MBA: ACCOUNTING

UNTIT 1:

1.1

Evolution of accounting

1.2

Accounting Concepts and Principles:

The Entity Concept -	An organization is a separate entity from the owner(s) of the organization.
The Reliability (Objectivity) Principle -	Accounting records and statements should be based on the most reliable data available so that they will be as accurate and useful as possible.
The Cost Principle -	Acquired assets and services should be recorded at their actual cost not at what they are believed to be worth.
The Going-Concern Concept -	The assumption that the business will continue operating for the foreseeable future.
The Stable-Monetary Unit Concept -	Accounting transaction are recorded in the monetary unit used in the country where the business is located.

1.3

Why study Accounting

The primary purpose of accounting is to provide information that is useful for decision making purposes. From the very short, we emphasize that accounting is not an end, but rather it id the mean of end.

The final product of accounting information is the decision that is ultimately enhanced by the use of accounting information weather that decision are made by owner, management, creditor, government regulatory bodies, labor unions, or the many other groups that have an interest in the financial performance of an enterprise.

1.4

Accounting Information System

Information user

1. Investors.

2. Creditors.

Managers.

4. Owners.

5. Customers

6. Employers.

7. Regulatory. SEC, IRS, EPA.

Cost and Revenue Determination

1. Job costing.

2. Process costing.

3. Activity based costing.

4. Sales.

Assets and liabilities

1. Plant and equipment.

2. Loan and equity.

3. Receivable, payable and cash.

Cash flows

1. From operation.

2. From finance.

3. From investing.

Decision supporting

1. Cost /volume/ profit analysis.

2. Performance evaluation.

3. Incremental analysis.

Budgeting.

5. Capital allocation.

6. Earnings per share.

7. Ratio analysis

1.5 Manual and computerized based accounting

1.6

Basic Accounting Model

Recording (All transaction should be recorded in journal).
Classifying (After recoding entries should be transfer to ledger).
Summarizing ( Last stages is to prepare the trial balance and final account with a view to ascertaining the profit or loss made during a trading period and the financial position of the business on a particular data).

Transaction

Balance sheet Journal

Final account Ledger

Trial balance

1.7

Financial statements

Financial statements are declarations of information in financial terms about an enterprise that are believed to be fair and accurate. They describe certain attributes of the enterprise that are important for decision makers, particularly investors (owners) and creditors.

We discus three primary financial statements

Statement of financial position or balance sheet.
Income statement.
Statement of cash flow. Statement of owners equity.

Income Statement - a summary of a company’s revenues and expenses for a specific period of time

Revenue - Amounts earned by delivering goods or services to customers.

Expense - The using up of assets or the accrual of liabilities in the course of delivering goods or services to the

                  customers.

Income Statement Format:

              Revenues           $xx,xxx

          -  Expenses              xx,xxx

         =  Net Income         $ x,xxx

            Statement of Owner’s Equity - a summary of the changes that occurred in the company’s owner’s equity during a specific period of time.

Statement of Owner’s Equity Format:

Capital, Jan 1 2000                                                 $xx,xxx

Add: Investments by owner               $x,xxx

Net Income for the period                   x,xxx                x,xxx

Subtotal                                                                  $xx,xxx

Deduct: Withdrawals by owner                   $x,xxx

Net Loss for the period                       x,xxx                x,xxx

Capital, Dec 31 2000                                              $xx,xxx

Balance Sheet - a summary of a company’s assets, liabilities, and owner’s equity on a specific date.

Balance Sheet Format:

                       Assets                                                                   Liabilities

Cash                                         $xx,xxx                  Accounts Payable                 $xx,xxx

Accounts Receivable                     x,xxx                  Notes Payable                          x,xxx

Supplies                                       x,xxx                  Total Liabilities                      $xx,xxx

                                                                                                 Owner’s Equity

                                                                               Capital                                  $xx,xxx

                                                                               Total Liabilities and

Total Assets                            $xx,xxx                  Owner’s Equity                      $xx,xxx

1.8

Characteristics of financial statements

1. Balance sheet

Assets liabilities

Cash notes payable

Notes payable accounts payable

Debtors creditors

Land, building etc capital

Fixed assets

2. Income statement

Revenue

Less all expenses

Net profit

3. Cash flow statement

· Cash from operating activities

· Cash from inverting activities

· Cash from financing activities

1.9

Constraints on relevant or reliable information

1.10

Users of accounting system

1. Investors

2. Creditors

3. Managers

4. Owners

5. Customers

6. Employees

7. Regulatory agencies

8. Trade associations

9. General public

10. Labor union

11. Government agencies

12. Suppliers.

1.11

Major fields of accounting

1. Financial accounting

2. Management accounting

3. Cost accounting

4. Tax accounting

5. Operational accounting

6. Advance accounting

UNIT 2:

2.1

Business event and business transaction

Vent: In ordinary language event means anything that happen.

There are two types of event.

Monetary event

Non monetary event

Monetary event: Event which are related with money e.g., which change the financial position of the person known as monetary event .e.g., shopping marriage etc.

Non monetary event: Event which is not related with money, which do not change the financial position of the position of the person are known as non monetary event e.g., winning a game, delivering a lecture in a meeting etc.

In business accounting only those events which change the financial position of the business and which call for accounting are recognized as EVENT. In other words all monetary events are regarded business transaction.

Business transaction: Any dealing between two persons or thing is called transaction. It may relate to purchase and sales of goods, receipt, payment of cash and rendering service by one part to another.

Transaction is of two kinds.

Cash transaction

Credit transaction

2.2

Evidence and authentication of transaction

2.3

The recording process

Debits and Credits:

A business’ debits must equal their credits. Applying this to the accounting equation, which states that a business’ assets must equal their liabilities and owner’s equity, shows how the normal balances for the accounts are determined.

2.4 Recording Transactions in the Journal

Recording transactions in a journal is similar to how they are recorded in the T-accounts

Posting from the journal to the ledger:

Posting - the transferring of amounts from the journal to the ledger accounts

Step 1: Enter the date from the journal entry into the date column of the ledger account

Step 2: Enter the journal page number in the journal reference column of the ledger account

Step 3: Transfer the amount for the first account in the entry to its ledger account as it is in the journal.  Debits in

             journal are recorded as debits in the ledger and the same for credits

Step 4: Update the account balance. If there is no beginning balance, then just transfer the amount to the

             appropriate balance column (Dr & Dr, Cr & Cr). If there is a beginning balance, then add or subtract the

             amount from the current balance and enter the new balance. If the transaction amount and the current

             balance are both in the same columns (Dr & Dr, or Cr & Cr), then add the amounts together for the new

             balance and enter the result in the same column. If the transaction amount and the current balance are in

             different columns, then subtract the amounts and enter the result in the column that has the larger amount.

Step 5: Enter the ledger account number in the journal’s Post Ref. column.

Repeat these steps until all amounts have been posted to the ledger accounts.

2.5

Balancing the accounts

2.6

Chart of accounts

Chart of accounts - a list of all the accounts and their assigned account numbers in the ledger

Accounts are assigned numbers consisting of 2 or more digits. The number of digits used is dependent on how many accounts a company has in their ledger. A small company may use only 2 digits while a large corporation may use 5 digit account numbers.

The first digit is used to identify the main category in which the account falls under.

1 is used for Asset accounts

2 is used for Liability accounts

3 is used for Owner's Equity accounts

4 is used for Revenue accounts

5 is used for Expense accounts

The second digit indicates the sub classification of the account if there are any.

Asset Accounts

1 is used to represent Current Assets

2 is used to represent Plant Assets

3 is used to represent Investments

4 is used to represent Intangible Assets

Liability Accounts

1 is used for Current Liabilities

2 is used for Long Term Liabilities

Expense Accounts

1 is used for Selling Expenses

2 is used for General and Administrative Expenses

All other digits are used just to indicate the order in which the accounts are listed in the chart of accounts.

2.7

Limitations of trial balance

The trial balance provides proof that the ledger is in balance. The agreement of the debit and credit totals of the trial balance gives assurance that;

1. Equal debits and credits have been recorded for all transaction.

2. The debit or credit balance of each account has been correctly computed.

3. The addition of the account balances in the trial balance has been correct performed.

2.8

Concept of accrual and deferrals

2.9

Need for adjusting entries

The purpose of adjusting entries is to allocate revenue and expenses among accounting periods in accordance with the realization and matching principles. These end-of-period entries are necessary because revenue may be earned and expenses incurred in periods other than the one in which the related transactions are recorded.

The four basic types of adjusting entries are made to (1) convert assets to expenses, (2) convert liabilities to revenue, (3) accrue unpaid expenses, and (4) accrue unrecorded revenue. Often a transaction affects the revenue or expenses of two or more accounting periods. The related cash inflow or outflow does not always coincide with the period in which these revenue or expense items are recorded. Thus, the need for adjusting entries results from timing differences between the receipt or disbursement of cash and the recording of revenue or expenses.

2.10 to 2.14

Adjusting Entries:

Adjusting entries can be divided into five categories:
(1) Deferred (Prepaid) Expenses
(2) Depreciation of assets
(3) Accrued Expenses
(4) Accrued Revenues
(5) Deferred (Unearned) Revenues
Questions to ask yourself when doing adjusting entries:
(1) What is the current balance?
(2) What should the balance be?
(3) How much is the adjustment?

Deferred (Prepaid) Expenses - includes miscellaneous assets that are paid for in advance and then expire or get used up in the near future. In the journal entry you would debit an expense account and credit the prepaid asset account. (Examples include Rent, Insurance, and Supplies)
Adjusting Journal entry:

       ?     Expense      $xxx                      the value of the asset

         Prepaid Asset                          $xxx             that was used up

Depreciation of Plant Assets - the allocation of a plant asset's cost to an expense account as it is used over its useful life. In the journal entry you would debit an expense account and credit a contra-asset account.
Why use Accumulated Depreciation instead of just crediting the original asset account?

(1) If the original asset account was used then the original cost of the asset would not be reflected

      in any of the asset accounts.

(2) The original cost is needed when assets are sold or disposed

(3) The original cost of the asset must be reported on the income tax return of the company

Adjusting Journal entry:

Depreciation Expense,                                           $xxx

         Accumulated Depreciation,                                       $xxx

Accrued Expenses - Expenses that a business incurs before they pay them. In the journal entry you would debit an expense account and credit a liability account (Examples include Wages and Interest)
Adjusting Journal Entry:

    ?     Expense                $xxx                for the amount

             ?     Payable                                $xxx             owed

Accrued Revenues - revenues that a business has earned but has not yet received payment for. In the journal entry you would debit an asset account and credit a revenue account. (Examples include Interest)
Adjusting Journal Entry:

Accounts Receivable            $xxx

          Revenue                                $xxx

Deferred (Unearned) Revenues - cash collected from customers before work is done by the business. The business has a liability to provide a product or service to the customer. In the journal entry you would debit a liability account and credit a revenue account.
Adjusting Journal Entry:

Unearned Revenue               $xxx                           for the value of services

          Revenue                                     $xxx            or products provided

Adjusted Trial Balance - a list of all ledger accounts with their adjusted balances. These amounts are used in creating the financial statements. The totals for the debit and credit columns should balance. If the totals are not the same then an error was made either in the journal entries, the posting, or in transferring the amounts to the trial balance.

2.15

The Worksheet:

Determination of Net Income or Net Loss from the Worksheet:

If the company has a Net Income, then

(1) The Cr column total for the Income Statement must be more than the Dr column total.

(2) The Dr column total for the Balance Sheet must be more than the Cr column total.

If the company has a Net Loss, then

(1) The Dr column total for the Income Statement must be more than the Cr column total.

(2) The Cr column total for the Balance Sheet must be more than the Dr column total.

Completing the Worksheet:

Step 1: List the accounts and enter their balances from the general ledger into the appropriate trial balance column (Dr or Cr). Total both columns.

Step 2: Enter in the amounts for the adjustments. Each adjustment should contain at least one debit entry and at least one credit entry, just as if you were entering these adjustments in a journal. Total both columns.

Step 3: Carry the balances from the Trial Balance columns to the Adjusted Trial Balance if there is no adjustment for the account. If an account has an adjustment then either add or subtract the adjustment to get the adjusted balance for the account. Total both columns.

Tip on knowing when to add or subtract:

(1) If the amount in the Trial Balance column and the amount in the Adjustments column are both in the same columns (Dr & Dr, or Cr & Cr) then add the two amounts together and place the result in the same column in the Adjusted Trial Balance.

(2) If the amount in the Trial Balance column and the amount in the Adjustments column are in different columns (Dr & Cr, or Cr & Dr) then subtract the amounts and enter the result in the column that has the larger amount (Dr or Cr) in the Adjusted Trial Balance.

Step 4: Carry the balances for all of your revenue and expense accounts to the Income Statement columns. Total both columns.

Note: These columns won’t balance because the difference between the columns represents your Net Income or Loss.

Step 5: Carry the balances for all other accounts (assets, liabilities, and owners equity) to the Balance Sheet columns. Total both of these columns.

Note: The difference between the columns should be the same as the difference between the Income Statement columns. If they are not the same then you have made a mistake.

Step 6: Enter in the difference between the Dr and Cr columns under the column which has the smaller balance for both the Income Statement and Balance Sheet. Total these four columns again. The Dr and Cr column totals should balance now on both the Income Statement and the Balance Sheet.

Tips on determining if you have a net income or loss:

(1) If there is a Net Income, then you should have the difference entered in the Dr column of the Income Statement and in the Cr column of the Balance Sheet.

(2) If there is a Net Loss, then you should have the difference entered in the Cr column of the Income Statement and in the Dr column of the Balance Sheet.

2.16

Closing Entries:

The information needed to complete the closing entries can be obtained from the Income Statement and Balance Sheet columns of the worksheet. These entries are made at the end of each accounting period.

The closing entry process consists of four journal entries:

(1) Close all revenue accounts - by debiting your revenue account and crediting Income Summary.

Journal Entry:

          Revenue Account              Total of all Revenues

                     Income Summary                           Total of all Revenues

(2) Close all expense accounts - by debiting Income Summary and crediting each individual
expense account.

Journal Entry:

        Income Summary                     Total of all Expenses

                Rent Expense                               Account balance

                Misc. Expense                           Account balance

(3) Close the Income Summary account - by either debiting Income Summary and crediting the Capital account if there is a Net Income or by debiting the Capital account and crediting Income
Summary if there is a Net Loss.

Journal Entry (if net income):

          Income Summary                        Net Income

                   Owner, Capital                                 Net Income

Journal Entry (if net loss):

         Owner, Capital                             Net Loss

                   Income Summary                               Net Loss

(4) Close the withdrawals account - by debiting the Capital account and crediting the Withdrawals
account.

Journal Entry:

         Owner, Withdrawals            Withdrawals account balance

                  Owner, Capital                          Withdrawals account balance

UNIT 3:

3.1

Difference between manufacturing and merchandising

Most merchandising companies purchase their inventories from other business organization in a ready to sell-condition. Companies that manufacture their inventories, such as General motors, IBM are called manufacturers, rather than merchandisers. The operating cycle of a manufacturing company is longer and more complex than that of the merchandising company, because the first transaction is purchasing merchandising is replaced by the many activities involved in manufacturing the merchandise.

The operating cycle is the repeating sequence of transactions by which a company generates revenue and cash receipts from customers. In a merchandising company, the operating cycle consists of the following transactions: (1) purchases of merchandise, (2) sale of the merchandise - often on account, and (3) collection of accounts receivable from customers.

UNIT 4:

4.1

Steps in Performing a Bank Reconciliation:

Step 1: Identify outstanding deposits and bank errors that need to be added to the current bank statement

            balance.

Step 2: Identify outstanding checks and bank errors that need to be subtracted from the current bank statement

            balance.

Step 3: Identify amounts collected by the bank (notes), amounts added to our balance by the bank (interest on

            account), and any errors made by the company, when recording the transactions, that need to be added

            to the current book balance.

Step 4: Identify bank service charges, NSF checks, and any errors made by the company that need to be subtracted

            from the current book balance.

Bank Reconciliation format:

Journal entries must be done to record all adjustments made to the book balance. For all of the adjustments made to increase the book balance cash will be shown as a debit in the entries. For all of the adjustments made to decrease the book balance cash will be shown as a credit in the entries.

Cash Short and Over:

Any differences between the cash register tape totals and the actual cash receipts is charged against the cash short and over account.

If the ending balance of the account is a debit, it is shown on the Income Statement as a Miscellaneous Expense.

If the ending balance of the account is a credit, it is shown on the Income Statement as Other Revenue.

Journal Entries:

For a cash shortage:

Cash                                    Actual cash received

Cash Short and Over            Difference

        Sales Revenue                                                Cash register tape totals

For a cash overage:

Cash                                      Actual cash received

         Cash Short and Over                                     Difference

         Sales Revenue                                               Cash register tape totals

Petty Cash:

Petty cash is a fund containing a small amount of cash that is used to pay for minor expenses.

The amount of the petty cash fund is dependent on how much a company feels it needs to have on hand to pay for this expenses. The fund is replenished on a regular basis, normally at the end of the month unless it is necessary to replenish it sooner. The amount of the fund may be increased or decreased after it is setup, if necessary.

Journal Entries:

For the setup of Petty Cash:

The Petty Cash fund is established by transferring money from the Cash account to the Petty Cash account for the amount of the fund. The size of the fund can always be readjusted at a later time, either up or down depending on whether you wish to increase or decrease the fund.

Petty Cash                              Amount of fund

       Cash in bank                                               Amount of fund

To increase the fund, you would use the same entry as above and debit the Petty Cash and credit Cash for just the amount of the increase. To decrease the fund, you would reverse the above entry, by debiting Cash and Crediting Petty Cash for the amount of the decrease.

For replenishment of petty cash:

When the Petty Cash fund needs to be replenished, you would debit each individual expense or asset account, not Petty Cash, for the amount spent on each one and credit Cash for the total. Petty Cash is only used in the journal entries when you are either establishing the fund or changing the size of the fund.

Office Supplies                        Amount spent

Delivery Expense                     Amount spent

Postage Expense                      Amount spent

Misc. Expense                          Amount spent

       Cash in bank                                                Total of receipts

4.2

Receivables:

Accounts Receivable - amounts to be collected from customers for goods or services provided

Notes Receivable - a written promise for the future collection of cash

Accounting for Uncollectible Accounts:

Allowance Method: - recording collection losses on the basis of estimates.  There are two methods that

                                    can be used to estimate the Uncollectible Accounts expense:

       (1) Percent of Sales - referred to as the Income Statement approach because it computes the uncollectible

                                        accounts expense as a percentage of net credit sales.

                               Adjusting Entry:

                      Uncollectible Accounts Exp                     Net credit sales * %

                                                          Allowance for D. A.                                                   Net credit sales * %

                 (2) Aging of Accounts Receivable - referred to as the Balance Sheet approach because this method estimates

                                                                       bad debts by analyzing individual accounts receivables according to the length

                                                                       of time that they are past due.  Once separated by past due dates, each group

                                                                       is then multiplied by the percentage that each group is estimated to be uncollectible

                                                                       (as shown in the display below).

                Adjusting Entry:

                                       Uncollectible Accounts Exp              Desired End Bal. - Current Bal.

                                                  Allowance for D.A                                            Desired End Bal. - Current Bal.

                               Writing off an Uncollectible Account:

                                       Allowance for D.A.                                       Amount uncollectible

                                                  Acct. Rec. - Customer name                                             Amount uncollectible

Direct Write-off Method - accounts are written off when determined to be uncollectible

                     Writing off an uncollectible account:

                                   Uncollectible Accounts Exp                              Amount Uncollectible

                                                    Acct. Rec. - Customer name                                         Amount Uncollectible

Recoveries of Uncollectible Accounts:

          Two entries are required: (1) reverse the write off of the account

                                                 (2) record the cash collection of the account

                  (1) Reinstating the Account:

                        Acct. Rec. - Customer name                 Amount written off

                 Allowance for D.A.                                                  Amount written off

(2) Collection on the Account:

Cash Amount received
Acct. Rec. - Customer name Amount received

Credit Card and Bankcard Sales:

        Non Bank Credit card sales - cash is not received at point of sale (Amer. Ex., Discover)

                Journal Entry for Credit Sale:

                       Acct. Rec. - credit card name                      Difference

                       Credit card Discount Exp.                           Sales Amount *  %

                                    Sales                                                                            Sales amount

                Journal Entry for Collection of Non Bankcard sale:

                       Cash                                                           Amount owed

                                    Acct. Rec. - credit card name                                       Amount owed

Bankcard sales - cash is considered to be received at the point of sale (Visa, MasterCard)

                Journal Entry for Bankcard Sale:

                       Cash                                                           Difference

                       Credit card discount Exp.                            Sales Amount *  %

                                    Sales                                                                            Sales amount

Notes Receivable:

Determining the maturity date of a note:

Step 1: Start of with the term (length) of the note

Step 2: Subtract the number of days remaining in the current month

Step 3: Subtract the number of days in the following month. Keep repeating this step until the result is less

            than the number of days for the next full month. This resulting number will be the day in which the

            note matures in the next month.

Example: Find the maturity date for a 120 day note dated on September 14, 1999

Maturity date would be the 12th day of January 2000.

Computing Interest on a note:

Principal of note * Interest % * Time = Interest Amount

Time can be expressed in years, months or days depending on the term of the note or the date on which the interest is being calculated.

If time is expressed in months, then time is should as a fraction of a year by dividing the number of months the interest is being calculated for by 12.

Time = (# of months) / 12

If time is expressed in days then time is shown as a fraction of a year by dividing the number of days the interest is being calculated for by 360. NOTE: Use 360 instead of 365.

Time = (# of days) / 360

Recording Notes Receivable:

If note was received because we lent out money:

         Notes Receivable                     Face Value of Note

                    Cash                                                           Face Value of Note

If note was received as a payment on an accounts receivable:

         Notes Receivable                      Face Value of Note

                    Accounts Receivable                                   Face Value of Note

The collection of the note at maturity:

         Cash                                         Maturity Value of Note

                   Notes Receivable                                         Face Value of Note

                   Interest Revenue                                           Interest Received

Accruing of Interest on a Note:

         Interest Receivable                    Principal  *  Interest %  *  Time

                   Interest Revenue                                           Principal  *  Interest %  *  Time)

Discounting of Notes Receivables:

There are five basic steps involved when discounting a note:

Step 1: Compute interest due on the note . . . . . . . . . . . . . . . . . . . . . Principal  *  Interest %  *  Time

Step 2: Compute maturity value (MV) of the note . . . . . . . . . . . . . .   Principal  +  Interest (from Step 1)

Step 3: Compute the number of days the bank will hold the note . . .  Term of Note  - number of days past

Step 4: Compute the bank’s interest on the note . . . . . . . . . . . . . . .   MV  *  Interest %  *  Time

Step 5: Compute the proceeds to be received . . . . . . . . . . . . . . . . .  MV - Bank’s Interest (from Step 4)

Journal Entry if the proceeds > maturity value:

            Cash                                                 Proceeds

                     Notes Receivable                                        Face Value of Note

                     Interest Revenue                                         Difference

Journal Entry ff the proceeds < maturity value:

            Cash                                                 Proceeds

            Interest Expense                                Difference

                     Note Receivable                                         Face Value

Accounting for Dishonored Notes:

If a note is dishonored (not paid on time) by the maker of the note, then the note receivable must be transferred to accounts receivable for the maturity value of the note.

            Accounts Receivable                         Maturity Value

                     Note Receivable                                         Face Value

                     Interest Revenue                                         Interest Earned

If the note was discounted to a bank and was then dishonored by the maker, then we must pay the bank the maturity value of the note plus a protest fee. This amount will then be charged to the person who gave us the note as an accounts receivable.

            Accounts Receivable                          Maturity Value + Protest fee

                     Cash                                                           Maturity Value + Protest fee

Financial Ratios:

Acid-Test (Quick) Ratio = (Cash + ST Investments + Net current receivables) / Total Current Liabilities

Day’s Sales in Receivables = (Average Net Receivables * 365) / Net Sales

UNIT 6:

Inventory Systems:

Purchasing Merchandise under the Perpetual Inventory system:

Quantity discounts

Discounts given when purchasing large quantities of merchandise
Purchases are recorded at the net purchase price (Purchase Amount - Quantity Discount)
No special account is needed to record the quantity discount

Purchase discounts

Discounts given for the prompt payment of the amount due
Purchases are recorded at the purchase price after taking any quantity discount but before deducting the purchase discount
Purchase discount will be recorded when payment is made
Discounts taken are credited to the Inventory account unless a special account (Purchases Discounts) is used to keep track of the discounts taken

Credit terms:

3/15, n/30       means you get a 3% purchase discount if payment is made within 15 days or the net (full) amount is

                       due in 30 days

n/eom              means that the net amount is due at the end of the month

Journal Entries for purchases:

Purchase of Merchandise on credit:

                 Inventory                                     Purchase amount

                          Accounts Payable                      Purchase amount

Payment within the discount period:

                 Accounts Payable                        Purchase amount

                                Cash                                     Amount paid

                                Inventory                                            Purchase amount * discount %

Recording purchase returns and allowances:

Purchase return - where a business chooses to return defective merchandise to the seller in exchange for a credit for the value of the merchandise returned

Purchase allowances - where a business chooses to keep defective merchandise in return for an allowance (reduction) in the amount owed to the seller

Both are recorded the same way. Accounts Payable is debited and Inventory is credited.

                   Accounts Payable                    Amount of return or allowance

                               Inventory                                       Amount of return or allowance

Transportation Costs:

FOB determines

(1) When legal title to merchandise passes from the seller to the buyer

(2) Who pays for the freight costs

FOB Destination - legal title does not pass to the buyer until the goods arrive at the buyers place of business. The seller still owns the merchandise until delivered so the seller must pay the freight costs.

FOB Shipping point - legal title passes to the buyer when the merchandise leaves the sellers place of business. The buyer now owns the goods so the buyer must pay the freight costs.

Recording the freight costs:

Under FOB Destination the seller records the following entry:

             Delivery Expense                                   Freight costs

                       Cash (or Accounts Payable)                                 Freight costs

Under FOB Shipping point the buyer records the following entry:

            Inventory                                              Freight costs

                       Cash (or Accounts Payable)                                 Freight costs

Use of Purchase Returns & Allowances, Purchase Discounts, and Freight In accounts:

Some businesses may want to use special accounts to keep track of their returns & allowances, discounts, and freight costs. Purchase returns & allowances and purchase discounts both have credit balances and are contra accounts to the inventory account

The cost of inventory is determined as follows:

Inventory                                                            xxxxx

Less: Purchases Discounts                  (xxxx)

Purchases Returns  & Allowances       (xxxx)      (xxxx)

Net Purchases of Inventory                                 xxxxx

Add: Freight In                                                       xxx

Total cost of Inventory                                        xxxxx

Journal Entries:

Returns & Allowances

              Accounts Payable                                       Amount of return or allowance

                        Purchases Returns  & Allow.                                   Amount of return or allowance

Purchase discount

              Accounts Payable                             Amount due

                         Cash                                                            Amount paid

                         Purchase discount                                         Amt due * discount %

Freight costs (buyer)

             Freight In                                                   Freight costs

                        Cash (or Accounts Payable)                                Freight costs

Sales of Inventory:

When inventory is sold there are two journal entries that must be done:

(1) To record the actual amount the goods were sold for
(2) To record the cost we paid for the goods sold

Recording the sale

             Cash (or Accounts Receivable)                Total sales price

                        Sales                                                                       Total sales price

Recording the cost

             Cost of goods sold                       Original cost paid

                        Inventory                                                    Original cost paid

Recording receipt of payment

             Cash                                                Amount received

                       Accounts Receivable                                          Amount received

Sales discounts and Sales returns & allowances:

Sales discounts and sales returns & allowances are contra accounts to Sales and have a normal debit balance.

Sales discounts are always calculated after deducting any returns or allowances from the amount due from the customer

Net Sales = Sales - Sales Returns & Allowances - Sales Discounts

Sales Discount - an incentive given by the seller to the customer to encourage prompt payment

              Cash                                        Amount Received

              Sales Discount                          Amount due * discount %

                        Accounts Receivable                                      Amount due

Sales Returns & Allowances - keeps track of defective merchandise returned to the seller by the customers

Sales returns required two journal entries just like the sale of merchandise

(1) to record the reduction in the amount due by the customer

        Sales Returns & Allowances          $xxx

                  Accounts Receivable                     $xxx

(2) to record the cost of the defective merchandise returned by the customer

       Inventory                                      $xxx

                  Cost of Goods Sold                    $xxx

For a sales allowance only the first journal entry, to record the reduction in the amount due, is required since the merchandise was not returned and added back into the inventory of the seller.

Adjusting Inventory for a Physical Count:

The inventory account will need to be adjusted if the physical count does not match the balance for the inventory account shown in the ledger.

If the physical count is less than the inventory account balance, then the difference is charged against the Cost of Goods Sold account.

               Cost of Goods Sold               $xxx

                          Inventory                              $xxx

If the physical count is more than the inventory account balance, then the difference could indicate a purchase of inventory that was not recorded.

              Inventory                                                 $xxx

                        Cash (or Accounts Payable)                  $xxx

If the difference can not be identified then it is credit to the Cost of Goods Sold account.

             Inventory                                            $xxx

                        Cost of Goods Sold                          $xxx

Financial Statement Ratios:

Gross Margin Percentage = Gross Margin / Net Sales

Inventory Turnover = Cost of Goods Sold / Average Inventory*

*Average Inventory = (Beginning Inventory + Ending Inventory) / 2

Single Step Income Statement Format:

Revenues:
     Net Sales                      $xx,xxx
     Interest Revenue               x,xxx
Total Revenues                                    $xx,xxx
Expenses:
     Cost of Goods Sold      $xx,xxx
     Wage Expense                 x,xxx
Total Expenses                                     $xx,xxx
Net Income                                          $xx,xxx

Multi-Step Income Statement Format:

Sales                                                                                 $xx,xxx
     Less: Sales Discounts                                 $x,xxx
              Sales Returns & Allowances                x,xxx            x,xxx
Net Sales                                                                           $xx,xxx
Cost of Goods Sold                                                             xx,xxx
Gross Margin                                                                     $xx,xxx
Operating Expenses:
     Wage Expense                                           $ x,xxx
     Supplies Expense                                          x,xxx
Total Expenses                                                                     xx,xxx
Operating Income                                                               $xx,xxx
Other Revenues and Expenses:
     Interest Revenue                                         $ x,xxx
     Interest Expense                                           (x,xxx)           x,xxx
Net Income                                                                         $xx,xxx

UNIT 7:

Characteristics of a Partnership:

Partnership agreement - A contract between partners that specifies such items as:
                 (1) the name, location, and nature of the business;
                 (2) the name, capital investment, and duties of each partner; and
                 (3) how profits and losses are to be shared.

Limited life - Life of a partnership is limited by the length of time that all partners continue to own a part of the business. When a partner withdraws from the partnership the partnership must be dissolved.

Mutual agency - Every partner can bind the business to a contract within the scope of the partnership’s regular business operations.

Unlimited personal liability - When a partnership can not pay its debts with the business’ assets, the partners must use their own personal assets to pay off the remaining debt.

Co-ownership of property - All assets that a partner invests in the partnership become the joint property of all the partners.

No partnership income taxes - The partnership is not responsible to the payment of income taxes on the net income of the business. Since the net income is divided among the partners, each partner is personally liable for the income taxes on their share of the business’ net income.

Partners owners equity accounts - Each partner has their own capital and withdraw account.

Initial Investment by Partners:

The Asset accounts will be debited for what the partners invests into the partnership and any Liabilities assumed by the partnership from the partners will be credited. Each partner will have their own capital account and it will be credited for the amount that they invested. The journal entry will look similar to the entry below.

Cash                                             Amount invested

Asset                                            MV of assets contributed

        Liabilities                                                           MV of liabilities assumed by the partnership

        Partner A, Capital                                              Total Investment by A

        Partner B, Capital                                              Total Investment by B

Sharing of Profits and Losses:

The profits or losses are allocated to each partner based on a fraction or percentage stated in the partnership agreement. If there is no method mention in the agreement for the division of profits and losses then they are to be allocated equally to each partner.

Journal entry to record the allocation of Net Income based on percentage:

Income Summary                               Net Income

        Partner A, Capital                                         Net Income  *  45%

        Partner B, Capital                                         Net Income  *  55%

Accounts would be reversed if the partnership had a Net Loss instead of a Net Income.

Allocation of Net Income based on the capital contributions of the partners:

Step 1: Add the capital account balances for all the partners together to find the total capital of the
business

Partner A, Capital         $22800

Partner B, Capital           34200

    Total Capital             $57000

Step 2: Divide each partner’s capital balance by the total capital to find each partner’s investment
percentage

Partner A, Capital          $22800 (Account Balance)  /  $57000 (Total Capital)  =  40%

Partner B, Capital            34200 (Account Balance)  /     57000 (Total Capital)  =  60%

Step 3: Allocate the net income or loss to each partner by multiplying their investment percentage
to the amount of net income or loss

Partner A’s share            $70000 (Net Income) *  40%  =  $28000

Partner B’s share              70000 (Net Income)  *  60%  =    42000

     Total                                                                           $70000

Step 4: Now enter the Journal Entry.

Income Summary                  $70000
      Partner A, Capital                           $28000
      Partner B, Capital                             42000

Allocation of Net Income based on Salary allowances and Interest percentage:

Step 1: Allocate Net Income between the partners, as below.

Step 2: Enter amounts in journal entry

Income Summary                    $96000
      Partner A, Capital                                 $51200
      Partner B, Capital                                   44800

Recording the withdraws made by partners:

               Partner A, Withdraws                      Amount withdrawn

               Partner B, Withdraws                      Amount withdrawn

                               Cash (or other asset)                                     Total withdrawn

Admission of New Partners:

By the purchasing of an existing partners interest:

The new partner gains admission by buying an existing partner’s capital interest with the approval of all other partners. In this situation, the existing partner's capital balance is simply transferred to the new partner's capital account.

Old Partner, Capital                     Capital balance of old partner

            New Partner, Capital                          Capital balance of old partner

By investing into the partnership:

Case 1: The new partner invests assets into the business and receives a capital interest in the partnership that is less than the total market value of the investment. In this case, part of the new partner's investment is given to the existing partners as a bonus.

Step 1: Determine the bonus to the old partners

Partnership capital of existing partners                                                 $xxxxx
New partner’s investment                                                                     xxxxx
Total partnership capital including new partner                                     $xxxxx
New partner’s capital interest (total capital * partnership %)                  xxxxx
Bonus to existing partners (total cap. - new partner)                             $xxxxx

Step 2: Allocate bonus to existing partners based on percentage

Bonus to existing partners                                           $xxxxx
Partner A’s share (Bonus * partnership %)                   xxxxx
Partner B’s share (Bouns * partnership %)                   xxxxx

Step 3: Record journal entry

Cash                                       Amount invested
        Partner C, Capital                                       New partner’s interest
        Partner A, Capital                                       Partner’s share of bonus
        Partner B, Capital                                       Partner’s share of bonus

Case 2: The new partner invests assets into the business and receives a capital interest that is more than the market value of the assets invested. In this case the existing partners must transfer part of their capital balances to the new partner's account

Step 1: Determine the bonus for the new partner

Partnership capital of existing partners                                                         $xxxxx
New partner’s investment                                                                             xxxxx
Total partnership capital                                                                              $xxxxx
New partner’s capital interest (total part. Cap. * partnership %)                    xxxxx
Bonus to new partner (total cap. - new partner’s interest)                            $xxxxx

Step 2: Allocate the new partner’s bonus to the old partners

Bonus to new partner                                           $xxxxx
Partner A’s share (Bonus * partner's %)                           xxxxx
Partner B’s share (Bonus * partner's %)                           xxxxx

Step 3: Record journal entry

Cash                                         Amount invested
Partner A, Capital                     Partner’s share of bonus
Partner B, Capital                     Partner’s share of bonus
        Partner C, Capital                                    Capital interest received

Revaluation of assets before the withdraw of a partner:

If the value of the assets went down:

Partner A, Capital                    Loss * partner's %
Partner B, Capital                    Loss * partner's %
Partner C, Capital                    Loss * partner's %
       Asset                                                                Amount of Loss in asset value

If the value of the assets went up:

Asset                                       Amount of Gain in asset value
       Partner A, Capital                                             Gain * partner's %
       Partner B, Capital                                             Gain * partner's %
       Partner C, Capital                                             Gain * partner's %

Withdraw of a partner from the business:

Partner withdraws receiving an amount equal to their capital balance:

Partner C, Capital Capital balance
Cash (or asset received) Amount received

Partner withdraws receiving an amount less than their capital balance:

Partner C, Capital                        Capital balance
        Cash                                                               Amount received
        Partner A, Capital                                           Difference * partner's %
        Partner B, Capital                                           Difference * partner's %

Note: The difference between what the leaving partner receives and what their capital balance was is treated as a bonus to the remaining partners paid by the leaving partner.

Partner withdraws receiving an amount more than their capital balance:

Partner C, Capital                        Capital balance
Partner A, Capital                                                   Difference * partner's %
Partner B, Capital                                                   Difference * partner's %
        Cash                                                               Amount received

Note: The difference between what the leaving partner receives and what their capital balance was is treated as a bonus to the leaving partner paid by the remaining partners.

Steps in the Liquidation of a Partnership:

Step 1: Sell all of the noncash assets - any gain or loss recognized is split between the partners

Journal Entry:

Cash                                       Amount received
        Noncash Assets                                         Book Value of assets
        Partner A, Capital                                      Gain * partner’s %
        Partner B, Capital                                      Gain * partner’s %

Note: If there was a loss on the sale of the noncash assets, then the partner’s capital account would have been debited for their share of the loss instead of credited.

Step 2: Pay off all partnership liabilities.

Journal Entry:

Liabilities Amount owed
Cash Amount owed

Step 3: Distribute the remaining cash to the partners.

Journal Entry:

Partner A, Capital                  Partner’s Capital balance
Partner B, Capital                  Partner’s Capital balance
        Cash                                                                   Total cash paid to partners

Note: If there was not enough cash to pay off the liabilities, then the partners would have been responsible for investing more cash into the partnership so that the liabilities could be paid off. Below is an example of the journal entry needed to record the additional investment by the partners.

Journal Entry:

Cash                                     Amount of additional cash needed
        Partner A, Capital                                       Amount Partner A invested
        Partner B, Capital                                       Amount Partner B invested

The information needed to complete the entries for these steps can be obtained from a liquidation worksheet like the one shown below.

Liquidation Summary Worksheet: