Accountingtools Q&A

What are the stockholders' equity accounts?

2013-05-25T18:44:50Z

The stockholders' equity accounts contain those accounts that express the monetary ownership interest in a business. In effect, these accounts contain the net difference between the recorded assets and liabilities of a company. If assets are greater than liabilities, then the equity accounts contain a positive balance; if not, they contain a negative balance. The stockholders' equity accounts normally have credit balances, and so are located on the balance sheet immediately after the liability accounts, and in opposition to the asset accounts.

The stockholders' equity accounts are as follows:

Common stock. Contains the portion of the price paid by investors for a company's common stock that is attributable to the par value of the stock. If the par value amount per share is minimal (as is usually the case), the balance in this account is quite small. If the stock has no par value, then this account is not used.
Additional paid-in capital on common stock. Contains the portion of the price paid by investors for a company's common stock that is attributable to the amount of the payment exceeding the par value of the stock.
Preferred stock. Contains the portion of the price paid by investors for a company's preferred stock that is attributable to the par value of the stock.
Additional paid-in capital on preferred stock. Contains the portion of the price paid by investors for a company's preferred stock that is attributable to the amount of the payment exceeding the par value of the stock.
Retained earnings. Contains the cumulative net income earned by the company, less any dividends paid.
Treasury stock. Contains the amount paid by the company to buy back shares from investors. This is a contra account, so the balance in the account is usually a debit.

Note that the purchase and sale of stock between investors on a secondary market, such as a stock exchange, does not impact any of these accounts, since the issuing entity is not involved in these transactions.

What is the bad debt reserve?

2013-05-24T16:57:53Z

The bad debt reserve is a provision set up to record an estimated amount of bad debt that is likely to arise from existing accounts receivable. The concept of the bad debt reserve is mandated by accrual basis accounting, where all expenses associated with a sale transaction should be recorded at the same time as the revenue from the sale (known as the matching principle). Otherwise, bad debts might be recorded for months afterwards, resulting in an initial surge in profitability, followed by a long series of additional expenses that create sub-standard profits.

A bad debt reserve is a contra account, which is designed to offset the receivables account, with which it is paired. The receivables account has a natural debit balance, while the bad debt reserve has a natural credit balance. The result is a net receivable balance reported in the balance sheet. For example, a balance sheet may reveal $1,000,000 of accounts receivable, against which is offset $50,000 of bad debt reserve. The net receivable balance is therefore $950,000.

The difficulty in using a bad debt reserve is how to estimate the amount of bad debt to record. This is typically derived by carrying forward a company's historical bad debt percentage, though this amount can be adjusted for more particular knowledge of the collection probability of specific receivables. Once derived, the accounting transaction is a debit to the bad debt expense account and a credit to the bad debt reserve. When a specific receivable is declared a bad debt, the accounting transaction is a debit to the bad debt reserve and a credit to the accounts receivable account.

The bad debt reserve is designed to be an offset only to the trade receivables account. However, a similar contra account could be constructed for other receivables, such as payroll advances to employees, that reserves against possible shortfalls in these other types of receivables.

If a company elects not to use a bad debt reserve, it is instead choosing to use the direct write off method, whereby receivables are only written off when a specific receivable is declared uncollectible. As noted earlier, writing off receivables in this manner is not considered to be the best accounting, since expense recognition is delayed. Auditors may refuse to certify the financial statements of a company that uses the direct write off method, unless the business first switches to a bad debt reserve.

Similar Terms

The bad debt reserve is also known as the allowance for doubtful accounts, the bad debt provision, and the doubtful debts provision.

What is a final dividend?

2013-05-24T12:10:33Z

A final dividend refers to the dividend declared by a company's board of directors after the company has issued its full-year financial statements for its fiscal year.

The final dividend is typically larger than any interim dividends that may have been issued during the fiscal year; this is because the board of directors is not sure of the entire amount of cash that is available for distribution to shareholders until the final results are available for the full year, and so it tends to be conservative in the size of any interim dividends that are issued. The amount of the final payment is a fixed amount per share of common stock, and is typically made known to the public during the annual shareholders' meeting.

The amount of the final dividend may be forecasted by analysts, or even by company management in its own earnings guidance, in which case the actual amount of the final dividend that is eventually settled upon is sometimes considered the adjusted final dividend or the revised final dividend.

The term final dividend is used more frequently in Europe than in the United States.

The term final dividend can also refer to the final, liquidating dividend issued to shareholders when a company is terminating its existence, but this type of dividend is more commonly known as a liquidating dividend.

The concept of a final dividend is flawed for businesses that routinely issue dividends, since they likely have a dividend policy already in place that mandates a steady or slightly increasing dividend level over time. By issuing dividends in such a consistent manner, a company attracts income-oriented investors who rely upon a steady stream of dividends. In this case, continually adjusting the dividend amount over time, as is implied by the final dividend concept, makes no sense from an investor relations perspective.

Similar Terms

The final dividend is also known as the year-end dividend.

What is contributed capital?

2013-05-24T12:04:46Z

Contributed capital is more commonly known as paid in capital. It can be a separate account within the stockholders' equity section of the balance sheet, or it can be split between an additional paid in capital account and a common stock account (where the par value of the shares sold is recorded in the common stock account and any excess payments are recorded in the additional paid in capital account), which are also within the stockholders' equity section of the balance sheet.

Contributed capital is merely an element of the total amount of equity recorded by a company. It is customary for investors to concentrate their attention on the net amount of total equity, rather than this single element of equity. Thus, the recordation of contributed capital is designed to fulfill a legal or accounting requirement, rather than providing additional useful information.

When an investor pays a company for shares of its stock, the typical journal entry is for the company to debit the cash account for the amount of cash received and to credit the contributed capital account. There are other possible transactions involving increases in contributed capital, of which the following are the most common:

Receive cash for stock. Debit the cash account and credit the contributed capital account.
Receive fixed assets for stock. Debit the relevant fixed asset account and credit the contributed capital account.
Reduce a liability for stock. Debit the relevant liability account and credit the contributed capital account.

The term contributed capital only refers to shares that investors have bought directly from the company, either from an initial public offering or a secondary issuance of stock; there is no accounting entry for shares that are exchanged between investors on the open market, since the company receives no cash from these transactions.

What are appropriated retained earnings?

2013-05-24T12:01:06Z

Appropriated retained earnings are retained earnings that have been set aside by action of the board of directors for a specific use. An appropriation of retained earnings may be for such purposes as:

Acquisitions
Debt reduction
Marketing campaign
New construction
New product development
Research and development
Reserve against expected insurance losses
Restriction imposed by a loan covenant
Stock buyback

To appropriate retained earnings, the entry is to debit the retained earnings account and credit the appropriated retained earnings account. There may be several appropriated retained earnings accounts, if retained earnings are being reserved for multiple purposes at the same time.

The board of directors can eliminate the appropriation designation at any time. For example, once a scheduled debt reduction has been completed, the appropriation is cancelled and the segregated retained earnings are returned to the main retained earnings account.

For example, the board of directors of ABC International wants to set aside $10 million for the construction of a new distribution facility, which it does by voting to appropriate $10 million of retained earnings for this purpose. The $10 million is segregated in a separate appropriated retained earnings account until the construction has been completed, after which the amount in the account is returned to the main retained earnings account.

The intent of retained earnings appropriation is to not make these funds available for payment to shareholders. However, if a company were to liquidate or enter bankruptcy proceedings, the appropriation status of retained earnings would be irrelevant - the retained earnings would be available for payout to creditors and investors.

Any retained earnings appropriation should be clearly stated either within the body of the balance sheet or in the accompanying disclosures.

There is generally no need to appropriate retained earnings, unless management or the board of directors is trying to communicate to investors that it wants to set aside funds for purposes other than to issue them as dividends to investors. Thus, appropriation is typically used to communicate intentions to outside parties, rather than for any internal management need.

What is a responsibility center?

2013-05-22T16:16:50Z

A responsibility center is a functional entity within a business that has its own goals and objectives, dedicated staff, policies and procedures, and financial reports. There may be many responsibility centers in a business, but never less than one such center. Thus, a responsibility center is usually a subset of a business.

A responsibility center is used to tie specific responsibility for revenues generated, expenses incurred, and/or funds invested to individuals. This allows the senior managers of a company to trace all financial activities and results of a business back to specific employees. Doing so preserves accountability, and may also be used to calculate bonus payments for employees.

A responsibility center may be one of four types, which are:

Revenue center. This group is solely responsible for generating sales. A typical revenue center is the sales department.
Cost center. This group is solely responsible for the incurrence of certain costs. A typical cost center is the janitorial department.
Profit center. This group is responsible for both revenues and expenses, which result in profits and losses. A typical profit center is a product line, for which a product manager is responsible.
Investment center. This group is responsible not only for profits, but also for the return on funds invested in the group's operations. A typical investment center is a subsidiary entity, for which the subsidiary's president is responsible.

From an accounting perspective, a financial report should be issued to each responsibility center that itemizes the revenues, expenses, profits, and/or return on investment for which the manager of each center is solely responsible. This can result in quite a large number of customized reports being issued on an ongoing basis.

The use of multiple responsibility centers requires a certain amount of corporate infrastructure to develop each center, track its results, and manage expectations with the various managers.

What is cost accounting?

2013-05-22T16:06:08Z

Cost accounting is the process of collecting information about the costs incurred by a company's activities, assigning selected costs to products and services and other cost objects, and evaluating the efficiency of cost usage. It is mostly concerned with developing an understanding of where a company earns and loses money, and providing input into decisions to generate profits in the future.

Key activities include:

Defining costs as direct materials, direct labor, fixed overhead, variable overhead, and period costs
Assisting the engineering and procurement departments in generating standard costs, if a company uses a standard costing system
Using an allocation methodology to assign all costs except period costs to products and services and other cost objects
Defining the transfer prices at which components and parts are sold from one subsidiary of a parent company to another subsidiary
Examining costs incurred in relation to activities conducted, to see if the company is using its resources effectively
Highlighting any changes in the trend of various costs incurred
Analyzing costs that will change as the result of a business decision
Evaluating the need for capital expenditures
Building a budget model that forecasts changes in costs based on expected activity levels
Determining whether costs can be reduced
Providing cost reports to management, so they can better operate the business
Participating in the calculation of costs that will be required to manufacture a new product design
Analyzing the system of production to understand where bottlenecks are positioned, and how they impact the throughput generated by the entire manufacturing system.

There are a multitude of tools that the cost accountant uses to accumulate and interpret costs, including job costing, process costing, standard costing, activity-based costing, throughput analysis, and direct costing.

Cost accounting is a source of information for the financial statements, especially in regard to the valuation of inventory, but is not directly involved in the generation of financial statements.

Related Questions

What is the difference between cost accounting and financial accounting?

What is variance analysis?

2013-05-21T15:37:47Z

Variance analysis is the quantitative investigation of the difference between actual and planned behavior. For example, if you budget for sales to be $10,000 and actual sales are $8,000, variance analysis yields a difference of $2,000.

Variance analysis is especially effective when you review the amount of the variance on a trend line, so that sudden changes in the variance level from month to month are more readily apparent.

Variance analysis also involves the investigation of these differences, so that the outcome is a statement of the difference from expectations, and an interpretation of why the variance occurred. To continue with the example, a complete analysis of the sales variance would be:

"Sales during the month were $2,000 lower than the budget of $10,000. This variance was primarily caused by the loss of ABC customer at the end of the preceding month, which usually buys $1,800 per month from the company. We lost ABC customer because we had several instances of late deliveries to it over the past few months."

This level of detailed variance analysis allows management to understand why fluctuations occur in its business, and what it can do to change the situation.

Here are the most commonly-derived variances used in variance analysis (they are linked to more complete descriptions, as well as examples):

Purchase price variance. The actual price paid for materials used in the production process, minus the standard cost, multiplied by the number of units used.
Labor rate variance. The actual price paid for the direct labor used in the production process, minus its standard cost, multiplied by the number of units used.
Variable overhead spending variance. Subtract the standard variable overhead cost per unit from the actual cost incurred and multiply the remainder by the total unit quantity of output.
Fixed overhead spending variance. The total amount by which fixed overhead costs exceed their total standard cost for the reporting period.
Selling price variance. The actual selling price, minus the standard selling price, multiplied by the number of units sold.
Material yield variance. Subtract the total standard quantity of materials that are supposed to be used from the actual level of use and multiply the remainder by the standard price per unit.
Labor efficiency variance. Subtract the standard quantity of labor consumed from the actual amount and multiply the remainder by the standard labor rate per hour.
Variable overhead efficiency variance. Subtract the budgeted units of activity on which the variable overhead is charged from the actual units of activity, multiplied by the standard variable overhead cost per unit.

It is not necessary to track all of the preceding variances. In many organizations, it may be sufficient to review just one or two variances. For example, a services organization (such as a consulting business) might be solely concerned with the labor efficiency variance, while a manufacturing business in a highly competitive market might be mostly concerned with the purchase price variance. In other words, put most of the variance analysis effort into those variances that make the most difference to the company if the underlying issues can be rectified.

There are several problems with variance analysis that keep many companies from using it. They are:

Time delay. The accounting staff compiles the variances at the end of the month before issuing the results to the management team. In a fast-paced environment, management needs feedback much faster than once a month, and so tends to rely upon other measurements or warning flags that are generated on the spot (especially in the production area).
Variance source information. Many of the reasons for variances are not located in the accounting records, so the accounting staff has to sort through such information as bills of material, labor routings, and overtime records to determine the causes of problems. The extra work is only cost-effective when management can actively correct problems based on this information.
Standard setting. Variance analysis is essentially a comparison of actual results to an arbitrary standard that may have been derived from political bargaining. Consequently, the resulting variance may not yield any useful information.

Many companies prefer to use horizontal analysis, rather than variance analysis, to investigate and interpret their financial results.

Podcasts

Variance analysis is discussed further in Episode 111 of the Accounting Best Practices podcast. Click here to listen.

Related Questions

What is standard costing?
When should I update standard costs?

What is a step variable cost?

2013-05-21T15:30:42Z

A step variable cost is a cost that generally varies with the level of activity, but which tends to be incurred at certain discrete points and to involve large changes in amounts when a discrete point is reached. Conversely, a truly variable cost will vary continually and directly in concert with the level of activity.

An example of a step variable cost is the compensation of a quality assurance (QA) worker in the assembly area of a production department. Each QA worker is capable of reviewing a certain number of parts per day. Once the production process exceeds that volume level, another quality assurance worker must be hired. Thus, the cost of the QA person generally varies with the level of activity, but only changes at discrete points - when the existing QA staff can no longer handle the work load, forcing another person to be hired.

The example shows a common characteristic of a step variable cost, which is that there tends to be a relatively wide activity range within which the existing cost can be incurred without incurring any additional cost, and after which a large additional cost must be incurred. To return to the example, this means that the QA person could be more efficient or work somewhat longer hours in order to avoid incurring the large incremental cost of an additional person.

Because a step variable cost can remain approximately the same while activity levels change, this step effect can impact the allocated cost per manufactured unit. The allocated amount per unit decreases as the number of units produced increases, until such time as the higher volume level triggers the incurrence of a new step variable cost, after which the cost per unit increases due to the higher total variable cost.

What is a semi-variable cost?

2013-05-21T15:25:38Z

A semi-variable cost is a cost that contains both fixed and variable cost elements. Thus, the fixed element of the cost will be incurred repeatedly over time, while the variable element will only be incurred as a function of volume. Thus, a base-level cost will be always be incurred, irrespective of volume, as well as an additional cost that is based only on volume. Here are several examples of a semi-variable cost:

A production line may require $10,000 of labor to staff it at a minimal level per day, but once a certain production volume is exceeded, the production staff must work overtime. Thus, the basic $10,000 daily cost will be incurred at all volume levels, and is therefore the fixed element of the semi-variable cost, while overtime varies with production volume, and is therefore the variable element of the cost.
In the billing structure for a cell phone, there is a flat-rate monthly charge, plus an overage charge for any bandwidth used that exceeds the cap allowed under the flat rate. Thus, the flat rate is the fixed element of the cost, and the excess bandwidth charge is the variable element of the cost.
Within the compensation of a salesperson, there is usually a salaried component (fixed cost) and commission (variable cost).

As the level of usage of a semi-variable cost item increases, the fixed component of the cost will not change, while the variable component will increase. The formula for this relationship is:

Y = a + bx

Y = Total cost
a = Total fixed cost
b = Variable cost per unit of activity
x = Number of units of activity

For example, if a company owns a production line, the total cost of that equipment in a month is a mixed cost. The depreciation associated with the asset is a fixed cost, since it does not vary from period to period, while the utilities expense will vary depending upon the amount of time during which the production line is operational. The fixed cost of the production line is $10,000 per month, while the variable cost of utilities is $150 per hour. If the production line runs for 160 hours per month, then the mixed cost calculation is:

$34,000 Total cost = $10,000 fixed cost + ($150/hour x 160 hours)

From the perspective of a company manager, it is generally safer to increase the variable portion of a semi-variable cost and decrease the fixed portion. Doing so lowers the revenue level at which a business can break even, which is useful if the business suffers from highly variable sales levels.

Similar Terms

A semi-variable cost is also known as a mixed cost and a semi-fixed cost.