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1.4.

Double entry system- Analyzing accounting transactions

Assets = Liabilities + Shareholders Equity


23,300 = 8,700 + 14,600
1.5. Double entry system- Journal entries

Rules for Debits and Credits are DEAD CLEAR


2.4. Preparing statement of cash flows INDIRECT METHOD

Summary: Operating Activities Indirect Method


4.3. Accounting for uncollectible receivables

Percentage of sales method Percentage of receivables method


Bad Debt Expense DR 7,500 Bad Debt Expense DR 6,000
Allowance for bad debts CR 7,500 Allowance for bad debts CR 6,000
(800,000 50,000) x 1% = 7,500 (160,000 x 5%) - 2,000 = 6,000

Allowance for bad debts Allowance for bad debts

2,000 Beg.
2,000 Beg.

7,500 Bad debt expense 6,000 Bad debt expense

9,500 End 8,000 End


5.3.1. Costs included in the inventory

Capitalize all costs incurred to ready inventory for sale

Following are typically included in the inventory cost


purchase cost including sales taxes
freight-in
all other taxes and duties
insurance for goods in transit
storage until good ready to sale (but not after)

Exclude:
selling costs
freight-out (delivery to customers)
storage for ready-to-sell goods
5.3.4. Financial statement impact of cost flow assumptions
If prices are increasing then following are true (opposite if prices are decreasing)

LIFO will show lower profit as more recent costs are matched to sales

LIFO will show lower inventory values because it reflects older market prices

Since LIFO ending inventories can be significantly lower than replacement costs, companies
using LIFO are required to disclose the amount at which the inventories would have been had the
company used FIFO method. The difference between these two methods is called LIFO reserve.
FIFO Inventory - LIFO Inventory = LIFO reserve

LIFO reserve can be viewed as an unrealized holding gain. A gain that results from holding
inventory as prices are rising
Disclosure of LIFO gain : The amount by which net income would be increased if the liquidation
had not occurred
5.6. Analysis of operating activities
Gross margin ratio = (Sales Cost of goods sold) / Sales
High ratio indicates some combination of higher product pricing and low product costs
Determined by competitive advantage of the firm

Receivables turnover = Sales / Account receivables


Receivable days = 365 / Receivables turnover
Higher turnover and lower days indicate efficient credit and collection policies
If receivables turnover is deteriorating over time, it might indicate difficulties in collection

Inventory turnover = COGS / Inventory


Inventory days = 365 / Inventory turnover
Higher turnover and lower days indicate fast moving inventory
Low inventory turnover indicates slow moving inventory possible due to technological
obsolescence or change in consumer preferences

Payable turnover = COGS / Account payable


Inventory days = 365 / Payable turnover
Low turnover would indicate (i) trouble in making payments; or (ii) the company enjoying
bargaining power over its supplier and hence extending payment terms

Working capital days or cash conversion cycle = Receivables days + Inventory days Payable days
This indicates the number of days cash is stuck in the operating cycle. Generally lower the better for liquidity
purposes
5.3.5. Lower of cost or market

When the value of inventory is lower than its cost


Companies have to write down the inventory to its market value in the
period in which the price decline occurs.
Market value = Replacement Cost
Example of conservatism.