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FINANCIAL ACCOUNTING (D.

YOUNG)
1. Basic Objectives
To allow better allocations of Capital market Ressources Useful to those making invest and credit decisions Provide info: economic resour, claims and changes Fundamental Concepts Relevant - Past, Present, Future Events Reliable - Dependable, Reasonably Free Of Error Verifiable Comparable to other entities Consistent over time Recognition And Measurement Concepts Economic entity Going concern Monetary unit Periodically Basic Principles Historical cost Accrual basis (recognize when goods are sold or service rendered) Revenue recognise when realised Matching principle Full disclosure Constraints-Cost/Benefit Materiality Industry practice Conservatism

1
Expenses as actual incurred expenses 4. Completed Contract Method (JE 78-79) All expenses capitalised (work in progress, construction in progress) Cash inflows generate a liability (Advance from customer) Income and Expense recognition when client takes over 5. Instalment Method Revenue is recognised as cash is received Recognise corresponding expenses 6. Cost-Recovery-First (revenues &expenses=cash receipts) Match revenue $ for $ working expenses Profit is recognised only after costs recovery How to cook the account : Barter, Front end loading (software recogn full rev even if promise for future upgrades), Channel Stuffing (coke), Grossing up (Priceline), Present Value Game (Xerox), Vendor Finance ,round trip,bill &hold 20 (4) 35 55 | | | 40 (5) 10 50 | | | Acc 30 17 (2a) 40 (8) (A) Buildings & Equi pment 100 | (6a) 135 | 10 225 | (L) (A) Contra Depreciation | (1a) 7 | | (L)

OCTOBER 2007
Operating Cycle A/P turnover Cash Cycle 1. Operations: ROIC = Profit Margin x Total Asset Turnover (example of desegregation) ROA=PMRxICT Measure Firm profitability in using assets to generate earnings (regardless how they finance the assets) Very relevant to lenders/creditors (Return on asset should > cost of asset) Higher = more efficient (in late 90 US 8-12%, EU lower) The goal maximise product of PM and TAT! If PM then TAT 1a.Profit(NOPAT) Margin Ratio = (Operating Income(1-T) +EquityIncome)/sales Measures the firms ability to control expenses level relative to sales High indicates a lower cost for given sales level To understand : we analyse pricing & brand equity, outsourcing, SWOT 1b. Total Asset(ic) Turnover Ratio = Sales / Average Total assets (IC) Tells how good is mngmnt at converting companys asset base into sales Gives an insight on Fixed asset turnover and Working Capital efficiency The higher the better! Lower in more capital intensive industries. 1bi. Fixed Asset(PP&E) Turnover = Sales / PP&E net (book-accum.depr) Measures success in converting LT productive assets into sales Decrease may show expansion with delayed payback on investment Increase may show cut back in capital expend (because of poor sales forecasts) or asset sales Relate to (a) expansion for future growth or prep for sales decline and (b) reduced investing on CF statement, reduced depreciation:sales. Sales normally lag capital expenditures for a growing company so decline in FA t/o need not concern Accelerated depr- > high ratio, straight-ine depr- >low ratio Working capital analysis efficiency of the companys operating cycle Operating cycle = Inventory period + Receivables Period The shorter - less investment & cash that company ties up in op.cycle - the better! 1bii. Inventory Turnover Ratio,Inventory period (30-150 days) Spe ed of inventory sale. Relate to potential loss of customers if inventory too depleted. Impr ove by reducing manufacturing cycles, speeding sales, improving distribution 1biii. Accounts Receivable Turnover, Receivables period Measures cash collection (times per year) Some payments made in cash so in fact time is overstated Compare to credit terms with customers Cash cycle = Inventory Period + Receivables Period Payables Period The shorter the better more operating cash flow 1biv. A/P Turnover(COGS+end inventory-begin inventory=purches),Payables Period Incre ase indicates firm pays obligation to suppliers quickly, requiring cash, but smaller portion of payables due in near future Higher A/P turnover will reduce cash Look at all 3 elements in inventory equation: purchases = COGS + ending inv beginning inv. Cash conversion efficiency ratio = CFFO / Sales 2. Rate of Return on Common Shareholders Equity ROE = ROIC x Adjusted leverage = PMR x ICT x CEL x CSL Denominator: average Common Shareholder equity during the period Explicitly considering financing Primary interest to investors in firm's common stocks ROE > ROICEarning more on borrowed money than cost of it. If ROE = ROIC then Company entirely financed by equity (all profits belong to shareholders) 2b. Adj. Leverage = Com.Earn. Lever. (CEL) x Capit Struct. Lever. (CSL) Tells what percent of profits belong to shareholders(all equity firms=1) 2bi. Common Earnings Leverage Net income/ NOPAT=(operting Income(1-T)+equity Income,net tax) Tells what % of unlevered profits belong to shareholders: if all-equity=1 2bii. Capital Structure Leverage or Financial Leverage or Leverage Ratio Measures capital structure Increasing leverage ratioincreasing proportion of debt. Financing with debt (and preferred stock) can increase the return on shareholders equity. If firm earns a rate of return on IC (ROIC) that exceeds the rate it paid for the use of debt, the rate of return on SE (ROE) will increase > ROIC. the proportion of debt to the capital structure, the risk to common shareholders. Firm cannot debt without the cost of debt. As it adds more debt to the capital structure, the risk of default or insolvency becomes greater. Financial leverage can enhance owners rate of return in good years, but owners run the risk that bad earnings years will be even worse than they would have been without the borrowing. Common stock S/H are last. Earnings per Share = NI / SE Income attributable to common stock per share. Not so useful since it takes into account only cost of debt and not cost of equity.
Analyse adjusted leverage by analysis of Short-term and long- term analysis

(1a)

A/P (Suppliers) | 30 | 20 (7) | 50

A/P (Other) | 10 | 2 | 12

Abbreviations
B.P. C.S. CSE EOF FV IE I.S. FS LCM M.S. N.I. PIC

(L) Salaries Payable | 5 | 1 (9) | 6 (SE) Earnings (3) 8 Retained | | | 15 20 27 (1)

(L)

Bonds Payable | 0 | 100 (10) | 100

2. Balance sheet
Assets Current Assets Cash Marketable Securities/Stocks Short Term Investment Receivables(Acct, note,interst) Inventories Advances To Supplier Prepaid Insurance, Rent Liabilities Current Liabilities Payable (Account, Note,Interest, Salaries, Income Tax) Adv. from Customer (Deferr. Rev) Rent Received In Advance Non-Current Liabilities Bonds Payable Mortgage Payable Deferred Income Taxes Other (Provisions) Shareholders' Equity Common Stock Preferred Stock Additional Paid In Capital (GAAP) Retained Earnings (Indirect) Treasury Shares O.C.Income (clean surplus acc.)

Bond Payable Common Stock Common SE End of Financing (Period) Future Value Interest Expense Income Statement Financial Statements Lower Cost & Market Marketable Securities Net Income Paid In Capital.

APIC PMR PV R.E. S.H. S.E. SYD TA ICT XA ~A $

Additional PIC Profit Margin Ratio Present Value Retained Earnings ShareHolder ShareHolder Equity Sum of the Years Digits Total Assets Invested CapitalTurnover Uncollectable Accounts Contra-Asset (negative) CASH

5. Cash Flow Statement

$ = Liab + SE N$A $ = CFO + CFI + CFF C$ begin + $ = C$ end Note : CFO+CFI+CFF (long term should be on average =0) CFO (includes paid interest on debt and received Dividends or Interests on Invest) Activities directly related to revenues and expenses Net Income + Depreciation + Other NonCash Expenses (Provisions) NonCash Income (Equity Income) -/+ Gain/Loss from sales of assets - WCR Assets: all current (non-cash) & Liabilities: all current except short-term borrowing or debt CFF Dividends paid CFF CFI (buying/selling Fixed Assets or Financial instr(shares/bonds) Other non-current assets CFI CFF (borrowing,paying principal ; Issuing & Buyback Shares, Dividend) Short-term and long-term borrowing & issue of capital stock Retained earnings : only dividend portion Columnar worksheet (indirect method) (Incr) Decr in BS CFO CFI CFF Assets
A/R Merch inv. Build & Equip Accum Depr (35000) (10000) (125000) 10000 (3500 0) (1000 0) 10000 Incr (Decr) in Liab. AP Salaries payable Bonds payable Common stock Retained earnings Incr (Decr) in Cash (12500 0)

6. Interpretation of Cash Flows


Key Relationship 1: COMPARE Net Income to CFO (WC) CFO>NI if not check! CFO shows how efficiently companies manage their operating cycle (buy material-produce, sell, collect loop) Working Capital is what you put into business to make fixed assets work Increase in WC may signal problems tied-up in useless places, eg inventory Net Working Capital = Current Assets Current Liabilities WCR = total invested into operating cycle (inventory, A/R, prepaid expenses ;) - total invested by others into our operating cycle (A/P, accrued expenses (wages, taxes), advances from clients). This is cash needed to operate business, provided investment in fixed capital is complete (WCR<0 Dell,Carrefour but not always good) Key Relationship 2 . Free Cash Flow (FCF) = CFO + CFI + Interest Expense FCF represents whats left before distribution to stakeholders FCF is used to pay interest, return principle (bankers); dividends, buy back shares (shareholders) Value of the company depends on these 4 (future expectations of FCF) If FCF>0 then CFI<0 (giving back) If FCF<0 then CFI>0 (borrowing, cant finance all activities internally) Want CFO>0, If CFO<0, must get cash from financing (below) If Net Income >0 but CFO is <0, company can be growing but has cash flow problems. Buying assets indicates expansion, inventory, AR Lag between Income and cash flow If CFO > Net Income, this is assurance that company really made profits Issuing debt & retiring equity increases leverage State what you see : change in income, change in CFO and its interpretation sign of growth/maturity/decline, asset replacement Vs depreciation, CFO sufficient/insufficient for investing in fixed assets Signs of weaknesses : CFO<0, increase in inventory, either bigor of receivables, pay of dividends by selling asset or when not enough cash, no new debt inability to borrow due to weak CFO, treasury stock or other securities investments without enough cash. As company grow, CFO, growth/investing, cash-in , WCR, FCF>0, start giving back Cash Flows from: A B C D Operations (3) 7 15 8 Investing (15) (12) (8) (2) Financing 18 5 (7) (6) Net Cash Flow 0 0 0 0 A. New, rapidly growing. Not yet operating profitably. Build ups of A/R & Inventories. To sustain growth must invest in PPE. Needs to rely on external sources of cash to finance operations and investing mainly SE (banks do not give much). FCF<0. Future for early growth: expect CFO , for high growth WCR, CFO>NI B. More seasoned than A but still growing. Operates profitably but since growth is slowing it has CFO>0. CFO not enough to finance investing in PPE- >still requires financing. FCF<0. C. Mature, stable firm. Healthy cash flow from operations, more than enough to cover PPE acquisitions. Uses excess cash flow to repay financing from earlier and dividends. CFO>NI, robust profit, large FCF give back to market, invest D. Stages of decline. CFO begun but still >0 due to reductions in A/R and inventories. Cut back on capital expenditure because it is in a declining industry. Uses some cash to repay outstanding financing. Remainder available for investing in new products or industries. Checks Good if CFO > NI + Depreciation + Amortisation Accounts Payable and Accounts Receivable movement Change in Debt situation (may affect ratios esp. Debt / Equity) What happens to bottom line if you remove some large items In CFF, if Div & Share buy back or big = very good $ back to investors In CFF , change in capital structure for wacc or tax shield or because r Cool Phrases Company is using CFO to finance Investing Short-term investment of temporarily excess cash Preferred stock offers more latitude than LT debt CFO should finance payment of dividends, if not seach other reason like WalMart family big stake their source of revenue Acquisitions to provide operating cap to sustain rapid growth Low dividends payoff suggests that it expects capital expenditures Investing activities are using cash Loan priniciple- CFF, loan interest-CFO/dividend received-CFO,payed- CFF

Non Current Assets Investment In Securities Land, Buildings & Equip(PP&E) Accumulative Depr (~A) Leasehold Patent (Only If Purchased) Goodwill (Only If Purchased) Recognition recorded and reflected in the FS Assets Recognition Firm has acquired rights to use in the future as a result of a transaction Future benefits are measurable or quantifiable Assets Valuation Monetary Assets at NPV Non-Monetary Assets at Acquisition cost (part adjusted for depreciation) Write-off if the asset is permanently impaired Revenue recognition Firm has performed all or most of the service or has received $ or equivalent Expense recognition If a particular revenue causes an asset expiration or an asset exprires

20000 1000 100000 2000 13000

2000 0 1000

(24000)

2000 0 6000

10000 0 2000 (7000) (1250 00) 9500 0

Liquid Assets

Cash Marketable Securities Investment of current cash excess,convertible to cash and Firm intend to convert them within a year Accounts receivable JE 52-55 (net of provisions for unpayments ~A)

Fixed Assets(PP&E)

Acquisition cost - Include all relevant charges Self-construct - Capitalise interest during construction Depreciation - Allocates cost of assets to periods of use Land - Do not depreciate. Can be adjusted to market value under IFRS Buildings - Salvage = 0 Changes in Depreciation Spread remaining undepreciated balance less new salvage value over new remaining life Repair & Maintenance Expense Improvement Capitalise & amortise. Retirement Bring depreciation up to sale date Goodwill (Adq. Costs Fair Value + Debt) Can be negative Capitalise if purchased. Write-off if sufficient evidence of impairment

Liabilities

Definition 1. Obligation involve future transfer of cash/goods/services on a definite date 2. Little/no discretion to avoid the transfer 3. The transaction related to the obligation has occurred Contingencies Potential obligation Should be recognised only if the impair/incur is probable and the amount of loss can reasonably estimated (JE 60) Current Liabilities Appear at amount payable Deferred Performance Liability Receive cash for future service (advance payments) (JE 61-63) Long-Term Liabilities Mortgages,Notes,Bonds PV of future payments at historical rate Mortgage Pay back every period interest & principal (JE 64-66) Mortgage Payable: = Cash - Interest Expenses - Interest Payable Notes Postpone equip purchase pay + interest (JE 67-69)

Statement of Cash Flow for Year n CFO Net income 20000 Additions (A, L): Depreciation expense not using cash (~A) 10000 Increased Accounts payable 20000 Increased Salaries payable 1000 Non-Cash Expenses Depreciation expense addback. X Amortisation expense addback..X Loss on sale of assets..............................X Increase in payables ................................X Loss on retirement of bond.....................X Bond amortization....................................X Decrease in NET receivables ..................X Increase in deferred revenue, taxes or provisions X Advances from customers.......................X Increase in liabilities................................X Decrease in inventory.............................X Increase in other current liabilities........X Decrease in other current assets...........X Subtractions (A, L): Increased Accounts receivable 35000 Increased Merchandise inventories 10000 Gain on sale of assets (X) Lack of coupon payment over int exp (bond) (X) Decrease in payables ...........................(X) Increase in NET receivables .................(X) Gain on retirement of bond..................(X) Decrease in deferred revenue, taxes / provisions (X) Decrease in liabilities............................(X) Increased inventories ............................(X) Decrease in other current liabilities. . .(X) Increase in other current assets..........(X) Cash Flow from Operations 6000 CFI Acquisition of building (125000) Sale of Marketable Securities (non-cash equ) X Sale of Non-Current assets (e.g. PPE) ............X (this records the net cash form sale or purchase of assets) (JE 3-5) Record principle on loans to others...............X Issue Bond ........................................................X Increase in Leased Liability account..............X Decrease in Leased Liability account.........(X) Purchase of Marketable Securities..............(X) Retirement Bond............................................ (X) Acquisition of Non-Current assets...............(X) Make loans ..................................................... (X) Cash Flow from Investing (125000) CFF Proceeds from bond issued 100000 Proceeds from common stock issued 2000 Dividends paid (7000) Float (Issue) (Common) Stock.........................X Incur debt (issue bonds, loans, notes pay).. .X Stock (shares) bought back..........................(X) Repayment (reduction) of debt and CS......(X) Cash Flow from Financing 95000 Net change in cash (24000) Cash January 1 30000 Cash December 31 6000 Preparation of Statement of Cash Flow: 1. Obtain Balance Sheet (beginning & end of period) 2. Enter beginning & end balances in each account given in Balance Sheet 3. Enter beginning & end balances for Cash 4. Reconstruct entries explaining change in Master between beginning and end in each non cash Account 5. Net Income = Increase in Retained Earnings + Dividends Selling equipment effect on CF statement (JE 3-5) Bonds, treasury stock and dividends Bonds: Gain/Loss on retirement: CFO -gain, +loss (CFF will have the sale proceeds) (?Included already:) Issued/Less than par: + Int. Exp-Cash outpayment, Issued/More than par: - (Cash outpayment -Int. Exp); Dividends calculated (NI RE) must be subtracted form CFF Create T account for PIC & CS, to track changes

7. DuPont Analysis
1.

Income Statement

Net Operating (Sales) Revenues Cost of Goods Sold Gross (Operating) Profit Selling Expenses, General Sales & Administrative Expenses, Salaries Insurance Expenses R&D Expenses (for GAAP) or Research Expenses (IFRS) Depreciation Expenses Operating Income Interest Expense Other Income Income before Income Taxes Less Income Taxes Equity Income (if Equity >20%) Net Income

ROE = measure earnings available to SH as % of equity capital (both financing choices and operatin profitability) ROIC-no leverage If PMR * ICT ROA then stated PMR must be pre- interest effects recalulate using new PMR R/E (Closing) = R/E (Opening) + Net Income - Dividend paid Net Income > Cash from operation Alarm Check whether Debt Equity = Debt / Equity or Debt Equity State: whats happening; why; whether of concern.

DONT FORGET TO AVERAGE

T-Account Worksheet
Asset Accounts Equity Dr (+) Cr. (-) Start Balances | Inc. (+) | Dec. (-) End Balances Net Income (1) Depr. Exp.(2a) Incr. A/P (7) Incr. A/P to Oth Incr. Sal. Pay.(9) Sale of Equip. L.T. Bond Issue | |

|Liability Accounts & S.H. Dr (-) | Dec. (-) | | Cr. (+) |Start Balances

3. Accounting Process

Accrual Basis JE 88-94 Recognise cash when goods are sold (delivered. Ex: Car manufacturer) Expenses at period when revenue it helped produce are recognised Adjusting Entries JE 80-85 Closing Temporary Accounts JE 86-87

Inc. (+) End Balances

4. Revenue Recognition

Revenues can be recognized if: measurable, earned and realizable 1. Accrual Basis JE 88-94 2.Cash Basis Recognise revenue when receive cash Expenses when cash is paid 3.% Completion Method (for long-term contracts) Sales revenue as % of completion

Cash 30 | Operations 20 | 35 17 | 10 20 | (8) 2 | 1 | Investing (1a) 3 | Financing (10) 100 | 5

Limitations of ratio analysis: Disa ggregate ratios so can see sources of profitability Recognise that circumstances change in firm/industry/economy Must be compared with some standard either trend of ratio, or w/ industry Should be used as a pointer for further investigation Profitability: ROIC, ROE Efficiency: Invested Capital t/o (ICT), A/R t/o, A/P t/o, Inventory t/o, PP&E t/o Short-term liquidity (risk): Current R, Quick R, CFO to Current liabilities R. Risk (long-term liquidity): Common Earnings Leverage R, Capital Structure Leverage R, Long-term debt R, Debt-Equity R, Interest coverage R

(4) Incr A/R (5) Incr. Inv.

135 8

(6a)Acqu. of Build. (3)Dividends

(A) Accounts Receivable

(A) Merchanise Inventory

ROIC ROE | | Profit IC Profit IC Levr Margin % turnov. ratio Margin % turnov ratio ratio | | | PP&E t/o as for ROIC as for ROIC CEL INV t/o CSL A/R t/o

RISK ANALYSIS (1-4 short term-liquidity; 5-7long term-capital struct) Factors to consider: Economy-wide (inflation, int rates, unemployment, recsn) Industry-wide (competition, raw mats, technology) Firm-specific (strikes, loss of facilities) Liquid resources give flexibility against risk. Compare inv t/o, a/c pay t/o, a/c rec t/o to determine liquidity risk and whether will need Short-Term financing 1. Current Ratio (0.9-1.5) higher-firm safer Shows firm's ability to meet its ST obligations (useless if CFO high (coke)) Prob lems:1.Unsure how liquid current assets are 2. Static B/S measure (so use CFO/Current Liabilities) If curr ent ratio is small, need mitigating factors (e.g. large cash from operation) current ratio less working capital and lower capital charges Can be manipulated Growth will bring about increased investments in A/R and inventories How is firm financed (e.g. bank loan vs. stretching A/P) 2. Quick Ratio (0.5-1.5) Stronger than current ratio to test ability to pay liabilities Numerator: use only cash and A/R (highly liquid assets) Days of receivabls and inventory: better measure of risk than quick and current rat. Notes: Retailers have negative cash cycles because of high inventory turnover. 3. A/R Turnover inventory Turnover The shorter the period , the closer the receivables are realized as cash 4. CFO to Current Liabilities Ratio >40% (30-70%) Not Static If the ratio the company can tolerate lower current ratios 5. Long term Debt Ratio 6. Debt(all forms of financing) / Equity (60% utility; 30% industrial) % of total assets financed by debt

FINANCIAL ACCOUNTING (D. YOUNG)


Likelihood meeting fixed interest & principal payments in future Debt cheap but risky with regard to equity Do not consider availability of liquid assets Evaluate debt level: short term borrowing vs. long term borrowing 7. Interest Coverage=Time Interest Earned (>3, probably 5) Abil ity to pay its interest A rule of thumb at least 5 for cyclical companies, but often lower lower rating when it issues bonds EBITDA interest coverage ratio (also relies on accounting earnings) Cash interest coverage ratio (covered with "real" cash) 8. Free Op. CF to Total Debt (not incude A/P)ratio Covers not only the interests, but also the principal

2
EP =EVA 1.focus on earnings instead of cash flow 2.better measure of year-on-year performance Value(firm) = Ve + Vd = PV (future FCFs + financial assets) = IC + PV (future EP) = Current_Operation_Value (COV) + Future_Growth_Value RONIC =increase inNOPAT over last year/increase in IC over last year Curr OperatingVal = IC + PV (future EP=EVA)=IC+EV/WACC=Market Value Relative Evaluation(P/E) What is value-based management? Creation of Shareholder Value should be the main goal because if you create value for SH it means that you took care of clients, employees, products, Its about the alignment of key management systems and processes with the value creation imperative: Strategic planning,Capital allocation,Performance measure Incentive compensation, Communication, Value capital market expectations of the future cash-flows, discounted at a cost of capital. Net income is a good measure of of corporate performance but does not take into account WACC, so NI can improve w/o improving SH value Impairment (Permanent) If "Fair Value" > NetBV Nothing (GAAP), increase NetBV (IFRS) If "Fair Value" < NetBV Write-off (JE 107) Once FV is used , updates required every year for all assets-costly barely used Asset retirement/Sale (JE 3-4-5, 13) Calculate the NetBV of what is sold: PPE AccumDepr (PPE = PPEb + PPEperiod PPEe) (AccDepr = AccDepr b + Period Depr AccDepr e)

OCTOBER 2007
2. Dividends received : Dividend Revenue or Cash (to BS & IS) but recognise revenue only when dividend is declared (JE 46) 3. Capital gain/loss : Market Value increase/decrease and Unrealized Gains/Losses on Trading Securities (IS) or Unrealized Gains/Losses on Securities Available for Sale (BS-OCI) (JE 47-48) 4. Sale of Invesment: debits Cash and adjusts Realised Loss on Investment Sale & credits Investment and adjusts Unrealised Loss on Investments (JE 49) Significant Active (Equity Method): AFFILIATES,associates 20 - 50 % Some Influence Less than 20% if existence of significant influence by investor is evidenced Investment Equity Method (change of share price no entries) 1. Acquisition : record initial investment at acquisition cost (JE 94) 2. Earnings : increase Investments account of Sub Earnings (JE 95) 3. Dividends : decrease Invesments acc. of Dividends and debit cash (JE 96) 4. Sale of Investment: sales proceeds (cash), eliminate investment at BV, recognize gain or loss from sale of Investment (IS) (JE 99) Majority (Control): SUBSIDIARIES > 50 % Control Consolidation (show minority x% interest if firm has 100-x%,BS SE &IS)

12. Leasing

How Liquid is the Company

Current Ratio, Quick Ratio, $Flow from ops to current liable ratio, Payable Turnover Short-term risk, Indicates ability to pay off debts as they fall due SEE DuPont for details (= Current Assets / Current Liabilities)

How Efficient is the Company

10. Uncollectibles / Bad Debts

Ability to generate sales from asset (an asset is only good if generates sales Rev.) Inventory Turnover (useless for service companies) Affects operation cost When COGS not reported use sales in numerator Increase indicates more efficient but risk of shortages Receivable Turnover Decrease may indicate risk of not being able to collect receivables Compare to payment terms (Days receivable = # days to collect sales) OPERATING CYCLE = Inv. Period + A/R Period Plant Assets Turnover Decrease may show expansion with delayed payback on investment Increase may show cut back in capital expend (because of poor sales forecasts) or asset sales Cash Cycle = Inventory Period + Receivable Period Payables Period(if <0 company is financing its customers)

How Risky is the Company


Debt = BS + PV(operating leases) + securitized receivables (if off-BS) + contingent liabilities (when payout is likely) + unconsolidated debt from affiliates (how much?) Ratio Analisis Debt-Equity ratio: Interest Bearing debt / SE Interest coverage: Op Income/Interest (>5 for cyclical bus., >3 for stable) EBITDA coverage: EBITDA / Interest expense Cash coverage: (CFFO + Interest paid + Taxes) / Interest paid FOCF / Total debt Risk of Bankruptcy. Shows if the firm relies on debt or equity to finance assets Capital Structure Long term risk Long Term Debt The debt holders portion of the firm's long-term capital. Debt-Equity % of total assets financed by debt Likelihood of meeting fixed interest & principal payments in future Debt cheap but risky with regard to equity Do not consider availability of liquid assets Evaluate total debt level: short term borrowing vs. long term borrowing Debt / total assets: company financed by who? CFO to Total Liabilities Consider the availability of liquid assets to cover debts > 20% for a healthy firm CFO to Current Liabilities > 40 % for a healthy firm Times Interest Earned (Interest Coverage) The relative protection that operating profitability provides bond holders, indicating probability firm can meet required interest payments Has to be at least equal to 1 High implies low long term solvency risk

Direct Write Off Method (JE 53-54) Decide on specific customer shortcomings in sale period No matching, can manipulate earnings, wrong receivable in BS Allowance Method (GAAP & IFRS) (JE 55-57) When firm can estimate uncollectible with reasonable precision Estimate can be adjusted by checking Debt Expense / %Sales or %historic A/R Firm make adjustment against the year sales at end of the year Reduces opportunity to manage earnings but can create hidden resurved Also used for Product Returns and Repairs & Replacement under Warr. (Dr. Sales Return & Allowances, Cr. Account Receivables) Write Off for Next Period (JE 56) no effect on earnings , IS is unaffected Allowance for Uncollectible is moved from Gross Accounts Receivable to Net Accounts Receivable Allowance account cannot be in debit it is a contra account Estimating Uncollectibles (JE 16-17, 55) Percentage Of Sales Method (defined by firm experience) Aging of Accounts Receivable Method More costly but more accurate Classify accts by age and estim the% per class Analyzing Receivables firm aggressive in revenue recognition-check A/R Receivable/Sale ration increase:lanient in credit terms/credit to risky customer/collection proble/Revenue recog to early in operating cycle

Inventory Accounting Policies

How Profitable is the Company


Profit (NOPAT) Margin Ratio (PMR) = (NI + IE) / Rev Measure the firm ability to control expenses level relative to sales Expresses expenses as % of sales Indicates the firms effectiveness to control level of cost/expenses relative to sales High indicates a lower cost for given sales level Invested capital Turnover (ICT) = Rev / IC (average) Measures firms ability to generate sales from particular level of investment in assets Breaks down into A/R, Inventory & Plant Asset Turnovers To improve it, increase sales without investing in assets Any other assets? High indicates that company requires less total assets per sales dollar Leverage = IC (average) / CSE (average) Increas es ROE when ROIC > after-tax cost of debt Return on Invested Capital (ROIC) = PMR * ICT Usually between 5% and 12% See Dupont Return on Common Shrhlder Equit (ROE) = PMR * ICT * Leverage (20%) Measures firms performance in using assets to generate profits Explicitly considering financing Primary interest to investors in firm's common stocks Numerator: deduct preferred shareholders dividend even if none declared if there is a cumulative feature Denominator: CS + CSs share of PIC + CSs share of RE (less cumulative preferred dividends) - treasury stock To calculate Leverage from ROE, PMR and ICT we must assume no minority interest When Leverage ROE / ROIC there must be some minority interest ROE > ROIC Earning more on borrowed money than cost of it ROE approaching value of ROIC Company entirely financed by equity Denominator in ratio - use CS only Earnings / Share of CS approaching value of Price / Earnings ratio Compare to industry norms INDUSTRY TRENDS HOTELS : low inventories, high PP&E BANKS : No inventory, lots of $ A/R and marketable securities, high Debt AIRLINES: high PP&E, low receiv., low inventory (replacements) SERVICE Co (adv): low or no inventory, high SG&A, high receivables RETAILER: high COGS, low profit margin, low A/R, high PP&E TECH co: High R&D, little inventory(outsource), low debt due high risk SOFTWARE: No inventory, intensive R&D, high profit PHARMA: high R&D,high profit margin, high FCF MOTOR : some R&D, everything is average UTILITY: massive assets, high D/E ratio, High Depr., Low margin TELECOM OP: High Fixed assets, high LT Debt, high SG&A (increase) CONSUMER : spend enormous amount on Advertising and some R&D

Inventories Merchandise / Raw Materials / Supplies / Work in process / Finished goods Begin Inventories(BI) + Purchases (P) End Inventories(EI) = CoGS CoGS Available forSale = BI + Net Purchases Inventory includes all NECESSARY costs incurred to acquire & prepare for sale (interests are expensed) Show inventory @ lower-of-cost-or-market (LCM replacement) (JE 18) Increase No Decrease Yes at Net Realizable Value Life on inventory journals(purches, manufacturing, finished, sold) (JE 100-103) Specific Identification Specific cost attached to each individual unit (on sale , inventory->COGS) Practical in firms w/ small num of expensive units (automobile) Manipulation:boost earnings FIFO (First-In-First-Out, Last-In-Still-Here) (most common) Compared to LIFO If prices are rising, lower COGS, higher Net Income, higher taxes Balance Sheet is more exact, Income statement is less exact LIFO (Last-In-First-Out, First-In-Still-Here) To provide tax benefits COGS represents current costs (better matching) LIFO Layers (Inventory costs from past years) If inventory declines company uses old LIFO layers Net Income increase(high profit) Low Current Ratio (Current Assets are too small)and large tax bill Can manipulate Net Income using year end purchases How much did company save by adopting LIFO? Difference in Ending Inventory (FIFO - LIFO) * Tax Rate Average Cost CoGs available for sale / Number of Units available for sale (= avg cost per unit) Operating Margin + Realised and Unrealised Holding Gains is same for LIFO & FIFO If inventory turnover is high, little difference between methods All transactions involving inventory affect Operations part of Cash Flow NI FIFO >NI Avg Cost >NI LIFO (rising prices for inventory) Inventory Tracking Table Total values Units Unit Cost FIFO LIFO Wghtd Av. Inventory (Start Period) 100 2,200 2,000 2,100 Purchases (June 12) 100 12 1,200 1,200 1,200 Goods available 200 3,400 3,200 3,300 Withdrawl (June 14) (120) (2,440)(1,600) (1,980) Inventory (End Period) 80 1,000 1,600 1,320 Periodic Count inventory at end of period Cant measure shrinkage Group all purchases together and calculate ending inventory / COGS using LIFO / FIFO / Average Weighted Perpetual (JE 19) Record COGS when take item from inventory Physical count enables measurement of shrinkage

Benefits: potential tax adv, off-BS-financing and management of obsolescence risk Operating Lease Method (JE 25-26) purchase agreement Not owner, Rent machine or building, Return at end of lease CFO: no impact (expenses already in Net Income) no journal entry Early years: lower expenses, higher NI, reverse later years Note: if necessary you can capitalize the operating lease before calcul ratios. If non-cancelable lease, liability since start, discounting back to the day it started. Capital Lease Method (JE 27-28) Buy the asset, with payment arrangement Alternative method to finance the acquisition of a longterm asset Equal to the lower of fair value and the PV of the minimum lease payment Capital lease if at least one of the following conditions hold: Transfers ownership to lessee at end of the lease term Transfer seems likely due to bargain purchase option Lease covers at least 75 % of assets economic life PV of lease payments 90 % of fair market val at the time sign contract Cash Flow Statement CFO : Interest expense already in Net Income (provide tax-shield) CFO if the lease is capitalized as part of the expense goes to CFF CFF : adjustments to Lease Liability Converting operating leases in capital leases (JE 29-30) Record asset at leases market value Cash = operating leases obligations (interest %liabilities, plug diff) Capital Lease Example (Lessee) Purchase computer of $ 45,000 with interest 15 % p.a. (over 3 years) Annual payment = 45,000 * 15% / (1-1/(1+15%)^3) = $ 19,709 Amortisation Table Year Lease Interest Payment Lease Lease n Start Expense (+/-) End 1 45,000 6,750 19,709 + 12,959 32,041 2 32,041 4,806 19,709 + 14,903 17,138 3 17,138 2,571 19,709 + 17,138 0 Capital vs. Operating Using above example assume: Total Company Liabilities =L (e.g. 200) Total Company Equity =E (e.g. 100) Asset Value at End of Period =V (e.g. 50) Capital Operating Apperance Debt/Equity L/E (L-V) / E reduces riskiness ROIC V / (L+E) ~V / (L+E-V) increases ROIC ROE V/E ~V / E little impact on ROE

16. Financial St. Manipulation

Why managers do it? Profit-based compensation ST boost Share Price Avoid debt covenants violations Minimize political costs Maximize proceeds from IPOs Evidence Profit Stream less volatile than business Small reported losses are rare Small reported profits are common Small declines in profit are rare Small increases in profit are common Meet or exceed forecast is common Just missing consensus forecasts is rare Huge discrepancies between accrued profits and CFO How Recognize fictitious revenues Recog rev too soon Over/under provisioning Uses reserves (cookie jar) to hide losses or expenses Mislabeling one-off gains Labeling losses "noncontinuing" or "extraordinary Red flags Changes in acc. policies Finan. St. inconsistent with business Inconsistencies between FS and MD&A Unusual wording in audit reports Delays in FS release Weak control environment Small audit firm Competitive pressure intensifies Suspect management team High-growth firms entering lower growth phase Frequent on-time charges Large deferred tax assets Growth in days of inventory Downward trends in CFO/Sales Sharp increase in receivables Unusual increases in intangibles Reduction of reserves Declines in Raw/Inv Growth in SG&A/Sales Large changes in provisions Abnormal growth of A/P Operating leases for core assets Securitizations that bypass the BS

Journal Entries

Dr. Cr.

1. Net Income Cash (Operations - Net Income).............X Retained Earning.....................................X 2. Depreciation Expense Depreciation Expense .............................X Accumulated Depreciation .....................X 3. Equipment Sold @ 3 (Original cost 10, Accumulated Depreciation 7) Cash (Inventory: Sale of Equipment).....3 Accumulated Depreciation......................7 Buildings & Equipment..........................10 4. Equipment Sold-Loss @ 2 (Original Cost 10, Accumulated Depreciation 7) Cash (Inventory: Sale of Equipment).....2 Loss on Asset retirement.........................1 Accumulated Depreciation......................7 PP&E(at cost)..........................................10 5. Equipment Sold-Gain @ 4 (Original Cost 10, Accumulated Depreciation 7) Cash (Inventory: Sale of Equipment).....4 Accumulated Depreciation......................7 Gain on Asset retirement........................1 PP&E (at cost).........................................10 6. Dividend Payment Retained Earning......................................X Cash (Finance - Dividend).......................X 7. Accounts Receivable Increase Accounts Receivable ................................X Cash (Operations.)...................................X 8. Merchandising Inventory Increase Merchandising Inventory.........................X Cash (Operations.)...................................X 9. Buildings & Equipment Acquisition Buildings & Equipment............................X Cash (Investments)..................................X 10. Accounts Payable Increase Cash (Operations)....................................X Accounts Payable .....................................X 11. Salaries Payable Increase Cash (Operations)....................................X Salaries Payable ......................................X 12. Long Term Bond issue Cash (Financing).......................................X Bonds Payable ..........................................X 13. Retirement of Asset Cash .................................................1,000 Accumulated Depreciation..............5,000 Equipment..........................................5,500 Gain on Sale of Equipment (IS)..........500
14. 15. Bad Debt Write-Off One specific account value $ 1.000 becomes uncollectible

13. Provisions & Contingencies

Provision (JE 108-110) (i.e restructuring) PRESENT obligation to transfer benefits from PAST event (legal/constructive obligation) Probable out-flow of economic benefits to settle obligation Reliable Evaluation of the amount of obligation Recorded as an expense (IS) and liability (BS) @ present value Best estimate for minimum expenditure.No tax deduction Reversals:rduction taken to the provisions account uring a year 1) pay a portion of liabilities 2)correcting over estimation,check for hidden reserve Contingent Liability: does not meet any of the 3 (i.e litigation) (JE 111-114) POSSIBLE obligation &/or not probable outflow &/or not reliable estimate No impact on financial statements (disclosed in notes) Contingent Asset (i.e cash receipts from a favorable lowsuit settelment) POSSIBLE asset from past events whose existence depends on an event not wholly in control of the firm No impact on financial statements (disclosed in notes)
Defer red IncomeTaxes Differencebetween BookIncomeand TaxableIncome(on tax stm t): Permanent differences: bookincludes item that are non-taxable Temporary differences: revenues and expenses taxable in another period Disclosure in Notes (JE 41) Balance sheet appr oach 1. Identify at each balance sheet date the differencesbetween bookand tax income 2. Elim inate permanent differences 3. Split remaining (Temporary) into futu re tax increases(Depreciation) and tax deductions (Warranty Liabilities) 4. Calculate 3 by the expected incometax rate to receivedeferred tax liabilities and deferred tax assets IncomeTaxExpense IncStm t IncomeS tm t to Shareholders IncomeTaxPayable TaxStm t Effective cash due to TaxAu thorities If TaxableIncome(TaxStm t) < Pre-TaxIncome(IncStm t) IncomeTaxPayable < Income TaxExpense Deferred TaxLiability (credited) ( JE 43 ) O pposite=JE 44 Income Statemen t appr oach

1.
2.

O n TaxStm t: calculate Income TaxPayableC urren t = EBT TaxStm t * tc Deferred IncomeTaxes= ( EBT TaxStm t EBT IncS tm t) * tc

3.

O n IncStm t: insert Income TaxExpense = IncomeTaxPayable Deferred IncomeTaxes= EBT IncStm t * tc

14. Shareholders Equity


Fundamental Principle: issuance, repurchase, distribution of stock should have no impact on net income Check Price-to-book value ratio. On average co with low P/B perform better. Companies are sold 3 or 4 times their book value (not true for holdings: P/B=1) Contributed Capital = Common Stock (par) + APIC Common Shares (vote + dividends + residual claim) Usually have par value, when issued, "APIC" is the excess of received market value over par: Cash (100x100)...............................10,000 Capital Stock (100x10).....................1,000 Additional Paid-In Capital (100x90)..........9,000 Preferred Shares (senior Claim + often dividend) Cumulative div. pref: div. in arrears must be paid before common div. Employee Stock options No entry when stock option is granted (JE 31) Convertible Bonds (JE 36-37) - two options under GAAP: Ignore the market price of the bond Convertible Bonds Payable + Loss = Market value of shares Retained Earnings Portion of the profits reinvested in the company (RE = NI DIV) Treasury Shares (JE 38-39) (GAAP dont cancel buy-backs reissue) All profits/losses from resale of treasury shares are set against Additional paid in Capital (if not possible, debit Retained Earnings) Assumption for treasury shares is either FIFO or weighted average Requirement of firms common stocks If reissue price < purchase, debit Additional PIC when possible, if not debit Retained Earnings Used for stock options Stock Split No entry required, just adjust par value Decreases Share Price more liquidity increases value Stock Dividend (split < 25%) JE 40 Amount transferred from Retained Earnings to CS+APIC Book Value per share = Book Value of Total SE / # shares outstanding

16. Increased Depreciation Allowance for Year Y Bad Debt Expense from Year Y Sales (I/S)........X Allowance for Uncollectible Accounts (or A/R) X 17. Decreased Depreciation Allowance for Year Y Allowance for Uncollectible Accounts from Year Y sales X Gain from allowance for Uncollectible Accounts (or A/R) X 18. Decreased Value of Inventory (Lower of Cost or Market) Loss from decline in value of Inventory X Inventory...................................................X 19. Inventory Loss after Stock Count Loss from Inventory Shrinkage..............X Inventory...................................................X
20. 21. 22. 23. 24. Bond: Issue Bond: First interestpayment (after 6 month) Bond: Second Interest Payment (after 12 month) Bond: Last Interest payment Bond: Repayment of Principal

11. Depr/Amort - PP&E

8. Valuation

Shareholder Value - Value based management (EV=DCF) VALUE = FCF1/(1+WACC)+FCF2/(1+WACC)^2+ (DCF ) FCF=EBIT(1-T)+depreciation-investment=NOPATchange in IC IC=investment in working capital+PP&E- depreciation EconomicProfit=EVA=NOPAT(I/S)-(Invested Capital(B/Sdebt+SE) * WACC) = (ROIC WACC)*IC

Acquisition All NECESSARY expenditures made in acquiring & preparing the asset (JE 104) Discounts are substracted (of the acq. cost) Interests are expensed Depreciation / Amortization (allocate asset cost over a certain time) Depreciation Tangible assets Amortization Intangible assets All Depreciation Expenses are journalised in a contra asset account (Depreciation Expense / Accumulated Depreciation) : (JE 2) Economic useful life(benefit) vs. Acquision cost=depreciable basis Salvage can be negative (require disposal expendures) NetBookValue = Cost less Accum Depreciation w/o subtracting salvage value Depreciation stops when NetBV reaches Salvage Value(plains) Repair and maintenance are expenses (JE 105) Improvements need to be capitalised (JE 106) 1. Straight Line (time) Method Period Depr = (Cost - Salvage Value) / Estimated useful Life 2. Straight Line (units of product) Method (km,barrol of oil) Rate = (Cost - Salvage Value) / Estimated units prodced over Life 3. Declining Balance Method /Acclerated Mathod-good for tax Period Depr = NetBV at start of period * FACT%(=2) / Periods of Life Salvage value is not taken in account up front

Marketable Sec & Investments

Minority Passive Investments (Market Value Method/Cost Method) < 20 % No influence Marketable Securities(ST securites) Market method Debt securities Cost method Trading Securities (TS):ST -buy and sell .(changes in MV>IS,violating earning) (JE 50) Available-for-sale account (AFS): LT -wait for dividend income/capital gain (common) (changes in MV->BS. (Dr. Investment(the diff), Cr. OCI(the diff)(SE account)) (JE 51) 1. Acquisition: record initial investment at acquisition cost (JE 45)

25. Operating Lease (Lessee) Rent Expense...................................19,709 Cash..................................................19,709 26. Operating Lease (Lessor) Inception Equipment (based on cost) 39,000 ..........................................Inventory...........39,000 Periodic Entries Cash ...............................................19,709 Rent Revenue ..................................19,709 Depreciation Expense (based on cost)13,000 Accumulated Depreciation ............13,000 1. Capital Lease (Lessee) Inception Capital Leased Asset (PV of asset based on PMT) 45,000 Capital Lease Liability (in Long-Term Debt) 45,000 2. ............................Periodic Entries Interest Expense (i.e. 15 % of 45,000)6,750 Capital Lease Liability (plug : 19,709 - 6,750)12,959 Cash (agreed PMT)..........................19,709 Depreciation Expense (PV of asset / n )15,000 Acc Depr of Leased Asset (e.g.Computer) 15,000 3. Converting Operating Lease into Capital Lease Inception

FINANCIAL ACCOUNTING (D. YOUNG)


Leased Asset (PV of operating leases) 8,000 Lease Liability (in Long-Term Debt).........8,000 4. ............................Periodic Entries Interest Expense (i.e. 10 % of 8,000).800 Lease Liability (plug : 1,300-800).......500 Cash (operating leases payments)..........1,300 Depreciation Expense (PV of asset / n )15,000 Acc Depr of Leased Asset ()...........15,000 5. Employee Stock option Cash & Tax Payable(sharet @ mkt price + Tax benefit) 35,000 Common Shares (Par)......................5,000 Additional Paid-in Capital...............30,000 6. Stock Warrant:: Issue Cash ...............................................15,000 Common Stock Warrants...............15,000 7. Stock Warrant:: Exercise Cash .............................................200,000 Common Stock Warrants...............15,000 Common Stock - Par value.............50,000 Additional Paid in Capital...............165,000 8. Stock Warrant:: If warrant expires without exercise Common Stock warrants ...............15,000 Additional paid in capital...............15,000 9. Convertible Bonds: Issue Cash ...............................................10,000 Convertible Bond Payable .............10,000 10. Convertible Bonds: Conversion Convertible Bonds Payable (book value) 10,000 Common Stock (par value)..............2,500 Additional Paid in Capital (C)...........7,500 11. Convertible Bonds: Using Market Price of Shares Convertible Bonds Payable ...........10,000 Loss (Gain - C) on conversion of bonds 5,000 Common Shares (par value)...........2,500 Additional Paid in Capital...............12,500 12. Treasury Shares: Purchase of 1,000 shares par value $ 1 for $ 1,200 Treasury shares - common stock....1,200 Cash (no IS or RE effect on resale of own shares) 1,200 13. Treasury Shares: Sale @ $ 1.400 Cash .................................................1,400 Treasury shares (at acquisition cost JE 38) 1,200 APIC (credit/debit if reissue >< purchase price) ....................................................200 14. Dividends: Declaration (can go via Dividends Payable) Retained Earnings.............................1,000 Dividends payable ............................1,000 Dividends payable ............................1,000 Cash....................................................1,000 Stock Dividend Retained Earnings (limits future availability of dividends) X Common Stock.........................................YAdditional Paid in Capital......................................................Z 15. Income Taxes (Deferral) Income Tax Expense............................800 Deferred Tax Asset (Calc. 4 Yr 2 - Calc. 4 Yr 1)200 Deferred Tax Liability (Calc.4 Yr 2 - Calc.4 Yr 1) 100 Cash or Income Tax Payable ..............900
16. Long Term Minority Passive Investments (adjusting to LCM)

3
39. Liability (Mortgage): End of year (mid-period with respect to loan payment) Interest Expense.......................................X 80. Interest Payable .......................................X 40. Liability (Mortgage): Periodic mortgage payment 81. Interest Expense.......................................X Interest Payable (only after mid of Y)....X Mortgage Payable ....................................X 82. Cash...........................................................X 41. Liability (Notes Receivable): At Purchase Equipment.................................................X 83. Note Payable (cash price of equipment). X 42. Liability (Notes Receivable): End of Year Interest Expense.......................................X 84. Note Payable ............................................X 43. Liability (Notes Receivable): At Payment Note Payable .............................................X Cash...........................................................X 85. 44. Recognise Revenues Asset (A) Increase OR Liability(L) Decrease ....X Revenues (IS)............................................X 45. Record Expense Expense (SE).............................................X Asset (A) Decrease OR Liability(L) Increase X 46. Dividend Declaration Retained Earning (SE)..............................X Dividends Payable (L).............................X 47. Record Dividend Payment Dividends Payable (L)..............................X Cash...........................................................X 86. 87. Repair expense ..................................X Cash...........................................................X PP&E: improvment PP&E .....................................................X Cash...........................................................X PP&E: Impairment Loss on Impariment ...........................X PP&E ..........................................................X Provisions: charges Expenes & Losses ..............................X Provisions ..................................................X Provisions: Reversals Provisions ............................................X Cash...........................................................X Provisions: Unused provisions Provisions ............................................X Other Incme & Expenses........................X Operating Profit.......................................X Income Tax expenses ..............................X Contingencies: establishment of provision for litigation Litigation Expenses ............................X Provisions ..................................................X Contingencies: litigation-related expenditures Provisions ............................................X Cash...........................................................X Contingencies: increase provisions Litigation expenses ............................X Provision...................................................X

OCTOBER 2007

48. Purchase Merchandise on account Merchandise Inventory............................X Accounts Payable .....................................X 49. Sell Merchandise for Cash & On Account Cash ........................................................X A/R ........................................................X Sales Revenue (SE)..................................X 50. Cost of Goods Sold Cost of goods sold (SE)............................X Merchandise Inventory............................X 51. Record Salaries Payment Salaries Expense ......................................X Cash...........................................................X 52. Income Recognition: Completed Contract Method Cash ........................................................X Advance from customer ..........................X Construction in progress.........................X Cash (actual outgoings)...........................X 53. Income Recognition: When work is completed Cash (remaining payment).....................X Advance from Customer (balance of prepayment) X Sales Revenue..........................................X Expenses ...................................................X Construction in progress (balance in account) X Cash (outgoings in period) .....................X 54. Adjusting Entry: Recognition of Accrued Revenues (Interest earned but not due) Interest Receivable (A)............................X Interest Revenue (IS)...............................X 55. Adjusting Entry: Recognition of Accrued Expenses (e.g. Salaries accrued (not paid) during last days of accounting period) Salaries Expense (IS)...............................X Salaries Payable (L).................................X 56. Adjusting Entry: Prepaid Operating Costs (Payment of 3 year insurance premium (1/1)) Prepaid Insurance....................................X Cash...........................................................X 57. Adjusting Entry: (31/12) to Recognise Insurance Expense Insurance Expense ...................................X Prepaid Insurance....................................X 58. Adjusting Entry: Depreciation Depreciation Expense (IS)......................X Accumulated Depreciation (XA).............X 59. Adjusting Entry: Valuation of Liability 1/12 - Receive 1 years rent Cash ....................................................600 Advance from tenants.........................600 31/12 - Recognise 1 months rent revenue Advance from tenants (L)......................50 Rent Revenue (IS)..................................50 60. Closing Temporary Accounts: Debit Balance (Expense Account) Retained Earnings (SE) ...........................X Account with Debit Balance....................X 61. Closing Temporary Accounts: Credit Balance (Revenue Account) Account with Credit Balance ..............X Retained Earnings (SE)............................X 62. Accrual Basis: Buy Raw Material on Account Raw Material Inventory..........................25 Account Payment...................................25 63. Accrual Basis: Transfer Raw Material of 20 to Production Department Work-in-Process Inventory....................20 Raw Material Inventory.........................20 64. Accrual Basis: Pay Salaries (40 to Factory Workers & 20 to Administration) Work-in-Process Inventory....................40 Salaries Expense ....................................20 Cash.........................................................60 65. Accrual Basis: Depreciation on Building & Equipment Factory (-8) & Administration (-2) Work-in-Process Inventory......................8 Depreciation Expense ..............................2 Accumulated Depreciation ...................10 Accrual Basis: Finished Goods (FG) Inventory 40 Work-in-Process Inventory....................40 66. Accrual Basis: Sales (Total 75) Cash ......................................................50 Accounts Receivable ..............................25 Sales Revenue........................................75 67. Accrual Basis: Costs of Goods Sold ( Total 42) Cost of Goods Sold (SE)..........................42 Finished Good Inventory (A).................42 68. Long Term Investment: Purchase (pay 50, 30% investment) Equity Investment (Full Cost)................50 Cash.........................................................50 69. Long Term Investment: Subsidiary Income (20 NetIncome,30%) Equity Investment (% Ownership of Earnings). 6 Equity Income (IS)....................................6 70. Long Term Investment: Dividend from Subsidiary (10 dividend,30%) Cash (Ownership % of Total Payout)......3 Investment in Stock of X..........................3
71. Long Term Investment: Income from Subsidiary

17. Deferred Liability: Incurring Taxes Income Tax Expense................................X Income Tax Payable or Cash..................Y Deferred tax Liabilities...........................Z 18. Deferred Liability: Paying Deferred Tax Income Tax Expense................................X Deferred Tax Liabilities...........................Z Income Tax Payable or Cash..................Y 19. Investment: Acquisition (incl. tax + other) 1,000 @ 45 Investment.......................................45,000 Cash..................................................45,000 20. Investment: Declared Revenue from Dividend Cash (or Dividend Receivable) ...............X Dividend Revenue (IS).............................X 21. Investment: Valuation at LCM (end Yr2 market price @ 41) Unrealised Loss (TSIS AFSBS SE) 4,000 Investment.........................................4,000 22. Investment: Valuation at LCM (end Yr3 market price @ 44) Investment.........................................3,000 Unrealised Loss (TSISAFSBS SE)......3,000 23. Investment: Selling (market price @ 55) Trading Security Cash ...............................................55,000 Investments (at BS value)..............44,000 Realized Gain on Sale (IS)..............11,000 Security Available for Sale Cash ...............................................55,000 Investment (at acquisition cost)....45,000 Realized Gain on Sale of AFS (IS)..10,000 Investment.........................................1,000 Unrealized Loss (BS SE)...................1,000 24. Investment:chng in Market ValueAFS( cost@5000,MarketValue@6000) Investment 1000 Other Comprehensive Income(BS SE)......1000 25. Investment:chng in Market ValueTS( cost@5000,MarketValue@6000) Investment 1000 Unrealized Gain..................................1000 26. Accounts Receivable: Increase Account Receivable (BS)..........................X Sales Revenue (IS)...................................X 27. Uncollectible: Direct Write Off Bad Debt Expense (IS)............................X Accounts Receivable (BS).......................X 28. Collection after Write Off: Direct Write Off Cash (BS)...................................................X Other Income (IS).....................................X 29. Uncollectible: Allowance Method (at time of sale) Bad Debt Expense (IS).............................X Allowance for Uncollectible Accounts (~A A/R) X 30. Uncollectible: Allowance Method (write off for next period) Allowance for Uncollectible Accounts (BS)........Y Accounts Receivable (BS).......................Y 31. Collection after Write Off: Allowance Method Cash (BS)....................................................Y Allowance for Uncollectible Accounts (BS) Y 32. Notes Receivable: At Year End before Note Payment Interest Payable ........................................E Interest Revenue......................................E 33. Fixed Asset: Bring Depreciation up to Sale Date Cash .......................................................23 Accumulated Depreciation....................30 Equipment...............................................50 Gain on sale of equipment (to I/S) .........3 34. Liabilities: Recognising Contingency Loss from Damage Claim (I/S)................X Estimated Liability for Damages (B/S).....X 35. Liability: Deferred Performance (receipt for future service/good) Cash ........................................................X Advances From Customer .......................X 36. Liability: Warranty Outstanding Warranty Expense (I/S)............................X Estimated Warranty Liability..................X 37. Liability: Specific Repair Made Estimated warranty liability....................X Cash/Inventory.........................................X 38. Liability (Mortgage): Borrow the money Cash ........................................................X Mortgage Payable ....................................X

74. 75. 76. 77. 78. 79.

72. Long Term Investment: Goodwill Amortisation (Overpaymt/Periods) Investment Income (Cost over Market Value / Periods) 30 Investment in Stock of Company X (% Ownership) 30 73. Long Term Investment: Sale Cash ....................................................660 Investment in Stock of Company X...........633 Gain on Sale of Investment in Company X 27 Inventory :purches Raw materials and supplies ...................X Cash/Account Payable .............................X Inventory: manufacturing process begin Work in process inventory......................X Raw materials and supplies ...................X Inventory: when product completed Finished goods inventory........................X Work in process inventory......................X Inventory: inventory sold COGS .....................................................X Finished goods inventory........................X PP&E: initial recognition PP&E .....................................................X Liability......................................................X PP&E: repair