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Fundamental Financial Accounting Concepts Fourth Edition by Edmonds, McNair, Milam, Olds

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Fundamental Financial Accounting Concepts Fourth Edition by Edmonds, McNair, Milam, Olds

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    1. Fundamental Financial Accounting Concepts Fourth Edition by Edmonds, McNair, Milam, Olds PowerPoint® presentation by J. Lawrence Bergin

    2. 3- 2 Chapter 3 Accounting for Deferrals

    3. 3- 3 What is a deferral? A deferral event occurs when: cash is received before revenue is earned or - cash is paid before an expense is incurred. Deferral events are a part of the accrual basis of accounting

    4. 3- 4 Accruals vs. Deferrals (Revenues) Accrual event Now Later Business action Cash exchange Deferral event Now Later Cash exchange Business action

    5. 3- 5 Accruals vs. Deferrals (Expenses) Accrual event Now Later Business action Cash exchange Deferral event Now Later Cash exchange Business action

    6. 3- 6 Deferred Expenses:

    7. 3- 7 Deferred Expenses related to Buildings & Equipment:

    8. 3- 8 Depreciation The portion of the cost of an asset allocated to any one accounting period is called-- DEPRECIATION EXPENSE Depreciation of an asset is an allocation process--spreading the cost of an asset that benefits more than one accounting period over the estimated useful life of the asset.

    9. 3- 9 Example of Depreciation: ABC Co. bought a satellite dish for $6000. The asset is expected to last five years and have a $1,000 salvage value at the end of its useful life. How will the purchase and use of the asset affect the financial statements?

    10. 3- 10 We want to allocate the cost of the asset to the income statement as an expense during the time period we use the asset. Why? To comply with the MATCHING principle. Expenses incurred must be “matched” to the same time period the revenues (from using this equipment) are recorded. If we depreciate the asset using the STRAIGHT LINE method, we will divide the cost of the asset (minus any estimated salvage value) by the useful life: (6000-1000)/5 yrs. = $1000 depreciation expense each year.

    11. 3- 11 Effect on the financial statements: Purchase of asset: Balance Sheet Income Statement Statement of Changes in Stockholders’ Equity Statement of Cash Flows

    12. 3- 12 Effect on the financial statements: Purchase of asset: Balance Sheet Increases assets (eg. Equip); may decrease “cash” asset (thus, no effect on net assets) or may increase a liability Income Statement Statement of Changes in Stockholders’ Equity Statement of Cash Flows

    13. 3- 13 Effect on the financial statements: Purchase of asset: Balance Sheet Increases assets; may decrease an asset (cash) or increase a liability (payable) if we haven’t paid yet. Income Statement No effect Statement of Changes in Stockholders’ Equity Statement of Cash Flows

    14. 3- 14 Effect on the financial statements: Purchase of asset: Balance Sheet Increases assets; may decrease an asset (cash) or increase a liability (payable) if we haven’t paid yet. Income Statement No effect Statement of Changes in Stockholders’ Equity No effect Statement of Cash Flows

    15. 3- 15 Effect on the financial statements: Purchase of asset: Balance Sheet Increases assets; may decrease an asset (cash) or increase a liability (payable) if we haven’t paid yet. Income Statement No effect Statement of Changes in Stockholders’ Equity No effect Statement of Cash Flows Depends on whether or not the asset was purchased for cash. If cash is paid it is an Investing Activity cash flow.

    16. 3- 16 Balance Sheet Income Statement Statement of Changes in Stockholders’ Equity Statement of Cash Flows

    17. 3- 17 Balance Sheet Reduces the net value of the asset by increasing a contra-asset called accumulated depreciation Income Statement Statement of Changes in Stockholders’ Equity Statement of Cash Flows

    18. 3- 18 Balance Sheet Reduces the net value of the asset by increasing a contra-asset called accumulated depreciation Income Statement Increase in depreciation expense reduces Net Income Statement of Changes in Stockholders’ Equity Statement of Cash Flows

    19. 3- 19 Balance Sheet Reduces the net value of the asset by increasing a contra-asset called accumulated depreciation Income Statement Increase in depreciation expense reduces Net Income Statement of Changes in Stockholders’ Equity Since the Net Income decreased, the remaining Retained Earnings will decrease causing total Stockholders’ Equity to decrease. Statement of Cash Flows

    20. 3- 20 Balance Sheet Reduces the net value of the asset by increasing a contra-asset called accumulated depreciation Income Statement Increase in depreciation expense reduces Net Income Statement of Changes in Stockholders’ Equity Since the Net Income decreased, the remaining Retained Earnings will decrease causing total Stockholders’ Equity to decrease. Statement of Cash Flows No cash involved. Depreciation is an adjusting entry.

    21. 3- 21 Deferred Revenue You’ve received payment for something you have NOT yet provided. Revenue is not recognized until the service is performed or the goods are delivered...but you have to record the fact that you have received the cash, and…. A related LIABILITY (Unearned Revenue) must be recorded and kept on the books until you EARN the revenue.

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    23. 3- 23 Bob Company’s 2004 transactions 1. Performed services for customers, charging $7,000 on account. 2. Collected $8,000 cash from customers for services to be provided in the future. 3. Collected $7,000 of the receivables. 4. Paid $2,000 salaries in cash. 5. On July 1st purchased office equipment by paying $9,000 cash. (estimates: life=4 years, salvage value=$1,000) 6. On Nov. 1st paid $3,000 to rent office space for the next three months. 7. Year-end adjustment recognizing 1/4 of the services required by transaction #2 have been performed. 8. Year-end depreciation adjustment. 9. Year-end rent adjustment.

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    44. 3- 44 Summary of General Ledger Accounts

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    48. 3- 48 Bob Company, Inc. Statement of Changes in Stockholders’ Equity For the Year Ended December 31, 2004 Beginning Common Stock $ Plus: Common Stock issued Ending Common Stock $ Beginning Retained Earnings $ Plus: Net income Less: Dividends Ending Retained Earnings $ Total Stockholders’ Equity $

    49. 3- 49 Bob Company, Inc. Statement of Changes in Stockholders’ Equity For the Year Ended December 31, 2004 Beginning Common Stock $ 7,000 Plus: Common Stock issued 0 Ending Commonn Stock $ 7,000 Beginning Retained Earnings $ 2,000 Plus: Net income 4,000 Less: Dividends 0 Ending Retained Earnings $ 6,000 Total Stockholders’ Equity $13,000

    50. 3- 50 Bob Company, Inc. Balance Sheet As of December 31, 2004

    51. 3- 51 Bob Company, Inc. Balance Sheet As of December 31, 2004

    52. 3- 52 Bob Company, Inc. Statement of Cash Flows For the Year Ended December 31, 2004 Cash from Operations: Cash receipts for services $ Cash payments for expenses Net cash flow from operations $ Cash from Investing Activities: Cash payment for equipment $ Net cash flow from investments $ Cash from Financing Activities Cash receipts from stock issue Dividends paid to stockholders’ $ Net cash flow from financing $ Net Increase (Decrease) in cash $ Plus: Cash balance, Jan. 1, 2004 Cash balance, Dec. 31, 2004 $

    53. 3- 53 Bob Company, Inc. Statement of Cash Flows For the Year Ended December 31, 2004 Cash from Operations: Cash receipts for services $ 15,000 Cash payments for expenses (5,000) Net cash flow from operations $10,000 Cash from Investing Activities: Cash payment for equipment $(9,000) Net cash flow from investments $(9,000) Cash from Financing Activities Cash receipts from stock issue 0 Dividends paid to stockholders’ $ (0) Net cash flow from financing $ (0) Net Increase (Decrease) in cash $ 1,000 Plus: Cash balance, Jan. 1, 2004 5,000 Cash balance, Dec. 31, 2004 $ 6,000

    54. 3- 54 Bob Company, Inc. Statement of Cash Flows For the Year Ended December 31, 2004 Cash from Operations: Cash receipts for services $ 15,000 Cash payments for expenses (5,000) Net cash flow from operations $10,000 Cash from Investing Activities: Cash payment for equipment $(9,000) Net cash flow from investments $(9,000) Cash from Financing Activities Cash receipts from stock issue 0 Dividends paid to stockholders’ $ (0) Net cash flow from financing $ (0) Net Increase (Decrease) in cash $ 1,000 Plus: Cash balance, Jan. 1, 2004 5,000 Cash balance, Dec. 31, 2004 $ 6,000

    55. 3- 55 Bob Company, Inc. Statement of Cash Flows For the Year Ended December 31, 2004 Cash from Operations: Cash receipts for services $ 15,000 Cash payments for expenses (5,000) Net cash flow from operations $10,000 Cash from Investing Activities: Cash payment for equipment $(9,000) Net cash flow from investments $(9,000) Cash from Financing Activities Cash receipts from stock issue 0 Dividends paid to stockholders’ $ (0) Net cash flow from financing $ (0) Net Increase (Decrease) in cash $ 1,000 Plus: Cash balance, Jan. 1, 2004 5,000 Cash balance, Dec. 31, 2004 $ 6,000

    56. 3- 56 Bob Company, Inc. Statement of Cash Flows For the Year Ended December 31, 2004 Cash from Operations: Cash receipts for services $ 15,000 Cash payments for expenses (5,000) Net cash flow from operations $10,000 Cash from Investing Activities: Cash payment for equipment $(9,000) Net cash flow from investments $(9,000) Cash from Financing Activities Cash receipts from stock issue 0 Dividends paid to stockholders’ $ (0) Net cash flow from financing $ (0) Net Increase (Decrease) in cash $ 1,000 Plus: Cash balance, Jan. 1, 2004 5,000 Cash balance, Dec. 31, 2004 $ 6,000

    57. 3- 57 Analysis of Financial Statements Using Ratios Bob Company’s Net Income is $4,000. Is this good or bad? If Bob only invested $1 to start the business, a $4,000 profit sounds great. If he expected a $10,000 profit, he’s not happy. If his competitor only earned $2,000 with a similar investment, Bob’s doing OK.

    58. 3- 58 Analysis of Financial Statements Using Ratios For a meaningful analysis we need: 1. a way to compare different size companies Use financial RATIOS. 2. A basis of comparison. a. Our past: (Are we getting better?) b. Our budget: (Did we meet expectations?) c. Our competitors: Who is better? Why?

    59. 3- 59 Analysis of Financial Statements Using Ratios (Data from Bob Co.) Return on assets Net income $ % Total assets $ Debt to assets Total debt (Liabilities) $ % Total assets $ Return on equity Net income $ % Stockholders’ Equity $

    60. 3- 60 Analysis of Financial Statements Using Ratios (Data from Bob Co.) Return on assets Net income $ 4,000 21.1% Total assets $19,000 Debt to assets Total debt (Liabilities) $ 6,000 31.6% Total assets $19,000 Return on equity Net income $ 4,000 30.8% Stockholders’ Equity $13,000

    61. 3- 61 Using Financial “Leverage”

    62. 3- 62 Chapter 3:

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