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An in-depth analysis of stockholders' equity, its components, and how it changes through various transactions. It also explains the recording process of debits and credits, the importance of internal control activities, and the accounting for merchandising operations. Essential for students studying accounting, finance, or business management.
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Chapter 1 Basic Accounting Equation: Stockholders’ Equity Assets = Liabilities + Stockholders’ Equity Revenue - Expenses = Net Income Do not count unearned service revenue Do we use money from net income to fund the business? Or does it come from retained earnings, so is net income and retained earnings the same? Stockholders’ Equity Ownership claim on total assets Referred to as residual equity Common stock and retained earnings Common stock + Retained earnings = revenues - (expenses + dividends) Change in Stockholder’s Equity 4,000 to 20, 4000 + stock from the year + Revenue - Expenses - Dividends = 20, Common stock → investments by stockholders of the company Retained earnings → income of the company that has been retained in the business Equity → common stock and retained earnings Stockholders’ Equity Increases ● Revenues (sales, fees, services, commissions, interest, dividends, royalties, rent) ● Investments by stockholders Decreases ● Dividends to stockholders ○ Distribution of cash or other assets to stockholders ○ ARE A PART OF RETAINED EARNINGS NOT NET INCOME (after the fact) ○ Reduce retained earnings
○ Not an expense ○ When company distributes share of profits to stockholders ● Giving out dividends would decrease a stockholder's equity → it comes out of retained earnings ● Expenses (cost of generating revenue/doing business: salaries, rent, utilities, tax) Transactions ● Internal or external ● Dual effect on the accounting equation Is it a transaction? Is the financial position (assets, liabilities, stockholders’ equity of the company changed? Assets = Liabilities + Stockholders’ Equity ● Each transaction must be analysed in terms of Companies prepare 4 financial statements ● Income statement (revenue less expenses) ○ Profitability of the company’s operations over a specific time period ○ Lists revenues first, then expense ○ Shows net income (or net loss) ○ Not include investment and dividend transactions between stockholders and business ● Retained earnings statement ○ Reports change retained earnings for a specific period of time ○ Time period is the same as the income statement ○ Indicates why retained earnings increased or decreased ○ Net income is needed to determine the ending balance in retained earnings Chapter 2 - The Recording Process Debits and Credits Debits must equal Credits If Credit entries are greater than the sum of debit entries = Credit Balance Assets → debits > credits Liabilities → debits < credits Normal balance → debit or credit for increase Credit Increase: Common Stock Credit for increase → normal balance Debit for decrease Retained Earnings Credit for increase → normal balance Debit for decrease
Why is it cash?
The Recording Process
○ Cash payment before expense recorded ○ Insurance, supplies, advertising, rent, building/equipment ■ Benefit more than one accounting period ■ Adjusting Entry: Costs that expire with time or through use ‘ ● Increase (debit) to an expense account ● Decrease (credit) to an asset account, eg. Supplies (which would decrease stockholders equity because Assets = Liabilities + Stockholders’ Equity) ○ Think depreciation ○ Depreciation ■ Buildings, vehicles (assets that service for years) → recorded as an asset on date acquired ■ Depreciation is when we allocate cost of the asset to expense over its useful life ■ Does not try to report the actual change in the value of the asset ■ accumulated depreciation accounting = CONTRA ASSET ACCOUNT (credit) ● This goes on the balance sheet ■ Depreciation expense: income statement account ○ Book Value: cost of depreciable asset - accumulated depreciation ● Unearned Revenues ○ Cash received before services are provided ○ Receipt of cash that is a liability because service has not been performed ○ Rent, airline ticket, subscriptions ■ Adjusting entry: record revenue for service performed during the period and to show the liability that remains at the end of accounting period ● Debit liability (-), credit revenue (+) ■ I am unsure how to make the adjusting entry after some revenue has been performed. ■ ○ Company debits cash and credits unearned revenue (current liability account) ○ When the company earns the revenue it debits the Unearned Revenue account and credits the Revenue account Adjusting Entries Example
a. Insurance Expense $100 (decreases debit) i. Prepaid Insurance $
Monetary Unit: only those things that can be measured in money are included in accounting records. Economic Entity: every economic entity can be separately accounted for. Time Period: life of business can be divided into time periods Going Concern: business will remain operation for foreseeable future. Historical Cost: companies record assets at their cost. Fair Value: assets and liabilities should be reported at price received to sell an asset or settle a liability (fair value). Revenue Recognition Principle: companies recognize revenue in the accounting period in which the performance obligation is satisfied. Expense Recognition Principle: efforts (expenses) are matched with results (revenue) expense follows revenue Full Disclosure Principle: companies disclose all circumstances and events that make a difference to financial statements users. Cost Constraint: Accounting standard-setters weigh the cost that companies will incur to provide the information against the benefit that financial statement users will gain from having the information available. Chapter 4 - Completing the Accounting Cycle Preparing Closing Entries and Post-Closing Trial Balance Temporary: these accounts are closed ● All revenue accounts ● All expense accounts ● Dividends ● (service revenue will not appear) Permanent: these accounts are not closed → they roll over to the next year ● All asset accounts ● All liability accounts ● Stockholders’ equity Closing entries: transfer of net income//net loss and dividends to retained earnings → start fresh at zero in the next accounting period
0 balance in each temporary account (income statement, dividend so they start at 0 in the new period) Post-Closing Trial Balance: prove the equality of the permanent account balance carried forward to next accounting period (the stuff that does not get closed into retained earnings) EXAMPLE: Accounts Payable $27,000 Dividends $15, Service Revenue $98,000 Retained Earnings $42, Rent Expense $22,000 Accounts Receivable $38, Supplies Expense $7,000 Salaries and Wage Expense $51, Service Revenue 98000 Income Summary Income Summary 80, Rent Expense Supplies Expense Salaries and Wage Expense Income Summary (98,000-80,000) 18, Retained Earnings 18, Retained Earnings 15, Dividends 15, Explain Steps in the Accounting Cycle
1. A collection of 3,000 from a client on account was debited ot cash $200 and credited to Service Revenue $ a. Service Revenue 200 b. Cash 2800 i. Accounts Receivable 3000 Correcting entry Classify Balance Sheet Standard Classifications Assets (what is shown below is an example from a balance sheet) Liabilities and stockholder’s equity Current Assets: assets that a company expects to convert to cash or use up within one year or its operating cycle (average time it takes to purchase inventory, sell, collect cash from customers) ● Cash ● Accounts receivable ● Notes receivable ● Inventory ● Supplies ● Prepaid insurance ● Equipment (sometimes) *note order Service revenue is not asset Current Liabilities: obligations the company pays within year/operating cycle List of notes payable first, accounts payable → items then follow in magnitude ● Notes payable ● Accounts payable ● Salaries ● Wages payable ● Interest payable ● Income taxes payable ● Current maturities of long-term obligations Liquidity : ability to pay obligations due within the year Property, plant, and equipment: long lives, currently used in operations eg. 10k item for 1o years Depreciation : allocating the cost of an asset to some years, 1k/year of depreciation expense (closes to 0 after every year) Accumulated depreciation : total amount of depreciation expensed thus far in the asset’s life: Year 1: 1k depreciation expense Year 2: 2k depreciation expense Year 3: 3k depreciation expense ● Land ● equipment Long-term liabilities: obligations a company pays after a year ● Mortgage Payable ● Notes payable ● Bonds Payable ○ Total Long-term liabilities ○ Total liabilities (current + long term) Long-term investments: investments in stocks and bonds of other companies. Land or buildings that are not currently being used in operating activities. long-term notes receivable. ● Stock investments ● Investment in real estate Stockholders’ equity: proprietorship: one capital account, partnership, Proprietorship: one capital account Partnership: capital account for each partner Corporation: common stock and retained earnings
Turns in cash after a period of time ● Common Stock ● Retained Earnings ○ Total Stockholders Equity ○ Total Liabilities & Stockholders Equity Intangible asset and goodwill ● Patent ● Character franchise copyrights ● FCC licenses ● Trademarks ● Goodwill Chapter 5 - Accounting for Merchandising Operations Merchandising Companies: buy and sell goods, primary source of revenue = sales revenue/sales Operating cycle normally longer than service company Flow of Cost: Perpetual System or Periodic System for Costing Inventory Perpetual System ● Detailed records of cost of each inventory purchase/sale ● Records show inventory that should be on hand for every item ● Company determines cost of goods sold each time a sale occurs ○ Advantages ■ Merchandise with high unit value ■ Quantity and cost of inventory at any point in time ■ Better control over inventory then periodic system Recording Purchases: ● Made using cash/credit ( on account) ● Record when goods are received from seller ● Purchase invoice should support each credit purchase Periodic System ● Does not keep detailed records of goods on hand ● Cost of goods sold determined by count at end of accounting period ● Calculation of cost of goods sold: ○ Beginning inventory + purchases/net = goods for sale ○ Then: - ending inventory = cost of goods sold Freight Costs (operating expense) :
Recording Sales of Merchandise: Journal Entry: PW records sale of $3800 on May 4 to Sauk on account, the merchandise cost PW $
1. Selling price: Cash/Accounts Receivable 3800 Sales Revenue 3800 2. Cost Cost of goods sold 2400 Inventory 2400 Sales Discount: offered to customers to promote prompt payment, contra-revenue account (debit) to sales revenue. Sauk pays the balance due of $3500 (gross invoice price of 3800 fewer purchase returns and allowances of 300) on May 14, the last day of the discount period. May 14 Cash 3430 ( 3500*0.02 = 70) Sales Discounts 70 ((3800-300)*0.02) Accounts Receivable 2500 Sales Returns and Allowances Sold merchandise → goes under sales revenue, accounts receivable ● Opposite side of purchase returns/allowances ● Contra-revenue account o sales revenue (debit) ● Sales not reduced (debited) because: ● The cost of goods sold is determined and recorded each time a sale occurs in a perpetual inventory system. Credit for returned goods on May 8 with $300 selling price ($140 cost) → goods were not defective May 8 Sales Returns and Allowances 300 Accounts Receivable 300 May 8 Inventory 140 (50 if defective) Cost of goods sold 140 (50 if defective) Adjusting Entries: PW supply has an unadjusted balance of 40,500. The actually inventory at year end is 40,000. Dec. 31 Cost of Goods Sold 500 Inventory 500 the asset inventory has to be reduced since $500 worth of inventory does not exist.
Closing net income and dividends Income summary retained earnings Close net income to retained earnings Retained earnings Dividends Close dividends to retained earnings Closing Sales Revenue and COGS Sales Revenue Income Summary Close sales revenue Income Summary Cost of goods sold Sales Discounts Close COGS and sales discounts Multiple-Step Income Statement: distinguishes between operating and non-operating activities ● Net sales ● Gross profit ○ Gross profit rate = gross profit/net sales ● Operating expenses ● Nonoperating activities ● Other revenues and gains ○ Interest revenue: from notes receivable and marketale securities ○ Dividend revenue: investments in capital stock ○ Rent revenue ○ Gain: from sale of property plant and equipment ● Other expenses and losses ○ Interest expense: on notes and loans payable ○ Casualty losses: from recurring causes such as vandalism and accidents ○ Loss: from sale or abandonment of property plant and equipment, strikes by employees/suppliers ● Net income Single-Step Income Statement ● Total Revenues - Total Expenses ○ Revenues ■ Net sales ■ Interest revenue ■ Gain on disposal of plant assets ○ Expenses ■ Cost of goods sold ■ Operating expenses ■ Interest expense
No entry is recorded for cost of goods sold at the time of the sale under a periodic system Returned purchase to you Sales returns and allowances 300 accounts receivable 300 Received payment early so gave customer 2% discount Cash 3, Sales discounts 70 accounts receivable 3, **Periodic Inventory System vs. Periodic Inventory System
Regardless of classification, all inventories should be reported under Current Assets on the balance sheet. Determining Inventory Quantities: physical inventory is taken for two reasons Perpetual System