Accounting and Finance for Lawyers
Law School: Liberty University School of Law
Course ID: LAW 630
Term: Spring 2020
Instructor: Dean Todd
- Introductory Accounting, Finance and Auditing for Lawyers by Lawrence A. Cunningham
- 7th edition (2017)
- Paperback (ISBN: 9781634604109)
- 7th edition (2017)
A journal is a chronological record of changes in a company's assets, liabilities, shareholders' equities, revenues, and expenses. These can then be added up to make a balance sheet.
To make a double-entries in a general journal, the three questions are:
- What has happened?
- Which accounts are affected?
- In which direction are the affected accounts?
E.g., if someone contributes $5,000 in exchange for stock, and $2,000 is used to buy supplies, half on credit:
O/E means owner's equity.
A/R means accounts receivable.
N/R means notes receivable.
A journal will include the entries for both the balance sheet and the income statement.
A balance sheet is an overview of assets, liabilities, and equities at a point in time.
Assets are increased by numbers in the left column and decreased by numbers in the right.
Liabilities and equities are decreased by numbers in the left column and increased by numbers in the right.
Before creating a balance sheet, an income statement must be closed so that the profit and loss can be assessed.
An income statement is a summary of revenues and expenses.
Revenue is a generation of equity from selling goods or rendering services in one's line of business.
Expenses are costs incurred by a business without receiving an equivalent asset in order to generate its revenue.
Revenues are decreased by numbers in the left column and increased by numbers in the right.
Expenses are increased by numbers in the left column and decreased by numbers in the right.
To close out an income statement, a nominal account called a profit and loss account is created.
When a period is closed out, this P&L account is closed out by decreasing/increasing the income statement entries to 0 with a new entry on the opposite side and a P&L entry on the first side.
The P&L account will then be closed out and added to equity.
After calculating the income statement and P&L account, the balance sheet can then be made.
Revenue for services not yet rendered cannot be entered be entered as Revenue when it is paid. Instead, a Deferred Revenue liability account must be increased. When the service is rendered, this account is then decreased and the Revenue account is increased.
"COGS" is an abbreviation of "cost of goods sold."
Perpetual Inventory System
A perpetual inventory system just adds journal entries as soon as goods are purchased and sold.
A purchase decreases Cash and increases Inventory by the purchase price.
A sale increases Cash and Sales (Revenue) by the sale price and decreases Inventory and increases COGS by the purchase price of the goods.
Periodic Inventory System
A periodic inventory system only logs COGS entries on fixed dates.
A purchase still immediately decreases Cash and increases a Purchases account by the purchase price.
A sale increases Cash and Sales (Revenue) by the sale price.
Then, on a fixed date, the Inventory is reassessed, and the cost of goods sold during the period is calculated by adding the beginning Inventory and the Purchases and subtracting the ending Inventory. (It's the consumed inventory.)
The purchase price for COGS has various ways of determination:
Specific Identification Method
The specific identification method looks at the actual cost of purchasing/producing the exact good sold.
Cost Flow Assumption Method
There are three ways of assuming cost flows:
FIFO stands for "first in, first out." The goods purchased the longest ago are assumed to be sold first.
FIFO is more accurate for balance sheets as the assets left at the end of the month are closest to the current price of purchasing them.
LIFO stands for "last in, first out." The last goods purchased are assumed to be sold first.
LIFO most accurately reflects the costs at the time of sale and is thus most accurate for the income statement. However, this messes up balance sheets.
The third possible assumption averages the costs.
Gross Profit is equal to Sales minus COGS.
Fixed assets are assets that will be used for more than one year.
Such assets should be depreciated to better reflect their expense.
Depreciation is allocating the upfront cost of an asset over multiple years to better match its cost of the asset against when its benefit is acquired. This is basically consuming the asset through wear and tear.
Depreciation goes from the historical cost to the scrap value over the asset's expected useful life.
Delivery, installation, and improvement costs are included in an asset's historical cost amount.
Scrap value is what the asset can be sold for at the end of its useful life.
Depreciation must be accounted in contra accounts to avoid messing up the historical costs of assets on the balance sheet.
A contra account is an account that keeps track of the depreciation or bad debt expense that accumulates for an asset.
A credit to a contra account essentially decreases the value of the opposed asset while keeping the original value.
|Gain on Sale||1000|
On the balance sheet, the accumulated depreciation will be listed below the fixed assets, and the resultant book value under that.
Sum of the Years' Digits Method
SYD depreciation multiplies the cost minus the scrap value by a fraction based on the years.
Example Fractions Over Five Years
- Year 1:
- Year 2:
- Year 3:
- Year 4:
- Year 5:
Double Declining Method
The double declining method depreciates by taking the percent of the useful life the year is, doubling it, and multiplying it by the opening balance.
- Note that unlike the others, scrap value does not change this depreciation every year. It just cannot depreciate it below such value.
|Year||Historical Cost||Opening Balance||Depreciation Expense (20%)||Accumulated Depreciation||Book Value|
To match the expected bad debt of accounts receivable, a contra account for such allowance should be created.
When debts actually become bad, the contra account is closed and removed from the Accounts Receivable account.
|Uncollectible Accounts Expense||4000|
|Allowance for Doubtful Accounts||4000|
|Allowance for Doubtful Accounts||4000|
Held-to-maturity debt is debt expected to be held until the debt is paid off.
Held-to-maturity debt is reported at cost.
Trading securities and other forms of debt are measured at fair value on the balance sheet.
For equity securities of less than 20% ownership, cost or fair value methods are used.
For equity securities of between 20% and 50% ownership, equity method accounting is used.
The equity method of account reports investments at cost and then adjusts according to the the investor's proportionate share of the investee's earnings and losses.
For equity securities of greater than 50% ownership, the books are merged. All the assets and liabilities of the subsidiary are reported on the books of the parent company.
An operating lease gives the lessee the right to use some property for a period of time, but he has no ownership in or obligation for the property.
A capital lease reports leased property as an asset and the payment obligations as a liability on its balance sheet.
This is not ideal as it makes one's debt ratio bigger.
Under GAAP, a lease must be reported as a capital lease if one of the following conditions is met:
- The lessee gets ownership at the end of the lease term.
- The lessee has the right to purchase the property for a "bargain price"—one dramatically below any possible sense of the asset's market value.
- The lease covers at least 75% of the property's useful life.
- The lease payments amount to at least 90% of the fair market value of the property.
To close out a P&L account to a capital account, debit the P&L account and credit the Retained Earnings. (No longer called Owner's Equity.)
To pay out a dividend, debit the Retained Earnings account and credit the Cash Dividend Payable account. When it is actually paid, debit that and credit Cash.
Large Stock Dividend
If a corporation pays out a dividend in stock of at least 20% of the recipients', dividends are recorded according to the par value.
Small Stock Dividend
If a corporation pays out a dividend in stock of less than 20% of the recipients', dividends are recorded according to the market value (divided into the stock according to the par value and the Additional Paid-in-Capital).
Gross Profit Margin
A company's profit margin is its gross profit on sales divided by its net sales.
Gross Profit on Sales
Gross profit on sales is a company's net sales minus its cost of goods sold.
A company's profit margin is its income divided by its net sales.
Cash flows show a business's increase or decreases in cash.
Cash flows are divided into three categories based on their origins:
- Operating activities
- The normal ways you get money
- Includes the receipt of interest and dividends
- Investing activities
- Purchases and sales of securities, investments, loans to others, and the purchase and sale of fixed assets
- Financing activities
- Borrowings, issuance of stock, and repayments and dividends related to such
It can either be done by the direct method, where all journal entries are just classified when entered, or it can be done by the indirect method, where all non-cash income is taken away from net income.
To find the indirect income, take the net income and add back:
- Depreciation expenses
- Other non-cash charges
- Decreases in assets
- Increases in liabilities
and subtract out:
- Increases in assets
- Decreases in liabilities