Kate Mooney

Cheat Sheet / Updated 02-28-2022

Accounting, as you may guess, involves a lot of math. As you practice various types of accounting problems, and when you begin doing accounting work for real, you will need to utilize various formulas to calculate the information you need.

Article / Updated 03-26-2016

After you create financial statements, you need some tools to analyze a company’s results. Following are the most frequently used formulas to analyze financial statements. Get familiar with them so that you can analyze statements with confidence. Components of work-in-process Direct materials + direct labor + factory overhead applied Work-in-process (WIP) represents cost incurred in production for partially completed goods. WIP is a subaccount within inventory. When goods are completed, they are moved to finished goods (another inventory account). Current ratio Current assets ÷ current liabilities The current ratio illustrates how easily a company can cover its current bills. Quick ratio (Current assets less inventory) ÷ current liabilities The quick ratio excludes inventory from current assets. The rationale is that inventory is the current asset that will take the longest time to convert into cash. Other current assets, such as collecting accounts receivable, may be converted into cash more quickly. Asset turnover ratio Revenue (or sales) ÷ assets This ratio explains how much profit a company generates for every dollar of assets. Return on equity Net income ÷ equity This ratio explains how much profit a company generates for every dollar of equity. Debt to equity ratio Debt ÷ equity This ratio measures what percentage of a firm’s total capitalization is debt. Capitalization refers to all funds raised by the company to operate the business. Contribution margin Sales less variable costs Contribution margin represents the amount that will be used to cover fixed costs. Any dollars remaining after paying fixed costs is considered profit. Return on capital Operating profit ÷ capital Capital is similar to equity. It represents funds raised to operate a business. Operating profit refers to profit generated from normal business activity. Break-even formula Sales – variable costs – fixed costs = $0 profit The break-even formula calculates the level of sales that will generate a profit of $0. Formula to assign overhead costs Total overhead costs incurred ÷ activity level Overhead costs, such as a factory’s utility costs, can’t be directly traced to a product. Instead, overhead costs are allocated based on an activity level. The activity level chosen should impact the amount of overhead costs incurred. For example, the number of machine hours used drives machinery repair costs. Machine hours should be the activity level for machine repair costs.

Article / Updated 03-26-2016

The following are some of the most frequently used accounting formulas. This list is not comprehensive, but it should cover the items you’ll use most often as you practice solving various accounting problems. Balance sheet formula Assets – liabilities = equity (or assets = liabilities + equity) This basic formula must stay in balance to generate an accurate balance sheet. This means that all accounting transactions must keep the formula in balance. If not, the accountant has made an error. Retained earnings formula Beginning balance + net income – net losses – dividends = ending balance Income statement formula Revenue (sales) – expenses = profit (or net income) Keep in mind that revenue and sales may be used interchangeably. Profit and net income may also be used interchangeably. The income statement is also referred to as a profit and loss statement. Gross margin Sales – cost of sales Gross margin is not a company’s net income or profit. Other expenses, such as selling, general, and administrative (SG and A) expenses, are subtracted to arrive at net income. Operating income (earnings) Gross profit – selling, general, and administrative (SG and A) expenses Statement of cash flows formula Beginning cash balance + cash flow sources (uses) from operations + cash flow sources (uses) from financing + cash flow sources (uses) from investing = ending cash balance This formula adds cash sources and subtracts cash uses. Inventory formula Beginning inventory + purchases – cost of sales = ending inventory (or beginning inventory + purchases – ending inventory = cost of sales) Net sales formula Gross sales – sales discounts – sales returns and allowances Book value of fixed (depreciable) assets Original cost – accumulated depreciation Straight line depreciation (Original cost – salvage value) / number of years in useful life Salvage value is the dollar amount that the owner can receive for selling the asset at the end of its useful life.

Article / Updated 03-26-2016

After you create financial statements, you need some tools to analyze the company’s results. Following are some additional formulas accountants use to analyze financial statements. Become familiar with these formulas, and use them as you practice various accounting problems. Burden rate Fixed manufacturing costs ÷ units produced Fixed costs can’t be directly traced to a unit produced. For example, a $50,000 monthly factory lease must be paid, regardless of the number of units produced in a given month. To assign fixed cost to each unit of product, companies used the burden rate. Cost of idle capacity Percentage of available capacity unused × fixed manufacturing overhead costs Idle capacity refers to unused capacity. Assume you could produce 20% more baseball gloves this month, using your existing factory costs (materials, labor, and overhead). Say that the factory pays a foreman $50,000 in salary and benefits to supervise production. The cost of idle capacity is 20% multiplied by $50,000, or $10,000. The firm is paying an extra $10,000 for production capacity it’s not using. Calculating loan interest Interest rate for period × principal amount of loan Interest can be compounded (computed) annually, monthly, or even daily. Pay attention to the stated annual interest rate on the loan and how often interest is compounded. If a 12% loan is compounded monthly, the monthly interest rate is 12% ÷ 12 months, or 1%. Effective interest rate Interest paid ÷ principal amount owed Because of the effects of compounding, the actual interest paid on a loan may be different from the stated interest rate on the note multiplied by the principal. Present value and future value factors Present value factor less than 1; future value factor more than 1 A present value factor discounts a cash flow to its present value. To calculate the present value, you multiply the factor times the cash flow amount. A present value factor will be less than 1. The future value of a cash flow adjusts the cash flow to its future value, given an interest rate. A future value factor will always be more than 1. Return on investment (ROI) Profit (net income) from investment ÷ cost of investment A more complex version of the formula is operating income divided by operating assets. Operating assets represent an investment in a project or business. The purpose of this formula is to determine the profitability of a given project. Return on investment (DuPont model) Profit margin × asset turnover This is a more complex formula that’s used for ROI. Profit margin is operating profit divided by sales. Asset turnover is calculated as sales divided by average assets. Average assets refers to assets at beginning of period + assets balance at end of period ÷ 2. Return of investment to shareholders Retained earnings balance – payments to shareholders A dividend is a payment of retained earnings to shareholders (investors). If a company makes payments to shareholders that are greater than the balance of retained earnings, those payments are a return of the investors’ original investment. Rule of 72 72 ÷ rate of return on investment The rule of 72 states how many years it will take for a sum of money to double, given a rate of return that is compounded each year. If, for example, the rate of return is 8%, a sum of money will double in 72÷8, or 9 years. Weighted average cost of capital (WACC) Annual cost to obtain financing ÷ capital balance Companies can raise funds by issuing debt or equity. Outstanding debt requires annual interest payments. Shareholders who purchase equity may also insist on required annual dividend payments. Interest payments on debt and dividend payments to shareholders are both considered financing costs. The annual cost of financing divided by the funds raised to operate the business (capital) is WACC.

Article / Updated 03-26-2016

An accountant uses depreciation is to allocate the cost of a fixed asset over the years of its useful life. The straight-line depreciation method is the most popular type because it allocates the same amount of depreciation to each year the asset is in use. The following practice questions show the straight-line depreciation method in action. Practice questions A company purchases a machine for its manufacturing facility for $90,000 in January and as of December has recorded only 11 months of depreciation. The machinery is estimated to have a useful life of 5 years. What is the proper entry to record the year-end adjustment for depreciation, assuming the straight-line method is used? A company purchased a truck for $25,000 on January 1 and as of December has not recorded any depreciation. The truck is estimated to have a useful life of 5 years, and straight-line depreciation is used. What is the proper entry to record the year-end adjustment for depreciation? Answers and explanations Debit depreciation expense–machinery $1,500 and credit accumulated depreciation–machinery $1,500 Annual depreciation is calculated as the cost of an asset divided by its useful life. In this case, the machinery was purchased for $90,000 and has a useful life of 5 years. Thus, the annual amount of depreciation should be $90,000 (purchase price of the machine) divided by 5 years, or $18,000 per year. In this example, the company already recorded 11 months of depreciation and needs to record only one more month. So, you need to find the monthly depreciation, which you calculate by dividing the annual depreciation of $18,000 by 12 months, or $1,500 per month. The adjusting entry should be recorded as a debit to depreciation expense and a credit to accumulated depreciation for $1,500, or one month's worth of depreciation. Debit depreciation expenses–equipment $5,000 and credit accumulated depreciation–equipment $5,000 Annual depreciation is calculated as the cost of an asset divided by its useful life. In this case, the truck was purchased for $25,000 and has a useful life of 5 years. Thus, the amount of depreciation should be $25,000 (purchase price of the truck) divided by 5 years, or $5,000 per year. The annual entry to record the depreciation should be a debit to depreciation expense and a credit to accumulated depreciation. If you need more practice on this and other topics from your accounting course, visit Dummies.com to purchase Accounting For Dummies! Featuring the latest information on accounting methods and standards, the information in Accounting For Dummies is valuable for anyone studying or working in the fields of accounting or finance.

Article / Updated 03-26-2016

Manufacturing costs are directly associated with production; they include direct materials, direct labor, variable overhead, and fixed overhead. A manufacturer will use this information to determine the cost of their product. In the following practice questions, you are asked to weed out the non-manufacturing costs and then calculate the total manufacturing costs for two different companies. Practice questions Red Cow Sleeping Drinks has the following costs: Direct materials: $3,507,000 Direct labor: $1,200,000 Variable overhead: $700,000 Fixed overhead: $250,000 Selling expenses: $890,000 General expenses: $400,500 Administrative expenses: $500,000 Calculate the total manufacturing costs. Herb's Herbs packages high-quality dried herbs for home use. The following costs are taken from Herb's accounting records: Fresh herbs: $137,000 Depreciation on the drying machine: $8,100 Glass jars for packaging the herbs: $5,000 Electricity to run the drying machines: $15,000 Gasoline for delivery trucks: $24,000 Internet advertising: $3,000 Depreciation on the computer used to do the accounting for the company: $1,000 Calculate the total manufacturing costs. Answers and explanations $5,657,000 The manufacturing costs are the costs directly associated with production: direct materials, direct labor, variable overhead, and fixed overhead. $165,100 The manufacturing costs are the costs directly associated with production—in this case, direct materials, variable overhead, and fixed overhead. The herbs and the glass jars are direct materials. The electricity to run the drying machines is a variable overhead cost. Depreciation on the drying machine is a fixed overhead cost. If you need more practice on this and other topics from your accounting course, visit Dummies.com to purchase Accounting For Dummies! Featuring the latest information on accounting methods and standards, the information in Accounting For Dummies is valuable for anyone studying or working in the fields of accounting or finance.

Article / Updated 03-26-2016

You need to be careful when using the accounting equation because there are two versions of the formula. One is assets – liabilities = equity. The other is assets = liabilities + equity. Keep in mind which version you’re using. Here are a couple of practice questions to help you get familiar with this formula. Practice questions At the end of an accounting period, a company’s total assets equaled $576,000, and liabilities equaled $245,000. How much was the company’s owners’ equity? The owners of a start�?up invest $1,000,000 into the business. After one year of operations, the business has assets of $850,000 and losses of $300,000. What are the total liabilities at the end of the first year? Answers and explanations $331,000 The basic accounting equation is assets = liabilities + owners’ equity. You can always double-check your answer by going back to the original equation assets = liabilities + owners’ equity. In this example, the sum of liabilities of $245,000 and owners’ equity of $331,000 is $576,000. This corresponds to the given amount of total assets, so you know your answer is right. $150,000 You need to go back to the basic accounting equation: assets = liabilities + owners’ equity. Step one is to determine total owners’ equity, which has two parts — the investment by owners and the losses that the business experienced during the first year of operations. Investment by owners is $1,000,000. So, the total owners’ equity is $700,000: Now you can use the basic accounting equation to calculate total liabilities at the end of the year: If you need more practice on this and other topics from your accounting course, visit Dummies.com to purchase Accounting For Dummies! Featuring the latest information on accounting methods and standards, the information in Accounting For Dummies is valuable for anyone studying or working in the fields of accounting or finance.

Article / Updated 03-26-2016

When customers buy products on credit or on account, the transaction is recorded in accounts receivable. In the following practice questions, you are asked to record purchases made on account, both with and without a down payment. Practice questions A company makes a $25,000 sale on account. The company expects that $10,000 will be collected within a week and the balance within a month. What is the proper entry to record the transaction at the time of sale? A company makes a $30,000 sale on account but with a 10% cash down payment. What is the proper entry to record this transaction? Answers and explanations Debit accounts receivable $25,000 and credit sales revenues $25,000 Both accounts receivable and sales revenues increase $25,000 as a result of the sale. The expected collection pattern doesn't impact how the original sale is recorded. Therefore, both accounts receivable and sales revenues need to be increased by a debit to accounts receivable and a credit to sales revenues. Debit cash $3,000, debit accounts receivable $27,000, and credit sales revenue $30,000 The company makes a sale of $30,000 and receives a down payment of 10%. First, you need to calculate the amount of the down payment by taking the total sale of $30,000 and multiplying by the percentage of down payment, or 10%. Based on that, the down payment amount is $3,000. This is the amount of cash the company receives, so it should be recorded as a debit to cash for $3,000. Next, you need to determine the outstanding balance. You calculate the balance due as the total sale amount of $30,000 less the amount of the down payment of $3,000, to give $27,000. The outstanding balance of $27,000 represents accounts receivable and should be recorded as a debit to accounts receivable. Now you have a debit to cash of $3,000 and a debit to accounts receivable of $27,000. To make the entry balance you need a credit of $30,000, and it should be recorded to sales revenue to record the revenue earned on the transaction. If you need more practice on this and other topics from your accounting course, visit Dummies.com to purchase Accounting For Dummies! Featuring the latest information on accounting methods and standards, the information in Accounting For Dummies is valuable for anyone studying or working in the fields of accounting or finance.

Article / Updated 03-26-2016

Cash-basis accounting posts income and expenses solely based on cash inflows and cash outflows—in other words, when cash exchanges hands. Accrual-basis accounting records revenues when earned and expenses when they occur, and not when cash exchanges hands. Here are two practice questions to show the difference. Practice questions Use the following information to answer the questions: Al LaMode Ice Cream Company produces high-quality ice cream that is distributed to shops in resort areas. On July 1, the company purchased the raw materials to make the ice cream. On July 15, the process was complete, and the product was stored in the freezer ready to ship to customers. On July 31, Ken and Mary’s Ice Cream Shop ordered 200 pounds of ice cream. On August 1, Al LaMode delivered the ice cream to Ken and Mary’s Ice Cream Shop. Ken and Mary paid Al LaMode on August 10. Ken and Mary sold all the ice cream between August 5 and August 12. If it uses accrual‐basis accounting, when will Al LaMode record the revenue from the sale to Ken and Mary? If it uses cash‐basis accounting, when will Al LaMode record the revenue from the sale to Ken and Mary? Answers and explanations August 1 Under accrual-basis accounting, revenues are recorded when the goods or services are delivered to the customer, regardless of whether the customer has paid for them. This distinguishes accrual-basis accounting from cash-basis accounting, where the revenues are not recorded until the customer pays for the goods or services. Although the company received an order for the ice cream on July 31, delivery didn’t happen until August 1. August 10 Cash-basis accounting records revenue when the cash is received from the customer. If you need more practice on this and other topics from your accounting course, visit Dummies.com to purchase Accounting For Dummies! Featuring the latest information on accounting methods and standards, the information in Accounting For Dummies is valuable for anyone studying or working in the fields of accounting or finance.

Article / Updated 03-26-2016

You can determine how much cash is generated from a company's operating activities based on its net income, depreciation expense, and accounts receivable and payable. The following questions ask you to calculate cash from operating expenses in two different scenarios. Practice questions During a year, a company reports a net income of $155,000, a depreciation expense of $35,000, an accounts receivable increase of $25,000, and an accounts payable increase of $10,000. How much was cash provided by operating activities (assuming no other changes occurred in current operating accounts)? During a year, a company reports a net income of $80,000, a depreciation expense of $5,000, an amortization expense of $2,000, and an accounts receivable decrease of $3,000. In addition, the company sold bonds for $400,000 cash. How much was cash provided by operating activities (assuming no other changes occurred in current operating accounts)? Answers and explanations $175,000 Depreciation expenses must be added back to net income to determine cash from operating activities. Also, the increase in accounts receivable must be deducted, and the increase in accounts payable must be added to net income to determine cash from operating activities. Therefore, net income of $155,000 plus the depreciation expense of $35,000 less the increase in accounts receivable of $25,000 plus the increase in accounts payable of $10,000 equals cash provided by operating activities of $175,000. $90,000 Both the depreciation expense and amortization expense must be added back to net income to determine cash from operating activities. Also, the decrease in accounts receivable must be added to net income to determine cash from operating activities. Therefore, net income of $80,000 plus depreciation expense of $5,000 plus amortization expense of $2,000 plus accounts receivable decrease of $3,000 equals cash provided by operating activities of $90,000. The proceeds from the sale of bonds are in the financing section and aren't operating activities. If you need more practice on this and other topics from your accounting course, visit Dummies.com to purchase Accounting For Dummies! Featuring the latest information on accounting methods and standards, the information in Accounting For Dummies is valuable for anyone studying or working in the fields of accounting or finance.