Fall 2016 BUSI 102 Notes

Financial Accounting (Chapters 1-5 H&S)

Chapter 1: Using Financial Accounting and why is it important?

● Financial Accounting: the communication of information about an organization (business, charity, gov’t) so
that individuals can assess its financial health & future
○ ex) organization -> reports info based on financial accounting -> interested individuals assess
financial health and future prospects
● Managerial Accounting: communication of information within an organization so that internal decisions
○ ex) whether to buy or rent a building) can be made in an appropriate manner
● Incorporation: process where owners of a business can apply to the state gov’t to become identified as an
entity legally set apart from others
● Corporation: organization that has been formally recognized by the state government as a separate legal
entity that can act independently of its owners
● Unincorporated: sole proprietorship (1 owner), partnership (2+), not separate from ownership
● Stock/Shareholders: a corporation has the ability to obtain money by selling (issuing) capital shares that
allow investors to become owners
○ These corporations are run by 10-25 member board of directors elected by shareholders to oversee
management of the company/make policy decisions
○ one benefit to holding a share for more than 12 months is LT capital gains (tax purposes)
● Dividends: periodic payments to shareholders as form of profit sharing
○ Younger business usually prefer to opt out of this so they can keep the capital they need to sustain
growth
● In order to compare with other investments, investors seek to estimate the following:
1. Price of corporation’s capital stock in the future
2. The amount of cash dividends that will be paid over time
● Verbal Explanations: accounting communicates to decision makers in 2 distinct steps
1. financial info is provided in monetary terms
2. Further explanations is given to clarify and expand on those monetary balances

Chapter 2: What Should Decision Makers Know about an Organization?

2.1: Creating a Portrait of an Organization that can be used by Decision Makers
● Financial Statements: takes all appropriate monetary information and constructs a set of financial
statements
○ Balance Sheet – measure things at a POINT in time
■ Assets (A)= Liabilities (L) + Owner's Equity (OE)
○ Statement of Cash Flows – Represents the Change in Cash – measure things in a PERIOD of time
■ Operating
■ Investing
■ Financing
○ Statement of Owner’s Equity
■
● Financial accounting should not contain any misstatements**
○ Misstatements can be an error or fraud
○ Misstatement = material if its so significant that its presence would impact a decision made by an
interested party
2.2 – Dealing with Uncertainty
 ● Reporting events in the face of uncertainty is surely one of the major challenges of being a financial
accountant
● Effective communication is possible in a language when:
○ Set terminology exists
○ Structural rules and principles are applied
2.3 – The Need for Accounting Standards
● U.S. GAAP (General Accepted Accounting Principles)
○ Applied to most financial information in the US
○ The financial Accounting Standards Board (FASB) has authority to develop GAAP
● IFRS (International Financial Reporting Standards)
○ Used almost exclusively in the rest of the world
○ Larger companies and bigger accounting firms favor the shift to international standards
● **In general, people want one standard, easier to communicate and understand**
● Financial accounting key to assessing the financial health and future prospects of an organization
○ ex) Expanding economy requires capital investment
● **Changes to the GAAP have large impacts**
● Value Investors: Look at assets first
● Growth Investors: Look at earnings momentum
● Journal Entry Format
○ Account Debited Amount Debited
○ Account Credited Amount Credited
○ DEBIT -> LEFT
○ CREDIT -> RIGHT
2.4 – Four Essential Terms Encountered in Financial Accounting
● Assets: Probable future economic benefit that an organization either owns or controls
○ ex) Cash and accounts receivable (money due from customers)
○ ex) Inventory (merchandise held for resale)
○ Assets vary largely based on the industry and company
● Liabilities: A probable future sacrifice of economic benefits arising from present obligations. (Debts of the
organization)
○ ex) Amount owed to vendors who supply merchandise
○ ex) Notes due to banks as a result of loans
○ ex) Income tax obligations
○ ex) Balances to be paid to employees, utility companies, advertising agencies, etc.
● Other Relevant Term - Net Assets: Assets (future benefits) less its liabilities (debts)
○ This balance is known as “equity” in reference to the owner's’ rights to all assets in excess of
liabilities
● Revenue: A measure of the financial impact on an organization that results from a particular process
○ A sale is the process to generate revenue
○ Revenue is NOT an asset, but instead a measure of the increase in net assets created by the sale of
inventory and services
● Expenses: An outflow or reduction in net assets that was incurred by an organization in hopes of generating
revenue.
○ Rent expense
○ Salary expense
○ Insurance expense

Chapter 3: How is financial information delivered to Decision Makers?

3.1: Construction of Financial Statements Beginning with the Income Statement
 ● Businesses periodically produce financial statements that provide a formal structure for conveying financial
information to decision makers
○ Income Statement: A listing of all revenues earned and expenses incurred by the reporting
organization
■ Gain – increase in the net assets of an organization created by an occurrence that is
outside its primary or central operations
● Ex) Apple sells land adjacent to warehouse above cost (not how they usually
make money)
■ Loss – decrease in net assets from similar type of incidental event
● EX: Pizza Hut disposes of an oven
■ Cost of Goods Sold/ Cost of Sales – expense reflecting the cost (to the supplier) of the
merchandise that customers purchased
○ Gross profit/gross margin/markup: the difference in revenue and costs of goods sold
■ Income tax figure is segregated (on the bottom of the income statement) b/c it’s not a
traditional expense
○ Statement of retained earnings: more inclusive statement of stockholders’ equity
■ NEEDS MORE INFO(?)
○ Balance sheet – measure things at a POINT in time
■ Assets (A)= Liabilities (L) + Owner's Equity (OE)
■ MORE INFO(?)
○ Statement of cash flows – Represents the Change in Cash – measure things in a PERIOD of time
■ Operating- related to income statement
■ Investing- buying/selling long term assets
■ Financing- Long term liabilities and owner's equity
3.2 – Reported Profitability and the Impact of Conservatism
● A cost is identified as an asset if the benefit clearly has value in generating future revenues whereas an
expense is a cost that has already helped earn revenues in the past.
○ Asset – utility associated w/ cost is yet to be consumed completely
○ Expense – utility has already been completely consumed
● Practice of Conservatism
○ When an accountant faces two or more equally likely possibilities, the one that makes the
reporting company look worse should be selected
○ **Conservatism is used to help safeguard the public
● **Dividends are not expenses and are not included in an income statement (sharing profits not directly
related to generating revenues)**
● Net income: growth in an organization's net assets
3.3 – Increasing the Net Assets of a Company
● Retained earnings is a measure of the profits left in a business throughout its existence to create growth
● Retained earnings figure informs decision makers of the amount of expansion was internally generated
○ One of the best ways to increase net assets is through profitable operations
○ Beyond operations, businesses accumulate net assets by receiving contributions from investors
who become owners through acquisition of capital stock
● Capital Stock/Contributed Capital – amount invested in the business by individuals and groups in order to
become owners
● Retained Earnings – total net income earned by the organization over its life less amounts disturbed as
dividends to owners.
3.4 – Reporting a Balance Sheet and a Statement of Cash Flows
● Purpose of a balance sheet to report a company’s assets and liabilities at a particular point in time.
○ Assets listed first, in order of liquidity, followed by all liabilities
 ● Current assets – those expected to be used/consumed within the following year
○ Noncurrent- those expected to remain for longer than a year
● Working Capital – current liabilities subtracted from current assets
○ Reflects short-term financial strength
● Current Ratio – current assets divided by current liabilities (short term operating strength)
● Balance sheet shows company’s financial condition on a specific date
○ Assets = liabilities + stockholder’s equity
○ Assets = liabilities + capital stock + retained earnings
● “Accounting Equation”
○ Increase in total assets can be caused by:
■ Inc in liabilities (money borrowed)
■ Inc in capital stock (additional $ to stockholders)
■ Inc created by operations (a sale that generates a rise in net income)
● Cash changes divided into 3 categories
○ Operating Activities: relate to receipts and disbursements arose in connection w/ central activity of
the organization
■ Shows how much cash the primary business function generated in this period of time
■ ex) Grocery Store: sells goods to customers, buys merchandise, pays salaries to
employees
○ Investing Activities
■ Involve an asset and are separate from central/daily business operations
■ Amount of cash collected/deducted when either equipment/land is sold/bought
○ Financing Activities: Transactions relate to either a liability or a stockholders’ equity balance
● Key Takeaway: Balance sheet is only statement created for a specific point in time

Chapter 4: How does an Organization Accumulate Info for Financial Statements?

● Transaction- any event that has an immediate financial impact on a company
○ Any event w/ measurable effect on assets, liabilities, revenues, expenses, gains, losses, capital
stock, or dividends paid
○ Everything referred to as an account
● Account Balance - Monetary amount attributed to account
○ ex) Rent expense and salary expense are expense accounts
● Accounts Payable – used in financial accounting to represent debts resulting from the acquisition of
inventory and supplies
● Financial Impact of Paying an Employee
○ Cash balance declined when salary is paid to an employee
○ Assets reduced as a result of a payment (Cash)
○ Salary paid after the fact is an Expense (Salary Expense) b/c it reflects past benefit
○ Assets decrease, and expense is recognized, reducing the net income
● Accrued expenses – expenses that increase gradually over time
○ ex) Salary, Rent, Interest
○ Some companies ignores accrued expenses until paid, where expense is recognized and cash is
reduced
● Borrowing Money from the Bank: Cash is inc by the amount of money received from the lender and Note
Payable (liability) inc by same amount
4.2 – Understanding the Effects Caused by Common Transactions
● Recording the Sale of Inventory
○ Sales revenue increase by amount
■ Accounts receivable increases by amount (if on credit)
 ■ Cost of goods sold (expense) increases, Inventory (Asset) decreases
● The Dual Effect of Transactions: Transactions must affect minimum of two accounts
● Paying a Previously Recorded Expense
○ Insurance Payable decreases
○ Cash decreases
● Acquisition of an Asset
○ Asset inc by amount
○ Cash dec by amount paid at the time
○ Notes Payable inc by whatever is still owed
● Recording a Capital Contribution by an Owner
○ Cash inc by amount
○ Capital Stock inc by amount
● The Collection of an Account Receivable
○ Cash inc by amount
○ Accounts Receivable dec by amount
● Payment made on an Earlier Purchase
○ Accounts Payable dec by amount
○ Cash dec by amount
● Payment of Rent in Advance
○ Prepaid rent (asset) inc by amount
○ Cash (asset) dec by amount
4.3 – Double-Entry Booking
● Analyze, Record, Adjust, and Report
● T-account
○ Debit on left, Credit on right
● Increase shown with a Debit, Dec shown w/ credit
○ Expenses and losses
○ Assets
○ Dividends paid
● Increase shown with Credit, Dec shown w/ debit
○ Liabilities
○ Capital Stock
○ Revenues and Gains
○ Retained Earnings
● Debits must always equal credits for every transaction
4.4 – Recording Transactions Using Journal Entries
● Journal Entry: – initially recorded financial changes caused by a transaction
● Journal: – List of companies journal entries
● Practicing with Debits and Credits
○ Ledger – how a company keeps its T-accounts together
○ Trial Balance – listing of the account balances found in the ledger
● Journal Entry for Acquisition of Inventory on Credit
○ Inventory inc (asset debit)
○ Accounts Payable credited
● Recording Payment of an Expense
○ Expense debited
○ Cash Credited
● Journal Entry When Money Is Borrowed
○ Cash is debited
 ○ Notes payable is credited
● Recording Sale of Inventory on Credit
○ Pt. 1
■ Accounts Receivable debited
■ Sales of merchandise (revenue) credited
○ Pt. 2
■ Cost of Goods Sold (expense) inc (debited)
■ Inventory dec (credited)
● Role of Accrual Accounting
○ Revenue realization principle: Revenue is recognized when:
■ The earning process needed to generate the revenue is substantially complete
■ The amount eventually to be received can be reasonably estimated
○ Matching Principle: Expenses are recognized in the same time period as the revenue they help
create
■ Expenses are matched with revenues
4.5 – Connecting the Journal to the Ledger
● Payment of a Previously Recognized Expense: No expense included b/c already recognized
○ ex) Insurance payable debited (dec)
○ ex) Cash credited (dec)
● Receiving Cash before the Earning Process Is Complete
○ Cash debited (inc)
○ Unearned Revenue credited (inc)
● Distribution of a Dividend
○ Dividends Paid debited
○ Cash credited
● Current T-Account Balances
● 2 Steps to Recording:
1. Journal entry created to reflect monetary impact of transaction
2. Each debit/credit added to specific T-account being altered (Process is called Posting)

Chapter 5: Why is Financial Information Adjusted?

5.1 – The Need for Adjusting Entries
● Some accounts inc/dec due to the passage of time
○ ex) Salary, rent, utilities, interest
● Adjusting entries: Incremental inc or dec recorded in debit/credit format, impact then posted to ledger
accounts
○ Identical to journal entries but occur at different time for different reason
● Examples of Adjusting entries
○ Accrued Expenses
○ Prepaid expenses
○ Accrued revenue
○ Unearned revenue
5.2 – Preparing Various Adjusting Entries
● Prepaid rent (ex) changes from asset to expense daily
○ Accrued Revenue
○ Earnings Process
● Revenue should not be recognized unless evidence predominates that the individual tasks are clearly
separate events
● Unearned Revenue: Credit sales of services and debit Unearned revenue to adjust
5.3 – Preparation of Financial Statements
● Cash flows – resulting from operating activities, investing activities, or financing activities
● Net Income – composition of all revenues, gains, expenses, and losses for the year.
○ No T account for net income
○ No T account for ending retained earnings balance
● The Purpose of Closing Entries
○ Final action performed by an accountant each year
○ T accounts must be returned to a zero balance after financial statements are produced
● Final Credit totals in every revenue and gain account are closed out by recording equal and off-setting debts
○ Ending debit balances for expenses, losses, and dividends paid require a credit entry of the same
amount to return each of these T-accounts to zero
○ Closing process effectively moves balance for every revenue, expense, gain, loss, and dividend
paid into retained earnings.
○ Closing entries recorded initially in journal then posted to ledges

Managerial Accounting (Chapters 1-11 WKK)

Chapter 4: Activity Based Costing
● Traditional Costing system
○ companies use estimates to assign overhead costs to products and services
○ the amount of direct labor used in many industries has greatly decreased, and total overhead costs
resulting from depreciation on expensive equipment and machinery, utilities, repairs, and
maintenance have significantly increased.
○ Companies that have complex processes need to use multiple allocation bases to compute accurate
product costs. An overhead cost allocation method that uses multiple bases is activity-based
costing.
● Activity Based Costing
○ Activity-Any event, action, transaction, or work sequence that incurs costs when producing a
product or performing a service.
○ Activity Cost Pool: The overhead cost attributed to a distinct activity (e.g., ordering materials or
setting up machines)
○ Cost Driver: Any factor or activity that has a direct cause-effect relationship with the resources
consumed
○ Step 1- identify all resource consuming activities. Then assign overhead costs to each activity
○ Step 2- identify the cost drivers for each cost pool. a high degree of correlation must exist between
the cost driver and the actual consumption of the overhead costs in the cost pool.
○ Step 3- compute activity based overhead rate (estimated overhead per activity/ expected use of
cost driver per activity)
○ Step 4- allocate overhead costs to products
● Classification of Activity Levels
○ Unit level activities- are performed for each unit of production. For example, the assembly of cell
phones is a unit-level activity because the amount of assembly the company performs increases
with each additional cell phone assembled.
○ Batch level activities- are performed every time a company produces another batch of a product.
For example, suppose that to start processing a new batch of ice cream, an ice cream producer
needs to set up its machines. The amount of time spent setting up machines increases with the
number of batches produced, not with the number of units produced.
○ Product level activities- are performed every time a company produces a new type of product. For
example, before a pharmaceutical company can produce and sell a new type of medicine, it must
 undergo very substantial product tests to ensure the product is effective and safe. The amount of
time spent on testing activities increases with the number of products the company produces
○ Facility level activities- are required to support or sustain an entire production process. Consider,
for example, a hospital. The hospital building must be insured and heated, and the property taxes
must be paid, no matter how many patients the hospital treats. These costs do not vary as a
function of the number of units, batches, or products.
● When to Use ABC
○ Product lines differ greatly in volume and manufacturing complexity.
○ Product lines are numerous and diverse, requiring various degrees of support services.
○ Overhead costs constitute a significant portion of total costs.
○ The manufacturing process or the number of products has changed significantly, for example,
from labor-intensive to capital-intensive due to automation.
○ Production or marketing managers are ignoring data provided by the existing system and are
instead using “bootleg” costing data or other alternative data when pricing or making other
product decisions.

Chapter 5: Cost-Volume-Profit
● Variable, Fixed, and Mixed Costs
○ Cost behavior analysis: the study of how specific costs respond to changes in the level of business
activity
■ The starting point in cost behavior analysis is measuring the key business activities
○ Variable costs: costs that vary in total directly and proportionately with changes in the activity
level
○ Fixed costs: costs that remain the same in total regardless of changes in the activity level
■ Fixed costs per unit vary inversely with activity: As volume increases, unit cost declines,
and vice versa.
■ The trend for many manufacturers is to have more fixed costs and fewer variable costs.
This trend is the result of increased use of automation and less use of employee labor. As
a result, depreciation and lease charges (fixed costs) increase, whereas direct labor costs
(variable costs) decrease.
○ Mixed costs: costs that contain both a variable- and a fixed-cost element.
○ High Low Method
■ The high-low method uses the total costs incurred at the high and low levels of activity to
classify mixed costs into fixed and variable components. The difference in costs between
the high and low levels represents variable costs, since only the variable-cost element can
change as activity levels change.
■ Step 1: determine variable cost per unit (Change in total costs/high-low activity level)=
VC/unit
■ Step 2: Determine fixed costs by subtracting total variable costs at either high or low
level activity level from total cost of activity level
○ CVP Analysis

VARGO VIDEO COMPANY

CVP Income Statement
For the Month Ended June 30, 2017
Total
Sales (1,600 camcorders) $
800,000
 Variable costs
480,000
Contribution margin   320,000
Fixed costs
200,000
Net income $
120,000

§ Unit selling price- 500

§ Unit variable costs 300
§ Total monthly fixed costs 200,000
§ Units sold 1600

Chapter 6: Applying Basic CVP Concepts

● Basic Concepts
○ Breaks costs into variable, fixed, and then computes contribution margin
■ Costs include manufacturing costs plus selling and administrative expenses
○ Breakeven in units = Fixed costs/unit contribution margin
○ Breakeven in dollars = Fixed costs/contribution margin ratio
○ Contribution margin = Sales price per unit -total variable costs per unit
○ Contribution margin ratio = Contribution margin per unit/sale price per unit
○ Target net income units = (Fixed costs + target net income)/unit contribution margin
○ Target net income dollars = (fixed costs + target net income)/ contribution margin ratio
○ Margin of Safety = Actual (Expected) Sales-Break even sales
○ Margin of Safety ratio = Margin of safety ($)/actual (expected) sales
● Sales Mix and its Effects
○ Sales mix is the relative percentage in which a company sells its multiple products
○ Sales mix percentage = Units of specified good produced/ total units produced
○ Weighted average unit contribution margin = (Unit contribution margin good 1 x Sales mix
percentage good 1) + (Unit contribution margin good 2 x Sales mix percentage good 2)
○ **Use weighted average unit contribution margin ratio in other formulas**
○ **Net income will be greater if higher contribution margin units are sold rather than lower
contribution margin units.**
● Break even sales in dollars
○ Companies that produce a large number of products calculate the break-even point in terms of
sales dollars rather than units sold
Indoor Plant Outdoor Plant Company
Division Division Total
Sales $ 200,000 $ 800,000 $1,000,000
Variable costs 120,000 560,000 680,000
Contribution margin $ 80,000 $ 240,000 $ 320,000
Sales mix percentage $ 200,000 =. $ 800,000 =.
20 80
(Division sales ÷ Total $1,000,000 $1,000,000
sales)

CMR 80,000/200,00=.4 CMR 240,000/800,00= .3 320,000/1,000,000= .32

(CMR good 1 x Sales Mix Percentage 1) + (CMR good 2 x Sales mix percentage good 2)
Fixed costs/weighted average contribution margin ratio= break-even point in dollars

● Determine Sales Mix When a Company Has Limited Resources

○ Contribution margin per unit of limited resource
■ Unit contribution margin/units of limited resource required
■ (CM/Machine Hours)
○ Incremental analysis
■ If a company can increase its limited resources, then you can find out what the increase
should be used to produced
§ for example say machine hours increase
· Increase in resource x contribution margin per unit of limited resource
· Indicating How Operating Leverage Affects Probability
o Cost structure refers to the relative proportion of fixed versus variable costs that a company incurs
o Companies that have higher fixed costs are more sensitive to changes in sales revenue
o Operating leverage refers to the extent which a company’s net income reacts to a given change in sales.
o Companies that have higher fixed costs relative to variable costs have higher operating leverage
§ When sales revenue is increasing high leverage is good because profit increases rapidly, but when sales are
declining, too much operating leverage has dire consequences
o Degree of Operating Leverage
§ Contribution Margin/Net Income
§ Operating leverage x increase (decrease in sales) =net income increases (decrease)

Chapter 7: Incremental Analysis

· Management Decision Making Process and Incremental Analysis
o Steps
§ Identify the problem and assign responsibility
§ Determine and evaluate possible courses of action
§ Make a decision
§ Review results of the decision
o Relevant cost
§ Costs that differ across alternatives. Costs that do not differ can be ignored
o Opportunity cost
§ The cost of the option you forgo in making a choice
o Sunk cost
§ Costs that have already been incurred
o Incremental analysis doesn’t take into consideration the time value of money
o Types of Incremental Analysis
§ Accept an order at a special rate
§ Make or buy component parts or finished products
§ Sell products or process them further
§ Repair, retain, or replace equipment
§ Eliminate an unprofitable business segment or product
· Analyzing the Relevant Costs in Accepting an Order at a Special Price
o Important to recognize if company is operating at full capacity
o Other markets shouldn’t be affected by special price orders
· Analyzing Relevant Costs in a Make-or-Buy Decision
o When a manufacturer assembles component parts in producing a finished product management must decide
whether to make or buy (outsource) components
o Important to consider the ethics of a decision