MGMT 120A Ch.2

What do financial statements tell

-The health of a company

What are the headings of a financial statement

1) name of business

2) name of the financial statement

3) date the information is reflective of

What is cash basis accounting

- Records only cash receipts and cash payments.

- There are no receivables, payables, and depreciation.

Who uses cash basis accounting

Only very small businesses (i.e. attorneys, doctors, and real estate agents) use the cash basis of accounting.

What is accrual basis accounting

Records the effect of each transaction as it occurs

Most businesses use this method

What are the steps in the accounting cycle

1) Business transaction (identifying + analysing)

2) Journalising

3) Posting to ledger

4) (Unadjusted) Trial Balance

5) Adjusting journal entries

6) Adjusted trial balance

7) Financial statements preparation

8) closing entry

9) Post closing trial balance (optional)

What's an account

Record/form used to document additions and deductions for each individual asset, liability, and Owner's Equity.

What's a ledger

The record holding all the accounts

What's a journal

A record used to document the effects of transactions in chronological order

What's a trial balance

- A list of all accounts with their balances

- It is used as a check for the accuracy of the ledger

What's double entry or dual entry accounting

Accounting is based on this system.

What's T-account

Form of an account resembling the capital letter T, showing debits on the left and credits on the right

What's debit

Left hand side, whether that be the left side of a journal entry or the left side of a T account.

What's credit

Right hand side, whether that be the right side of a journal entry or the right side of a T account

What are business transactions

- Business transactions are events that happen as the firm does business.

- It changes the elements of the accounting equation

- Ultimately, it affects the financial position of the company

What's the typical layout of journal entries

- The first line has the date and one account effected. This is the "left side."

- The second line is indented to the right and has the second account effected. This is the "right side."

- The third line is a short explanation of the transaction.

What are the steps to journalising

- Record the date of the transaction

- Identify each account affect and whether it an asset, liability, or owners' equity (contribution, withdrawal, revenue, or expense)

- Determine whether each account was increased or decreased. Then depending on its behavior (i.e. if it is an asset, liability, contribution, withdrawal, revenue, or expense), you would classify it as a debit or credit.

- Record the accounts affected and their amounts

- If it is a debit, you should record the transaction on the left side. If it is a credit, you should record the transaction on the right side

- Write a short explanation of the transaction.

What's the purpose of adjusting entries

- Bring the accounts up to date at the end of the accounting period

- Affect at least one income statement and one balance sheet account.

What are types of accounts that need to be adjusted

- Prepaid expenses

- Supplies

- Depreciation

- Unearned revenue / Deferred revenue

- Accrued expenses

- Accrued revenues

How to record a prepaid expense

Initial JE:

DR: Prepaid rent

CR: Cash

Adjusting JE:

DR: Rent expense

CR: Prepaid rent

How to adjust supplies account

Initial JE:

DR: Supplies

CR: Cash

Adjusting JE

DR: Supplies expense

CR: Supplies

What is depreciation

process of allocating a fixed assets cost over time to expense.

Does land depreciate

No

What are fixed assets

Long lived assets used in a business

What's the major difference between prepaid expense + fixed assets

- Amount of time

- Prepaid expenses are usually within a year, while fixed assets are useful for more than 1 year.

How to calculate straight line depreciation

(Cost of asset - Salvage value) / Expected Useful Life

What's the JE for accrued expenses

Initial JE:

DR: Wages Expense

CR: Wages Payable

Adjusting JE:

DR: Wages Payable

DR: Wages Expense (The remainder)

CR: Cash

What does closing the accounts mean

- This is the process at the end of the period that gets the accounts ready for the next period

- Zeroes out all of the revenue and expense accounts so as to measure the net income of each period separately from other periods

What are temporary accounts

Accounts that represent business activity for a single period

Eg)

Revenue

Expenses

Drawings, dividends

Income summary

What are permanent accounts

Assets: Cash, accounts receivable, inventory, etc.

Liabilities: Accounts payable, notes payable, etc.

Equity: Capital, common stock, retained earnings, etc.

- Only B/S accounts are permanent

What are the steps to close accounts

1) Close revenue accounts to Income summary

2) Close expense accounts to Income Summary

3) Make sure balance in Income summary equals net income

4) Close Income summary to Capital (if sole proprietorship / partnership) or Retained Earnings (if corporation)

5) Close the drawing account to Capital(if sole proprietorship / partnership) or Retained Earnings (if corporation)

What's the post closing trial balance

- Optional step that lists the accounts and their adjusted balances after closing

- Only permanent accounts (assets, liabilities, and capital) appear on the post-closing Trial Balance

- This is prepared to make sure the ledger is in balance at the beginning of the next period.

- This trial balance should only have balance sheet accounts and no income statement accounts