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Accounting. Zoubida SAMLAL - MBA , CFA Member, PHD candidate for HBS program. PLAN. Introduction to Accounting and Regulators. Fundamental concepts. What is accounting? the language of business

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accounting

Accounting

Zoubida SAMLAL - MBA , CFA Member, PHD candidate for HBS program

fundamental concepts
Fundamentalconcepts

What is accounting?

  • the language of business
  • a process of identifying, recording, summarizing, and reporting economic information to decision makers in the form of financial statements
  • a mean to communicate financial information.
  • a way to convey information about a business to users.
definitions of accounting
Definitions of Accounting
  • “The process of identifying, measuring, and communicating economic information to permit informed judgements and decisions by users of the information.”

—American Accounting Association (AAA)

  • “A service activity whose function is to provide quantitative information, primarily financial in nature, about economic entities that is intended to be useful in making economic decisions.”

—American Institute of Certified Public Accountants (AICPA)

primary functions of accounting
Primary Functions of Accounting
  • Recording data about business transactions
  • Summarizing results of business activity into useful report- However, managers in today's environment demand more detailed reports like sales by district or sales by product type.
  • Providing assurances that the business is operating as intended and that the assets of the organization are protected
accounting as an aid to decision making
Accounting as an Aid to Decision Making
  • Accounting helps in decision making by showing where and when money has been spent, by evaluating performance, and by showing the implications of choosing one plan instead of another.
  • Fundamental relationships in the decision-making process:

Accountant’s

analysis and

recording

Financial

statements

Event

Users

fundamental concepts1
Fundamental concepts

Who uses accounting information?

  • Owners
  • Managers
  • Investors (including potential)
    • Analysts on their behalf
  • Creditors (including potential)
  • Government (tax assessment)
  • Regulators
  • Customers
fundamental concepts2
Fundamental concepts
  • Accounting has two main divisions:

1- Financial accounting

Primarily prepared for users external to the company: Revenues,

earnings, assets, etc.

2- Management accounting

Primarily for internal purposes : Costing, budgeting, net present

value, etc.

fundamental concepts3
Fundamental concepts

There are several ways that cash gets into a company:

  • Investment by owners
  • Investment by creditors (loans)
  • Payments from customers
  • Repayment of amounts loaned to other entities
  • Return on investments (interest and dividend)
  • Proceeds from selling assets
fundamental concepts4
Fundamental concepts

Cash going in can be organized into three categories:

Operations

  • Payments from customers
  • Refunds from suppliers

Financing

  • Investment by owners
  • Investment by creditors (loans)

Investing

  • Return on investments (interest and dividend)
  • Proceeds from selling assets
  • Repayment of amounts loaned to other entities
fundamental concepts5
Fundamental concepts

Similarly, money going out of an entity can be categorized:

Operations

  • Payments to suppliers
  • Refunds to customers

Financing

  • Payment of dividends or capital to owners
  • Repayment of creditors

Investing

  • Purchase of assets
  • Amounts invested in other entities (debt or equity)
fundamental concepts6
Fundamental concepts

Financial accounting categorizes all transactions and events based

on their substance because the users of the information are using

it with the assumption that these categorizations are being made

accurately.

If money invested by owners was reported as revenue, this would

be counter to the fundamental definition of revenue (i.e. that it

results from the operations of the company).

The separation of income and capital is a fundamental concept of

financial accounting.

securities and exchange commission
Securities and Exchange Commission
  • Established by federal government
  • Accounting and reporting for public companies

Securities Act of 1933

Securities Act of 1934

  • Encouraged private standard-setting body
  • SEC requires public companies to adhere to GAAP aka IFRS
  • Oversight
  • Enforcement Authority
financial accounting standards board
Financial Accounting Standards Board

Wheat Committee’s recommendations resulted in the creation of a the Financial Accounting Standards Board (FASB)in 1973.

Financial Accounting Foundation

Selects members of the FASB

Funds their activities

Exercises general oversight.

Financial Accounting Standards Board

Mission to establish and improve standards of financial accounting and reporting.

Financial Accounting Standards Advisory Council

Consult on major policy issues.

financial accounting standards board1
Financial Accounting Standards Board

Missions is to establish and improve standards of financial accounting and reporting. Differences between FASB and APB include:

  • Full-time, Remunerated Membership
  • Greater Autonomy
  • Increased Independence
  • Broader Representation
slide18

Standard-Setting Organizations

  • Generally accepted accounting principles (GAAP) encompass the conventions, rules, and procedures for determining acceptable accounting practices at a particular time.
  • Financial Accounting Standards Board (FASB) is primarily responsible for evaluating, setting, or modifying GAAP in the U.S.
  • Sarbanes-Oxley Act responded to cases of accounting fraud.
    • Created the Public Accounting Oversight Board, which sets audit standards and investigates and sanctions accounting firms that certify the books of publicly traded firms.
    • Senior executives must personally certify that the financial information reported by the company is correct.
    • Resulted in increase in demand for accountants.
financial reporting challenges
Financial Reporting Challenges

IFRS in a Political Environment

financial reporting challenges1
Financial Reporting Challenges

The Expectations Gap

What the public thinks accountants should do vs. what accountants think they can do.

Significant Financial Reporting Issues

  • Non-financial measurements
  • Forward-looking information
  • Sort assets
  • Timeliness
financial reporting challenges2
Financial Reporting Challenges

Ethics in the Environment of Financial Accounting

  • Companies that concentrate on “maximizing the bottom line,” “facing the challenges of competition,” and “stressing short-term results” place accountants in an environment of conflict and pressure.
  • IFRS does not always provide an answer.
  • Doing the right thing is not always easy or obvious.
financial reporting challenges3
Financial Reporting Challenges

International Convergence

  • In 2002 the IASB and the FASB formalized their commitment to the convergence of U.S. GAAP and international standards. The Boards agreed to:
    • Make their existing financial reporting standards fully converged as soon as practicable, and
    • Coordinate their future work programs to ensure that once achieved, convergence is maintained.
1 business entity concept
1) BUSINESS ENTITY CONCEPT
  • Business is treated as separate & distinct from its members
  • Separate set of books are prepared.
  • Proprietor is treated as creditor of the business.
  • For other business of proprietor different books are prepared.
2 money measurement concept
2) MONEY MEASUREMENT CONCEPT
  • Transactions of monetary nature are recorded.
  • Transactions of qualitative nature, even though of great importance to business are not considered.
3 going concern concept
3) GOING CONCERN CONCEPT
  • Business will continue for a long period.
  • As per this concept, fixed assets are recorded at their original cost & depreciation is charged on these assets.
  • Because of this concept, outside parties enter into long term contracts with the enterprise.
4 accounting period concept
4) ACCOUNTING PERIOD CONCEPT
  • Entire life of the firm is divided into time intervals for ascertaining the profits/losses are known as accounting periods.
  • Accounting period is of two types- financial year(1st Apr to 31st March) & calendar year(1st Jan to 31st Dec).
  • For taxation purposes financial year is adopted as prescribed by the Govt.
  • Companies having their shares listed on stock exchange publishes their quarterly results.
5 historical cost concept
5) HISTORICAL COST CONCEPT
  • Assets are recorded at their original price.
  • This cost serves the basis for further accounting treatment of the asset.
  • Acquisition cost relates to the past i.e. it is known as historical cost.
justification for historical cost concept
JUSTIFICATION FOR HISTORICAL COST CONCEPT
  • This cost is objectively verifiable.
  • Justified by going concern concept.
  • Current values are difficult to determine.
  • Difficult to keep track of up down of the market price.
drawbacks of historical concept
DRAWBACKS OF HISTORICAL CONCEPT
  • Assets for which nothing is paid will not be recorded like reputation, brand value, etc.
  • Information based on historical cost may not be useful to its members.
6 dual aspect concept
6) DUAL ASPECT CONCEPT
  • Every transaction recorded in books affects at least two accounts.
  • If one is debited then the other one is credited with same amount.
  • This system of recording is known as “DOUBLE ENTRY SYSTEM”.
  • ASSETS = LIABILITIES + CAPITAL
7 revenue recognition realisation concept
7) REVENUE RECOGNITION/REALISATION CONCEPT
  • Revenue means the addition to the capital as a result of business operations.
  • Revenue is realized on three basis-:
      • Basis of cash
      • Basis of sale
      • Basis of production
8 matching concept
8) MATCHING CONCEPT
  • All the revenue of a particular period will be matched with the cost of that period for determining the net profits of that period.
  • Accordingly, for matching costs with revenue, first revenue should be recognized & then costs incurred for generating that revenue should be recognized.
following points must be considered while matching costs with revenue
Following points must be consideredwhile matching costs with revenue
  • Outstanding expenses though not paid in cash are shown in the P&L a/c.
  • Prepaid expenses are not shown in the P&L a/c.
  • Closing stock should be carried over to the next period as opening stock.
  • Income receivable should be added in the revenue & income received in advance should be deducted from revenue.
9 accrual concept
9) ACCRUAL CONCEPT
  • In this concept revenue is recorded when sales are made or services are rendered it is immaterial whether cash is received or not.
  • Same with the expenses i.e. they are recorded in the accounting period in which they assist in earning the revenues whether the cash is paid for them or not.
10 objectivity concept
10) OBJECTIVITY CONCEPT
  • Accounting transactions should be recorded in an objective manner, free from the personal bias of either management or the accountant who prepares the accounts.
  • It is possible only when each transaction is supported by verifiable documents & vouchers such as cash memos, invoices.
11 timeliness
11) TIMELINESS
  • This principle states that the information should be provided to the users at right time for the purpose of decision making.
  • Delay in providing accounts serves no usefulness for the users for decision making.
12 cost benefit principle
12) COST BENEFIT PRINCIPLE
  • This principle states that the cost incurred in applying the principles should be less than the profits derived from them.
accounting conventions1
ACCOUNTING CONVENTIONS
  • An accounting convention may be defined as a custom or generally accepted practice which is adopted either by general agreement or common consent among accountants.
1 convention of full diclosure
1) CONVENTION OF FULL DICLOSURE
  • Information relating to the economic affairs of the enterprise should be completely disclosed which are of material interest to the users.
  • Proforma & contents of balance sheet & P&L a/c are prescribed by Companies Act.
  • It does not mean that leaking out the secrets of the business.
2 convention of consistency
2) CONVENTION OF CONSISTENCY
  • Accounting method should remain consistent year by year.
  • This facilitates comparison in both directions i.e. intra firm & inter firm.
  • This does not mean that a firm cannot change the accounting methods according to the changed circumstances of the business.
3 convention of conservatism
3) CONVENTION OF CONSERVATISM
  • All anticipated losses should be recorded but all anticipated gains should be ignored.
  • It is a policy of playing safe.
  • Provisions is made for all losses even though the amount cannot be determined with certainty
4 convention of materiality
4) CONVENTION OF MATERIALITY
  • According to American Accounting Association, “An item should be regarded as material if there is reason to believe that knowledge of it would influence decision of informed investor.”
  • It is an exception to the convention of full disclosure.
  • Items having an insignificant effect to the user need not to be disclosed.
the nature of accounting
The Nature of Accounting
  • The accounting system is a series of steps performed to analyze, record, quantify, accumulate, summarize, classify, report, and interpret economic events and their effects on an organization and to prepare the financial statements.
accounting as an aid to decision making1
Accounting as an Aid toDecision Making
  • Fundamental relationships in the decision-making process:

Accountant’s

analysis &

recording

Financial

Statements

Event

Users

financial and management accounting
Financial and Management Accounting
  • The major distinction between financial and management accounting is the users of the information.
    • Financial accounting serves external users.
    • Management accountingserves internal users, such as top executives, management, and administrators within organizations.
financial and management accounting1
Financial and Management Accounting

The primary questions about an organization’s success that decision makers want to know are:

What is the financial picture of the organization on a given day?

How well did the organization do during a given period?

chart of accounts
CHART OF ACCOUNTS

The Chart of Accounts is organized using three different methods.

  • First:  Accounting Types
  • Second:  Order of Liquidity - the ease of converting to cash without loss of value
  • Third: Account Numbers
7 types of accounts
7 TYPES OF ACCOUNTS
  • Assets - Things you own
  • Liabilities - Things you owe
  • Equity - Owners Stake in Company
  • Revenue - Income through Sales of the Products of the Business
  • Costs of Goods Sold - Costs to provide the service or to manufacture or acquire the product the business sells
  • Expenses - Things that are paid for that are consumable and are part of the cost of running a business
  • Other Revenue and Expenses - Revenue and Expenses that are unusual cases and are not directly related to the business product and are not usual costs of running a business.
order of liquidity
ORDER OF LIQUIDITY
  • The Chart of Accounts’ second method of organization is Order of Liquidity.  Liquidity refers to the expectation that the item can be converted to cash at least close to its current value within one year.
  • Accounts are listed in descending order of liquidity within their accounting types, with cash at the top of the list for Assets. 
  •   The liquidity classification is so important that Assets and Liabilities are divided into the Subtypes of Current and Long Term/Fixed to group items of similar liquidity together.
account numbers
ACCOUNT NUMBERS
  • Assigning Account numbers starts by assigning a range of numbers to each Accounting Type. 
  • The number of digits will be important in your software system so when using ranges in the 1000’s there are 4 digits, and the Account Numbers would range from 1000 to 9999.
account numbers1
ACCOUNT NUMBERS
  • Assets: 1000’s
    • Current Assets 1000 – 1499; Fixed Assets 1500 -1999
  • Liabilities: 2000’s
    • Current Liabilities 2000 – 2499; Long Term Liabilities 2500 - 2999
  • Equity: 3000’s
  • Revenue: 4000’s
  • Costs of Goods Sold: 5000’s
  • Expenses: 7000’s
  • Other Revenue: 8000’s
  • Other Expenses: 9000’s
use of funds debit accounting types
Use of Funds (Debit) Accounting Types
  • Each Accounting Type under the “Funds/Use of Funds” Category increases in value or balance with each debit (Use of Funds) transaction entry and decreases in value or balance with each credit (Source of Funds) transaction entry.  Use of Funds Accounts are sometimes referred to as Debit Accounts.
use of funds debit accounting types1
Use of Funds (Debit) Accounting Types

Positive balances for these accounts are balances where total

debits > total credits to the account and their balances should

show in the Debit Column.

  • Assets 
  • Costs of Goods Sold
  • Expenses 
  • Other Expenses
source of funds credit accounting types
Source of Funds (Credit) Accounting Types
  • Each Accounting Type under the “Source of Funds” Category increases in value or balance with each credit  (Source of Funds) transaction entry and decreases in value or balance with each debit (Use of Funds) transaction entry.  Source of Funds Accounts are sometimes referred to as Credit Accounts.
source of funds credit accounting types1
Source of Funds (Credit) Accounting Types

Positive balances for these accounts are balances where total

credits > total debits to the account and their balances should

show in the Credit Column.

  • Liabilities - Things you owe
  • Equity - Owners’ Stake in Company
  • Revenue - Income through Sales of the Products of the Business
  • Other Revenues - Revenues that are unusual cases and are not directly related to the business product and are not usual revenues from running a business.
slide62

ANNUAL REPORT

  • Financial Statements
    • Income Statement
    • Statement of Retained Earnings
    • Balance Sheet
    • Statement of Cash Flows
  • Management Discussion and Analysis
  • Notes to Financial Statements
  • Auditor's Report
financial accounting statements
Financial Accounting Statements
  • Income Statement - reports the results of operations for a specific period of time
  • Retained Earnings Statement - reports the changes in retained earnings for a specific period of time
  • Balance Sheet - reports the assets, liabilities, and stockholders’ equity at a specific date
  • Statement of Cash Flows - reports the cash receipts and payments for a specific period of time
management discussion and analysis
Management Discussionand Analysis

Covers three aspects of a company:

  • liquidity - ability to pay near term obligations
  • capital resources - fund operations and expansions
  • results of operation
notes to financial statements
Notes to Financial Statements
  • Provide additional information not included in body of statements
  • Describe accounting policies or explain uncertainties and contingencies
auditor s report
Auditor's Report
  • Auditor, a professional accountant who conducts an independent examination of the financial accounting data presented by a company.
  • Auditor gives an unqualified opinion if the financial statements present the financial position, results of operations, and cash flows in accordance with GAAP.
statement of cash flows1
Statement of Cash Flows

The Cash Flow Statement (Statement of Cash Flows) provides an overview of the way Funds move through an Entity, how they impact Overall Value and eventually reconcile with Cash Balances and determine Net Cash Flow in any given year.

3 types of business activity
3 Types of Business Activity
  • Financing
  • Investing
  • Operating
investing activities
Investing Activities

Obtaining the

Resources or Assets

needed to operate the business

Examples of assets...

  • Cash
  • Accounts Receivable
  • Prepaid Rent
  • Buildings, Equipment, Furniture
investing activities examples
Investing Activities - Examples
  • Purchase or Sale of computers, delivery trucks, furniture, buildings
  • Purchase or Sale of investments
slide72

Cash flow statement

  • Operating Activities

Net Income

+ Depreciation Expense (+ Increase and -Decrease in Accumulated Depreciation)

+ Increases in Current Liabilities

+ Decreases in Current Assets

- Increases in Current Assets

- Decreases in Current Liabilities

slide73

Cash flow statement

2. Investing Activities

+ Decreases in Long Term/Fixed Assets (Independent of Accumulated Depreciation)

- Increases in Long Term/Fixed Assets (Independent of Accumulated Depreciation)

slide74

Cash flow statement

3. Financing Activities

+ Increases in Long Term Liabilities/Debt

- Decreases in Long Term Liabilities/Debt

+ Increases in Owners’ Capital

- Decreases in Owners’ Capital

- Increases in Dividends

Beginning Cash Balance - Net Increase/Decrease = Ending Cash Balance

slide77

Income Statement

  • The Income Statement Accounting Types are Revenue, Cost of Goods Sold and Expenses. The Accounts that are not on the Income Statement are on the Balance Sheet.
  • As its name suggests, the purpose of the Income Statement is to report Income. Income = Revenue - Expenses. It is almost that simple, but there is more to the Income Statement than a simple calculation.
slide78

Income Statement

Revenue

-Cost of Goods Sold

—————-

=Gross Margin

-Expenses

—————-

=Operating Income

+Other Revenue

-Other Expenses

—————-

=Net Income

csu corporation income statement for the year ended december 31 2008
CSU CORPORATIONIncome StatementFor the Year Ended December 31, 2008
  • 1st- head up the statement
  • name of company
  • name of statement
  • period of time covered
csu corporation income statement for the year ended december 31 20081
CSU CORPORATIONIncome StatementFor the Year Ended December 31, 2008

Revenues Service revenue $17,000

2nd - List the revenues

csu corporation income statement for the year ended december 31 20082
CSU CORPORATIONIncome StatementFor the Year Ended December 31, 2008

Revenues Service revenue $17,000 Expenses Rent expense $9,000

Insurance expense 1,000

Supplies expense 200

Total expenses 10,200

3rd - List and total the expenses

csu corporation income statement for the year ended december 31 20083
CSU CORPORATIONIncome StatementFor the Year Ended December 31, 2008

Revenues Service revenue $17,000 Expenses Rent expense $9,000

Insurance expense 1,000

Supplies expense 200

Total expenses 10,200

Net Income $ 6,800

4th - Subtract expenses from revenues to obtain net income.

csu corporation retained earnings statement for the year ended december 31 2008
CSU CORPORATIONRetained Earnings StatementFor the Year Ended December 31, 2008
  • 1st- head up the statement
  • name of company
  • name of statement
  • period of time covered
csu corporation retained earnings statement for the year ended december 31 20081
CSU CORPORATIONRetained Earnings StatementFor the Year Ended December 31, 2008

Retained earnings, January 1 $ 0

2nd - Start with beginning retained earnings

csu corporation retained earnings statement for the year ended december 31 20082
CSU CORPORATIONRetained Earnings StatementFor the Year Ended December 31, 2008

Retained earnings, January 1 $ 0

Add: Net Income 6,800

6,800

3rd - Add net income from the current year - subtotal

csu corporation retained earnings statement for the year ended december 31 1998
CSU CORPORATIONRetained Earnings StatementFor the Year Ended December 31, 1998

Retained earnings, January 1 $ 0

Add: Net Income 6,800

6,800

Less: Dividends 0

Retained earnings, December 31 $ 6,800

4th - Subtract current year’s dividends and total

the balance sheet
The Balance Sheet

The balance sheet equation:

Assets = Liabilities + Owners’ Equity

or

Owners’ Equity = Assets - Liabilities

csu corporation balance sheet december 31 2008
CSU CORPORATIONBalance Sheet December 31, 2008
  • 1st- head up the statement
  • name of company
  • name of statement
  • date
csu corporation balance sheet december 31 20081
CSU CORPORATIONBalance Sheet December 31, 2008

Assets

Cash $ 2,000

Accounts receivable 4,000

Supplies 1,800

Equipment 16,000

Total assets $23,800

2nd - list the assets and total

csu corporation balance sheet december 31 20082
CSU CORPORATIONBalance Sheet December 31, 2008

Assets

Cash $ 2,000

Accounts receivable 4,000

Supplies 1,800

Equipment 16,000

Total assets $23,800

Liabilities and Stockholders’ Equity

Liabilities

Accounts payable $ 2,000

Notes payable 5,000

Total liabilities 7,000

3rd - list the liabilities and sub-total

csu corporation balance sheet december 31 20083
CSU CORPORATIONBalance Sheet December 31, 2008

4th - list stockholders’ equity

subtotal. Add to liabilities,

Total

csu corporation balance sheet december 31 20084
CSU CORPORATIONBalance Sheet December 31, 2008

Assets

Cash $ 2,000

Accounts receivable 4,000

Supplies 1,800

Equipment 16,000

Total assets $23,800

Liabilities and Stockholders’ Equity

Liabilities

Accounts payable $ 2,000

Notes payable 5,000

Total liabilities 7,000

Stockholders’ equity

Common stock 10,000

Retained earnings 6,800

Total Stockholders’ equity 16,800

Total liabilities and stockholders’ equity $23,800

csu corporation balance sheet december 31 20085
CSU CORPORATIONBalance Sheet December 31, 2008

Assets

Cash $ 2,000

Accounts receivable 4,000

Supplies 1,800

Equipment 16,000

Total assets $23,800

Liabilities and Stockholders’ Equity

Liabilities

Accounts payable $ 2,000

Notes payable 5,000

Total liabilities 7,000

3rd - list the liabilities and sub-total

csu corporation balance sheet december 31 1998
CSU CORPORATIONBalance Sheet December 31, 1998

4th - list stockholders’ equity

subtotal. Add to liabilities,

Total

csu corporation income statement for the year ended december 31 20084
CSU CORPORATIONIncome StatementFor the Year Ended December 31, 2008

Revenues Service revenue $17,000 Expenses Rent expense $9,000

Insurance expense 1,000

Supplies expense 200

Total expenses 10,200

Net Income $ 6,800

Net Income is needed for the

Statement of Retained Earnings.

csu corporation retained earnings statement for the year ended december 31 20083
CSU CORPORATIONRetained Earnings StatementFor the Year Ended December 31, 2008

Retained earnings, January 1 $ 0

Add: Net Income 6,800

6,800

Less: Dividends 0

Retained earnings, December 31 $ 6,800

Ending Retained Earnings is needed

for the balance sheet.

csu corporation balance sheet december 31 20086
CSU CORPORATIONBalance Sheet December 31, 2008

Assets

Cash $ 2,000

Accounts receivable 4,000

Supplies 1,800

Equipment 16,000

Total assets $23,800

Liabilities and Stockholders’ Equity

Liabilities

Accounts payable $ 2,000

Notes payable 5,000

Total liabilities 7,000

Stockholders’ equity

Common stock 10,000

Retained earnings 6,800

Total Stockholders’ equity 16,800

Total liabilities and stockholders’ equity $23,800

analyzing and recording process
Analyzing and Recording Process

Exchanges of economic consideration between two parties.

External Transactions occur between the organization and an outside party.

Internal Transactions occur within the organization.

analyzing and recording process1
Analyzing and Recording Process
  • Accounting process:
  • -Identifiesbusiness transactions and events,
  • -Analyzes and records their effects, and
  • -Summarizes and presents information in reports and financial statements.
  • Steps in accounts process that focus on analyzing and recordingtransactions and events are:
  • Record relevant transactions and events in a journal,
  • (2) Post journal information to ledger accounts, and
  • (3) Prepare a trial balance.
  • Accounting records are informally referred as the accounting books, or simply the books.
analyzing and recording process2

Record relevant transactions and events in a journal

Analyze each transaction and event from source documents

Post journal information to ledger (T) accounts

Prepare and analyze the trial balance

Analyzing and Recording Process
source documents
Source Documents

Bills from Suppliers

Checks

Purchase Orders

Employee EarningsRecords

Bank Statements

Sales Tickets

the account and its analysis
The Account and its Analysis

An account is a record of increases and decreases in a specific asset, liability, equity, revenue, or expense item.

The general ledger is a record containing all accounts used by the company.

the account and its analysis1

AssetsAccounts

AssetsAccounts

+

AssetAccounts

LiabilityAccounts

LiabilityAccounts

LiabilityAccounts

EquityAccounts

EquityAccounts

EquityAccounts

The Account and its Analysis

=

asset accounts
Asset Accounts

Cash

Accounts Receivable

Land

AssetAccounts

Notes Receivable

Buildings

Prepaid Accounts

Equipment

Supplies

liability accounts
Liability Accounts

Accounts Payable

Notes Payable

LiabilityAccounts

Dividends

Payable

Accrued Liabilities

Unearned Revenue

equity accounts
Equity Accounts

Retained

Earnings

CommonStock

Dividends

Declared

EquityAccounts

Revenues

Expenses

the account and its analysis2

+

+

CommonStock

Dividends

Revenues

Expenses

The Account and its Analysis

=

+

Assets

Liabilities

Equity

ledger and chart of accounts
Ledger and Chart of Accounts

The ledger is a collection of all accounts for aninformation system.

A company’s size and diversity of operations affect

the number of accounts needed.

The chart of accounts is a list of all accounts andincludes an identifying number for each account.

debits and credits
A T-account represents a ledger account and is a tool used to understand the effects of one or more transactions. Debits and Credits
double entry accounting normal balance
Double-Entry AccountingNORMAL Balance

ASSETS = LIABILITIES + EQUITY

DR = CR CR

Assets are on the left side of the equation; therefore, the left, or debit side is the normal balance side for assets.

Liabilities and equities are on the right side; therefore, the right, or credit side is the normal balance side for liabilities and equity.

double entry accounting
Double-Entry Accounting

ASSETS = LIABILITIES + EQUITY||

ASSETS = LIABILITIES + Common Stock – DIV + REV - EXP

Total amount that is debited to accounts must equal the total amount credited to accounts for each transaction.

Sum of debit account balances in the ledger must equal the sum of credit account balances.

double entry accounting normal balance1

=

+

Assets

Liabilities

Equity

EQUITIES

ASSETS

LIABILITIES

Debit Credit

Debit Credit

Debit Credit

+-

- +

- +

Double-Entry AccountingNORMAL Balance

Whether a debit or a credit is an increase or decrease depends on the NORMAL Balance of the account.

slide117

Double-Entry AccountingNORMAL Balance

_

_

CommonStock

Dividends

+

Revenues

Expenses

Stock

Dividends

Revenues

Expenses

Debit Credit

Debit Credit

Debit Credit

Debit Credit

- +

+-

- +

+-

Equity

slide118

Double-Entry AccountingNORMAL Balance

An account balance is the difference between the increases and decreasesin an account.

Notice the T-Account

journalizing posting transactions

=

+

Assets

Liabilities

Equity

Step 1: Analyze transactions and source documents.

Step 2: Apply double-entry accounting

Step 4: Post entry to ledger

Step 3: Record journal entry

Journalizing & Posting Transactions
journalizing transactions

Titles of Affected Accounts

  • Transaction Date
  • Transaction explanation
Journalizing Transactions
  • Dollar amount of debits and credits
posting journal entries
Posting Journal Entries

1

Identify the debit account in ledger.

posting journal entries1
Posting Journal Entries

2

Enter the date.

posting journal entries2
Posting Journal Entries

3

Enter the amount and description.

posting journal entries3
Posting Journal Entries

Enter the journal reference.

4

posting journal entries4
Posting Journal Entries

Compute the balance.

5

posting journal entries5
Posting Journal Entries

6

Enter the ledger reference.

analyzing transactions

Analysis:

Double entry:

101

Posting:

301

Analyzing Transactions
analyzing transactions1

Analysis:

Double entry:

Posting:

101

126

Analyzing Transactions
analyzing transactions4

Analysis:

Double entry:

Posting:

101

403

Analyzing Transactions
analyzing transactions5

Analysis:

Double entry:

Posting:

101

Analyzing Transactions
analyzing transactions6
Analyzing Transactions

Transactions 7: Payment of Salaries expenses in cash

Analysis: - Assets (Cash) = – Equity (Expenses)

Double entry: Debit Salaries Expenses and credit Cash

Transaction 8: Provide services and rents test facilities for credit

Analysis: + Assets (Accts Receivable) = + Equity (Revenues)

Double entry: Debit Accounts Receivable and Credit Consulting Revenue and Credit Rental Revenue

Transaction 9: Receipt of cash from accounts receivable

Analysis: + Assets (Cash) = – Assets (Accounts Receivable)

Double entry: Debit Cash and credit Accounts Receivable

analyzing transactions7
Analyzing Transactions

Transaction 10: Payment of accounts payable

Analysis: – Assets (Cash) = – Liability (Accounts Payable)

Double entry: Debit Accounts Payable and credit Cash

Transaction 11: Payment of cash dividend

Analysis: – Assets (Cash) = – Equity (Dividends)

Double entry: Debit Dividends and credit Cash

Transaction 12: Receipts of cash from a customer for future consulting services

Analysis: + Assets (Cash) = + Liabilities (Unearned Revenue)

Double entry: Debit Cash and credit Unearned Consulting Revenue

analyzing transactions8
Analyzing Transactions

Transaction 13: Pay cash for future insurance coverage

Analysis: – Assets (Cash) = + Assets (Prepaid Insurance)

Double entry: Debit Prepaid Insurance and credit Cash

Transaction 14: Purchase supplies for cash

Analysis: - Assets (Cash) = + Assets (Supplies)

Double entry: Debit Supplies and credit Cash

Transactions 15: Payment of utilities expenses in cash

Analysis: – Assets (Cash) = – Equity (Expenses)

Double entry: Debit Utilities Expense and credit Cash

Transactions 16: Payment of salaries expenses in cash

Analysis: – Assets (Cash) = – Equity (Expenses)

Double entry: Debit Salaries Expense and credit Cash

slide137

FastForward

Trial Balance

December 31, 2009

Debits

Credits

Cash

$

4,350

The trial balance lists all account balances in the general ledger. If the books are in balance, the total debits will equal the total credits.

Accounts receivable

-

Supplies

9,720

Prepaid Insurance

2,400

Equipment

26,000

Accounts payable

$

6,200

Unearned consulting revenue

3,000

Common stock

30,000

Dividends

200

Consulting revenue

5,800

Rental revenue

300

Salaries expense

1,400

Rent expense

1,000

Utilities expense

230

Total

$

45,300

$

45,300

After processing its remaining transactions for December, FastForward’s Trial Balance is prepared.

six steps for searching for and correcting errors
SixSteps for Searching for and Correcting Errors

If the trial balance does not balance, the error(s) must be found and corrected.

Make sure the trial balance columns are correctly added.

Recompute each account balance in the ledger.

Make sure account balances are correctly entered from the ledger.

Verify that each journal entry is posted correctly.

See if debit or credit accounts are mistakenly placed on the trial balance.

Verify that each original journal entry has equal debits and credits.

using a trial balance to prepare financial statements
Using a Trial Balance to Prepare Financial Statements

Point inTime

Point inTime

Period of Time

Income Statement

Statement of Retained Earnings

Statement of Cash Flows

Beginning Balance Sheet

Ending Balance Sheet

slide144

What is a Worksheet?

  • multiple-column form used for the adjustment process and preparing financial statements
  • working toolfor the accountant
  • not a permanent accounting record
  • Eases preparation of adjusting entries and financial statements
remember
Remember:
  • A work sheet is not a permanent accounting record
  • When it is used:
    • financial statements are prepared from the work sheet
    • adjustments are journalized and posted from the work sheet after financial statements, so management can receive the financial statements more quickly
to prepare a work sheet
To Prepare A Work Sheet:

1 Prepare the trial balance

2 Enter adjustments in the adjustments columns

3 Enter adjusted balances in adjusted trial balance columns

4 Extend adjusted trial balance amounts to the appropriate financial statement columns

5 Total the statement columns, compute net income (loss), and complete the work sheet

slide148

FastForwardWork Sheet

For Month Ended December 31, 2011

First, enter the unadjusted trial balance amounts to the worksheet!

here are our adjusting entries for december
Here are our adjusting entries for December
  • Insurance expense 100

Prepaid insurance 100

  • Supplies expense 1050

Supplies 1050

  • Depreciation expense 375

Accum. Depr. – Equip. 375

here are more adjusting entries for december
Here Are More Adjusting Entries for December
  • Unearned revenue 250

Consulting Revenue 250

  • Salaries Expense 210

Salaries Payable 210

  • Accounts Receivable 1,800

Consulting Revenue 1,800

slide151

FastForwardWork Sheet

For Month Ended December 31, 2011

Next, enter the adjustments!

slide152

FastForwardWork Sheet

For Month Ended December 31, 2011

Prepare the adjusted trial balance!

slide153

Then, extend the adjusted trial balance amounts to the financial statements!

FastForwardWork Sheet

For Month Ended December 31, 2004

slide154

Total statement columns, compute income or loss, and balance columns.

FastForwardWork Sheet

For Month Ended December 31, 2004

prepare the financial statements
Prepare the Financial Statements

Prepare the Income

Statement.

A work sheet does not substitute for financial statements.

which of these characteristics are true about a work sheet
Which of these characteristics are true about a work sheet?
  • a permanent accounting record
  • an optional device used by accountants
  • a part of the general ledger
  • a part of the journal
answer
Answer!
  • permanent accounting record
  • optional device used by accountants
  • part of the general ledger
  • part of the journal

Although it’s optional, the work sheet is a very useful tool!

slide160

TEMPORARY VS. PERMANENT ACCOUNTS

TEMPORARY (NOMINAL) PERMANENT (REAL) These accounts are closed These accounts are not closed

All revenue accounts All asset accounts

All expense accounts All liability accounts

Owner’s drawing Owner’s capital account

Now, let’s talk about closing entries and income summary!

closing entries
CLOSING ENTRIES
  • Closing entries
    • Transfer net income (loss) and owner’s drawings to owner’s capital
    • Journalizing and posting is a required step in the accounting cycle
  • Income Summary
    • A temporary account
    • Used in closing revenue and expense accounts
    • Minimizes the details in the permanent owner’s capital account
closing process
Resets revenue, expense and withdrawal account balances to zero at the end of the period.

Helps summarize a period’s revenues and expenses in the Income Summary account.

Identify accounts for closing.

Record and post closing entries.

Prepare post-closing trial balance.

Closing Process
temporary and permanent accounts

Revenues

Assets

Owner’s Capital

Permanent Accounts

Temporary Accounts

Liabilities

Withdrawals

Expenses

Income Summary

Temporary and Permanent Accounts

The closing process applies only to temporary accounts.

recording closing entries

Let’s see how the closing process works!

Recording Closing Entries
  • Close Revenue accounts to Income Summary.
  • Close Expense accounts to Income Summary.
  • Close Income Summary account to Owner’s Capital.
  • Close Withdrawals to Owner’s Capital.
closing process1
Closing Process

Balances before closing.

closing process2
Closing Process
  • Close Revenue accounts to Income Summary.
closing process3
Closing Process
  • Close Expense accounts to Income Summary.

The balance in Income Summary equals net income.

closing process4
Closing Process
  • Close Income Summary to Owner’s Capital.
closing process5
Closing Process
  • Close Withdrawals account to Owner’s Capital.
close revenue accounts to income summary
Close Revenue Accounts to Income Summary

Now, let’s look at the ledger accounts after posting this closing entry.

close expense accounts to income summary
Close Expense Accounts to Income Summary

Now, let’s look at the ledger accounts after posting this closing entry.

close income summary to owner s capital
Close Income Summary to Owner’s Capital

Now, let’s look at the ledger accounts after posting this closing entry.

close income summary to owner s capital1
Close Income Summary to Owner’s Capital
  • Close Income Summary to Owner’s Capital
close withdrawals to owner s capital
Close Withdrawals to Owner’s Capital

Now, let’s look at the ledger accounts after posting this closing entry.

slide181

ABOUT CLOSING ENTRIES

Be Careful!

  • Avoid doubling revenue and expense balances – watch debits and credits
  • Remember: owner’s drawing does not move to the Income Summary account. Owner’s drawing is not an expense and it is not a factor in determining net income.
slide182

RESULTS OF POSTING CLOSING ENTRIES

  • Temporary accounts
    • All temporary accounts will have zero balances after posting the closing entries
    • Temporary accounts (revenues and expenses) are totaled, balanced and double ruled
  • Owner’s capital
    • Total equity of the owner at the end of the accounting period
    • No entries are journalized and posted to owner’s capital during the year
  • Permanent accounts (assets, liabilities, and owner’s capital) are not closed
post closing trial balance
POST-CLOSING TRIAL BALANCE

After all closing entries have been journalized the post-closing trial balance is prepared from the ledger.

The purpose of this trial balance is to

prove the equality of the permanent account balances that are carried forward into the next accounting period.

post closing trial balance1
Post-Closing Trial Balance
  • List of permanent accounts and their balances after posting closing entries.
  • Total debits and credits must be equal.

Let’s look at FastForward’s post-closing trial balance.

summary of steps in the accounting cycle
Summary of Steps in the Accounting Cycle

1 Analyze business transactions

2 Journalize the transactions

3 Post to ledger accounts

4 Prepare a trial balance

5 Journalize and post adjusting entries

steps in the accounting cycle
STEPS IN THE ACCOUNTING CYCLE

6 Prepare an adjusted trial balance

7 Prepare financial statements: Income Statement, Owner’s Equity Statement, Balance Sheet

8 Journalize and post closing entries

9 Prepare a post-closing trial balance

correcting entries
Correcting Entries
  • Correcting Entries
    • errors should be corrected as soon as discovered
    • correcting entries are unnecessary if records are free of errors
    • can be journalized and posted whenever an error is discovered
    • involve any combination of balance sheet and income statement accounts
illustrative example of correcting entry

Cash 50

Service Revenue 50

Cash 50

Accounts Receivable 50

Service Revenue 50

Accounts Receivable 50

Illustrative Example Of Correcting Entry
another illustrative example of correcting entry

Delivery Equipment 45

Accounts Payable 45

Office Equipment 450

Accounts Payable 450

Office Equipment 450

Delivery Equipment 45

Accounts Payable 405

Another Illustrative Example Of Correcting Entry
question the closing entry process consists of closing
Question: The closing entry process consists of closing:
  • all asset and liability accounts
  • out the owner's capital account
  • all permanent accounts
  • all temporary accounts

Which answer is correct?

the closing entry process consists of closing
The closing entry process consists of closing
  • all asset and liability accounts
  • out the owner's capital account
  • all permanent accounts
  • all temporary accounts
slide194

Standard Balance Sheet Classifications

  • Financial statements become more useful when the elements are classified into significant subgroups.
  • A classified balance sheetgenerally has the following standard classifications (see next slide):
classified balance sheet
Classified Balance Sheet

Current items are those expected to come due (both collected and owed) within the longer of one year or the company’s normal operating cycle.

slide196

Current assets are expected to be sold, collected, or used within one year or the company’s operating cycle.

slide197

Long-term investments are expected to be held for the longer of one year or the operating cycle.

slide199

Intangible assets are long-term resources used to produce or sell products and services and that lack physical form.

slide200

Current liabilities are obligations due within the longer of one year or the company’s operating cycle.

slide201

Long-term liabilities are obligations notdue within the longer of one year or the company’s operating cycle.

learning goals
Learning Goals

Tax depreciation procedures and the effect of depreciation on the firm’s cash flows.

Firm’s statement of cash flows, operating cash flow, and free cash flow.

The financial planning process,

long-term (strategic) financial plans

short-term (operating) plans.

Cash-planning process and the cash budget.

Pro forma income statement and balance sheet

analyzing the firm s cash flows
Analyzing the Firm’s Cash Flows

Cash flow is the primary focus of the financial manager.

An important factor affecting cash flow is depreciation.

From an accounting perspective - statement of cash flows.

From a financial perspective,

Managerial decision-making - operating cash flow

Participants in the capital market - free cash flow

depreciation
Depreciation

Depreciation is the systematic charging of a portion of the costs of fixed assets against annual revenues over time.

Depreciation for tax purposes - the modified accelerated cost recovery system (MACRS).

Other depreciation methods are often used for reporting purposes.

depreciation depreciation cash flow
Depreciation: Depreciation & Cash Flow

Financial managers are much more concerned with cash flows rather than profits.

To adjust the income statement to show cash flows from operations, all non-cash charges should be added back to net profit after taxes.

By lowering taxable income, depreciation and other non-cash expenses create a tax shield and enhance cash flow.

depreciation macrs depreciable value depreciable life
Depreciation: MACRS Depreciable Value & Depreciable Life

The depreciable value of an asset is its full cost, including outlays for installation.

No adjustment is required for expected salvage value.

For tax purposes, the depreciable life of an asset is determined by its MACRS recovery predetermined period.

MACRS property classes and rates are shown in Table 3.1 and Table 3.2 on the following slides.

depreciation1
Depreciation

First Four Property Classes under MACRS

slide210

Rounded Depreciation Percentages by Recovery Year Using MACRS for First Four Property Classes

depreciation an example
Depreciation: An Example

Baker Corporation acquired, for an installed cost of $40,000, a machine having a recovery period of 5 years. Using the applicable MACRS rates, the depreciation expense each year is as follows:

depreciation2
Depreciation

Question:

If as a business owner you could design a depreciation schedule to look the way you wanted it to, what would it look like?

developing the statement of cash flows
Developing the Statement of Cash Flows

The statement of cash flows summarizes the firm’s cash flow over a given period of time.

The statement of cash flows is divided into three sections:

Operating flows

Investment flows

Financing flows

developing the statement of cash flows classifying inflows and outflows of cash
Developing the Statement of Cash Flows: Classifying Inflows and Outflows of Cash

The statement of cash flows essentially summarizes the inflows and outflows of cash during a given period.

Inflows and Outflows of Cash

interpreting statement of cash flows
Interpreting Statement of Cash Flows

The net increase (or decrease) in cash and marketable securities should be equivalent to the difference between the cash and marketable securities on the balance sheet at the beginning of the year and the end of the year.

operating cash flow
Operating Cash Flow

A firm’s Operating Cash Flow (OCF) is the cash flow a firm generates from normal operations—from the production and sale of its goods and services.

OCF may be calculated as follows:

NOPAT = EBIT x (1 – T)

OCF = NOPAT + Depreciation

OCF = [EBIT x (1 – T)] + Depreciation

operating cash flow cont
Operating Cash Flow (cont.)

Substituting for Baker Corporation, we get:

Thus, we can conclude that Baker’s operations are generating positive operating cash flows.

OCF = [$370 x (1 - .40) + $100 = $322

free cash flow
Free Cash Flow

Free Cash Flow (FCF) is the amount of cash flow available to debt and equity holders after meeting all operating needs and paying for its net fixed asset investments (NFAI) and net current asset investments (NCAI).

Where:

FCF = OCF – NFAI - NCAI

NFAI = Change in net fixed assets + Depreciation

NCAI = Change in CA – Change in A/P and Accruals

free cash flow cont
Free Cash Flow (cont.)

Using Baker Corporation we get:

This FCF can be used to pay its creditors and equity holders.

NFAI = [($1,200 - $1,000) + $100] = $300

NCAI = [($2,000 - $1,900) + ($800 - $700)] = $0

FCF = $322 – $300 - $0 = $22

the financial planning process
The Financial Planning Process

Financial planning involves guiding, coordinating, and controlling the firm’s actions to achieve its objectives.

cash planning and profit planning.

Cash planning involves the preparation of the firm’s cash budget.

Profit planning involves the preparation of both cash budgets and pro forma financial statements.

the financial planning process long term strategic financial plans
The Financial Planning Process: Long-Term (Strategic) Financial Plans

Long-term strategic financial plans lay out a company’s planned financial actions and the anticipated impact of those actions over periods ranging from 2 to 10 years.

the financial planning process long term strategic financial plans cont
The Financial Planning Process: Long-Term (Strategic) Financial Plans (cont.)

Long-term financial plans consider a number of financial activities including:

Proposed fixed asset investments

Research and development activities

Marketing and product development

Capital structure

Sources of financing

These plans are generally supported by a series of annual budgets and profit plans.

cash planning cash budgets
Cash Planning: Cash Budgets

The cash budget or cash forecast is a statement of the firm’s planned inflows and outflows of cash.

It is used to estimate short-term cash requirements with particular attention to anticipated cash surpluses and shortfalls.

Surpluses must be invested and deficits must be funded.

cash planning cash budgets cont
Cash Planning: Cash Budgets (cont.)

The cash budget begins with a sales forecast, which is simply a prediction of the sales activity during a given period.

cash planning cash budgets cont1
Cash Planning: Cash Budgets (cont.)

The General Format of the Cash Budget

cash planning cash budgets an example coulson industries
Cash Planning: Cash Budgets An Example: Coulson Industries

Coulson Industries, a defense contractor, is developing a cash budget for October, November, and December. Halley’s sales in August and September were $100,000 and $200,000 respectively. Sales of $400,000, $300,000 and $200,000 have been forecast for October, November, and December. Historically, 20% of the firm’s sales have been for cash, 50% have been collected after 1 month, and the remaining 30% after 2 months. In December, Coulson will receive a $30,000 dividend from stock in a subsidiary.

cash planning cash budgets an example coulson industries cont
Cash Planning: Cash Budgets An Example: Coulson Industries (cont.)

Based on this information, we are able to develop the following schedule of cash receipts for Coulson Industries.

A Schedule of Projected Cash Receipts for Coulson Industries ($000)

cash planning cash budgets an example coulson industries cont1
Cash Planning: Cash Budgets An Example: Coulson Industries (cont.)

Coulson Company has also gathered the relevant information for the development of a cash disbursement schedule. Purchases will represent 70% of sales—10% will be paid immediately in cash, 70% is paid the month following the purchase, and the remaining 20% is paid two months following the purchase. The firm will also expend cash on rent, wages and salaries, taxes, capital assets, interest, dividends, and a portion of the principal on its loans. The resulting disbursement schedule thus follows.

cash planning cash budgets an example coulson industries cont2
Cash Planning: Cash Budgets An Example: Coulson Industries (cont.)

The Cash Budget for Coulson Industries can be derived by combining the receipts budget with the disbursements budget. At the end of September, Coulson’s cash balance was $50,000, notes payable was $0, and marketable securities balance was $0. Coulson also wishes to maintain a minimum cash balance of $25,000. As a result, it will have excess cash in October, and a deficit of cash in November and December. The resulting cash budget follows.

profit planning pro forma statements
Profit Planning: Pro Forma Statements

Pro forma financial statements are projected, or forecast, financial statements – income statements and balance sheets.

profit planning pro forma financial statements cont
Profit Planning: Pro Forma Financial Statements (cont.)

Vectra Manufacturing’s Balance Sheet, December 31, 2009

profit planning pro forma financial statements cont1
Profit Planning: Pro Forma Financial Statements (cont.)

Step 1: Start with a Sales Forecast

The first and key input for developing pro forma financial statements is the sales forecast for Vectra Manufacturing.

2010 Sales Forecast for Vectra Manufacturing

profit planning pro forma financial statements cont2
Step 1: Start with a Sales Forecast (cont.)

The previous sales forecast is based on an increase in price from $20 to $25 per unit for Model X and from $40 to $50 per unit for Model Y.

These increases are required to cover anticipated increases in various costs, including labor, materials, & overhead.

Profit Planning: Pro Forma Financial Statements (cont.)
profit planning pro forma financial statements cont3
Step 2: Preparing the Pro Forma Income Statement

A simple method for developing a pro forma income statement is the “percent-of-sales” method.

Profit Planning: Pro Forma Financial Statements (cont.)
profit planning pro forma financial statements cont4
Profit Planning: Pro Forma Financial Statements (cont.)

A Pro Forma Income Statement, Using the Percent-of-Sales Method, for Vectra Manufacturing for the Year Ended December 31, 2010

profit planning pro forma financial statements cont5
Step 2: Preparing the Pro Forma Income Statement (cont.)

Clearly, some of the firm’s expenses will increase with the level of sales while others will not.

As a result, the strict application of the percent-of-sales method is a bit naïve.

The best way to generate a more realistic pro forma income statement is to segment the firm’s expenses into fixed and variable components.

This may be demonstrated as follows.

Profit Planning: Pro Forma Financial Statements (cont.)
profit planning pro forma financial statements cont7
Step 3: Preparing the Pro Forma Balance Sheet

Probably the best approach to use in developing the pro forma balance sheet is the judgmental approach.

Under this simple method, the values of some balance sheet accounts are estimated and the company’s external financing requirement is used as the balancing account.

Profit Planning: Pro Forma Financial Statements (cont.)
profit planning pro forma financial statements cont8
Step 3: Preparing the Pro Forma Balance Sheet (cont.)

A minimum cash balance of $6,000 is desired.

Marketable securities will remain at their current level of $4,000.

Accounts receivable will be approximately $16,875 which represents 45 days of sales on average [(45/365) x $135,000].

Ending inventory will remain at about $16,000. 25% ($4,000) represents raw materials and 75% ($12,000) is finished goods.

A new machine costing $20,000 will be purchased. Total depreciation will be $8,000. Adding $20,000 to existing net fixed assets of $51,000 and subtracting the $8,000 depreciation yields a net fixed assets figure of $63,000.

Profit Planning: Pro Forma Financial Statements (cont.)
profit planning pro forma financial statements cont9
Step 3: Preparing the Pro Forma Balance Sheet (cont.)

Purchases will be $40,500 which represents 30% of annual sales (30% x $135,000). Vectra takes about 73 days to pay on its accounts payable. As a result, accounts payable will equal $8,100 [(73/365) x $40,500].

Taxes payable will be $455 which represents one-fourth of the 1998 tax liability.

Notes payable will remain unchanged at $8,300.

There will be no change in other current liabilities, long-term debt, and common stock.

Retained earnings will change in accordance with the pro forma income statement.

Profit Planning: Pro Forma Financial Statements (cont.)
profit planning pro forma financial statements cont10
Profit Planning: Pro Forma Financial Statements (cont.)

A Pro Forma Balance Sheet, Using the Judgmental Approach, for Vectra Manufacturing (December 31, 2010)