Wednesday, April 30, 2008

Accounting Tips Adjusting Entries

Three Main Rules to follow when working with adjusting entries:

1. An Adjusting Entry always involves at least one account from the income statement and one balance sheet account.
2. Adjusting entries never involve the CASH account.
3. Adjusting entries are made at the end of the accounting period.

Related Adjusting Entry Links:
Four Types of Adjusting Entries
Adjusting Journal Entry for Note Receivable

Monday, April 28, 2008

Differences Financial Managerial Accounting

Six Differences between Financial Accounting and Managerial Accounting:

1. Financial accounting statements are mainly used by external users. Managerial accounting reports are prepared for internal users.

2. Financial accounting data is objective and verifiable. Managerial accounting data should be relevant for decision making, even if it is not objective and verifiable.

3.Financial accounting summarizes past transactions. Managerial accounting has a strong emphasis on the future.

4. Financial accounting statements must conform to generally accepted accounting principles (GAAP). Managerial accounting is not required to follow GAAP.

5. Financial accounting is mandatory and required by outside parties such as the Securities and Exchange Commission (SEC) and tax authorities. Managerial accounting is not mandatory.

6. Financial accounting is concerned with reporting for a company as a whole. Managerial accounting focuses on segments of a company such as product lines, divisions, and departments.

Thursday, April 24, 2008

Accounting Balance Sheet Example

An accounting balance sheet displays a company’s assets and claims to those assets by creditors and owners at a specific point in time. It is a summary of the accounting equation. The balance sheet has a similar property to the accounting equation in that the total of assets reported on the balance sheet must equal the combined total of liabilities and owners’ equity. This always must be true.

Example Bookkeeping Balance Sheet:

Text Version of Accounting Balance Sheet:

New York Business Car Company
Balance Sheet
At January 31, 2008

Cash $ 10,300
Merchandise Inventory $ 1,400
Equipment $ 32,000
Total Assets $ 43,700

Liabilities and Owner’s Equity
Notes Payable $ 30,000
Contributed Capital $ 12,000
Retained Earnings $ 1,700
Total Liabilities and Owner’s Equity $ 43,700

Additional Links to Accounting Problems and Examples:

Wednesday, April 23, 2008

Cost of Preferred Stock

A firm has outstanding preferred stock that has face value of $100 per share and pays a fixed annual dividend of $6.80. Today, the preferred stock's current market price is $97.00. What is the company's cost of preferred stock?

The cost of preferred stock is the dividend yield on the preferred stock. Notice that there is no subscript for the dividend. This is because this preferred stock pays a constant annual dividend.

Rp = D / Po
= $6.80 / $97.00
= 0.0701, or 7.01%

Similar to bonds, preferred stocks are rated in a similar manner. There are published ratings available for subscription on the internet. An alternative way of finding the cost of preferred stock is to observe the required returns on other, similarly rated preferred stock.

Additional Accounting Examples and Explanations:

Tuesday, April 22, 2008

Degree of Financial Leverage

What does degree of Financial Leverage mean in an Accounting Context?

Financial leverage is very similar to operating leverage, except fixed costs that are interested in are the fixed financing costs this time around.

These are the interest expense and preferred dividends that will be issued. A company can measure financial leverage by examine percentage changes in earnings per share (EPS) to percentage changes in EBIT. This is reffered to as the degree of financial leverage formula.

Equation for Degree of Financial Leverage (DFL):

DFL = %Δ in EPS/ %Δ in EBIT


Degree of Operating Leverage (DOL) = Contribution Margin (CM) ÷ Net Operating Income

High-Operating Leverage and Low-Operating Leverage

A company with a high fixed cost structure will show higher net income in good years than companies with lower fixed cost structures. The reverse will happen in bad years. Leverage is a double-bladed sword.

Additional Accounting Related Information on Financial Leverage:

Sunday, April 20, 2008

Accumulated Depreciation Balance Sheet

Example Accumulated Depreciation Statement:

True or False: If you add up all the depreciation expenses from each year of a company's existence, that would equal its depreciation costs?


Accounting Explanation:

Accumulated depreciation represents the sum of all depreciation expenses on the firm's fixed assets. Yet, it only represents the accumulated depreciation of the firm's existing assets. Assets that have retired are deleted from the balance sheet, along with their associated accumulated depreciation.

Additional Links to Accounting Problems and Examples:

Calculate Current Ratio and Quick Ratio

A shoe manufacturing company currently has a current ratio of 2.30 times on current liabilities of $800,000. If the company has $300,000 worth of inventory, what is the firm's quick ratio?

To calculate quick ratio, you first need to calculate current assets. To do this, you need to understand the relationship between a firm's current ratio and its current assets and current liabilities. The current ratio of 2.30 times means the firm's current assets are 2.30 times its current liabilities. Therefore, the current assets can be found by multiplying the current ratio by the current liabilities, as follows:

Current Ratio Equation:
Current Ratio = Current Assets / Current Liabilities

Formula to Solve:
2.30 times = Current Assets / $800,000
$1,840,000 = Current Assets

The quick ratio is very similar to the current ratio, yet it is different because it takes inventories out of the current assets. Therefore, the quick ratio is calculated as follows:

Quick Ratio Equation:
Quick Ratio = (Current Assets - Inventories) / Current Liabilities

Formula to Solve:
= ($1,840,000 - $300,000) / $800,000
= $1,540,000 / $800,000
= 1.9250 times, or 1.93 times

Additional Accounting Examples and Explanations:

Saturday, April 19, 2008

Calculate Preferred Stock Value

Preferred Stock Example Problem:

A yacht manufacturing company has issued perpetual preferred stock outstanding with a par value of $100 per share and a dividend yield of 8.8% of its stated value. If the appropriate interest rate for the company's preferred stock is 8.3%, how much is each share of preferred stock worth?

Calculate Cost of Preferred Stock Shares:

The company has perpetual preferred stock, so it pays a constant dividend forever. The preferred stock pays a dividend that is 8.804 of stated value.

Therefore, the constant dividend equals $100 x 0.088 = $8.80.

The value of perpetual preferred stock is the dividend payment divided by the required return, which in this case is given by the "appropriate interest rate."

P = D / R
= $8.80 / 0.083
= $106.0241, or $106.02

Each Share of Perpetual Preferred Stock is valued at $106.02

Additional Help:
Reasons Companies Issue Preferred Stock

Purchase Texas Instruments BA II Plus Professional Financial Calculator
Purchase HP 10bII Financial Calculator
Purchase Texas Instruments BA II Plus Financial Calculator

Thursday, April 17, 2008

Margin of Safety Equation

The margin of safety is the additional budgeted (or actual) sales over the break-even volume of sales. The break-even point is the amount of sales when total revenue (TR) equals the total costs (TC) of a particular product or product line. Using the break even-point formula is useful for predicting how profitable a product will be when produced.

To calculate margin of safety, use the following equation:

Margin of safety = Total sales - Break-even sales

Related Information:

Calculate Break Even Analysis

Wednesday, April 16, 2008

Corporate Bond Pricing Theorems

The following are the three most important Bond Theorems that apply to government, municipal, and corporate bonds:

1) Bond prices will vary inversely with yields
– an increase in yields leads to a decrease in bond prices

2) Bond price volatility is greater for longer bonds
– bond price volatility is the percentage change in a bond's price for a certain change in its yield

3) Bond price volatility is much higher for bonds with lower coupon rates.

What is a Mortgage Note?

Purchase Texas Instruments BA II Plus Professional Financial Calculator
Purchase HP 10bII Financial Calculator
Purchase Texas Instruments BA II Plus Financial Calculator

Tuesday, April 15, 2008

Calculate Invested Capital

A database company reports a return on investment of 10%, a capital turnover of 8, and an income of $180,000. Using only this information, the company's invested capital is:

ROI = income/sales x sales/capital
10% = 180,000/sales x 8
sales = 14,400,000

Investment turnover ratio = sales/capital
8 = 14,400,000/capital
Capital = 1,800,000

Additional Help:
Expanded ROI Formula
Ratio Analysis and Financial Control

Monday, April 14, 2008

Principles of Internal Controls

List of 7 Main Principles of Internal Controls

  1. Establish responsibilities for each employee
  2. Maintain adequate records of all transactions
  3. Insure assets and bond critical employees
  4. Separate bookkeeping from the custody of assets
  5. Divide responsibility among employees for related transactions.
  6. Apply technological controls for safety.
  7. Perform regular and independent reviews within company

Sunday, April 13, 2008

Reasons Companies Issue Preferred Stock

Why do companies issue preferred stock?

  • To raise capital without sacrificing control of company to outsiders
  • To boost the returns earned by common stockholders through using financial leverage.
  • To appeal to investors who believe the common stock is risky or that the expected return on common stock is too low for their needs.

Additional Examples:

Calculate Preferred Stock Value

What is Financial Leverage?

Degree of Financial Leverage

Calculate Gain or Loss on Sale

A Internet Hosting Service purchased a computer (equiptment) on January 1, 2001 for $170,000, with an estimated life of 8 years and a residual value of $10,000. On July 1, 2007, the computer is sold for $30,000 cash. Calculate the loss or gain on the sale.

$10,000 LOSS

Additional Accounting Examples on Depreciation:

Thursday, April 10, 2008

Accounting Going Concern Principle

What is the Going Concern Accounting Principle ?

This accounting principle makes an assumption that a company will continue to exist long enough to carry out its stated objectives and commitments. Meaning it will not liquidate in the foreseeable future. If the company's financial situation changes so that the accountant believes the company will not be able to uphold commitments, the accountant is required to disclose this assessment when making financial statements. Here is some information on the sources of the accounting principles we know and use today

Wednesday, April 9, 2008

Characteristics of Segment Reporting

A Segment is any part or activity of a business organization which a managers needs cost, revenue, or profit data

Characteristics of Segmented Reporting (performance report)

  • contribution income format
  • traceable fixed costs should be separated from common fixed costs to enable the calculation of a segment margin

The traceable fixed costs of one segment can be common fixed cost of other segments.

Common costs should not be arbitrarily allocated to segments based on the fact that a profitable business segment appear to be unprofitable forces managers to be held accountable for costs they cannot control

Popular Accounting Problems

The information on this site is for informational purposes only and should not be used as a substitute for the professional advice of an accountant, tax advisor, attorney, or other professional.