Financial Accounting (Lectures 4,5,6)

Periodicity assumption

economic life of business can be divided into artificial time periods (month, quarter, year)

Revenue recognition principle

revenue recognized in the accounting period in which the performance obligation is satisfied

Matching principle

expenses should match revenue recognized

Expense recognition principle

recognize expenses with revenues in the period when the company makes efforts to generate those revenues

Revenue and expense recognition

in accordance with generally accepted accounting principles (GAAP)

Accrual basis

recognize revenues when services are performed, recored expenses when they are incurred, cash does not have to be paid, compliant with GAAP, expensive to implement 

Cash basis

recognize revenue when cash is received, record expenses when cash is paid, matches up with cash activity in bank statement, not GAAP complaint, not so expensive (doesn’t require CPA)

Deferrals

prepaid expenses, unearned revenue

Accruals

accrued revenues, accrued expenses

Adjusting for deferrals (prepaid expenses)

paid in cash before the expense is incurred, cots that expire as time passes, examples include depreciation, rent, and insurance

Adjusting for deferrals (unearned revenues)

paid in cash before the service is performed, revenue that is recognized over time, examples include airline tickets and landscaping services 

Depreciation

process of allocating the cost of an asset to expense over its useful life

Contra asset account

fixed asset is written of using this

Adjusting for accruals (accrued revenues)

services performed but not yet recorded, services may not have been billed yet, needs to be recorded or receivables and revenue will be understated, examples include interest, rent, and commissions

Adjusting for accruals (expenses)

expenses incurred but not yet paid, needs to be recorded or both liabilities and expenses will be understated, examples include interest, taxes, utilities and salaries

Accrued interest

face value of note x annual interest rate x time in terms of a year

Adjusted trial balance

prepared after adjusting entries are journalized and posted, proves equality of debit and credit balances, list all accounts in order (assets, liabilities, equity, revenue, and expenses)

Earnings management

an attempt to plan out timing of net income to eliminate surprises that may not be viewed favorably by investment community

Closing the books

process needed to zero out the income statement

Merchandising company

buy and sell merchandise instead of services (ex: walmart and amazon)

Specialized income statement (merchandising company)

sales revenue - COGS = gross profit - operating expenses = net income (loss)

Inventory

balance sheet account

COGS

income statement account

Perpetual inventory system

maintains detailed records of the cost of each inventory purchase and sale and determine COGS each time a sale occurs

Perpetual system disadvantage

expensive to implement

Perpetual system advantages

helps companies sell expensive inventory to track each item, help accountants know inventory n hand at any given time, helps detect theft 

Periodic inventory system

doesn’t keep detailed records of goods on hand, determines COGS by a year end inventory count, calculates COGS: beginning inventory + purchases = net goods available for sale - ending inventory = COGS

FOB shipping point

buyer pays freight (pays for shipping)

FOB destination

seller pays freight (company pays for shipping)

Purchase return

unacceptable inventory is returned

Purchase allowance

unacceptable inventory is kept but seller offers some compensation

Purchase discounts

buyer gets a discount if they pay the seller soon

Operating expenses

salaries expenses, rent expense, utilities, repairs and maintenance

Other expenses and losses

interest expense on notes and loans payable, loss from sale and abandonment of PP&E, loss from strikes by employees and supplies

Other revenues and gains

interest revenue from notes receivable and marketable securities, dividend revenue from investments in capital stock, rent revenue from subleasing a portion of the store, gains from PP&E

Manufacturing company (3 categories of inventory)

raw materials, work in progress, finished goods, covered in managerial accounting course

Determining inventory quantity

take physical count at year end, look who owns goods in transit (FOB shipping point vs FOB destination), goods sold on consignment

Determining inventory costs

FIFO - first in first out, LIFO - last in first out, average cost

FIFO

produces higher net income (lower COGS), lower COGS appearing to management for calculation of bonuses, higher income can be appealing to stockholders

LIFO

produces lower net income (higher COGS), presents a more realistic picture, results in lower income taxes in periods of inflation

Inventory turnover ratio

indicates liquidity of inventory (how quick inventory can be turned into cash), higher inventory turnover (company has minimal inventory on hand), used by management to optimize inventory control