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Chapter 2

ACTG 2010 Chapter Notes - Chapter 2: Gross Margin, Cash Flow, Net Income

Course Code
ACTG 2010
Douglas Kong

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Type of Asset and What is it? Why is it a liability?
Cash- money Future Benefit-cash can be spent to buy
g/s, pay debts and dividends
Control-the company can use the cash
however it wishes
Past Transaction-events in the past,
such as the sale of furniture gave rise to
the cash
Measureable-the amount of cash can be
determined by counting
Accounts receivable- money owed to
the company who received g/s but
haven’t paid for them yet
Future Benefit-right to receive cash in
the future
Control-the right to collect cash belongs
to the company
Past Transaction-accounts recievable
arise when goods are sold to customers
on credit
Measureable-measurability with
uncertainty. The exact amount that will
be collected isn’t known because some
customers may not pay
Inventory- merchandise that the
company has available for sale to
Future Benefit-the company can sell the
inventory to customers and receive cash
Control-the company owns the inventory
and can determine how, when, where, and
at what price it can be sold
Past Transaction-the inventory was
purchased in a transaction with the
Measureable- the cost of the inventory
can be determined from invoices
Property, plant and equipment-
includes land, buildings, equipment,
furniture and fixtures, vehicles, computer
hardware and software, and so on that
allow the company to sell its merchandise
to customers. The company doesn’t sell
these but uses them to operate the
Future Benefit-a building provides a
location to operate the business
Control-the company can use the
building in any way it deems appropriate
(sell, renovate, rent to others, etc.).
Past Transaction-a building would have
been purchased from a previous owner or
built to the company’s specifications
Measureable-the cost of the building can
be determined from purchase documents
or from construction cost details.
Page 39, 3 (in notes)
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Type of Liability and What is it? Why is it a liability
Accounts payable and accrued
liabilities-amounts owed to suppliers for
g/s purchased on credit. Includes
amounts owed to inventory suppliers,
utilities, property owners, and employees,
to name a few.
Obligation-pay for g/s provided by
Past transaction or economic event-
the suppliers have provided the g/s.
Economic Sacrifice-in most cases money
must be paid to settle the liabilities.
Customers’ deposits- customers pay in
advance for goods to be provided in
Obligation-provide g/s that have been
paid for by customers but not yet
Past transaction or economic event-
payment has been received from
customers for g/s
Economic Sacrifice- g/s must be
Income taxes payable- amounts owed
to the government for income taxes
Obligation-pay governments for income
taxes owed but not paid
Past transaction or economic event-
income taxes are based on income in
earlier years
Economic Sacrifice-cash must be paid
Deferred warranty plan revenue-
amounts paid to company for extended
warranty protection on merchandise
Obligation-provide warranty service to
customers as required
Past transaction or economic event-
customers have purchased extended
Economic Sacrifice- warranty service
must be provided (parts and labour)
Dividends payable-dividends that have
been declared by the board of directors
but not yet paid to its shareholders
Obligation-pay shareholders dividends
Past transaction or economic event-
dividend has been declared by the board
Economic Sacrifice- cash must be paid
Page 41, 4(in notes)
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Page 42
- In order to make sense of information, it is important to have benchmarks
(like the company’s information over a number of years, information for
similar firms or industry averages)
- Different financial ratios will be introduced- but there are no universal rules
for evaluating ratios(because of the different norms in different industries)
Owners’ Equity
-Owners’ equity (OR shareholders’ equity- owners’ equity of a corporation OR
partners’ equity-owners’ equity of a partnership OR owner’s or proprietor’s
equity- owner’s equity of a proprietorship) is the amount that owners have
invested in an entity. In terms of the accounting equation, owners’ equity
represents the amount financed by the owners.
oOwners’ investments can be direct or indirect
Direct investments –are made by purchasing shares of a
corporation or units in a partnership, or by contributing money
to a proprietorship; it is direct because investors contribute
their own assets directly to the entity; usually cash, sometimes
others assets
Indirect investments- occurs when an entity’s net income or
profit isn’t paid to the owners but is ‘reinvested; in the entity;
indirect because investors don’t choose to invest and the
decision to do so is made by the management or board of
in a corporation’s balance sheet the shareholders’
equity section separates direct investments and the
reinvestment of net income
ocommon shares (OR share capital OR capital stock)- account reflects
the amount of money ( or other assets) that shareholders have
contributed to the corporation in exchange for shares; direct
investments by shareholders are reported here
oretained earnings is the sum of al the net incomes a corporation has
earned since its inception, less dividends paid (there are some other
adjustments but net income and dividends are the main items).
Dividends are payments, usually in cash, by a corporation to its
shareholders. If retained earnings is negative, its referred to as a
The debt-to-equity ratio
Debt-to-equity ratio= liabilities/ shareholders’ equity
- it is a measure of how an entity is financed- the higher the ratio, the more
debt an entity is using relative to equity- and a measure of risk
o the more debt, more risk because debt has a fixed cost associated
with it called interest (=is the cost of borrowing money and is usually
calculated as a percentage of the amount borrowed);
oif an entity doesn’t pay the interest and principle (=the amount
originally borrowed), the lenders can take legal action
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