because the only the separate legal entities maintain accounting records. All the items in the individual statements of financial position are included in the consolidated statement except amounts that pertain to transactions between the affiliated companies. Transaction between the affiliated companies are identified the as intercompany transactions. The process of excluding this transactions in preparing consolidated statements is referred to as intercompany eliminations. These eliminations are necessary to avoid overstating assets, liabilities, and equity in the consolidated statement of financial position. The objective in a consolidated statement is to show only obligations to end receivables from parties who are not part of the affiliated group of companies. The preparation of a consolidated statement of financial position is usually facilitated by the user of a worksheet. It is important to recognize that companies make intercompany eliminations only on the worksheet to present correct consolidated data. Neither of the affiliated companies journalize or posts eliminations. Therefore, eliminations do not affect the Ledger accounts. Sometimes the cost of acquiring the ordinary shares of another company may be above the book value. In this case is the accessor of cost over book value is recognized in the worksheet in an account called excessive cost over book value of subsidiary. The company recognizes this amount separately in eliminating the parent company's investment account. Total assets and total equity and liabilities are not affected. CONSOLIDATED INCOME STATEMENT Affiliated companies also prepare a consolidated income statement. This statement shows the result of operations of affiliated companies as though they are one economic unit. This means that the statement shows the only revenue and expense transactions between the consolidated entity and companies and individuals who are outside the affiliated group. Consequently, all intercompany revenue and expense transactions must be eliminated. Intercompany transactions such as sales between affiliate and interest on loans charged by one affiliate to another must be eliminated. A worksheet facilitates the preparation of consolidated income statements in the same manner as it does for the statement of financial position. STATEMENT OF FIN.POSITION PRESENTATION In the statement of financial position companies classify investments as either short term or long term investments. Trading securities are always classified as short term . Non trading securities and held for collection securities can be short term or long term depending on the circumstances. Short term investments are securities held by company that are readily marketable, (an investment is readily marketable when it can be sold easily whenever the need for cash arises), and intended to be converted into cash, (intend to convert to means that management intends to sell the investment within the next year or the operating cycle, whichever is longer) . Because of their high liquid iti, short term investments appear immediately above the cash in the ‘current assets’ section of the statement of financial position. They are reported at fair value. Long term investments are generally reported in a separate section of the statement of financial position immediately above current assets. long term investments even held for collection debt are reported at the amortized cost . long term investments in non trading share investments are reported at fair value. Investments in ordinary shares are accounted for under the equity method are reported at equity. STATEMENT OF CASH FLOWS USEFULNESS The statement of cash flows reports the cash receipts, cash payments, and net changes in cash resulting from operating, investing, and financing activities during a period. The statement of cash flows help investors and creditors to understand the entity’s ability to generate future cashflows; The entities ability to pay dividends and meet obligations; the reasons for the difference between the net income and net cash provided by operating activities; the cash investing and financing transactions during the period. CLASSIFICATION The statement of cash flows classifies cash receipts and cash payments as operating, investing, and financing activities. Operating activities include the cash effects of transactions that create revenues and expenses. They enter into the determination of net income. This category is the most important, Because it shows the cash provided by company operations. this sort of cash is generally considered to be the best measure of a company's ability to generate sufficient cash to continue as a going concern. investing activities include acquiring and disposing of investments and property, plant, and equipment, and lending money and collecting the loans. Financing activities include obtaining cash from issuing debt and repaying the amounts borrowed, and obtaining cash from shareholders, repurchasing shares, and paying dividends. TYPES OF CASH INFLOWS AND OUTFLOWS Operating Activities-Income statement items Cash Inflows From sale of goods or services from interest received in 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 non-current assets items cash inflows from sale of property, plant, an 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 non-current liabilities and equity items cash inflows from sale of ordinary shares from issuance of long-term debt (bonds and notes) cash outflows to shareholders as dividends to redeem long-term debt or reacquire ordinary shares (treasury shares) CLASSIFICATION OF ALL THE ACCOUNTS ALPHABETICAL ORDER ACCOUNT TITLE CLASSIFICATION FINANCIAL STATEMENT Accounts Payable Current liability Statement of Fin. Position Accounts Receivable Current Asset Statement of Fin. Position Accumulated Depreciation Plant Asset-Contra Statement of Fin. Position Administrative Expenses Operating Expenses Income Statement Advertising Expenses Operating Expenses Income Statement Allowance for Doub. Accounts Current Asset-Contra Statement of Fin. Position Amortization Expense Operating Expenses Income Statement Accumulated Other Compr. Incom Equity Statement of Fin. Position Bank Fees Other Revenue and Expense Items Bad Debt Expense Operating Expenses Income statement Bonds Payable Non-current Liability Statement of Fin. Position Buildings Plant Asset Statement of Fin. Position c Cash Current Asset Statement of Fin. Position Cash Dividends Equity-Contra Statement of Fin. Position Copyrights Intangible Asset Statement of Fin. Position Cost Of Goods Sold Cost Of Goods Sold Income Statement D Debt Investments Current Asset/Long Term Investments Statement of Fin. Position Depreciation Expense Operating Expenses Income Statement Dividend Revenue Other Income And Expense Income Statement Dividends Temporary account closed to RE Retained Earnings Statement Dividends in arreas Share Dividends Distributable Equity Statement of Fin. Position Share Premium-Ordinary Equity Statement of Fin. Position Sh are Premium-preferen ce Equity Statement of Fin. Position Supplies Current Asset Statement of Fin. Position Supples Expen se Operating Expen se Income Statement Trading Debt Securities Current Asset Statement of Fin. Position Trading share investments Current Asset Statement of Fin. Position Trasury Shares Equity-Contra Statement of Fin. Position Union Dues Payable Current liability Statement of Fin. Position Unearned Service Revenue Current liability Statement of Fin. Position Utilities Expense Operating Expense Income Statement Unrealized Gain or Loss- Income(tr. Other Income And Expense Income Statement Unrealized Gain or Loss- Equity(no Equity Compreh en sive Income Statem ent/statem ent of fil v VAT Payable Current liability Statement of Fin. Position w Warranty Liability Current liability Statement of Fin. Position Warranty Expense Operating Expense (Selling Expense) Income Statement 1 Financial Accounting - March 26, 2021 COMPREHENSIVE EXAM Solutions to multiple-choice and fill-in-the-blanks questions 1. RECLASSIFICATION OF FINANCIAL STATEMENT ITEMS (MC: 1 point) (1) CLASSIFICATION. In the Statements, Bank Fees are classified as: Other Revenue and Expense Items (1) CLASSIFICATION. In the Statements, Goodwill is classified as: Non-current Assets (1) CLASSIFICATION. In the Statements, Investments Held-for-Trading are classified as: Current Assets (1) CLASSIFICATION. In the Statements, Sales Returns and Allowances are classified as: Operating Revenues 2. JOURNAL ENTRIES (MC: 2 points) (2) JOURNAL ENTRIES - MULTIPLE-CHOICE. On Oct 01, 2020, the Co borrowed euro 10000 by signing a 3%, 6-month note maturing on Apr 01, 2021. The financial year coincides with the calendar year. What will the Co record on Dec 31, 2020? Debit Interest Expense 75; Credit Interest Payable 75 (2) JOURNAL ENTRIES - MULTIPLE-CHOICE. On July 1, 2020, the Co issued euro 10000, 6%, 10-year bonds at a price of euro 10780. The price resulted in a 5% effective interest rate on such bonds. The bonds pay semi-annual interest on each Jul 1 and Jan 1. The Financial Year coincides with the Calendar Year. What will the Co record on Dec 31, 2020? Debit Interest Expense 270; Debit Bonds Payable 30; Credit Interest Payable 300 (2) JOURNAL ENTRIES - MULTIPLE-CHOICE. The Co on March 15 sells merchandise on account to Barley Co. for 3000, terms 2/10, n/30. On March 20, Barley Co. returns merchandise worth 1200 to the Co. On March 24, payment is received from Barley Co. for the balance due. What is the amount of cash received? 1764 (2) JOURNAL ENTRIES - MULTIPLE-CHOICE. Equipment was purchased for 100000. Freight charges amounted to 5000 and there was a cost of 15000 for building a foundation and installing the equipment. It is estimated that the equipment will have a 25000 residual value at the end of its 5-year useful life. Depreciation expense each year using the straight-line method will be: 19000 3. JOURNAL ENTRIES (FIB: 4 points) (3) JOURNAL ENTRIES. The Company uses the percentage of receivables method for recording bad debt expense. Year-end accounts receivable are equal to euro 1500000, and the allowance account has an euro 2000 debit balance. Management estimates that 1% accounts receivable will be uncollectible. To record the adjusting entry, the company will: N.B.: For each account you use, you must specify whether it relates to assets (A), liabilities (L), equity (E), revenues (Rev), or expenses (Exp). Debit Bad Debt Expense (Exp) 17000; Credit Allowance For Doubtful Accounts (A) 17000 (3) JOURNAL ENTRIES. On January 31, 2021, the Co. accounted for Payroll Tax Expense totalling euro 8000, of which 5500 for social security taxes and 2500 for unemployment taxes. The payment will take place on February 16, 2021. On January 31, 2021, the company will: N.B.: For each account you use, you must specify whether it relates to assets (A), liabilities (L), equity (E), revenues (Rev), or expenses (Exp). Debit Payroll Tax Expense (Exp) 8000; Credit Social Security Taxes Payable (L) 5500; Credit Unemployment Taxes Payable (L) 2500 (3) JOURNAL ENTRIES. The company issued ordinary 5-year bonds for euro 1050. The par value was euro 1000. At the end of the second year, the book value of the bonds is 1035, and the company redeems them for Debit Bonds Payable (L) 1035; Debit Loss on Bond Redemption (Exp) 5; Credit account. The freight costs on such purchase are equal to 200 and are paid cash immediately. The company will make two subsequent accounting entries and record: (ENTRY A) (ENTRY B) N.B.: For each account you use, you must specify whether it relates to assets (A), liabilities (L), equity (E), revenues (Rev), or expenses (Exp). euro 1040. The company will: Cash (A) 1040 N.B.: For each account you use, you must specify whether it relates to assets (A), liabilities (L), equity (E), revenues (Rev), or expenses (Exp). (3) JOURNAL ENTRIES. A merchandising company uses the periodic ENTRYA: inventory system. On March 22, it purchases goods for 10000 on Debit Purchases (Exp) 10000; Credit Accounts Payable (L) 10000 ENTRY B: Debit Freight-in Expense (Exp) 200; Credit Cash (A) 200 5. INVENTORY MEASUREMENT EXERCISE (FIB: 3 points) (5) INVENTORY MEASUREMENT EXERCISE. The Co has the following data related to an item of inventory: (i) Inventory, May 1: 300 units at euro 4; Purchase, May 7: 1000 units at euro 4.50; Purchase, May 16: 200 units at euro 5. The inventory, at the end of May, consists of 400 units. Calculate the value assigned to inventory at the end of May, according to FIFO and LIFO. The FIFO value of inventory at May 31 is [a]. The LIFO value of inventory at May 31 is [b]. [a] FIFO = 1900 [b] LIFO = 1650