FINANCIAL ACCOUNTING Revision of double-entry. Today we want to: Revise double-entry Understand the cash flow statement Practice with examples 2

FINANCIAL ACCOUNTING

Revision of double-entry


Today we want to:

Revise double-entryUnderstand the cash flow

statementPractice with examples

2


Example: Marvin Company

Assets € Liabilities + Equity €Cash and cash equivalents 25,000 Capital 55,000Inventory 50,000

Total current assets 75,000 20,000PPE 0Total assets 75,000 Total Liabili.+Equity 75,000

Short-term borrowing

Marvin Company balance sheet at the 1st of January was as follows

3


Transaction 1a

Goods were sold for 12,000€. The client pays cash. Analysis

– The asset Cash increases– The revenue Sales Revenue increases

Journal entryCash……………………….12,000

Sales revenue…………………..12,000

Posting

0 25,000 12,000 (1a)(1a) 12,000

Cash and cash equivalents Sales revenue

4


Transaction 1b

The inventory value of the goods sold is 7,000€. Analysis– The asset Inventory decreases– The expense Cost of Sales increases

Journal entry

Cost of sales……………………….7,000

Inventory……..…………………..7,000 Posting

(0) 50,000 7,000 (1b) (1b) 7,000

Inventory Cost of Sales

5


Transaction 2 Marvin places an order to Star Company merchandise for

7,000€ and receives the goods. Analysis

– The asset Inventory increases– The liability Trade payables increases

Journal entryInventory……………………….7,000

Trade payables…………………..7,000

Posting

(0) 50,000 7,000 (1b) 7,000 (2)(2) 7,000

Inventory Trade payables

6


Transaction 3a Goods sold for 2,500€ and paid in cash Analysis

– The asset Cash increases– The revenue Sales revenue increases

Journal entryCash……………………….2,500

Sales revenue…………………..2,500

Posting

0 25,000 12,000 (1a)(1a) 12,000 2,500 (3a)(3a) 2,500

Cash and cash equivalents Sales revenue

7


Transaction 3b The inventory value of the goods sold is 1,500€.

Analysis– The expense Cost of Sales increases– The asset Inventory decreases

Journal entry

Cost of sales……………………….1,500


(0) 50,000 7,000 (1b) (1b) 7,000(2) 7,000 1,500 (3b) (3b) 1,500


8


Transaction 4a Goods sold for 3,400€ on credit Analysis

– The asset Trade receivables increases– The revenue Sales revenue increases

Journal entry

Trade receivables……………….3,400

Sales revenue…………………..3,400 Posting

(4a) 3,400 12,000 (1a)2,500 (3a)3,400 (4a)

Trade receivables Sales revenue

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Transaction 4b The inventory value of the goods sold is 2,000€.

Analysis– The expense Cost of Sales increases– The asset Inventory decreases

Journal entry

Cost of sales……………………….2,000


(0) 50,000 7,000 (1b) (1b) 7,000(2) 7,000 1,500 (3b) (3b) 1,500

2,000 (4b) (4b) 2,000


10


Transaction 5 Marvin pays the employees for January 4,200€ in cash Analysis

– The expense Wages increases– The asset Cash decreases

Journal entry

Wages………………………….4,200

Cash………..…………………..4,200 Posting

(0) 25,000 4,200 (5) (5) 4,200(1a) 12,000(3a) 2,500

Cash and cash equivalents Wages

11


Transaction 6 Marvin purchases land for 20,000€ and pays in cash Analysis

– The asset PPE increases– The asset Cash decreases

Journal entry

PPE(Land)…………………….20,000

Cash………..…………………..20,000 Posting

(0) 25,000 4,200 (5) (6) 20,000(1a) 12,000 20,000 (6)(3a) 2,500

Cash and cash equivalents PPE

12


Transaction 7 Marvin purchases a two year insurance policy for 2,800€ and pays in cash Analysis

– The asset Prepaid expenses increases– The expense Insurance increases– The asset Cash decreases

Journal entry

Prepaid expenses…………….2,683

Insurance…………………………117

Cash………..…………………..2,800 Posting

(0) 25,000 4,200 (5) (7) 2,683(1a) 12,000 20,000 (6)(3a) 2,500 2,800 (7)

(7) 117

Cash and cash equivalents Prepaid expenses

Insurance

13


General journal for Marvin

DateEntry no. Accounts and explanations Debit Credit

1 Jan 1a Cash 12000 Sales Revenue 12000

1b Cost of Sales 7000 Inventory 7000Sale for cash

2 Jan 2 Inventory 7000 Trade payables 7000Purchased inventory on credit

3 Jan 3a Cash 2500 Sales revenue 2500

3b Cost of sales 1500 Inventory 1500Sale for cash

4 Jan 4a Trade receivables 3400 Sales revenue 3400

4b Cost of sales 2000 Inventory 2000Sale on credit

5 Jan 5 Wages 4200 Cash 4200Paid wages to emplyees

8 Jan 6 PPE (Land) 20000 Cash 20000Purchased land for cash

9 Jan 7 Prepaid expense 2683Insurance 117 Cash 2800Paid insurance policy for two years14


Assets = Liabilities + Equity

Short-term borrowing(6) 20,000 20,000 20,000 20,000 (0) 55,000 55,000 (0)

20,000 20,000 20,000 55,00020,000

(0) 50,000 7,000 (1b) 7,000 7,000 (2) 3,083 3,083 (2)(2) 7,000 1,500 (3b) 7,000 3,083

2,000 (4b)46,500

57,000 57,00046,500

(4) 3,400 3,400 (1b) 7,000 12,000 (1a)3,400 (3b) 1,500 2,500 (3a)

(4b) 2,000 10,500 17,900 3,400 (4a)10,500 10,500 17,900 17,900

(7) 2,683 2,683 10,500 17,9002,683 2,6832,683

(7) 117 117

(0) 25,000 4,200 (5) 117(1a) 12,000 20,000 (6)

(3a) 2,500 2,800 (7)

12,500 (5) 4,200 4,20039,500 39,500 4,20012,500

Retained earnings

Cost of sales Sales revenue

Wages

Owner's capital

Prepaid expenses

InsuranceCash and cash equivalents

PPE

Trade payablesInventory

Trade receivables

15


Trial balance for Marvin at the 9 of January

Debit CreditCash and cash equivalents 12,500Trade receivables 3,400Inventory 46,500Prepaid expenses 2,683PPE 20,000Trade payables 7,000Short-term borrowing 20,000Owner's capital 55,000Retained earnings (initial balance) 0Sales revenues 17,900Cost of sales 10,500Wages 4,200Insurance 117Total 99,900 99,900

16


Trial balance, income statement and balance sheet

Debit CreditCash and cash equivalents 12,500Trade receivables 3,400Inventory 46,500Prepaid expenses 2,683PPE 20,000Trade payables 7,000Short-term borrowing 20,000Owner's capital 55,000Retained earnings (initial balance) 0Sales revenues 17,900Cost of sales 10,500Wages 4,200Insurance 117Total 99,900 99,900

Assets € Liabilities + Equity €PPE 20,000 Capital 55,000Total fixed assets 20,000 Profit 3,083Inventory 46,500 Owners' equity 58,083Trade receivables 3400 20,000Prepaid expenses 2683Cash and cash equivalents 12,500 7000

Total current assets 65,083Total assets 85,083 Total Liabili.+Equity 85,083


Trade payables

€Sales 17,900Deduct: cost of sales -10,500Gross profit 7,400Deduct: operating expensesWages 4200Insurance 117

-4,317Operating profit 3,083Deduct: Interest expense 0Profit 3,083Deduct: income taxes 0Net profit 3,083

Balance sheet for Marvin co. asat the 9 of January - €

Income statement for Marvin co. for the period ending 9 of January - €

17

Revision of double-entry18

Statement of Cash Flows

The Statement of Cash Flow can help answer the following questions:

How did cash increase when there was a net loss for the period?

Is cash flow greater or less than net income? How was the expansion in the plant and equipment

financed? How was the the debt retired? How much money was borrowed during the year? What amount was paid in dividends?


Sources of Information for theStatement of Cash FlowsThe cash flow statement is a created

statement that relies on information from the income statement and balance sheet. Therefore, to prepare the cash flow statement, you need:

Current income statement (only current year) Comparative balance sheet (2 years) Additional information


Format of the Statement of Cash FlowsCash Flow Statement has four sections: operating investing financing significant non-cash investing and financing

activities


Operating Activities

Income Statement Information Needed:– Net income– Depreciation and amortization (noncash

expenditures)– Gain(loss) on sale of assets or investments

Balance Sheet Information Needed:– Change in Current Assets– Change in Current Liabilities


Investing Activities

Income Statement Information Needed :– Gain(Loss) on Assets

Balance Sheet Information Needed :– Change in Long-Term Assets– Property Plant and Equipment– Long-Term Investments


Financing Activities

Income Statement Information Needed:– None

Balance Sheet Information Needed:– Change in Long-Term Liabilities– Change in Stockholders’ Equity

Retained Earnings Stmt Information:– Dividends Paid


Significant Non-Cash Activities Transactions that do not affect cash are NOT

reported in the body of the statement of cash flows. However, these items are reported:– In a separate schedule at the bottom of the

statement of cash flows or– In a separate note or supplementary schedule to

the financial statements.


Examples of Significant Non-Cash Activities Issuance of common stock to purchase

assets. Conversion of bonds into common stock. Issuance of debt to purchase assets. Exchanges of plant assets.


Converting Net Income to Cash Flow From Operations

Accrual Method

Revenue earned

- Expense incurred

NET INCOME

Cash Method

Non cash expenses(e.g. depreciation)

Decreases in current assets Increases in current liabilities

Increases in current assets Decreases in current liabilities

CASH FLOW FROM OPERATIONS

+

+

-


Steps in Preparing Cash Flow Statement

1. Determine the net Increase (decrease) in cash. Note: This will serve as the check figure.

2. Determine the cash provided (used) by operations.

3. Determine the cash provided (used) by investing.

4. Determine the cash provided (used) by financing.

5. Determine any significant noncash transactions that should be disclosed.

Cash Flow statement (1)


Marvin co. - Comparative balance sheetsAssets € Liabilities + Equity €

1st Jan 9th Jan 1st Jan 9th JanPPE 0 20,000 Capital 55000 55,000Total fixed assets 0 20,000 Profit 0 3,083Inventory 50,000 46,500 Owners' equity 55,000 58,083

Trade receivables 0 3400 20,000 20,000Prepaid expenses 0 2683Cash 25000 12,500 0 7000

Total current assets 75,000 65,083

Total assets 75,000 85,083 Total Liabili.+Equity 75,000 85,083


Trade payables

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Cash Flow statement (2)


Cash Flow statement - Marvin Co.Period ending on the 9th of January

Operating activities €Net Profit 3,083Increase in (non-cash) current assets -2,583Increase in trade payables 7,000Cash flow from operating activities 7,500Investing activitiesAcquisition of fixed assets -20,000Cash flow from investing activities -20,000Financing activitiesIssue of capital 0New short-term borrowing 0Cash flow from financing activities 0

Net cash flow for the period -12,500Beginning cash balance 25,000Ending cash balance 12,500

Indirect method

Cash Flow statement - Marvin Co.Period ending on the 9th of January

Operating activities €Collections from customers 14,500Labor -4,200Insurance -117Pre-paid insurance -2,683Cash flow from operating activities 7,500Investing activitiesAcquisition of fixed assets -20,000Cash flow from investing activities -20,000Financing activitiesIssue of capital 0New short-term borrowing 0Cash flow from financing activities 0

Net cash flow for the period -12,500Beginning cash balance 25,000Ending cash balance 12,500

Direct method

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Using The Accounting Framework:

America Online Inc.



Accounting Tools That Will Be Used

The accounting equation Relationships (Articulation) among the

financial statements Information disclosed in footnotes to the

financial statements Debits, credits and T-accounts

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Total Assets 1996 $ 959 million

Total Assets 1997 $ 847 million

Change in Total Assets $(112 million)

WHY?32


The accounting equation

= + +

Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. + - - + - + - +

Assets Liabilities Capital Retained earnings

Equity

33


Total Liabilities 1996 $446 million

Total Liabilities 1997 $719 million

Change in Liabilities $273 million

34


Total Equity 1996 $ 513 million

Total Equity 1997 $ 128 million

Change in Equity $(385 million)

HERE IS THE KEY!35


Explanation for Changes In Shareholders’ Equity Retained earnings: decreased by $499

million Common stock and additional-paid-in capital:

increased by $98 million AOL issued additional shares of stock

36


The role of the income statement

= + +

Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. + - - + - + - +

Assets Liabilities Capital Retained earnings

Dr. Cr. Dr. Cr. + - - +

Total expenses Total Revenues

Dr. Cr. Dr. Cr. + - - +

Expense account Revenue account

Income Statement

Equity

37



Analysis of the expenses

Cost of revenues $1,041 million

Marketing $ 409 million

General & administrative $ 194 million

Write-off of deferredsubscriber acquisition cost $ 385 million

What is the last entry?

39


Subscriber Acquisition Costs - Footnote #2

Costs attributable to marketing programs that result in subscriber registrations

These expenditures are recorded as an asset– What?

Amortized (as opposed to depreciated) monthly over a period less than 24 months

40


Subscriber Acquisition Costs - Footnote #3 Due to change in business model, AOL

changed to a flat-rate pricing and reduced reliance on online subscriber revenues.

This change in the future stream of revenue created uncertainty as to whether these expenditures created an asset (i.e., produced a future benefit)

After 10/1/96 these costs were expensed as incurred - no longer recorded as assets. Thus, the asset must be written off.

41


How Does A Company Write Off An Asset ?

• AOL must remove the asset from its books and debit the expense, deferred subscriber acquisition expense and credit the asset, deferred subscriber acquisition cost. Footnote 3 indicates that AOL wrote off $385 million for the year.

Deferred subscriber acquisition expense 385,221,000Deferred subscriber acquisition cost 385,221,000

42


How Does A Company Write Off An Asset ? Remove (credit) the asset from the books Add (Debit) the corresponding expense Footnote 3 indicates that AOL wrote off $385

million for the year. Journal entryDeferred subscriber acquisition expense 385,221,000

Deferred subscriber acquisition cost 385,221,000

43

T-accounts (1)

Accumulated Deficit(Retained Earnings)

7,767Balance 6/30/96From balance sheet

499,3471997 loss fromincome statement

507,114Balance 6/30/97From balance sheet


T-accounts (2)

Deferred Subscriber Acquisition Costs(Asset account)

314,181Balance 6/30/96

The Statement of Cash Flows indicates that an additional$130,229 cash was spent on these costs between 7/1/96and 9/30/96.

130,229

45


T-accounts (3)

314,181

130,229

The Statement of Cash Flows indicates that amortization of these costs between 7/1/96 and 9/30/96 was $56,189. AOL estimated that $56,189 of the asset expired over this time period.

56,189


46


Writing-off the asset (1)

314,181

130,229

385,221

56,189

Balance 9/30/96

It was this 385,221 that was “written off” as an expense on 10/1/96


385,221 Write-offon 10/1/96

47


Writing-off the asset (2)

Deferred Subscriber Acquisition Costs(Expense account)

385,221

This expense will enter the income statement and will affectThe Balance sheet through the profit and/or loss for the year

48

Income statement and cash flow


Information from the Cash Flow StatementAOL’s cash flow statement shows that:

– Cash flow from operations was a positive $123 million.

– Cash flow from financing activities provided cash of $79 million. Note this is consistent with our earlier analysis of stockholders’ equity.

– Investing activities used cash of $197 million. This is to be expected from a growing company.

– Overall increase in cash, $6 million.

How could AOL’s income statement show such a large loss, yet have a positive cash flow?

50


Information from the Cash Flow Statement Operating cash flows, positive $123 million Investing activities used cash of $197 million -

this is to be expected from a growing company Financing activities provided cash of $79 million

- from issuance of new stock Overall increase in cash, $6 million.How could a large loss have caused no cashflow problem?

51


Explanation of Increase in Cash Flow

The write-off (expense) of the $385 million in deferred subscriber acquisition costs, current subscriber acquisition costs of $59 million, $22 noncash restructuring charges, and $64 million of depreciation and amortization are all noncash expenses that are added back to net income. It is a noncash expense. Therefore, the income statement reported $530 million dollars in expenses that did not require the outlay of cash!

52


Summing up

Accounting is far from being an exact picture of the situation of the company

Crucial importance of the balance sheet equation

The relationship between the income statement at the balance sheet equation

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Documents

FINANCIAL ACCOUNTING Revision of double-entry. Today we want to: Revise double-entry Understand the cash flow statement Practice with examples 2