accounting notes
Income Statement and Temporary Accounts
Introduction to Income Statement
The income statement represents financial performance over a period.
Temporary Accounts
Definition of Temporary Accounts
Also known as nominal accounts.
Include revenues, expenses, and dividends.
These accounts are closed at the end of the accounting period.
Closing Process
Resets temporary accounts (revenues, expenses, dividends) to zero at the end of the period.
Objective: Make all temporary accounts zero to prepare for the next period.
Natural Balance of Accounts
Revenue Accounts: Have a natural credit balance.
To zero these accounts, debit each revenue account.
Expense Accounts: Have a natural debit balance.
To zero these accounts, credit each expense account.
Post Closing Trial Balance
Definition of Post Closing Trial Balance
A balance containing only permanent accounts.
Includes no temporary accounts; all have been zeroed out.
Examples of Permanent Accounts
Include assets, liabilities, and owner's equity (not temporary accounts such as revenues and expenses).
The Closing Entries Process
How to Close Accounts
Close revenue accounts to Income Summary (credit to Income Summary).
Close expense accounts (debit Income Summary).
Resulting in Income Summary having a credit balance if revenues exceed expenses.
Closing Income Summary Account for Owner’s Capital
Move balance of Income Summary to Owner's Capital.
Sequence of Closing Process
After adjustments:
Make financial statements first.
Journalize and post closing entries.
Prepare the post closing trial balance.
Burden of Closing
Regulations on Accounting Software
Certain systems like Oracle, SAP require understanding the closing cycle and procedures.
Types of Accounts
Temporary Accounts Include:
Revenues
Expenses
Owner's Withdrawals (dividends)
Permanent Accounts Include:
Assets
Liabilities
Owner's Equity
Adjusting Entries and Financial Statements
Before Closing Accounts: Adjust entries must be completed (e.g., adjusted trial balance).
Classified Balance Sheet
Definition of Classified Balance Sheet
Separates current from non-current (long-term) assets and liabilities.
Current vs Non-current Assets and Liabilities
Current Assets
Are expected to be converted to cash or used within one year.
Examples: Cash, Accounts Receivable, Merchandise Inventory, Prepaid Expenses.
Non-current Assets
Assets held for longer than one year.
Examples: Property, plants, and equipment (PPE), Intangible Assets.
Characteristics of Current vs Non-current Liabilities
Current Liabilities: Obligations due within one year.
Non-current Liabilities: Obligations beyond one year.
Intangible Assets
Definition
Intangible assets have no physical presence (e.g., copyrights, patents, trademarks).
Examples of Intangibles
Copyrights: Protection for artistic works.
Patents: Legal rights for inventions.
Trademarks: Identifiers for brands.
Goodwill: Defined as the amount paid over the fair market value of net assets acquired during business acquisition.
Goodwill Calculation
Goodwill is the excess of the purchase price over the fair market value of net assets acquired.
Example of Goodwill:
If one buys a business valued at $1 million for $1.5 million:
Goodwill recorded = $500,000.
Liquidity and Operating Cycle
Liquidity Definition
Refers to the ease of converting assets to cash without loss of value.
Operating Cycle
Helps determine whether to classify based on one year or the operating cycle which may be longer for certain items like inventory.
FIFO and LIFO Inventory Methods
Definitions
FIFO (First-In, First-Out): The oldest inventory items are considered sold first.
LIFO (Last-In, First-Out): The most recently acquired inventory items are sold first.
Example
If the first lacrosse ball costs $1 and the second costs $2, under FIFO:
Selling a ball for $10 implies a profit calculation based on the $1 cost (profit = $10 - $1 = $9).
Significance of FIFO and LIFO
Impact on financial statement reporting and taxes due to different profit calculations based on the inventory method used.