Accounting Chapter 9 PDF

CHAPTER 9 W ell, you and your family had the best time on your trip! You got to order fancy desserts and eat at the sort of restaurants that your parents never take you to when you’re home. You got to watch lots of television in hotel rooms. You saw all sorts of wild stuff and spent whatever mone...

CHAPTER 9 W ell, you and your family had the best time on your trip! You got to order fancy desserts and eat at the sort of restaurants that your parents never take you to when you’re home. You got to watch lots of television in hotel rooms. You saw all sorts of wild stuff and spent whatever money your parents gave you. You even spent your own hard-earned money, on something that you promised yourself you’d keep forever. But now, you’re home. And—guess what?!—you have to go back to school in a couple of weeks. Summer’s almost over. Time to shake out the mental cobwebs and get ready for reading, writing, and math! In fact, with school just around the corner, you decide to quit the lemonade business, at least for this summer. Yes, sad to say, it’s time to close up shop, pay our bills, and complete your final statements. For starters, let’s look at our last Balance Sheet from last week and correct it for taxes for the summer. Because would we owe taxes on all the earnings? Yes. Here’s that last Balance Sheet, for review. 140 T H E AC C O U N T I N G GA M E $46.00 $32.00 $ 0.00 $ 1 6.00 $ 10 $ 0 $1 0.00 $ 3.00 $35.00 $ 2.00 $ 5.00 $12 $1 $ 1 1 .00 $52.00 $ 9 .00 $20 $4 $ 1 6.00 $66.00 $ 101.00 $ 101.00 Our pre-tax profit last week was $12 (add the $3 tax back into the $9 Earnings Week to Date) and the retained earnings were $52. Adding pre-tax profit and Retained Earnings, our total pretax earnings for the summer are $64. Figure 25 percent as our tax rate. So, our total tax liability is? $16.00. Now do the new Balance Sheet. 141 C H APTER 9 $46.00 $32.00 $ 0.00 $ 1 6.00 $ 10 $ 0 $1 0.00 $ 2.00 $ 5.00 $12 $1 $ 1 1 .00 $20 $4 $ 1 6.00 $52.00 $ 101.00 Are we going to leave those old and now very ugly lemons in the family refrigerator? No way! Mom and Dad want those lemons gone—and soon! We have another inventory system we have to look at. It’s called FISH. Which stands for, First In, Still Here. And in what condition? Rotten, very rotten. What do we need to do about those lemons? Throw them out. Right. But what do we need to do about those lemons, as far as accounting is concerned? Write them off. Let’s get rid of those lemons. What goes off the left side of the Balance Sheet? Inventory. And what will that reduce on the right side? Earnings. Go ahead. 142 T H E AC C O U N T I N G GA M E $32.00 $46.00 $ 0.00 $ 1 6.00 $ 14.00 $ 0 $ 0 $46.00 $ 0.00 $ 2.00 $ 5.00 $12 $1 $40.00 $ 1 1 .00 $ 0 . 00 $20 $4 $ 1 6.00 $45.00 $ 9 1 .00 $ 9 1 .00 Problem? If so, look at the tax liabilities as a likely source. Why? Would the $10 write off of inventory affect taxes? Yes. See if you can recalculate earnings and taxes (round off to the next dollar). BEFORE WRITE-OFF EARNINGS TAXES @ 25% $__________ $__________ AFTER WRITE-OFF EARNINGS TAXES @ 25% $__________ $__________ Now, if necessary, make any corrections to the last Balance Sheet. Are we in balance now? Yes. How are we going to write the inventory off on the Income Statement? You may say, “Expense them”—however, what’s our ending inventory now? Zero. C H APTER 9 Instead of expensing it, we are going to write it off…where? Ending Inventory. Reduce it to zero. We write it off in inventory because it’s the cost of our product or inventory. As a result, this week’s Income Statement would have higher Cost of Goods Sold and lower Gross Profit. Earlier, when we were doing our statements during these weeks, have we been a little creative about the value of our inventory? Yes. Have our assets possibly been overstated? Yes. Did the lemons go bad? Yes. Do you know exactly when they went bad? No, not exactly. We really don’t know if it was the second, third, or fourth week. True. So, when should we have written them off? Hard to say exactly. What should have happened the moment the lemons went bad? We should have thrown them away and written off the loss then. All that time when we went to our banker without statements, what were we doing? We were overstating or inflating the true value of our assets. By how much? $10.00. What else were we overstating? Our Earnings. Because we should have put what there for ending inventory? Zero, a long time ago. What happens if your inventory is widgets? Or nuts and bolts, or anything that is not perishable? And you want to know if it’s good or bad? If you went to the warehouse, what would you look for? Dust. And what else could you have on there? Cobwebs, maybe. If you’re planning to buy a company or loan money to a company and you’re going to go and look at inventory, what are you going to look for? Cobwebs and dust. And then, what are you going to know about that inventory? It’s old. And what else? It’s not selling very well! Now, let’s just say it’s your business, and you want to sell your business. And you’ve got this inventory, what are you going to do? For starters, clean it. Right, get the vacuum cleaner out. Move the inventory around the shelves to make sure you get all the dust off. You want it to look pristine. What have we here? Have we another area where people are sometimes creative? When you go to your Balance Sheet, how do you find out how much cash is in the business? You count it. 143 144 T H E AC C O U N T I N G GA M E How do you find out about the Accounts Receivables? You check the books or call the customers up to see if they agree how much they owe. Prepaid Insurance Policy? Read the policy to see what the dates are. The stand? Go out and look at it. Easy to determine if they’re still good or not, right? Right. Inventory, on the other hand, is the toughest part to determine when you’re buying or selling a business. This is where you need the most expertise and help, because lots of people get creative in how they present their inventory. If you’re ever in the position of buying or selling a business that involves inventory get an expert in to help determine its true value. Mom’s always harping about keeping our room clean. Especially if you’re ever trying to sell the house. The same is true in business. So, let’s clean up our Balance Sheet. How much do we owe our suppliers? $32.00. Let’s pay them. And let’s pay off our taxes of $14.00. Let’s collect the $16.00 dollars still due in receivables. Let’s also cancel the insurance policy and receive a $2 refund. Okay. On the next Balance Sheet, demonstrate where we stand at the end of the summer. $ 1 8.00 $ 0.00 $ 0.00 $ 0.00 $ 0 $ 0 $ 0.00 $ 0.00 $ 0.00 $ 0.00 $ 5.00 $12 $1 $ 1 1 .00 $40.00 $ 0.00 $20 $4 $ 1 6.00 $45.00 $ 45.00 $ 45.00 C H APTER 9 We still have our $5 original investment and $40 in earnings—for $45 in total equity. But we only have how much cash? $18.00. Again, you can see the lesson we learned earlier. You have $45 in Equity, but only $18 in Cash. And why is that? Because $27 in Equity is tied up in the building and the wagon. Still, are we in good shape for next year? Or, should we liquidate the building and wagon? It’s an option. It is an option. If you decide to stay in the lemonade business you are all set for next summer with your stand and wagon. Of course, the downside is you’ve only got $18 Cash—not that great. If you decide to liquidate the building and wagon you need to find a buyer, which could be difficult. That’s why these two are last in the order of Assets. In general, Assets are organized on the Balance Sheet in descending order of Liquidity. (Liquidity means how quickly something can be converted to cash.) If you sell the Fixed Assets for more than book value, you have to recognize the “gain” as profit. If they are sold for less than book value, you recognize the “loss.” Okay, do a final, Income Statement for the whole summer. To do this you need to get information from the previous five week’s income statements. 145 146 T H E AC C O U N T I N G GA M E YEAR-TO-DATE INCOME STATEMENT SALES Beginning Inventory + Purchases + Labor Total Available for Sale - Ending Inventory = C OST OF GO ODS SOLD GROSS PROFIT = EXPENSES Glass Rental • Advertising • Rent • Bad Debt • Interest • Insurance • Paint • Roof Repair • Depreciation • Salary • = TOTAL EXPENSES NET PROFIT BEFORE TAXES INC OME TAXES NET PROFIT AFTER TAXES Begin: End: $ $ $ $ So, is that the end of it? Is that the end of our lemonade business? Our plans to build a great commercial empire? No, not quite. Before we gear up for back to school, we need to do some analysis regarding what we accomplished this summer.