Question

How do you solve the following types of problems? No data needed. Just need to know HOW one would solve or define these problems.

Compute Net Income and Retained Earnings

Calculate total assets and total liabilities from general ledger accounts

Characteristics of liabilities and assets

Debt and Credit rules and types of accounts affected by each

Explain the transactions when given a journal entry

Identify recordable transactions

Calculate current assets and current liabilities

Depreciable assets vs capitalized assets

Answer 1

Net Income and Retained Earnings

Finding how much a company pays in total dividends is pretty easy if you know where to look. One way to calculate total dividends paid in any given period is to look at net income, and the change in retained earnings.

Net income = profits or losses earned a period of time.

Retained earnings = Cumulative net income minus cumulative dividends paid to shareholders.

Therefore, logic follows that the amount paid out in dividends is equal to net income minus the change in retained earnings for any period of time. Confused? Don't be. I'll use a really friendly example so that you can calculate this on your own.

Calculating Costco's dividends in 2014
In 2014, Costco reported net income of $2.058 billion on its income statement. On its balance sheet, it reported having retained earnings of $6.283 billion at the end of 2013, and $7.458 billion at the end of 2014. These are the three numbers we need to calculate how much it paid in dividends in 2014.

The first step is to figure out how much of Costco's earnings it retained in 2014. We can find this by taking retained earnings at the end of 2014, and subtracting retained earnings at the end of 2013.

Calculating the change in Costco's retained earnings
Retained earnings in 2014	$7.458 billion
Subtract retained earnings in 2013	$6.283 billion
Change in retained earnings	$1.175 billion

This figure ($1.175 billion) shows us how much of Costco's net income was retained by the company during the fiscal 2014 year. By definition, this is how much of its earnings Costco didn't pay out in a dividend.

To find out how much was paid out in dividends, we simply have to find the difference between what Costco earned, and what it retained. A dollar earned, but not retained, is obviously a dollar paid out.

Thus, we take net income of $2.058 billion and subtract the change in retained earnings over the past year, or $1.175 billion. In doing so, we arrive at $0.883 billion. This figure is how much Costco paid out in dividends to its shareholders using net income and retained earnings.

total assets and total liabilities from general ledger accounts

Every time you make a transaction for your business, you must record it. Transactions go through several steps in the accounting process.

First, you record transactions in a journal. A journal is used to identify transactions. Also known as the book of original entry, the journal is a running list of business transactions. Each line is a journal entry. Entries include the dates, descriptions, and amount of items bought or sold.

Journals are separated into different accounts to stay organized. You will have five main accounts: assets, expenses, liabilities, revenue, and equity. Each of the main accounts can be divided into smaller subcategories. For example, you can break down assets into inventory and receivable categories.

If you use a double-entry bookkeeping system, you will also include a debit or credit. Debits and credits are equal but opposite entries. The debits and credits balance each other. Make one debit and one credit entry for each transaction.

Debits and credits affect the accounts differently. Some accounts are increased by debits, while others are increased by credits. Use the table below to see how debits and credits affect accounts:

Let’s break down each line item:

Line one (5/1): You deposited money into your bank account.

You earned cash, which is an asset. Assets are increased by debits. Debit the cash account $20,000.

The cash you gained is also capital. Capital is part of your owner’s equity. Equity is increased by credits. Credit the capital account $20,000.

Line two (5/4): You paid rent for your business location.

You gained an expense. Expenses are increased by debits. Debit the expense account $1,500.

You lost the cash used to pay rent. Cash (an asset) is decreased by credits. Credit the cash account $1,500.

Line three (5/8): You bought inventory.

You gained inventory, which is an asset. Assets are increased by debits. Debit the inventory account $2,000.

You owe the supplier money as part of accounts payable. Accounts payable is a liability. Liabilities are increased by credits. Credit accounts payable $2,000.

After recording transactions in the journal, transfer them to the general ledger. You must post every transaction from your journal into the ledger.

The ledger is the book of final entry. You use the ledger to organize and classify transactions. Each journal entry is moved into an individual account. The line items are called ledger entries.

Transfer the debit and credit amounts from the journal to the ledger account. After posting entries to the general ledger, calculate the balance of each account.

Calculate the balance of an asset or expense account by subtracting the total credits from the total debits.

Calculate the balance of a liability or equity account by subtracting the total debits from the total credits.

If you don’t want to balance accounts and calculate totals yourself, use basic accounting software to record transactions in your ledger. The software will automatically calculate totals for you.

Without software, you can record your ledger in a spreadsheet. However, this method could be time consuming and lead to more errors while posting to the ledger.

Ledger account example

As a small business owner, you should be posting to the general ledger as you make transactions. At the end of each month, transfer journal entries into a ledger. The ledger organizes the same information in a different format.

Instead of a comprehensive list, ledger entries are separated into different accounts. The accounts, called T-accounts, look like an uppercase “T” and trace debits and credits in your accounting records.

Characteristics of liabilities and assets

Characteristics of Liabilities:

According to Institute of Chartered Accountants of India, liability is “the financial obligation of an enterprise other than owners’ funds”.

(1) Occurrence of a Past Transaction or Event:

The obligations must arise out of some past transaction or event. A liability is not a liability of an enterprise until something happens to make it a liability of that enterprise.

The kinds of transactions and other events and circumstances that result in liabilities are the following Acquisition of goods and services, impositions by law or governmental units, and acts by an enterprise that obligate it to pay or otherwise sacrifice assets to settle its voluntary non-reciprocal transfers to owners and others.

In contrast, the act of budgeting the purchase of a machine and budgeting the payments required to obtain it results neither in acquiring an asset nor in incurring a liability. No transaction or event has occurred that gives the enterprise access to or control of future economic benefit or obligates it to transfer assets or provide service to another entity.

The following are the essential characteristics of an asset

resource must contain future economic benefits

control or requiring a capacity to benefit from the asset in the pursuit of the entity’s objectives and an ability to deny or regulate the access of others to those benefits.

past event which giving rise to the entity’s control over future economic benefits

With the proposed definition of an asset, namely “An asset of an entity is a present economic resource to which through an enforceable right or other means the entity has access or can limit the access of others” there will be less focus on future economic benefits and more on present resource; and less on control, with more on the existence of enforceable rights to limit access of others.

Debt and Credit rules and types of accounts affected by each

Debits and credits are the opposing sides of an accounting journal entry. They are used to change the ending balances in the general ledger accounts. The rules governing the use of debits and credits in a journal entry are as follows:

Rule 1: All accounts that normally contain a debit balance will increase in amount when a debit (left column) is added to them, and reduced when a credit (right column) is added to them. The types of accounts to which this rule applies are expenses, assets, and dividends.

Rule 2: All accounts that normally contain a credit balance will increase in amount when a credit (right column) is added to them, and reduced when a debit (left column) is added to them. The types of accounts to which this rule applies are liabilities, revenues, and equity.

Rule 3: Contra accounts reduce the balances of the accounts with which they are paired. This means that (for example) a contra account paired with an asset account behaves as though it were a liability account.

Rule 4: The total amount of debits must equal the total amount of credits in a transaction. Otherwise, a transaction is said to be unbalanced, and the financial statements from which a transaction is constructed will be inherently incorrect. An accounting software package will flag any journal entries that are unbalanced.

Explain the transactions when given a journal entry

1. General: Agreement, contract, exchange, understanding, or transfer of cash or property that occurs between two or more parties and establishes a legal obligation. Also called booking or reservation.

2. Accounting: Event that effects a change in the asset, liability, or net worth account. Transactions are recorded first in journal and then posted to a ledger.

3. Banking: Activity affecting a bank account and performed by the account holder or at his or her request.

4. Commerce: Exchange of goods or services between a buyer and a seller. Every transaction has three components: (1) transfer of good/service and money, (2) transfer of title which may or may not be accompanied by a transfer of possession, and (3) transfer of exchange rights.

5. Computing: Event or process (such as an input message) initiated or invoked by a user or computer program, regarded as a single unit of work and requiring a record to be generated for processing in a database.

Be of a financial character (in a certain amount of money) Transactions must involve monetary values, meaning a certain amount of money must be assigned to the elements or accounts affected. ... The mere request (order) of a customer is not a recordable business transaction.

Calculate current assets and current liabilities

A current asset is an item on an entity's balance sheet that is either cash, a cash equivalent, or which can be converted into cash within one year. If an organization has an operating cycle lasting more than one year, an asset is still classified as current as long as it is converted into cash within the operating cycle. Examples of current assets are:

Cash, including foreign currency

Investments, except for investments that cannot be easily liquidated

Prepaid expenses

Accounts receivable

Inventory

These items are typically presented in the balance sheet in their order of liquidity, which means that the most liquid items are shown first. The preceding example shows current assets in their order of liquidity.

Creditors are interested in the proportion of current assets to current liabilities, since it indicates the short-term liquidity of an entity. In essence, having substantially more current assets than liabilities indicates that a business should be able to meet its short-term obligations. This type of liquidity-related analysis can involve the use of several ratios, include the cash ratio, current ratio, and quick ratio.

A current liability is an obligation that is 1) due within one year of the date of a company's balance sheet and 2) will require the use of a current asset or will create another current liability. If a company's operating cycle is longer than one year, current liabilities are those obligation's due within the operating cycle.

Current liabilities are usually presented in the following order:

the principal portion of notes payable that will become due within one year

accounts payable

the remaining current liabilities such as payroll taxes payable, income taxes payable, interest payable and other accrued expenses

The parties who are owed the current liabilities are referred to as creditors. If the creditors have a lien on company assets, they are known as secured creditors. The creditors without a lien are referred to as unsecured creditors.

Depreciable assets vs capitalized assets

Capitalize refers to adding an amount to the balance sheet. For example, certain interest from loans to self-construct a building will be added to the cost of the building. The building's cost including the capitalized interest will be recorded as an asset on the balance sheet.

Depreciate refers to reducing an amount reported on the balance sheet. Depreciation is defined as systematically allocating the cost of a plant asset from the balance sheet and reporting it as depreciation expense on the income statement. If the building has a cost of $600,000 and a useful life of 30 years, then (assuming no salvage value and straight-line depreciation) each year $20,000 of cost is removed from the asset section of the balance sheet and will appear on the income statement as depreciation expense. (This in turn reduces owner's equity and keeps the balance sheet in balance.)

The interest on debt that is capitalized will not be expensed during the year of construction. Instead, it is added to the cost of the building (capitalized) and will be part of the annual depreciation expense occurring during the building's 30-year life.

In summary, capitalize means to add an amount to the balance sheet. Depreciate means to systematically remove an amount from the balance sheet during the asset's useful life.

Capitalization

Capitalization is essentially the practice of reporting a large expense on the company's balance sheet than on the company's income statement. This is possible because most large purchases -- such as cars or machinery -- remain assets owned by the company that could be sold for cash at some later date. Smaller purchases are usually of items such as office supplies that are expended fairly readily, so they can't be considered assets that the company retains for future sale.

Limits to Capitalization

Not all expenses can be capitalized. Generally, an expense should only be capitalized if its value is retained in the form of an asset. When businesses spend on services such as rent, utilities and salaries, they often cannot record an asset because they gain no marketable items in exchange for their cash outlay. Services that increase the value of an asset, such as construction or renovation of a building, are capitalized. Companies and institutions often develop a capitalization policy based on generally accepted accounting principles that determines a threshold for how large an expenditure can be before it is capitalized.

Depreciation

Depreciation is the practice of expensing the cost of a capitalized asset over time. Many assets cannot be sold later to fully recover the business's cost. This is because of the effects of gradual long-term use on the asset -- for example, a car is more likely to break down the longer it has been operating, so its resale value tends to be less than that of the original purchase. This decay in an asset's value is predictable and the business reports it as a depreciation expense as it takes place.

Key Differences

Capitalization and depreciation are similar and related, but have some key differences in practice. Capitalization is basically moving an expense from the income statement to the balance sheet, while depreciation is the process of moving it back to the income statement over time. Tax authorities usually require businesses to depreciate large purchases over time rather than report them as expenses in the tax year of the purchase. This prevents companies from reducing their income, and lowering their tax liability, if they still retain the ability to sell their assets to meet tax obligations.