Principles of Finance with Excel (Основы финансов c Excel)
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PFE, Chapter 7: Accounting principles page 11
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ABCDEFGH
28-Feb-03
Assets Liabilities and equity Profit and loss for the period
Cash
Current liabilities
Sales 12,000
Cash at beginning of month 13,000 Taxi loan from bank 8,000 Owner salaries -2,000
Fares 12,000 Fuel -4,000
Gas -4,000 Profit 6,000
Salaries -2,000
Equity
Dividends 0
Used to buy new taxi -10,000 Initial stock 25,000 Retained earnings 6,000
Cash at end of month 9,000 Accumulated retained earnings
January 2003 6,000
Taxis 36,000 February 2003 6,000
Total assets 45,000 Total liabilities and equity 45,000
ANYTOWN TRAVEL SERVICES (ATS), Inc.
Notice that on the right-hand side of the balance sheet we’ve started to distinguish
between “liabilities” and “equity.” The former represents financing from outside sources, while
“equity” is financing by the owners of the company.
31 March 2003
ATS had another very successful month:
• They hired an extra driver for each of the two taxis (Brother and Sister still drive a couple
of hours per day, but the drivers bear most of the brunt). The drivers are getting $1,500
each. Each taxi brought in $20,000 for the month. However, $8,000 of this derives from
a contract signed to provide transportation for the local flour mill and its
executives/guests. The flour mill hasn’t paid this money yet; they pay their bills on the
15
th
of the month following. As you will see below, this unpaid bill generates an account
receivable on ATS’s balance sheet—a bill to customers which is outstanding and is
anticipated to be paid within a year. An account receivable is an asset of the firm (some
firms sell their accounts receivable—if you can sell it, it must be an asset).
• One of the drivers was promised a signing bonus of $800 which would be paid only if she
proved herself for at least 6 weeks. If she’s still working for ATS by 20 May 2003, this
driver will be paid the $800 bonus. The bonus (as yet unpaid) is listed as a Current
PFE, Chapter 7: Accounting principles page 12
liability; this is accounting terminology for an unpaid bill which will be paid within a
year.
• Brother and Sister bought a computer for the office (still located in the spare room of
their house). The computer cost $2,000.
• Other expenses: Gas $6,000; Brother-Sister raised their salaries to $2,000 each, for a
total of $4,000.
• They paid off $800 on the car loan. The bank charges them 1% per month, so that
they’ve also paid $80 interest.
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ABCDEFGH
31-Mar-03
Assets Liabilities and equity Profit and loss for the period
Current assets Current liabilities
Sales 40,000
Cash Unpaid signing bonus 800 Driver salaries -3,000
Cash at beginning of month 9,000 Taxi loan from bank 7,200 Owner salaries -4,000
Fares paid 32,000 Signing bonus -800
Driver salaries -3,000 Fuel -6,000
Owner salaries -4,000 Interest -80
Fuel -6,000 Profit 26,120
Interest -80
Repayment of principal -800
Computer -2,000
Cash at end of month 25,120
Equity
Accounts receivable 8,000 Initial stock 25,000
Retained earnings
Fixed assets
January 2003 6,000
Computer 2,000 February 2003 6,000
Taxis 36,000 March 2003 26,120
Total assets 71,120 Total liabilities and equity 71,120
ANYTOWN TRAVEL SERVICES (ATS), Inc.
Here are some notes on the balance sheet:
• Look at how the computer is listed (cells B74 and B80). On the one hand, it was paid for
out of cash and therefore there’s a -$2,000 item in the cash lines (B74). On the other
hand, the computer is not an expense—instead it’s a capital investment (like the two
taxis) and is listed under fixed assets (B80). Accountants (and the tax authorities) define
a capital asset as an asset that: i) has a life longer than a year and ii) produces income
PFE, Chapter 7: Accounting principles page 13
over its lifetime. Capital assets are not immediately listed on the profit and loss as
expenses; instead, their cost is written off over their lifetime as depreciation.
3
• Notice that the $880 paid to the bank is fully deducted from the cash in the balance sheet
(cells B72 and B73) but that only $80 of this sum (the interest payment) is an expense on
the profit and loss statement (H68). Repayment of loan principal is not an expense
(you’re only paying back what you got—it’s not a cost, although it is a negative cash
flow, see below). The $800 repayment of loan also materializes on the right-hand side of
the balance sheet as a reduction in the auto loan under current liabilities (cell E67).
• We’ve started to distinguish between current assets and fixed assets on the left-hand side
of the balance sheet. “Current assets” are short-lived assets, which can or will be
liquidated at short notice, usually a year or less. The cash account on the balance sheet is
obviously a current asset. AST’s accounts receivable are also current assets because they
relate to the unpaid bills of the flour mill which will be paid off within the month.
• Note that the receivable of $8,000 is part of the sales of the firm on the profit and loss
statement (cell H65). That is—not all the firm’s sales are in cash. Any reasonably
anticipated receipt should be put in the profit and loss statement as a sale. Similarly—
see next bullet—any reasonably anticipated expense should be recorded in the profit and
loss statement as a cost. On the other hand the repayment of this $8,000 receivable in the
coming month will not affect the profit and loss statement.
3
As we write this chapter, a financial scandal in the United States involves WorldCom, which misclassified some
expenses of doing business as the purchase of long-term assets. (This would be similar to ATS listing the salaries of
their taxi drivers as the purchase of a fixed asset.) By doing this WorldCom over-reported its income.
PFE, Chapter 7: Accounting principles page 14
• In a similar way, the $800 unpaid signing bonus is listed as a current liability (E66) and
reduces the month’s profits (H68), even though it has not yet actually been paid. In the
next statement the company will pay this $800 bonus, and at that point it will not affect
the profit and loss statement.
April - June
The following events occurred during this three-month period:
• The two taxis produced sales of $25,000/month each, $150,000 for the whole period.
$30,000 ($10,000 per month) of this figure is for the transportation contract with the local
flour mill. This company always pays one month in arrears, so that at the end of June,
they still have a $10,000 bill outstanding.
4
• The drivers were paid $1,500 each per month = $9,000.
• Brother and Sister salaries stayed the same as in March ($2,000 each per month) =
$12,000.
• Gasoline for the two taxis cost $7,000 per month per taxi = $42,000. The gas station has
agreed to extend credit to ATS—the company can now pay its gasoline bills on the 10
th
of the month following. At the end of June, $14,000 in gasoline bills remained to be paid
(this will be recorded as an account payable on the liabilities side of the balance sheet).
• In each of the three months, ATS paid $800 off on the taxi loan, so that the total loan
outstanding at the end of June is $4,800 (this is the initial $8,000 loan, minus repayments
4
During the April-June period, the flour mill i) paid off the $8,000 bill left from March, ii) was billed $10,000 per
month, and iii) paid off April’s $10,000 bill in May and paid off May’s $10,000 bill in June. At the end of the
period, the company still owed ATS $10,000 for services rendered in June.
PFE, Chapter 7: Accounting principles page 15
of $800/month for March – June). The interest payments (1% per month on outstanding
balances) during the April – June period were:
o $72 for April (1% of $7200)
o $64 for May (1% of $6400)
o $56 for June (1% of $5600)
• ATS was billed by its insurance company for a policy that has been in force since
January. The cost is $12,000. They paid this whole amount in May 2003. At the end of
June, $6,000 of this amount relates to insurance for the period January – June; this will be
included in the profit and loss statement as an expense. The other $6,000 relates to
insurance for the rest of the year. As you will see below, the unused portion of the
insurance ($6,000) is recorded as a prepaid expense on the asset side of the balance sheet.
• On 30 June 2003 Brother and Sister bought a small building to house the ATS offices.
The building (an old gas station) includes a garage, some office space, and fuel pumps for
the taxis. The cost of the building was $80,000. They financed the purchase with
$20,000 in cash and a $60,000, 10-year mortgage from bank. The mortgage conditions
are:
o Monthly principle repayment
10 years*12 months/year
$60,000
$500
10*12
=
.
o Monthly interest payment: ½% on outstanding mortgage balance.
• They paid the signing bonus to the driver ($800).
Here are the new balance sheet and profit and loss statement:
PFE, Chapter 7: Accounting principles page 16
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ABCDEFGHI
30-Jun-03
Assets Liabilities and equity Profit and loss for the period
Current assets Current liabilities Sales 150,000 <-- =B92+B104
Cash Taxi loan from bank 4,800 Driver salaries -9,000 <-- =B94
Cash at beginning of April 25,120 Unpaid signing bonus 0 Owner salaries -12,000 <-- =B95
Fares paid 140,000 Accounts payable (gasoline) 14,000 Fuel -42,000 <-- =B96-E92
Payment of outstanding receivable 8,000 Total current liabilities 18,800 Interest -192 <-- =B97
Driver salaries -9,000 Insurance -6,000 <-- =B99+B105
Owner salaries -12,000 Long-term liabilities Profit 80,808 <-- =SUM(H89:H94)
Fuel -28,000 Mortgage to buy building 60,000 Dividends 0
Interest -192 Retained earnings 80,808
Repayment of principal -2,400
Insurance -12,000
Building, cash payment -20,000
Signing bonus -800
Cash at end of June 88,728
Accounts receivable 10,000
Equity
Prepaid expenses (insurance) 6,000 Initial stock 25,000
Total current assets 104,728 Retained earnings
January 2003 6,000
Fixed assets February 2003 6,000
Computer 2,000 March 2003 26,120
Taxis 36,000 April-June 2003 80,808
Building 80,000 Total equity 143,928
Total fixed assets 118,000
Total assets 222,728 Total liabilities and equity 222,728
ANYTOWN TRAVEL SERVICES (ATS), Inc.
In columns G and H we’ve given a profit and loss statement for the period which ignores
depreciation and taxes (we’ll get to these in a moment). An outlay is recorded as an expense
only if it is required in the current period to produce income. Here are some examples:
• The $20,000 paid in cash for the building is balanced by an asset of $80,000 (the building
itself) and the $60,000 mortgage which is recorded as a liability. Thus the $20,000 is not
an expense, even though it’s a cash outlay. When the building starts to be depreciated,
this depreciation will be recorded as an expense (it represents the cost of the building in
producing the current period’s income).
• The $800 for the signing bonus is a cash outlay balanced by a reduction in a
corresponding current liability. The signing bonus was an expense in the April
accounting period.
• The $12,000 spent for insurance is partially offset by a $6,000 prepaid expense. Thus
only $6,000 of the insurance outlay is an expense on the profit and loss statement.
PFE, Chapter 7: Accounting principles page 17
Preparing a profit and loss statement for January - June
Their accountant insists that Brother and Sister prepare a profit and loss statement for the
first half-year of the company’s operations. The accountant explains that:
o It is important they know how the new company has performed thus far
o Brother and Sister have to pay an estimated tax payment to the IRS on July 15
based on their profit for the first half year.
The main difference between the profit and loss statements shown thus far and the
statement that the accountant prepares is depreciation. There are several different interpretations
of depreciation:
• Depreciation is a cost allowed by the tax authorities for the use of a fixed asset. Since we
have not thus far included the costs of fixed assets (the taxis, the computer, and the
building) in our profit and loss statements, depreciation is a way to spread out these costs
over the useful life of the assets.
• Depreciation represents the economic cost of using a fixed asset over the life of the asset.
o The accountant depreciates the computer over a 2-year useful life. The monthly
depreciation of the computer is therefore
$2,000
$83.33
24
=
. Since they’ve owned
the computer for three months, the total depreciation on the computer for the
period is 3*83.33=$250.
o The taxis are depreciated over a 3-year useful life; this works out to
$18,000
$500
3*12
= per month. They bought the first taxi on 1 January, so that it has
6 months of depreciation (= $3,000). The second taxi is 4 months old (it was
PFE, Chapter 7: Accounting principles page 18
purchased the last day of February), so that its depreciation is $2,000. Thus total
depreciation on the taxis is $5,000.
o Finally, the building, bought on 30 June 2003, is going to be depreciated over 10
years. However, since it has just been put on the balance sheet, there is no
depreciation to be taken for this building yet.
The corporate tax rates applicable to ATS are 5% state tax and 36% Federal tax. For
purposes of computing the Federal tax, the state tax is an expense (see cells H129 and H130
below). Here’s the way the balance sheet and the profit and loss look after taking into account
depreciation and the tax rates:
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ABCDEFGHI
30-Jun-03
Assets Liabilities and equity Profit and loss for the period
Current assets Current liabilities Sales 214,000 <-- =H36+H50+H65+H89
Cash Taxi loan from bank 4,800 Driver salaries -12,000 <-- =H66+H90
Cash at beginning of period 25,000 Unpaid signing bonus 0 Owner salaries -20,000 <-- =H37+H51+H67+H91
Cash sales 204,000 Accounts payable (gasoline) 14,000 Signing bonus -800 <-- =H68
Driver salaries -12,000 Taxes payable 44,562 Fuel -56,000 <-- =H38+H52+H69+H92
Owner salaries -20,000 Total current liabilities 63,362 Interest -272 <-- =H70+H93
Signing bonus -800 Insurance -6,000 <-- =H94
Fuel -42,000 Long-term liabilities Depreciation -5,250 <-- =B142+B144+B146
Interest -272 Mortgage to buy building 60,000 Profit 113,678 <-- =SUM(H120:H127)
Repayment of car loan principal -3,200 State income tax (5%) -5,684 <-- =-5%*H128
Insurance -12,000 Federal income tax (36%) -38,878 <-- =-36%*(H128+H129)
Building, cash payment -20,000 Profit after taxes 69,116 <-- =H128+H129+H130
Cash paid for taxis -28,000 Dividends 0
Cash paid for computer -2,000 Retained earnings 69,116 <-- =H131-H132
Cash at end of period 88,728
Accounts receivable 10,000
Prepaid expenses (insurance) 6,000
Current assets 104,728
Fixed assets Equity
Computer 2,000 Initial stock 25,000
Minus accumulated depreciation -250 Accumulated retained earnings 69,116
Taxis 36,000 Total equity 94,116
Minus accumulated depreciation -5,000
Building 80,000
Minus accumulated depreciation 0
Net fixed assets 112,750
Total assets 217,478 Total liabilities and equity 217,478
ANYTOWN TRAVEL SERVICES (ATS), Inc., Jan-June 2003
financial statements including depreciation and taxes
Note that on 1 July 2003, ATS hasn’t actually paid the taxes (they’re due only on 15
July). To take care of this, the accountant creates a category called
taxes payable; this is a
current liability for taxes i) due within a short period of time, ii) that have already been
accounted for in the profit and loss statement, and iii) that have not yet been paid. The taxes
PFE, Chapter 7: Accounting principles page 19
payable account (cell E124) of $44,562 is the sum of the state and Federal taxes owed ($5,684 +
$38,878).
7.3. The consolidated statement of cash flows
This is the third accounting statement we’re mastering in this chapter. The purpose of the
consolidated statement of cash flows is to explain the growth over the period of the cash balances
on the balance sheet. The statement of cash flows accomplishes this by classifying all the firm’s
cash inflows and outflows into three categories: cash flow from operating activities, cash flow
from investing activities, and cash flow from financing activities.
Cash flow from operating activities
Cash flow from operating activities includes the profit after taxes for the period minus
increases in operating current assets plus increases in operating current liabilities:
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AB
Consolidated statement of cash flows
Cash flow from operating activities
Profit after taxes 69,116
Add back depreciation 5,250
Subtract increase in current assets -16,000
Add increases in current liabilities 58,562
Cash provided from operating activities
116,928
•
In the period January – June, ATS had profits of $69,116. It recorded depreciation of
$5,250 on its taxis and computer; this depreciation is not a cash expense, and it is added
back in the cash flow statement.
•
In addition, the company’s current assets excluding cash grew by $16,000. This is the
sum of the end-June account receivable from the flour mill plus the pre-paid insurance
PFE, Chapter 7: Accounting principles page 20
expenses. This $16,000 is a cost of business not recorded in the profit and loss; the cash
flow statement subtracts this amount.
•
At the end of June, the company had $44,562 of unpaid taxes and $14,000 of unpaid
gasoline bills. This
increase in current liabilities is an expense which was recorded on
the P&L but which has (as yet—ultimately these bills will, of course, be paid) no cash
implications. Therefore we add it back.
Cash flow from investing activities
Cash flow from investing activities includes acquisition of fixed assets (land, property,
machines) and investments made by the company in marketable securities.
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Cash flow from investing activities
Payments for fixed assets
Taxis -36,000
Computer -2,000
Building -80,000
Purchases of marketable securities 0
Proceeds from sales of marketable securities 0
Cash used in investing activities
-118,000
?????Meni: why isn’t depreciation here?
Cash flow from financing activities
This item includes money raised by the company from sale of stock, from taking loans,
and so on.
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AB
Cash flow from financing activities
Proceeds from new debt 68,000
Debt repayments -3,200
Cash dividends paid 0
New stock sold 0
Stock repurchased 0
Cash used in financing activities
64,800
?????Meni: explain more. Why isn’t interest here? Why only debt repayments?