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Accounting & Financial Management
AFM 101
Donna Psutka

AFM  101  Midterm  Exam  Aid     Chapter  1:  Financial  Statements  and  Business  Decisions     Four  Major  Financial  Statements       1) The  Balance  Sheet   • The  company’s  financial  position  at  a  point  in  time       ABC  Co.   Balance  Sheet   December  31,  2009   Assets         (list  all  assets)         $XX   Total  Assets                XX     Liabilities         (list  all  liabilities)           $XX   Owner’s  Equity/Shareholder’s  Equity       (list  owner’s  equity  components)        XX   Total  Liabilities  and  Owner’s  Equity        XX       Assets   • Economic  resources  of  the  company,  listed  in  order  of  liquidity  i.e.  what  the  company  owns       Liabilities   • The  company’s  obligations,  listed  in  order  of  when  the  liabilities  come  due  i.e.  what  the  company  owes     Owner’s  Equity/Shareholder’s  Equity   • Two  parts:   o The  amount  of  financing  provided  by  the  owners  of  the  company  t hrough  share  capital   o The  earnings  from  the  business  operations  from   retained  earnings       2) Income  Statement   • How  the  company  operated  during  the  accounting  period       ABC  Co.   Income  Statement   For  the  Period  Ended  December  31,  2009   Revenue           (List  all  sources  of  revenue)       $XX   Total  Revenue                XX     Expenses           (List  all  Expenses)           $XX   Total  Expenses              XX   Net  Income                XX           AFM  101  Midterm  Exam  Aid     Revenue   • Money  received  from  sale  of  goods,  or  providing  a  service     Expenses   • Resources  used  up  by  the  entity  to  run   the  business  and  generate  revenue       3) Statement  of  Retained  Earnings  (Statement  of  Shareholders’  Equity)   • Used  to  calculate  the  ending  retained  earnings  number  for  the  balance  sheet       ABC  Co.   Statement  of  Retained  Earnings   For  the  Period  Ended  December  31,  2009     Beginning  Retained  Earnings          $XX         Add  Net  Income  for  period          XX       Subtract  Dividends  paid  to  owners          XX   Ending  Retained  Earnings                XX     • When  net  income  is  earned  every  year,  the  company  can  choose  to:   o Distribute  all  (or  a  portion)  to   shareholders  in  the  form  of  dividends   o Retain  all  (or  a  portion)  to  continue  to  run  the  day  to  day  business   • Retained  Earnings:  the  accumulation  of  all  net  income   NOT  distributed  as  dividends  since  the  first  year  of   business       4) Statement  of  Cash  Flows   • Used  to  show  all  inflows  and  outflows  of  company  cash  during  the  year   • Used  to  calculate  the  cash  balance  on  the  balance  sheet     ABC  Co.     Statement  of  Cash  Flow     For  the  Period  Ended  December  31,  2009     Cash  flows  from  Operating  Activities      (List  details)             $XX   Cash  flows  from  Investing  Activities      (List  details)             $XX   Cash  flows  from  Financing  Activities      (List  details)             $XX   Net  Increase/Decrease  in  Cash          XX     Cash  balance  beginning  of  period  (Jan  1,  2009)      XX   Cash  Balance  end  of  period  (Dec  31,  2009)        XX       5) Notes  to  the  Financial  Statements   • Required  by  accounting  standards  (GAAP)   • Further  explain  the  numbers  in  the  financial  statements   • Explain  accounting  policies  used  by  the  management  of  the  company     • Contain  supporting  schedules  and  calculation s   • Additional  important  non -­‐quantitative  disclosures               AFM  101  Midterm  Exam  Aid     Ratio  Analysis   𝑀𝑎𝑟𝑘𝑒𝑡    𝑃𝑟𝑖𝑐𝑒 𝑃𝑟𝑖𝑐𝑒  𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠  𝑅𝑎𝑡𝑖𝑜 =   𝑁𝑒𝑡  𝐼𝑛𝑐𝑜𝑚𝑒   • Represents  the  “value”  an  investor  thinks  this  company  is  worth     • Investors  will  multiply  the  P/E  ratio  by  the  company’s  net  income  to  determine  a  price  one  would  pay  for   the  company   • The  higher  the  P/E  ratio,  the  greater  confidence  investors  have  in  this  company’s  abilities  to  generate   income         Chapter  2:  Investing  and  Financing  Decisions  and  the  Balance  Sheet     The  Conceptual  Framework     The  conceptual  framework  is  used  to  make  connections  to  lead  us  from  the  purpose  of  financial  statements  to  the   components  and  characteristics  of  F inancial  Statements  and  the  methods  and  assumptions  management  use  to   create  the  Financial  Statements.     Objectives  of  Financial  Reporting  (creating  financial  statements)   • To  provide  useful  information  to  external  users  of  the  financial  statements  so  they  can  make  business   decisions     Elements  of  the  financial  statements   • Assets,  liabilities,  shareholder’s  equity,  revenue,  expenses,  etc.     Qualitative  Characteristics  of  good  financial  statements   • Understandability,  relevance,  reliability,  comparability     Underlying  Assumptions  of   accounting  information   • Separate  entity:  each  business  is  accounted  for  as  an  individual  organization   • Unit-­‐of-­‐measure:  a  business  accounts  for  its  operations  and  reports  the  results  using  the  monetary  unit  of   the  country  in  which  it  is  operating   • On-­‐Going  concern:  a  business  is  expected  to  continue  to  operate  in  the  foreseeable  future;  there  is   nothing  to  suggest  it  will  go  out  of  business  soon     Basic  Accounting  Principles  (GAAP)   • Cost  Principle   • Revenue  Recognition   • Matching   • Full  Disclosure       Constraints  of  financial  reporting   • Cost-­‐benefit:  sometimes  we  want  to  collect  as  much  information  as  possible,  but  we  need  to  view  it  on  a   cost-­‐benefit  basis;  is  it  worth  the  costs  to  collect  the  extra  information?   • Materiality:  information  from  the  financial  statements  that  will  affect/influence  a  user’s  decision  is   considered  material  in  nature         AFM  101  Midterm  Exam  Aid       Elements  of  a  Classified  Balance  Sheet     Assets   • Economic  resources  arising  from   past  transactions   • Future  benefits  (i.e.  conversion  to  cash)  can  be  obtained     Current  Assets   • Assets  that  can  generally  be  “converted”  to  cash  within  one  year   à  very  liquid   o Cash  and  cash  equivalents   o Short  term  investments  (i.e.  shares  in  other  companies,  can  sell  very  easily)   o Accounts  receivable  (a  promise  to  pay  from  a  customer  or  another  party)   o Note  Receivable     o Inventory   o Prepaid  expenses  (expenses  paid  before  they  are  actually  used)     Non-­‐Current  Assets   • Assets  that  are  generally  converted  to  cash  after  more  than  one  year   o Long  term  investments   o Property,  plant,  equipment  (reported  on  a  net  of  amortiz ation  basis)   o Intangible  assets  (patents,  trademarks,  licenses,  franchises)   o Goodwill       Liabilities   • Debts  and  obligations  owed  to  other  parties,  which  will  be  paid  off  using  assets  in  the  future     Current  Liabilities   • Obligations  that  will  be  paid  within  one   year   o Accounts  Payable   o Accrued  liabilities  (i.e.  unearned  revenue)   o Current  portion  of  long-­‐term  debt     Long  Term  Liabilities   • Obligations  that  will  take  longer  than  a  year  to  pay  off   o Long  term  debt   o Mortgage  payable   o Bonds  payable     Shareholder’s  Equity     Share  Capital   • Money  received  from  the  company  issuing  its  own  shares,  purchased  by  the  shareholders  of  the    any • A  form  of  “equity  financing”,  also  known  as  raising  money  through  equity       Retained  Earnings   • The  accumulation  of  net  income  not  distributed  as   dividends  since  the  company  began  operations   • Dividends  are  paid  out  of  retained  earnings  and  distributed  to  the  shareholders  as  a  return  on   their   investment  in  the  company           AFM  101  Midterm  Exam  Aid         Example  of  a  Classified  Balance  Sheet           Ratio  Analysis     𝑇𝑜𝑡𝑎𝑙  𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 𝐷𝑒𝑏𝑡 − 𝑡𝑜 − 𝐸𝑞𝑢𝑖𝑡𝑦 =   𝑇𝑜𝑡𝑎𝑙  𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟  𝐸𝑞𝑢𝑖𝑡𝑦     • Measures  how  much  debt  has  been  used  to  finance  the  company  (versus  financing  through  the   owners/shareholders  of  the  company     • Companies  need  to  pay  back  debt  before  they  can  pay  dividends  to  owners,  so  a  high  debt -­‐to-­‐equity  ratio   means  there  is  a  higher  risk  that  a  company  may  not  be  able  to  meet  its  financial  obligations     E.g.  the  D/E  ratio  of  the  above  balance  sheet  is:    481,000  /  289,000  =  1.66     AFM  101  Midterm  Exam  Aid         Business  Transactions  and  Journal  Entries     Business  Transactions   • Whenever  a  transaction  occurs,  it  changes  the  financial  position  of  the  company,  so  the  transaction  must   be  recorded   • External  events:  exchanges  of  assets  and  liabilities  between  the  business   and  other  parties   • Internal  events:  adjustments,  unforeseeable  events,  they  do  not  involve  external  parties  but  must  still  be   recorded  as  the  transactions  affect  the  financial  position  of  the  company       Double  Entry  Accounting   • Every  time  a  transaction  occurs ,  at  least  two  accounts  are  affected   • The  total  debits  =  total  credits  in  a  transaction   • The  fundamental  accounting  equation  remains  in  balance  after  each  transaction       An  increase  to  an  asset  account  is  a  debit  entry   An  increase  to  a  liability  account  is  a  credit  entry   An  increase  to  a  shareholder’s  account  is  a  credit  entry   • Since  dividends  decrease  shareholder’s  equity,  thus  an  increase  to  dividends  is  a  debit  entry   Debits  are  always  on  the  left  side  of  a  transaction  entry   Credits  are  always  on  the  right  side  of  a  transaction  entry     Whenever  a  transaction  occurs   à  record  in  General  Journal       Post. Date Description Ref. Debit Credit Feb 15 Equipment 10,000     Accounts Payable 8,000   Cash 2,000       28 Rent Expense 5,000 Cash 5,000   AFM  101  Midterm  Exam  Aid     All  transactions  are  posted  to  general  ledger  accounts,  or  we  use  t-­‐accounts  for  simplicity.  The  ending  balances  to   each  t-­‐account  form  the  balances  on  the  Ba lance  Sheet.     Chapter  3:  Operating  Decisions  and  the  Income  Statement     The  Operating  Cycle   • The  cycle  of  activities  that  goes  from  paying  suppliers  for  goods  and  materials  to  generating  inventory  to   selling  the  inventory  to  customers  to  collecting  the  cash   from  customers  (for  a   manufacturing/merchandising  company)   • At  the  end  of  every  operating  cycle,  a  set  of  “year -­‐end”  financial  statements      made • This  supports  the  periodicity  assumption:  the  operations  of  a  company  are  reported  in  specified  periods   (usually  a  year     Elements  of  an  Income  Statement     Revenue/Sales   • Results  of  selling  a  good  or  providing  a  service   • A  company  can  have  more  than  one  source  of  revenue;  if  this  is  the  case,  then  the  revenue  section  should   have  more  detailed  line  items     Cost  of  Goods  Sold   • The  cost  to  the  company  for  obtaining  the  product  to  sell       Gross  Profit   • Revenue  –  Cost  of  Goods  Sold     Operating  Expenses   • The  expenses  incurred  to  operating  the  business   o Salaries  expense   o Utilities  expense   o Administrative  expenses   o Rent  expense   o Insurance  expense   o Amortization  expense     Operating  Income   • Subtotal  of  operating  revenues -­‐  operating  expenses     Other  Expenses   • Other  expenses  incurred  that  do  not  directly  relate  to  the  daily  operations  of  the  business   o Interest  Expense   o Investing  Expenses     Earnings  Before  Income  Tax   • Operating  Income–  other  expenses     Income  Tax  Expense   • Calculated  by  tax  professionals ,  often  calculated  from  a  percentage     Net  Income   • Net  Income  =  Earnings  before  income  tax-­‐income  tax  expense     AFM  101  Midterm  Exam  Aid       Earnings  Per  Share     𝑁𝑒𝑡  𝐼𝑛𝑐𝑜𝑚𝑒 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠  𝑃𝑒𝑟  𝑆ℎ𝑎𝑟𝑒 =   𝐴𝑣𝑒𝑟𝑎𝑔𝑒  𝑁𝑢𝑚𝑏𝑒𝑟  𝑜𝑓  𝑆ℎ𝑎𝑟𝑒𝑠  𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔   • Required  to  be  disclosed  on  the  bottom  of  the  income  statement         Accrual  vs.  Cash  Basis  of  Accounting   • GAAP  specifies  the  Accrual   basis  of  accounting,  where  revenue  is  only  recorded  when  it’s  “earned”  and   expenses  are  recorded  when  “incurred”   • This  timing  can  be  quite  different  from  the  Cash  basis  of  accounting,  where  revenue  is  recorded  when   cash  is  received  and  expenses  are  recorded  when  cash  is  paid     Revenue  Recognition  Principle   • Revenue  should  be  recognized  on  the  income  statement  when  the  following  3  criterion  are  satisfied:   o Earnings  process  is  complete  or  almost  complete:  the  company  providing  the  good  or  service   must  have  completed  its  services     o An  exchange  of  transaction:  the  customer  must  have  already  paid  or  have  promised  to  pay  in  the   near  future  (price  agreed  upon  by  both  parties)   o Collection  of  payment  is  reasonably  assured:  if  the  customer  has  agreed  to  pay  in  the  near   future,  then  there  is  a  low  risk  of  default     Matching  Principle   • Expenses  should  be  recorded  in  the  same  period  as  the  revenue  it  helped  to  earn   • All  expenses  of  a  company  either  directly  or  indirectly  contribute  to  the  company’s  abilities  to  earn   revenue;  thus,  expenses  should  be  recorded  when  they  are  used  up     **Note:  Even  if  revenue  isn’t  recognized  or  expenses  haven’t  been  incurred,  we  still  need  to  record  any  business   transaction  as  a  journal  entry  (it  just  won’t  affect  a  revenue  or  expense  account  yet;   that’s  what  adjusting  entries   are  for  in  chapter  4)  **     Comparison  of  Accrual  vs.  Cash  Basis  of  Accounting     Cash  is  paid  before  expense  is  incurred   On  September  30  ABC  Co  just  made  a  $3,000  cash  payment  for  the  next  6  months  of  rent   Cash  Basis   Accrual  Basis   Rent  Expense                                3,000   Prepaid  Rent  (Asset)              3,000            Cash                                                  Cash                                                            3,000     Cash  is  received  before  revenue  is  earned   On  Nov  25  TIX  Co,  a  ticketing  service  agency   received  $5,000  worth  of  payments  from  customers  for  a  Broadway   show  later  in  the  year     Cash  Basis   Accrual  Basis   Cash                                                   Cash                                                              5,000            Revenue                                                Unearned  Revenue  (L)                5,000             AFM  101  Midterm  Exam  Aid     Expenses  are  incurred  before  cash  is  paid     st The  company  received  a  $500  hydro  bill  on  December  31 ,  they  didn’t  make  the  payment  until  the  next  fiscal   period     Cash  Basis   Accrual  Basis   NO  ENTRY   Utilities  Expense                              500                        Utilities  Payable  (L)                      500     Revenue  is  earned  before  cash  is  received     You  own  a  lawn-­‐mowing  business  and  you’ve  mowed  $200  worth  of  lawns,  yet  your  clients  have  promised  to  pay   within  the  next  week     Cash  Basis   Accrual  Basis   NO  ENTRY   Accounts  Receivable  (A)              200                        Revenue                                                        200   ***More  adjusting  entries  in  Chapter  4       Ratio  Analysis     𝑇𝑜𝑡𝑎𝑙  𝑆𝑎𝑙𝑒𝑠 𝐴𝑠𝑠𝑒𝑡  𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟 =   𝐴𝑣𝑒𝑟𝑎𝑔𝑒  𝑇𝑜𝑡𝑎𝑙  𝐴𝑠𝑠𝑒𝑡𝑠   • Average  Total  Assets  =  [last  year’s  total  assets  +  this  year’s  total  assets]  /  2   • Measures  how  much  sales  is  generated  for  every  $1  of  assets   • A  high  ratio  is  favourable     𝑅𝑒𝑡𝑢𝑟𝑛  𝑜𝑛  𝐴𝑠𝑠𝑒𝑡𝑠 = 𝑁𝑒𝑡  𝐼𝑛𝑐𝑜𝑚𝑒   𝐴𝑣𝑒𝑟𝑎𝑔𝑒  𝑇𝑜𝑡𝑎𝑙  𝐴𝑠𝑠𝑒𝑡𝑠   • Measures  management’s  effectiveness  at  utilizing  assets  to  generate  income   • A  high  ratio  is  favourable           Chapter  4:  Adjustments,  Financial  Statements  and  the  Quality  of  Earnings     Unadjusted  Trial  Balance   • A  list  of  ALL  of  the  company’s  accounts,  used  for  internal  purposes   • Contains  both  balance  sheet  and  income  statement  accounts   • The  total  columns  for  debits  and  credits  must  be  equal   • After  closing  entries,  all  revenue  and  expense  accounts  will  have  zero  balances,  leav ing  only  balance  sheet   accounts                 AFM  101  Midterm  Exam  Aid       ABC  Co.     Trial  Balance       December  31,  2009                 Debit     Credit       \       Cash               XX     Accounts  Receivable           XX     Inventory             XX     ….     ….       Accounts  Payable                 XX     Income  Tax  Payable               XX     Accrued  Liabilities               XX     ….     ….       Share  Capital                 XX   Retained  Earnings               XX           Revenue                   XX         Other  Revenue                 XX         Cost  of  Goods  Sold               XX         Salaries  Expense             XX                   Rent  Expense             XX           ….         ….                         Totals     XX     XX           Adjusting  Entries   • Throughout  the  normal  course  of  business,  we  record  all  transactions  as  journal  entries   • Adjusting  entries  transfer  amounts  to  different  accounts,  allowing  us  to  properly  recognize  revenue  and   record  expenses     • Adjusting  entries  NEVER  affect  cash   • At  the  end  of  the  business  cycle,  we  record  entries  to  close  revenue  and  expense  accounts,  and  prepare   the  final  financial  statements       Types  of  Adjusting  Entries     Deferred  Revenue  (unearned  revenue)   • Cash  was  received  before  revenue  is  earned     During  operations,  when  cash  was  received   DR  Cash     CR  Unearned  Revenue  (Liability)     Adjusting  entry,  when  revenue  is  earned   DR  Unearned  Revenue  (erases  the  liability  account)     CR  Revenue  (recognizes  the  revenue)   AFM  101  Midterm  Exam  Aid       st E.g.  On  Jan  1 ,  ABC  Co  signed  a  contract  stating  they  will  provide  2  months  of  services.  They  received  $1,200   payment  up  front.     st Jan  1  During  Operations   DR  Cash       1,200     CR  Unearned  Revenue   1,200     Jan  31  Adjusting  Entry   DR  Unearned  Revenue   600     CR  Revenue       600   First  month  of  revenue  is  earne d     Feb  28 Adjusting  Entry   DR  Unearned  Revenue   600     CR  Revenue       600   Second  month  of  revenue  is  earned     **Note:  because  we  were  told  the  contract  was  for  2  months  of  services,  we  are  able  to  adjust  at  the  end  of   every  month;  usually,  we  would  recognize  the  revenue  and  erase  the  liability  for  the  entire  amount  when   revenue  was  deemed  earned.     Deferred  Expense  (Prepaid  Expenses)   • Cash  is  paid  for  expenses  to  be  incurred  in  the  future  (specified  amount  of  time)   • Includes  prepaid  rent,  prepaid  insurance   • Adjustments  are  made  at  the  end  of  every  month  when  expenses  are  incurred     During  operations,  when  payment  was  made   DR  Prepaid  Expenses  (Current  Asset)     CR  Cash     Adjusting  entry,  when  expenses  are  incurred   DR  Expense     CR  Prepaid  Expenses  (decline  in  the  value  of  the  asset  as  expenses  are  incurred)     th E.g.  On  April  30 ,  ABC  Co  paid  for  8  months  worth  of  insurance  for  $2,400     April  30 When  payment  was  made   DR  Prepaid  Insurance  2,400     CR  Cash       2,400     st   May  31 Adjusting  Entry   DR  Rent  Expense     300     CR  Prepaid  Insurance   300   First  month  of  rent  expense     th June  30  Adjusting  Entry   DR  Rent  Expense     300     CR  Prepaid  Insurance   300   Second  month  of  rent  expense   **Same  entries  made  for  months  3   –  8         AFM  101  Midterm  Exam  Aid     Accrued  Revenue  (receivables)   • Revenue  is  earned  before  payment  is   received  from  customer     During  operations,  when  service  was  performed/product  was  sold   DR  Accounts  Receivable   (customer  has  yet  to  pay)     CR  Revenue     Adjusting  entry,  when  cash  is  received   DR  Cash     CR  Accounts  Receivable  (erases  the  receivable)   st th E.g.  On  Mar  1 ,  ABC  Co  provided  services  worth  $500,  the  customer  subsequently  paid  on  Apr  24       Mar  1  When  service  was  performed   DR  Accounts  Receivable   500     CR  Revenue       500     th   Apr  24 Adjusting  Entry   DR  Cash       500     CR  Accounts  Receivable   500   Payment  is  received  from  customer     Accrued  Expenses  (Payables)   • Expenses  are  incurred  before  the  company  makes  a  payment     During  operations,  when  expenses  were  incurred   DR  Expense     CR  Accounts  Payable  (company  has  yet  to  pay)     Adjusting  entry,  when  cash  is  paid   DR  Accounts  Payable  (erases  the  payable)     CR  Cash   E.g.  The  company  pays  their  employees  on  a  bi -­‐weekly  basis.  Total  salaries  expense  for  each  period  is  $20,000.   The  next  payday  is  Jan  2 .  Dec  31  is  the  company’s  year  end.     st Dec  31  Adjusting  entry  to  accrue  for  exp enses  at  year  end   DR  Salaries  Expense   16,000     CR  Salaries  Payable     16,000   Expenses  must  be  accrued  at  year  end,  but  the  company  has  not  paid  anything  yet     nd Jan  2  Entry  to  record  payment  of  salaries   DR  Salaries  Payable   16,000  (to  erase  payable)   DR  Salaries  Expense   4,000     CR  Cash       20,000   Payment  is  made     Amortization   • The  matching  principle  states  that  a  company  needs  to  match  expenses  to  the  revenue  it  helped  generate   • Capital  assets  (machinery,  equipment,  plant,  etc.)  are  used  to  help  the  company  generate  r evenue     • Thus,  portions  of  the  assets’  costs  are  allocated  as  amortization  expense   • The  cost  principle  states  that  assets  must  be  listed  on  the  balance  sheet  at  their  historical  cost  (i.e.   purchase  price)   AFM  101  Midterm  Exam  Aid     • Therefore,  the  amortization  expense  is  accumulated  in  a  contra  asset  account:  accumulated  amortization   • On  the  balance  sheet,  the  capital  assets  are  presented  in  the  non -­‐current  assets  section  at  their  net  value:   Equipment               15,000   Less:  Accumulated  Amortization  –  Equipment        5,000      10,000                 The  amount  of  amortization  expense  each  year:     [𝐶𝑜𝑠𝑡  𝑜𝑓  𝐴𝑠𝑠𝑒𝑡 − 𝑆𝑎𝑙𝑣𝑎𝑔𝑒  𝑉𝑎𝑙𝑢𝑒} 𝐴𝑛𝑛𝑢𝑎𝑙  𝐴𝑚𝑜𝑟𝑡𝑖𝑧𝑎𝑡𝑖𝑜𝑛  𝐸𝑥𝑝𝑒𝑛𝑠𝑒 =   𝑁𝑢𝑚𝑏𝑒𝑟  𝑜𝑓  𝑈𝑠𝑒𝑓𝑢𝑙  𝑌𝑒𝑎𝑟𝑠   st E.g.  On  April  1 ,  ABC  Co  purchased  equipment  for  80,000  on  account.  It  was  assumed  this  equipment  would  have  a   salvage  value  of  8,000  and  a  useful  life  of  9  years.  Record  the  journal  entry  on  purchase  date  and  the  requirement   adjusting  entry  at  year  end.     Annual  Amortization  Expense  =  [80,000  –  8,000]  /  9  =  8,000   Amortization  expense  for  this  year  (9  months)  =  8,000  *  9  /  12  =  6,000     Journal  Entry  to  record  amortization  expense:   Amortization  Expense       6,000     Accumulated  Amortization   –  Equipment     6,000     Accrued  Interest  on  Bonds  or  Notes  Payable     • Companies  borrow  money  by  issuing  bonds  or  notes  to  third  parties  (creditors)   • Before  they  pay  back  the  amount  borrowed,  companies  need  to  pay  interest  on  the  amount  borrowed   • Since  interest  payment  days  do  not  usu ally  correspond  with  year  end  dates,  accrued  interest  must  be   recorded  at  each  year  end   E.g.  On  April  1 ,  ABC  Co  issued  a  $10,000  bond  paying  6%  interest  semi  annually;  interest  is  paid  every  September   th st   30  and  March  31   st   April  1  Company  issues  the  bond  (incurs  the  liability) Cash       10,000     Bond  Payable     10,000     Sept  30  First  interest  payment   Interest  Expense   300     Cash       300   Every  6  months,  the  company  needs  to  pay  0.06  *  10,000  *  0.5  =  $300     December  31  Year  end,  need  to  adjust  for  the  interest  expense  incurred  (but  not  paid)   Interest  Expense   150     Interest  Payable   150     st March  31  Second  interest  payment   Interest  Expense   150   Interest  Payable   150     Cash       300             AFM  101  Midterm  Exam  Aid     Closing  Entries   • Relationship  between  the  Balance  Sheet  and  Income   Statement:   o Net  Income  each  year  adds  to  the  Retained  Earnings  account  on  the  Balance  Sheet   • At  the  end  of  each  operating  cycle,  we  need  to  transfer  the  net  income  earned  during  the  period  to   Retained  Earnings   o This  is  done  through  closing  entries     Temporary  (Nominal)  Accounts     • Revenue,  Expense  accounts     • Close  out  to  retained  earnings  at  end  of  fiscal  period   • Start  with  $0  balance  at  beginning  of  fiscal  period     Permanent  (Real)  Accounts   • Accounts  on  the  Balance  Sheet  (they  have  a  beginning  balance  at  the  start   of  each  operating  period)     ***We  close  Temporary  Accounts  and  do  not  close  Permanent  Accounts     The  Closing  Entry  Process     Step  1:  Close  Revenue  Accounts     Sales  Revenue       XX   Rent  Revenue         XX   …     Income  Summary       XX     The  Income  Summary  is  another  temporary   account  that  we  use  only  in  the  closing  entry  process.  This  account  itself   gets  closed  out  to  retained  earnings.     Step  2:  Close  Expense  Accounts     Income  Summary       XX     Rent  Expense       XX     Salaries  Expense       XX     Interest  Expense       XX     …     Step  3:  Close  Income  Summary  Account     If  there  was  a  net  income   Income  Summary       XX     Retained  Earnings       XX   **  Retained  earnings  increased  (credit  entry)     If  there  was  a  net  loss   Retained  Earnings       XX     Income  Summary         XX   **  Retained  earnings  decreased  (debit  entry)               AFM  101  Midterm  Exam  Aid       Ratio  Analysis     𝑃𝑟𝑜𝑓𝑖𝑡 𝑁𝑒𝑡  𝑃𝑟𝑜𝑓𝑖𝑡  𝑀𝑎𝑟𝑔𝑖𝑛 =   𝑁𝑒𝑡  𝑆𝑎𝑙𝑒𝑠  (𝑆𝑎𝑙𝑒𝑠 − 𝑆𝑎𝑙𝑒𝑠  𝑅𝑒𝑡𝑢𝑟𝑛𝑠  𝑎𝑛𝑑  𝐴𝑙𝑙𝑜𝑤𝑎𝑛𝑐𝑒𝑠)   • Measures  how  much  income  is  generated  for  each  dollar  of  sales   • i.e.  For  every  $1  of  sales,  how  much  does  the  company  get  to  retain?   • A  higher  net  profit  margin  is  more  favourable     𝑃𝑟𝑜𝑓𝑖𝑡 𝑅𝑒𝑡𝑢𝑟𝑛  𝑜𝑛  𝐸𝑞𝑢𝑖𝑡𝑦 =   ▯   𝐴𝑣𝑒𝑟𝑎𝑔𝑒  𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠 𝐸𝑞𝑢𝑖𝑡𝑦 • Average  Shareholder’s  Equity
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