7. Transactions with Non-Current Assets

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Accounting: Principles of Financial Accounting

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IESE Business School

Accounting: Principles of Financial Accounting

737 notes

Cours 1 sur 5 dans Specialization Foundations of Management

Financial Accounting is often called the language of business; it is the language that managers use to communicate the firm's financial and economic information to external parties such as shareholders and creditors. Nobody working in business can afford financial illiteracy. Whether you run your own business, work as a manager or are just starting your career, you want to understand financial information and be able to interact with accountants, controllers, and financial managers. You want to talk business! This course will provide you with the accounting language's essentials. Upon completion, you should be able to read and interpret financial statements for business diagnosis and decision-making. More importantly, you will possess the conceptual base to keep learning more sophisticated accounting and finance on your own. Do not forget that, as with any other language, becoming proficient with accounting requires constant practice.

À partir de la leçon

Week 3: The Cash Flow Statement

Now that you have a good grasp of the balance sheet and income statement, I'll help you master how to recognize the transactions we went over in week two. I'll also introduce a third financial report - the cash flow statement - and discuss liquidity. Course objectives: To understand the difference between liquidity and profitability, become familiar with T-accounts and gain insight into the purpose of the cash flow report.

1. Introduction to Week 32:10

2. Recap of Week 23:15

3. T-Accounts and Journal Entries5:45

4. Setting up T-Accounts for the Campus Bookstore3:06

5. Sales, Cost of Goods Sold, Collections from Customers and Payment to Suppliers7:05

6. Other Operating Costs4:10

7. Transactions with Non-Current Assets8:09

8. Bank Loans and Interest4:03

9. Taxes, Closing Entries and Payments of Dividends5:44

10. Preparing the Balance Sheet3:54

11. Preparing the Income Statement4:30

12. Introducing the Cash Flow Statement I7:29

13. Introducing the Cash Flow Statement II4:03

14. Recap of Week 3 and Conclusions3:12

Rencontrer les enseignants

Marc Badia
Assistant Professor
Accounting and Control

[MUSIC]

In this video clip we're going to account for

a few transactions related to the noncurrent assets.

Remember that the noncurrent assets that we have in the campus bookstore

are the furniture and equipment and the software.

So let us start first with the depreciation of the furniture

and equipment.

Remember that we purchased the furniture and equipment and the end of year x0.

And the useful life that Christina estimated for this furniture and

equipment is five years.

So every year, the furniture and equipment is losing value.

Recall that the depreciation schedule we estimated in the previous period was

the following that you see on the table.

So as you see, we take the total purchase cost minus the salvage value of zero.

So 25,000 minus 0 divided by 5 years.

That will give you the annual depreciation that we need to recognize as an expense

and is decreasing the value of the asset.

So, by the end of the year x1 the net book value of the asset was 25,000

minus the 5,000 that we had recognized as depreciation in the first year.

So the net book value of the asset is 20,000 Euros.

This period, we need to recognize 5,000 Euros more of depreciation.

How would you account for this?

First, we are going to credit the cumulative depreciation.

Remember, what we want to do here is to decrease the value of the asset,

furniture and equipment, but instead of doing it directly,

what we do is to use a different account called depreciation,

accumulative depreciation that subtracts from the original cause of the value.

In this way,

the advantage of this method is that we always keep track of the original costs

and the proportion of that original cost that has been already depreciated.

In this way, shareholders know what percentage of the total

asset has been depreciated and

therefore if there is any need to make new investments, maybe in the following year.

Besides decreasing the value of the asset,

the next thing that we do is recognize that now, we are poorer.

Therefore, we need to recompense a depreciation expense in the profit

and lost account.

So, we debit the profit on this account for a total amount of 5,000 Euros, great.

So after this transaction, clearly we are poorer, because the profit and

loss account has decreased, the owner's equity, the net worth of the shareholders

has decreased and second, liquidity has not changed.

So actually depreciation as you can see,

is just an allocation of the purchase cost over time.

However the payment of that asset was done in the beginning,

when we purchased the asset and there for it is a mismatch in time between

the payment of this asset and the recognition of the expense over time.

Our next transaction is the recognition of the amortization of the software.

Remember that depreciation refers to tangible noncurrent assets,

whereas amortization is the same concept applied to

intangible noncurrent assets such as software.

In the case of software, we have to recognize amortization of 1,000 Euros.

Remember that the original cost was 3,000 Euros.

The estimated salvage value was 0 because this software was becoming obsolete after

three years,

according to the estimation the subjective estimation of Christina, of course.

And third, she estimated the useful life of three years.

So, it's going to be 3,000 minus 0 divided by 3 years.

The annual amortization that we need to recognize every year is 1,000 Euros.

First thing, we credit accumulated amortization,

that's going to decrease the value of the software.

Second, we need to decrease the profit and loss account,

shareholders are now poorer by 1,000 Euros.

Okay, we are making progress.

Now, let's go for the next transaction.

This is a new transaction that we have not seen before, and

it's the sale of part of the furniture and equipment.

So what happens when you sell an asset?

How do you recognize that?

So we sell it for a price of 1,800 Euros.

So that's the cash that we are going to receive, therefore, we debit cash for

this amount.

Now, what we are giving in exchange for

that cash is an asset that the original cost of which was 5000 Euros.

But it also has an accumulated depreciation of 2000 Euros,

therefore the net book value of this asset is 3000 Euros.

So we receive 1800 Euros in exchange,

we're giving an asset with a net book value of 3000 Euros.

Now as you can see here, the transaction doesn't balance.

So what do we do with the difference?

Well, the difference is going to be in this case a loss.

Why?

Because we have received an asset of 1800 Euros but

we have given an asset of 3000 Euros, therefore here we are poorer.

And we need to recognize that in the P and L, so in the P and L we debit P and

L with the loss on the sale of furniture.

The think you need to remember for this kind of transactions where we sell

an asset is that we need to estimate always the accounting gain or loss.

And accounting gain or loss will be the result of these formulas you see here.

So it's going to be the difference between the price that we are getting and

the net book value of the asset.

And remember that the net book value of the asset is the original cost

minus the accumulated depreciation, So the remaining value of that asset.

The difference between the price and

this net book value is going to be the profit or loss in this operation.

Probably you're wondering why are they selling some of the furniture?

Well, Christina told us that actually she needed to change some of the shelves in

the store in order to have more books.

She's increasing the amount of inventories because sales are also increasing,

she wants to increase sales, and so she's replacing some of the shelves for

other shelves that have more capacity.

This is why the next transaction is a purchase of new furniture for

a total amount of 6000 Euros, this one is easy.

So how would you account for this?

Well first we pay this in cash, therefore cash is going to decrease by 6,000 Euros,

we credit the cash account.

Remember, for an asset debit increases, credit decreases an asset.

So we credit the cash account.

Next in exchange of this cash we are getting the furniture, so

the furniture account is going to increase.

So we are going to debit furniture and equipment by 6,000 Euros as well.

After this transaction, we have less liquid because we have paid some cash but

profitability has no change, the net worth of the shareholders is the same.

Now, that profitability is going to be changing in the future

once we start next year to depreciate these assets that we have purchased.

Next transaction.

So, at the end of year x2 Christina felt that she had a lot of cash and

she wanted to invest some of this cash while she was not using it.

So, she decided to purchase some Apple shares.

First thing that will happen is that cash will decrease because we are paying this

stock in cash.

So, we credit cash by 15,000 Euros.

Next, what else we recognize here?

Is this an expense?

Well clearly, I mean we have purchased some stock of Apple and

this has a future value.

Actually tomorrow we could sell this stock in the stock market, right?

So we need to recognize another asset, something that has a future value that

we own and is the result of a past transaction.

And we don't have any asset right now that fits this kind of investment.

So we need to open a new account that we can call Marketable Securities.

As you see I'm writing this account very close to cash

because actually marketable securities are very liquid,

at any moment we can sell these shares in the stock market and get the cash.

So we debit marketable securities by the same amount, 15,000 Euros.

Note that this purchase has been done on December 31st.

Now, what will happen if next year the price in the stock market

of Apple shares changes?

Well, the way how you recognize financial assets is a very interesting question that

goes beyond the scope of this course, but

I'm going to talk a little bit about this in the next session.

In the next video clip, I'm going to take care of the bank loans and

the cost of interest of these loans.

[MUSIC]

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