Thursday, May 31, 2012

Summary of Cash Related Items

Cash and cash equivalents can mean many different things for a company. Companies must segregate and analyze cash that is unavailable for payment of liabilities in the long-term assets section.

If the cash equivalent item cannot be quickly converted to a exchangeable currency, a company can separately classify it as a cash, an investment, temporary investment, receivable,  current liability, or prepaid expense.

The chart below summarizes the classification of cash-related items.

Classification of Cash Related Items 

If not restricted, report as cash.
If restricted, identify and classify as current and noncurrent assets
Short-Term Note
Cash Equivalents
These are investments with maturity of less than three months
Petty Cash
Report as cash on balance sheet
Short- Term Paper
Temporary Investments
These are generally investments with maturity of 3-12 months
Postdated Checks
Accounts Receivables
Assumed to be collectible
Prepaid Expense
Could be classified as office supplies inventory
Travel Advances
Will be collected by employees and deducted from their pay
Bank Overdrafts
Current Liability
Offset and Reduce Cash
Compensating balances
Cash will be classified as a deposit maintained as compensating balance
Classify as a current or noncurrent liability in the balance sheet.

Additional Accounting Definitions:

What are cash equivalent?

Wednesday, May 30, 2012

Using Comparative Income Statement

Accountants will use a comparative income statement in many different ways to assess the income of a company over a specified period of time.

Put simply, the comparative income statement examines accounting  trends of the same items/group in multiple accounting income statements that have been generated over multiple periods of time.

For the careful observer, changes in the income statement items over the period show the performance of the company in a comparative format.

When examining a comparative income statement, examine the following things closely:

  1. Increases in operating expenses or decreases in sales usually indicate that there is a decrease in net operating profit and a decrease in operating expenses.
  2. Changes in sales need to be compared with the changes in cost of goods sold (COGS). If the major increase in sales is more than the increase in the company's cost of goods sold COGS), then there will be a noticeable increase in the company's profitability.

Direct Materials are Conversion, Manufacturing, or prime cost?

In managerial accounting, is the cost of direct materials (DM) classified as a conversion, manufacturing or prime costs by an accountant?

Direct materials are part of prime cost and should be recorded appropriately by accountants.

Prime cost = Direct Materials (DM) + Direct Labor  (DL)
Conversion cost = Direct Labor + Manufacturing overhead

Manufacturing costs generally include a combination of all three : Direct materials, Direct labor, and manufacturing overhead.

Tuesday, May 29, 2012

Manufacturing Overhead Practice Problems

Assume that the accounting computations all require that the company use a job order cost system.

This corporation will apply manufacturing overhead to its jobs using a predetermined overhead rate based on direct labor-hours requires to complete a job. Last period, the company's manufacturing overhead  was $80,000. The direct labor hours were 16,000 hours.

Halfway through the year, job #10 was completed. Materials costs that the company spent on job #10 were $1,500. The labor costs that it spent totaled $2,400 at exactly $6 per hour.

At the end of the accounting year, the in-house accountants determined that the company worked 15,000 direct labor-hours for the year. During the same time, it incurred $78,000 in actual manufacturing overhead costs for the entire manufacturing year. 

Calculate the following using accounting manufacturing overhead formulas.

a. Determine amount of overhead that will be charged to jobs during the year.

b. Calculate predetermined overhead rate for the year.

c. Calculate amount of under- or overapplied overhead for the year.

d. Assume that 100 units were completed, what is the unit product cost (UPC) that would appear on the accounting job cost sheet for Job #10.

Answers to Manufacturing Overhead Accounting Problems


Predetermined overhead rate (POHR) = ( $80,000 / 16,000 ) = $5 per direct labor hour (DLH)


Hours worked at the company for year = 15,000 hour
Overhead applied with the Predetermined Overhead Rate (POHR) = ( 15,000 x $5 ) = $ 75,000


Actual Overhead was $ 78,000
Actual Overhead Underapplied by ( $78,000 - $75,000 ) = $ 3,000


Direct materials Cost = $ 1,500
Direct Labor Cost 2,400

Overhead applied  (400 Direct Labor Hour (DLH)* × $5/DLH) = 2,000

Total Cost= $5,900
Unit Product Cost = $59

$2,400/ $6 = 400/DLH

Additional Accounting Examples:

Calculate Manufacturing Overhead

Monday, May 28, 2012

Purchase Returns Journal Entry

Generally, purchase returns are goods returned to suppliers because of various reasons. For example, there might be wrong products sent, the products are damaged while being shipped, or the purchaser is simply not satisfied with the purchase.

This is also known as returns outwards. The double entry journal entry for goods which have been to suppliers is : 

Debit the returns outward accounting account in the general ledger to increase its value
Credit to the purchases account to decrease its value.

The purchase return account its a temporary account that accountants close  o Purchase accounts, it will directly affect the purchase account and income statement.

Thursday, May 24, 2012

What is difference between owner's equity and stockholder's equity?

In accounting terms, is there any meaningful distinction between owner's equity and stockholder's equity?

Common equity is the outstanding common stock of a company that is currently issued. After the stock is issued and publicly traded (maybe on a small private stock exchange), the value is determined by the market. The market value or market capitalization refers to the entire value of the outstanding stock as valued by a rapidly changing market

Shareholders equity is an account on the balance sheet. Its basically assets minus liabilities as reflected by the accounting equation.  It reflects the financial health, or in some ways, the worth of the company. But its a purely accounting kind of value that reflects the book value of a company's assets.  The market cap is a much better valuation of the company than the shareholders equity.

Generally, sole proprietorship use owner's equity, and corporation use stockholders' equity as it issued shares and the ones who buy those shares are called stockholders.

Wednesday, May 23, 2012

Tax Treatment of Annuities

Annuities – Part Gain and Part Return on Capital

An annuity provides, in exchange for one or more payments by or on behalf of the beneficiary (annuitant), a stream of equal periodic payments for the life of the annuitant, thus protecting the annuitant against the risk of depleting her savings by outliving her life expectancy.

Understanding the tax treatments of annuities is important. Instead of a basis-first rule, Congress has provided for gradual recovery of an annuitant’s basis, according to the exclusion ratio of § 72(b)(1). OPPOSITE OF INSTALLMENT SALES METHOD.

 Under the statutory approach, the portion of an annuity payment treated as a tax-free recovery of basis “bears the same ration to the amount of the annuity payment as the invest in the contract (as of the annuity start date) bears to the expected return under the contract (as of such date).

Nontaxable amount = annuity payment * (investment in the contract/expected return)2.    PRODUCES AMOUNT EXCLUDED FROM GROSS INCOME.

§ 72(c)(1) says that the investment in the contract equals the premiums paid reduced by any amounts received before the annuity starting date and excluded from her income.

§ 72(c)(1) also says that if the expected return on an annuity depends on the annuitant’s life expectancy, the expected return shall be based on actuarial tables prescribed by the treasury. If someone gets an annuity before it starts to pay out, it is treated as tax-free unrealized appreciation on the gains of the investment.

§ 72  offers two significant tax advantages to owners of annuities:

1.    The deferral of tax on the increase in the value of the annuity during the period before payments begin
2.    The understatement of the income portion of payments in the early years is beneficial.

 If someone dies early, the undeclared portion left on their annuity can pass through to the estate and the heirs can claim it. However, remember if you convert life insurance into an annuity, you will be taxed and there is no tax free death benefit. Overall, annuities can have significant tax benefits.

Calculate Allowance for Uncollectible Accounts

Accounting Problem and Answer for Allowance for Uncollectible Accounts 

On the date Jan. 1, 2011, a company had a credit balance of $260,000 in its allowance for uncollectible accounts.  Based on its prior sales history from numerous years, 2% of the company's credit sales have generally been uncollectible.

During 2011, the company wrote off $325,000 of uncollectible accounts.  Credit sales for 2011 were $9,000,000.  In its December 31, 2011, balance sheet, what amount should the company report as allowance for uncollectible accounts?

In order to solve this problem, you have a fund for reducing your Accounts Receivable called allowance for uncollectible accounts and it's purpose is to help you reflect your real Accounts Receivable given the fact that some people just don't pay their bills.  

Steps to Accounting Solution:

  1. Start in the year Jan 1st with the balance at $260,000.
  2. They sold 9,000,000 worth of stuff so you add to this number because 2% of those people won't pay their bills to the company
  3. Write off $325,000 of the Accounts Receivable, which reduces the Allowance for Uncollectible's account by $325,000 as well. 

DEBIT: Allowance for uncollectible accounts.........325,000  
CREDIT: Accounts Receivable................................325,000

Answer: 260,000 + 2% of 9,000,000 - 325,000 of writeoff = 115,000

GAAP mandates the Allowance Method of estimating uncollectible accounts receivable. Most companies estimate their uncollectible accounts receivable using one of three approaches:

1. The percent of sales method
2. The percent of receivables method
3. The aging of receivables method

Additional Accounting Examples:
Percent of Accounts Receivable Method for Estimating Bad Debts Expense
Percent of Sales Method for Estimating Bad Debts Expense

What is Net Present Value (NPV)?

Net Present Value (NPV) is a very important concept in Accounting

Net Present Value (often referred to as NPV by accountants), is a financial concept used in making different financial choices. Basically, it is an easy a way for accountants to express a decision in "today's dollars".

For an accountant to calculate net present value (NPV), they must use the difference between the present value (PV) of cash inflows and the current value of cash outflows by a company.

NPV is defined mathematically as the present value of cash flow less the initial outflow n NPV= Σ Ct - Co t=1 (1+k)t

Most often, NPV is used in capital budgeting type analyses to analyze the profitability of a potential investment, project, or product line that a company is thinking about undertaking in the future.

Generally,  if the NPV of a prospective project is positive, it should be accepted by management or the relevant decision makers in a department.  However, if NPV is negative, the project should probably be rejected because cash flows in the future will be negative and the company will experience net losses on the project. The company may still undertake the project if there are other non-financial accounting reasons.

Capital Budgeting Practice by Real Accountants

There was a study of capital budgeting practices of fourteen large worldwide companies and it was discovered that all the companies, except one, used a payback. With payback method and/or other techniques, about 66% of companies used internal rate of return (IRR) and about 40% used net present value (NPV). 

Overall, the survey indicated that Internal rate of return (IRR) was the second most popular method. 

The reasons for the popularity of payback in order of significance were stated because of its simplicity to use and understand. Also, the popularity of payback was due to the strong emphasis on the early recovery of investment and good focus on risk. 

Lastly, it was also found that 33% of companies always insisted on the computation of payback for all projects that they undertake, 33% for majority of projects and remaining for some of the projects.

For most companies, standard payback ranged between three and five years.

Tuesday, May 22, 2012

Four Categories of Features to Show Debt or Equity

Four Categories of Features to Show Debt or Equity to Internal Revenue Service (IRS)

  1. Features about the parties formal rights and remedies LEGAL RIGHTS 
    1. What legal rights and remedies in the contract 
    2. Maturity date- usually for fixed term if lender 
    3. Participation in Corporate Gains- Generally associated with equity interests that participate in the corporate adventure, although some debt securities have upside advantage d. Participation in Corporate losses. Debt holders don’t participate 
    4. Certainty of Return – Dividends legally only if the corp has adequate earnings or surplus. Credits have an unconditional right to get the interest on their contract.  You pay all the time.  
    5. Remedies upon default- legal- if the company does not pay, the creditors may sue for the amount. Lenders can force debtors into bankruptcy. 
    6. Right to convert debt into stock, at will, then the question will be in what way was this ever really debt? Convertible securities. 
    7. Subordination- Important with bankruptcy, who has the prior claim to the corps earners and assets. Equity holders subordinate.  Priority of interest holders 
    8. Voting Control – Equity holders often have voting powers, but it is an equity like feature 2. Facts showing the parties intent? 
  2. What evidence is available to show that the arties want. OBJECTIVE TEST. What the parties are doing at time of deal. 
    1. All the documents surrounding the transaction. Totality of the circumstances will be looked at. Written and Oral Communication.
    2. What is the document labled? Promissory notes.
    3. What happens when parties don’t observe the formalities. 
    4. Do the specify the terms of the debt and keep referring to it as debt.
    5. If the parties are related, does this look like stock that unrelated parties would exchange
    6. What about the accounting books. Label it correctly in records and balance sheet
    7. Parties practices matter. If there is purported right to interest, but the corporation never pays the right amount. Irregular paying dividends. 
    8. Paying dividends before interest payments does not look so good either. 
  3. Economic reality of the instruments 
    1. Two important economic factors: 
      1. Do the parties debt interest, mirror the parties equity interests? This raises the possibility that maybe its just equity disguised as debt. Look at proportions. 
      2. Thin Capitalization- Lots of equity
        1. Debt without much equity looks like an equity investment. 
        2. Look for factors that are pointing more at a corporate adventure. 
  4. What the parties say at the actual time of the dispute – Subjective. How they label it. It counts for something.  
    1. Different taxpayers have different incentives. These factors often matter the most with hybrid securities because they have many different characteristics.  
    2. When does IRS come in? When parties do not negotiate at arms length. The courts are particular skeptical of non- arm lengths negotiations. 

Journal entry assigning Factory Payroll if using a job order cost accounting system?

Which journal entry to assign factory payroll if using a job order cost accounting system?

In the last several months, the total system accumulated labor time receipts totaling $24,600 for direct labor and $4,300 for indirect labor. All the costs were accumulated in factory payroll account when they were paid.

These are the relevant transactions:

a.  Payroll expense..... 28,900 cash.... 28,900
b.  payroll expense....24600 factory overhead......4300 factory payroll ....28900
c.  goods in process inventory.... 24600 factory overhead....4300 factory payroll....28900
d.  goods in process inventory....24600 factory overhead....4300 accrued wages payable....28900
e.  goods in process inventory....28900 factory payroll..... 28900

Accounting Answer:

b. payroll expende....24600 factory overhead......4300 factory payroll ....28900
(Indirect labor is an overhead cost).

Main purpose of financial statements and managerial reports?

What is the main purpose of financial statements and managerial reports?

The most important financial statements are the income statement (information over a set period of time), balance sheet (exact point in time) and cash flow statements (information over a period of time).  '

The cash flow statement links the income statement and the balance sheet.  There is the cash accounting method (cash in and cash out) and GAAP (generally accepted accounting principles) accrual-based accounting.

Most small businesses will use cash accounting system and larger companies (complex operations) and, for sure, publically traded companies, use GAAP accounting system.  There is also tax accounting for the IRS, which has different rules and requires an accountant to use separate books.

Overall, managerial reports are designed to answer internal management questions about a company and are only for internal use. Therefore, the most important factor in picking a system for management reports should be considerations to what is important in the business, either quantitavely or qualitatively.

Related Accounting Examples:

How to Calculate Net Income
Manufacturing Overhead
Average Accounting Return

HP Photosmart 5510 e-All-in-One CQ176A

How to Achieve Operating Income Target

Severe economic conditions are forcing a manufacturing company to lower prices from $50 to $40 per unit, however the company expects sales to rise from 600,000 to 750,000 units.

The manufacturing company's current cost of production is $38 per unit. Suppose this company would like to maintain a 16% target operating income (OI) on all of its sales current revenue.

To achieve this operating income target, the manufacturing company must lower its cost of production by

A. $33.60 per unit
B. $6.40 per unit
C. $2 per unit
D. $4.40 per unit

Correct Answer:

D. $4.40 per unit

Operating income = 16%* 40$= 6.4
Target cost= 40-6.4=33.6
Current cost = 38
Reduction needed = 38-33.6=4.4 $ per unit

Monday, May 21, 2012

Canceled Checks Bank Reconciliation Journal Entry

If there are canceled checks on a bank reconciliation, what journal entry adjustments must be made by an accountant?

The check that was issued by you, unless presented to bank for clearance and debited to your account by bank, cannot be recorded by the bank in a bank statement.

Therefore, if a check is later cancelled by you before being sent to the bank, it will have no effect/treatment in bank statement. It will appear in bank reconciliation statement as a reconciling item.

To fix your accounting records, you will need to reverse the accounting journal entry in the accounts that were affected by the transaction.

Additional Accounting Examples:
Accounting Bank Reconciliation

Tuesday, May 15, 2012

What is a Stock Dividend?

A stock dividend is a pro rata distribution to stockholders of the corporation’s own stock.  In comparison to a cash dividend where a company pays cash,  a company will issue shares of its own stock in a stock dividend.

On the balance sheet, a stock dividend results in a decrease in retained earnings and an increase in paid-in capital. Unlike a cash dividend, a stock dividend does not decrease total stockholders’ equity or total assets.

What are American Insider Trading Laws?

Insider Trading is a form of deception that is based of 10b5. The toughest part of the inquiry is element 1. The Material Misstatement of Omission.  Insider trading is usually not a misstatement but more like an omission.

1. Insider Trading law - When _____ possess material NON-PUBLIC information, they must disclose or abstain from trading.
2. If you disclose, you can trade away. Disclosure is a remedy for this.
3. NOTE: This information must be material and matter to investors.  You got to wait a little bit of time for the information to hit the market. The market must have a short opportunity to digest info.

A tippee is joint and severally liable for insider trading in two situation.

1. An insider breaches a fiduciary duty in making the tip. Improper Purpose
2. AND, Tippee knows or should know of the insider’s breach.

What is the most important word? Insider? Must determine who has fiduciary duties to the company’s shareholders.  You must base the tippees liability on the insider’s liability.

When does an insider breach a duty? The courts are very specific with insider breach. LOOK FOR IMPROPER PURPOSE= Personal Benefit or a Gift.

Look for kickbacks, personal relationship. Look for the purpose. OBJECTIVE Court has to be convinced by the purpose.

Saturday, May 12, 2012

Accounting Journal Entry for Inventory Sample

What accounting methods do you use for inventory that is used for samples in an ongoing business? Specifically, the inventory items are spilt up and used in multiple samples (i.e. carpet pieces). At the end of the day, there will be some left over that will also be discarded.

Accounting Answer:

It should work out to treat the sample inventory as a cost of sale. That is, you can separate sample inventory from your current inventory by doing an easy journal entry:

Debit Sample Inventory......x
Credit Inventory..........x

When your sample inventory is depleted or discarded, then charge it to net income.

Debit Cost of Sales.........x
Credit Sample Inventory.........x

The reason for this accounting method is because you are treating the sample inventory as a means to sell original inventory (cost of selling the product). Thus, it is appropriate for an acceptant to charge it as a cost of sales or cost of goods sold account when discarded.

Also see how to calculate beginning inventory.

Friday, May 4, 2012

Section 444 and Partnership Taxable Year

Section 444 of the Internal Revenue Code generally allows a partnership to retain or adopt any taxable year provided that certain requirements are met:

  1. For new partnerships, the deferral period is no longer than three months and 
  2. the partnership is not part of a tiered structure. IRC §444(b)(1) and (d)(3). 
The "deferral period" is the number of months between the beginning of the year in question and the close of the first "required taxable year" ending within the year in question (as determined pursuant to §706(b)).

The policy and purpose of §444 is permitting  existing business entities to retain existing nonconforming entity taxable years or to change to years of lesser deferral without sacrificing revenue and to permit new entities to obtain limited deferred periods in order to meet the concerns of tax return preparers.

The "toll charge" for a partnership §444 election is payment of the entity-level excise tax imposed by §7519.  

Thursday, May 3, 2012

What is a Supplier Statement?

A Supplier Statement generally includes all the transactions that affect the specific supplier account including debit notes, supplier invoices, credit notes, payments and adjustments.

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.