Accounting Exam 2

Cash Basis Accounting

Accounting method that records revenues only when cash is received and expenses only when cash is paid

Accrual Basis Accounting

Accounting method that records revenues when earned and expenses when incurred.

Details of Cash Basis

• does not adhere to GAAP

• does not give an accurate measure of cash flows

Details of Accrual Basis

• revenue is recorded once performance obligations are fulfilled

• expenses are recorded when incurred/used

• adheres to GAAP

• more accurate picture of revenues, expenses, cash flows

Time Period Concept

business activities are recorded using time segments such as a month, quarter or a year.

Revenue Recognition Principle

requires companies to record revenue when (or as) each performance obligation is satisfied

5 Steps for Revenue Recognition

1) Identify the contract with the customer

2) Identify performance obligations in the contract

3) determine the transaction price

4) Allocate the price to the performance obligations in the contract

5) Recognize revenue when (or as) the entity satisfies each performance obligation

Matching Principle

Record expense in the period when incurred. Match expense against revenues in the same period

Adjusting Entry

an entry made at the end of a period to record revenues in the period they are earned and expenses in the period when they occur

Deferrals

Defers the recognition of revenue or expense to a date after the cash is received or paid

Accruals

recognizes the revenue or expense before the cash has been received or paid

Deferred Expenses

expenses paid for in cash before used (prepaid expenses, supplies, depreciation)

Deferred Revenues

cash collected in advance before revenue is earned (unearned revenues)

Accrued Expenses

expenses incurred/used, but not yet paid (accrued salaries expense, accrued interest expense, etc.)

Accrued Revenues

revenues earned but not yet collected

Adjusted Trial Balance

a list of all the accounts with their adjusted balances (debits=credits)

Income Statement

Revenues-expenses=Net Income or Loss

Statement of Retained Earnings

(Beginning Retained Earnings + net income or - net loss) - dividends = ending retained earnings

Balance Sheet

Assets = Liabilities + Stockholder’s Equity (Common stock + retained earnings)

Classified Balance Sheet

a balance sheet that places each asset and each liability into a specific category

Assets on a Classified Balance Sheet

listed in order of liquidity

Liquidity

Measures how quickly and easily an account can be converted to cash (AR → Supplies → buildings and furniture)

Liabilities on a Classified Balance Sheet

listed in the order they must be paid

Current Assets

an assets that is expected to be converted to cash, sold, or used up during the next 12 months or within the operating cycle

long term assets

an asset that will not be converted to cash or used up within the businesses operating cycle or within the next 12 months

Types of Long term assets

long term investments, property plant and equipment, and intangible assets

long term investments

an investment in debt and equity securities that the investor intends to hold for longer than one year (notes receivable, bonds, stocks)

Property, plant, and equipment

fixed assets. land, buildings, furniture, and equipment used in operations. presented in the order of the category name (property first, then plant, then equipment)

intangible assets

assets with no physical form (patents, copyrights, and trademarks)

current liabilities

liabilities that are paid with cash or with goods/services within one year or the operating cycle (AP, notes payable due within one year, payables, unearned revenue)

long term liabilities

all liabilities that do not need to be paid within one year or within the operating cycle (notes payable for mortgage)

Set up of classified balance sheet

current assets, property plant equipment, intangible assets, long term investments, total assets, current liabilities, long term liabilities, total liabilities, stockholder’s equity, total liabilities and stockholder’s equity

closing process

zeros all revenue and expense accounts to prepare for the next period

temporary accounts

an account that relates to a particular period and is closed at the end of that period (revenues, expenses, dividends, income summary)

permanent accounts

an account that is not closed at the end of a period (assets, liabilities, common stock, retained earnings)

closing entries

transfer revenues, expenses, and dividends to the retained earnings account

income summary

a temporary account into which revenues and expenses are transferred prior to their final transfer to the retained earnings account

steps for closing entries

1) make revenue accounts zero (DR service revenue, CR income summary)

2) make expense accounts zero (DR income summary, CR expense accounts)

3) make income summary zero once account total is calculated (revenues-expenses) (DR income summary, CR retained earnings)

4) make dividends zero (DR retained earnings, CR dividends)

post closing trial balance

a list of the accounts and their balances at the end of the period after journalizing and posting the closing entries (permanent accounts only)

Current Ratio

= total current assets/total current liabilities

debt ratio

= total liabilities/total assets

return on assets

= net income/average total assets (beginning assets + ending assets/2)