INTRODUCTION
Nicol David spent time learn the art of cookie-making from her grandmother
and involved in the squash games during her childhood. She mastered every type of
cookie imaginable and created new recipes with her grandmother. Now, she is at her
second year in the University and she is investigating the possibilities of opening her
own business as a part of the entrepreneurship program in which she is enrolled.
Nicol decided to open a cookie-making school after discuss with her family
and friends. To begin, she will start on a part-time basis and provide her services in
peoples’ homes. Nicol will concentrate on making holiday cookies during her long
semester break. She will offer group sessions and individual lessons of making
cookies. She decided to include the children in her target market. Nicol has decided to
opearate her business as a Corporation “Cookie Creation Inc”.
Nicol is introduced to Mr.Bean, the operation manager of “London Biscuits”
at a trade show. Nicol is asked to become the major supplier of oatmeal chocolate chip
cookies. Mr Bean expects Nicol will supply approximately 1500 dozen cookies a
week to “London Biscuits” Ayer Keroh warehouse. Nicol will be paid after 30 days
from the invoice date after Nicol sent the invoive to London Biscuit KL office every
month.
Nicol is excited with the offer. Unfortunately, she has recently found that the
consumer demand for the London Biscuit company’s product has decreased because
of selling cookies and donuts with high amounts of sugar and fats.
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BAC 1614
FUNDAMENTALS OF FINANCIAL ACCOUNTING
Trimester 1
2012/2013
(a)What type of information does each financial statement provide?
Financial statements are used to provide the record of the financial status for
any individuals, organizations and business. There are four basic types of financial
statement, which is balance sheet, income statement, cash flows statement and
statement of retained earnings.
Income statement lists revenues first, followed by expenses. Finally the
statement shows net income ( or net loss). Net income results when
revenues exceed expenses. A net loss occurs when expenses exceed
revenues.
Retained earning statement reports the changes in retained earning for
a specific period of time. The retained earnings statement uses the
information in income statement and provides the information in
balance sheet. The retained earnings will record in the balance sheet
and it will affected by the amount of net income and dividends.
Balance sheet provides the statement of financial position of a
company at a given point of time. The balance sheet reports the total
assets, total liabilities and the stockholders’ equity at a specific date.
Cash flow statement provides information on the cash receipts and
payments for a specific period of time. The cash inflows show the
receipts during the business and the cash outflows show the payments
for the business.
Conclusion, the four financial statements are connected with each other
because the net income or net loss in the income statement is used to add or subtract
from the beginning retained earnings in the Statement of Retained Earnings. Then, the
retained earnings of the end period in retained earnings statement are reported into the
balance sheet. The amount of cash present in the balance sheet is reported in the cash
flows statement.
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BAC 1614
FUNDAMENTALS OF FINANCIAL ACCOUNTING
Trimester 1
2012/2013
b) What financial statements would Nicol need in order to evaluate :
(I) Whether London Biscuits will have enough cash to meet its current liabilities?
Nicol can refer to London Biscuits’ cash flow statement or sometimes can call
as funds flow statement to determine whether London Biscuits have enough cash to
meet its current liabilities. The statement of cash flows reports the cash receipts, cash
payments, and net change in cash resulting from operating, investing and financing
activities. The cash flow statement reflects a firm’s liquidity. It is very vital as it will
show the cash in the company’s hand and their ability to pay their current liabilities.
The cash flow statement is intended to provide information that can be used to
generate future cash flows, to pay dividends and meet their obligations.
Statement of cash flow can be classified into operating activities, investing
activities and financing activities.
Operating activities
This tells us how much cash the company generated from its core business, as
opposed to the peripheral activities such as investing and borrowing. The
indirect method adjusts the net income figure to remove non-cash revenues
and expenses. It also removes items like gains and losses that are not
attributable to the operating activities of the business.
Investing activities
This report the aggregate change in a company’s cash position resulting from
any gains (or losses) from investment in the financial markets and operating
subsidies and changes resulting from amount spent on investments in capital
assets such as plant and equipment.
Financing activities
This tells us activities that involve the company’s owners or creditors. This
section is relates to long-term liabilities and shareholders’ equity.
(II) Whether London Biscuits will be able to survive over a long period of time?
Nicol can refer to balance sheet of the London Biscuits to determine whether
they can survive over a long period of time. Balance sheet reports the assets,
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BAC 1614
FUNDAMENTALS OF FINANCIAL ACCOUNTING
Trimester 1
2012/2013
liabilities and stockholders’ equity of a company at a specific time period. A balance
sheet shows the financial position of a company. It often described as “snapshot of a
company’s financial condition”. According to accounting equation, assets are always
equals to liabilities plus stockholder’s equity. If in a company, the assets are less than
current liabilities, this will create a working capital deficiency, also called a working
capital deficit. The company is facing short of liquidity under this situation because
the assets cannot readily be converted into the cash. This will lead a company to stop
their operations. When assets are greater than current liabilities, the company will
obtain a positive working capital that is very important for a company because this
show that the company is financially health. It is to ensure that the company is able
to continue its operations and to satisfy both maturing short-term debt and upcoming
expenses.
Nicol can also refer to retained earnings statement of the London Biscuits.
Retained earnings refer to the portion of net income which is retained by the
corporation rather than distributed to its owner as dividends. If retained earnings
balance is a positive, this means that the company is generating profit and it is able to
survive longer. If retained earnings is a negative, this mean that the company is
incurring loss and the company is unable to survive long period of time in this
situation.
(III) London Biscuits profitability?
Nicol can refer to Income statement to determine London Biscuits
profitability. Income statement can be called as profit and loss statement (P&L),
statement of operations, or statement of income. Besides balance sheet, statement of
cash flow and the statement of stockholders’ equity, income statement is one of the
financial statements frequently used by the accountants and business owners. The
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BAC 1614
FUNDAMENTALS OF FINANCIAL ACCOUNTING
Trimester 1
2012/2013
main aim of preparing an income statement is to report a company’s earning to the
investors over a specific period of time. Income statement is important because it
shows the profitability of a company during a specific time interval. Most of the
company will have revenue and expenses from primary activities, secondary
activities as well as gains and losses reported in their income statement. If total
amount of revenues and gains exceeds the total amount of expenses and losses, it
means that the company is gaining profit. However, if the total expenses and losses
exceed the total revenues and gains, it means that the company is suffering from loss.
By referring to an income statement, we can know more than a company’s net
earnings. For instance, by looking at any company’s income statement, we can know
how the management of the company controls their expenses, interest income, and
taxes. Besides, in order for investors to know the rate of return of the business, they
may use the income statement analysis to calculate the financial ratios. As we know,
many entrepreneurs start business is to generate profits. Some examples of the tool
needed in order to analyze a company’s operations and to compute the profitability
are profitability ratios, break-even analysis, return on assets and return on
investment.
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BAC 1614
FUNDAMENTALS OF FINANCIAL ACCOUNTING
Trimester 1
2012/2013
(c) Where can Nicol find out whether London Biscuits has outstanding debt? How
can Nicol determine whether London Biscuits would be able to meet its interest
and debt payments on any debt it has?
Outstanding debt is an unsettled portion of a debt that may include interest
accrued on the balance. In a simple word, outstanding debt stand for unpaid debt.
Nicole may find out the London Biscuit outstanding debt by referring to its Balance
Sheet. Balance sheet is a financial statement that summarizes a company's assets,
liabilities and shareholders' equity in a specific point of time. These three balance
sheet segments give investors an idea as to what the company owns and owes, as well
as the amount invested by the shareholders. Liabilities can be split into two categories
which are current liabilities and long-term liability. Current liabilities are debts
payable within one year, while long-term liabilities are debts payable over a longer
period. To find outstanding debt, Nicol should look for the total amount of liabilities
for the current amount in the Balance Sheet.
Besides, Nicol may use Interest Coverage Ratio to determine whether London
Biscuits would be able to meet its interest. Interest Coverage Ratio is used to verify
how simply a company can pay its interest on outstanding debt. Interest coverage ratio
is calculated by dividing a company's earnings before interest and taxes (EBIT) by the
company's interest expenses.
Formula :
interest coverage ratio=
EBIT
interest expenses
Nicol can calculate Interest Coverage Ratio by referring to income statement.
The lower the ratio, the more London Biscuit will be burden by the debt expense. On
the other hand, a high coverage ratio is neglecting opportunities to increase earnings
through leverage. An interest coverage ratio that below 1.0 indicates that a company is
not able to meet its interest obligations.
The best way to determined debt payments on any debt that would be able to
meet for London Biscuits is to use Debt Ratio. Debt Ratio is a ratio that indicates the
proportion of debt a company has relative to its assets. A debt ratio is basically a
company's total debt divided by its total assets.
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BAC 1614
FUNDAMENTALS OF FINANCIAL ACCOUNTING
Trimester 1
2012/2013
Formula:
debt ratio=
total debt
total assets
When the debt ratio is high, it means that London Biscuit has more debt relative to its
assets. This will result a burden in the sense that the interest payment might take a
very large amount of the company’s cash flow or courses a rise in the interest rate.
Meanwhile, when the debt ratio is low, the interest payments do not control a large
portion of the company's cash flows. Therefore, debt ratio can quantifies how
leveraged a company is.
There is also another solvency ratio that measures the portion of the assets of a
business which are financed through debt. This debt-to-assets ratio or simply debt
ratio is the ratio of total liability of the company over its total assets. The total
liabilities include both the current liabilities and non-current liabilities.
Formula:
debt ratio=
total liabilities
totalassets
The range of the ratio is from 0.00 to 1.00. When the debt ratio is lower, it is more
complimentary. Meanwhile, a higher value indicates that higher portion London
Biscuit assets are claimed by it creditors which leads a higher risk in operation. If the
debt ratio is 0.5, it means that half of the company's assets are financed through debts.
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BAC 1614
FUNDAMENTALS OF FINANCIAL ACCOUNTING
Trimester 1
2012/2013
(d)In deciding whether to go ahead with this opportunity, are there other areas of
concern that Nicol should be aware of?
Others than concerning about the London Biscuit Company’s financial status,
Nicol should also concern about the image and the reputation of the company. It is
because that the image and the reputation are very important for a company to do
their business. If the reputation of the company is good, then there are more
consumers choose to purchase the goods of the company, the company will
increases their sales of the product and generate a higher profit. But if the reputation
of company is not good as like the London Biscuit Company, the sales of the
product will decreases because the consumers have changes their decision and
choose another products rather than buying the product of London Biscuit. So, the
company will has a low profit and it may cause the losses if it keeps unchanged for
a long time. As a conclusion, company’s image and reputation are also important for
the business. Although the financial statement shows the company is generating the
profit, but if suddenly the reputation of company drop, it may influence the sales of
company and at last it may causes the loss of the company.
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BAC 1614
FUNDAMENTALS OF FINANCIAL ACCOUNTING
Trimester 1
2012/2013
e) Prepare journal entries to record the November transactions
COOKIE CREATIONS INC.
GENERAL JOURNAL
DATE
ACCOUNT TITLE
DEBIT
($)
500
2011
Nov 8
Cash
Common Stock
Nov 11
Supplies
Cash
95
Baking Supplies
Cash
125
Baking Equipment
Common Stock
300
Cash
Note Payable
2000
Baking Equipment
Cash
900
Cash
Unearned Revenue
60
Cash
Service Revenue
100
Website
Note Payable
600
Prepaid Insurance
Cash
1200
Account Receivable
Service Revenue
300
Cell Phone Bill Expenses
Cell Phone Bill Payable
50
Nov 14
Nov 15
Nov 16
Nov 17
Nov 25
Nov 29
Nov 30
Nov 30
Nov 30
Nov 30
CREDIT
($)
500
95
125
300
2000
900
60
100
600
1200
300
50
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BAC 1614
FUNDAMENTALS OF FINANCIAL ACCOUNTING
Trimester 1
2012/2013
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BAC 1614
FUNDAMENTALS OF FINANCIAL ACCOUNTING
Trimester 1
2012/2013
f) Post the journal entries to the general ledger accounts
GENERAL LEDGER
Cash
DATE
Nov 8
11
14
16
17
25
29
30
ACCOUNT TITLE
Common stock
Supplies
Baking Supplies
Note Payable
Baking Equipment
Unearned Revenue
Service Revenue
Prepaid Insurance
DEBIT($)
500
CREDIT($)
95
125
2000
900
60
100
1200
BALANCE($)
500
405
280
2280
1380
1440
1540
340
Common Stock
DATE
Nov 8
15
ACCOUNT TITLE
DEBIT($)
CREDIT($)
500
300
BALANCE($)
500
800
DEBIT($)
95
CREDIT($)
BALANCE($)
95
CREDIT($)
BALANCE($)
125
CREDIT($)
2000
BALANC ($)
2000
Cash
Baking Equipment
Supplies
DATE
Nov 11
ACCOUNT TITLE
Cash
Baking Supplies
DATE
Nov 14
ACCOUNT TITLE
DEBIT($)
125
Cash
Note Payable
DATE
Nov 16
ACCOUNT TITLE
Website
DEBIT($)
Baking Equipment
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BAC 1614
FUNDAMENTALS OF FINANCIAL ACCOUNTING
DATE
Nov 15
17
Trimester 1
2012/2013
ACCOUNT TITLE
Common Stock
Cash
DEBIT($)
300
900
CREDIT($)
BALANCE($)
300
1200
CREDIT($)
60
BALANCE($)
60
DEBIT($)
CREDIT($)
100
300
BALANCE($)
100
400
DEBIT($)
600
CREDIT($)
BALANCE($)
600
CREDIT($)
BALANCE($)
1200
CREDIT($)
BALANCE($)
CREDIT($)
100
300
BALANCE($)
100
400
CREDIT($)
BALANCE($)
300
Unearned Revenue
DATE
Nov 25
ACCOUNT TITLE
DEBIT($)
Cash
Service Revenue
DATE
Nov 29
30
ACCOUNT TITLE
Cash
Account Receivable
Website
DATE
Nov 30
ACCOUNT TITLE
Account Payable
Prepaid Insurance
DATE
Nov 30
ACCOUNT TITLE
DEBIT($)
1200
Cash
Account Receivable
DATE
Nov 30
ACCOUNT TITLE
Service Revenue
DEBIT($)
300
Account Payable
DATE
Nov 29
30
ACCOUNT TITLE
Website
Cell Phone Bill Expenses
DEBIT($)
Cell Phone Bill Expenses
DATE
ACCOUNT TITLE
DEBIT($)
Nov 30
Account Payable
300
g) Prepare a trial balance at November 30, 2011
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BAC 1614
FUNDAMENTALS OF FINANCIAL ACCOUNTING
Trimester 1
2012/2013
COOKIE CREATIONS INC.
Trial Balance as of November 31, 2011
DEBIT
($)
340
ACCOUNT TITLE
Cash
Common Stock
Supplies
Baking Equipment
Baking Supplies
Note Payable
Unearned Revenue
Service Revenue
Website
Prepaid Insurance
Account Receivable
Account Payable
Cell Phone Bill Expenses
TOTAL
CREDIT
($)
800
95
1200
125
2000
60
400
600
1200
300
650
50
3910
13
3910
BAC 1614
FUNDAMENTALS OF FINANCIAL ACCOUNTING
Trimester 1
2012/2013
h) Journalize the above transactions
COOKIE CREATIONS INC.
GENERAL JOURNAL
DATE
2011
Dec 5
Dec 8
Dec 9
Dec 15
Dec 16
Dec 19
Dec 23
Dec 23
Dec 23
Dec 28
ACCOUNT TITLE
Unearned Revenue
Cash
Service Revenue
DEBIT
($)
60
90
CREDIT
($)
150
Cash in Bank
Account Receivable
300
Cash
Unearned Revenue
750
Cell Phone Bill Payable
Cash
50
Account Payable
Cash in Bank
600
Cash
Unearned Revenue
60
Cash
Account Receivable
Service Revenue
3000
1000
Baking Supplies
Cash
1250
Salaries Expense
Cash in Bank
800
Dividend
Cash
500
300
750
50
600
60
4000
1250
800
500
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BAC 1614
FUNDAMENTALS OF FINANCIAL ACCOUNTING
Trimester 1
2012/2013
i) Post the December transactions. (Use the General ledger accounts that was
prepared earlier in (f) above)
GENERAL LEDGER
Cash
DATE
Dec 1
5
9
15
19
23
23
28
ACCOUNT TITLE
Balance b/d from November
Service Revenue
Unearned Revenue
Cell Phone Bill Payable
Unearned Revenue
Service Revenue
Supplies
Dividend
DEBIT($)
340
90
750
CREDIT($)
50
60
3000
1250
500
BALANCE($)
340
430
1180
1130
1190
4190
2940
2440
Cash In Bank
DATE
Dec 8
16
23
ACCOUNT TITLE
Service Revenue
Account Payable
Salaries Expense
DABIT($)
300
CREDIT($)
600
800
BALANCE($)
300
(300)
(1100)
CREDIT($)
400
90
60
3000
1000
BALANCE($)
400
490
550
3550
4550
CREDIT($)
BALANCE ($)
300
0
1000
Service Revenue
DATE
Dec 1
5
23
ACCOUNT TITLE
Balance b/d from November
Cash
Unearned Revenue
Cash
Account Receivable
DABIT($)
Account Receivable
DATE
Dec 1
8
23
ACCOUNT TITLE
Balance b/d from November
Cash in Bank
Service Revenue
DABIT($)
300
300
1000
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BAC 1614
FUNDAMENTALS OF FINANCIAL ACCOUNTING
Trimester 1
2012/2013
Unearned Revenue
DATE
Dec 1
5
9
19
ACCOUNT TITLE
Balance b/d from November
Service Revenue
Cash
Cash
DEBIT($)
CREDIT($)
60
60
750
60
BALANCE($)
60
0
750
810
Account Payable
DATE
Dec 1
15
16
ACCOUNT TITLE
Balance b/d from November
Cash
Cash in Bank
DEBIT($)
CREDIT($)
650
BALANCE($)
650
600
0
CREDIT($)
BALANCE($)
125
1375
DEBIT($)
800
CREDIT($)
BALANCE($)
800
DEBIT($)
500
CREDIT($)
BALANCE($)
500
CREDIT($)
BALANCE($)
1200
50
600
Baking Supplies
DATE
Dec 1
23
ACCOUNT TITLE
Balance b/d from November
Cash
DEBIT($)
125
1250
Salaries Expense
DATE
Dec 23
ACCOUNT TITLE
Cash in Bank
Dividend
DATE
Dec 28
ACCOUNT TITLE
Cash
Prepaid Insurance
DATE
Dec 1
ACCOUNT TITLE
Balance b/d from November
DEBIT($)
1200
Website
DATE
Dec 1
ACCOUNT TITLE
Balance b/d from November
16
DEBIT ($)
600
CREDIT ($)
BALANCE ($)
600
BAC 1614
FUNDAMENTALS OF FINANCIAL ACCOUNTING
Trimester 1
2012/2013
Note Payable
DATE
Dec 1
ACCOUNT TITLE
Balance b/d from November
DEBIT($)
CREDIT($)
2000
BALANCE($)
2000
CREDIT($)
BALANCE($)
1200
DEBIT$)
CREDIT($)
800
BALANCE($)
800
DEBIT($)
95
CREDIT($)
BALANCE($)
95
CREDIT($)
50
BALANCE($)
50
0
CREDIT($)
BALANCE($)
50
Baking Equipment
DATE
Dec 1
ACCOUNT TITLE
Balance b/d from November
DEBIT($)
1200
Common Stock
DATE
Dec 1
ACCOUNT TITLE
Balance b/d from November
Supplies
DATE
Dec 1
ACCOUNT TITLE
Balance b/d from November
Cell Phone Bill Payable
DATE
Dec 1
15
ACCOUNT TITLE
Balance b/d from November
Cash
DEBIT($)
50
Cell Phone Bill Expenses
DATE
Dec 1
ACCOUNT TITLE
Balance b/d from November
DEBIT($)
50
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BAC 1614
FUNDAMENTALS OF FINANCIAL ACCOUNTING
Trimester 1
2012/2013
j) Prepare a trail balance at December 31, 2011.
COOKIE CREATIONS INC.
Trial Balance as of December 31, 2011
ACCOUNT TITLE
DEBIT
($)
2440
Cash
Cash in Bank
Account Receivable
Note Payable
Service Revenue
Unearned Revenue
Supplies
Baking Supplies
Common Stock
Salaries Expense
Prepaid Insurance
Dividend
Baking Equipment
Website
Cell Phone Expenses
TOTAL
m) Prepare an income statement and a retained earnings statement for the 2 month
period ending December 31, 2011 and a classified balance sheet as of December
31,2011.
COOKIE CREATION INC.
Income Statement at December 31, 2011
($)
Revenue
Service Revenue
($)
5450
Expenses
Salaries Expenses
Cell Phone Bill Expense
Baking Supplies Expenses
Supplies Expense
Amortization
Interest Expense
Insurance Expense
Depreciation – Baking Equipment
Net Income
856
125
1025
45
25
11
100
40
(2227)
3223
COOKIE CREATION INC.
Retained Earnings Statement at December 31,2011
($)
0
3223
3223
(500)
2723
Retained Earnings, December 1
Net Income
Dividend
Retained Earnings, December 31
COOKIE CREATION INC.
Balance Sheet as of December 31, 2011
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