Professional Documents
Culture Documents
Discussion topics
Introduction to accounting
Background Business Cycle Use of Financial Statements
Income Statement
Introduction Accrual basis of accounting Cash basis of accounting Revenue recognition principle Matching principle of costs
Balance Sheet
Introduction Accounting Equation Debit and Credit Assets / Liabilities Key Questions
Introduction to Accounting
Private and Confidential Not Circulation Private and Confidential Not forfor Circulation
Cash Inflow
Uses the money to purchase trucks, inventory, pay labor and admin costs
Cash Outflow
Kartik receives money from the clients Profit or Loss Kartik has following options
Kartik can reinvest the profit made in the business to expand his business or
Can simply keep the money!
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The business will incur expenses in operating the business, such as a salary for Kartik, labors, expenses associated with packaging material, delivery vehicle, advertising, etc
With thousands of such transactions in a given year, Kartik is being advised to make an entry of these transactions in an accounting software on a daily basis
Why Accounting?
Understanding of companys profitability, assets and cash position
Can you now explain Kartik, the content and purpose of the three main financial statements Income Statement, Balance Sheet and Cash Flow statement
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Income Statement
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The income statement shows the profit for the period of time under consideration
FastTrack Movers & Packers Inc. Income Statement, for year ended 31st December, 2007 Sales Cost of goods sold Gross Profit Selling,general and admin. expenses Income from operations Interest expense Income before taxes Net Income Earnings per share $ xxx $ xxx $ xxx $ xxx $ xxx $ xxx $ xxx $ xxx $ xxx
Revenues result from the entitys operating activities (selling merchandise, selling services)
Costs and expenses are incurred in generating revenues and operating the entity
Interest Expenses
Tax Expenses
If Kartik delivers 200 parcels in December for $5 per delivery, he has technically earned fees totaling $1,000 for that month. He sends invoices to his clients for these fees and his terms require that his clients must pay by January 15
Even though Kartiks clients won't be paying FastTrack Inc until January 15, the accrual basis of accounting requires that the $1,000 be recorded as December revenues, since that is when the delivery work actually took place
What is accrual basis of accounting? What is cash method of accounting? What is revenue recognition principle?
After expenses are matched with these revenues, the income statement for December will show just how profitable the company was in delivering parcels in December
When Kartik receives the $1,000 worth of payment checks from his customers on January 15, he will make an accounting entry to show the money was received.
Receipts of $1,000 will not be considered to be January revenues, since the revenues were already reported as revenues in December when they were earned This $1,000 of receipts will be recorded in January as a reduction in Accounts Receivable (In December Kartik had made an entry to Accounts Receivable and to Sales) Dont worry, we will explain you this in a bit!
Case 3: Expenses
If Kartik hires some labor to help him with December deliveries and Kartik agrees to pay him $300 on January 3 and another $100 for pakaging and other supporting material; Total expenses of $400 expense for December deliveries
The actual date of payment of $400 does not matter What matters is when the work was done and when the corresponding expense was incurred In our case work was done in December and hence, $400 expense is counted as a December expense even though the money will not be paid out until January 3 What is matching principle?
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FastTrack Movers and Packers borrowed $20,000 from a bank to start his business on 1st December and the company agrees to pay 5% in interest, or $1,000. The interest is to be paid in a lump sum on December 1st of each year.
What is the monthly interest expense that is shown for Kartiks monthly income statement?
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Sales Cost of goods sold Gross Profit Selling,general and admin. Expenses 1 Income from operations Interest expense Income before taxes Income Tax @ 33% Net Income
Note 1: SG&A expense is assumed to be $30 in December,2007
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Balance Sheet
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Assets
Liability
Shareholders Equity
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Balance Sheet
Case 5: Cash and Common Stock
On December 1, 2007 Kartik starts his business FastTrack Movers and Packers. The first transaction that Kartik will record for his company is his personal investment of $20,000 in exchange for 5,000 shares of FastTrack Movers & Packers common stock. There are no revenues because no delivery fees were earned by the company, and there were no expenses.
FastTrack Movers & Packers Inc Balance Sheet, December 1st 2007 Assets Cash $20,000 Liabilities & Stockholder's Equity Liabilities Stockholder's Equity Common Stock Total Assets $20,000 $0
$20,000 $20,000
Shareholders Equity
Common Stock will be increased when the corporation issues shares of stock in exchange for cash (or some other asset) Retained Earnings will increase when the corporation earns a profit and there will be a decrease when the corporation has a net loss Core link between a company's balance sheet and income statement
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Balance Sheet
Case 6: Purchase of Vehicle
On December 2, FastTrack Movers & Packers purchases a truck for $14,000 by writing a check for $14,000. The two accounts involved are Cash and Vehicles (or Delivery Truck)
FastTrack Movers & Packers Inc Balance Sheet, December 2nd 2007 Assets Cash Vehicle $6,000 $14,000 Liabilities & Stockholder's Equity Liabilities Stockholder's Equity Common Stock Total Assets $20,000 $0
$20,000 $20,000
Kartik also needs to know that the reported amounts on his balance sheet for assets such as equipment, vehicles, and buildings are routinely reduced by depreciation What is Depreciation
Matching principle? Depreciation of land?
The accountant might match $2,800 ($14,000 year's revenues for five years
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Balance Sheet
Case 7: Prepaid Expenses
On December 2 when Kartik contacts an insurance agent regarding insurance coverage for the Truck just purchased. The agent informs him that $1,200 will provide insurance protection for the next one year. Kartik immediately writes a check for $1,200.
FastTrack Movers & Packers Inc Balance Sheet, December 2nd 2007 Assets Cash Prepaid Insurance Vehicle Total Assets $4,800 $1,200 $14,000 $20,000 Stockholder's Equity Common Stock $20,000 $20,000 Liabilities & Stockholder's Equity Liabilities $0
Cash reduces further to $4,800 and Prepaid insurance account increases to $1,200
Between Dec 1st & Dec 31st, $100 worth of insurance premium is "used up" or "expires"
The expired amount will be reported as Insurance Expense on December's income statement The remaining portion of unexpired insurance premium is reported as Pre-paid Insurance
What is the remaining portion of Pre-paid insurance as of Dec 31st , 2007?
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Balance Sheet
Case 4 Revisited : Raising Debt
FastTrack Movers and Packers borrowed $20,000 from a bank to start his business on 1st December and the company agrees to pay 5% in interest, or $1,000. The interest is to be paid in a lump sum on December 1st of each year.
FastTrack Movers & Packers Inc Balance Sheet, December 3rd 2007 Assets Cash Prepaid Insurance $24,800 $1,200 Liabilities & Stockholder's Equity Liabilities Long term debt Stockholder's Equity Common Stock Liabilities & Stockholder's Equity $0 $20,000
$14,000 $40,000
$20,000 $40,000
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Balance Sheet
Case 8: Inventory
Kartik keeps an inventory of packing boxes not only to use it for his business but also earn additional revenues by carrying an inventory of packing boxes to sell. Let's say that FastTrack Movers and Packers purchased 1,000 boxes wholesale for $1.00 each.
FastTrack Movers & Packers Inc Balance Sheet, December 3rd 2007 Assets Cash Prepaid Insurance Inventory $23,800 $1,200 $1,000 Liabilities & Stockholder's Equity Liabilities Long term debt Stockholder's Equity Common Stock $0 $20,000
$20,000
No change
On 10th December, wholesale price of boxes has been risen by 20% & at today's price Kartiks could purchase them for $1.20 each. What is the value of inventory shown on balance sheet?
What is Cost Principle?
Lets say that since the time Kartik bought inventory, the wholesale price of boxes has been cut by 40% and at today's price he could purchase them for $0.60 each. What is the value of inventory shown on the balance sheet in this case?
What is the principle of Conservatism?
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Balance Sheet
Case 9: Unearned Revenues
In addition to 200 parcels delivered by FastTrack Movers and Packers in December, they enters into an agreement with one of its customers stipulating that the customer prepays $600 in return for the delivery of 30 parcels every month for 6 months. Assume FastTrack Movers & Packers receives $600 payment on Dec 1,2007 for deliveries to be made between Dec 1,2007 and May 31,2007
FastTrack Movers & Packers Inc Balance Sheet, December 4th 2007 Assets Cash Prepaid Insurance Inventory $24,400 $1,200 $1,000 Liabilities & Stockholder's Equity Liabilities Unearned Revenue Long term debt Stockholder's Equity Common Stock Liabilities & Stockholder's Equity $0 $600 $20,000
$14,000 $40,600
$20,000 $40,600
Other liabilities
For the loan Kartik received from Bank (Notes Payable or Loan Payable), the interest on the loan he owes to his bank (Interest Payable) Amount he owes to the supply store for items purchased on credit (Accounts Payable) Wages he owes an employee but hasn't yet paid to him (Wages Payable)
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Missing links
Accounts Receivables
Case 1&2: Revenues
If Kartik delivers 200 parcels in December for $5 per delivery, he has technically earned fees totaling $1,000 for that month. He sends invoices to his clients for these fees and his terms require that his clients must pay by January 15
Accounts Payable
Case 3: Expenses
If Kartik hires some labor to help him with December deliveries and Kartik agrees to pay him $300 on January 3 and another $100 for pakaging and other supporting material; Total expenses of $400 expense for December deliveries
Interest Payable
Case 4: Expenses
FastTrack Movers and Packers borrowed $20,000 from a bank to start his business on 1st December and the company agrees to pay 5% in interest, or $1,000. The interest is to be paid in a lump sum on December 1st of each year.
Balance Sheet Assets = Liabilities + Owners' Equity Net income = Income Statement Revenues Expenses
The arrow indicates that net income affects retained earnings, which is a component of owners equity
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$1,100 $400 $700 $30 $233 $100 $337 $83 $254 $84 $170
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$41,237
Revenues worth $100 earned in December, hence Unearned revenue of $600 adjusted for the earned revenues
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Balance sheet does not provide us with the fair market value of the company?
Long-term assets reported at their cost minus amounts already sent to Income Statement as depreciation expense The asset Land is not depreciated, so it will appear at its original cost even if the land is now worth one hundred times more than its cost However, Short-term asset amounts are likely to be close to their market values, since they tend to "turn over" in relatively short periods of time
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Net Cash
Cash Outflows:
Purchase of plants and equipments Investments in long term investments Private and Confidential Not for Circulation
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Cash flow from operations Cash flow from investing Cash flow from financing Total Change in cash
End Cash
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Sum up..
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