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FInancial and Managerial Accounting Chapters 1 - 3

by: Stacy OK

FInancial and Managerial Accounting Chapters 1 - 3 51499

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Outline of notes from Wiley Financial and Managerial Accounting Textbook Second Edition. Use this for Continuing Cookie Chronicles homework and Exam.
Introduction to Financial Accounting
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This 33 page Study Guide was uploaded by Stacy OK on Wednesday September 14, 2016. The Study Guide belongs to 51499 at Leeward Community College taught by Kamida in Fall 2016. Since its upload, it has received 66 views. For similar materials see Introduction to Financial Accounting in Accounting at Leeward Community College.

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Date Created: 09/14/16
Friday, September 2, 2016 Financial and Managerial Accounting Accounting 201 I. Chapter 1: Accounting in Action
 LO 1: Identify the activities and users associated with accounting. -Accounting consists of 3 basic activities: It identifies, records and communicates the economic events of an organization to interested users. A. Three Activities
 -Identifies the economic events relevant to its business
 -Records events in order to provide a history of its financial activities by keeping a systematic, chronological diary of events.
 -Communicates collected info through accounting reports/financial statements
 -“In the aggregate” reporting all similar sales transactions over a certain period of time as one amount
 -Analysis: use of ratios, percentages, graphs, and charts to highlight significant financial trends and relationships
 -Interpretation: explaining the uses, meaning and limitations of reported data
 -Bookkeeping- involves ONLY the recording of economic events, just one part of accounting process B. Who Uses Accounting Data 1. Internal Users
 -Internal Users- managers who plan, organize and run the business using accounting information. 
 Questions asked by internal users:
 -Finance: Is cash sufficient to pay dividends to stockholders?
 -Marketing: What price should we charge to maximize company’s net income?
 -Human Resources: Can we afford to give employees pay raises?
 -Management: Which product line is most profitable? Should any be eliminated?
 Managerial Accounting - field of accounting that provides internal reports to help users make decisions about their companies. 1 Friday, September 2, 2016 2. External Users
 External Users - individuals and organizations outside a company who want financial information about the company. 
 Two most common types:
 Investors (Owners) - use accounting information to decide whether to buy, hold or sell ownership shares of a company
 Creditors (suppliers, bankers, etc.) - use accounting information to evaluate the risks of granting credit or lending money.
 Questions asked by external users:
 Investors: Is company earning satisfactory income?
 Investors: What is the comparability in size and profitability to company a vs company b?
 Creditors: Is company able to pay its debts as they come due?
 Taxing authorities (IRS): Does company comply with tax laws?
 Regulatory agencies (SEC, FTC): Is company operating within prescribed rules?
 Customers: Will company continue to honor product warranties and support its product lines?
 Labor unions: Will owners have ability to pay increased wages and benefits?
 Financial Accounting - provides economic and financial information for investors, creditors and other external users. LO2. Explain the building blocks of accounting: ethics, principles, and assumptions. C. Ethics in Financial Reporting
 Sarbanes-Oxley Act (SOX) - Law passed by Congress to reduce unethical corporate behavior and decrease the likelihood of future corporate scandals.
 Ethics - the standards of conduct by which actions are judged as right or wrong, honest or dishonest, fair or not fair.
 Steps in analyzing ethics cases and situations 3. Identify the alternatives and 1. Recognize an ethical 2. Identify and analyze the weigh the impact of each situation and the ethical principal elements in the alternative on various issues involved situation stakeholders 2 Friday, September 2, 2016 Use your personal ethics to Identify the stakeholders— Select the most ethical identify ethical situations and persons or groups who may be alternative, considering all the issues. Some businesses and harmed or benefited. Ask the consequences. Sometimes there professional organizations question: What are the will be one right answer. Other provide written codes of ethics responsibilities and obligations of situations involve more than one for guidance in some business the parties involved? right solution; these situations situations require an evaluation of each and a selection of the best alternative. D. Generally Accepted Accounting Principles
 Generally Accepted Accounting Principles (GAAP) - Common set of standards on how to report economic events that are generally accepted and universally practiced within the accounting profession.
 Financial Accounting Standards Board (FASB) - primary accounting standard- setting body in the United States
 Securities and Exchange Commission (SEC) -agency of the US government that oversees US financial markets and accounting standard-setting bodies.
 SEC relies on the FASB to develop accounting standards which public companies must follow.
 International Accounting Standards Board (IASB) - An accounting standard- setting body that many countries outside of the US follow.
 International Financial Reporting Standards (IFRS) - International accounting standards set by the IASB
 Convergence - The process to reduce the differences between US GAAP and IFRS. E. Measurement Principles
 -GAAP generally uses one of two measurement principles: historical cost or fair value principle. 
 -Selection of which trades off between:
 Relevance - financial information is capable of making a difference in a decision
 Faithful Representation - numbers and descriptions match what really existed or happened — they are factual. 1. Historical Cost Principle
 HIstorical Cost Principle (Cost Principle) - dictates that companies record assets at their cost at time purchased through time held. 3 Friday, September 2, 2016 2. Fair Value Principle
 Fair Value Principle - assets and liabilities should be reported at fair value (the price received to sell an asset or settle a liability)
 -Only in situations where assets are actively traded do companies apply the fair value principle extensively.
 -In determining which measurement principle to use, companies weigh the factual nature of cost figures vs the relevance of fair value. F. Assumptions Monetary Unit Assumption
 1. Monetary Unit Assumption - requires that companies include in the accounting records only transaction date that can be expressed in money terms.
 -Enables accounting to quantify economic events
 -vital to applying the historical cost principle 2. Economic Entity Assumption
 *An economic entity can be any organization or unit in society (ex. company, governmental unit, municipality, school district, church, etc.)
 Economic Entity Assumption - requires activities of the entity be kept separate and distinct from the activities of its owner and all other economic entities. Personal living costs must be kept separate from business expenses. a) Proprietorship
 Proprietorship - A business owned by one person.
 -The owner is often the manager/operator of the business.
 *Usually only a relatively small amount of money (capital) is necessary to start in business as a proprietorship. The owner (proprietor) receives any profits, suffers any losses, and is personally liable for all debts of the business.
 -There is no legal distinction between the business as an economic unit and the owner, but economic entity assumption still holds. b) Partnership
 Partnership - business owned by two or more persons associated as partners.
 -Each partner generally has unlimited personal liability for the debts of a partnership
 4 Friday, September 2, 2016 *Like a proprietorship, for accounting purposes the partnership transactions must be kept separate from the personal activities of the partners. c) Corporation
 Corporation - A business organized as a separate legal entity under state corporation law and having ownership divided into transferable shares of stock. Enjoys an unlimited life.
 -Enjoy limited liability
 -May transfer all or part of their ownership shares to other investors at any time
 -The combined number of proprietorships and partnerships in the US is more than 5x the number of corporations, but revenue produced by corporations is eight times greater. LO3. State the accounting equation, and define its components.
 -The two basic elements of a business are what it owns and what it owes.
 -Assets - resources a business owns. Liabilities and stockholders’ equity are the rights or claims against these resources.
 -Liabilities - Claims of those to whom the company owes money (creditors)
 -Stockholders’ Equity -Claims of owners
 The Basic Accounting Equation Assets = Liabilities + Stockholders’ Equity Basic Accounting Equation - Relationship between assets, liabilities and stocholders’ equity. Liabilities appear before stockholders’ equity because they are paid first if a business is liquidated.
 -Applies to all economic entities regardless of size, nature of business or form of business organization,
 -Provides the underlying framework for recording and summarizing economic events G. Assets
 -Common characteristic possessed by all assets is the capacity to provide future services or benefits.
 -Cash/Service Potential/Future Economic Benefit = Cash Inflows (receipts) 5 Friday, September 2, 2016 H. Liabilities
 Liabilities - claims against assets — existing debts and obligations.
 Accounts Payable - purchases on credit from suppliers
 Note Payable - money borrowed from banks
 Salaries and Wages Payable - money owed to employees
 Sales and Real Estate Taxes Payable - money owned to local government
 Creditors - All persons or entities to whom company owes money
 -Creditors may legally force the liquidation of a business that does not pay its debts. Law requires that the creditor claims be paid before ownership claims, I. Stockholders’ Equity
 Stockholders’ Equity - ownership claim on a corporation’s total assets
 -Equal to total assets minus total liabilities.
 Residual Equity - Equity “leftover” after creditors’ claims are satisfied, liabilities minus assets.
 -Stockholders’ equity section of a corporation’s balance sheet generally consists of: Common Stock and Retained Earnings 1. Common Stock
 Common Stock - used to describe the total amount paid in by stockholders for the shares they purchase. 2. Retained Earnings
 Retained Earnings - Sections of the balance sheet is determined by three items: Revenues, Expenses and Dividends a) Revenues
 Revenues - the gross increases in stockholders’ equity resulting from business activities entered into for the purpose of earning income. b) Expenses
 Expenses - cost of assets consumed or services used in the process of earning revenue, decreases in stockholders’ equity that result from operating the business. c) Dividends
 Dividends - The distribution of cash or other assets by corporations to stockholders’.
 -Reduces retained earnings, but not an expense. 6 Friday, September 2, 2016 Increases and decreases in stockholders’ equity Increases Decreases Investments by Stockholders’ Dividends to stockholders —> Equity —> stockholders Revenues Expenses LO4. Analyze the effects of business transactions on the accounting equation. J. Transactions
 Transactions (business transactions) - a business’s economic events recorded by accountants
 External transactions - involve economic events between the company and some outside enterprise (ex. purchase from supplier, payment of rent to landlord, sale to customer)
 Internal Transactions - economic events that occur entirely within one company (use of supplies) 
 -Examples of activities that do not represent business transactions: hiring employees, responding to emails, placing merchandise orders.
 *Transaction-Identification process: Ask— Is the financial position (assets, liabilities or stockholders; equity) of the company changed?
 -Each transaction must have a dual effect on the account equation, two or more items could be affected. K. Transaction Analysis
 7 Friday, September 2, 2016 
 1. Transaction 1. Investment by Stockholders
 Assets = Liabilities + Stockholders’ Equity Cash = Common Stock +$15,000 +$15,000 -Cash increases/Common Stock increases
 -Equality of basic equation has been maintained,
 -Investments of not represent revenues, excluded in determining net income 2. Transaction 2. Purchase of Equipment for Cash
 -Cash decrease/Asset Equipment increases 3. Transaction 3. Purchase of Supplies on Credit
 Asset Supplies increases/Liability Accounts Payable increases 4. Transaction 4. Services Performed for Cash
 *Revenue increases stockholders’ equity
 -Asset Cash increases/Stockholders’ equity increases due to Service Revenue 5. Transaction 5. Purchase of Advertising on Credit
 -Liability Accounts Payable increases/Stockholders’ equity decreases due to Advertising Expense
 -When paid at a later date, the liability Accounts Payable will decrease and the asset Cash will decrease.
 -Cost of advertising is an expense (rather than an asset) because the benefits are already used.
 -Advertising Expense is used in determining net income. 6. Transaction 6. Services Performed for Cash and Credit
 Three specific items are affected: Asset Cash increases/Asset Accounts Recievable increases and Stockholders’ Equity increases an equal amount to both due to Service Revenue.
 -Accounts Receivable represents customers’ promises to pay in the future. When received collections on account, Asset Cash will increase/Accounts Receivable decreases. 8 Friday, September 2, 2016 7. Transaction 7. Payment of Expenses
 -Asset Cash decreases/Stockholders’ equity decreases
 -Separate lines required in analysis to indicate the different types of expenses that have been incurred (ex. separate lines for Rent Expense, Salaries and Wages Expense, Utilities Expense, etc.) 8. Transaction 8. Payment of Accounts Payable
 Cash payment “on account” decreases Asset Cash/decreases Liability Accounts Payable
 -0Does not affect stockholders’ equity, as it is an already recorded expense. Transaction 9. Receipt of Cash on Account
 9. -Asset Cash increases/Assets Accounts Receivable decreases
 -Does not change total assets, but changes composition of assets
 -Does not affect stockholders’ equity, already recorded revenue and should not be recorded again. 10. Transaction 10. Dividends
 -Asset Cash decreases/Stockholders’ Equity decreases due to Dividends
 -Dividends reduces Retained Earnings, which is part of Stockholders’ Equity
 *Dividends are not expenses!
 -Excluded in determining net income L. Summary of Transactions 1. Each transaction must be analyzed in terms of its effect on: a) The three components of the basic accounting equation b) Specific types (kinds) of items within each component. 2. The two sides of the equation must always be equal 3. The Common Stock and Retained Earnings columns indicate the causes of each change in the stockholders’ claim on assets. LO5. Describe the four financial statements and how they are prepared.
 Companies prepare four financial statements from the summarized accounting data: 1. Income Statement - presents the revenues and expenses and resulting net income or net loss for a specific period of time. 
 2. Retained Earnings Statement - summarizes the changes in retained earnings for a specific period of time.
 9 Friday, September 2, 2016 3. Balance Sheet - Reports the assets, liabilities, and stockholders’ equity of a company at a specific date.
 4. Statement of Cash Flows - summarizes information about the cash inflows (receipts) and outflows (payments) for a specific period of time. 
 These statements provide relevant financial data for both external and internal users. Data from statements are interrelated:
 1. Net Income on the Income Statement is added to the beginning balance of Retained Earnings in the Retained Earnings Statement.
 2. Retained earnings at the end of the reporting period shown in the Retained Earnings Statement is reported on the Balance Sheet.
 3. Cash on the Balance Sheet is reported on the Statement of Cash Flows. M. Income Statement
 -Reports the success of profitability of the company’s operations over a specific amount of time.
 -The heading of the statement identifies the company, the type of statement and the time period covered by the statement.
 Income Statement List Order:
 1. Revenues
 2. Expenses
 3. Net Income* (Net Loss)**
 *Net Income - When revenues exceed expenses
 **Net Loss - When expenses exceed revenues
 ***List expenses in order of magnitude. (Although practice varies) 
 -Does not include investment and dividend transactions between stockholders and the business in measuring net income. N. Retained Earnings Statement
 -Reports the changes in retained earnings for a specific period of time.
 -Data for Retained Earnings Statement comes from the Retained Earnings Columns of the tabular summary and from the income statement.
 Retained Earnings Statement List Order:
 1. Beginning Retained Earnings amount
 2. Net Income
 10 Friday, September 2, 2016 3. Dividends
 4. Retained Earnings Ending Balance
 -Information provided by this statement indicates the reasons why retained earnings increased or decreased during the period.
 -If there is net loss, it is deducted with dividends in the retained earnings statement. O. Balance Sheet
 -Reports the assets, liabilities, and stockholders’ equity at a specific date. 
 -Prepared from the column headings and the month0end data shown in the last line of the tabular summary.
 Balance Sheet List Order:
 1. Assets
 2. Liabilities
 3. Stockholders’ Equity P. Statement of Cash Flows
 -Provides information on the cash receipts and payments for a specific period of time.
 1. Cash effects of a company’s operations during a period
 2. Investing activities
 3. Financing activities
 4. Net increase or decrease in cash during the period.
 5. Cash amount at the end of the period.
 Provides answers to following questions:
 1. Where did the cash come from during the period?
 2. What was cash used for during the period?
 3. What was the change in the cash balance during the period? LO6. Appendix 1A: Explain the career opportunities in accounting. Q. Public Accounting
 Public Accounting - offer expert service to the general public.
 Auditing - when a Certified Public Accountant (CPA) examines company financial statements and provides an opinion as to how accurately the financial 11 Friday, September 2, 2016 statements present the company’s results and financial position. CPA’s have exclusive right to issue.
 Taxation - major area of public accounting, includes tax advice and planning, preparing tax returns and representing clients before governmental agencies such as the Internal Revenue Service
 Management Consulting - Installing basic accounting software or highly complex enterprise resource planning systems, to performing support services for major marketing projects and merger and acquisition activities. R. Private Accounting
 Private (Managerial) Accounting - involved in activities such as cost accounting (finding the cost of producing specific products), budgeting, accounting information system design and support, and tax planning and preparation. S. Governmental Accounting
 -Working for governmental agencies such as the IRS, FBI, SEC, to education. T. Forensic Accounting
 Forensic Accounting - uses accounting, auditing, and investigative skills to conduct investigations into theft and fraud. 
 -Listing among top 20 career paths of the future. U. “Show Me the Money”
 - 12 Friday, September 2, 2016 II. Chapter 2: The Recording Process 
 LO 1: Describe how accounts, debits and credits are used to record business transactions
 -Account - an individual accounting record of increases and decreases in a specific asset, liability, or stockholders’ equity item. (ex. separate accounts for Case, Accounts Receivable, Service Revenue, Salaries and Wages Expense, etc.)
 -Accounts consist of 3 parts: title, left/debit side, right/credit side.
 -T-account - Format of an account that resembles the letter T A. Debits and Credits
 -Debit (DR.) - indicates left side of an account
 -Credit (CR.) - indicates right side of an account
 -does not indicate increase or decrease
 -used in recording process to describe where entries are made in accounts. 
 -Debit Balance - when comparing totals of two sides of an account, the total of the debit amounts exceeds the credits
 -Credit Balance - if credit amounts exceed the debits
 -Every positive item in the tabula summary represents a receipt of case
 -Every negative amount represents a payment of case.
 -In the account form, we record the increases of cash as debits and the decreases in cash as credits.
 -Increases on one side/decreases on the other side reduces recording errors and helps in determining the totals of each side of the account as well as the account balance
 -Balance is determined by netting the two sides (subtracting one amount from the other) 1. Debit and Credit Procedure
 * Debits MUST EQUAL credits: Each transaction must affect two or more accounts to keep the basic accounting equation in balance
 -Double-entry system - equality of debits and credits of recording transactions in appropriate accounts, helps ensure accuracy of of the recorded amounts as well as the detection of errors.
 13 Friday, September 2, 2016 2. DR./CR. Procedures for Assets and Liabilities
 *Increases and decreases in liabilities will have to be recorded opposite from increases and decreases in assets.
 Debits Credits Increase assets Decrease assets Decrease liabilities Increase liabilities 
 *Asset accounts normal show debit balances (asset account should exceed credits to that account
 *Liability accounts normally show credit balances (credits to a liability account should exceed debits to that account.)
 -Normal balance - the side where an increase in the account is recorded.
 -The opposite side entries should never exceed the normal balance.
 -Knowing the normal balance in an account may help you trace errors
 Assets Liabilities Debit for Increase (+) Credit for decrease (-) Debit for decrease (-) Credit for increase (+) ^NORMAL BALANCE ^NORMAL BALANCE 3. Stockholders Equity
 -There are five subdivisions of stockholders’ equity: common stock, retained earnings, dividends, revenues and expenses.
 -Accounts kept for each of these subdivisions a) Common Stock
 -Common Stock - issued in exchange for the owners’ investment paid in to the corporation.
 *Credits increase the Common Stock account, debits decrease it. b) Retained Earnings
 -Retained Earnings - net income that is kept in the business, represents the portion of stockholders’ equity that the company has accumulated through the profitable operation of the business.
 *Credits (net income) increase the Retained Earnings accountant debits (dividends or net losses) decrease it. 14 Friday, September 2, 2016 c) Dividends
 -Dividend - a company’s distribution to its stockholders on a pro rata (equal) basis.
 -Cash Dividend - most common form of a distribution
 -Dividends reduce the stockholders’ claims on retained earnings
 *Debits increase the Dividends account and credits decrease it d) Revenues and Expenses
 -Purpose of earning revenues is to benefit the stockholders of the business.
 *Credits increase revenue accounts and debits decrease them
 *The effect of debits and credits on revenue accounts is the same as their effect on stockholder’ equity.
 -Credits to revenue accounts should exceed debits (Credit balance)
 -Expenses decrease stockholders’ equity.
 *Expense accounts are increased by debits and decreased by credits.
 -Debits to expense accounts should exceed credits (Debit balance) B. Stockholders’ Equity Relationships
 -Common stock and retained earning is reported on stockholders’ equity section of balance sheet.
 -Dividends reported on retained earnings statement
 -Revenues and expenses reported on income statement
 -Dividends, revenues and expenses eventually transferred to retained earnings at end of period
 -Change in either dividends, revenues and expenses affect stockholders’ equity. C. Summary of Debit/Credit Rules
 Basic Assets = Liabilities + Stockholders’ Equity Equation + + Expanded Assets = Liabilities Common Retained + - - Equation Stock Earnings Revenues Expenses Dividends Debit/ Credit Dr. Cr. 
 Cr. Dr. Cr. 
 Dr. Cr. 
 Cr. Dr.
 Effects + - - + - + - + - + + - + - 15 Friday, September 2, 2016 D. Steps in the Recording Process
 LO2. Indicate how a journal is used in the recording process.
 Three basic steps in the recording process: 1. Analyze each transaction for its effects on the accounts through business documents - sales receipt, check or bill to provide evidence of transaction 2. Enter the transaction information in a Journal by determining transactions effect’s on specific accounts 3. Transfer the journal information to the appropriate accounts in a Ledger. E. The Journal
 -Journal - referred to as the book of original entry for records of transactions in chronological order. Shows debit and credit effects on specific accounts.
 -General Journal - the most basic form of journal, has spaces for dates, account titles and explanations, references and two amount columns.
 -Discloses in one place the complete effects of a transaction
 -Provides a chronological record of transactions
 -Helps to prevent or locate errors because the debit and credit amounts for each entry can be easily compared. 1. Journalizing
 -Journalizing - entering transaction data
 A complete entry consists of:
 -date of transaction
 -accounts and amounts to be debited and credited
 -brief explanation of the transaction
 -Date of transaction is entered in Date column
 -Debit account title (Account to be debited, ex. Cash) is entered first at the extreme left margin of the column headed “Account Titles and Explanation,” and the amount is recorded in the Debit column
 -Credit account title (ex. Common Stock) is indented and entered on the next line in the column headed “Account Titles and Explanation,” and the amount of the credit is recorded in the Credit column
 16 Friday, September 2, 2016 -Brief explanation of the transaction appears on the line below the credit account title. A space is left between journal entries to separate individual entries and make it easier to read.
 -The column titled Ref. (Reference) is left blank when the journal entry is made. It is filled when the journal entries are transferred to the ledger.
 *It is important to use correct and specific account titles in journalizing. 2. Simple and Compounds Entries
 -Simple entry - involves only two accounts, one debit and one credit
 -Compound Entry - Entry that requires three or more accounts. (Ex. Making a purchase where you pay partially now and pay the rest later/accounts payable)
 -Compound Entry requires that all debits be listed before credits.
 The Ledger
 F. LO3. Explain how a ledger and posting help in the recording process
 -Ledger - Entire group of accounts maintained by a company, provides the balance in each of the accounts as well as keeps track of changes in these balances.
 -General Ledger -contains all the asset (cash, supplies, land, equipment), liability (notes payable, accounts payable, salaries and wages payable, interest payable) and stockholders’ equity accounts (common stock, retained earnings, dividends, service revenue, salaries and wages expense).
 -Companies arrange the ledger in the sequence in which they preset the accounts in the financial statements. In order: assets, liabilities, stockholders’ equity, revenues, and expenses. Each account is numbered.
 -The ledger provides the balances of each account. 1. Standard Form of Account
 -Three Column Form of Account- has three money columns — debit, credit, and balance. Balance in the account is determined after each transaction. G. Posting
 -Posting- Transferring journal entries to the ledger accounts, accumulates the effects of journalized transactions into the individual accounts.
 17 Friday, September 2, 2016 Steps:
 -In the ledger, in the appropriate columns of the accounts debited, enter the date, journal page and debit amount shown in the journal.
 -In the reference column of the journal, write the account number to which the debit amount was posted.
 -In the ledger, in the appropriate columns of the account(s) credited, enter the date, journal page, and credit amount shown in the journal.
 -In the reference column of the journal, write the account number to which the credit amount was posted.
 *After the last entry has been posted, the account should scan the reference column in the journal, to confirm that all posting have been made
 -Posting should be performed in chronological order (post all debits and credits of one journal entry before proceeding to the next journal entry) and should bee made on a timely basis to stay up-to-date.
 -The reference column of a ledger account indicates the journal page from which the transaction was posted
 -The explanation space of the ledger account is used infrequently because an explanation already appears in the journal. 1. Chart of Accounts
 -The number of accounts depends on the amount of detail management desires in a company (Ex. one “utility” expense account vs separate account for gas, electricity, water, etc.)
 -Chart of Accounts- lists the accounts a company has and the account numbers that identify their location in the ledger (Ex. Accounts 101-199 for asset accounts; 200-299 for liabilities; etc.)
 -Companies may leave gaps between numbers for accounts to permit the insertion of new accounts as needed during the life of the business. The Recording Process Illustrated
 H. *Follow these steps:
 -Determine what type of account is involved
 -Determine what items increased or decreased by how much
 -Translate the increases and decreases into debits and credits
 Illustration 2-20: Investment of cash by stockholders
 -Credit Cash/Debit Common Stock
 18 Friday, September 2, 2016 
 Illustration 2-21: Purchase of office equipment
 Costing $5000 by signing a 3-months, 12%, $5000 note payable
 -Credit Equipment/Debit Notes Payable
 Illustration 2-22: Receipt of cash for future service
 -Credit Cash/Debit Unearned Service Revenue
 Illustration 2-23: Payment of monthly rent
 -Credit Rent Expense/Debit Cash
 Illustration 2-24: Payment for insurance
 -Credit Prepaid Insurance/Debit Cash
 Illustration 2-25: Purchase of supplies on credit/on account
 -Credit Supplies/Debit Accounts Payable
 Illustration 2-26: Hiring of employees
 -No Entry
 Illustration 2-27: Declaration and payment of dividend
 -Credit Dividends/Debit Cash
 Illustration 2-28: Payment of salaries
 -Credit Salaries and Wage Expense (Paid salaries TO DATE)/Debit Cash
 Illustration 2-29: Receipt of cash for services performed
 -Credit Cash/Debit Service Revenue (received CASH for services)
 -The purpose of transaction analysis is first to identify the type of account involved, and then to determine whether to make a debit or a credit to the account I. Summary Illustration of Journalizing and Posting
 LO4. Prepare a trial balance.
 -Trial Balance - a list of accounts and their balances at a given time. 
 -Proves the mathematical equality of debits and credits after posting. Debit = 19 Friday, September 2, 2016 Credit
 -A trial balance may also uncover errors in journalizing and posting
 -Useful in the preparation of financial statements
 Steps for preparing a trial balance:
 -List the account titles and their balance in the appropriate debit or credit column
 -Total the debit and credit columns
 -Prove the equality of the two columns J. Limitations of a Trial Balance
 -The trial balance does not prove that the company has recorded all transactions or that the ledger is correct.
 Trial balance may balance even when:
 -A transaction is not journalized
 -A correct journal entry is not posted
 -A journal entry is posted twice
 -Incorrect accounts are used in journalizing or posting
 -Offsetting errors are made in recording the amount of a transaction K. Locating Errors
 -Errors generally result from mathematical mistakes, incorrect postings or transcribing the data incorrectly.
 What to Do if Your Trial Balance Does Not Balance:
 -Determine the amount of difference between the two columns of the trial balance
 -If the error is $1, $10, $100, or $1000, re-add the trial balance columns and recompute the account balances
 -If the error is divisible by 2, scan the trial balance to see whether a balance equal to half the error has been entered in the wrong column.
 -If the error is divisible by 9, retrace the account balances on the trial balance to see whether they are incorrectly copied from the ledger for Transposition Errors (reversing the order of numbers)
 -If the error is not divisible by 2 or 9, scan the ledger to see whether an account balance in the amount of the error has been omitted from the trial balance, and scan the journal to see whether a posting of that amount has been omitted. 20 Friday, September 2, 2016 L. Dollar Signs and Underlining
 -Dollar signs do not appear in journals or ledgers.
 -Dollar signs only appear in trial balance and the financial statements (shown only for the first item in the column and for the total.)
 -A single line (a totaling rule) is placed user the column of figures to be added or subtracted.
 -Total amounts are double underlined to indicate final sums
 21 Friday, September 2, 2016 III.Chapter 3
 LO1: Explain the accrual basis of accounting and the reasons for adjusting entries.
 Time period assumption - accountants divide the economic life of a business into artificial time periods A. Fiscal and Calendar Years
 *Accounting time periods are generally a month, a quarter or a year.
 Interim periods - monthly and quarterly time periods, most large companies prepare both quarterly and annual financial statements
 Fiscal year - an accounting time period that is one year in length
 Calendar year - Jan 1 - Dec 31
 B. Accrual- versus Cash-Basis Accounting
 Accrual-basis accounting - companies record transactions that change a company’s financial statements in the periods in which the events occur. (Recognizing revenue after performing services vs when receiving cash, recognizing expenses when incurred vs when paid, etc.)
 Cash-basis accounting - companies record revenue when they receive cash or an expense when they pay out cash, alternative to accrual-basis accounting. 
 -Often produces misleading financial statements. Fails to record revenue for a company that has performed services but has yet to receive cash. Expenses do not match revenues.
 *Accrual-basis accounting is therefore in accordance with generally accepted accounting principles (GAAP).
 -Individuals/small companies are justified in using cash-basis accounting if they have few receivables and payables
 -Medium and large companies use accrual-basis accounting C. Recognizing Revenues and Expenses 1. Revenue Recognition Principle
 Performance Obligation - when company agrees to perform a service or sell product to a customer
 Revenue Recognition Principle - Requires that companies recognize revenue in the accounting period in which the performance obligation is satisfied. 2. Expense Recognition Principle
 -“Let the expenses follow the revenues” - Expense recognition is tied to 22 Friday, September 2, 2016 revenue recognition
 -must report salary expense incurred from performing service in the same period in which it recognizes the service revenue, may not be in the same period in which the expense is paid.
 Expense Recognition Principle/Matching Principle - Efforts (expenses) must be matched with Results (Revenues) D. The Need for Adjusting Entries
 Adjusting Entries - ensures that the revenue recognition and expense recognition principles are followed.
 Trial balance - the first pulling together of the transaction data, may not contain up-to-date and complete data making adjusting entries necessary
 Reasons why trial balances are not up-to-date:
 1. Some events are not recorded daily because it is not efficient to do so, such as use of supplies and earning of wages by employees
 2. Some costs are not recorded during the accounting period because these costs expire with the passage of time rather than as a result of recurring daily transaction such as rent, insurance, use of buildings and equipment
 3. Some items may be unrecorded such as a bill not received until the next accounting period
 *Adjusting entires are required every time a company prepares financial statements
 *Every adjusting entry will include one inch statement account and one balance sheet account E. Types of Adjusting Entries
 1. Prepaid expenses: Expenses paid in cash before they are used or consumed
 2. Unearned revenues: Cash Received before services are performed
 1. Accrued revenues: Revenues for services performed but not yet received in cash or recorded
 2. Accrued expenses: Expenses incurred but not yet paid in cash or recorded
 LO2: Prepare adjusting entries for deferrals.
 Deferrals - expenses are revenues that are recognized at a date later than the 23 Friday, September 2, 2016 point when cash was originally exchanged. Two types: prepaid expenses and unearned revenues.
 F. Prepaid Expenses
 Prepaid Expenses/Prepayments - expenses that will benefit more than one accounting period such as insurance, supplies, advertising and rent. 
 *Prepaid expenses are costs that expire either with the passage of time (rent and insurance) or through use (supplies, equipment).
 *An adjusting entry for prepaid expenses results in an increase (a debit) to an expense account and a decrease (a credit) to an asset account. 1. Supplies
 -Supplies purchased; record Asset under Supplies. At end of accounting period: Record supplies used in Supplies Expense under Stockholders’ Equity.
 -Supplies balance should be equal to the cost of supplies on-hand
 -Supplies Expense balance should be equal to the cost of supplies used
 *If adjusting entry is not made, expenses are understated and net income is overstated. Both assets and stockholders’ equity will be overstated on balance sheet. 2. Insurance
 -Cost of Insurance (premiums) is recorded as an increase (debit) in the asset account Prepaid Insurance. At the financial statement date, companies increase (debit) Insurance Expense and decrease (credit) Prepaid Insurance for the cost of insurance that has expired during the period.
 -Prepaid Insurance should be equal to unexpired cost of coverage.
 -Insurance Expense balance equals the insurance cost that expired.
 *If adjustment is not made, expenses and net income are understated and both assets and stockholders’ equity will be overstated. 3. Deprecation
 Useful life - period of service of an asset, such as buildings, equipment and motor vehicles.
 -Assets are recorded at cost, as required by historical cost principle. To follow expense recognition principle, companies allocate a portion of this cost as an expense during each period of the asset’s useful life.
 Deprecation - process of allocating the cost of an asset to expense over its useful life 24 Friday, September 2, 2016 a) Need for Adjustment
 *Deprecation is an allocation concept, not a valuation concept (needed to recognize the cost that has been used [an expense] during the period and to report the unused cost [as asset] at the end of period.)
 *Deprecation allocates an asset’s cost to the periods in which it is used. Does not attempt to report the actual change in the value of the asset.
 -Equipment purchased; record asset. Deprecation recognized; record Deprecation Expense.
 -Instead of decreasing (credit) the asset account directly, credit Accumulated Depreciation — Equipment account to offset the asset account Equipment for the balance sheet.
 Contra asset account - an account that is offset against an asset account on the balance sheet, all contra accounts have increases, decreases and normal balances opposite to the account to which they relate, normal balance is credit.
 *This account keeps track of the total amount of depreciation expense taken over the life of the asset.
 -To keep accounting equation in balance, decrease stockholders’ equity by increasing an expense account, Deprecation Expense.
 -Balance in the Accumulated Deprecation — Equipment account will increase each month and the balance in Equipment remains the same. b) Statement Presentation
 -The use of a contra asset account is preferable to decreasing the asset account because it discloses both the original cost of the equipment and the total cost that has been expensed to date.
 Book Value - difference between the cost of any depreciable asset and its related accumulated depreciation, book value and fair value of the asset are generally two different values.
 *Without this adjusting entry, total assets, total stockholders’ equity, and net income are overstated and depreciation expense is understated.
 Summary for Accounting for Prepaid Expenses Examples Reason for Accounts Before Adjusting Entry Adjustment Adjustment 25 Friday, September 2, 2016 Insurance, supplies, Prepaid expenses Assets overstated. Dr. Expenses
 advertising, rent, recorded in asset Expenses understated. Cr. Assets or Contra deprecation accounts have been Assets used G. Unearned Revenues
 Unearned revenues - a liability account to record when companies receive cash before services are performed (opposite of prepaid expenses)
 -Company receives payment for services to be performed, increases (credits) an unearned revenue (liability) account. Company delays recognition of revenue until adjustment process. Adjusting entry records the revenue for services performed during period.
 -Prior to adjustment, liabilities are overstated and revenues are understated
 *The adjusting entry for unearned revenues results in a decrease (debit) to a liability account and an increase (credit) to a revenue account.
 -Company receives cash for services expected to be completed. Payment is credited to Unearned Service Revenue. After evaluation of services, company determines how much revenue should be recognized for the month. Liability (Unearned Service Revenue) is decreased an stockholders’ equity (Service Revenue) is increased.
 -Liability Unearned Service Revenue should equal the amount remaining of services expected to be performed in the future.
 -Service Revenue equals total revenue recognized/services already performed.
 *Without this adjustment, revenues and net income are understated in the income statement. Liabilities will be overstated and stockholders equity will be understated on balance sheet. Summary of Accounting for Unearned Revenues Examples Reason for Accounts Before Adjusting Entry Adjustment Adjustment Rent, magazines, Unearned revenues Liabilities overstated. Dr. Liabilities
 subscriptions, customer recorded in liability Revenues understated. Cr. Revenues deposits for future accounts are now service recognized as revenue for services performed 
 LO3. Prepare Adjusting entries for accruals.
 accruals - second category of adjusting entries, prior to an accrual adjustment, the 26 Friday, September 2, 2016 revenue account (and related asset account) or the expense account (and the related liability account) are understated.
 *adjusting entry for accruals will increase both a balance sheet and an income statement account H. Accrued Revenues
 Accrued Revenues - revenues for services performed but not yet recorded at the statement date
 -Accrued revenues may accumulate with the passing of time, as in the case of interest revenue. Unrecorded (until adjustment balance) because earning of interest does not involve daily transactions and impractical. 
 -Accrued revenues also may result from services that have been performed but not yet billed or collected.
 -Adjusting entry records the receivable that exists at the balance sheet date and the revenue for the services performed during the period. Prior to adjustment both assets and revenues are understated.
 *An adjusting entry for accrued revenues results in an increase (debit) to an asset account and an increase (credit) to a revenue account.
 -When services are not billed, they are not recorded. The accrual of unrecorded service revenue increases an asset account, Accounts Receivable. It also increases stockholders’ equity by increasing a revenue account, Service Revenue.
 -The asset Accounts Receivable is equal to what clients owe at the balance sheet date.
 -The balance of Service Revenue represents the total revenue for services performed during the month.
 *Without the adjusting entry, assets and stockholders’ equity on the balance sheet and revenues and net income on the income statement are understated.
 -Company receives cash for services performed; company records the collection of receivables by a debit (increase) to Cash and a credit (decrease) to Accounts Receivable (to record cash collected on account) Summary of Accounting for Accrued Revenues Examples Reason for Accounts Before Adjusting Entry Adjustment Adjustment 27 Friday, September 2, 2016 Interest, rent, servicesServices performed but Assets understated.
 Dr. Assets
 not yet recorded in cash Revenues understated. Cr. Revenues or recorded I. Accrued Expenses
 Accrued Expenses - Expenses uncured but not yet paid or recorded at the statement date (ex. interest, taxes, and salaries)
 -Companies make adjustments for accrued expenses to record the obligations that exist at the balance sheet date and to recognize the expenses that apply to the current accounting period. Prior to adjustment, both liabilities and expenses are understated.
 *An adjusting entry for accrued expenses results in an increase (debit) to an expense account and an increase (credit) to a liability account. 1. Accrued Interest
 The amount of interest recorded is determined by three factors:
 1. the face value of the note
 2. the interest rate, which is always expressed as an annual rate
 3. the length go time the note is outstanding
 Formula for Computing Interest Annual Time in Face Value x Interest Rate x Terms of equals Interest of Note (APR) One Year $5000 x 12% x 1/12 equals $50 
 -Accrual of interest increases a liability account, Interest Payable, decreases stockholders’ equity by increasing an expense account, Interest Expense.
 -Interest Expense equals interest charges for the month
 -Interest Payable shows the amount of interest the company owes at the statement date.
 -Companies use the Interest Payable account instead of crediting Note Payable, to disclose the two different types of obligations — interest and principal — in the accounts and statements.
 *Without this adjusting entry, liabilities and interest expense are understated, and net income and stockholders’ equity are overstated. 2. Accrued Salaries and Wages
 -Companies pay for some types of expenses after the services have been performed, such as salaries and wages. 
 28 Friday, September 2, 2016 -If pay period falls between two months, the days in the first month need to be accounted for, even if next payment of salaries isn’t until the second month. These days represent an accrued expense and related liability.
 -Accrued salty increases a liability, Salaries and Wages Payable.
 -Decreases stockholders’ equity by increasing an expense account, Salaries and Wages Expense.
 *Without the adjustment for salaries ands ages, expenses are understated and liabilities are understated.
 Summary for Accounting for Accrued Expenses Examples Reason for Accounts Before Adjusting Entry Adjustment Adjustment Interest, rent, salaries Expenses have been Expenses understated.
 Dr. Expenses
 incurred but not yet paid Liabilities understated. Cr. Liabilities in cash or recorded J. Summary of Basic Relationships
 *Each adjusting entry affects one balance sheet account and one income statement account.
 Type of Adjustment Accounts Before Adjustment Adjusting Entry Prepaid expenses Assets overstated
 Dr. Expenses
 Expenses understated Cr. Assets or Contra Assets Unearned Revenues Liabilities overstated
 Dr. Liabilities
 Revenues understated Cr. Revenues Accrued revenues Assets understated
 Dr. Assets
 Revenues understated Cr. Revenues Accrued expenses Expenses understated 
 Dr. Expenses
 Liabilities understated Cr. Liabilities 
 Helpful Hints: 
 (1)Adjusting entries should not involve debits or credits to Cash
 (2) Evaluate whether the adjustment makes sense. For example, an adjustment to recognize supplies used should increase Supplies Expense.
 (3) Double-check all computations.
 (4) Each adjusting entry affects one balance sheet account and one income statement account. 
 29 Friday, September 2, 2016 LO4. Describe the nature and purpose of an adjusted trial balance.
 Adjusted trial balance - after a company has journalized and posted all adjusting entries, to prepares another trial balance from the ledger accounts.
 -THe purpose of an adjusted trial balance is to prove the equality of the total debit balances and the total credit balances in the ledger after all adjustments.
 -Adjusted trial balance is the primary basis for the preparation of financial statements. K. Preparing the Adjusted Trial Balance L. Preparing Financial Statements
 *Companies can prepare financial statements directly from the adjusted trial balance.
 -Companies prepare the income statement from the revenue and expense accounts
 -Use the Retained Earnings and Dividends accounts and the net income (or net loss) from the income statement to prepare the retained earnings statement.
 -Prepare the balance sheet from the asset and liability accounts and the ending retained earnings balance as reported in the retained earnings statement.
 LO5. Appendix 3A: Prepare adjusting entries for the alternative treatment of deferrals.
 Prepaid expenses: Debited prepayments to an asset account
 Unearned revenue: Credit to liability account to record cash received
 (1) When a company prepays an expense: debit amount to an expense account.
 (2) Payment for future services: credit amount to revenue account. M. Prepaid Expenses
 -Prepaid expenses become expired cost either th


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