Transaction Analysis and Accounting Entries Part II

1
Transaction Analysis and Accounting Entries (Part
II)

• Straight-line Amortization Calculation
• Asset Acquisition
• Prepaid and Accrued Expenses
• Recording Dividends
• Cash Flow vs. Income Statement
• Profitability Ratios

2
Straight-line Amortization

• Calculation
• Original Cost - Estimated Residual Value
• Estimated Useful Life

3
Asset Acquisition

• 3 Questions
• ) Has an asset been created?
• ) If so, what is the value of the asset?
• ) How does the asset get used up over time, and
  when does it cease to exist?

4
Prepaid Expenses

• Meets the criteria of an asset.
• Cash paid for future goods or services.
• Expenses will be recognized (on the income
  statement) in the period in which the goods or
  services are used.
• e.g. insurance, rent.

5
Accrued Expense

• Meets the criteria of a liability.
• Recognizes the obligation to pay for goods or
  services in the future.
• Expenses are recognized (on the income statement)
  in the period in which the goods or services are
  used and prior to the period in which they are
  paid in cash.

6
Recording of Dividends

• Dividends do not appear on the income statement.
  They are not expenses of doing business since
  they are not incurred for the purpose of
  generating revenues. They are a disbursement of
  part of the profits to the shareholders.
• They do impact retained earnings however. As
  such, they show on a statement of retained
  earnings and, if they are declared but not yet
  paid, also as dividends payable .

7
Recording of Dividends (continued)

• Since the payment of dividends is an outflow of
  cash, the transaction shows as dividends or
  dividends paid on the CFS.
  (as an example, see Canadian Tire Exhibit 1-9,
  Statement of Retained Earnings at the
  bottom of pg. 54
  and Statement of Cash Flows Financing
  Activities on pg. 55)

8
Cash Flow Statement vs. Income Statement

• Income stmt. shows the income flow of the company
  (revenues - expenses). It doesnt record the
  companys source and use of cash.
• Cash flow stmt. adjusts the net income to
  back-out non-cash transactions and also
  communicates the source and use of cash regarding
  financing and investing activities.

9
Profitability Ratios

• Ratios allow users to compare corporations of
  different sizes and to compare the same
  corporation over time.
• In the case of profitability, the profit number,
  by itself, tells you limited information (i.e.
  profit or loss amount and whether it was greater
  or less than last period). It doesnt tell you
  whether or not there was a greater return per
  sales dollar, on assets or equity invested.

10
Profitability Ratios

• Profit Margin Ratio (Profit Margin)
• net income/revenues
  - measures the of revenue s remaining
  after all expenses have been deducted.
• Return on Assets (ROA)
• net income/average total assets
  - measures the return on asset s invested.
• Return on Equity (ROE)
• net income/average shareholders equity -
  measures the return on equity s invested.
• (average refers to the averaging of the
  beginning and ending balances for the accounting
  cycle or year.)