Survey of Accounting Chapter 19 PDF

Survey of Accounting Second Edition Kimmel Weygandt Chapter 19 Statement of Cash Flows This slide deck contains anim...

Survey of Accounting Second Edition Kimmel Weygandt Chapter 19 Statement of Cash Flows This slide deck contains animations. Please disable animations if they cause issues with your device. Copyright ©2020 John Wiley & Sons, Inc. Chapter Outline Learning Objectives LO 1 Discuss the usefulness and format of the statement of cash flows. LO 2 Prepare a statement of cash flows using the indirect method. LO 3 Use the statement of cash flows to evaluate a company. Copyright ©2020 John Wiley & Sons, Inc. 2 Learning Objective 1 Discuss the Usefulness and Format of the Statement of Cash Flows. LO1 Copyright ©2020 John Wiley & Sons, Inc. 3 Usefulness of the Statement of Cash Flows Provides information to help assess Entity’s ability to generate future cash flows. Entity’s ability to pay dividends and meet obligations. Reasons for difference between net income and net cash provided (used) by operating activities. Cash investing and financing transactions during the period. LO1 Copyright ©2020 John Wiley & Sons, Inc. 4 Classification of Cash Flows Operating Investing Financing Activities Activities Activities Income Changes in Changes in Long- Statement Items Investments and Term Liabilities and Long-Term Stockholders’ Assets Equity LO1 Copyright ©2020 John Wiley & Sons, Inc. 5 Classification of Cash Flows Operating activities—Income statement items Cash inflows: o From sale of goods or services. o From interest received and dividends received. Cash outflows: o To suppliers for inventory. o To employees for wages. o To government for taxes. o To lenders for interest. o To others for expenses. LO1 Copyright ©2020 John Wiley & Sons, Inc. 6 Classification of Cash Flows Investing activities—Changes in investments and long-term assets Cash inflows: o From sale of property, plant, and equipment. o From sale of investments in debt or equity securities. o From collection of principal on loans to other entities. Cash outflows: o To purchase property, plant, and equipment. o To purchase investments in debt or equity securities. o To make loans to other entities. LO1 Copyright ©2020 John Wiley & Sons, Inc. 7 Classification of Cash Flows Financing activities—Changes in long-term liabilities and stockholders’ equity Cash inflows: o From sale of common stock. o From issuance of debt (bonds and notes). Cash outflows: o To stockholders as dividends. o To redeem long-term debt or reacquire capital stock (treasury stock). LO1 Copyright ©2020 John Wiley & Sons, Inc. 8 Significant Noncash Activities Noncash activities examples: Direct issuance of common stock to purchase assets. Conversion of bonds into common stock. Issuance of debt to purchase assets. Exchanges of plant assets. Companies report noncash activities in either a Separate schedule (bottom of the statement) or Separate note or supplementary schedule to the financial statements. LO1 Copyright ©2020 John Wiley & Sons, Inc. 9 Format of the Statement of Cash Flows Company Name Statement of Cash Flows For the Period Covered Cash flows from operating activities (List of individual items) XX Net cash provided (used) by operating activities XXX Cash flows from investing activities (List of individual inflows and outflows) XX Net cash provided (used) by investing activities XXX Cash flows from financing activities (List of individual inflows and outflows) XX Net cash provided (used) by financing activities XXX Net increase (decrease) in cash XXX Cash at beginning of period XXX Cash at end of period XXX Noncash investing and financing activities (List of individual noncash transactions) XXX LO1 Copyright ©2020 John Wiley & Sons, Inc. 10 DO IT! 1: Classification of Cash Flows Illustration: Classify each of these transactions by type of cash flow activity. 1. Issued 100,000 shares of common stock at par for $800,000 cash. 2. Borrowed $200,000 from Castle Bank, signing a 5-year note bearing 8% interest. 3. Purchased two semi-trailer trucks for $170,000 cash. 4. Paid employees $12,000 for salaries and wages. 5. Collected $20,000 cash for services performed. LO1 Copyright ©2020 John Wiley & Sons, Inc. 11 Learning Objective 2 Prepare a Statement of Cash Flows Using the Indirect Method. LO2 Copyright ©2020 John Wiley & Sons, Inc. 12 Preparing the Statement of Cash Flows—Indirect Method Three sources of information. o Comparative balance sheets. o Current income statement. o Additional information. LO2 Copyright ©2020 John Wiley & Sons, Inc. 13 Steps to Prepare a Statement of Cash Flows – Step 1 Determine net cash provided/used by operating activities by converting net income from an accrual basis to a cash basis. Involves analyzing the current year's income statement, comparative balance sheets, and selected additional data. LO2 Copyright ©2020 John Wiley & Sons, Inc. 14 Steps to Prepare a Statement of Cash Flows – Step 2 Analyze changes in noncurrent asset and liability accounts and stockholders’ equity accounts and report as investing and financing activities, or disclose as noncash transactions. Involves analyzing comparative balance sheet data and selected additional information for their effects on cash. LO2 Copyright ©2020 John Wiley & Sons, Inc. 15 Steps to Prepare a Statement of Cash Flows – Step 3 Compare the net change in cash on the statement of cash flows with the change in the Cash account reported on the balance sheet to make sure the amounts agree. Difference between beginning and ending cash balances is easily computed from comparative balance sheets. LO2 Copyright ©2020 John Wiley & Sons, Inc. 16 Indirect and Direct Methods Companies favor the indirect method for two reasons: 1. Easier and less costly to prepare. 2. Focuses on differences between net income and net cash flow from operating activities. LO2 Copyright ©2020 John Wiley & Sons, Inc. 17 Indirect Method Computer Services Company Income Statement For the Year Ended December 31, 2022 Sales revenue $507,000 Cost of goods sold $150,000 Operating expenses (excluding depreciation) 111,000 Depreciation expense 9,000 Loss on disposal of plant assets 3,000 Interest expense 42,000 315,000 Income before income tax 192,000 Income tax expense 47,000 Net income $145,000 LO2 Copyright ©2020 John Wiley & Sons, Inc. 18 Indirect Method - Assets Computer Services Company Comparative Balance Sheets December 31 Assets 2022 2021 Change Current assets Cash $55,000 $33,000 $22,000 Increase Accounts receivable 20,000 30,000 10,000 Decrease Inventory 15,000 10,000 5,000 Increase Prepaid expenses 5,000 1,000 4,000 Increase Property, plant, and equipment Land 130,000 20,000 110,000 Increase Buildings 160,000 40,000 120,000 Increase Accum. depreciation-buildings (11,000) (5,000) 6,000 Increase Equipment 27,000 10,000 17,000 Increase Accum. depreciation-equipment (3,000) (1,000) 2,000 Increase Total assets $398,000 $138,000 LO2 Copyright ©2020 John Wiley & Sons, Inc. 19 Indirect Method - Liabilities and Equity Computer Services Company Comparative Balance Sheets December 31 Liabilities and Stockholders’ Equity 2022 2021 Change Current liabilities Blank Blank Blank Accounts payable $28,000 $12,000 $16,000 Increase Income taxes payable 6,000 8,000 2,000 Decrease Long-term liabilities Blank Blank Blank Blank Bonds payable 130,000 20,000 110,000 Increase Stockholders’ equity Blank Blank Blank Blank Common stock 70,000 50,000 20,000 Increase Retained earnings 164,000 48,000 116,000 Increase Total liabilities and stockholders’ equity $398,000 $138,000 Blank Blank LO2 Copyright ©2020 John Wiley & Sons, Inc. 20 Indirect Method Additional information 2022 1. Depreciation expense was comprised of $6,000 for building and $3,000 for equipment. 2. The company sold equipment with a book value of $7,000 (cost $8,000, less accumulated depreciation $1,000) for $4,000 cash. 3. Issued $110,000 of long-term bonds in direct exchange for land. 4. A building costing $120,000 was purchased for cash. Equipment costing $25,000 was also purchased for cash. 5. Issued common stock for $20,000 cash. 6. The company declared and paid a $29,000 cash dividend. LO2 Copyright ©2020 John Wiley & Sons, Inc. 21 Step 1: Operating Activities Determine net cash provided/used by operating activities by converting net income from an accrual basis to a cash basis. Three types of adjustments to net income (loss): o Add back noncash expenses. Depreciation, amortization, or depletion expense. o Deduct gains and add losses. o Analyze changes to noncash current asset and current liability accounts. LO2 Copyright ©2020 John Wiley & Sons, Inc. 22 Step 1: Operating Activities Depreciation Expense Although depreciation expense reduces net income, it does not reduce cash. The company must add it back to net income. Cash flows from operating activities Net income $145,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense 9,000 Net cash provided by operating activities $154,000 LO2 Copyright ©2020 John Wiley & Sons, Inc. 23 Step 1: Operating Activities Loss on Disposal of Plant Assets Companies report as a source of cash in the investing activities section the actual amount of cash received from the sale. Any loss on disposal is added to net income in operating section. Any gain on disposal is deducted from net income in operating section. LO2 Copyright ©2020 John Wiley & Sons, Inc. 24 Step 1: Operating Activities Computation of Loss on Disposal of Plant Assets Cost of equipment $ 8,000 Less: Accumulated depreciation 1,000 Book value at date of disposal 7,000 Proceeds from sale 4,000 Loss on disposal of plant assets $ 3,000 LO2 Copyright ©2020 John Wiley & Sons, Inc. 25 Step 1: Operating Activities Adjustment for Loss on Disposal of Plant Assets Cash flows from operating activities Net income $145,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense 9,000 Loss on disposal of plant assets 3,000 Net cash provided by operating activities $157,000 LO2 Copyright ©2020 John Wiley & Sons, Inc. 26 Step 1: Operating Activities Changes to Noncash Current Assets-Accounts Receivable When Accounts Receivable balance decreases, cash receipts are higher than revenue earned under accrual basis. Accounts Receivable 1/1/22 Balance $ 30,000 Sales revenue 507,000 Less: Receipts from customers 517,000 12/31/22 Balance $ 20,000 Amount of decrease in accounts receivable is added to net income LO2 Copyright ©2020 John Wiley & Sons, Inc. 27 Step 1: Operating Activities Adjustment for Change in Accounts Receivable Cash flows from operating activities Net income $145,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense 9,000 Loss on disposal of plant assets 3,000 Decrease in accounts receivable 10,000 Net cash provided by operating activities $167,000 LO2 Copyright ©2020 John Wiley & Sons, Inc. 28 Step 1: Operating Activities Changes to Noncash Current Assets-Inventory When Inventory balance increases, cost of merchandise purchased exceeds cost of goods sold. Inventory 1/1/22 Balance $ 10,000 Purchases 155,000 Less: Cost of goods sold 150,000 12/31/22 Balance $ 15,000 Company deducts increase in inventory from net income. LO2 Copyright ©2020 John Wiley & Sons, Inc. 29 Step 1: Operating Activities Adjustment for Change in Inventory Cash flows from operating activities Net income $145,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense 9,000 Loss on disposal of plant assets 3,000 Decrease in accounts receivable 10,000 Increase in inventory (5,000) Net cash provided by operating activities $162,000 LO2 Copyright ©2020 John Wiley & Sons, Inc. 30 Step 1: Operating Activities Changes to Noncash Current Assets - Prepaid Expenses When the Prepaid Expense balance increases: o Cash paid for expenses is higher than expenses reported on an accrual basis. o Increase is deducted from net income to arrive at net cash provided by operating activities. When the Prepaid Expense balance decreases: o Reported expenses are higher than the expenses paid. o Decrease is added to net income to arrive at net cash provided by operating activities. LO2 Copyright ©2020 John Wiley & Sons, Inc. 31 Step 1: Operating Activities Adjustment for Change in Prepaid Expenses Cash flows from operating activities Net income $145,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense 9,000 Loss on disposal of plant assets 3,000 Decrease in accounts receivable 10,000 Increase in inventory (5,000) Increase in prepaid expenses (4,000) Net cash provided by operating activities $158,000 LO2 Copyright ©2020 John Wiley & Sons, Inc. 32 Step 1: Operating Activities Changes in Current Liabilities - Accounts Payable and Income Tax Payable When Accounts Payable increases: o More in goods were received than paid for. o Increase is added to net income to determine net cash provided by operating activities. When Income Tax Payable decreases: o Income tax expense reported on the income statement is less than amount of taxes paid during period. o Decrease is subtracted from net income to determine net cash provided by operating activities. LO2 Copyright ©2020 John Wiley & Sons, Inc. 33 Step 1: Operating Activities Adjustments for Changes in Current Liabilities Cash flows from operating activities Net income $145,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense 9,000 Loss on disposal of plant assets 3,000 Decrease in accounts receivable 10,000 Increase in inventory (5,000) Increase in prepaid expenses (4,000) Increase in accounts payable 16,000 Decrease in income taxes payable (2,000) Net cash provided by operating activities $172,000 LO2 Copyright ©2020 John Wiley & Sons, Inc. 34 Summary of Conversion to Net Cash Provided by Operating Activities— Indirect Method Adjustment Required to Convert Net Income to Net Cash Provided by Blank Blank Operating Activities Noncash Depreciation expense Add Charges Amortization expense Add Gains Loss on disposal of plant assets Add and Losses Gain on disposal of plant assets Deduct Changes in Increase in current asset account Deduct Current Assets Decrease in current asset account Add and Increase in current liability account Add Current Liabilities Decrease in current liability account Deduct LO2 Copyright ©2020 John Wiley & Sons, Inc. 35 Operating Activities Review Question Which is an example of a cash flow from an operating activity? a. Payment of cash to lenders for interest b. Receipt of cash from the sale of capital stock c. Payment of cash dividends to the company’s stockholders d. None of the above LO2 Copyright ©2020 John Wiley & Sons, Inc. 36 Operating Activities Review Question Answer Which is an example of a cash flow from an operating activity? a. Payment of cash to lenders for interest b. Receipt of cash from the sale of capital stock c. Payment of cash dividends to the company’s stockholders d. None of the above LO2 Copyright ©2020 John Wiley & Sons, Inc. 37 DO IT! 2a: Cash from Operating Activities Josh’s PhotoPlus reported net income of $73,000 for 2022. Included in the income statement were depreciation expense of $7,000 and a gain on disposal of plant assets of $2,500. Josh’s comparative balance sheets show the following balances. 12/31/21 12/31/22 Accounts receivable $17,000 $21,000 Accounts payable 6,000 2,200 Calculate net cash provided by operating activities for Josh’s PhotoPlus. LO2 Copyright ©2020 John Wiley & Sons, Inc. 38 DO IT! 2a: Cash from Operating Activities - Solution Calculate net cash provided by operating activities. Cash flows from operating activities Blank Net income $73,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense 7,000 Gain on disposal of plant assets (2,500) Increase in accounts receivable (4,000) Decrease in accounts payable (3,800) Net cash provided by operating activities $69,700 LO2 Copyright ©2020 John Wiley & Sons, Inc. 39 Step 2: Investing and Financing Activities Increase in Land Company purchased land of $110,000 by issuing long-term bonds. Land 1/1/22 Balance $ 20,000 Purchase 110,000 12/31/22 Balance $ 130,000 Bonds Payable 1/1/22 Balance $ 20,000 Issuance 110,000 12/31/22 Balance $ 130,000 LO2 Copyright ©2020 John Wiley & Sons, Inc. 40 Step 2: Investing and Financing Activities Disclosure of Noncash Investing and Financing Activities Partial Statement: Cash flows from financing activities: Issuance of common stock $ 20,000 Payment of cash dividends (29,000) Net cash provided by financing activities (9,000) Net increase in cash 22,000 Cash at beginning of period 33,000 Cash at end of period $ 55,000 Noncash investing and financing activities Issuance of bonds payable to purchase land $110,000 LO2 Copyright ©2020 John Wiley & Sons, Inc. 41 Step 2: Investing and Financing Activities Increase in Building From the additional information, the company acquired an office building for $120,000 cash. Cash outflow reported in the investing section. Buildings 1/1/22 Balance $ 40,000 Purchase 120,000 12/31/22 Balance $ 160,000 LO2 Copyright ©2020 John Wiley & Sons, Inc. 42 Step 2: Investing and Financing Activities Disclosure of Purchase of Building Cash flows from investing activities: Purchase of building (120,000) Purchase of equipment (25,000) Sale of equipment 4,000 Net cash provided by investing activities (141,000) Cash flows from financing activities: Issuance of common stock 20,000 Payment of cash dividends (29,000) Net cash provided by financing activities (9,000) Net increase in cash 22,000 Cash at beginning of period 33,000 Cash at end of period $ 55,000 LO2 Copyright ©2020 John Wiley & Sons, Inc. 43 Step 2: Investing and Financing Activities Increase in Equipment The equipment increase resulted from two transactions: (1) a purchase of equipment of $25,000, and (2) the sale for $4,000 of equipment costing $8,000. Equipment 1/1/22 Balance $ 10,000 Purchase of equipment 25,000 Less: Cost of equipment sold 8,000 12/31/22 Balance $ 27,000 LO2 Copyright ©2020 John Wiley & Sons, Inc. 44 Step 2: Investing and Financing Activities Disclosure of Purchase and Sale of Equipment Cash flows from investing activities: Purchase of building (120,000) Purchase of equipment (25,000) Sale of equipment 4,000 Net cash provided by investing activities (141,000) Cash flows from financing activities: Issuance of common stock 20,000 Payment of cash dividends (29,000) Net cash provided by financing activities (9,000) Net increase in cash 22,000 Cash at beginning of period 33,000 Cash at end of period $ 55,000 LO2 Copyright ©2020 John Wiley & Sons, Inc. 45 Step 2: Investing and Financing Activities Increase in Common Stock The increase in common stock resulted from the issuance of new shares. Common Stock 1/1/22 Balance $ 50,000 Shares sold 20,000 12/31/22 Balance $ 70,000 LO2 Copyright ©2020 John Wiley & Sons, Inc. 46 Step 2: Investing and Financing Activities Disclosure of Issuance of Common Stock Net cash provided by investing activities (141,000) Cash flows from financing activities: Issuance of common stock 20,000 Payment of cash dividends (29,000) Net cash provided by financing activities (9,000) Net increase in cash 22,000 Cash at beginning of period 33,000 Cash at end of period $ 55,000 LO2 Copyright ©2020 John Wiley & Sons, Inc. 47 Step 2: Investing and Financing Activities Increase in Retained Earnings Retained earnings increased $116,000 during the year. Explained by two factors o Net income of $145,000 increased retained earnings. o Dividends of $29,000 decreased retained earnings. Retained Earnings 1/1/22 Balance $ 48,000 Net income 145,000 Less: Dividends declared 29,000 12/31/22 Balance $ 164,000 LO2 Copyright ©2020 John Wiley & Sons, Inc. 48  Step 2: Investing and Financing Activities Net Income and Payment of Cash Dividends Cash flows from operating activities: Net income $145,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense 9,000 Loss on disposal of plant assets 3,000 Decrease in accounts receivable 10,000 Increase in inventory (5,000) Increase in prepaid expenses (4,000) Increase in accounts payable 16,000 Decrease in income taxes payable (2,000) Net cash provided by operating activities 172,000 Cash flows from investing activities: Purchase of building (120,000) Purchase of equipment (25,000) Sale of equipment 4,000 Net cash provided by investing activities (141,000) Cash flows from financing activities: Issuance of common stock 20,000 Payment of cash dividends (29,000) Net cash provided by financing activities (9,000) LO2 Copyright ©2020 John Wiley & Sons, Inc. 49 Step 3: Net Change in Cash Compare the net change in cash on the statement of cash flows with the change in the cash account reported on the balance sheet to make sure the amounts agree. Computer Services Company Comparative Balance Sheets (partial) December 31 Assets 2022 2021 Change Current assets Cash $55,000 $33,000 $22,000 Increase Accounts receivable 20,000 30,000 10,000 Decrease Inventory 15,000 10,000 5,000 Increase LO2 Copyright ©2020 John Wiley & Sons, Inc. 50 Learning Objective 3 Use the Statement of Cash Flows to Evaluate a Company. LO3 Copyright ©2020 John Wiley & Sons, Inc. 51 The Corporate Life Cycle LO3 Copyright ©2020 John Wiley & Sons, Inc. 52 Analyzing the Statement of Cash Flows Free Cash Flow Describes the cash remaining from operations after adjustment for capital expenditures and dividends. Net Cash Free Cash Provided by Capital Cash = − − Flow Operating Expenditures Dividends Activities LO3 Copyright ©2020 John Wiley & Sons, Inc. 53 Free Cash Flow Apple’s Cash Flow Information Apple Inc. Statement of Cash Flows Information (partial) For the Year Ended September 28, 2019 Net cash provided by operating activities $ 69,391 Cash provided by investing activities Blank Purchases of marketable securities (39,630) Proceeds from maturities of marketable securities 40,102 Proceeds from sales of marketable securities 56,988 Payments for acquisition of property, plant and equipment (10,495) Payment made in connection with business acquisitions, net (624) Purchases of non-marketable securities (1,001) Proceeds from non-marketable securities 1,634 Other (1,078) Cash generated by/(used in) investing activities $ 45,896 Cash paid for dividends $ (14,119) LO3 Copyright ©2020 John Wiley & Sons, Inc. 54 Free Cash Flow Calculation of Apple’s Free Cash Flow Net cash provided by operating activities $69,391 Less: Expenditures on property, plant, and equipment 10,495 Dividends paid 14,119 Free cash flow $44,777 LO3 Copyright ©2020 John Wiley & Sons, Inc. 55 Price to Cash Flow Variant of the price to earnings (P-E) ratio: Divides the company’s stock price by its cash flow per share. A high measure suggests that the stock price is high relative to the company’s ability to generate cash. A low measure indicates that the company’s stock might be a bargain. LO3 Copyright ©2020 John Wiley & Sons, Inc. 56  Survey of Accounting Second Edition Kimmel Weygandt Chapter 6 Merchandising Operations and the Multiple-Step Income Statement Prepared by Diane Fisico Seneca College This slide deck contains animations. Please disable animations if they cause issues with your device. Copyright ©2020 John Wiley & Sons, Inc. Chapter Outline Learning Objectives LO 1 Describe inventory systems and record purchases under a perpetual inventory system. LO 2 Record sales under a perpetual inventory system. LO 3 Prepare a multiple-step income statement. LO 4 Compute and analyze gross profit rate and profit margin. Copyright ©2020 John Wiley & Sons, Inc. 2 Learning Objective 1 Describe Inventory Systems and Record Purchases Under a Perpetual Inventory System LO 1 Copyright ©2020 John Wiley & Sons, Inc. 3 Merchandising Operations and Inventory Purchases Merchandising Companies Buy and Sell Goods The primary source of revenues is referred to as sales revenue or sales. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 4 Merchandising Company Income Measurement Cost of goods sold is the total cost of merchandise sold during the period. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 5 Flow of Costs Companies use either a perpetual inventory system or a periodic inventory system to account for inventory. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 6 Flow of Costs Perpetual System Maintain detailed records of the cost of each inventory purchase and sale. Records continuously show inventory that should be on hand for every item. Company determines cost of goods sold each time a sale occurs. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 7 Flow of Costs Periodic System Does not keep detailed records of goods on hand. Cost of goods sold determined by count. Calculation of Cost of Goods Sold: Beginning inventory $100,000 Add: Purchases, net 800,000 Goods available for sale 900,000 Less: Ending inventory (physical count) 125,000 Cost of goods sold $775,000 LO 1 Copyright ©2020 John Wiley & Sons, Inc. 8 Flow of Costs Combined Use of Perpetual and Periodic Systems Many companies use a perpetual system to record purchases and sales of inventory on a day-to-day basis. At the end of the period, they perform a physical count of their inventory, combined with the periodic approach, to determine the final values of ending inventory and cost of goods sold. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 9 Recording Purchases Under a Perpetual Inventory System Made using cash or credit (on account). Normally record when goods received from seller. Purchase invoice should support each credit purchase. Cash purchase should be supported by a canceled check or a cash register receipt. Companies record cash purchases by an increase in Inventory and a decrease in Cash. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 10 Recording Purchases Under a Perpetual System Illustration: Suppose Sauk Stereo received an invoice from PW Audio Supply for goods with a purchase price to Sauk Stereo of $3,800. Sauk Stereo increases Inventory and increases Accounts Payable. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 11 Recording Purchases Under a Perpetual System Solution Illustration: Suppose Sauk Stereo received an invoice from PW Audio Supply for goods with a purchase price to Sauk Stereo of $3,800. Sauk Stereo increases Inventory and increases Accounts Payable. This event is recorded as follows. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 12 Freight Costs Seller places the goods free on Seller places the goods free on board the carrier, and the buyer board to the buyer’s place of pays the freight costs. business, and the seller pays the freight. Freight costs incurred by the seller are an operating expense. FOB- free on board LO 1 Copyright ©2020 John Wiley & Sons, Inc. 13 Freight Costs Incurred by the Buyer When the buyer incurs the transportation costs, these costs are considered part of the cost of purchasing inventory. Assume Sauk Stereo (the buyer) pays Public Carrier Co. $150 for freight charges on May 6. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 14 Freight Costs Incurred by the Buyer Solution When the buyer incurs the transportation costs, these costs are considered part of the cost of purchasing inventory. Assume Sauk Stereo (the buyer) pays Public Carrier Co. $150 for freight charges on May 6, the event is recorded by Sauk Stereo as follows. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 15 Freight Costs Incurred by the Buyer Summary Freight costs incurred by the buyer are part of the cost of merchandise purchased. Inventory cost should include all costs to acquire the inventory, including freight necessary to deliver the goods to the buyer. Companies recognize these costs as cost of goods sold when inventory is sold. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 16 Freight Costs Incurred by the Seller Freight costs incurred by the seller on outgoing merchandise are an operating expense to the seller (Freight-Out or Delivery Expense). Assume the seller (PW Audio Supply) pays the $150 freight charges for Sauk Stereo’s purchase. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 17 Freight Costs Incurred by the Seller Solution Freight costs incurred by the seller on outgoing merchandise are an operating expense to the seller (Freight-Out or Delivery Expense). Assume the seller (PW Audio Supply) pays the $150 freight charges for Sauk Stereo’s purchase, the event is recorded by PW Audio Supply as follows. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 18 Purchase Returns Versus Purchase Allowances Purchaser may be dissatisfied because goods are damaged or defective, of inferior quality, or do not meet specifications. Purchase Return Return goods for credit if the sale was made on credit, or for a cash refund if the purchase was for cash. Purchase Allowance May choose to keep the merchandise if the seller will grant a reduction of the purchase price. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 19 Purchase Returns and Allowances Illustration: Assume that Sauk Stereo returned goods costing $300 to PW Audio Supply on May 8. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 20 Purchase Returns and Allowances Solution Illustration: Assume that Sauk Stereo returned goods costing $300 to PW Audio Supply on May 8. Sauk Stereo records the returned merchandise as follows. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 21 Purchase Returns and Allowances Review Question In a perpetual inventory system, a return of defective merchandise by a purchaser is recorded by crediting: a. Purchases b. Purchase Returns c. Purchase Allowance d. Inventory LO 1 Copyright ©2020 John Wiley & Sons, Inc. 22 Purchase Returns and Allowances Review Question Answer In a perpetual inventory system, a return of defective merchandise by a purchaser is recorded by crediting: a. Purchases b. Purchase Returns c. Purchase Allowance d. Inventory LO 1 Copyright ©2020 John Wiley & Sons, Inc. 23 Purchase Discounts Advantages Credit terms may permit buyer to claim a cash discount for prompt payment. Advantages: Purchaser saves money. Seller converts the accounts receivable into cash more quickly. Example: Credit terms may read 2/10, n/30. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 24 Purchase Discounts Examples 2/10, n/30 2% discount if paid within 10 days, otherwise net amount due within 30 days. 1/10 EOM 1% discount if paid within first 10 days of next month. n/10 EOM Net amount due within the first 10 days of the next month. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 25 Purchase Discounts Payment on May 14 Illustration: Assume Sauk Stereo pays the balance due of $3,500 (gross invoice price of $3,800 less purchase returns and allowances of $300) on May 14, the last day of the discount period. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 26 Purchase Discounts Payment on May 14 Solution Illustration: Assume Sauk Stereo pays the balance due of $3,500 (gross invoice price of $3,800 less purchase returns and allowances of $300) on May 14, the last day of the discount period. Sauk Stereo records the payment as follows. *(Discount = $3,500 × 2% = $70) LO 1 Copyright ©2020 John Wiley & Sons, Inc. 27 Purchase Discounts Payment on June 3 Illustration: Assume Sauk Stereo failed to take the discount and instead made full payment of $3,500 on June 3. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 28 Purchase Discounts Payment on June 3 Solution Illustration: Assume Sauk Stereo failed to take the discount and instead made full payment of $3,500 on June 3, Sauk would record the transaction as follows. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 29 Purchase Discounts Should discounts be taken when offered? Discount of 2% on $3,500 $ 70.00 $3,500 invested at 10% for 20 days 19.18 Savings by taking the discount $ 50.82 Example: 2% for 20 days = Annual rate of 36.5% 2% × (365 ÷ 20) = 36.5% LO 1 Copyright ©2020 John Wiley & Sons, Inc. 30 Summary of Purchasing Transactions The following tabular summary provides a summary of the effect of the previous transactions on Inventory. This results in a balance in Inventory of $3,580. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 31 DO IT! 2: Purchase Transactions On September 5, De La Hoya Company buys merchandise on account from Junot Diaz Company. The purchase price of the goods paid by De La Hoya is $1,500, and the cost to Diaz Company was $800. On September 8, De La Hoya returns defective goods with a selling price of $200. Use a tabular summary to record the transactions on the books of De La Hoya Company. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 32 DO IT! 2: Purchase Transactions Inventory Purchase On September 5, De La Hoya Company buys merchandise on account from Junot Diaz Company. The purchase price of the goods paid by De La Hoya is $1,500, and the cost to Diaz Company was $800. On September 8, De La Hoya returns defective goods with a selling price of $200. Use a tabular summary to record the transactions on the books of De La Hoya Company. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 33 DO IT! 2: Purchase Transactions Purchase Return On September 5, De La Hoya Company buys merchandise on account from Junot Diaz Company. The purchase price of the goods paid by De La Hoya is $1,500, and the cost to Diaz Company was $800. On September 8, De La Hoya returns defective goods with a selling price of $200. Use a tabular summary to record the transactions on the books of De La Hoya Company. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 34 Learning Objective 2 Record Sales Under a Perpetual Inventory System LO 2 Copyright ©2020 John Wiley & Sons, Inc. 35 Recording Sales Under a Perpetual Inventory System Sales may be made on credit or for cash. Sales revenue, like service revenue, is recorded when the performance obligation is satisfied. Performance obligation is satisfied when goods are transferred from seller to buyer. Sales invoice should support each credit sale. Invoice shows the date of sale, customer name, total sales price, and other relevant information. LO 2 Copyright ©2020 John Wiley & Sons, Inc. 36 Recording Sales For each sale, the seller: 1. Increases Accounts Receivable or Cash, as well as Sales Revenue. 2. Increases Cost of Goods Sold and decreases Inventory. Inventory account will show at all times the amount of inventory that should be on hand. LO 2 Copyright ©2020 John Wiley & Sons, Inc. 37 Recording Sales Sales Revenue PW Audio Supply sold inventory to Sauk Stereo for $3,800. These goods had a cost to PW Audio Supply of $2,400. LO 2 Copyright ©2020 John Wiley & Sons, Inc. 38 Recording Sales Sales Revenue Solution PW Audio Supply sold inventory to Sauk Stereo for $3,800. These goods had a cost to PW Audio Supply of $2,400. PW Audio Supply records the sale to Sauk Stereo as follows. LO 2 Copyright ©2020 John Wiley & Sons, Inc. 39 Recording Sales Cost of Goods Sold Solution PW Audio Supply sold inventory to Sauk Stereo for $3,800. These goods had a cost to PW Audio Supply of $2,400. PW Audio Supply records the sale to Sauk Stereo as follows. LO 2 Copyright ©2020 John Wiley & Sons, Inc. 40 Sales Returns and Allowances Purchaser may be dissatisfied with the merchandise received. Seller either accepts goods back (a return) or Grants a reduction in the purchase price (an allowance) so that the buyer will keep the goods. Seller records these as sales returns and allowances. Sales Returns and Allowances is subtracted from sales revenue on the income statement to determine net sales. LO 2 Copyright ©2020 John Wiley & Sons, Inc. 41 Sales Returns and Allowances (continued) Purchaser may be dissatisfied with the merchandise received. Company also decreases Accounts Receivable at the selling price. If goods are returned, Inventory is increased and Cost of Goods Sold is decreased for the cost of the goods. If the goods were defective, seller would then reduce the Inventory account to reflect their decline in value. LO 2 Copyright ©2020 John Wiley & Sons, Inc. 42 Sales Returns and Allowances Selling Price of Returned Goods Illustration: Assume PW Audio Supply received returned goods that had a selling price of $300 and a cost of $140. LO 2 Copyright ©2020 John Wiley & Sons, Inc. 43 Sales Returns and Allowances Selling Price of Returned Goods Solution Illustration: Assume PW Audio Supply received returned goods that had a selling price of $300 and a cost of $140, it would be recorded as follows. LO 2 Copyright ©2020 John Wiley & Sons, Inc. 44 Sales Returns and Allowances Cost of Goods Returned Solution Illustration: If PW Audio Supply received returned goods that had a selling price of $300 and a cost of $140, it would be recorded as follows. LO 2 Copyright ©2020 John Wiley & Sons, Inc. 45 Sales Returns and Allowances Review Question The cost of goods sold is determined and recorded each time a sale occurs in: a. periodic inventory system only. b. a perpetual inventory system only. c. both a periodic and perpetual inventory system. d. neither a periodic nor perpetual inventory system. LO 2 Copyright ©2020 John Wiley & Sons, Inc. 46 Sales Returns and Allowances Review Question Answer The cost of goods sold is determined and recorded each time a sale occurs in: a. periodic inventory system only. b. a perpetual inventory system only. c. both a periodic and perpetual inventory system. d. neither a periodic nor perpetual inventory system. LO 2 Copyright ©2020 John Wiley & Sons, Inc. 47 Sales Discounts Offered to customers to promote prompt payment. Subtracted from revenues on the income statement to determine net sales. Illustration: PW Audio Supply records the cash receipt on May 14 from Sauk Stereo within the discount period. LO 2 Copyright ©2020 John Wiley & Sons, Inc. 48 Sales Discounts Solution Offered to customers to promote prompt payment. Subtracted from revenues on the income statement to determine net sales. Illustration: PW Audio Supply records the cash receipt on May 14 from Sauk Stereo within the discount period as follows. LO 2 Copyright ©2020 John Wiley & Sons, Inc. 49 Data Analytics and Credit Sales Effectively analyzing data regarding current as well as potential customers can help a company expand its sales base while minimizing the risk of unpaid receivables. Companies such as Best Buy, REI, and Costco have all refined their customer return policies as a result of data analytics applied to their data. Companies statistically analyze past discount practices to determine how large the discount should be, how long the payment period should be, and other factors. LO 2 Copyright ©2020 John Wiley & Sons, Inc. 50 DO IT! 3: Purchase Transactions On September 20, De La Hoya sells on account merchandise with a cost of $750 to Marin Inc. for $1,100 cash. On September 25, De La Hoya receives returned goods from Marin that had a selling price of $200 and a cost of $150. Use a tabular summary to record the transactions for the books of De La Hoya Company. LO 2 Copyright ©2020 John Wiley & Sons, Inc. 51 DO IT! 3: Purchase Transactions Sale of Merchandise On September 20, De La Hoya sells on account merchandise with a cost of $750 to Marin Inc. for $1,100 cash. On September 25, De La Hoya receives returned goods from Marin that had a selling price of $200 and a cost of $150. Use a tabular summary to record the transactions for the books of De La Hoya Company. LO 2 Copyright ©2020 John Wiley & Sons, Inc. 52 DO IT! 3: Purchase Transactions Cost of Goods Sold On September 20, De La Hoya sells on account merchandise with a cost of $750 to Marin Inc. for $1,100 cash. On September 25, De La Hoya receives returned goods from Marin that had a selling price of $200 and a cost of $150. Use a tabular summary to record the transactions for the books of De La Hoya Company. LO 2 Copyright ©2020 John Wiley & Sons, Inc. 53 DO IT! 3: Purchase Transactions Sales Returns On September 20, De La Hoya sells on account merchandise with a cost of $750 to Marin Inc. for $1,100 cash. On September 25, De La Hoya receives returned goods from Marin that had a selling price of $200 and a cost of $150. Use a tabular summary to record the transactions for the books of De La Hoya Company. LO 2 Copyright ©2020 John Wiley & Sons, Inc. 54 DO IT! 3: Purchase Transactions Cost of Goods Returned On September 20, De La Hoya sells on account merchandise with a cost of $750 to Marin Inc. for $1,100 cash. On September 25, De La Hoya receives returned goods from Marin that had a selling price of $200 and a cost of $150. Use a tabular summary to record the transactions for the books of De La Hoya Company. LO 2 Copyright ©2020 John Wiley & Sons, Inc. 55 Learning Objective 3 Prepare a Multiple-Step Income Statement LO 3 Copyright ©2020 John Wiley & Sons, Inc. 56 Multiple-Step Income Statement Highlights the components of net income Three important line items: 1. Gross profit. 2. Income from operations. 3. Net income. LO 3 Copyright ©2020 John Wiley & Sons, Inc. 57 Multiple-Step Income Statement Example LO 3 Copyright ©2020 John Wiley & Sons, Inc. 58 Multiple-Step Income Statement Sales LO 3 Copyright ©2020 John Wiley & Sons, Inc. 59 Multiple-Step Income Statement Gross Profit LO 3 Copyright ©2020 John Wiley & Sons, Inc. 60 Multiple-Step Income Statement Operating Expenses LO 3 Copyright ©2020 John Wiley & Sons, Inc. 61 Multiple-Step Income Statement Nonoperating Activities LO 3 Copyright ©2020 John Wiley & Sons, Inc. 62 Nonoperating Activities Revenues and expenses and gains and losses unrelated to company’s main line of operations. Examples include: Other Revenues and Gains Interest revenue from notes receivable and marketable securities. Dividend revenue from investments in capital stock. Rent revenue from subleasing a portion of the store. Gain from the sale of property, plant, and equipment. Other Expenses and Losses Interest expense on notes and loans payable. Casualty losses from such causes as vandalism and accidents. Loss from sale of property, plant, and equipment. Loss from strikes by employees and suppliers. LO 3 Copyright ©2020 John Wiley & Sons, Inc. 63 Multiple-Step Income Statement Net Income LO 3 Copyright ©2020 John Wiley & Sons, Inc. 64 Multiple-Step Income Statement Review Question The multiple-step income statement for a merchandiser shows each of the following features except: a. gross profit. b. cost of goods sold. c. a sales revenue section. d. investing activities section. LO 3 Copyright ©2020 John Wiley & Sons, Inc. 65 Multiple-Step Income Statement Review Question Answer The multiple-step income statement for a merchandiser shows each of the following features except: a. gross profit. b. cost of goods sold. c. a sales revenue section. d. investing activities section. LO 3 Copyright ©2020 John Wiley & Sons, Inc. 66 DO IT! 3: Multiple-Step Income Statement The following information is available for Art Center Corp. for the year ended December 31, 2022. Other revenues and gains $8,000 Sales revenue $462,000 Other expenses and losses 3,000 Operating expenses 187,000 Cost of goods sold 147,000 Sales discounts 20,000 Prepare a multiple-step income statement for Art Center Corp. The company has a tax rate of 25%. LO 3 Copyright ©2020 John Wiley & Sons, Inc. 67 DO IT! 3: Multiple-Step Income Statement Sales Prepare a multiple-step income statement. Tax rate is 25%. LO 3 Copyright ©2020 John Wiley & Sons, Inc. 68 DO IT! 3: Multiple-Step Income Statement Net Sales Prepare a multiple-step income statement. Tax rate is 25%. LO 3 Copyright ©2020 John Wiley & Sons, Inc. 69 DO IT! 3: Multiple-Step Income Statement Gross Profit Prepare a multiple-step income statement. Tax rate is 25%. LO 3 Copyright ©2020 John Wiley & Sons, Inc. 70 DO IT! 3: Multiple-Step Income Statement Income from Operations Prepare a multiple-step income statement. Tax rate is 25%. LO 3 Copyright ©2020 John Wiley & Sons, Inc. 71 DO IT! 3: Multiple-Step Income Statement Income Before Income Taxes Prepare a multiple-step income statement. Tax rate is 25%. LO 3 Copyright ©2020 John Wiley & Sons, Inc. 72 DO IT! 3: Multiple-Step Income Statement Net Income Prepare a multiple-step income statement. Tax rate is 25%. LO 3 Copyright ©2020 John Wiley & Sons, Inc. 73 Learning Objective 4 Compute and Analyze Gross Profit Rate and Profit Margin LO 4 Copyright ©2020 John Wiley & Sons, Inc. 74 Gross Profit Rate May be expressed as a percentage by dividing the amount of gross profit by net sales. Analysts generally consider the gross profit rate to be more informative than the gross profit amount. Helps companies decide if the prices of their goods are in line with changes in the cost of inventory. LO 4 Copyright ©2020 John Wiley & Sons, Inc. 75 Gross Profit Rate by Industry LO 4 Copyright ©2020 John Wiley & Sons, Inc. 76 Gross Profit Rate Examples The gross profit rate often differs across retailers because of differences in the nature of their goods. LO 4 Copyright ©2020 John Wiley & Sons, Inc. 77 Profit Margin Measures the percentage of each dollar of sales that results in net income. How do the gross profit rate and profit margin ratio differ? Gross profit rate measures the margin by which selling price exceeds cost of goods sold. Profit margin ratio measures the extent by which selling price covers all expenses (including cost of goods sold). LO 4 Copyright ©2020 John Wiley & Sons, Inc. 78 Profit Margins by Industry LO 4 Copyright ©2020 John Wiley & Sons, Inc. 79 Profit Margin Examples A change in the profit margin can be caused by a change in the gross profit rate, a change in the amount of operating expenses relative to sales, or a change in the amount of other items relative to sales. LO 4 Copyright ©2020 John Wiley & Sons, Inc. 80 DO IT! 4: Gross Profit Rate Rachel Rose, Inc. reported the following in its income statements. 2022 2021 Net sales $80,000 $120,000 Cost of goods sold 40,000 60,000 Operating expenses 19,000 36,000 Income tax expense 3,000 4,000 Net income $18,000 $20,000 Determine the company’s gross profit rate. 2022 2021 LO 4 Copyright ©2020 John Wiley & Sons, Inc. 81 DO IT! 4: Gross Profit Rate 2022 Rachel Rose, Inc. reported the following in its income statements. 2022 2021 Net sales $80,000 $120,000 Cost of goods sold 40,000 60,000 Operating expenses 19,000 36,000 Income tax expense 3,000 4,000 Net income $18,000 $20,000 Determine the company’s gross profit rate. 2022 2021 ($80,000  $40,000) 50% $80,000 LO 4 Copyright ©2020 John Wiley & Sons, Inc. 82 DO IT! 4: Gross Profit Rate 2021 Rachel Rose, Inc. reported the following in its income statements. 2022 2021 Net sales $80,000 $120,000 Cost of goods sold 40,000 60,000 Operating expenses 19,000 36,000 Income tax expense 3,000 4,000 Net income $18,000 $20,000 Determine the company’s gross profit rate. 2022 2021 ($80,000  $40,000) ($120,000  $60,000) 50% 50% $80,000 $120,000 LO 4 Copyright ©2020 John Wiley & Sons, Inc. 83 DO IT! 4: Profit Margin Rachel Rose, Inc. reported the following in its income statements. 2022 2021 Net sales $80,000 $120,000 Cost of goods sold 40,000 60,000 Operating expenses 19,000 36,000 Income tax expense 3,000 4,000 Net income $18,000 $20,000 Determine the company’s profit margin. 2022 2021 LO 4 Copyright ©2020 John Wiley & Sons, Inc. 84 DO IT! 4: Profit Margin 2022 Rachel Rose, Inc. reported the following in its income statements. 2022 2021 Net sales $80,000 $120,000 Cost of goods sold 40,000 60,000 Operating expenses 19,000 36,000 Income tax expense 3,000 4,000 Net income $18,000 $20,000 Determine the company’s profit margin. 2022 2021 $18, 000 22.5% $80, 000 LO 4 Copyright ©2020 John Wiley & Sons, Inc. 85 DO IT! 4: Profit Margin 2021 Rachel Rose, Inc. reported the following in its income statements. 2022 2021 Net sales $80,000 $120,000 Cost of goods sold 40,000 60,000 Operating expenses 19,000 36,000 Income tax expense 3,000 4,000 Net income $18,000 $20,000 To Determine the company’s profit margin. 2022 2021 $18, 000 $20, 000 16.7% 22.5% $120, 000 $80, 000 LO 4 Copyright ©2020 John Wiley & Sons, Inc. 86  Survey of Accounting Second Edition Kimmel Weygandt Chapter 2 A Further Look at the Balance Sheet Prepared by Coby Harmon University of California, Santa Barbara Westmont College This slide deck contains animations. Please disable animations if they cause issues with your device. Copyright ©2020 John Wiley & Sons, Inc. Chapter Outline Learning Objectives LO 1 Identify the sections of a classified balance sheet. LO 2 Use ratios to evaluate a company’s balance sheet. Copyright ©2020 John Wiley & Sons, Inc. 2 Learning Objective 1 Identify the Sections of a Classified Balance Sheet LO 1 Copyright ©2020 John Wiley & Sons, Inc. 3 The Classified Balance Sheet Presents a snapshot at a point in time. To improve understanding, companies group similar assets and similar liabilities together. Standard Classifications Assets Liabilities and Stockholders’ Equity Current assets Current liabilities Long-term investments Long-term liabilities Property, plant, and equipment Stockholders’ equity Intangible assets LO 1 Copyright ©2020 John Wiley & Sons, Inc. 4 The Classified Balance Sheet (partial) Assets LO 1 Copyright ©2020 John Wiley & Sons, Inc. 5 The Classified Balance Sheet (partial) Liabilities and Stockholders’ Equity LO 1 Copyright ©2020 John Wiley & Sons, Inc. 6 The Classified Balance Sheet Current Assets Assets a company expects to convert to cash or use up within one year or the operating cycle, whichever is longer. Operating cycle is the average time it takes from purchase of inventory, to sale of goods, and then to collection of cash from customers. Common types include cash, investments, receivables, inventories, and prepaid expenses. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 7 Current Assets Presentation Companies list current asset accounts in the order they expect to convert them into cash. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 8 The Classified Balance Sheet Cash Review Question Cash, and other resources that are reasonably expected to be realized in cash or sold or consumed in the business within one year or the operating cycle, are called: a. Current assets. b. Intangible assets. c. Long-term investments. d. Property, plant, and equipment. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 9 The Classified Balance Sheet Cash Review Question Answer Cash, and other resources that are reasonably expected to be realized in cash or sold or consumed in the business within one year or the operating cycle, are called: a. Current assets. b. Intangible assets. c. Long-term investments. d. Property, plant, and equipment. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 10 The Classified Balance Sheet Long-Term Investments Investments in stocks and bonds of other corporations that are held for more than one year. Long-term assets such as land or buildings that a company is not currently using in its operating activities. Long-term notes receivable. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 11 The Classified Balance Sheet Long-Term Investments Example LO 1 Copyright ©2020 John Wiley & Sons, Inc. 12 The Classified Balance Sheet Property, Plant, and Equipment Long useful lives. Currently used in operations. Includes land, buildings, equipment, delivery vehicles, and furniture. Depreciation - allocating the cost of assets to a number of years. Accumulated depreciation - total amount of depreciation expensed thus far in the asset’s life. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 13 The Classified Balance Sheet Property, Plant, and Equipment Example LO 1 Copyright ©2020 John Wiley & Sons, Inc. 14 The Classified Balance Sheet Intangible Assets Assets that do not have physical substance. Includes goodwill, patents, copyrights, and trademarks or trade names. Helpful Hint Sometimes intangible assets are reported under a broader heading called “Other assets.” LO 1 Copyright ©2020 John Wiley & Sons, Inc. 15 The Classified Balance Sheet Intangible Assets Example LO 1 Copyright ©2020 John Wiley & Sons, Inc. 16 The Classified Balance Sheet Patents Review Question Patents and copyrights are a. Current assets. b. Intangible assets. c. Long-term investments. d. Property, plant, and equipment. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 17 The Classified Balance Sheet Patents Review Question Answer Patents and copyrights are a. Current assets. b. Intangible assets. c. Long-term investments. d. Property, plant, and equipment. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 18 DO IT! 1a: Assets Section of Classified Balance Sheet Baxter Hoffman recently received the following information related to Hoffman Corporation’s December 31, 2022, balance sheet. Prepaid insurance $ 2,300 Cash 800 Equipment 10,700 Debt investments (long-term) 2,100 Inventory 3,400 Accumulated depreciation - equipment 2,700 Accounts receivable 1,100 Trademarks 4,700 Prepare the asset section of Hoffman Corporation’s classified balance sheet. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 19 DO IT! 1a: Assets LO 1 Copyright ©2020 John Wiley & Sons, Inc. 20 DO IT! 1a: Current Assets LO 1 Copyright ©2020 John Wiley & Sons, Inc. 21 DO IT! 1a: Long-Term Investments LO 1 Copyright ©2020 John Wiley & Sons, Inc. 22 DO IT! 1a: Property, Plant, and Equipment LO 1 Copyright ©2020 John Wiley & Sons, Inc. 23 DO IT! 1a: Intangible Assets LO 1 Copyright ©2020 John Wiley & Sons, Inc. 24 DO IT! 1a: Total Assets LO 1 Copyright ©2020 John Wiley & Sons, Inc. 25 The Classified Balance Sheet Current Liabilities Obligations the company is to pay within the next year or operating cycle, whichever is longer. Common examples are accounts payable, salaries and wages payable, notes payable, unearned revenue, interest payable, and income taxes payable. Also included are current maturities of long-term obligations—payments to be made within the next year on long-term obligations. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 26 The Classified Balance Sheet Current Liabilities Example LO 1 Copyright ©2020 John Wiley & Sons, Inc. 27 The Classified Balance Sheet Long-Term Liabilities Obligations a company expects to pay after one year. Include bonds payable, mortgages payable, long-term notes payable, lease liabilities, and pension liabilities. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 28 The Classified Balance Sheet Long-Term Liabilities Example LO 1 Copyright ©2020 John Wiley & Sons, Inc. 29 The Classified Balance Sheet Long-Term Liabilities Review Question Which of the following is not a long-term liability? a. Bonds payable. b. Current maturities of long-term debt. c. Long-term notes payable. d. Mortgages payable. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 30 The Classified Balance Sheet Long-Term Liabilities Review Question Answer Which of the following is not a long-term liability? a. Bonds payable. b. Current maturities of long-term debt. c. Long-term notes payable. d. Mortgages payable. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 31 The Classified Balance Sheet Stockholders’ Equity Common stock - investments of assets into the business by the stockholders. Retained earnings - income retained for use in the business. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 32 DO IT! 1b: Balance Sheet Classifications Match each of the account names on the next slides to its proper balance sheet classification, shown below. If the item would not appear on a balance sheet, use “NA.” Current assets (CA) Current liabilities (CL) Long-term investments (LTI) Long-term liabilities (LTL) Property, plant, and equipment (PPE) Stockholders’ equity (SE) Intangible assets (IA) LO 1 Copyright ©2020 John Wiley & Sons, Inc. 33 DO IT! 1b: Balance Sheet Classifications (continued) Match each account to its proper balance sheet classification. If the item would not appear on a balance sheet, use “NA.” Account name Classification Salaries and wages payable Investment in real estate Unearned service revenue Debt investments (short-term) Mortgage payable (due in 3 year) Accumulated depreciation— equipment LO 1 Copyright ©2020 John Wiley & Sons, Inc. 34 DO IT! 1b: Balance Sheet Classifications (continued) Match each account to its proper balance sheet classification. If the item would not appear on a balance sheet, use “NA.” Account name Classification Salaries and wages payable CL Investment in real estate LTI Unearned service revenue CL Debt investments (short-term) CA Mortgage payable (due in 3 year) LTL Accumulated depreciation— PPE equipment LO 1 Copyright ©2020 John Wiley & Sons, Inc. 35 DO IT! 1b: Balance Sheet Classifications (concluded) Match each account to its proper balance sheet classification. If the item would not appear on a balance sheet, use “NA.” Account name Classification Service revenue Interest payable Goodwill Depreciation expense Retained earnings Equipment LO 1 Copyright ©2020 John Wiley & Sons, Inc. 36 DO IT! 1b: Balance Sheet Classifications (concluded) Match each account to its proper balance sheet classification. If the item would not appear on a balance sheet, use “NA.” Account name Classification Service revenue N/A Interest payable CL Goodwill IA Depreciation expense N/A Retained earnings SE Equipment PPE LO 1 Copyright ©2020 John Wiley & Sons, Inc. 37 Learning Objective 2 Use Ratios to Evaluate a Company's Balance Sheet LO 2 Copyright ©2020 John Wiley & Sons, Inc. 38 Analyzing the Balance Sheet Using Ratios Ratio Analysis Ratio analysis expresses the relationship among selected items of financial statement data. A ratio expresses the mathematical relationship between one quantity and another. A single ratio by itself is not very meaningful. LO 2 Copyright ©2020 John Wiley & Sons, Inc. 39 Ratio Analysis LO 2 Copyright ©2020 John Wiley & Sons, Inc. 40 Using a Classified Balance Sheet LO 2 Copyright ©2020 John Wiley & Sons, Inc. 41 Using a Classified Balance Sheet (continued) LO 2 Copyright ©2020 John Wiley & Sons, Inc. 42 Using a Classified Balance Sheet Liquidity The ability to pay obligations expected to become due within the next year or operating cycle. One measure of liquidity is working capital, which is the difference between the amounts of current assets and current liabilities. Working Capital = Current Assets – Current Liabilities Best Buy had working capital in 2017 of $3,394 million ($10,516 million − $7,122 million). LO 2 Copyright ©2020 John Wiley & Sons, Inc. 43 Using a Classified Balance Sheet Liquidity Ratios Liquidity ratios measure short-term ability to pay maturing obligations and meet unexpected needs for cash. The current ratio is a more dependable indicator of liquidity than working capital. In 2017, for every dollar of current liabilities, Best Buy has $1.48 of current assets. LO 2 Copyright ©2020 John Wiley & Sons, Inc. 44 Using a Classified Balance Sheet Solvency The ability to pay interest as it comes due and to repay the balance of a debt due at its maturity. Solvency ratios measure the ability of the company to survive over a long period of time. Helpful Hint - Some users evaluate solvency using a ratio of liabilities divided by stockholders’ equity. The higher this “debt to equity” ratio, the lower is a company’s solvency. LO 2 Copyright ©2020 John Wiley & Sons, Inc. 45 Using a Classified Balance Sheet Debt to Assets Ratio Debt to assets ratio measures the percentage of total financing provided by creditors rather than stockholders. The 2017 ratio means that every dollar of assets was financed by 66 cents of debt. LO 2 Copyright ©2020 John Wiley & Sons, Inc. 46 DO IT! 2: Ratio Analysis Listed below are assets and liabilities of Steno Corporation. Assets and Liabilities 2022 2021 Accounts receivable $ 1,600 $ 1,400 Cash 900 800 Equipment (net) 42,000 40,000 Inventory 3,800 3,200 Land 22,000 22,000 Supplies 400 500 Total assets $70,700 $67,900 Accounts payable $ 2,900 $ 3,200 Bonds payable 21,000 28,000 Notes payable (current) 1,200 1,500 Notes payable (long-term) 4,000 4,200 Total liabilities $29,100 $36,900 Steno reported net income of $48,000 for 2022 and $42,000 for 2021. LO 2 Copyright ©2020 John Wiley & Sons, Inc. 47 DO IT! 2: Ratio Analysis Debt to Assets Ratio For Steno Corporation: Compute the debt to assets ratio for each year. (Round to two decimal places.) Solution LO 2 Copyright ©2020 John Wiley & Sons, Inc. 48 DO IT! 2: Ratio Analysis Debt to Assets Ratio (continued) For Steno Corporation: Compute the debt to assets ratio for each year. (Round to two decimal places.) Solution LO 2 Copyright ©2020 John Wiley & Sons, Inc. 49 DO IT! 2: Ratio Analysis Debt to Assets Ratio (concluded) For Steno Corporation: Compute the debt to assets ratio for each year. (Round to two decimal places.) Solution LO 2 Copyright ©2020 John Wiley & Sons, Inc. 50