Fall 2014 – Concise 2 week class – Schenk
Textbook – Accounting for Lawyers, Concise 4th edition
Common Exam Construction :
· Couple journal entries, figure out if they are right or wrong, if they are wrong, figure out how to correct them to make sure they are not misleading.
· Time Value of Money
· Revenue Recognition and Contingency
Financial statements are historic: They don’t tell us about the future, they tell us about what already happened.
Financial statements are statements of management.
· Management is responsible to put out these statements
· Designed to aid management
o Management wants to know that there are holes on the shelves, that they can’t sell certain products, etc.
o Management also wants to know who they owe money to and who owes them money.
· Also aids lenders – Lenders will want to see financial statements before they lend money
o They will generally request an auditor to review financial statements to see if the auditor gives a clean opinion (an unbiased opinion of the financials)
§ Clean opinion – statements fairly represent the financials of the company and are prepared in accordance with generally accepted accounting principles.
· Other people that it aids – Shareholders, SEC, etc.
Established companies use the normal, standard financial statements. Companies who are trying to make their numbers look better, they will report other metrics, such as EBIDA:
· EBI(t)DA = Earnings before Interest, taxes, depreciation and amortization.
Balance sheet tells us a snapshot of what the company has as of a certain date
· Measures Assets vs. (Liabilities and Equity)
· Financial condition
Income Statement tells us what the company has over a given period
· Results of operation
Two parts of Annual Reports that are important to look at when investing:
· Management discussion and analysis
o Discusses what they are planning on doing in the future
o Discusses forward looking risks that may jeopardize the financials
· Separated the financial parts of the company.
· We want more than one person to approve a expenditure over a certain amount
· We want the person who receives the check to be different from the person who was recording the money who is also different from the person depositing the money.
o EX: This was the problem with Enron
International Standards v. U.S. Generally Accepted Accounting Standards
· Originally these differed pretty greatly, but there has been a push to move to the international standard.
· Since 2001, there has been a push to convergence between International and US
· We have Statement of Accounting Standards, or Accounting Codification
o This is the primary authority of what generally accepted accounting principles
· Under International standard, assets can be revalued and, thus, accurately reflects a company’s holdings.
Problems with financial statements:
· There is a lot that is not reported on financial statements, such as having really good management, loyal employees, loyal customers, etc.
· Goodwill: Ability to earn an above average return on investment
o Consumers and Investors know what they are going to get
o Almost like name or brand recognition
o This is not on a balance sheet, unless it is purchased
§ This would be in a situation where a business is purchased for more than its tangible assets
· There is lots of value that is not represented on a financial statement or on a balance sheet.
· Three Questions
1. What’s coming in and what’s going out, what’s the transaction?
2. What accounts are affected?
3. In what direction are the accounts affected?
· (Left Side of Balance Sheet)
§ Cash, Equipment, Inventory, Accounts Receivable, Furniture, Building, Land, Intangible Assets (Patents, Copyrights, Trademarks)
§ Current Assets: Cash, Accounts Receivable, Inventory
§ Fixed Assets: Equipment, Land, Building
§ Intangible Assets: Goodwill, Patents, Affiliation Contracts
· (Right Side of Balance Sheet) – These are Source of Funds
§ Account Payable, Note payable, Mortgage payable,
§ Current Liability: Accounts Payable, Wages, Mortgage monthly payments, etc.
§ Long Term Liability: 20 year notes, Mortgage
§ Sole Proprietorship, Partnerships, Joint Ventures, Ltd Partnership, LLC, PC, LPC, Corp, S Corp
· Left side of balance sheet are debits, right side of balance sheet are credits
o Increase in an asset (More on the left side) = Debit
o Reduce an asset = Credit
o Increase in Liability (More on the right side) = Credit
o Decrease in Liability = Debit
o Increase in proprietorship (equity) = Credit
o Putting money into the business = increase in proprietorship, increase in cash à Credit to proprietorship and debit to cash
· Each Journal Entry is posted to a T-Account
Trial Balance Sheet:
· Assets from Trial Balance goes to Balance sheet in Debit
· Liabilities from Trial balance go to balance sheet in credit
· Revenue from trial balance goes to Income statement in credit
· Expenses from trial balance goes to income statement in debit
Connection between income statement and balance sheet:
· Net profit from income statement increases equity, credit
· Net loss from income statement decreases equity, debit
Difference between income statement and balance sheet:
· Income statement accounts are always closed out at the end of the period, balance sheet never has accounts closed.
o i.e. Income statement starts fresh at the beginning of the per
Deferral & Accrual Accounting
· System that makes sure that the revenue that is generated in this period is recorded in this period and nothing else.
o We want to adjust the disparity between cash in/cash out and income in/expenses out
· We want to understand, when is revenue reportable and when are expenses incurred and reportable?
· Revenue is earned when a transaction occurs and the earning process is complete or substantially complete.
· Expenses are incurred when you have an obligation to pay.
o When the bill is issued
· If the accounting period is from Jan 1 to Dec 31, and on Dec 15, business receives cash from a customer for goods that are going to be delivered in Jan:
o If we were on the cash method, debit cash and credit revenue, but that revenue doesn’t belong in this period.
o If we are on accrual accounting method, we would credit customer advances and debit cash.
· Shift forward a revenue or expense that has already been recorded in the current period but doesn’t belong there.
· Adjusting a journal entry that is made in a current period but belongs in the next period
· Already have a journal entry that was recorded in error because the revenue or expense belongs in a different period.
· Essentially, this is a correction
o If we defer an expense, we are creating an asset
o If we defer income (rev), we are creating a liability
· The adjustment that changes the deferral to the income or expense column is not a transaction, it is just an adjustment entry.
· Adjusting entry that records something that has not been record.
· No actual cash in or cash out, but we record it in order to get the revenue or expense in the correct period.
· Obligation has occurred, but we haven’t paid yet.
o Revenue: Account Receivable
§ Setting up an asset that has not been earned yet, so that we can properly record the revenue in the correct period.
o Expense: If we get a bill but haven’t paid it yet, set up an Accrued Account Payable.
§ Depreciation Expense Account – If we know the life of something, say X, (original payment – salvage value)/Useful Life)
ú Useful Life = X – time used
ú Salvage value = how much it will be worth at the end. when X is expired
§ We also will set up accounts such as Accumulated Depreciation value to add the depreciation of assets all together.