HBX- Accounting 3

Question 1

Journey from identifying a transaction to creating a financial statement

Answer 1

Question 2

Real Accounts

(Also name other names)

Answer 2

Real Accounts/Permanent Accounts/Stock Measures

Accounts which contain cumulative balances since the inception of the business. The balances in these accounts flow from one accounting period to the next. Real accounts include all asset, liability, and owners’ equity accounts and may also be referred to as permanent accounts or Balance Sheet accounts.

Question 3

Nominal Accounts

(Also name other names)

Answer 3

​Nominal Accounts/Temporary Accounts/Flow Accounts

Accounts that are reset to zero at the end of each accounting period. Nominal accounts include all revenue and expense accounts, and may also be referred to as temporary accounts or Income Statement accounts. The net balance of nominal accounts is transferred to retained earnings at the end of each accounting period.

Question 5

How Real & Nominal Accounts are Organized on a Trial Balance Sheet

Answer 5

Question 6

Are Revenues and Expenses actually equity or not?

Answer 6

Revenues and expenses impact the owners’ equity part of the accounting equation. However, revenues and expenses are not just a subcategory of equity accounts. Rather, they are each their own account types. The distinction between owners’ equity as compared with revenues and expenses is contained in the definition of real versus nominal accounts itself.

Owners’ equity accounts, like common stock and retained earnings, are real or permanent accounts. This means they go on the balance sheet and maintain a cumulative balance over time. Revenue and expense accounts, on the other hand, are nominal or temporary accounts. This means they go on the income statement and reflect activity over a period of time.

Question 7

Balance Sheet

Answer 7

Balance Sheet = FINANCIAL POSITION

Financial report that shows the financial position of a company at a specific point in time-they literally have a specific date on them.; a snapshot of the resources that are owned or controlled by company, and how those resources were financed. The balance sheet shows the balance of all asset, liability, and equity accounts as of a given date.

Question 8

Difference between a trial balance and a balance sheet.

Answer 8

a trial balance is much more detailed than the info on the balance sheet.

(Because of materiality)

Question 9

Materiality

Answer 9

Materiality

Something is considered to be material if it is reasonably likely to impact the decision-making of those who are using the accounting data or financial reports. Businesses are only required to do detailed record-keeping and reporting for items that are material.

Question 10

What are the Typical Sections of a Balance Sheet?

Answer 10

Typical Sections of a Balance Sheet Are:

• Current Assets
• Non-Current Assets
• Current Liabilities​
• Non Current Liabilities
• Owner’s Equity

At the beginning of a financial period- there should be nothing on the balance sheet for nominal accounts- because they start at 0.

Question 11

US GAAP STANDARDS: Order for a Balance Sheet

Answer 11

Assets

• Current Assets- Assets that are expected to be converted into cash within one year (Cash, Cash Equivalents, Accounts Receivable, Inventory, Other Current assets)
• Non-Current Assets- those that the business will hold for more than 1 year (Equipment or a building)

Liabilities

• Current- Liabilities that are due within one year
• Non-current Liabilities- those that are due in more than 1 year

Equity

The US uses LIQUIDITY- The order accounts in “how quickly and easily they can be converted into cash” for Assets & likely to be paid the soonest first for liabilities.

Question 12

IFRS Balance Sheet Order

Answer 12

Equity (the order of this section is the SAME that it is in the US)

Liabilities (ORDER- Likely to be paid the soonest LAST )

• Non-Current Liabilities- those that are due in more than 1 year
• Current Liabilites- Liabilities that are due within one year

Assets

• Non-Current Assets- those that the business will hold for more than 1 year (Equipment or a building)
• Current Assets- Assets that are expected to be converted into cash within one year (Cash, Cash Equivalents, Accounts Receivable, Inventory, Other Current assets)

Question 13

Is a Note Receivable a Current or Non-Current Asset?

Answer 13

Notes Receivable (Short Term)- Notes Receivable is an asset that arises when a business issues a promissory note to another business. Essentially, it is a loan recorded from the lender’s point of view. A portion or all of the note receivable may be recorded in the current assets or non-current assets section of the balance sheet, depending on how soon the business expects to settle the note.

Question 14

Intangible Asset

Answer 14

Non-physical long-lived assets such as patents, brands, and goodwill.

Question 15

Typical Liquidity Order of Assets for US GAAP (It’s reverse for IFRS)

Answer 15

Current

• Cash & Cash Equivalents
• Accounts Receivable (Net)
• Inventory
• Prepaid Insurance
• Other Prepaid Expenses
• Notes Receivable (Short Term)

Non Current

• Investments
• P, P, & E (Property, Plant, & Equipment)
• Software
• Ingtangables
• Other Long Term Assets

Question 16

Deferred revenue

Answer 16

Deferred revenue is a liability that represents the obligation to provide goods or services to a customer in the future. Deferred revenue is recorded when a business receives a payment in advance from a customer, but the business has not yet delivered the good or provided the service. Once the business fulfills its obligation to provide goods or services, the liability is reduced and the revenue is recognized. May also be referred to as unearned revenue. Remember that deferred revenue is NOT revenue.

Question 17

Order for Equity items on a balance sheet

Answer 17

There’s normally not an order for Equity HOWEVER In the US, you will usually see

• Common Stock listed first,
• Preferred Stock
• Treasury Stock
• Retained Earnings are listed after all stock items.

Again, as a company adds equity accounts beyond those mentioned above, they will determine their ordering preferences, and it is relatively unimportant that there may be differences from one company to the next.

US GAAP and IFRS generally present this section in a similar order with capital stock accounts first and the retained earnings account last, but you may see some variations. The only thing to remember is that US GAAP places the equity section after liabilities, while IFRS usually places it before liabilities.

Question 18

Accrued Expenses

Answer 18

Accrued Expenses

Liability account used to record amounts at the end of an accounting period to recognize expenses that were incurred in the period but for which no invoice has yet been received nor payment has yet been made. Examples are salaries/wages payable, accrued rent expense, accrued legal fees. When the accrual is made, the debit is to the appropriate expense account (payroll expense, rent expense, legal expense) and the credit is to the accrued expense account, which is a liability because it represents an obligation which will need to be paid in the future. Remember accrued expenses are NOT expenses.

Question 19

Liability Order for US GAAP (It’s the reverse for IFRS)

Answer 19

Current

• Accounts Payable
• Wages/Salaries Payable
• Deferred Revenue
• Accrued Expenses**
• Taxes Payable**
• Deferred Income Tax (Current)**
• Notes Payable (short term)

Non Current

• Deferred Income Tax (Non-Current)
• Notes Payable

Question 20

What Categories would these things be in….

• Petty Cash
• Bank account
• Payroll account
• Accounts Receivable
• Employee Advances
• Grocery Inventory
• Other Current Assets
• Leasehold Improvements
• Machinery & Equipment
• Furniture & Fixtures
• Accumulated Depreciation
• Liquor License
• Other Assets
• Wages Payable
• Current portion of loan payable
• Gift Certificates
• Loan payable
• Capital Stock
• Retained Earnings

Answer 20

Question 21

Employee Advances

Answer 21

Employee Advances are CURRENT ASSETS

Amounts paid to employees in advance of the employee earning the amount. Equivalent to a loan to the employee. These advances are made at the discretion of the management of the business and they are often repaid by deducting them from subsequent payroll amounts.

Question 22

Accumulated Depreciation

Answer 22

Accumulated Depreciation- A NON CURRENT ASSET

A contra asset (A contra asset account is an asset account where the balance will be either a credit balance or a zero balance. ) account that includes the cumulative total of all depreciation expenses recorded to date for specific assets. The credit balance in this account offsets the debit balance in the asset account which shows the original value of the asset. When the original asset value is netted against the accumulated depreciation for the asset you arrive at the net book value of the asset.

Question 23

What is the difference between revenues and expenses?

Answer 23

The net income for the period

Question 24

An accounting period:

Answer 24

An accounting period: any length of time the business is evaluating its financial performance.
Most business prepare a balance sheet and an income statement after every period. Most businesses also publish quarterly financial statements (public company have to). ALL report annual financial statements.

At the end of each year, balances in the revenue & expense accounts (nominal accounts & make up income statement) are transferred into the owner’s equity account (real account & part of the balance sheet.)

Question 25

When are financial statements prepared during a period?
Ex: 12 months

Answer 25

Question 26

Which are more detailed- nominal accounts or real accounts?

Answer 26

Nominal accounts give a more detailed look of owner’s equity as a whole.

At the end of the year net effect of the nominal accounts is transferred to RETAINED EARNINGS in what is called the CLOSING PROCESS. (This process updates the retained earnings to the current point in time and resets the balance in the nominal accounts to 0)

Question 27

INCOME STATEMENT

Answer 27

INCOME STATEMENT = FINANCIAL PERFORMANCE

The income statement shows the company’s financial performance because it shows the accumulation of all nominal accounts over a period of time, such as for the year ended December 31, 2014. This is a view into a period of time—think of a video, as opposed to a photograph. The income statement is sometimes referred to as the statement of profit or loss, or P&L.

Other definition: Summarizes the earnings of a business (revenues minus expenses) over a designated period of time. Shows activity during the period for all nominal accounts.

Question 28

How do Nominal Accounts Start and end?

Answer 28

Revenue - Expenses = Net Income

Question 29

What is the first section of the income Statement?

Answer 29

• *GROSS PROFIT**
• (Some companies don’t put this on their income statement- like* pepsi**)

Sales - Cost of Goods Sold = Gross Profit

Question 30

For the year 2012, suppose Cardullo’s Gourmet Shoppe had revenues of $1,100,000. Their income statement shows that Gross Profit was $500,000 and Other Expenses were $350,000.

What was Cardullo’s Cost of Goods Sold (COGS)?

Answer 30

$600,000

Question 31

For the year 2013, suppose Green Mountain Coffee Roasters had Net Revenue of $4.4 billion, $2.8 billion of Cost of Goods Sold (COGS) and $0.5 billion of selling and operating costs.

What is GMCR’s Gross Profit in the year?

Answer 31

1.6 billion

Question 32

What is the 2nd section of the income statement?

Answer 32

OPERATING INCOME

ACCOUNTS FOR ALL OF THE OPERATING EXPENSES - costs that the business incurs to run its normal operation

THE OPERATING INCOME SECTION- provides information of if the business is earning enough to cover the necessary expenses to operate.

Question 33

Which of the following would be considered operating expenses?

• Salaries & Wages
• Interest Expenses
• Selling, General, & Admin Expenses
• Marketing Expenses
• Research & Development
• Interest Income
• Loss on Disposal
• Other Operating Expenses
• Income Tax Expenses
• Depreciation
• Selling Expense

Answer 33

YES

• Salaries & wages
• Selling, General, & Admin Expenses
• Marketing expense
• Research & Development
• Other Operating Expenses
• Deprecation
• Selling Expense

NO
Interest Expenses are not operating since it is not incurred in a company’s normal operations. It will be shown after operating income.
Income Tax Expenses are not operating since it is not incurred in a company’s normal operations. It will be shown after operating income. ​
Interest Income
Loss on Disposal

Question 34

For 2012, suppose Cardullo’s had Gross Profit of $500,000 and the following expenses:

• Salaries and Wages Expense $200,000
• Building and Utilities Expense $80,000
• Other Operating Expenses $30,000
• Interest Expense $15,000
• Income Tax Expense $25,000
• Cost of Goods Sold (COGS) $500,000

What would be Cardullo’s Operating Income for 2012?

Answer 34

$190,000

Question 35

What is the 3rd section of the income statement?

Answer 35

OTHER INCOME & EXPENSES

• It’s common for businesses to engage in other business activities that aren’t it’s usual course of business. For example, a business might rent out a room in its warehouse for events. (this is NOT part of its normal business)
• This is the purpose of this section (to separate it from the other income/expenses)
• Interest Expenses are typically included here too!

Question 36

Suppose Hipzone’s Operating Income for 2014 was $2,042,000. Their income and expenses during the year include the following:

• Sales, General, & Admin Expense $2,397,000
• Interest Income $3,000
• Income Taxes $155,000
• Depreciation Expense $374,000

What was Hipzone’s Income Before Taxes for 2014?

Answer 36

$2,045,000

Income Before Taxes is equal to Operating Income adjusted for any non-operating activity.

In this example, S,G,& A and Depreciation Expenses are operating expenses that have already been deducted to arrive at Operating Income. Income Taxes will be deducted after Income Before Taxes. To get to Income Before Taxes, simply add Interest Income to Operating Income: $2,042,000 + $3,000 = $2,045,000

Question 37

Suppose there is a start-up service company that is growing fast. It has a positive Gross Profit, positive Operating Income, and negative Income Before Taxes. Is the negative Net Income sustainable in the long term?

Answer 37

NO

Suppose the company also has more Long Term Debt than Equity. What do you think the company should do to finance its growth opportunities?
The company should probably raise more money through equity.

If the company has positive gross profit, positive operating income, and negative net income, it means there are large non-operating expenses hitting the income statement between operating income and income before taxes. Knowing that the company has more long term debt than equity, it is likely that the large non-operating expense is interest expense. Equity capital is probably more appropriate financing for an early stage company and will help alleviate the high non-operating expenses.

Question 38

What is the 4th Section of the Income Statement?

Answer 38

NET INCOME
Subtracts the tax expense from profit before taxes. We obtain the tax expense by multiple profit before taxes by the income tax rate. The result is the Net Income.

NET INCOME = Revenue after all the expenses! It reveals whether the business is profitable.
In practice, determining the tax expense can be quite complicated.

Question 39

Which amount on the income statement do you think managers care the most about?

Answer 39

Net Income

Question 40

Suppose Green Mountain Coffee Roasters presents the following information in its 2012 financial statements:

• Net Sales $4.5B
• Cost of Sales $3B
• Income Tax Expense $0.2B
• General & Admin Expenses $0.4B
• Selling & Marketing Expenses $0.3B
• Interest Expense $0.2B

What would the Net Income be in this fiscal year?

Answer 40

$.4 B

To get Net Income, we need to subtract from Net Sales the Cost of Sales, all Operating and Admin Expenses as well as Interest and Tax Expense.

The calculation would be: $4.5B - 3B - 0.4B - 0.3B - 0.2B - 0.2B = $0.4B

Question 41

Suppose Hipzone had Net Income of $1,600,000 for the year 2011. They also had the following income and expenses:

• COGS $7,000,000
• SG&A Expense $2,100,000
• Other Non-Operating Income $100,000
• Interest Income $20,000
• Depreciation Expense $350,000
• Income Tax Expense $150,000

What would the Operating Income be for the year 2011?

Answer 41

$1,630,000

To get from Net Income to Operating Income, we need to add back the Tax Expense ($150,000) and eliminate the impact of any non-operating income or expenses ($20,000 Interest Income and $100,000 Other Income).

$1,600,000 +150,000 - 20,000 - 100,000 = $1,630,000

Question 42

What are the purposes of an income statement?

Answer 42

The income statement provides many useful insights into the financial performance of the business, and communicates key financial information to those interested. This information is used both by outside investors, such as those looking to invest in a company’s stock, and by management to analyze the results of the business’ operations.

Question 43

What are the 4 Sections of the Income Statement?

Answer 43

1. GROSS PROFIT- (((Sales - Cost of Goods Sold = Gross Profit)))
2. OPERATING INCOME
   ACCOUNTS FOR ALL OF THE OPERATING EXPENSES - costs that the business incurs to run its normal operation
   THE OPERATING INCOME SECTION- provides information of if the business is earning enough to cover the necessary expenses to operate.
3. OTHER INCOME & EXPENSES
   It’s common for businesses to engage in other business activities that aren’t it’s usual course of business. For example, a business might rent out a room in its warehouse for events. (this is NOT part of its normal business)
   This is the purpose of this section (to separate it from the other income/expenses)
   Interest Expenses are typically included here too!
4. NET INCOME = Revenue after all the expenses! It reveals whether the business is profitable.
   In practice, determining the tax expense can be quite complicated.

Question 44

What Categories do these items fall under in the trial balance sheet?

• SALES DISCOUNTS
• ACCESSORY PRODUCTS
• PRODUCT SHIPPING
• INSURANCE + UTILITIES

(We put them in smaller categories for the income statement)

Answer 44

• SALES DISCOUNTS = NET SALES
• ACCESSORY PRODUCTS = COST OF GOODS SOLD
• PRODUCT SHIPPING = COST OF GOODS SOLD
• INSURANCE + UTILITIES = GENERAL ADMINISTRATIVE EXPENSE

Question 45

What is a LOSS?

Answer 45

Loss

Similar to an expense, a loss reduces owners’ equity. However, a loss relates to some activity that is outside the normal operations of the business, such as the sale of a long-lived asset for less than its net book value.