Description
ppt is to distinguish accrual-basis accounting from cash-basis accounting, apply the revenue and matching principles, make adjusting entries at the end of the accounting period, prepare an adjusted trial balance, prepare the financial statements from the adjusted trial balance
Measuring Business Income: The Adjusting Process
Disappointed by blind dates and personal ads, – Andrea McGinty founded a prescreened lunch dating service.
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It’s Just Lunch
In 1996, the business earned revenues of $4.5 million. ? Also, the business earned a net income of $400,000. ? How was this number computed? ? Expenses were deducted from revenues to determine net income.
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It’s Just Lunch
1 Distinguish
accrual-basis accounting from cash-basis accounting. 2 Apply the revenue and matching principles.
Chapter Objectives
3 Make
adjusting entries at the end of the accounting period. 4 Prepare an adjusted trial balance. 5 Prepare the financial statements from the adjusted trial balance.
Chapter Objectives
Distinguish accrualbasis accounting from cash-basis accounting.
Objective 1
1 Accrual-basis
2 Cash-basis
The Two Bases of Accounting:
Accountants record transactions... – when revenues are earned, – or when expenses are incurred, – regardless of when cash changes hands.
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Accrual Basis
Accountants record transactions... – when cash is paid, – or when cash is received, – regardless of when a revenue is earned or an expense is incurred.
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Cash Basis
Generally Accepted Accounting Principles ? GAAP requires that a business use the accrual basis.
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Remember GAAP?
Accountants record revenues as they are earned... – and expenses as they are incurred, – not necessarily when cash is received or paid.
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GAAP
Using accrual accounting, Its’ Just Lunch records revenue when it sells dating services, not when it collects cash later. ? Likewise, It’s Just Lunch records expenses when incurred.
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Accrual Accounting
Salary expense not only includes amounts paid to employees, – it includes any amount owed to employees.
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Example
Services performed during the month of July - $15,000. ? Cash collected from customers - $6,000. ? Expenses for the month - $12,000. ? Cash paid out - $9,000.
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Dennis’ Landscaping
Revenues are the cash collected from customers - $6,000. ? Expenses are the cash paid out during the month - $9,000.
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Cash Basis
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Dennis’ Landscaping lost $3,000 during the month of July.
Cash Basis
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Cash Basis
Revenue: $15,000 Cash In: $6,000 Expenses: $12,000 Cash Out: $9,000 Dennis’ Landscaping Income Statement For the Month Ended July 31, 19xx Revenues $6,000 Expenses 9,000 Net Loss $3,000
Revenues of $15,000 are recognized for the services performed during the month. ? Expenses are the $12,000 incurred during the month.
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Accrual Basis
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Dennis’ Landscaping made a profit of $3,000.
Accrual Basis
Landscaping Income Statement For the Month Ended July 31, 19xx Revenues $6,000 Expenses 9,000 Net Loss Cash $3,000
? Dennis’
Landscaping Income Statement For the Month Ended July 31, 19xx Revenues $15,000 Expenses 12,000 Net Accrual Income $ 3,000
? Dennis’
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Because accrual accounting provides a more complete portrayal of operating performance and financial position.
Why Does GAAP Require the Accrual Basis?
Over or understatement of... – Revenue – Expense – Accounts receivable – Accounts payable
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Problems with Cash Basis
– requires
that accounting information be reported at regular intervals. – requires that income be measured accurately each period.
The Time Period Concept...
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Managers adopt an artificial period of time to evaluate performance.
Accounting Period
–a
calendar year (January 1st to December 31st), or – a fiscal year (any consecutive 12-month period).
The Annual Accounting Period Can Be...
– are
prepared for less than one year. ? Monthly ? Quarterly ? Semi-annually
Interim Period Statements...
Apply the revenue and matching principles.
Objective 2
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? ? ? ?
Revenue is recognized when it is deemed earned. Recognition of revenue and cash receipts do not necessarily occur at the same time. Cash could be received at the same time. Cash could be received after the earning. Cash could be received before the earning.
Revenue Principle
– is
the basis for recording expenses. ? Expenses are the costs of assets and the increase in liabilities incurred in the earning of revenues.
The Matching Principle...
Expenses are recognized when the benefit from the expense is received. ? Recognition of expenses and cash payments do not necessarily occur at the same time.
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Expense Recognition
– allows
businesses to report accounting information on a regular basis. – interacts with the revenue principle and the matching principle to underlie the use of accruals.
The Time Period Concept...
? In
order to measure income accurately, businesses update the revenue and expense accounts before the end of the period.
The Time Period Concept
Make adjusting entries at the end of the accounting period.
Objective 3
At the end of the period accountants prepare financial statements. ? This end-of-period process starts with the unadjusted trial balance.
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Adjusting Entries
– are
made to bring accounts to correct balances before preparing financial statements.
Adjusting Entries...
– assign
revenue to period earned. – assign expenses to the period incurred. – bring related asset and liability accounts into correct balance.
Adjusting Entries...
1 Prepaids
2 Accruals
Two Types Of Adjusting Entries
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A prepaid, or deferral, is the postponement of the recognition of an expense already paid or incurred or a revenue already received.
Prepaids
These are goods or services paid for in advance that do not expire during the current accounting period. ? They include miscellaneous assets that will expire or will be used up in the near future.
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Prepaid Expenses
Examples: – Prepaid rent – Prepaid insurance – Supplies – Buildings – Equipment
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Prepaid Expenses
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On January 2, 19x1, Dennis’ Landscaping paid $1,200 for a one year insurance policy. Prepaid Insurance Cash 1,200 1,200
Prepaid Expenses
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Jan. 2, 19x1 Prepaid Insurance Cash Paid insurance
1,200
1,200
Prepaid Expenses
This insurance expense must be matched to the months to which it applies. ? What is the journal entry on January 31, 19x1?
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Prepaid Expenses
On January 31, 19x1, one month of the 12-month insurance policy has expired. ? $1,200/12 = $100 ? Jan. 31, 19x1 Insurance expense 100 Prepaid insurance 100 One month’s insurance premium
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Prepaid Expenses
What was the determining factor in matching this expense? ? Time
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???????
Wordcrafters started business the beginning of the month. ? $500 worth of office supplies were purchased on March 15, 19x1, for cash.
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Supplies
Office Supplies 500
Cash 500
Office Supplies 500 Cash or Accounts Payable 500 Supplies Purchased office supplies
An inventory at month end indicated that $120 in office supplies remained. ? Therefore, $380 worth of supplies was used during the month ($500 - $120).
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Supplies
The cost of supplies must be matched to the period in which they were used. ? What is the journal entry on March 31, 19x1?
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Supplies
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Mar. 31, 19x1 Office Supplies Expense Office Supplies
380
380
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One month’s usage of supplies Supplies Expense Supplies 380 500 380 Bal. 120
Supplies
What was the determining factor in matching this expense? ? Usage
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Plant assets are large prepaid expenses.
Depreciation of Plant Assets
– is
a cost allocation of a long-lived asset. ? Depreciation expense is the cost converted from an asset to an expense. ? Estimates are used.
Depreciation...
On January 2nd, the business purchased a truck for $30,000 cash. ? The truck is expected to last for 3 years.
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Dennis’ Landscaping
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January 2, 19x1 Machinery 30,000 Cash 30,000 Purchase of truck
Journalizing
The cost of the truck must be matched with the accounting periods in which it was used to earn income. ? What would the journal entry be for the year ended December 31, 19x1?
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Matching Principle
Cost: $30,000 ? Service life: 3 Years ? Cost/Estimated useful life ? $30,000/3 = $10,000 per year
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Straight Line Method
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Dec. 31, 19x1 Depreciation Expense 10,000 Accumulated Depreciation 10,000 To record depreciation expense for a oneyear period
Depreciation Expense
A contra account is one that is paired with and deducted from another related account in the financial statements. ? Normal balance is opposite its companion account. ? Accumulated depreciation is a contra account to plant assets.
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Contra Accounts
– is
the cost of an asset that has not been depreciated.
Book Value...
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Partial Balance Sheet December 31, 19x1
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Plant Assets Machinery $30,000 Less Accumulated Depreciation $20,000
10,000
Dennis’ Landscaping
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Contra account
Book value
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Partial Balance Sheet December 31, 19x2
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Plant Assets Machinery $30,000 Less Accumulated Depreciation Contra account Book value
20,000 $10,000
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Dennis’ Landscaping
An accrual is the recognition of an expense or revenue that has risen but has not yet been recorded. ? Expenses or revenues are recorded before the cash settlement.
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Accruals
– are
expenses that have been incurred but not yet paid.
Accrued Expenses...
Employees of Mary Business Services are paid every Friday. ? Weekly salaries total $30,000.
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Accrued Expenses
Mary’s is closed on Saturday and Sunday. ? The employees were last paid on April 26th, which was a Friday.
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Accrued Expenses
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? ? ?
The employees will be paid on May 3rd. What is the adjusting entry on April 30th? They worked April 29th and 30th. $30,000/5 = $6,000 per day $6,000 x 2 days = $12,000
Accrued Expenses
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Apr. 30, 19x1 Salaries Expense 12,000 Salaries Payable To accrue two days salaries
12,000
Accrued Expenses
These are revenues that have been earned but not yet received. ? They are an asset.
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Accrued Revenues
During the month of August, Dennis’ Landscaping rendered services to customers totaling $15,000. ? At the end of August, the customers have not as yet been billed.
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Accrued Revenues
What is the August 31st adjusting entry? ? August 31, 19x1 Accounts Receivable 15,000 Service Revenue 15,000 To record unpaid invoices
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Accrued Revenues
What is the determining factor in recognizing this service revenue? ? Performance
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Collecting cash from customers in advance of doing work creates a liability called unearned revenue.
Unearned Revenue
Examples: – Commissions collected In advance – Season tickets to sporting events – Magazine subscriptions
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Unearned Revenue
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On September 1, 19x1, a football team received $200,000 from season ticket holders to attend 16 games.
Unearned Revenue
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Sept. 1, 19x1 Cash 200,000 Unearned Ticket Revenue Season ticket receipts
200,000
Unearned Revenue
Four of the sixteen games had been played by September 30, 19x1. ? What would the journal entry be?
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Unearned Revenue
Revenue per game = $200,000/16 ? $12,500 ? $12,500 x 4 = $50,000
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Unearned Revenue
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Sept. 30, 19x1 Unearned ticket revenue Ticket revenue 50,000 To record four games
50,000
Unearned Revenue
Adjusting entries always have: – one income statement account and – one balance sheet account. ? Adjusting entries never involve cash.
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Notice
Prepare an adjusted trial balance.
Objective 4
The adjusting process starts with the unadjusted trial balance. ? Adjusting entries are made at the end of the accounting period and then an adjusted trial balance is prepared.
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Adjusted Trial Balance
The adjusted trial balance verifies the equality of debits and credits after the adjusting process. ? It serves as the basis for the preparation of the financial statements. ? The adjusted trial balance is an internal statement.
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Adjusted Trial Balance
Prepare the financial statements from the adjusted trial balance.
Objective 5
The adjusted trial balance is an internal statement used to prepare the financial statements. ? Financial statements are external statements.
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Prepare the Statements
The financial statements are: – Income Statement – Statement of Owners’ Equity – Cash Flow Statement – Balance Sheet
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Financial Statements
Financial statements have two parts: 1 The first part includes the following: – Name of the entity – Title of the statement – Date or period covered 2 The second part is the body of the statement.
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Financial Statements
The income statement reports net income or net loss. ? Net income or net loss is determined by subtracting expenses from revenues.
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Relationships Among Statements
the
Revenues and expenses are owners’ equity account. ? Net income or net loss is transferred to the statement of owners’ equity.
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Relationships Among Statements
the
Capital is a balance sheet account. ? The ending balance in the statement of owners’ equity is transferred to the balance sheet.
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Relationships Among Statements
the
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The statement of cash flow explains the cause for the change in the cash balance between two balance sheets dates.
Relationships Among Statements
the
Completing the Accounting Cycle
Chapter 4
This company is best known for its computer chips, cellular phones and other electronic products. ? In order to successfully compete, Motorola gets its financial data to management quickly.
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Motorola Company
Motorola accomplishes this goal by rapidly closing its books. ? Motorola can close its accounts in just two days.
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Motorola
1 Prepare
an accounting work sheet. 2 Use the work sheet to complete the accounting cycle. 3 Close the revenue, expense and withdrawal accounts.
Chapter Objectives
4 Correct
typical accounting errors. 5 Classify assets and liabilities as current or long-term. 6 Use the current and debt ratios to evaluate a business.
Chapter Objectives
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The accounting cycle is the process by which accountants prepare financial statements for an entity for a specific period of time.
The Accounting Cycle
For a new business, begin by setting up ledger accounts. ? For an established business, begin with account balances carried over from the previous period.
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The Accounting Cycle
Start with the account balances in the ledger at the beginning of the period. ? Analyze and journalize transactions. ? Post journal entries to the ledger accounts.
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Work Performed This Period
Compute the unadjusted balance in each account. ? Make adjustments. ? Prepare the adjusted trial balance. ? Prepare the financial statements.
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End of Period Work
Journalize and post the adjusting entries. ? Journalize and post the closing entries. ? Prepare the post closing trial balance. This trial balance readies the accounts for the next period.
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End of Period Work
Prepare an accounting work sheet.
Objective 1
A work sheet is a multi-columned document used by accountants to help move data from the trial balance to the financial statements. ? It is an internal document.
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Accounting Work Sheet
Enter the account titles. ? Then enter the unadjusted ending balances in the trial balance column and total.
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Steps in Preparing the Work Sheet
The Accounting Work Sheet Adjusted Trial Balance
TRIAL BALANCE ADJUSTMENTS ADJ. TRIAL BAL.
ACCOUNT TITLE
CASH ACCTS RECEIVABLE SUPPLIES EQUIPMENT ACCUM DEPRECIATION ACCOUNTS PAYABLE SALARY PAYABLE UNEARNED REVENUE CAPITAL WITHDRAWALS REVENUE SALARY EXPENSE
DEBIT CREDIT DEBIT CREDIT DEBIT CREDIT
12,100 1,350 250 15,500 7,500 1,200 1,100 1,500 7,200 1,000 23,700 12,000
TOTALS
42,200
42,200
The company has earned revenue of $1,700 which will be collected next month. b Inventory of supplies at month end totaled $150. c Depreciation for the period was calculated as $200.
a
Adjustments
The Accounting Work Sheet Adjusted Trial Balance
TRIAL BALANCE ADJUSTMENTS ADJ. TRIAL BAL.
ACCOUNT TITLE
CASH ACCTS RECEIVABLE SUPPLIES EQUIPMENT ACCUM DEPRECIATION ACCOUNTS PAYABLE SALARY PAYABLE UNEARNED REVENUE CAPITAL WITHDRAWALS REVENUE SALARY EXPENSE SUPPLIES EXPENSE DEPRECIATION EXP TOTALS
DEBIT CREDIT DEBIT CREDIT DEBIT CREDIT
12,100 1,350 250 15,500 7,500 1,200 1,100 1,500 7,200 1,000 23,700 12,000 b) c) 42,200 42,200 100 200 2,000 a) 1,700 a) 1,700 b) c) 100 200
2,000
The Accounting Work Sheet Adjusted Trial Balance
TRIAL BALANCE ADJUSTMENTS ADJ. TRIAL BAL.
12,100 3,050 150 15,500 7,700 1,200 1,100 1,500 7,200 1,000 23,700 12,000 b) c) 42,200 42,200 100 200 2,000 a) 1,700 12,000 100 200 44,100 25,400
ACCOUNT TITLE
CASH ACCTS RECEIVABLE SUPPLIES EQUIPMENT ACCUM DEPRECIATION ACCOUNTS PAYABLE SALARY PAYABLE UNEARNED REVENUE CAPITAL WITHDRAWALS REVENUE SALARY EXPENSE SUPPLIES EXPENSE DEPRECIATION EXP TOTALS
DEBIT CREDIT DEBIT CREDIT DEBIT CREDIT
12,100 1,350 250 15,500 7,500 1,200 1,100 1,500 7,200 1,000 a) 1,700 b) c) 100 200
2,000
44,100
The Accounting Work Sheet Adjusted Trial Balance
ADJ. TRIAL BAL. INC. STATEMENT BALANCE SHEET
12,100 3,050 150 15,500 7,700 1,200 1,100 1,500 7,200 1,000 25,400 12,000 100 200 44,100 1,000 7,700 1,200 1,100 1,500 7,200
ACCOUNT TITLE
CASH ACCTS RECEIVABLE SUPPLIES EQUIPMENT ACCUM DEPRECIATION ACCOUNTS PAYABLE SALARY PAYABLE UNEARNED REVENUE CAPITAL WITHDRAWALS REVENUE SALARY EXPENSE SUPPLIES EXPENSE DEPRECIATION EXP TOTALS
DEBIT CREDIT DEBIT CREDIT DEBIT CREDIT
12,100 3,050 150 15,500
44,100
31,800
18,700
The Accounting Work Sheet Adjusted Trial Balance
ADJ. TRIAL BAL. INC. STATEMENT BALANCE SHEET
12,100 3,050 150 15,500 7,700 1,200 1,100 1,500 7,200 1,000 25,400 12,000 100 200 44,100 12,000 100 200 12,300 25,400 1,000 7,700 1,200 1,100 1,500 7,200
ACCOUNT TITLE
CASH ACCTS RECEIVABLE SUPPLIES EQUIPMENT ACCUM DEPRECIATION ACCOUNTS PAYABLE SALARY PAYABLE UNEARNED REVENUE CAPITAL WITHDRAWALS REVENUE SALARY EXPENSE SUPPLIES EXPENSE DEPRECIATION EXP TOTALS
DEBIT CREDIT DEBIT CREDIT DEBIT CREDIT
12,100 3,050 150 15,500
44,100
25,400
31,800
18,700
The Accounting Work Sheet Adjusted Trial Balance
ADJ. TRIAL BAL. INC. STATEMENT BALANCE SHEET
12,100 3,050 150 15,500 7,700 1,200 1,100 1,500 7,200 1,000 25,400 12,000 100 200 44,100 12,000 100 200 12,300 13,100 25,400 25,400 1,000 7,700 1,200 1,100 1,500 7,200
ACCOUNT TITLE
CASH ACCTS RECEIVABLE SUPPLIES EQUIPMENT ACCUM DEPRECIATION ACCOUNTS PAYABLE SALARY PAYABLE UNEARNED REVENUE CAPITAL WITHDRAWALS REVENUE SALARY EXPENSE SUPPLIES EXPENSE DEPRECIATION EXP TOTALS NET INCOME
DEBIT CREDIT DEBIT CREDIT DEBIT CREDIT
12,100 3,050 150 15,500
44,100
25,400 25,400
31,800 31,800
18,700 13,100 31,800
Use the work sheet to complete the accounting cycle.
Objective 2
The work sheet helps identify the accounts that need adjustments. ? Actual adjustment of the accounts requires journalizing and posting the entries.
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Recording the Adjusting Entries
The adjusting entries may be recorded in the journal when they are entered on the work sheet. ? Many accountants journalize and post the adjusting entries just before they make the closing entries.
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Recording the Adjusting Entries
Close the revenue, expense and withdrawal accounts.
Objective 3
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Closing the accounts is the end of period process that prepares the accounts for recording transactions during the next period.
Closing the Accounts
What accounts are closed at the end of the period? ? Revenue, Expenses and Withdrawals. ? These relate to a specific period and are called temporary accounts.
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Closing the Accounts
The Income Summary account is used to close the temporary accounts. ? This is the “most temporary” account. ? It is used only to facilitate the closing process.
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Income Summary
Revenues and Expense accounts are closed to Income Summary. ? Income Summary is closed to Capital. ? Withdrawals are closed to Capital.
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Closing the Accounts
Net income will be represented by a credit balance in the Income Summary. ? Net loss by a debit balance.
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Closing the Accounts
Flowchart of Closing Process
Revenue 28,500 12,000 7,500 9,000 Salary Exp 1,500 3,300 1,800
Rent Exp 800 800 Supplies Exp 350 350 (Close Revenue Account) Income Summary 28,500 (Close Expense 4,450 Accounts) 24,050
(Close Income Summary) Capital Account 2,500 24,050
(Close Withdrawals Withdrawals Account) 2,500 2,500
The accounting cycle ends with the postclosing trial balance. ? The postclosing trial balance is dated as of the end of the period for which the statements have been prepared.
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Postclosing Trial Balance
These never close : – Assets – Liabilities – Owners’ equity ? Balances of permanent accounts carry over to the next period.
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Permanent Accounts
Correct typical accounting errors.
Objective 4
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Suppose that Dennis’ Landscaping bought supplies for $3,000 and erroneously debited equipment.
Correcting Errors
What ? Debit ? What ? Debit
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was the incorrect entry? Equipment and credit Cash. is the correcting entry? Supplies and credit Equipment.
Correcting Errors
Classify assets and liabilities as current or long-term.
Objective 5
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This is a measure of how quickly an item can be converted to cash.
Liquidity
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On the balance sheet, assets and liabilities are classified as either current or long-term to indicate their relative liquidity.
Current or Long-term
Current assets are cash, or will be converted to cash, in one year or within the normal business operating cycle. – Cash – Short term receivables – Inventory – Prepaid expenses
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Assets are Classified as Current or Long-term
Long-term assets include all other assets. – Property, equipment and intangibles
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Assets are Classified as Current or Long-term
Current liabilities are debts or obligations due within one year or within the operating cycle. – Accounts and salary payables – Short term notes payable – Unearned revenue
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Liabilities are Classified as Current or Long-term
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Long-term liabilities are all other debts due in longer than one year or the entity’s operating cycle.
Liabilities are Classified as Current or Long-term
The debit side – Current assets – Long-term assets ? Assets are listed in order of decreasing liquidity.
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The Classified Balance Sheet
The credit side – Current liabilities – Long-term liabilities ? Liabilities are listed in the order of how soon they must be paid.
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The Classified Balance Sheet
Classified Balance Sheet XYZ Services January 31, 19xx
Assets Current Assets Cash Accounts Receivable Supplies Total Current Assets Plant Assets Equipment Less Accum Deprec Total Assets 15,500 7,700 7,800 23,100 Total Liabilities and Equity 23,100 12,100 3,050 150 15,300 Liabilities Current Liabilities Accounts Payable Salary Payable Unearned Revenue Total Liabilities Owners’ Equity Capital 19,300 1,200 1,100 1,500 3,800
The report format lists assets first, then liabilities and then owners’ equity. ? The account format reports assets on the left side and liabilities and owners’ equity on the right side.
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Different Formats of the Balance Sheet
Use the current and debt ratios to evaluate a business.
Objective 6
– are
statements that show two or more consecutive periods. ? They enhance the user’s ability to analyze a company’s past performance.
Comparative Financial Statements...
Two common ratios used to measure liquidity are: 1 Current ratio 2 Debt ratio
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Evaluating with Ratios
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This measures the ability of a business to pay its current liabilities with its current assets.
Current Ratio
Current assets/Current liabilities ? A Current Ratio indicates that a ratio of 1.0 or more business should have no trouble paying its current bills.
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It indicates the proportion of a business’ assets that are financed with debt. ? It measures their ability to pay both current and long-term debt.
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Debt Ratio
Total liabilities/Total assets ? The lower the ratio, the safer.
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Debt Ratio
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Decision makers compare various ratios over a period of time, looking for improving trends.
Trend Analysis
doc_249846132.pptx
ppt is to distinguish accrual-basis accounting from cash-basis accounting, apply the revenue and matching principles, make adjusting entries at the end of the accounting period, prepare an adjusted trial balance, prepare the financial statements from the adjusted trial balance
Measuring Business Income: The Adjusting Process
Disappointed by blind dates and personal ads, – Andrea McGinty founded a prescreened lunch dating service.
?
It’s Just Lunch
In 1996, the business earned revenues of $4.5 million. ? Also, the business earned a net income of $400,000. ? How was this number computed? ? Expenses were deducted from revenues to determine net income.
?
It’s Just Lunch
1 Distinguish
accrual-basis accounting from cash-basis accounting. 2 Apply the revenue and matching principles.
Chapter Objectives
3 Make
adjusting entries at the end of the accounting period. 4 Prepare an adjusted trial balance. 5 Prepare the financial statements from the adjusted trial balance.
Chapter Objectives
Distinguish accrualbasis accounting from cash-basis accounting.
Objective 1
1 Accrual-basis
2 Cash-basis
The Two Bases of Accounting:
Accountants record transactions... – when revenues are earned, – or when expenses are incurred, – regardless of when cash changes hands.
?
Accrual Basis
Accountants record transactions... – when cash is paid, – or when cash is received, – regardless of when a revenue is earned or an expense is incurred.
?
Cash Basis
Generally Accepted Accounting Principles ? GAAP requires that a business use the accrual basis.
?
Remember GAAP?
Accountants record revenues as they are earned... – and expenses as they are incurred, – not necessarily when cash is received or paid.
?
GAAP
Using accrual accounting, Its’ Just Lunch records revenue when it sells dating services, not when it collects cash later. ? Likewise, It’s Just Lunch records expenses when incurred.
?
Accrual Accounting
Salary expense not only includes amounts paid to employees, – it includes any amount owed to employees.
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Example
Services performed during the month of July - $15,000. ? Cash collected from customers - $6,000. ? Expenses for the month - $12,000. ? Cash paid out - $9,000.
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Dennis’ Landscaping
Revenues are the cash collected from customers - $6,000. ? Expenses are the cash paid out during the month - $9,000.
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Cash Basis
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Dennis’ Landscaping lost $3,000 during the month of July.
Cash Basis
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Cash Basis
Revenue: $15,000 Cash In: $6,000 Expenses: $12,000 Cash Out: $9,000 Dennis’ Landscaping Income Statement For the Month Ended July 31, 19xx Revenues $6,000 Expenses 9,000 Net Loss $3,000
Revenues of $15,000 are recognized for the services performed during the month. ? Expenses are the $12,000 incurred during the month.
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Accrual Basis
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Dennis’ Landscaping made a profit of $3,000.
Accrual Basis
Landscaping Income Statement For the Month Ended July 31, 19xx Revenues $6,000 Expenses 9,000 Net Loss Cash $3,000
? Dennis’
Landscaping Income Statement For the Month Ended July 31, 19xx Revenues $15,000 Expenses 12,000 Net Accrual Income $ 3,000
? Dennis’
?
Because accrual accounting provides a more complete portrayal of operating performance and financial position.
Why Does GAAP Require the Accrual Basis?
Over or understatement of... – Revenue – Expense – Accounts receivable – Accounts payable
?
Problems with Cash Basis
– requires
that accounting information be reported at regular intervals. – requires that income be measured accurately each period.
The Time Period Concept...
?
Managers adopt an artificial period of time to evaluate performance.
Accounting Period
–a
calendar year (January 1st to December 31st), or – a fiscal year (any consecutive 12-month period).
The Annual Accounting Period Can Be...
– are
prepared for less than one year. ? Monthly ? Quarterly ? Semi-annually
Interim Period Statements...
Apply the revenue and matching principles.
Objective 2
?
? ? ? ?
Revenue is recognized when it is deemed earned. Recognition of revenue and cash receipts do not necessarily occur at the same time. Cash could be received at the same time. Cash could be received after the earning. Cash could be received before the earning.
Revenue Principle
– is
the basis for recording expenses. ? Expenses are the costs of assets and the increase in liabilities incurred in the earning of revenues.
The Matching Principle...
Expenses are recognized when the benefit from the expense is received. ? Recognition of expenses and cash payments do not necessarily occur at the same time.
?
Expense Recognition
– allows
businesses to report accounting information on a regular basis. – interacts with the revenue principle and the matching principle to underlie the use of accruals.
The Time Period Concept...
? In
order to measure income accurately, businesses update the revenue and expense accounts before the end of the period.
The Time Period Concept
Make adjusting entries at the end of the accounting period.
Objective 3
At the end of the period accountants prepare financial statements. ? This end-of-period process starts with the unadjusted trial balance.
?
Adjusting Entries
– are
made to bring accounts to correct balances before preparing financial statements.
Adjusting Entries...
– assign
revenue to period earned. – assign expenses to the period incurred. – bring related asset and liability accounts into correct balance.
Adjusting Entries...
1 Prepaids
2 Accruals
Two Types Of Adjusting Entries
?
A prepaid, or deferral, is the postponement of the recognition of an expense already paid or incurred or a revenue already received.
Prepaids
These are goods or services paid for in advance that do not expire during the current accounting period. ? They include miscellaneous assets that will expire or will be used up in the near future.
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Prepaid Expenses
Examples: – Prepaid rent – Prepaid insurance – Supplies – Buildings – Equipment
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Prepaid Expenses
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On January 2, 19x1, Dennis’ Landscaping paid $1,200 for a one year insurance policy. Prepaid Insurance Cash 1,200 1,200
Prepaid Expenses
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Jan. 2, 19x1 Prepaid Insurance Cash Paid insurance
1,200
1,200
Prepaid Expenses
This insurance expense must be matched to the months to which it applies. ? What is the journal entry on January 31, 19x1?
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Prepaid Expenses
On January 31, 19x1, one month of the 12-month insurance policy has expired. ? $1,200/12 = $100 ? Jan. 31, 19x1 Insurance expense 100 Prepaid insurance 100 One month’s insurance premium
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Prepaid Expenses
What was the determining factor in matching this expense? ? Time
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Wordcrafters started business the beginning of the month. ? $500 worth of office supplies were purchased on March 15, 19x1, for cash.
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Supplies
Office Supplies 500
Cash 500
Office Supplies 500 Cash or Accounts Payable 500 Supplies Purchased office supplies
An inventory at month end indicated that $120 in office supplies remained. ? Therefore, $380 worth of supplies was used during the month ($500 - $120).
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Supplies
The cost of supplies must be matched to the period in which they were used. ? What is the journal entry on March 31, 19x1?
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Supplies
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Mar. 31, 19x1 Office Supplies Expense Office Supplies
380
380
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One month’s usage of supplies Supplies Expense Supplies 380 500 380 Bal. 120
Supplies
What was the determining factor in matching this expense? ? Usage
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Plant assets are large prepaid expenses.
Depreciation of Plant Assets
– is
a cost allocation of a long-lived asset. ? Depreciation expense is the cost converted from an asset to an expense. ? Estimates are used.
Depreciation...
On January 2nd, the business purchased a truck for $30,000 cash. ? The truck is expected to last for 3 years.
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Dennis’ Landscaping
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January 2, 19x1 Machinery 30,000 Cash 30,000 Purchase of truck
Journalizing
The cost of the truck must be matched with the accounting periods in which it was used to earn income. ? What would the journal entry be for the year ended December 31, 19x1?
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Matching Principle
Cost: $30,000 ? Service life: 3 Years ? Cost/Estimated useful life ? $30,000/3 = $10,000 per year
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Straight Line Method
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Dec. 31, 19x1 Depreciation Expense 10,000 Accumulated Depreciation 10,000 To record depreciation expense for a oneyear period
Depreciation Expense
A contra account is one that is paired with and deducted from another related account in the financial statements. ? Normal balance is opposite its companion account. ? Accumulated depreciation is a contra account to plant assets.
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Contra Accounts
– is
the cost of an asset that has not been depreciated.
Book Value...
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Partial Balance Sheet December 31, 19x1
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Plant Assets Machinery $30,000 Less Accumulated Depreciation $20,000
10,000
Dennis’ Landscaping
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Contra account
Book value
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Partial Balance Sheet December 31, 19x2
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Plant Assets Machinery $30,000 Less Accumulated Depreciation Contra account Book value
20,000 $10,000
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Dennis’ Landscaping
An accrual is the recognition of an expense or revenue that has risen but has not yet been recorded. ? Expenses or revenues are recorded before the cash settlement.
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Accruals
– are
expenses that have been incurred but not yet paid.
Accrued Expenses...
Employees of Mary Business Services are paid every Friday. ? Weekly salaries total $30,000.
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Accrued Expenses
Mary’s is closed on Saturday and Sunday. ? The employees were last paid on April 26th, which was a Friday.
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Accrued Expenses
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? ? ?
The employees will be paid on May 3rd. What is the adjusting entry on April 30th? They worked April 29th and 30th. $30,000/5 = $6,000 per day $6,000 x 2 days = $12,000
Accrued Expenses
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Apr. 30, 19x1 Salaries Expense 12,000 Salaries Payable To accrue two days salaries
12,000
Accrued Expenses
These are revenues that have been earned but not yet received. ? They are an asset.
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Accrued Revenues
During the month of August, Dennis’ Landscaping rendered services to customers totaling $15,000. ? At the end of August, the customers have not as yet been billed.
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Accrued Revenues
What is the August 31st adjusting entry? ? August 31, 19x1 Accounts Receivable 15,000 Service Revenue 15,000 To record unpaid invoices
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Accrued Revenues
What is the determining factor in recognizing this service revenue? ? Performance
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Collecting cash from customers in advance of doing work creates a liability called unearned revenue.
Unearned Revenue
Examples: – Commissions collected In advance – Season tickets to sporting events – Magazine subscriptions
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Unearned Revenue
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On September 1, 19x1, a football team received $200,000 from season ticket holders to attend 16 games.
Unearned Revenue
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Sept. 1, 19x1 Cash 200,000 Unearned Ticket Revenue Season ticket receipts
200,000
Unearned Revenue
Four of the sixteen games had been played by September 30, 19x1. ? What would the journal entry be?
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Unearned Revenue
Revenue per game = $200,000/16 ? $12,500 ? $12,500 x 4 = $50,000
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Unearned Revenue
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Sept. 30, 19x1 Unearned ticket revenue Ticket revenue 50,000 To record four games
50,000
Unearned Revenue
Adjusting entries always have: – one income statement account and – one balance sheet account. ? Adjusting entries never involve cash.
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Notice
Prepare an adjusted trial balance.
Objective 4
The adjusting process starts with the unadjusted trial balance. ? Adjusting entries are made at the end of the accounting period and then an adjusted trial balance is prepared.
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Adjusted Trial Balance
The adjusted trial balance verifies the equality of debits and credits after the adjusting process. ? It serves as the basis for the preparation of the financial statements. ? The adjusted trial balance is an internal statement.
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Adjusted Trial Balance
Prepare the financial statements from the adjusted trial balance.
Objective 5
The adjusted trial balance is an internal statement used to prepare the financial statements. ? Financial statements are external statements.
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Prepare the Statements
The financial statements are: – Income Statement – Statement of Owners’ Equity – Cash Flow Statement – Balance Sheet
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Financial Statements
Financial statements have two parts: 1 The first part includes the following: – Name of the entity – Title of the statement – Date or period covered 2 The second part is the body of the statement.
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Financial Statements
The income statement reports net income or net loss. ? Net income or net loss is determined by subtracting expenses from revenues.
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Relationships Among Statements
the
Revenues and expenses are owners’ equity account. ? Net income or net loss is transferred to the statement of owners’ equity.
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Relationships Among Statements
the
Capital is a balance sheet account. ? The ending balance in the statement of owners’ equity is transferred to the balance sheet.
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Relationships Among Statements
the
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The statement of cash flow explains the cause for the change in the cash balance between two balance sheets dates.
Relationships Among Statements
the
Completing the Accounting Cycle
Chapter 4
This company is best known for its computer chips, cellular phones and other electronic products. ? In order to successfully compete, Motorola gets its financial data to management quickly.
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Motorola Company
Motorola accomplishes this goal by rapidly closing its books. ? Motorola can close its accounts in just two days.
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Motorola
1 Prepare
an accounting work sheet. 2 Use the work sheet to complete the accounting cycle. 3 Close the revenue, expense and withdrawal accounts.
Chapter Objectives
4 Correct
typical accounting errors. 5 Classify assets and liabilities as current or long-term. 6 Use the current and debt ratios to evaluate a business.
Chapter Objectives
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The accounting cycle is the process by which accountants prepare financial statements for an entity for a specific period of time.
The Accounting Cycle
For a new business, begin by setting up ledger accounts. ? For an established business, begin with account balances carried over from the previous period.
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The Accounting Cycle
Start with the account balances in the ledger at the beginning of the period. ? Analyze and journalize transactions. ? Post journal entries to the ledger accounts.
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Work Performed This Period
Compute the unadjusted balance in each account. ? Make adjustments. ? Prepare the adjusted trial balance. ? Prepare the financial statements.
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End of Period Work
Journalize and post the adjusting entries. ? Journalize and post the closing entries. ? Prepare the post closing trial balance. This trial balance readies the accounts for the next period.
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End of Period Work
Prepare an accounting work sheet.
Objective 1
A work sheet is a multi-columned document used by accountants to help move data from the trial balance to the financial statements. ? It is an internal document.
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Accounting Work Sheet
Enter the account titles. ? Then enter the unadjusted ending balances in the trial balance column and total.
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Steps in Preparing the Work Sheet
The Accounting Work Sheet Adjusted Trial Balance
TRIAL BALANCE ADJUSTMENTS ADJ. TRIAL BAL.
ACCOUNT TITLE
CASH ACCTS RECEIVABLE SUPPLIES EQUIPMENT ACCUM DEPRECIATION ACCOUNTS PAYABLE SALARY PAYABLE UNEARNED REVENUE CAPITAL WITHDRAWALS REVENUE SALARY EXPENSE
DEBIT CREDIT DEBIT CREDIT DEBIT CREDIT
12,100 1,350 250 15,500 7,500 1,200 1,100 1,500 7,200 1,000 23,700 12,000
TOTALS
42,200
42,200
The company has earned revenue of $1,700 which will be collected next month. b Inventory of supplies at month end totaled $150. c Depreciation for the period was calculated as $200.
a
Adjustments
The Accounting Work Sheet Adjusted Trial Balance
TRIAL BALANCE ADJUSTMENTS ADJ. TRIAL BAL.
ACCOUNT TITLE
CASH ACCTS RECEIVABLE SUPPLIES EQUIPMENT ACCUM DEPRECIATION ACCOUNTS PAYABLE SALARY PAYABLE UNEARNED REVENUE CAPITAL WITHDRAWALS REVENUE SALARY EXPENSE SUPPLIES EXPENSE DEPRECIATION EXP TOTALS
DEBIT CREDIT DEBIT CREDIT DEBIT CREDIT
12,100 1,350 250 15,500 7,500 1,200 1,100 1,500 7,200 1,000 23,700 12,000 b) c) 42,200 42,200 100 200 2,000 a) 1,700 a) 1,700 b) c) 100 200
2,000
The Accounting Work Sheet Adjusted Trial Balance
TRIAL BALANCE ADJUSTMENTS ADJ. TRIAL BAL.
12,100 3,050 150 15,500 7,700 1,200 1,100 1,500 7,200 1,000 23,700 12,000 b) c) 42,200 42,200 100 200 2,000 a) 1,700 12,000 100 200 44,100 25,400
ACCOUNT TITLE
CASH ACCTS RECEIVABLE SUPPLIES EQUIPMENT ACCUM DEPRECIATION ACCOUNTS PAYABLE SALARY PAYABLE UNEARNED REVENUE CAPITAL WITHDRAWALS REVENUE SALARY EXPENSE SUPPLIES EXPENSE DEPRECIATION EXP TOTALS
DEBIT CREDIT DEBIT CREDIT DEBIT CREDIT
12,100 1,350 250 15,500 7,500 1,200 1,100 1,500 7,200 1,000 a) 1,700 b) c) 100 200
2,000
44,100
The Accounting Work Sheet Adjusted Trial Balance
ADJ. TRIAL BAL. INC. STATEMENT BALANCE SHEET
12,100 3,050 150 15,500 7,700 1,200 1,100 1,500 7,200 1,000 25,400 12,000 100 200 44,100 1,000 7,700 1,200 1,100 1,500 7,200
ACCOUNT TITLE
CASH ACCTS RECEIVABLE SUPPLIES EQUIPMENT ACCUM DEPRECIATION ACCOUNTS PAYABLE SALARY PAYABLE UNEARNED REVENUE CAPITAL WITHDRAWALS REVENUE SALARY EXPENSE SUPPLIES EXPENSE DEPRECIATION EXP TOTALS
DEBIT CREDIT DEBIT CREDIT DEBIT CREDIT
12,100 3,050 150 15,500
44,100
31,800
18,700
The Accounting Work Sheet Adjusted Trial Balance
ADJ. TRIAL BAL. INC. STATEMENT BALANCE SHEET
12,100 3,050 150 15,500 7,700 1,200 1,100 1,500 7,200 1,000 25,400 12,000 100 200 44,100 12,000 100 200 12,300 25,400 1,000 7,700 1,200 1,100 1,500 7,200
ACCOUNT TITLE
CASH ACCTS RECEIVABLE SUPPLIES EQUIPMENT ACCUM DEPRECIATION ACCOUNTS PAYABLE SALARY PAYABLE UNEARNED REVENUE CAPITAL WITHDRAWALS REVENUE SALARY EXPENSE SUPPLIES EXPENSE DEPRECIATION EXP TOTALS
DEBIT CREDIT DEBIT CREDIT DEBIT CREDIT
12,100 3,050 150 15,500
44,100
25,400
31,800
18,700
The Accounting Work Sheet Adjusted Trial Balance
ADJ. TRIAL BAL. INC. STATEMENT BALANCE SHEET
12,100 3,050 150 15,500 7,700 1,200 1,100 1,500 7,200 1,000 25,400 12,000 100 200 44,100 12,000 100 200 12,300 13,100 25,400 25,400 1,000 7,700 1,200 1,100 1,500 7,200
ACCOUNT TITLE
CASH ACCTS RECEIVABLE SUPPLIES EQUIPMENT ACCUM DEPRECIATION ACCOUNTS PAYABLE SALARY PAYABLE UNEARNED REVENUE CAPITAL WITHDRAWALS REVENUE SALARY EXPENSE SUPPLIES EXPENSE DEPRECIATION EXP TOTALS NET INCOME
DEBIT CREDIT DEBIT CREDIT DEBIT CREDIT
12,100 3,050 150 15,500
44,100
25,400 25,400
31,800 31,800
18,700 13,100 31,800
Use the work sheet to complete the accounting cycle.
Objective 2
The work sheet helps identify the accounts that need adjustments. ? Actual adjustment of the accounts requires journalizing and posting the entries.
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Recording the Adjusting Entries
The adjusting entries may be recorded in the journal when they are entered on the work sheet. ? Many accountants journalize and post the adjusting entries just before they make the closing entries.
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Recording the Adjusting Entries
Close the revenue, expense and withdrawal accounts.
Objective 3
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Closing the accounts is the end of period process that prepares the accounts for recording transactions during the next period.
Closing the Accounts
What accounts are closed at the end of the period? ? Revenue, Expenses and Withdrawals. ? These relate to a specific period and are called temporary accounts.
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Closing the Accounts
The Income Summary account is used to close the temporary accounts. ? This is the “most temporary” account. ? It is used only to facilitate the closing process.
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Income Summary
Revenues and Expense accounts are closed to Income Summary. ? Income Summary is closed to Capital. ? Withdrawals are closed to Capital.
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Closing the Accounts
Net income will be represented by a credit balance in the Income Summary. ? Net loss by a debit balance.
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Closing the Accounts
Flowchart of Closing Process
Revenue 28,500 12,000 7,500 9,000 Salary Exp 1,500 3,300 1,800
Rent Exp 800 800 Supplies Exp 350 350 (Close Revenue Account) Income Summary 28,500 (Close Expense 4,450 Accounts) 24,050
(Close Income Summary) Capital Account 2,500 24,050
(Close Withdrawals Withdrawals Account) 2,500 2,500
The accounting cycle ends with the postclosing trial balance. ? The postclosing trial balance is dated as of the end of the period for which the statements have been prepared.
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Postclosing Trial Balance
These never close : – Assets – Liabilities – Owners’ equity ? Balances of permanent accounts carry over to the next period.
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Permanent Accounts
Correct typical accounting errors.
Objective 4
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Suppose that Dennis’ Landscaping bought supplies for $3,000 and erroneously debited equipment.
Correcting Errors
What ? Debit ? What ? Debit
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was the incorrect entry? Equipment and credit Cash. is the correcting entry? Supplies and credit Equipment.
Correcting Errors
Classify assets and liabilities as current or long-term.
Objective 5
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This is a measure of how quickly an item can be converted to cash.
Liquidity
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On the balance sheet, assets and liabilities are classified as either current or long-term to indicate their relative liquidity.
Current or Long-term
Current assets are cash, or will be converted to cash, in one year or within the normal business operating cycle. – Cash – Short term receivables – Inventory – Prepaid expenses
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Assets are Classified as Current or Long-term
Long-term assets include all other assets. – Property, equipment and intangibles
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Assets are Classified as Current or Long-term
Current liabilities are debts or obligations due within one year or within the operating cycle. – Accounts and salary payables – Short term notes payable – Unearned revenue
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Liabilities are Classified as Current or Long-term
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Long-term liabilities are all other debts due in longer than one year or the entity’s operating cycle.
Liabilities are Classified as Current or Long-term
The debit side – Current assets – Long-term assets ? Assets are listed in order of decreasing liquidity.
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The Classified Balance Sheet
The credit side – Current liabilities – Long-term liabilities ? Liabilities are listed in the order of how soon they must be paid.
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The Classified Balance Sheet
Classified Balance Sheet XYZ Services January 31, 19xx
Assets Current Assets Cash Accounts Receivable Supplies Total Current Assets Plant Assets Equipment Less Accum Deprec Total Assets 15,500 7,700 7,800 23,100 Total Liabilities and Equity 23,100 12,100 3,050 150 15,300 Liabilities Current Liabilities Accounts Payable Salary Payable Unearned Revenue Total Liabilities Owners’ Equity Capital 19,300 1,200 1,100 1,500 3,800
The report format lists assets first, then liabilities and then owners’ equity. ? The account format reports assets on the left side and liabilities and owners’ equity on the right side.
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Different Formats of the Balance Sheet
Use the current and debt ratios to evaluate a business.
Objective 6
– are
statements that show two or more consecutive periods. ? They enhance the user’s ability to analyze a company’s past performance.
Comparative Financial Statements...
Two common ratios used to measure liquidity are: 1 Current ratio 2 Debt ratio
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Evaluating with Ratios
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This measures the ability of a business to pay its current liabilities with its current assets.
Current Ratio
Current assets/Current liabilities ? A Current Ratio indicates that a ratio of 1.0 or more business should have no trouble paying its current bills.
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It indicates the proportion of a business’ assets that are financed with debt. ? It measures their ability to pay both current and long-term debt.
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Debt Ratio
Total liabilities/Total assets ? The lower the ratio, the safer.
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Debt Ratio
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Decision makers compare various ratios over a period of time, looking for improving trends.
Trend Analysis
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