Chapter 3 - Accounting for Business Transactions

Time Period Assumption

presumes that an organization’s activities can be divided into specific time periods (month, 2 month Quarter, six-month year)

Annual Financial Statements

reports covering a one-year period

Interim Financial Statements

covering one/three/six months activity

Annual Reporting Periods …..

varies somewhat from company to company

Calendar Year & what companies chooses this

ending December 31st , companies w/ little seasonal variation in sales often choose

True or False: Annual Reporting Period DOES NOT need to be a calendar year on Dec. 31st

True

Calendar Year (ending Jan. 31st)

natural business year for retailers, AFTER the holiday season

Examples of Companies in the Calendar Year (ending Jan. 31st)

Walmart & Target

Fiscal Year

Consecutive 12-month (or 52-week) period chosen as the organization’s annual accounting period.

Accrual Basis

Revenues when services/products are delivered and expenses when incurred

Cash Basis

Revenues when cash is received and records expense when cash is paid

For Transactions/Events that extend over more than one period

• Deferral of Expense

• Deferral of Revenue

• Accrued Expense

• Accrued Revenue

Step 1: Adjusting Process

determine what the current account balance equals

Step 2: Adjusting Process

Determine what the current account balance should equal

Step 3: Adjusting Process

Record an Adjusting Entry to get from Step 1 —> Step 2

Adjusting Entries

made at the end of an accounting period to reflect a transaction or event that is not yet recorded

Every Adjusting Entry Affect what two financial statements?

income statement and balance sheet

Every Adjusting Entry Includes:

• A debit to an EXPENSE account and a credit to an ASSET account OR

• A debit to a LIABILITY account and a credit to a REVENUE account OR

• A debit to an EXPENSE account and a credit to a LIABILITY account OR

• A debit to an ASSET account and a credit to a REVENUE account

An Adjustment NEVER NEVER NEVER involves ____

CASH

Prepaid (deferred) Expenses

assets paid for in advance of receiving their benefits

• reflect transactions when cash is paid BEFORE the related revenue is recognized

What adjustment is made on Prepaid (Deferred) Expenses T Account?

……………….Asset ……………………………………………..Expense

________________________________ …….. ________________________________

Unadjusted Balance | Credit Adjustment ……….Debit Adjustment |

Plant Asset

long term tangible assets used to produce and sell products/services (benefit - 1+ accounting period)

Examples of Plant Assets

Cars, Machines, Building, and Equipment

(The cost of these assets are initially deferred but must be gradually reported as expenses on income statement)

Depreciation Expense

process of allocating the cost of these assets over their expected useful lives

Related Expense

recorded with an adjusting entry similar to that of other prepaids w/ two distinctions

• Depreciation Expense

• Original Cost of assets be readily available from company records

Contra Account

linked to another account that has opposite normal balance

Example of a Contra Account

Accumulated Depreciation - Equipment

Salvage Value

assets expected value at the end of its useful life

Straight Line Depreciation Method

allocates equal amounts of asset’s net cost to depreciation during its useful life

Accumulated Depreciation - Equipment has a NORMAL _____ balance

credit

Contra Account reports as a Subtraction from the related accounts balance in the financial statements. Equation

Book Value Plant Asset = Asset’s Cost - Accumulated Depreciation

Unearned (deferred) Revenue

cash received in advance of providing products/services

What adjustment is made on Unearned (deferred) Revenue T Account?

……………….Liability……………………………………………..Revenue

________________________________ …….. ________________________________

Debit Adjustment | Unadjusted Balance ………………………….. | Credit Adjustment

Accrued Expenses

are costs that are incurred in a period but both are unpaid and unrecorded

What adjustment is made on Accrued Expenses T Account?

……………….Expense……………………………………………..Liability

________________________________ …….. ________________________________

Debit Adjustment | ……………………….. ………………………….. | Credit Adjustment

Examples of Accrued Expenses

Accrued {Salaries, Interest, Rent, Taxes} Expense,

Accrued Revenue

revenues earned in a period that are both unrecorded/not yet received in cash (or other Asset)

What adjustment is made on Accrued Revenue T Account?

……………….Asset……………………………………………..Revenue

________________________________ …….. ________________________________

Debit Adjustment | ……………………….. ………………………….. | Credit Adjustment

Examples of Accrued Revenue

Accrued {Services, Products, Interest, Rent} Revenue

Deferral of Expense *

*

Balance Sheet: Asset Overstated

Income Statement: Expense understated

Adjusted Entry:

Dr. Expense

… Cr. Asset

Deferral of Revenue*

*

Balance Sheet: Liability Overstated

Income Statement: Revenue understated

Adjusted Entry:

Dr. Liability

… Cr. Revenue

Accrued Expense*

*

Balance Sheet: Liability Understated

Income Statement: Expense Understated

Adjusted Entry:

Dr. Expense

… Cr. Liability

Accrued Revenue

*

Balance Sheet: Asset Understated

Income Statement: Revenue Understated

Adjusted Entry:

Dr. Asset

… Cr. Revenue

Step 1: The Closing Process

close income statement credit balances (close revenue accounts)

How?

Dr. Revenue

…..Cr. Income Summary

Step 2: The Closing Process

close income statement debit balances (close expenses accounts)

How?

Dr. Income Summary

…..Cr. Expenses

Step 3: The Closing Process

Close income summary account (transfer balance to Retained Earnings)

How?

Dr. Income Summary

… Cr. Retained Earnings

*** to get the retained earnings amount, you need to (Income Summary of Revenues - Income Summary of Expenses = Incomse Summary to Debit. Match it with Retained Earnings)

these two values show equal what your get for retained earnings = 0

Step 4: The Closing Process

Close Dividends Account

How?

Dr. Retained Earnings

… Cr. Dividends

these two values show equal what your get for retained earnings = 0

Post-Closing Balance Trial

lost of permanent accounts and their balances after all closing entries have been journalized and posted

Examples of Permanent Accounts (green)

• Cash acct receivable, supplies, prepaid insurance, equipment, accumulated depreciation equip, accounts payable, salaries payable, unearned consulting, revenue, common stock, retained earnings

Temporary Accounts (blue)

• revenues

• expenses

• dividends

• Income summary

have ending balances =0

Step 1: Accounting Cycle

Analyze Transactions to prepare for journalizing

Step 2: Accounting Cycle

Journalize record accounts (debits/credits) in a journal

Step 3: Accounting Cycle

Post - transfer debits/credits from the journal to the ledger

Step 4: Accounting Cycle

Prepare Unadjusted Trial Balance - summarize unadjusted ledger accounts/amounts

Step 5: Accounting Cycle

Adjust and Post Accounts - Record adjustments to bring accounts balances up to date, then journalize and post

Step 6: Accounting Cycle

Prepare Adjusted Trial Balance - Summarize adjusted ledger accounts and amounts

Step 7: Accounting Cycle

Prepare Financial Statements - use adjusted trial balances to prepare financial statements

Step 8: Accounting Cycle

Close Accounts

Step 9: Accounting Cycle

Prepare Post-Closing Trial Balance

Step 10: Accounting Cycle

Prepare Reversing Entries *OPTIONAL Step

Profit Margin

Profit Margin = Net Income/Net Sales

OR

Return on Sales = /the percent of profit/each dollar of sales

Current Ratio

Current Ratio = Current Assets/Current Liabilities

one measures of a company’s ability to pay its short-term obligations

Current Ration Statement:

Company’s Current Ration less than 1.0, current liabilities _________ current assets

exceed

Unclassified Balance Sheet

broadly groups assets, liabilities, and equity

Classified Balance Sheet

organizes assets/liabilities into subgroups that provide more information to decision makers

Company’s Operating Cycle

time span from when cash is used to acquire goods/ services until cash is received from the scale of goods/services

Comapany’s Operating Cycle in Action

Service Company

1. paying employees who perform the services and

2. receiving cash from customers

Comapany’s Operating Cycle in Action

Merchandiser Selling Product

1. Paying suppliers for merchandise and

2. receiving cash from costumers

Current Items

expected to come due (either collected/owed) WITHIN ONE YEAR or COMPANY’S OPERATING CYCLE

Non Current Items

expected to come due (either collected/owed) AFTER ONE YEAR or COMPANY’S OPERATING CYCLE

*memorize

Items on Current Assets or Liabilities, are listed in the order of HOW QUICKLY they will be CONVERTED to OR PAID IN CASH

Order of Classified Balance Sheet

1. Current Assets

2. Long Term Investment

3. Plant Assets

4. Intangible Assets

5. Current Liabilities

6. Long-Term Liabilities

7. Equity

Reversing Entries (Not Used/Used)

used for adjusting entries involving ACCRUED REVENUES & ACCURED EXPENSES

Examples of Current Assets

• Cash

• Short-term Investments

• Accounts Receivable, net

• Merchandise Inventory

• Prepaid Expenses

• Short Term Receivable (other example)

Examples of Long-Term Investment

1. Notes Receivable*

2. Investment in Stocks/Bonds*

3. Land held for future expansion

Are long-term when they are expected to be held for MORE than ONE YEAR

Examples of Plant Assets

• Equipment

• Less Accumulated depreciation (-)

• Equipment, net

• Land

Examples of Intangible Assets

• trademarks

• patents

• goodwill

Examples Current Liabilities

• Accounts Payable

• Wages Payable

• Notes Payable

• Current port of Long-Term Liability

• Tax Payable (not on example)

• Interest Payable ( not on example)

• Unearned revenue (not on example)

reported in order of those to be settled first

Long-Term Liabilities

* net of current portion *

• Notes payable

• Mortgage Payable

• Bonds Payable

• Lease Obligations

Examples of Equity

• Common Stock

• Retained Earnings