Revision of double-entry FINANCIAL ACCOUNTING Revision of double-entry

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

Example: Marvin Company Marvin Company balance sheet at the 1st of January was as follows Revision of double-entry

Revision of double-entry Transaction 1a Goods were sold for 12,000€. The client pays cash. Analysis The asset Cash increases The revenue Sales Revenue increases Journal entry Cash……………………….12,000 Sales revenue…………………..12,000 Posting Revision of double-entry

Revision of double-entry 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 Revision of double-entry

Revision of double-entry 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 entry Inventory……………………….7,000 Trade payables…………………..7,000 Posting Revision of double-entry

Revision of double-entry Transaction 3a Goods sold for 2,500€ and paid in cash Analysis The asset Cash increases The revenue Sales revenue increases Journal entry Cash……………………….2,500 Sales revenue…………………..2,500 Posting Revision of double-entry

Revision of double-entry 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 Inventory……..…………………..1,500 Posting Revision of double-entry

Revision of double-entry 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 Revision of double-entry

Revision of double-entry 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 Inventory……..…………………..2,000 Posting Revision of double-entry

Revision of double-entry 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 Revision of double-entry

Revision of double-entry 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 Revision of double-entry

Revision of double-entry 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 Revision of double-entry

General journal for Marvin Revision of double-entry

Revision of double-entry

Trial balance for Marvin at the 9 of January Revision of double-entry

Trial balance, income statement and balance sheet Balance sheet for Marvin co. asat the 9 of January - € Income statement for Marvin co. for the period ending 9 of January - € Revision of double-entry

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? Revision of double-entry

Sources of Information for the Statement of Cash Flows The 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 Revision of double-entry

Format of the Statement of Cash Flows Cash Flow Statement has four sections: operating investing financing significant non-cash investing and financing activities Revision of double-entry

Revision of double-entry 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 Revision of double-entry

Revision of double-entry 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 Revision of double-entry

Revision of double-entry 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 Revision of double-entry

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. Revision of double-entry

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. Revision of double-entry

Converting Net Income to Cash Flow From Operations Accrual Method Cash Method Revenue earned Non cash expenses (e.g. depreciation) + - Expense incurred Decreases in current assets Increases in current liabilities + NET INCOME Increases in current assets Decreases in current liabilities - CASH FLOW FROM OPERATIONS Revision of double-entry

Steps in Preparing Cash Flow Statement Determine the net Increase (decrease) in cash. Note: This will serve as the check figure. Determine the cash provided (used) by operations. Determine the cash provided (used) by investing. Determine the cash provided (used) by financing. Determine any significant noncash transactions that should be disclosed. Revision of double-entry

Revision of double-entry Cash Flow statement (1) Revision of double-entry

Revision of double-entry Cash Flow statement (2) Indirect method Direct method Revision of double-entry

Using The Accounting Framework: America Online Inc. Revision of double-entry

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 Revision of double-entry

Revision of double-entry Total Assets 1996 $ 959 million Total Assets 1997 $ 847 million Change in Total Assets $(112 million) WHY? Revision of double-entry

The accounting equation Equity Revision of double-entry

Revision of double-entry Total Liabilities 1996 $446 million Total Liabilities 1997 $719 million Change in Liabilities $273 million Revision of double-entry

Revision of double-entry Total Equity 1996 $ 513 million Total Equity 1997 $ 128 million Change in Equity $(385 million) HERE IS THE KEY! Revision of double-entry

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 Revision of double-entry

The role of the income statement Equity Income Statement Revision of double-entry

Revision of double-entry

Analysis of the expenses Cost of revenues $1,041 million Marketing $ 409 million General & administrative $ 194 million Write-off of deferred subscriber acquisition cost $ 385 million What is the last entry? Revision of double-entry

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 Revision of double-entry

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. Revision of double-entry

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 385,221,000 Deferred subscriber acquisition cost 385,221,000 Revision of double-entry

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 entry Deferred subscriber acquisition expense 385,221,000 Deferred subscriber acquisition cost 385,221,000 Revision of double-entry

T-accounts (1) Accumulated Deficit (Retained Earnings) Balance 6/30/96 From balance sheet 7,767 1997 loss from income statement 499,347 Balance 6/30/97 From balance sheet 507,114

T-accounts (2) Deferred Subscriber Acquisition Costs Balance 6/30/96 (Asset account) Balance 6/30/96 314,181 130,229 The Statement of Cash Flows indicates that an additional $130,229 cash was spent on these costs between 7/1/96 and 9/30/96. Revision of double-entry

T-accounts (3) Deferred Subscriber Acquisition Costs 314,181 56,189 (Asset account) 314,181 130,229 56,189 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. Revision of double-entry

Writing-off the asset (1) Deferred Subscriber Acquisition Costs (Asset account) 314,181 130,229 385,221 56,189 Balance 9/30/96 385,221 Write-off on 10/1/96 It was this 385,221 that was “written off” as an expense on 10/1/96 Revision of double-entry

Writing-off the asset (2) Deferred Subscriber Acquisition Costs (Expense account) 385,221 This expense will enter the income statement and will affect The Balance sheet through the profit and/or loss for the year Revision of double-entry

Income statement and cash flow

Information from the Cash Flow Statement AOL’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? Revision of double-entry

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 cash flow problem? Revision of double-entry

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 non- cash 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! Revision of double-entry

Revision of double-entry 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 Revision of double-entry