Comprehensive Study Notes for Financial Accounting: Inventory, Assets, Liabilities, Equity, and Financial Statement Analysis

Chapter 6: Inventory and Cost of Goods Sold

Cost of Goods Sold (COGS)

COGS is categorized as an expense and represents the cost of inventory sold during a period. It is a key component in determining gross profit on the income statement.

• Cost of Inventory on Hand: Recorded as an asset on the balance sheet until sold.

• Cost of Inventory Sold: Expense on the income statement; calculated as the cost of producing or purchasing inventory sold during the period.

• Formula: $\text{COGS} = \text{Beginning Inventory} + \text{Purchases} - \text{Ending Inventory}$

Inventory Systems

• Periodic Inventory System: Inventory is counted at intervals; COGS is determined periodically.

• Perpetual Inventory System: Inventory records are updated continuously; provides real-time inventory data.

Inventory Transactions

• Recording Purchases: Inventory is recorded as an asset; payment may be cash or credit.

• Freight In: Cost to transport inventory to the buyer; added to inventory cost.

• Purchase Allowances/Discounts: Reductions in cost due to returns or early payment.

Inventory Costing Methods

• Specific Identification: Tracks individual items; used for unique, high-value inventory.

• FIFO (First-In, First-Out): Assumes oldest inventory is sold first.

• LIFO (Last-In, First-Out): Assumes newest inventory is sold first.

• Weighted Average: Uses average cost of goods available for sale.

Lower of Cost and Net Realizable Value Rule

• Inventory must be reported at the lower of its cost or net realizable value (NRV).

• Protects against overstating assets if inventory becomes obsolete or damaged.

Inventory Errors

• Overstated Ending Inventory: Understates COGS, overstates gross profit.

• Understated Ending Inventory: Overstates COGS, understates gross profit.

Key Equations

• $\text{COGS} = \text{Beginning Inventory} + \text{Purchases} - \text{Ending Inventory}$

• $\text{Weighted Average Cost per Unit} = \frac{\text{Total Cost of Goods Available for Sale}}{\text{Total Units Available for Sale}}$

Chapter 7: Plant Assets, Natural Resources, and Intangibles

Tangible and Intangible Assets

Assets are classified as tangible (physical) or intangible (non-physical). Tangible assets include property, plant, and equipment; intangible assets include patents, copyrights, and trademarks.

• Tangible Assets: Physical items used in operations (e.g., buildings, machinery).

• Intangible Assets: Non-physical items (e.g., patents, trademarks).

Cost of Plant Assets

• Includes purchase price, taxes, installation, and improvements.

• Assets are recorded at cost and depreciated over their useful lives.

Depreciation Methods

• Straight-Line Method: Equal depreciation expense each year. $\text{Depreciation Expense} = \frac{\text{Cost} - \text{Residual Value}}{\text{Useful Life}}$

• Units of Production Method: Depreciation based on usage. $\text{Depreciation Expense} = \frac{\text{Cost} - \text{Residual Value}}{\text{Total Units}} \times \text{Units Produced}$

• Diminishing Balance Method: Higher depreciation in early years. $\text{Depreciation Expense} = \text{Book Value} \times \text{Depreciation Rate}$

Recording Depreciation

• Debit depreciation expense, credit accumulated depreciation.

• Reduces asset value and equity.

Additional Info:

• Double declining balance method multiplies straight-line rate by two.

• Gain or loss on asset sale: difference between sale price and book value.

Chapter 9: Liabilities

Current and Long-Term Liabilities

Liabilities are obligations to pay cash or provide services in the future. They are classified as current (due within one year) or long-term (due after one year).

• Current Liabilities: Accounts payable, short-term loans, accrued expenses.

• Long-Term Liabilities: Bonds payable, long-term loans, contingent liabilities.

Bonds

• Principal (Face Value): Amount repaid at maturity.

• Interest: Paid periodically at a stated rate.

• Bond Premium: Issued above face value.

• Bond Discount: Issued below face value.

Bond Pricing

• Market Price: Determined by investor demand and interest rates.

• Stated Rate vs. Market Rate: Premium if stated rate > market rate; discount if stated rate < market rate.

Amortization Methods

• Straight-Line: Equal amounts each period.

• Effective Interest: Interest expense increases over time.

Chapter 10: Stockholders' Equity

Components of Stockholders' Equity

Stockholders' equity represents ownership in a corporation. It includes common stock, preferred stock, retained earnings, and additional paid-in capital.

• Common Stock: Basic ownership; voting rights.

• Preferred Stock: Priority for dividends; limited voting rights.

• Retained Earnings: Cumulative net income not distributed as dividends.

Advantages and Disadvantages of Corporations

• Advantages: Raise capital, limited liability, continuous life, transferable ownership.

• Disadvantages: Separation of ownership, double taxation, government regulation.

Dividends

• Date of Declaration: Board declares dividend; liability created.

• Date of Record: Shareholders eligible for dividend determined.

• Date of Payment: Dividend paid to shareholders.

Stock Transactions

• Stock Issuance: Increases equity.

• Stock Repurchase: Decreases equity.

Table: Types of Stock and Dividend Features

Stock Type	Voting Rights	Dividend Priority	Conversion Feature
Common	Yes	Last	No
Preferred	Limited	First	Possible

Chapter 13: Financial Statement Analysis

Types of Analysis

• Horizontal Analysis: Compares changes over time.

• Vertical Analysis: Compares items as a percentage of a base amount.

• Trend Analysis: Examines patterns over multiple periods.

Key Ratios and Equations

• Return on Assets (ROA): $\text{ROA} = \frac{\text{Net Income}}{\text{Average Total Assets}}$

• Return on Equity (ROE): $\text{ROE} = \frac{\text{Net Income} - \text{Preferred Dividends}}{\text{Average Common Shareholders' Equity}}$

• Debt Ratio: $\text{Debt Ratio} = \frac{\text{Total Liabilities}}{\text{Total Assets}}$

• Gross Profit Percentage: $\text{Gross Profit Percentage} = \frac{\text{Gross Profit}}{\text{Net Sales}}$

• Asset Turnover: $\text{Asset Turnover} = \frac{\text{Net Sales}}{\text{Average Total Assets}}$

• Price/Earnings Ratio: $\text{P/E Ratio} = \frac{\text{Market Price per Share}}{\text{Earnings per Share}}$

• Dividend Yield: $\text{Dividend Yield} = \frac{\text{Dividend per Common Share}}{\text{Market Price per Common Share}}$

Liquidity and Efficiency Ratios

• Current Ratio: $\text{Current Ratio} = \frac{\text{Current Assets}}{\text{Current Liabilities}}$

• Quick Ratio: $\text{Quick Ratio} = \frac{\text{Cash} + \text{Short-Term Investments} + \text{Net Receivables}}{\text{Current Liabilities}}$

• Accounts Receivable Turnover: $\text{Accounts Receivable Turnover} = \frac{\text{Net Sales}}{\text{Average Accounts Receivable}}$

• Inventory Turnover: $\text{Inventory Turnover} = \frac{\text{COGS}}{\text{Average Inventory}}$

Cash Conversion Cycle

• Measures time to convert inventory and receivables into cash.

• Formula: $\text{Cash Conversion Cycle} = \text{DIO} + \text{DSO} - \text{DPO}$

• DIO: Days Inventory Outstanding

• DSO: Days Sales Outstanding

• DPO: Days Payable Outstanding

Additional Info:

• 15% is considered a good ROE for most industries.

• Horizontal analysis uses percentage change formulas: $\text{Percentage Change} = \frac{\text{Current Year} - \text{Base Year}}{\text{Base Year}} \times 100$

• Vertical analysis expresses each item as a percentage of a base (e.g., total assets or net sales).