9. Taxes, Closing Entries and Payments of Dividends

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En provenance du cours de IESE Business School

Accounting: Principles of Financial Accounting

737 notes

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]

Remember that at the end of year X1, Christina estimated the total

amount of taxes she had to pay in year X2 once she did the tax filing.

The total amount was 3,600 Euros,

and we recognized that as an obligation we had with the tax authorities.

Now during year X2, Christina paid this amount.

And so, the next transaction is to account for the payment of taxes during year X2.

So, how would you account for this transaction?

Let us start with the easy part.

First, cash will decrease, because we are paying cash.

And therefore, we credit the cash account for 3,600 Euros.

Next, we are honoring this obligation we have with the tax authorities.

So, we recognize the decreasing the liability of taxes payable and

we do that by debiting taxes payable.

Remember, to decrease liability accounts, we debit the account.

And to increase liability accounts, we credit the account.

So these made reference to the payment of taxes that we had already recognized,

as an expense in year X1.

Now, we need to estimate the taxes we will have to pay next

year corresponding to the profits we have in year X2.

So the estimation that Christina has made of the tax expense corresponding to

the profit of this year is 3,060 Euros.

How would you account for this?

Well, first thing, we need to recognize the expense right now,

because we know that we have to pay this for sure.

So, we are poorer already.

And therefore, we recognize a debit in the profit and loss account.

In accounting, expenses are recognized as soon as you smell them.

So you try to anticipate them, and as soon as you know that you have to pay something

that you have an obligation the future, you recognize the expense right now.

You recognize that you are poorer,

you are going to be poorer right now even though you have not paid yet.

The tax expense is 30%, the corporate tax rate applied to the profit before taxes.

In this case, we said that the tax rules and accounting rules are the same.

And therefore, we don't need to make any adjustments to the accounting profit in

order to get the taxable profit.

Second thing, we are not paying for the taxes yet, remember.

Actually, Christina has not even done the tax filing for this year profits.

So we need to recognize that in the future, we have to pay this.

And therefore, we need to recognize an obligation, a liability.

This is why we credit taxes payable for 3,060 Euros.

So in this case now, we are poorer.

Liquidity has not changed, but we have an obligation to pay this amount.

Very good, we are close to the end of our transactions here.

The next thing that we have to do is the closing entry.

Remember, I told you this is something that companies do every year at the end of

the year, and it consists of taking calculating the profit from the profit and

loss account.

So in this case, as you see the profit for the year is going to be 7,140 Euros.

And so this is a credit balance, ending balance you have in the P&L account.

And we have to move this profit to retained profits.

And the reason why we do this is so that next year the profit and

loss account will start from zero.

And so, we are not mixing profits from one year with the previous year profits.

And so what we have to do here is debit the profit and loss account for

the total amount of the profit, so that the ending balance is zero.

And we are moving all these profits to another account that is called retained

profits, where we accumulate the profits from previous years.

And we do that by crediting the retained profits account for the same amount.

So the only thing that we did here, this is not the real transaction.

The only thing that we did is an accounting of reclassification.

So, we move the profits from the P&L account to retained profits.

Okay, so we are going to finish this with one last transaction that is the first

time that we see here, the payment of dividends.

So by the end of the year, Christina thought that she had all of cash and

she wanted to distribute part of this cash to the shareholders,

that is to herself and to her uncle.

And so she decides, together with her uncle,

to pay cash dividends of 10,000 Euros.

Now, let's see how to account for the payment of dividends.

Actually, first of all, let's think about the concept of dividends.

So, what is a dividend?

Well, a dividend is a way to reward the shareholders for

the capital they have provided to the company.

We could understand the dividend as a sort of partial liquidation of the firm.

So basically, we are taking some of the cash from the firm and

giving it to the shareholders.

So, the value of the firm is shrinking actually.

So, let's see how to account for this.

The first thing we should do is to credit cash.

So, cash is going to decrease by 10,000 Euros.

Now the next thing we need to do is to decrease the value,

the accounting value of the company.

So, owner's equity should decrease by the same amount.

And we do that through the retained profits account.

So, we debit the retained profits for 10,000 Euros.

Note that dividends are paid out of retained profits.

Obviously, they are paid in cash.

So, the first thing is that you need to have cash in your cash account.

Second thing, they are paid out of retained profits.

So, not from the profit and loss account.

So, dividends are not part of the profit and loss account, remember.

So even in the case that you have losses in the year, you could still pay dividends

as long as you retain profits from previous years are positive.

So in most of the countries,

one of the conditions to pay dividends is that retained profits are positive.

Excellent.

So believe it or not, we are done with all the transactions for the year X2.

Our next step now is to prepare the balance sheet and

we're going to this in the next video.

[MUSIC]

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