unit 8 Flashcards
what are retained earnings
- Cumulative amount of net income leftover after dividends have been paid to the shareholders
- A permanent account
- An equity line item on the balance sheet
- Has its own financial statement under ASPE
- Link between income statement and balance sheet (because of net income)
how does retain earnings connect income statement and balance sheet
net income on the income statement is added into the statement of retained earnings to calculate the new retained earnings, which are put into the balance sheet
what do retained earnings represent
Retained earnings represent cumulative earnings that haven’t been paid out to the owners
if there are no dividends declared what is retained earnings equal to
retained earnings = net income
what is the formula for retained earnings on the statement of retained earnings
Opening Retained Earnings +/- Net Income/Net Loss - Dividends = Closing Retained Earnings
what is accumulated deficit
- Cumulative losses overtime (if generating losses instead of income)
- Or also called just deficit
- Most common in newer companies (startups)
- Shows up on the balance sheet as an equity line item instead of “retained earnings”
what is Opening (Beginning of Period) Retained Earnings
- The closing retained earnings from the prior period
- If a company just went through its first year, opening = 0 because the company didn’t exist in the prior period
- Contains all of the companies past net income and dividends (cumulative)
what is net income/net loss on the statement fo RE
The net income/net loss for the period (+ net income, - net loss)
- add to opening if net income
- subtract from opening if net loss
what is dividends on the statement fo RE
- Represents amount of dividends declared to shareholders during the period
- If they are declared and not paid, dividend payable is recognized (accrued accounting)
what is Closing (End-of-Period) Retained Earnings
- The balance at the end of the period
- Factors all the net income/losses and dividends
- Retained earnings at any given point in time = closing retained earning balance at that time (a running total)
what is the journal entry to recognize dividends declared and not paid
DR dividends (SE)
CR dividends payable (L)
what is the natural balance of dividends
debit
(DEALER acronym)
what is the journal entry for when dividends are actually paid out
DR dividends payable (L)
CR Cash (A)
where are temporary accounts from the trial balance closed to
retained earnings account
- At the end of the year, revenue, and expense accounts are closed out into the retained earnings account (they are both temporary accounts)
- not net income bc its not a journal account
which financial statements does dividends show up on
retained earnings
trial balance
what is the natural balance of revenue
credit
what is the natural balance of expenses
debit
what is the natural balance of retained earnings
credit
what is the journal entry to close revenue and expense accounts at the end of the fiscal year
book entries in the opposite direction
so:
- revenue accounts are debited
- expense accounts are credited
revenue will = expenses
then since you are putting the stuff into retained earnings (adding), you credit the left over amount to retained earnings
this amount should = net income
then all revenue and expense accounts will have balances of 0
what is liquidity
- Term used to describe the ease/speed at which assets can be turned into cash
- Assets within each classification often appear in order of liquidity (not required)
- Cash is the most liquid; can be used immediately
what are current assets
Assets that are expected to be used (or received) within one year
what are long-term assets
Assets that are expected to be used (or received) longer than one year
what are cash equivalents
- Represent short-term investments that are highly liquid
- Investments typically mature in 90 days or less
- They are readily convertible to known amounts of cash
- Are subject to an insignificant risk of change in value
what are examples of cash equivalents
- Treasury bills: short-term bonds issued by the government
- Money market funds: a type of highly liquid, short-term mutual fund (that doesn’t invest in equities)
- Commercial paper: a type of short-term debt issued by corporations
what is the first line of current assets in the balance sheet
cash
sometimes “cash and cash equivalents”
what accounts usually follow cash in current assets
short-term investments
accounts receivable
inventory
prepaid expenses
what are short-term investments
Investments that typically mature or are sold within a period of 3-12 months
what are examples of short-term investments
Can include same types of investments that are considered cash equivalents & include the following if it matures in a year:
- Government Bonds (GICs): Type of debt issued by the government that typically carries the least risk when compared to other bonds
- Corporate Bonds: Type of debt issued by corporations to raise money
- Certificates of Deposit: Like savings account provided by the bank, but with a fixed time to maturity and often a fixed rate of interest
what is the point of short-term investments
allow the company to invest excess cash and earn income through the interest that the investments pay
what is the journal entry when purchasing a short-term investment
DR short-term investments (A)
CR cash (A)
what does the journal entry look like for interest earned from short-term investments, assuming the amount of interest earned every month is so small that the full amount is booked when the investment matures
Dr cash (A)
Cr short-term investments (A)
Cr interest income (NOI)
what are some other current asset accounts
- short term investments
- notes receivable
- prepaid expenses
what is notes receivable
- A written promise to receive a specified amount of money from another party at a future date, typically greater than 90 days, and with interest
- Like a more formal a/r
- A/r are informal, interest-free, and usually no longer than 30 days
- Notes receivable is like a formal legal contract with an interest rate, and the receipt of the principal plus interest
what is a creditor in terms of a note receivable
- The issuer or lender of the note
- Sets the rate of interest and terms of payment
what is a maturity date
The specified time the amount “loaned” (principal) is due
what is the journal entry for giving out a notes receivable
DR notes receivable (A)
CR revenue (R)
if a note receivable had interest that is paid every 4 months, and the principal of the note is due 8 months from the issue date, what does the journal entries for the look like for the first 4 months
at the end of the month, a month’s worth of interest is earned
DR interest receivable (A)
CR interest income (NOI)
the same journal entry is done for the next three 3 months
when the fourth month comes, interest is paid
DR cash (A) - total 4 months of interest
CR interest receivable (A) - amount of interest from the past 3 months
CR interest income (NOI) - the interest for the 4th month
if a note receivable had interest that is paid every 4 months, and the principal of the note is due 8 months from the issue date, what does the journal entries for the look like for the last 4 months
at the end of the month, a month’s worth of interest is earned
DR interest receivable (A)
CR interest income (NOI)
the same journal entry is done for the next three 3 months
when the last month comes, the interest and note is paid
DR Cash (A)
CR notes receivable (A)
CR interest receivable (A)
CR interest income (NOI)
what are prepaid expenses
- Expenses for which a company has paid for in advance
- Sometimes shown as “prepaids”
- Usually includes rent & insurance, which would be called prepaid rent & prepaid insurance
- If it is prepaid for a year, the benefits of it need to be spread out over the course of the year
what is the journal entry for when a prepaid is paid
DR prepaids (A)
CR cash (A)
what is the journal entry for a prepaid when a month has passed
DR expense the prepaid was for
CR Prepaid
the amount is one month’s worth of benefit
what is net working capital
- Difference between a company’s current assets & current liabilities
- Indicator of the company’s operating efficiency and short-term financial health
- If negative, should be a cause for concern
what is working capital ratio
current assets / current liabilities
if the ratio is below 1, it should be a cause for concern
what are the two main types of long-term assets
- Tangible; have a physical form (ex. Buildings & equipment)
- Intangible; don’t have a physical form (ex. Copyrights & software)
what are long-term (fixed) assets
- Assets that are expected to be used by the company for more than one year
- Are expected to help generate financial benefits for the company during their use
what are examples of tangible long-term assets
Land
Buildings
Factories
Equipment
Machinery
Vehicles
Furniture
what are examples of intangible long-term assets
Patents
Trademarks
Customer lists
Licenses
Copyrights
Software
what are the 3 criteria to determine if an asset is considered a PP&E
- Used in the production/supply of goods and services, for rental to others, for administrative purposes, or for the development, construction, maintenance, or repair of other PP&E
- Have been acquired, constructed, or developed with the intention of being used on a continuing basis
- Are not intended for sale in the ordinary course of business
which tangible assets are depreciated
all expect for land
what happens if tangible assets dont meet the PP&E criteria
they are recorded as assets - after the asset criteria
why is land, a tangible asset not depreciable
- Land is tangible, but not a depreciable asset (no associated accumulated depreciation)
- Long-term assets are depreciated because they have a time horizon (definite life)
- Land doesn’t have a definite life, it has an indefinite life, so it can’t be depreciated (when doing depreciation you do it based on estimated useful life, since land doesn’t have that it can’t be depreciated)
- Land instead appreciates value
where is the appreciated value of land recorded
- The appreciated value of land is not added into the land value
- Any appreciation in land value would be done as a gain on disposal from the sale of the land
what are intangible assets
- those that don’t have a physical form
- Usually are purchased and not made by the company
- If there are research & development costs, they are typically expensed in the period they are incurred in
- Intangibles can have finite lives (like tangible assets) or indefinite lives where the usability or value of the asset doesn’t decrease with time
what happens to intangibles with finite lives
they are amortized (like depreciation, but just called that)
what happens to intangibles with infinite lives
are not amortized
Instead, the need to be tested for impairment under ASPE (if events and changes in circumstances indicate that the carrying amount of the asset is not recoverable)
what is impairment
The state of an asset where its carrying value (value on the balance sheet) > fair value (how much it can be sold for in the market)
what is fair value
Fair market value. The amount two parties would agree to if transacting freely in an open market
what happens if intangibles with infinite lives are impaired
- When circumstances change that causes the company to believe the fair value < carrying value of an intangible asset, a test is conducted to verify
- If an asset is impaired, an impairment loss is booked
- Impairment losses can’t be reversed if the asset’s fair market value increases
what is the journal entry to recognixe an impairment loss
DR impairment loss - intangible assets (NOE)
CR intangible asset (A)
what is return on assets (ROA)
- An accounting performance measure that shows how effective a company’s assets are in generating net income
- How well management used its capital to generate income
- Expressed as a %
what does ROA measure
- how much benefit the company actually got from the assets
- The higher the ROA the better
what is the formula for ROA
Return on assets (ROA) = (Net income + interest expense) / average total assets
interest expense - from the income statement
average total assets = (total assets @ beginning of period + total assets @ end of period) / 2
