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Chapter 4 and 5 Notes

by: Sarah Smithson

Chapter 4 and 5 Notes 202

Sarah Smithson
GPA 3.689

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Chapter 4 and 5 Notes
Principles of Financial Accounting
Robert J. Tepper
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This 5 page Bundle was uploaded by Sarah Smithson on Tuesday March 1, 2016. The Bundle belongs to 202 at University of New Mexico taught by Robert J. Tepper in Spring 2016. Since its upload, it has received 24 views. For similar materials see Principles of Financial Accounting in Business, management at University of New Mexico.

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Date Created: 03/01/16
Chapter 4 Notes Revisiting Financial Reporting Concepts • We divide the economic future into artificial time periods ◦ Periodicity assumption • Revenue Recognition Principle ◦ Recognize revenue in period when realized and when revenue is earned • Expense recognition principle ◦ Expenses matched with revenues • Cash Basis v Accrual Basis ◦ Cash Recognize revenue when cash is received Recognize expenses when cash is paid not GAAP ◦ Accrual Recognize revenue when earned Recognize expenses when incurred US GAAP Implements the revenue recognition and expense recognition principles Adjusting Entries • Needed to implement revenue and expense recognition principles • Can be classified as deferrals (prepayments) or accruals • Will always involve one balance sheet and one income statement account • Internal transaction-does not involve cash account Deferrals (prepayments)- Cash has changed hands-AJE merely allocates • Deferred (prepaid) expenses ◦ Expenses paid in cash and recorded as assets until used or consumed • Generally expire with the passage of time or as consumed • Deferred (unearned) revenues ◦ Revenues received in cash and recorded as liabilities until earned • Generally earnings will occur with passage of time (interest) or with the furnishing a product or service Accruals- Cash has not changed hands- AJE records for first time • Accrued expense (liability) ◦ Expenses have been incurred but cash has not yet been paid ◦ Accrued wages, interest, ect • Accrued revenue (asset) ◦ Revenue has been earned but not yet received in cash or recorded • Accounting Cycle • Analyze transactions • Journalize transactions • Post transactions to ledger accounts • Prepare trial balance • Journalize and post adjusting entires • Prepare adjusted trial balance • Prepare financial statements • Journalize and post closing entires • Prepare post-closing trial balance Accounts • Balance sheet accounts are called real or permanent accounts and are not closed • Income statement accounts (R&E) and dividends are nominal or temporary accounts- closed at end of period Closing Process • Close revenue accounts by debiting them and crediting income summary • Close expense accounts by crediting them and debiting income summary. Balance in income summary represents net income if a credit balance, net loss if a debit balance • Close income summary to retained earnings • Close dividends account by crediting it and debiting retained earnings 2 Chapter 5 Notes Merchandising v Service Firm • Merchandising ◦ Main source of revenue is sale of mdse ◦ Expenses in two categories COGS and Operating Expenses • Service Firm ◦ Main source of revenue is sale of services Net Sales • Sales-Sales Returns and Allowances-Sales Discounts=Net Sales • Difference between a sales return and allowance ◦ With latter, customer keeps merchandise and receives discount • Sales Discounts ◦ Customer pays within discount period Additional sales entry with a perpetual system • A/R or Cash ◦ Sales • COGS • Merchandise Inventory ◦ The second entry is new. Inventory and COGS updated with each transaction Perpetual v Periodic System • Perpetual system ◦ Advantages Current information on inventory and costs resulting in better control disadvantages ◦ Disadvantages Cost Complexity (reduced with automation) Used for items with high unit values • Periodic System ◦ Advantages Simple Appropriate for small businesses ◦ Disadvantages Don’t have current information until the end of the period Recording Purchase of MDSE with Perpetual System • Purchase of MDSE ◦ MDSE Inventory ◦ A/P • Payment of freight ◦ MDSE Inventory ◦ A/P or Cash • Return of MDSE ◦ A/P or Cash ◦ MDSE Inventory • Payment within the discount period ◦ A/P ◦ MDSE Inventory ◦ Cash Freight Costs • FOB shipping point ◦ Ownership of the goods passes to the buyer when the public carrier accepts the goods from the seller • FOB Destination ◦ Ownership of the goods remains with the seller until the goods reach the buyer • Freight costs incurred by the seller are an operating expense Taking a Physical Inventory • Periodic system ◦ Essential for determining EI and COGS • Perpetual System ◦ Control device Inventory updated continually Useful for detecting inventory loss Operating v. Non Operating Activities • Why does it matter ◦ Investors and creditors want to know about revenues and gains ◦ Expenses and losses not related to companies main line of business Profitability Ratios • Gross Profit Ratio ◦ GP/Net Sales ◦ After paying for product, how much of every net sales $1 is 2 available to cover expenses and net income? • Profit Margine ◦ NI/Net Sales ◦ How much of every net sales $1 results in net income? • Return on Assets ◦ NI/Average Total Assets ◦ Overall measure of profitability ◦ How much net income is generated by every $1 invested • Would prefer these ratios to be higher IFRS v US GAAP • Under US GAAP or IFRS a company can choose perpetual or periodic inventory system • Under US GAAP, expenses usually classified by function (sales or administrative) • Under IFRS, expenses may be classified by nature or function • IFRS allows revaluation of land, buildings, and equipment with gains or losses flowing to OCI • Unrealized holding gains and losses not included in income flow through to OCI 3


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