ACG 2021 Exam 2 Study Guide The Classified Balance Sheet There is a specific order in which accounts appear on the Balance Sheet The assets are listed in order of their liquidity the amount of time it takes to convert the asset into cash Current Assets more liquid cash and other assets that are expected to be converted into cash sold or used up consumed within one year Current assets are sources of cash within a year Ex Cash Accounts Receivable Notes Receivable Inventory Supplies Prepaid Rent Prepaid Insurance Prepaid Advertising Short Term Investment in Stock etc Long Term Assets less liquid assets that are not expected to be converted into cash sold or used up consumed within one year Ex Land Equipment Buildings Accumulated Depreciation Long Tern Receivables Long Term Investments in Stock etc The liabilities are listed in order of their due date Current Liabilities due earlier obligations that will come due within one year Current liabilities are demands on cash within a year Ex Accounts Payable Wages Payable Notes Payable Interest Payable Unearned Revenue etc Long Term Liabilities due later obligations that will not come due within one year Ex Long Term Payables etc The Relationship Between Current Assets and Current Liabilities It helps predict a company s short term liquidity aka can they pay their bills Working Capital Current Ratio Working Capital Current Assets Current Liabilities Do we have enough cash to pay off our current liabilities Current Ratio Current Assets Current Liabilities How many times can the current assets cover our current liabilities Types of Companies Service Companies have no inventory Merchandising Companies have inventory that they sell to customers Manufacturing Companies will be discussed in ACG 2071 Merchandise Inventory 1 Example if the ratio is 2 1 then our current assets can cover two times our current liabilities Goods that the company has purchased in finished form and is holding for sale to customers When it is sold it becomes an expense called Cost of Goods Sold This is different than supplies Although they are both current assets merchandise inventory is sold and supplies are only used internally When supplies are used it becomes supplies expense This is different than equipment Merchandise inventory is current asset while equipment is a long term asset Merchandise inventory is for sale and equipment is for internal use only and is not for sale to customers When equipment is sold it becomes depreciation expense Example Office Depot both sells and uses office supplies and office equipment They would have several accounts to categorize these into Office supplies that they internally use would be called the supplies account Office supplies that they sell would be called inventory Office equipment that they use would be called equipment Office equipment that they sell to customers would be called inventory Example Inventory Journal Entries 1 Shoe Warehouse purchases inventory on credit Assume the purchase consists of 10 pairs of flip 2 The business pays for the inventory purchased above flops at 1 a pair Inventory A P A P Cash 5 Cash Cost of Goods Sold Expense 10 Sales Revenue Inventory Multi Step Income Statement 10 10 Current Asset Current Liability 10 50 10 50 10 Current Liability Current Asset Current Asset Revenue Expense Current Asset 2 The business sells the inventory purchased above for cash Assume the selling price of each pair is Principal Activities Sales Revenue Costs of Goods Sold Gross Margin Selling and Administrative Expense and Operating Income deals with principal activities aka what you are in the business of selling 2 Sales Revenue Sales Revenue has to be from sales of whatever you re in the business of selling Selling and Administrative Operating Expenses Examples of Selling and Administrative expenses include utility expense rent expense wage expense deprecation expense supplies expense insurance expense FOB destination and advertising expenses Income from principle activities is calculated by the following equation Operating income Gross Margin Sales and Administrative Expenses Other Revenues and Gains Other Expenses and Losses Income before Tax Income Tax Expense and Net Income deals with secondary activities aka other ways for you to make money that aren t what you are in the business of selling Income before tax operating income other revenues interest revenue other expenses interest expenses Cost of Goods Sold is the cost of inventory sold during a period CGS of units sold x cost per unit This is NOT the same thing as purchases No matter what you CGS is your total cost from purchases will remain the same Operating Income Secondary Activities Income Before Tax Cost of Goods Sold Gross Margin or Profit Gross Margin Rate Gross Margin Profit Sales Revenue Cost of Goods Sold The percentage of sales that can go to other expenses Gross Margin Rate Gross Margin Sales Revenue The higher the Gross margin the more profitable the company Net Income and the Profit Margin Ratio The percentage of sales going to net income Net Income and Profit Margin Ratio Net Income Sales Quality of Earnings Income that comes from what a company is supposed to be doing their principle activities is considered repetitive income and results in a higher quality of earnings Historical Cost Principle in the eyes of the purchaser The cost of an asset the purchase price all of the cost necessary to get the asset to the location and in the condition required for its intended use 3 Inventory Cost From The Eyes of the Purchaser Purchase Discounts in the eyes of the purchaser Percentage discount offered by the seller to the purchaser to encourage prompt payment This reduces the cost of inventory Ex 5 15 n45 means that the purchaser will receive a 5 discount if they pay within 15 days otherwise the full amount is due in 45 days Purchase Returns in the eyes of the purchaser Merchandise purchases that are returned by the purchaser to the seller Purchase Allowances in the eyes of the purchaser This is a price reduction offered by the seller to the purchaser due to some problem with the merchandise Purchase allowances are offered to encourage the purchaser to accept the merchandise and to keep them happy FOB Shipping Point in the eyes of the purchaser The purchaser pays for the shipping costs of the inventory that they buy This is called Freight In Transportation In and it is added to inventory cost FOB Destination in the eyes of the purchaser The seller pays
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