Current Liabilities, Stockholders’ Equity, and Statement of Cash Flows: Study Notes

Chapter 8: Current and Contingent Liabilities

Accounts Payable Turnover and Days Payable Outstanding

Accounts payable turnover measures how efficiently a company pays its suppliers. Days payable outstanding (DPO) converts this turnover into the average number of days it takes to pay suppliers.

• Accounts Payable Turnover: Indicates how many times a company pays off its accounts payable during a period.

• Formula: $\text{Accounts Payable Turnover} = \frac{\text{Cost of Goods Sold}}{\text{Average Accounts Payable}}$

• Days Payable Outstanding: Shows the average number of days a company takes to pay its suppliers.

• Formula: $\text{DPO} = \frac{365}{\text{Accounts Payable Turnover}}$

• Example: If COGS is $730,000 and average accounts payable is $100,000, turnover is 7.3, so DPO is 50 days.

Notes Payable: Calculating Interest and Accrued Interest Expense

Notes payable are formal written promises to pay a certain amount plus interest. Interest must be accrued if the note spans more than one accounting period.

• Interest Calculation: $\text{Interest} = \text{Principal} \times \text{Rate} \times \text{Time}$

• Accrued Interest Expense: Recognized as a liability and expense before payment.

• Balance Sheet Effect: Accrued interest increases liabilities (Interest Payable) and reduces equity (Interest Expense).

• Example: $10,000 note at 6% for 3 months: $10,000 \times 0.06 \times \frac{3}{12} = $150$ interest.

Interest Expense Accrual: Notes Payable or Bonds Payable

Accruing interest expense affects both the income statement and balance sheet.

• Accounts Affected: Interest Expense (debit), Interest Payable (credit).

• Journal Entry: Debit Interest Expense, Credit Interest Payable.

• Example: To accrue $150 interest: Debit Interest Expense $150, Credit Interest Payable $150.

Unearned Revenue and Adjusting Journal Entries

Unearned revenue is a liability representing cash received before services are performed. Adjusting entries recognize revenue as it is earned.

• Initial Entry: Debit Cash, Credit Unearned Revenue.

• Adjusting Entry: Debit Unearned Revenue, Credit Revenue.

• Example: $1,000 received in advance: Debit Cash $1,000, Credit Unearned Revenue $1,000. After earning $600: Debit Unearned Revenue $600, Credit Revenue $600.

Sales Tax Payable Journal Entries

Sales tax collected from customers is a liability until remitted to the government.

• Entry for Sale: Debit Cash (total), Credit Sales Revenue (net), Credit Sales Tax Payable (tax).

• Example: $100 sale with 5% tax: Debit Cash $105, Credit Sales Revenue $100, Credit Sales Tax Payable $5.

Bonds Issued at Par, Discount, or Premium

Bonds can be issued at par, below par (discount), or above par (premium) depending on market interest rates.

• At Par: Issue price equals face value.

• At Discount: Issue price is less than face value; market rate > stated rate.

• At Premium: Issue price is more than face value; market rate < stated rate.

• Accounts Affected: Cash, Bonds Payable, Discount/Premium on Bonds Payable.

• Journal Entry at Par: Debit Cash, Credit Bonds Payable.

• Example: Issue $100,000 bond at par: Debit Cash $100,000, Credit Bonds Payable $100,000.

Chapter 10: Stockholders’ Equity

Advantages and Disadvantages of a Corporation

Corporations are legal entities separate from their owners, offering unique benefits and drawbacks.

• Advantages: Limited liability, ease of raising capital, transferability of ownership, continuity.

• Disadvantages: Double taxation, regulatory requirements, more complex structure.

Main Categories of Stockholders’ Equity

Stockholders’ equity represents owners’ claims on the assets of a corporation.

• Paid-In Capital: Amount invested by shareholders.

• Retained Earnings: Cumulative net income retained in the business.

• Treasury Stock: Shares repurchased by the company.

• Total Paid-In Capital Includes: Common stock, preferred stock, additional paid-in capital.

Journal Entry for Issuance of Common Stock

Issuing common stock increases equity. The entry depends on whether shares are issued at par or above par.

• At Par: Debit Cash, Credit Common Stock.

• Above Par: Debit Cash, Credit Common Stock (par), Credit Additional Paid-In Capital (excess).

• Example: Issue 1,000 shares at $10 par for $12: Debit Cash $12,000, Credit Common Stock $10,000, Credit Additional Paid-In Capital $2,000.

Treasury Stock’s Effect on Stockholders’ Equity

Treasury stock reduces stockholders’ equity. Selling treasury stock above or below cost affects additional paid-in capital.

• Decrease in Equity: By cost of treasury stock.

• Journal Entry for Sale Above Cost: Debit Cash, Credit Treasury Stock (cost), Credit Additional Paid-In Capital (excess).

• Journal Entry for Sale Below Cost: Debit Cash, Debit Additional Paid-In Capital (if available), Credit Treasury Stock (cost).

• Example: Sell treasury stock bought at $10 for $12: Debit Cash $12, Credit Treasury Stock $10, Credit Additional Paid-In Capital $2.

Stockholders’ Equity Partial Balance Sheet: Shares Issued vs. Outstanding

Shares issued are total shares ever sold; shares outstanding are shares currently held by shareholders (excluding treasury stock).

• Issued Shares: All shares ever issued.

• Outstanding Shares: Issued shares minus treasury shares.

• Balance Sheet Presentation: Shows both issued and outstanding shares.

Earnings per Share (EPS)

EPS measures profitability per share and is a key indicator for investors.

• Formula: $\text{EPS} = \frac{\text{Net Income}}{\text{Number of Common Shares Outstanding}}$

• Importance: Helps investors evaluate operating performance and compare companies.

• Example: Net income $50,000, 10,000 shares outstanding: EPS = $5.

Chapter 11: The Statement of Cash Flows

Purpose of the Statement of Cash Flows

The statement of cash flows reports a company’s cash inflows and outflows, helping users assess liquidity and financial flexibility.

• Shows: How cash is generated and used.

• Assists: In evaluating ability to meet obligations and invest.

Three Main Types of Activities

Cash flows are classified into operating, investing, and financing activities. Operating activities are most important for long-term survival.

• Operating Activities: Cash from core business operations.

• Investing Activities: Cash from buying/selling assets.

• Financing Activities: Cash from borrowing/repaying debt, issuing stock.

• Most Important: Operating activities indicate ongoing viability.

Classifying Transactions into Types of Activities

Transactions are classified based on their nature.

• Operating: Receipts from customers, payments to suppliers.

• Investing: Purchase/sale of equipment, investments.

• Financing: Issuing stock, paying dividends, borrowing.

Gains and Losses: Add or Deduct?

In the indirect method, gains are deducted and losses are added to net income to reconcile to cash flows from operating activities.

• Gains: Deducted.

• Losses: Added.

• Reason: These are non-cash items included in net income.

Full Cash Flow Statement

The cash flow statement summarizes cash flows from all activities and reconciles beginning and ending cash balances.

• Sections: Operating, Investing, Financing.

• Reconciliation: Beginning cash + net cash flows = ending cash.

Bottom of the Cash Flow Statement: Notes and Disclosures

At the bottom, companies disclose non-cash investing and financing activities and provide supplemental information.

• Non-Cash Activities: E.g., conversion of debt to equity.

• Supplemental Disclosures: Interest and income taxes paid.

Activity Type	Examples
Operating	Cash received from customers, cash paid to suppliers
Investing	Purchase of equipment, sale of investments
Financing	Issuance of stock, payment of dividends, borrowing