MGA 201 Day 5

Cash Transactions and Adjustments

  • Cash does not change hands during adjustments.

  • Non-cash transactions only involve recording, no cash involved during the adjustment.

Tax Liability Example

  • Taxes are incurred due to generated income.

  • Recognize tax-related expenses via accrual accounting: expense recognized now, payment in future.

Interest Accounting

  • Accrual adjustments for interest: interest is receivable even though cash may come later.

  • Cash received for interest is anticipated, hence the accrual adjustment is critical.

Accrual vs. Deferral Adjustments

  • Accrual Adjustment (A):

    • Represents future anticipated cash transactions.

    • Asset is tied to income statement (revenue).

    • Recognize revenues/expenses before actual cash transactions occur.

  • Deferral Adjustment (D):

    • Represents past transactions where cash has changed hands already.

    • Expense recognized upon usage of an already paid asset (like prepaid expenses).

Examples of Adjustments

  1. Interest Receivable

    • Recognize monthly revenues accruing as receivable until payment is made.

    • Receivables create an asset on balance sheet; revenue on income statement.

  2. Tax Expense

    • Recognize tax liabilities and expenses regularly (quarterly, monthly).

    • Liability recording is concurrent with expense recognition.

Practical Examples of Adjustments

Deferral Adjustment: Supplies

  • Purchases: $600 worth supplies; $250 remain.

  • Adjustment

    • Expense recognized: $350 (used supplies) = $600 - $250.

    • Journal: Debit Expense $350, Credit Supplies (asset) $350.

Deferral Adjustment: Prepaid Rent

  • Three months rent paid in advance: total $7,200, one month elapsed = $2,400 used.

  • Adjustment made to recognize expense:

    • Rent Expense increase (Debit) $2,400, Prepaid Rent (Asset) decrease (Credit) $2,400.

Depreciation

  • Defined as recognizing the decrease in value of an asset over time.

  • Depreciation is a contra asset account, reducing overall asset values.

  • Journal entry:

    • Recognize depreciation expense (Debit) and increase accumulated depreciation (Credit).

Wages and Accruals

  • Unpaid wages at month-end create liabilities and need to be recognized in the financials.

  • Journal entry: Debit Wage Expense and Credit Wages Payable.

Interest and Income Taxes

  • Example for incurred interest: Acknowledge expense and liability as they occur irrespective of payment.

  • Income taxes can be calculated and accrual made for expenses as payment is not done immediately.

Closing Process

  • After adjustments, prepare financial statements: Income Statement, Retained Earnings Statement, Balance Sheet.

  • Close temporary accounts: Revenue/Expense accounts reset to zero post-closure, impacting Retained Earnings.

Quiz Preparation Examples

  1. Adjusting journal entries for supplies need. Recognize difference between what remains and what was originally purchased.

  2. Recognizing interest income earned but not yet received, reflecting in accrual adjustment required.

  3. Adjusting salaries owed to employees at year-end identifying liability.

Important Inventory Concepts

  • Definition: Inventory is an asset; items available for sale.

  • Categories of Inventory Systems:

    • Periodic Inventory System: Updates at set intervals, less accurate estimating shrinkage.

    • Perpetual Inventory System: Continuous tracking of inventory, allows for real-time information on assets.

Inventory Purchase Dynamics

  • FOB Shipping Point vs. FOB Destination.

  • Ownership transfer upon shipment has implications for recording inventory on balance sheets.

Revenue Recognition Principles

  • Recognize revenue when earned, matching expenses to revenue in the same reporting period.

  • Multistep income statement: Starts with net sales; includes cost of goods sold, gross profit, and operating expenses.

Bundled Products Revenue Recognition

  • Bundled products (e.g., subscriptions and products) need allocation of the total price to service vs equipment.

  • Journal entries will reflect deferred revenue until the performance obligations are satisfied over time.

Summary of Key Terms and Concepts

  • Cash transactions: adjustments versus actual cash flow timelines.

  • Accruals vs. deferrals: when to recognize revenue/expense.

  • Inventory management & accounting: impact on financial statement presentation and metrics like gross profit.

  • Importance of recognizing accrued liabilities as well as prepaid expenses correctly in accounting cycles.