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Financial Accounting ACG 2021, Week 4, Chapter 3 Notes

by: Virginia Johnson

Financial Accounting ACG 2021, Week 4, Chapter 3 Notes ACG2021

Marketplace > University of Florida > Accounting > ACG2021 > Financial Accounting ACG 2021 Week 4 Chapter 3 Notes
Virginia Johnson
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Chapter 3 Notes
Introduction to Financial Accounting
Goslinga,Jill Kristen
Class Notes
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This 5 page Class Notes was uploaded by Virginia Johnson on Monday January 18, 2016. The Class Notes belongs to ACG2021 at University of Florida taught by Goslinga,Jill Kristen in Fall 2015. Since its upload, it has received 119 views. For similar materials see Introduction to Financial Accounting in Accounting at University of Florida.


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Date Created: 01/18/16
 Accrual Accounting o Records business transactions as they occur, even if it pays no cash  EX: you sell inventory that costs you $500, for $800 on account. You collect $800 from the customer 30 days later. Two transactions occur: making a sale for $800 on account and collecting $800 in cash. Making the sale increases your wealth. The second transaction just replaces receivables with cash  Cash-basis Accounting o Records only cash transactions o Two Defect with waiting to collect the cash to record the transaction  Balance Sheet Defect:  The balance sheet reports no accounts receivable (which is an asset), so assets are understated  Income-Statement Defect:  The income statement reports no sale on account (which is revenue), so Revenue and Net Income are understated o Companies that use cash basis of accounting do not follow GAAP. Their statements leave out transactions o All but the smallest businesses use the accrual basis of accounting  Accrual Accounting and Cash Flows o Accrual records the following transactions as cash transactions  Collecting cash from customers  Receiving cash from interest earned  Paying salaries, rent, and other expenses  Borrowing money  Paying off loans  Issuing stock o Accrual records the following as noncash transactions  Sales on account  Purchases of inventory on account  Accrual of expenses incurred but not yet paid  Depreciation expense  Usage of prepaid, insurance and supplies  Earning of revenue when cash was collected in advance  Time Period Concept o Liquidation  sell assets, pay liabilities and return any leftover cash to the owners ( shutting down is the only way of knowing how well a business performed)  Going out of business o The concept ensures that accounting information is reported at regular intervals  A typical 'regular interval' is one year  A fiscal year may end on a date other than Dec. 31st, like January 31st to wait for the holiday shopping and returning to subside  Some companies prepare 'interim statements' that are less than one year o Revenue Principle o(1) When to record (recognize) revenue o (2) What amount of revenue to record o Record revenue after its been earned  EX: Starbucks makes a contract with a customer to give them a latte; When Starbucks supplies the latte, fulfilling their end of the contract, they are then entitled to collect revenue o Record the cash value of the good  EX: Starbucks collects the price they charge. If lattes go on sale for $2 instead of $4, then they collect $2. o Expense Recognition Principle o (1) Identify all the expenses incurred during the accounting period o (2) Measure the expenses and recognize them in the same period in which any related revenues are earned o Recognizing expenses along with related revenues means to subtract expenses from related revenues to compute net income(loss) o Adjusting the Accounts o Need no adjustment:  Cash, Land, Equipment, Accounts Payable, Common Stock and Dividends o Need Adjustment  Accounts Receivable, Supplies, Prepaid Rent and others  EX: Cost of supplies is an expense. Supplies expense and Supplies (assets) needs adjusting o Adjusting Entries o Deferrals  An adjustment for payment of an item or receipt of cash in advance  Supplies Expense, Prepaid Rent, Prepaid Insurance… require deferrals  EX: Starbucks delivers goods to Publix and Publix pays Starbucks ahead of time. Before Starbucks delivers the transaction is an Unearned Sales Revenue(liability) and after Starbucks delivers it is a Sales Revenue(revenue-->net income) o Depreciation  Allocation of the cost of a plant asset to expense over the asset's useful life  Most common long term deferral  EX: Starbucks buys buildings and equipment and the wear and tear decrease asset's book value o Accruals  An expense or revenue that occurs before the business pays or receives cash (opposite of deferral)  Accrual Expense : a business records the expense before paying cash  Accrual revenue: a business records the revenue before collecting cash  Accrual of interest revenue debits Interest Receivable and credits Interest Revenue o Prepaid Expenses o Expense paid in advance  They are assets because they provide a future benefit Rent 1,000 Expense Prepaid 1,00 Rent 0  Assets and Stockholder's Equity decrease Supplie 700 s Cash 700  Increase in Assets and decrease in Assets; no effect o Formula  Asset Available During the Period [700]- Asset on Hand at the End of the Period [400] = Asset Used (Expense) During the Period [300] o Depreciation of Plant Assets  Plant assets are long lived tangible assets like land, buildings, furniture and equipment (land doesn’t decline in usefulness)  When an asset is used, a portion of the asset's cost is moved to Depreciation Expense  Expense recognition principle: a machine/equipment is making revenue at the same time that it is depreciating(an expense). The cost of machinery should be matched against the revenue  Accumulated Depreciation Account o Shows the sum of all depreciation expense from using the asset  The balance in the Accumulated Depreciation account increases over the assets life  This asset has normal credit balance  A contra account  It is always has a companion account  Normal balance is opposite that of the companion account o Book Value  The net amount of a plant asset (cost minus accumulated depreciation) o Accrued Expenses  Liability that arises from an expense that has not yet been paid  Accrued expenses increases liabilities and decreases stockholder's equity o Accrued Revenue  A revenue that has been earned but not yet collected  Revenue increases both assets and stockholder's equity o Unearned Revenues  Collecting cash from customers before earning the revenue  Unearned Revenue is a liability, not a revenue  Summary of the Adjusting Process o Purposes  (1) measure income  (2) update the balance sheet o Every adjusting entry affects both  (1) revenue or expense (to measure income)  (2) asset or liability (to update the balance sheet)  Accrual of income tax o Follows pattern for accrued expenses  Adjusted Trial Balance o Lists all the accounts and their final balances in a single place  Construct the Financial Statements o (1) income statement lists revenue and expense accounts  This reports net income and net loss. Net income is transferred to retained earnings o (2)statement of retained earnings shows changes in retained earnings o (3) balance sheet reports assets, liabilities, and stockholders' equity  Close the Books Means to prepare the accounts for the next period's transactions The closing entries set the revenue, expense and dividends balances back to zero at the end of the period  Temporary Accounts  The revenue and expense accounts that relate to a limited period and are closed at the end of the period are temporary accounts. For a corporation, the Dividends accounts is also temporary  Permanent Accounts  Not closed at the end of the period because they carry over to the next period  EX: Assets, Liabilities, Stockholders equity; cash, receivables, equipment, accounts payable, common stock and retained earnings  Debit revenue accounts for the amount of its credit balance. Credit Retained Earnings for the sum if revneues  Credit the expense accounts for the amount of uts debit balance. Debit Retained Earnings  Credit Dividends account for the amount of uts debit balance. Debit Retained Earnings  Classifying Assets and Liabilities Based on Their Liquidity  Liquidity measures how quickly an item can be converted to cash. Cash is the most liquid asset  Current Assets  Are the most liquid assets  Long term assets  Are all assets not classified as current assets  EX: Property, Land Equipment  Current Liabilities  Debts that must be paid within one year or within the entity's operating cycle  EX: Accounts Payable, Notes Payable, Salary Payable, Unearned Revenue, Interest Payable and Income Tax Payable  Long Term Liabilities  Liabilities not classified as current liabilities  EX: Some notes payable o Reporting Assets and Liabilities: Starbucks Corporation  Classified Balance Sheet separates current assets from long term assets and current liabilities from long term liabilities o Format for the Financial Statements  Balance Sheet Format  Report form lists the assets at the top, followed by liabilities and stockholder's equity  Account Format lists the assets on the left and liabilites and stockholders's equity on the right like a T-account  Income Statement Format  Single-step income statement lists all the revenues together under a heading such as Revenues  Expenses are listed in a category titled Expenses  Multi-step income statement reports a number of subtotals to highlight relationships between revenues and expenses o Analyze and Evaluate a company's debt paying ability  Net working Capital  Is a computational data that represents operating liquidity  Net working capital = Total current Assets - Total current Liabilities  Current Ratio  Divides total current assets by total current liabilities  Current ratio = (total current assets)/ (total current liabilities)  Debt Ratio  Ratio of total liabilties to total assets  Debt Ratio = total liabilities / total assets  Represents proportion of company's assets that is financed with debt


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