300525 2111.01-.07 Flashcards
Accounting Profit
Accounting Profit
Accounting profit is the difference between total revenues and measurable or estimable expenses paid to outsiders to acquire and use all necessary factors of production. Accounting profit does not include those implicit costs that are not measurable, such as opportunity costs and return to the owner for use of owner’s capital and entrepreneurial skills (the normal profit). It is the profit in excess of actual costs of production. The residual accrues to the owners.
Gross revenue from sales XXX
Less:
Direct materials xx
Direct labor xx
Factory overhead xx
Cost of goods sold XX
Equals Gross Profit XXX
Less: Nonmanufacturing costs XX
Equals ACCOUNTING PROFIT
(before income taxes) XX
Less: Income tax X
Equals ACCOUNTING PROFIT after tax XX
Less: NORMAL PROFIT (imputed
return to owner for
the use of capital and
for risk-taking) X
Equals ECONOMIC PROFITS X
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As a general rule, accounting profit is greater than normal profit, and normal profit is greater than economic profit because implicit costs are considered in the determination of normal and economic profits. (Income tax is basically applied to accounting profit that has been adjusted to taxable income per tax rules and regulations.)
Accounting profit is the basis for the financial statements of individual firms and is often extrapolated to the industry. It is not used when referring to the entire market.
Additional Paid-in Capital
Additional paid-in capital (APIC) is an increase in equity (net assets) in excess of par or stated value arising from transactions involving the enterprise’s own stock. Usually, it is reported for each class of stock or each type of transaction (e.g., APIC from common, from preferred, from treasury stock (both par and cost methods), from conversion of convertible shares, from retirement of callable or redeemable shares from payment of a liquidating dividend, and from quasi-reorganization).
Additional paid-in capital is sometimes called “paid-in capital in excess of par” or “contributed capital in excess of par.”
Capital Stock
Capital stock is an ownership interest in an incorporated business enterprise, represented by stock certificates that may be bought and sold or otherwise transferred. It conveys the right to influence management via participation in and voting at stockholders’ meetings, to participate in earnings through dividends, and to share in the distribution of net assets upon liquidation. There may be different classes of stock with different rights in the same corporation.
Capital is specified in state law and the entity’s articles of incorporation.
Capital stock is that portion of contributed capital equal to the par, or stated, value of stock outstanding. The issue price of stock is allocated between the par value and the price in excess of par (e.g., $5 par common stock is issued for $20—$5, the par value, is recorded as capital stock and $15 is recorded as contributed capital in excess of par (CCEP, common)). Each class of common stock is recorded separately.
Treasury stock is recorded as a contra, or negative, element of capital stock under the par value method (with the excess price paid over par to reacquire the stock recorded as CCEP, treasury stock).
Dividends
Dividends are the distributions of cash, other corporate assets or property, or the corporation’s own stock to stockholders in proportion to the number of outstanding shares held. Accounting for dividends represents a debit to retained earnings and the establishment of a liability at the date of declaration. Dividends must meet the preferences of preferred stock first and then may be extended to common stock.
There are two types of dividends:
- Common, such as cash, stock (treasury or newly issued shares), and property
- Special, such as scrip and liquidating
Four dates are relevant to dividends: date of declaration, record, ex-dividend, and distribution (payment).
Date of declaration is the date whereby the dividend amount is decided by the board of directors for those shareholders owning stock on the date of record (usually 1 month later) and to be paid on the date of distribution. Ex-dividend date is a date prior to the date of record (see ex-dividend date).
Retained Earnings
Retained earnings are an increase in net assets from results of operations, retained by the corporation for use in the enterprise. They are internally generated financing or the corporation’s undistributed earnings. They are accumulated earnings, less accumulated losses and dividends paid, from inception. Retained earnings are a major source of owners’ equity and can be viewed as additional investments by the owners as foregone dividends.
Negative balance is called a deficit.
Retained earnings may also be decreased by purchase of treasury stock at a price higher than the amount originally received for the stock.
Retained earnings may be appropriated (i.e., restricted as to use) by:
- contractual specification (e.g., bond covenants),
- legal requirement (e.g., by state law), or
- management discretion (e.g., for future expansion).
Retained earnings are increased by net income, prior-period adjustments, and quasi-reorganization. Retained earnings are decreased by net loss, prior-period adjustments, cash, property, scrip, stock dividends, and treasury stock and stock retirement transactions.
Stockholders’ Equity
Stockholders’ Equity
Stockholders’ equity is total residual ownership interest in the corporation: net assets and total assets in excess of total liabilities. The source of equity should be specified and segregated:
Contributed capital (paid-in capital):
Capital stock, at par:
Common
Preferred
Less: Treasury stock (under the par value method)
Other contributed capital:
Contributed capital in excess of par (CCEP) (also called Additional paid-in capital (APIC)) on both common and preferred
Contributed capital from treasury stock (under the par value method or cost method)
Donated capital
Retained earnings (earned capital):
Appropriated
Unappropriated
Unrealized capital
Less: Treasury stock (under the cost method)
SFAC 6.60
The following trial balance of Mint Corp. on December 31, 20X1, has been adjusted except for income tax expense.
TRIAL BALANCE
December 31, 20X1
Debit Credit Cash $ 600,000 Accounts receivable (net) 3,500,000 Cost in excess of billings on long-term contracts 1,600,000 Billings in excess of costs on long-term contracts $ 700,000 Prepaid taxes 450,000 Property, plant, and equipment (net) 1,480,000 Note payable (noncurrent) 1,620,000 Common stock 750,000 Additional paid-in capital 2,000,000 Retained earnings (unappropriated) 900,000 Retained earnings (restricted for note payable) 160,000 Earnings from long-term contracts 6,680,000 Costs and expenses 5,180,000
$12,810,000 $12,810,000
=========== =========== Other financial data for the year ending December 31, 20X1:
Mint uses the same method to account for long-term construction contracts for financial statement and income tax purposes. All receivables on these contracts are considered to be collectible within 12 months.
During 20X1, estimated tax payments of $450,000 were charged to prepaid taxes. Mint has not recorded income tax expense. There were no temporary or permanent differences. Mint’s tax rate is 30%.
In Mint’s December 31, 20X1, balance sheet (statement of financial position), what amount should be reported as total current assets?
$5,000,000
$5,450,000
$5,700,000
$6,150,000
Mint Corp.’s current assets on December 31, 20X1:
Cash $ 600,000
Accounts receivable (net) 3,500,000
Costs in excess of billings
on long-term contracts 1,600,000
Total current assets $5,700,000
Current assets consist of cash and other assets reasonably expected to be realized in cash or sold or consumed in operations within one year or an operating cycle, whichever is longer. It is important to note that Mint’s trial balance has not been adjusted for income taxes. Since there are no temporary or permanent differences, Mint’s taxable income (for tax purposes) and income before income taxes (for financial reporting purposes) is $1,500,000 (earnings from long-term contracts of $6,680,000 less costs and expenses of $5,180,000). Mint’s income tax expense for 20X1 is $450,000 ($1,500,000 × 30%).
Therefore, Mint will have no “prepaid taxes” once the trial balance is adjusted for income taxes. The balance in the unadjusted Prepaid Taxes account will be transferred to the Income Tax Expense account.
2111.01
2111.01
An example of the comparative balance sheet for Tiger Co., prepared in the account form (assets on the left, equities on the right), is presented as follows as of December 31, 20X1, and December 31, 20X2.
The following major categories typically appear on corporate balance sheets.
Assets:
Definition (SFAC 6): Probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events
Subcategories: Current assets; Investments; Property, plant, and equipment; Intangible assets; Other
Liabilities:
Definition (SFAC 6): Probable future sacrifices of economic benefits arising from present obligations to transfer assets or provide services to other entities as a result of past transactions
Subcategories: Current; Noncurrent
Equity:
Definition (SFAC 6): The residual interest in the assets of an entity that remains after deducting its liabilities. For a corporation, equity is the ownership interest (identified as “stockholders’ equity”).
Subcategories: Contributed capital (Par/stated value, Amounts in excess of par/stated value, Donated capital, Capital arising from asset revaluation); Retained earnings; Treasury stock; Accumulated other comprehensive income
2111.02
2111.02
Another form of the balance sheet, usually identified as the report form, includes the assets at the top of the statement and the equities at the bottom. An abbreviated example of this statement is as follows:
2111.03
2111.03
A third form of the balance sheet, usually identified as the financial position form, shows the net working capital (by deducting current liabilities from current assets), adds noncurrent assets, deducts noncurrent liabilities, and finally nets to the stockholders’ equity, which is presented in detail in a balancing section. An abbreviated example of this balance sheet form for Tiger Co., which is encountered infrequently in practice, is illustrated as follows.
2111.04
A general principle of accounting is that the offsetting of assets and liabilities in the balance sheet is improper except where a right of setoff exists. For example, a debtor with a payable to an entity may not offset a receivable from that same entity and display only the difference as a net payable or receivable unless the following specified conditions are met for the right of setoff to exist:
a. Each of the two parties owes the other determinable amounts.
b. The reporting party has the right to set off the amount owed with the amount owed by the other party.
c. The reporting entity intends to set off.
d. The right of setoff is enforceable at law.
2112.05
Several definitions of the basic elements of an income statement are as follows:
a. Revenue: Inflows of assets or settlements of liabilities, during a period, from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations
b. Expenses: Outflows of assets or incurrences of liabilities, during a period, from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations
c. Gains: Increases in net assets other than from revenues or investments by owners
d. Losses: Decreases in net assets other than from expenses or withdrawals by owners
e. Income: The result of combining these four concepts for a specified period of time (sometimes referred to as earnings):
Income = Revenues − Expenses + Gains − Losses
2112.06
The concepts of gains and losses, as illustrated, relate to peripheral or secondary activities rather than to the major or central operations of the enterprise. While revenues and expenses are presented in gross amounts in the income statement, gains and losses are presented in the income statement in net amounts (i.e., they are measured by subtracting two or more other measures or they involve only an increase or decrease in an asset or liability with no offsetting decrease or increase in another asset or liability).
2112.07
The income statement may be presented in either of two formats—single step or multiple step.
Single step: The single-step income statement is a simple and relatively straightforward presentation whereby all revenues and gains are combined at the top of the statement. From this subtotal, a total amount of all expenses and losses is deducted to render a net income figure. A popular variation of the single-step income statement is the separation of income taxes from the other expenses, resulting in an income figure before taxes (when revenues and gains are reduced by all other expenses and losses). Income tax is then deducted as a separate item, resulting in a net income figure.
Multiple step: Under the multiple-step income statement, a distinction is made between operating and nonoperating items. The typical format is that illustrated previously in the example of Tiger Co. (section 2112.01), wherein cost of goods sold is deducted from revenues to yield gross profit; selling and administrative expenses are then deducted to yield operating income; other income and expense items are then added and deducted to yield net income.
The following changes in Vel Corp.’s account balances occurred during 20X1:
Increase
Assets $89,000
Liabilities 27,000
Capital stock 60,000
Additional paid-in capital 6,000
Except for a $13,000 dividend payment and the year’s earnings, there were no changes in retained earnings for 20X1. What was Vel’s net income for 20X1?
$4,000
$9,000
$13,000
$17,000
$9,000
Increases in assets must equal increases in liabilities and equity (specifically increase in retained earnings in equity): Assets = Liabilities + Equity.
Increase in Assets $89,000
Increase in Liabilities (27,000)
Increase in stockholder’s equity $62,000
Add back: Dividend Payment 13,000
Increase in stockholders’ equity
BEFORE dividends $75,000
Less increase-new capital stock issued:
Capital Stock $60,000
Additional Paid-in Capital 6,000 66,000
20X1 Net Income $ 9,000
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