Chapter 2 Flashcards
Three ways to get assets?
(1) Debt financing = increase in bank loan (represents IOU)
(2) Share capital
(3) Retained earnings - earnings retained and accumulated from the first day of business
What is the cash flow statement about?
It summariz information about the cash inflows (receipts) and cash outflows (payments) for a specific period of time
What is the income statement about?
It presents revenues, expenses, and resulting net income or net loss for a specific periof of time
What is the statement of changes?
It summarizes changes in shareholders’ equity for a specific period of time
What is the balance sheet about?
It presents assets, libailities, and shareholders’ equiry on December 31
Does revenue equal cash inflow?
No
What is revenue recognition principle?
Revenues are recognized at the points of delivery of products or services
What are the two components to revenues?
(1) Cash sales revenues (assets: cash increase)
(2) Non-Cash credit sales transaction (assets: accounts recievable increases. Accounts receivable = claims to collect money later)
What is a receivable?
The right to receieve cash from another party. Account receivable is right to receive cash from customers in the future.
What are the components to expenses?
(1) Cash
(2) Non-Cash
Is the net income always the same as cash?
No, only if the company only accepts cash.
What is expenses?
The use of assets/services (such as employee services)
When do you create the Balance sheet?
As at (on) December 31
Assume you get hired by starbucks and the payday is every 20th of the month. After the payday you continue to provide services till December 31 in your balance sheet. why?
Because services are still being used so they must count as expenses. Those 11 days worth of salary component is still captured as non-cash component as expenses since the service is still used despite the company not having payed the employer yet
Is dividend an expense item on income statement?
No. Dividend is never part of income statement because it has nothing to do with asset use and services it is a pure return or compensation for owners investment. This is why is it not considered as an expense item.
What is the equation of assets?
Assets = Liability + Expenses
What is the equation for Expenses?
Expenses = Retained Earnings + Common Stock/Share capital
What is the equation for Net Income?
Net Income = Revenues - Expenses
What is the equation for Retained Earnings?
Retained Earnings = End Retained Earnings + Net Incomes - Dividend
What are the two classifications of assets?
(1) Current Assets
(2) Non-Current Asset
Definition of assets?`
(1) Must come from a past transcation
(2) There is present control or ownership
(3) Future economic benefit
What happens if economic benefits comes in to the new year (jan 1st, 2022 - dec 31st 2022) how is the item classified?
As current asset
What are the items under the current assets?
(1) Cash
(2) Inventory - merchandise held for sale to customers
(3) Trading investments - includes investments in debt and equity of other companies
(4) Accounts receivable - promise of future cash payment from a customer. Sales or services on accounts means accounts recievable goes up
(5) Notes receivable - Written promise of future cash payment to the company
(6) Supplies
(7) Prepaid expense - expenses paid in advance (e.g., rent or insurance)
What is the difference between accounts recievable and notes receivable?
Note is the IOU that the borrower gives the lendor. Big difference is interest. Transaction with customers means yuo do not have to worry about interest (you just give them number of days to make payment). In terms of lendor and borrower relationship you always talk about interest (N/R). A note is between two legal persons whereas a bond (A/R) a corporation issues a bond in the bond market and there are many people buying and selling the bonds. There is no market for notes (N/R) since it is only the relationship between the two individuals
If Dell has a computer for sale, is that considered as inventory or equipment?
Since it is for sale it must be inventory (current asset)
If Dell uses a computer to process the customer order, is that considered as inventory or equipment?
It is not for sale but it is in use for the company so it is equipment (Non-current asset)
Why are prepaid expenses an asset?
Because it represents unused economic benefits (e.g., office space, insurance coverage) for future use during the year
What is under non-current assets?
(1) Long-term investments
(2) property, plant and eqipment (fixed assets, capital assets) - Land, building, equipment, furniture, and fixtures
(3) Intangible assets (no physical form) - Patents, trademarks, and copyrights
Suppose you ordered beer and it is poured in a pint glass. Is this considered as inventory or equipment from the bar owner’s perspective?
Both because something for sale in this case is the liquid itself. The pint glass is going to be considered as the equipment since it is used multiple times and has use over a year. The liquid however is yours and is what you have purchased.
Which one of the current assets generates future economic benefits, but not in the form of cash?
Prepaid expenses. It is not expense on the income item. The future economic benefit is not cash but rather the right to enjoy the rental space.
What is depreciation?
The systematic allocation of the cost of property, plant, and equpment over the multiple year of the asset’s useful life
Is land depreciable?
It is easy to calculate the cost of land but it is considered harder to consider the useful life. For this reason land is not depreciable
What do you need to know to calculate depreciation expense amount?
(1) The cost of the thing
(2) The useful life of the item
Is land improvement (e.g., parking lot, driveway, sidewalk) depreciable?
It is possible to calculate the useful life of land improvemet. So yes it is.
If Dell has a computer for sale, is it subject to depreciation?
No. If Dell sells a computer it is an inventory, so it is a current asset (future economic benefit comes in within one year). This means that you plan to sell the inventory as soon as possible to get cash. There is no concept of depreciation with inventory because you are trying to sell it right awy. With depreciation we assume we are going to use the asset over multiple years.
If a Dell uses a computer to process the customer order, is it subject to depreciation?
This is not something for sale, so yes since we classify this as property, plan, equipment so it is under non current assets.
Does depreciation only happen on non current assets?
Yes since we assume we wil use the asset for more than a year
Accounting characteristic tradeoff
Relevance and faithful representation
What is relevance?
TImely information that makes a difference in decision-making
What is faithful representation?
Free of errors and bias
If you buy land for 20,000 six months ago and the current price of it as of Dec 31, 2019 is 100,000, how do you report the balue on the B/S?
As long as the land is being used for company operation, it is going to be part of property plant equipment (PPE) under non-current asset. Hence it is not for sale. In this case we care more about reliable numbers which is what we present to investors. There is no debate of the actual purchase price from yeard ago but the current price is not as reliable.
What does historical cost principle mean?
Assets should be recorded at their original purchase price cost and there is not any adjustment.
You buy a land for 20,000 and the market price of the land as at Dec 31 was 10,000. Assume that there is zero cost to sell the land and you plan to sell it at 50,000. How would you report the value of your land?
Since you plan to sell the land is it not part of PPE but it is under the current asset section. Since historical cost is 20,000 and the current market value is 10,000 so we would report 10,000.
In general, standard setters require that most assets be recorded using historical costs. Why?
Because current values may not always be reliable and representationally faithful
What is the book value?
Shareholders’ equity (asset-liability) on B/S
What is market value?
Number of shares in stock market X market share price
Which is typically higher between market value and book value and why?
Market value because market share price likely reflects other information not on the B/S (e.g., higher talent CEOs, employee love & loyalty that might increase the value of the company, and growth opportunities). Because of historical cost principle, some asstes are recorded at historical cost, which is likely to be lower than the fair market price. Thus, book value would be lower
What sum of two things gives us the equity value?
Share capital and retained earnings
Second Cup recieved 25$ from a customer in exchange for a gift card. Is $25 cash receipt considered revenues?
No. Second Cup is in the business of selling coffee so when this is purchases that is when revenue increases. Since you buy a gift card this does not count as revenue. This is a gift card liability - company has to give coffee to customers when you come in with gift card so this is the liability
Definition of liability?
(1) It has to come from a past transcation
(2) It has to represent a present obligation
(3) Have to make a future economic sacrifice (normally in the form of cash or in case of Second Cup and gift cards giving coffee)
What is unearned revenue (deferred revenue)?
Obligations arising from receiving cash in advance of providing a product or service (e.g., gift card liability in Second Cup)
What is under B/S current liabilities?
(1) Unearned revenue
(2) Notes payable or bonds payable
(3) Current maturities of long-term debt
(4) Banl indebtedness (short term bank loands)
(5) Accoutns payable - promise to pay a vendor arising from credit purchases. Purchases (paid) on account means A/P increases
(6) Accrued liabilities (accrued expenses) - expenses that are owed but have not yet been paid (e.g., interest payable, salaries payable)
Why are unearned revenues a liability?
Because the company has an obligation to sacrifice future economic resources from receiving the prepayment from customers. When the gift cards are redeemed, the company delivers its products or services. That is when the company can recognize revenues while reducing the liability of unearned revenues.
Among the our financial statements which is prepared first?
Income statement since we need income number to prepare other financial statements.
