Principles of Accounting - Chapters 1-4

Identifying

Sales transactions and events

ex. sale of an iPhone by Apple

Recording

Input, measure, and log

ex. log of transactions

Communicating

Prepare, analyze, and interpret

ex. preparing financial statements

Accounting Duty - Financial

Preparation, analysis, auditing, consulting, planning, criminal investigation

Accounting Duty - Managerial

General accounting, cost accounting, budgeting, internal auditing, consulting, controller, treasurer, strategy

Accounting Duty - Taxation

Preparation, planning, regulation, investigation, consulting, enforcement, legal services, estate plans

GAAP - Generally Accepted Accounting Principles

Concepts and rules that govern financial accounting in the United States.

Aims to make information relevant, reliable, and comparable for all companies

FASB - Financial Accounting Standards Board

Private group that sets accounting principles for U.S. companies

Securities and Exchange Commission (SEC)

establishes accounting reporting requirements for corporations that issue stock to the public.

IASB - International Accounting Standards Board

Independent group of accountants from many countries

IFRS - International Financial Reporting Standards

Accounting standards set by the IASB

Measurment/Cost Principle

Accounting information is based on the actual cost

Revenue Recognition Principle

recognize revenue when it is earned, proceeds don't need to be in cash, measure revenue by cash received plus cash value of items received

Expense recognition principle (matching principle)

A company records the expenses incurred to generate revenue in the same accounting period

Full Disclosure Principle

A company is required to report the details behind financial statements that would impact users' decisions.

Going Concern Assumption

Assumption that the business will continue operating instead of be closed or sold

Monetary Unit Assumption

Express transactions and events in monetary, or money, units.

Business Entity Assumption

A business' accounting records are kept separate from its owner's records.

Time Period Assumption

Presumes that the life of a company can be divided into time periods, such as months and years.

Owner's Equity is increased by ?

owners investments and revenue

Owner's equity is decreased by ?

Owner's withdrawals and expenses

Accounting Equation

Assets = Liabilities + Equity

must balance for each individual transaction and the sum of all transactions that have occurred

What is the order of financial statements?

income statement, statement of owner's equity, balance sheet

Net Income

Revenues - Expenses

Return on Assets (ROA)

Net income/average total assets

Classify: Accounts Payable

liability, balance sheet

Classify: Accounts Receivable

asset, balance sheet

Classify: Cash

asset, balance sheet

Classify: Cash withdrawals by Owner

equity, statement of owner's equity

Classify: Consulting Revenue

equity/revenue, income statement

Classify: Miscellaneous expenses

equity/expense, income statement

Classify: Owner investments

equity, statement of owner's equity

Analyzing and Recording Process

(1) Analyze each transaction and event from source documents, (2) Record relevant transactions and events in the general journal, (3) Post journal information to the general ledger, and (4) Prepare and analyze the trial balance.

Account

a record of increases and decreases in one asset, liability, equity, revenue, or expense

General Ledger

a record containing all accounts used by a company

General Journal

Contains the chronological list of all journal entries recorded in the accounting systems

Journalizing and Posting Transactions

1. Identify transactions and source documents

2. Analyze transactions using the accounting equation

3. Record journal entry

4. Post entry to ledger

Trial Balance

The purpose is to be sure that the ledger's total debits = total credits before preparing the financial statements

Steps in preparing a trial balance

1. For each account in the General Ledger, list the account's title on a line. Enter debit balances in the debit column. Enter credits in the credit column. If an account has a 0 balance, list it with a 0 in the normal balance column

2. Compute the total of the debit balances and the total of the credit balances.

3. Verify that total debit balances equal total credit balances

Debt Ratio

total liabilities/total assets

evaluates the level of debt risk

a higher ratio indicates a greater risk of the company not being able to pay its debt in the future

Accounting Cycle

1. Analyze transactions

2. Journalize transactions to the General Journal

3. Post transactions to the General Ledger

4. Prepare unadjusted trial balance

5. Adjust journal entries

6. Prepare adjusted trial balance

7. Prepare financial statements

8. Closing Entries

9. Prepare post-closing trial balance

10. Reversing entries (optional)

What is the normal balance for Assets?

Debit (increase with debit)

What is the normal balance for Liabilities?

Credit (increase with credit)

What is the normal balance for owner's capital and revenue?

Credit (increase with credit)

What is the normal balance for owner's withdrawals and expenses?

Debit (increase with debit)

Fiscal Year

12 consecutive months and the company chooses its accounting year-end date, but it must be the same every year

Natural Year

At slow time of business year. For seasonal businesses, the date often chosen for the accounting (fiscal) year-end

Accrual Basis

Revenues are recognized when earned and expenses are recognized when incurred.

Learning accrual basis accounting.

Cash Basis

Revenues are recognized when cash is received and expenses are recognized when cash is paid.

Not GAAP.

The adjusting process

the analysis and updating of accounts at the end of the period before the financial statements are prepared

Adjusting Entries

Brings an asset or liability account balance to its proper amount according to the accrual basis

All adjusting entries impact:

at least one income statement account and at least one balance sheet account

Impact of omitting an adjusting entry

Net income will be incorrect.

Errors in the balance sheet.

Adjusting Entries are made to

Get ledger account balances on the accrual basis before preparing financial statements

3-step adjustment process

1. Determine what the current account (unadjusted) balance equals

2. Determine what the current account balance should equal

3. Record an adjusting entry to get from step 1 to step 2

Four Categories of Adjustments

Prepaid expenses, unearned revenues, accrued expenses, accrued revenues

Prepaid Expenses

assets paid for in advance of receiving their benefits/when cash is paid before recognizing the related expense

Unearned Revenues

Cash receipt in advance of earning the related revenue

Normal balance: credit, its a liability so it increases with credit

Accrued Expenses

Cash is paid after related expense is incurred

Costs incurred in a period that are both unpaid and unrecorded.

ex. A company pays its employee $70 per week day, or $350 for a five-day work. Salaries are paid every two weeks on a Friday. 12/31 is a Wednesday, so three days' salaries are owed at year end (70 * 3 = 210). Adjusting entries increases Salaries payable (a liability so credit) and increases the Salaries expense account for $210 (expenses increase with debit)

Accrued Interest Example

A company borrowed $6000 from a bank on December 1st, 2019. The note bears interest at the annual rate of 5% and is due to be repaid in one year. Let's accrue interest for the month ended December 31, 2019.

To accrue interest: Amount borrowed x Annual Rate x Days left before year end/period for which the interest is incurred

$6000 x 5% x 30/360 = 25

Debit interest expense for 25, credit interest payable for 25

Accrued Revenues

Receive cash after related revenue is earned

Revenues earned in a period that are unrecorded and not yet received

Accrued Revenues Example

Step 1. On 12/12/19, A company's customer agrees to pay 2700 on 01/10/20 for services provided over the next 30 days.

Step 2. By 12/31/19, 20 days worth of services have been provided. 2700/30 days = 90 per day * 20 days = 1800

Step 3 - Adjusting entry increases accounts receivable (debit because assets increase with debit) by 1800 and increase consulting revenue (credit because revenues increase with credit) by 1800. - to record 20 days' accrued revenue

Accrued revenue- Record cash receipt from Customer for Consulting Work Ex.

On Jan. 10, The company completed its obligation under the consulting contract. The client was billed 2700 and the company received 2700 in cash

Journal entry:

Jan 10 Cash 2700

Accounts receivable 1800

Consulting Revenue 900

This is because the accounts receivable has been paid and by now they also completed all the work so we add in the revenue that has been made by this time.

Depreciation

we allocate (spread) the cost over its expected useful life

formula for calculating straight-line depreciation is:

(Asset cost - est. salvage value)/est. useful life

Estimated useful life

The period of time that we expect to use the plant asset

Estimated Salvage Value

The expected market value or selling price of an asset at the end of its useful life

aka scrap value, residual value

Depreciation Expense's normal balance is ?

debit

Accumulated Depreciation is

a contra asset account

reflected in a trial balance sheet in the asset section just below the asset it applies to

Accumulated Depreciation's normal balance is ?

credit

Book Value

fixed asset's original cost - accumulated depreciation as of that date

Represents the portion of the asset's cost that has not yet been depreciated

On a balance sheet, equipment is shown net of accumulated depreciation at is book value

Before Adjusting Prepaid Expenses...

Expenses are understated

Asset is overstated

Before Adjusting Unearned Revenues....

Liability overstated

Revenue understated

Before Adjusting Accrued Expenses.....

Expense understated

Liability understated

Before Adjusting Accrued Revenues

Asset understated

Revenue understated

Steps for Preparing Financial Statements from an Adjusted Trail Balance

1. Prepare income statement using revenue and expense accounts from trial balance

2. Prepare statement of owner's equity using capital and withdrawals from the trial balance, and net income from the income statement

3. Prepare balance sheet using asset and liability accounts from the trial balance; Capital comes from the ending balance in the Statement of Owner's Equity

Profit Margin

net income/net sales

between 10% and 30% is the goal

Highest = most profitable

End of Period Worksheet Benefits Not a required report

Aids the preparation of financial statements

Reduces risk of errors

Links accounts and their adjustments

Helps in preparing interim financial statements

Shows the effect of proposed transactions

End of Period Worksheet Steps

1. Enter Unadjusted Trial Balance

2. Enter Adjusting entry amounts

3. Prepare Adjusted Trial Balance

4. Enter Adjusted Trial Balance amounts into financial statement columns

5. Total Statement Columns, Compute Income or Loss, and Balance columns

Closing Entries Process

1. Identify accounts for closing

2. Record and post closing entries

3. Prepare post-closing trial balance

What is the point of Closing Entries?

1. They reset revenue, expense and withdrawal account balances to 0 at the end of the period

2. They help summarize a period's revenues and expenses in the Income Summary account

Temporary accounts include

Revenues, expenses, withdrawals, and income summary

The closing process applies only to..?

temporary accounts

Permanent Accounts

Liabilities, assets, owner's capital

The balance in permanent accounts is...

carried forward to the next accounting year

Recording the 4 Closing Entries

Step 1 - Close credit balances (get to 0) in revenue accounts to income summary.

To close, debit revenue and credit income summary.

Step 2 - Close debit balances in expense accounts to income summary.

To close, debit income summary and credit each expense

Subtract income summary in step 2 from income summary in step 1 to get net income or loss

Step 3 - Close income summary account to Owner's capital

To close, debit income summary (credit if net loss) and credit Owner's capital (because it is increasing) by the amount that net income is.

Step 4 - Close withdrawals to owner's capital

To close, debit capital and credit withdrawals (since they are decreasing) for the withdrawal amount for that accounting year.

Income Summary

an account in the chart of accounts

Journal entries are ONLY made to it at the end of the accounting year when closing entries are recorded

Does not appear on any financial statement

Does not have a normal balance. A credit if company earned net income and a debit if the company suffered net loss

Closing Revenue Accounts example

Dec. 31 Consulting Revenue 7850

Rental Revenue 300

Income Summary 8150

Closing Debit Accounts example

Dec. 31 Income Summary 4365

Deprecation expense - Equipment 300

Salaries Expense 1610

Insurance Expense 100

Rent Expense 1000

Supplies Expense 1050

Utilities Expense 305

Closing Income Summary to Owner's Capital example

8150 - 4365 = 3785

Dec. 31 Income Summary 3785

C. Taylor Capital 3785

Close Withdrawals Account to Owner's Capital example

Dec. 31 C. Taylor, Capital 200

C. Taylor, Withdrawals 200

Post-Closing Trial Balance

a list of permanent accounts and their balances AFTER posting closing entries

Total debits and credits must be equal

Achieved Goals after closing accounts include:

All temporary accounts have a $0 balance before beginning the next accounting year

All permanent accounts have balances that will carry forward to the next accounting year

The Capital account has been updated to reflect the past year's net income (or loss) and owner's withdrawals

Capital account agrees to Capital in the December 31 balance sheet

What are current assets?

assets that are expected to be sold, collected, or used within one year or the company's operating cycle

What are long-term investments

Falls under assets and are investments that are expected to be held for more than one year or the operating cycle.

Includes land not currently used in operations that is being held for future expansion

What are plant assets?

Assets that are tangible assets with long-lives that are used to produce or sell products and services

What are intangible assets?

long-term resources used to produce or sell products and services and that lack physical form

ex. patents, copyrights

What are current liabilities?

obligations due within one year or within the company's normal operating cycle

What are long-term liabilities?

obligations not due within one year or the operating cycle, whichever is longer

Equity

The owners' claim on assets.

What category on the classified balance sheet does buildings fall under?

Plant assets