1.

General Topics
1.1 Generally
Accepted Accounting
Principles (GAAP)

1.2 Rules of Double-

Entry Accounting/
Transaction Analysis/
Accounting Equation
1.3 The Accounting
Cycle
1.4 Business Ethics
1.5 Purpose of,
Presentation of, and
Relationships
Between Financial
Statements

1.6 Forms of
Business
1.1 Generally Accepted Accounting
Principles (GAAP)
• (GAAP) are a set of
principles where
they are a set of
rules considered
vital in the realm of
Accounting
• GAAP were created
by the Financial
Accounting
Standards Board
(FASB)
• GAAP contain
specific facts that
must be adhered to,
and they include:
1. Transactions get
recorded twice
2. Financial
statements report on
the business entity
only
3. Debts are paid
within one year, or
one business cycle,
whichever is longer
• GAAP contains
Principles:
• Conservative
Principle:
• Going-Concern
Principle:
• Historical Cost
Principle:
• Objectivity
Principle:
• Stable Monetary
Unit Principle:
1.1.1 Generally Accepted Accounting
Principles (GAAP): Summary
GAAP standards
created by the Financial
Accounting Standards
Board (FASB)

REMEMBER- FASB:
• Governing body
• Not gov’t. entity
GAAP: Stresses essential characteristics of
accounting, which initiate regulations
• the identification, measurement, and
communication of financial information,
about;
• economic business-oriented entities, to;
• interested parties.
GAAP’s Primary Concern: Financial Statement
Regulation
• Balance Sheet
• Income Statement
• Statement of Cash Flows
• Statement of Owners’ or Stockholders’ Equity
• Note Disclosures
What is the purpose of information presented in
notes to the financial statements?

• To provide disclosure required by generally

accepted accounting principles.
Summary of Financial Reporting: Information to
help users with capital allocation decisions
• Who are the Users of info?
• Investors, creditors, and other users
• Capital Allocation
• The process of determining how and at
what cost money is allocated among
competing interests
 GAAP Standard Setting: Summary
• WHO: Parties Involved in Standard Setting
• Four primary parties
• Securities and Exchange Commission (SEC)
• American Institute of Certified Public Accountants
(AICPA)
• Financial Accounting Standards Board (FASB)
• Government Accounting Standards Board (GASB)
SEC (Profile)
• Accounting and reporting for public
companies
• Enforcement Authority for the Government in
this area
• Encouraged private standard-setting body
• SEC requires public companies to adhere to
GAAP, and performs a lot of Oversight
Summary of Issues in Financial Reporting
• Standard Setting in a Political Environment
• SEC, IRS other Agencies ALL have a vested
interest
• Expectation Gap
• What the public thinks accountants should
do vs. what accountants think they can do.
• Sarbanes-Oxley Act (2002)
• (SOX): a system that auditors must test and
evaluate
• Ethics in the Environment of Financial
Accounting
• frequently encounter ethical dilemmas;
doing right thing is not always easy or
obvious
• GAAP does not always provide an answer
 Summary OF (3 Components of) : GAAP
Principles
1. Transactions get recorded twice
2. Financial statements report on the business
entity only
3. Debts are paid within one year, or one
business cycle, whichever is longer;
Business Cycles do not always last one
year
• GAAP’s Primary Principles:
Conservative Principle:
• Resolving financial statement
uncertainty in least favorable way
• Anticipates future losses, not gains
• Understates net assets/net income
• Allows companies to play it safe
• Going-Concern Principle:
financial statements are to
assume that businesses
will last indefinitely;
• THIS IS DONE in order to
fulfill:
• Obligations
• Commitments
• Objectives
Objectivity Principle: Business
Transactions are recorded using best
objective evidence
• Organizational financial statements
be based on solid evidence
• Prevent any accounting department
of a business from documenting
slanted information, based on bias
 1.2 Rules of Double-Entry
Accounting/Transaction Analysis
Accounting Equation
1.2.1 Rules for Double-
Entry Accounting
1.2.2 Rules of
Transaction
Analysis
1.2.3 Rules of the
Accounting
Equation
1.2.1 Rules for Double-Entry
Accounting
• Double-Entry
accounting is a
principle requiring
that transactions
gets recorded twice.
• Therefore equal
debits and credits
are made in
accounts for all
transactions.
• This principle of
accounting includes
factors which need
to be monitored,
such as:
• Where the money
comes from, and;

• Where the money is

going, and why
• Thus, the total
debits will always
equal the total
credits in order for
the accounting
equation will always
stay in balance.
1.2.2 Rules of Transaction Analysis
• This concept is an
examination of
where transactions
are identified,
recorded, and
summarized
• The Transaction
Analysis is
conducted in order
to prepare financial
statements for the
accounting data
received, and
maintained
• For any business,
an analysis of
transactions must
display two things:
• Clear and concise:
1. increases, and;
2. decreases within
the statement
• Any increases or
decreases from
business
transactions should
display where the
assets, liabilities,
and owner’s equity
are balanced
1.2.3 Rules of the Accounting
Equation
• The Accounting
Equation are
balanced
calculations, to
include three
components:
• Assets
• Liabilities
• Owner’s Equity
• There are three (3)
ways to
demonstrate the
accounting
equation in real-
time
• Traditional
examples of the
equation are as
follows:
• Assets= Liabilities +
Owner’s Equity, or;
• Owner’s Equity=
Assets – Liabilities,
or;
• Liabilities= Asset –
Owner’s Equity
1.3 The Accounting Cycle
• The accounting
cycle is the process
of recording and
processing the
accounting events
of a business.
• It begins when
transactions occur
• The Accounting
Cycle also begins
with the recording
of the transactions
• The Accounting
Cycle is continual
throughout the
Business Operating
Cycle.
• The natural period
of time occurs
before certain
business activities
tend to repeat
• Transactions are
recorded using
entries, based on
receipts, in
recognition of a
sale.
• After businesses
post entries to
accounts, a balance
sheet is prepared
• Hence, the Balance
Sheet ensures the
total debits equals
the total credits in
the financial
records.
• Adjustments are
often made,
followed by
creating financial
statements.
• Financial
Statements allow
for the following:
• Revenues and
expenses are
closed at the end of
the accounting
period.
• Net income
transferred into
earnings, as the
business prepares
to ensure debits
and credits match
1.4 Business Ethics
• Ethics are
internalized
standards
considered to be
the legality of any
action performed
• Ethics also initiate
Internal Controls
• Internal Controls
are not only allow
for monitoring, but
also allow for an
increase in profit.
• Several primary
internal controls for
Accounting:
• Sarbanes-Oxley Act
(SOX): a system that
auditors must test
and evaluate
• Code of ethics:
• Law:
• Full disclosure:
• Conflicts of interest:
1.5 Purpose of, Presentation of, and
Relationships Between Financial
Statements
1.5.1 Purpose of
Financial Statements
1.5.2 Presentation of
Financial
Statements
1.5.3 Relationships
Between Financial
Statements
1.5.1 Purpose of Financial Statements
• The objective of
financial
statements:
• Financial
Statements also
exhibit changes in
financial position of
an business
• Financial
Statements are
useful for making
economic decisions
• Income statement:
• Statement of
owner’s equity:
1.5.2 Presentation of Financial
Statements
• Financial
Statements may be
best demonstrated
and displayed by:
• The specific rules
used to govern the
creation of the
statements
themselves.
• These rules include:
• All financial
statements have a
three-line heading
• The first line is the
business name.
• The second is the
name of the report.
• The third is the date,
or period of time
• Financial
statements start all
computations by
placing numbers in
the column farthest
to the right
• Next, to make a sub-
calculation, move
one column to the
left;
• Draw a single line
under the last
number in a
calculation;
• Put a double
underline under
final numbers
• Accountants place
the results of a
business
calculation in one of
three different
places on the
statement
• Accountants should
use the method that
allows for the
clearest
communication.
1.5.3 Relationships Between Financial
Statements
• Financial
statements, as there
are various types,
possess many
common
components
• Regardless of the
industry, these
components are
ever-present and
observable in
accounting.
• Financial
Statements for
businesses show:
• Inventory
• Accounts, such as
Income and
Expenses
• Costs of goods sold
• Net Income
1.6 Forms of Business
• Similar to the
concept of existing
types of financial
statements,
businesses
themselves vary, as
well.
• Business variations
are categorized
based primarily on
ownership.
• Sole Proprietor:
• Partnership:
• Corporation:
• Corporation
management is very
regulated and
structured
• Regulations and
structure are good
for handling up to
thousands of
individual
stockholders.
2. The Income Statement
2.1 Presentation
Format Issues
2.2 Recognition of
Revenue and
Expenses
2.3 Cost of Goods Sold
2.4 Irregular Items
(e.g. Discontinued
Operations,
Extraordinary
Items, etc.)
2.5 Profitability
Analysis
2.6 Summary
2.1 Presentation Format Issues
• Multiple
components of
formatting
accounting Income
Statements, and
other financial
statements
• All of which affect
the Income
Statement, based
on performance

• Affecting the
Business itself, as
an entity
• Organization and
Alignment = Key
Factor
• Accounting =
Oversight
• To re-iterate:

• Financial
Accounting =
Business
Operations, not
Individual Owners
• Income Statement
• The financial report
that shows the
results of business
operations over a
period of time.
• This period of time
can vary: Owner’s
discretion, or Fiscal
Period
• A month, a quarter
or a year.
• Statement that
measures the
outcomes

• Gauges Growth

• Growth occurs over

time
• Time period
documentation:

• Can conflict with a

Balance Sheet
• Balance Sheet:
account balances
for one exact date,
by majority.
• Hence, a formatting
“issue”
• Book keeping =
Paramount
• Net Income:
• Core of the Income
Statement
• Accounts that
explain why Assets
went Up
• Stems from
business
operations
• Assets “Up”:
• Profit Sales
• Liquidity
• And even possibly:
• Investments
• Another account
goes up as well:
• Owner’s Equity

• Must be accounted
for
• Most important:
Owner/Investors
• Both accounts =
Value
• Alleviating
formatting issues
• Accountants simply
use a historical, yet
traditional diagram,
or chart, of sorts:
• T-Account
• This is a tool to keep
track of the ups and
downs in accounts,
often called a:
• General ledger
• Debtor’s ledger
• Wage Expense
ledger
• Payroll ledger
• The Ups go on one
side of the T
• The Downs on the
other side of the T

• Here’s an example:
2.2 Recognition of Revenue and
Expenses
• The income
statement is
essentially, as
Summary.
• It summarizes all
the revenue, and
expense accounts,
into a single
number.
• This number is vital,
as previously
mentioned:
• “Net Income” =
Revenue
• Income and Expense
accounts are actually
just part of Owner’s
Equity
• Each help explain
increases in Equity,
based on earnings
• Income Statement:
• Take the number
that appears in the
Statement of
Owner’s Equity
• Income Statement:
• gets combined into
the Final number
for Income and
Expenses
• Income Statement:
• called “owner’s
equity—end of
period”
• “Owner’s equity—
End of period”
• Appears in the
Balance Sheet
simultaneously
• Liability section
• Expenses are
accounts that
explain why assets
went down from
operations.
• Expense accounts
explain the
decreases in equity
as a result of using
up assets.
• The final part of the
liability section
includes accounts
called Deferred
Revenues
• Deferred Revenues
are liabilities that
result from
receiving cash prior
to earning the
income.
• Annuities
• Charges
• Other income
2.3 Cost of Goods Sold
• Cost of goods sold
(CGS)
• Accounting concept
• Businesses
calculate on the
Income Statement
• For businesses that
buy and resell
goods

• Cost of goods sold

• A single number
on the Income
Statement
• Cost of goods sold

• The actual cost to

the business =

• “Goods” that it
sells
• Other Businesses
• Doctors and
Lawyers
• Sell services
• They do not
calculate cost of
goods sold
• Manufacturers

• Cost of goods sold

usually includes:

• Three amounts (3)

• Materials
• Labor
• Overhead
• Cost of Goods Sold:

• Two (2) important

formulas
1. Gross Profit Formula:
2. Income Statement
Formula:
2.4 Irregular Items (e.g. Discontinued
Operations, Extraordinary Items, etc.)
• Discontinued
operations:
• Both the income
and expenses from
discontinued
operations =
• Netted into a single
number
• Then reduced by
income tax expense,
or income tax
savings.
• Extraordinary gains
and losses:
• Losses lower income
taxes at a certain
point
• In this section,
gains and losses:

• On business
equipment, or;

• Per results of
lawsuits:

• NOT included
2.5 Profitability Analysis
• Profitability analysis
• Allows businesses
to forecast the
lucrativeness of an
existing project
• Profitability analysis
also:

• Permits an
anticipation of sales
potential specific to
such elements, like:
• Customer age
• Geography
• Product types
• 3 Types of
Profitability Analysis
• Horizontal Analysis
• Ratio Analysis
• Vertical Analysis
2.6 Summary
• PROFITABILITY ANALYSIS
• Allows businesses to forecast the
lucrativeness of an existing project
• Permits an anticipation of sales potential
specific to such elements
• BOTH are applicable to Financial
Statements and Business Operations
Sales potential:
1. Specific to formula
that I will display for
the exam in a few
minutes, and;
2. Three particular
Elements
Customer Age

• Trends per ages (toys, technology, clothing)

• Needs (infants, toddlers, pre-teen, adult,
elderly)
• Motivations (based: Education level/Social
Status)
Geography:
• Urban
• Suburban
• Rural

Each type of jurisdiction has the potential to

drive sales, and allow for forecasting
Product Types

• What business activity is geared towards

Example: Fidget Spinner (Patented)
• Side Note: That means it will also have a
specific LIFE SPAN
• Selling for $5-$10 a pop
• 1,500 specialty retail shops in the nation
• By May, each gross $130,000-$150,000
revenue, each!
• $500,000,000 in profits
3 Types of Profitability Analysis
Horizontal analysis:
• Used when a company compares its
current results to a previous year
• LESS COMPUTATION
Ratio analysis:
• Used when a company computes a ratio
from various numbers on the financial
statements in order to analyze results.
• INVOLVES THE MOST MATH AND
COMPUTATION
Vertical analysis:
• Used when a company compares all the
numbers of a financial report with a key
number from the report
• SECOND MOST COMPUTATION
Gross margin tells you about the profitability
of your goods and services. It tells you how
much it costs you to produce the product.

It is calculated by dividing your gross profit

(GP) by your net sales (NS) and multiplying
the quotient by 100:
Exam Question:
Gross profit margin is useful for
evaluating….?

Answer: Profitability
Gross Margin = Gross Profit/Net Sales * 100

GM = GP / NS * 100
Example: Imagine that you run a company that
sold $50,000,000 in running shoes last year and
had a gross profit of $7,000,000. What was your
company's gross margin for the year?

GM = $7,000,000 / $50,000,000 * 100

GM = .14 * 100
GM = 14%

For every dollar in shoe sales, you earned 14

cents in profit but spent 86 cents to make it.
3. The Balance Sheet
3.1 Cash and Internal
Controls
3.2 Valuation of
Accounts/Notes
Receivable
(Including Bad Debts)
3.3 Valuation of
Inventories
3.4 Acquisition and
Disposal of Long-
Term Assets
3.5 Depreciation/
Amortization/
Depletion
3.6 Intangible Assets
(e.g., Patents,
Goodwill, etc.)
3.7 Accounts and
Notes Payable
3.8 Long-Term
Liabilities (e.g.
Bonds Payable)
3.9 Owner's Equity
3.10 Preferred and
Common Stock
3.11 Retained Earnings
3.12 Liquidity,
Solvency, and
Activity Analysis
3.12 Summary
3.1 Cash and Internal Controls
• As stated, Cash is
generated from
various sources.
• Since cash is an
asset acquired and
generated from
business activity,
Internal controls
must be attributed
and created
• As mentioned
previously, this is
for compliance
purposes, which are
regulated
• Nonetheless, this
implementation
allows for an
increase in:
• There are other
reasons to possess
Internal Controls,
besides
safeguarding
assets such as
Cash:
• Accurate financial
statements:
• Adherence to
policies:

• Legal protection:
• Separate accounting
from operations:

• Separate accounting
from custody of
assets:
3.2 Valuation of Accounts/Notes Receivable
(Including Bad Debts)
3.2.1 Valuation of
Accounts Receivable

3.2.2 Valuation of
Notes Receivable
(Including Bad Debts)
3.2.1 Valuation of Accounts Receivable
• Accounts receivable
(universally
abbreviated as A/R),
is a Control Account
• This A/R Control
Account contains
the amounts that all
customers owe the
business.
• Elements include:
• Sell on account:

• Collect from
customers:
• Warning of
uncollectability:
• Accrual accounting:
• A Write-off:

• Estimate uncollectible
accounts:
• May include allowance for
doubtful accounts:
• Contra-asset account:
• It measures the
decrease in the value
of accounts receivable.
• Percentage of
accounts receivable
method:
• The method of
estimating the
allowance for
uncollectible
accounts.
• The equation is:
A/R X Est%= What
allowance should be –
What allowance is
= Adjustment
3.2.2 Valuation of Notes Receivable
(Including Bad Debts)
• Notes receivable are
a current asset
when they mature
within one year.
• Notes are recorded
at their present
value of each dollar
amount.
• To discount a note
is to sell a note to a
bank that subtracts
a discount
• Discounting gives
the seller the
proceeds.
• Components of a
Note Receivable:
Face amount:

Face interest:
• Future value of a
note:

• Interest-bearing
note:
3.3 Valuation of Inventories
• Inventory Valuation
is the dollar amount
associated with the
items contained in a
company's
inventory
• Also the cost of the
items defined as all
of the costs
necessary to get the
inventory items in
place and ready for
sale.
• Inventory valuation
will include the
costs of:
• Production
• Materials
• Labor
• Overhead
• Methods to Track
Inventory:
• Periodic inventory
method:
• Perpetual inventory
method:
• Days in Inventory:
• Inventory turnover:
3.4 Acquisition and Disposal of
Long-Term Assets
3.4.1 Acquisition of
Long-Term Assets

3.4.2 Disposal of
Long-Term Assets
3.4.1 Acquisition of Long-Term Assets
• Long-term assets
may also known as
Plant assets,
Capital assets or
Fixed assets
• These are assets
that have a life
longer than one
year.
• Long-term assets,
by in large, allow for
the transition of
Capital.

• These assets that

help a business or a
person make
money.
• Long-term assets,
as well as money,
are changed into
another asset that
helps the business
make money
• This is when an
asset is termed
Capitalized.
3.4.2 Disposal of Long-Term Assets
• A business can
dispose an asset by
selling it.

• However, one must

know the value, as
it is needed
• Book value (BV):
The book value of
an asset is the
historical cost, i.e.
on the books at less
accumulated
depreciation for that
asset.
• The formula for
computing the gain
or loss on the
disposal of an asset
is:
• Amount received –
Book value give up =
Gain or Loss
3.5 Depreciation/Amortization/Depletion
3.5.1 Depreciation

3.5.2 Amortization

3.5.3 Depletion
3.5.1 Depreciation
• Depreciation is the
official name for a
type of expense
• This expense which
is the recording of
the amount of long-
lived assets used up
during business
operations
• It is must be
allocated for future
financial periods.
• Depreciation is not
an attempt to show
the decline in the
value of assets.

• Some assets, like

buildings, may
actually appreciate
during the year.
• Let’s remember:
• Businesses
depreciate all fixed
assets (except land)
every year.

• Depreciation is not
money set aside to
replace aging
assets.
3.5.2 Amortization
• Amortization is also
an expense
• Amortization is the
amount of an
intangible asset is
used up during the
period.
• The credit for
amortization directly
lowers intangible
asset
• There is no
accumulated
amortization
account.
• Bottom line, to be
fully amortized, an
intangible asset’s
total cost will have
been allocated to
past fiscal periods
3.5.3 Depletion
• Depletion is another
expense
• It is where the
amount of a natural
resource is used up
during the financial
period.
• Book value = Zero
• They are also
contra-asset
accounts which get
subtracted from
other accounts.
3.6 Intangible Assets (e.g. Patents,
Goodwill, etc.)
• Intangible assets
have no physical
form, yet they offer
value to the
business for a long
time.
• The total cost of an
intangible asset is
everything
necessary to make it
useful.
• Examples of types
of costs that often
end up in intangible
assets are:
• Legal fees, design,
artwork,
engineering,
software, franchise
contracts, and
marketing programs
• FACT:
• If the life of an
intangible asset is
known, such as a
franchise term or a
copyright limit, then
the cost of the
intangible asset is
spread over the
useful life (not legal
life)
• Some intangible
assets have
indefinite lives.
• They are not amortized.
• In the future, if these
intangible assets are
impaired (lose their
value)
• They are written down.
• They are never written
up.
• Patents: The
exclusive right to
produce and sell an
invention.
• The legal right may
be 20 years, but the
useful life may be
shorter.
• Copyrights: The
exclusive right to
publish, perform, or
reproduce music,
art, film, books, or
software.
• Legal life can be
more than 100
years, but the
opportunity to make
money from the
copyright may be 3
to 5 years.
• Trademarks and
trade names: Special
identifications that
are protected
against
infringement.
• Many have indefinite
lives.
• Goodwill: The extra
cost a business pays
for another business
as recognition for
being unusually
profitable.
• It has an indefinite
life.
• Franchises and
licenses: Contracts
or government
grants that give the
owner special
rights.
• Many have indefinite
lives.
3.7 Accounts and Notes Payable
3.7.1 Accounts Payable

3.7.2 Notes Payable

3.7.1 Accounts Payable
• Accounts payable,
or (A/P), is a liability
account.
• Even though no cash
changes hands,
Accounts Payable
gets credited due to
an accrual occurring.
3.7.2 Notes Payable
• Payment on a note
is exhibited when a
business or a
person borrows
money
• In writing states a
promise to pay in
the money back in
the future.
• The amount
borrowed, or the
principal, separate
from the interest, if
any, is called the
Present Value of a
Note.
• Once paid, this
must be credited on
the sheet.
• A note can be
defaulted on.

• All bank
agreements require
the discounter to
guarantee
collection on the
note.
3.8 Long-Term Liabilities (e.g. Bonds
Payable)
• Liabilities, a core
component of the
accounting
equation as we now
know, can often be
viewed as Long-
Term.
• Also, as stated, the
liabilities possess a
separate and
important section
on the statement.
• Credits are stored in
the liability section,
often broken it into
two accounts:
• Deferred warranty
revenues, as
current, and;

• Deferred warranty
revenue, as long-
term.
• Later, such credits
will move to the
revenue section as
they will not always
last as long-term
liabilities.
• Bonds are also
within the long-term
liability category.
• Bonds are a way to
borrow large
amounts of money
from a large number
of people.
• The normal four-
step process is as
follows:
• Step 1. A
corporation (or a
government) prints
up a number of
paper bond
• Step 2. The
corporation sells the
bonds.
• Step 3. The
corporation makes
regular cash
payments on the
payment dates
• Step 4. On the
maturity date, the
corporation pays
the bondholder the
face amount.
• The bondholder is
the current investor
in the bond.
• The bond payable
account and the
discount on bonds
payable are both in
the long-term debt
section of the
balance sheet.
• A discount has a
debit normal balance
because it is a
contra-liability
account.
• It represents a
reduction of the
bond liability.
• For example, a
$1,000,000 bond
payable, less a
$106,775 discount,
represents the bond
book value, or the
true liability, of
$893,225 (100,0000 –
106,775).
• If the company
wanted to eliminate
this debt, it could
buy the bonds back
for the same price
of $893,225.
3.9 Owner's Equity
• Owner’s equity is
the official name for
the owner’s claim
on the assets in the
business.
• The statement of
owner’s equity
contains net income
from the income
statement, and that
number covers a
period of time
• Therefore, the
statement of
owner’s equity
covers the same
period of time as
the income
statement.
The equation of the
statement of owner’s
equity is always the
same:
3.10 Preferred and Common Stock
3.10.1 Preferred Stock

3.10.2 Common Stock

3.10.1 Preferred Stock
• Corporations may
wish to attract more
cautious investors by
issuing preferred
stock.

• Preferred stock is
stock with special
privileges.
• Corporations have
total freedom to mix
and match these
privileges to suit
investors.
• Preferred stock
commonly has a
steady price
• It does not go up
when the
corporation does
well, nor does it
drop much when
the company does
poorly.
• Preferred
stockholders
usually do not get
to vote in
stockholder
meetings
• Examples of
privileges for
preferred
stockholders are:
• The first right to
cash dividends
before common
stockholders
• The right to
participate in
corporate profits the
same as common
stockholders
• The right to be paid
dividends in arrears
if years go by
without paying a
dividend
• The right to convert
preferred stock into
common stock
3.10.2 Common Stock
• Corporation law
grants to common
stockholders certain
rights:
• Right to vote

• Right to share in
dividends
• Right to a certain
percentage of the
corporation upon
liquidation
• The preemptive
right, which is the
choice to buy a
portion of each new
issuance of stock in
order to maintain
the same ownership
percentage
• Common Stock:
• Every corporation
must have common
stock.

• Common stock
represents the basic
ownership of a
corporation.
• Sometimes
corporations issue a
second class of
common stock
(normally called
Class B Common
Stock) with different
rights than Class A
Common Stock.
3.11 Retained Earnings
• Retained earnings
are located in the
equity account in a
corporation
• Retained earnings
contain all the
earnings all the
corporation has
ever earned
• However, they have
not yet distributed
to stockholders.
3.12 Liquidity, Solvency, and Activity
Analysis
3.12.1 Liquidity Analysis
3.12.2 Solvency Analysis
3.12.3 Activity Analysis
3.12.1 Liquidity Analysis
• Liquidity is defined
as the ability of a
company to meet its
financial obligations
as they come due.
• It also allows for a
capability to sell
assets quickly to
raise cash.
• An analysis of
liquidity, or the ratio
of paying all
financials outright,
is a computation.
• This computation is
used to measure a
company's ability to
pay its short-term
debts.
• Investors often take
a close look at
liquidity ratios when
performing
fundamental
analysis on a firm.
• If a company is
having trouble
meeting its short-
term debt, it is at a
higher risk of
bankruptcy.
• Liquidity ratio
analysis are a good
measure of whether
a company will be
able to continue as
a operational entity.
3.12.2 Solvency Analysis
• Solvency is the
ability of a company
to meet its long-term
financial obligations,
primarily, as
opposed to short-
term.
• The Analysis of
Solvency is used to
measure an
enterprise’s ability
to meet its debt
obligations.
• The solvency ratio
analysis indicates
whether the lower a
company's
solvency ratio, the
greater the
probability that it
will default on its
debt obligations.
• The measure is
usually calculated
as follows:
• Solvency Ratio = Net
Income +
Depreciation
– Divided by
• Short-term Liabilities
+ Long-term
Liabilities
3.12.3 Activity Analysis
• Activity ratios are
financial analysis
tools
• Measure the ability
of a business to
alter various asset,
liability and capital
accounts into cash,
or sales.
• The faster a
business is able to
convert its assets
into cash or sales,
operations run
better.
3.13.1 Summary
Inventory Valuation:

The dollar amount associated with the

items contained in a company's
inventory

• Can be separated into the cost of

the items in place and ready for
sale.
Inventory valuation will include the costs of:
• Production
• Materials
• Labor
• Overhead
• Methods to Track Inventory: Two Primary
Periodic inventory method:
• keeps track of merchandise costs in
various purchases, then computes cost of
goods sold on the income statement.
Perpetual inventory method:
• increases the inventory account with
every purchase, and lowers the inventory
account with every sale.
3.13.2 Summary
Days in Inventory:
• Measures the average number of
days before merchandise sells.
Inventory turnover:
• Measures the number of times
inventory completely sells per
year.
FIFO:
• Accounting method: first in, first out
• Cost of inventory on balance sheet
represents the inventory most
recently purchased
• Oldest items recorded sold first, yet
may not have been sold
LIFO
• Last in, first out
• Most recently produced items
recorded as sold first (Costs of
Goods Sold attributed)
• Only allowed in US; GAAP
APPROVED
Exam:
In a period of rising prices, which of the
following inventory methods results in the
highest cost of goods sold?
(A)FIFO
(B)LIFO
(C)Average cost
(D)Periodic inventory
(E)Perpetual inventory
Exam:

An inventory valuation method such

as FIFO or LIFO affects?
(A) the cost of goods sold but not the
balance sheet
(B) the balance sheet but not the cost of
goods sold
(C) both the income statement and the
balance sheet (CGS is located on IC)
(D) neither the income statement nor the
balance sheet
(E) the cost of goods sold but not the
income statement
4. Statement of Cash Flows
4.1 Indirect Method
4.2 Cash Flow
Analysis
4.3 Operating,
Financing, and
Investing Activities
4.4 Summary
4.1 Indirect Method
• The Indirect Method
is the usual method
of computing cash
flow from business
operations
• The Indirect Method
starts with net
income
• Indirect Method
then uses the
changes in the
asset and liability
accounts to adjust
net income
• This adjustment
allows for net
income to transfer
into cash flow from
business operation
activity.
• A line for total cash
flow from financing
activities uses a
single line under it.
• This means that the
total is not part of
the calculation
below it:
• By adding total net
cash flow to the
beginning cash
account balance, we
get the value for
“cash—end of
period.”
• This number must
equal the balance in
the cash account at
the end of the
period.
4.2 Cash Flow Analysis
• Cash flow analysis
is utilized for
reporting purposes
in the cash flow
statement.
• Cash flow analysis
exhibits a starting
balance
• Then will display an
ending balance
after accounting for
cash expenses in
the period
• The Cash Flow
Statement shows
where the cash
came from, and
where it went during
the period
• It appears at bottom
of cash flow
worksheet, include
interest incurred.
• The Cash Flow
Statement displays
cash flow from the
following areas:
• Cash flow from
Operations
• Cash flow from
investing activities
• Cash flow from
financing activities
• The calculation for
the Cash Flow
Statement utilizes
the components of:

(1) net cash flow

(2) cash—end of
period.
The formula used in
this analysis is as
follows:
• Cash from
operations + Cash
from investing
activities + Cash
From Financing
Activities = Total
change in cash +
Cash—Beginning Of
Period = Cash—End
Of Period.
4.3 Operating, Financing, and
Investing Activities
4.3.1 Operating Activities

4.3.2 Investing Activities

4.3.3 Financing Activities

4.3.1 Operating Activities
• Operational Activity
is found in the first
section of the Cash
Flow Statement.
• “Operations” refers
to what a business
normally does to
make money
4.3.2 Investing Activities
• Investing Activities
appear in the
second section of
the cash flow
statement
• Investing Activity
displays a business’
income-producing
sources, such as
properties.
• On the cash flow
statement, it is
normal to observe a
negative number
pertaining to an
investment
• It signifies that cash
went out of the
company to
purchase assets
4.3.3 Financing Activities
• Appears in the third
section of the cash
flow statement
• It’s the process of
finding money for
the business from
sources other than
normal operations:
• Primary Source 1:
• Lenders
• Primary Source 2:
• Investors
• This activity will
display all reports
on money returned
to investors:
• This is where
money is paid to the
principal on a loan
from a lender.
4.4 Summary
Cash flow analysis is
utilized for reporting
purposes, as applied
in the cash flow
statement.
• Cash flow analysis exhibits a starting balance
• Then will display an ending balance after
accounting for cash expenses in the period
• The Cash Flow Statement shows where the
cash came from, and where it went during the
period
• It appears at bottom of cash flow worksheet,
include interest incurred
The Cash Flow Statement displays cash
flow from the following areas:
• Cash flow from Operations
• Cash flow from investing activities
• Cash flow from financing activities
The calculation for the Cash Flow
Statement utilizes the components of:

(1) net cash flow

(2) cash—end of period.
• The formula used in this analysis is as
follows:
• Cash from operations +
• Cash from investing activities +
• Cash From Financing Activities (net cash
flow) =
• Total change in cash + Cash—Beginning Of
Period = Cash—End Of Period
Exam:

The financial statement that includes

classifications for operating, financing, and
investing activities of a business entity for a
period of time is called the:
(A) Income Statement
(B) Statement of Retained Earnings
(C) Balance Sheet
(D) Statement of Changes in Owners’ Equity
(E) Statement of Cash Flows
5. Miscellaneous Accounting
Components
5.1 Investments
5.2 Contingent
Liabilities
5.3 Summary
5.1 Investments
• Investments are
uses of a
business’s money
to buy assets.
• Businesses also
possess the option
to sell assets
• One type of
Investment:
• Long-term
investments
• Another term
representing Long-
term:
• Held-to-Maturity
investments
• Another type of
Investment
• Short-term
investments
• These are also
assets, and they
may include:
1. Certificates of
deposit (CD)
2. Stock
• An investment is
any source that can
change into cash
within, or slightly
over one year
• Trading
Investments

• Available-for-Sale
Investments
5.2 Contingent Liabilities
• A Contingent
Liability is a
potential, yet
unknown cost, that
may, or may not
incur.
• There are three
categories of
Contingent
Liabilities
• High Probability:
• Medium Probability:
• Low Probability:
• Important Example:
• Your client sold a
faulty product

• Had significant
warranty claims as
a result.
• Its OK= Low
Probability

• If your client has:

• Isolated the bad
product
• Recalled it
• Settled the related
warranty claims
• Chances are LOW
for dealing with
similar warranty
issues on that
product in the
future.
5.3 Summary
• First, lets talk…..:
• Contingent Liabilities
A Contingent Liability is a:
• 1. potential, yet;
• 2. unknown cost, that;
• 3. may, or may not incur
• These particular liabilities are not
recorded in a company's accounts, or
shown in the balance sheet, unless:
• The scenario presents these liabilities as
both probable, and reasonably estimable
as 'contingency‘, or;

• deemed 'worst case' financial outcome.

Three examples of contingent liabilities
include:
1. Warranty of a company's products
2. The guarantee of another party's
loan, and;
3. Lawsuits filed against a company
• There are three categories of Contingent
Liabilities
High Probability: the costs can be
estimated and loss must be disclosed
and described in financial statements.
High Probability example:
• Property
• Mortgage, home improvement, a
catastrophe, or a sale will deem allow
for a cost to be estimated, and the loss
100% is documented
Medium Probability: costs must be
disclosed in statements if the
contingency is probable, yet not
necessarily probable.
Medium Probability example:
• Lawsuits
• Sometimes a contingent liability can arise
suddenly, catching both management and
investors by surprise.
• The billions in liabilities for BP
related to the Deep Horizon oil
spill and Volkswagen's massive
liabilities from its 2015
emissions scandal are two such
scenarios
Low Probability: No reporting required
due to low likelihood of cost being
triggered.
Low Probability example:
• Your client sold a faulty product; Had
significant warranty claims as a result.
• Its OK= Low Probability
• If your client has:
• isolated the bad product
• recalled it
• settled the related warranty claims
Chances are LOW for dealing with
similar warranty issues on that
product in the future.