Intermediate 1, Chapter 3 Notes
Intermediate 1, Chapter 3 Notes 3310
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This 7 page Class Notes was uploaded by Emily Sears on Sunday January 24, 2016. The Class Notes belongs to 3310 at Auburn University taught by Dr. Duane Brandon in Spring 2016. Since its upload, it has received 50 views. For similar materials see Intermediate Accounting I in Accounting at Auburn University.
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Date Created: 01/24/16
1 CHAPTER 3: Review of the Accounting System Purpose andComponents of an Accounting System The purpose of a company’s accounting system is to record, organize, summarize, and report useful information to external financial statement users and stakeholders, as well as to the company’s managers for making operating, investing, and financing decisions. The basic components include: Accounting equation (framework of the system) Source documents (to generate accounting information) Records (to organize and store accounting information) Outputs (ex: financial statements) The Accounting Equation Assets = Liabilities + Stockholders’ Equity Stockholders’ Equity = Contributed Capital + Retained Earnings + AOCI Retained Earnings = Beginning Retained Earnings + Net Income – Dividends Net Income = Revenues – Expenses + Gains – Losses Transactions, Events, Arrangements and Supporting Documents For accounting purposes, a change in assets, liabilities, or stockholders’ equity may be caused by a transation, event , or arrangement Transaction- a transfer of something valuable between parties Event- an internal or external “happening” that affects the company Arrangement- an agreement or a promise by the company with another party or entity Transactions, events, and arrangements are entered into the accounting system based on the details of related source documents (ex: sales invoices, checks, bills) Accounts Monetary amounts related to the transactions, events, and arrangements are stored in the accounting system using accounts The Chart of accounts is a numbering system designed to organize accounts efficiently and minimizes errors in the recording process The T-account format is used for all accounts. Each T-account has a left (debit) and a right (credit) side. 2 For each transaction/event recorded, the total dollar amounts of all debits must equal the total dollar amount of all credits. Referred to as the “double-entry” rule. Permanent (Real) Accounts Permanent Accounts- the assets, liabilities, and shareholders’ equity accounts whose balance at the end of the period are carried forward to the next period Temporary (Nominal) Accounts Temporary Accounts- are used to determine the changes in retained earnings that occur during the period, and their account balances are not carried forward 3 Financial Statements 1. The Income Statement- summarizes the results of a company’s income-producing activities for an accounting period 2. The Balance Sheet- summarizes the amounts of a company’s assets, liabilities, and stockholders’ equity on a particular date 3. The Statement of Cash Flows- summarizes a company’s cash receipts and cash payments during the accounting period 4. The Statement of Shareholders’ Equity- provides information about the common shareholders’ equity claims and how those claims changed during the period Overview of the Accounting Cycle 1. Record daily transactions in a general and/or special journal (example, sales, purchases, cash receipts, or cash payments journal). This process is called journalizing 2. Post the journal entries to the accounts in the general ledger and/or subsidiary ledgers. This process is called posting. Prepare unadjusted trial balance 3. Prepare and post adjusting entries (see following information). Prepare adjusted trial balance. 4. Prepare the financial statements based on the adjusted trial balance. 5. Prepare the post-closing entries for the temporary accounts: revenues, expenses, gains, loses, and dividend accounts. This step (a) reduces the balance in each temporary account to zero and (b) updates the retained earnings account. Prepare post-closing trial balance. 6. Prepare reversing entries if applicable (see following information) Adjusting Entries Recall, under accrual accounting a company recognizes revenues in the period in which it satisfies performance obligations to customers and records expenses when assets have been consumed (or liabilities incurred), regardless of cash inflows and outflows. In many instances many accounts may not be up-to-date at the end of the accounting period. Therefore, a company must adjust certain accounts so that it correctly reports revenues and expenses for the period and balance sheet accounts as of the end of the period. Adjusting entries are journal entries made at the end of the period so that a company’s financial statements include the correct amounts for the current period. Adjusting entries always affect a permanent (balance sheet) account and a temporary (income statement) account Adjusting entries can be classified into three categories: 1. Accruals- occur when revenues and expenses are recorded before cash is received or paid out (ex: accrued revenues and accrued expenses) 2. Deferrals- occur when revenues and expenses are recorded after cash is received or paid out (ex: unearned or deferred revenues and prepaid expenses) 3. Estimated Items (ex: depreciation and bad debt expense) Closing Entries 4 Closing entries are used to transfer temporary account balances (income statement accounts) to permanent accounts (balance sheet accounts). The Income Summary account is a temporary account ath facilitates this process The Closing Process is generally a 4-step process: 1. Close revenue/gain accounts to Income Summary Account 2. Close expense/loss accounts to Income Summary Account 3. Close Income Summary account to Retained Earnings Account 4. Close Dividends to Retained Earnings Reversing Entries Reversing entries are optional and simplify the recording of a later transaction related to the adjusting journal entry Reversing entries should be made for AJE that creates/increases a balance sheet account. For example: AJE created/increased accrued revenues or expenses to be collected or paid in the next accounting period AJE related to prepayments of cost initially recorded as expenses or receipts-in-advance initially recorded as revenue Reversing entries should not be made for: AJE related to prepayments of cost initially recorded as assets or receipts-in-advance initially recorded as liabilities AJE related to estimated items (ex: deprecation or bad debts) Examples On Aug 1 Z CORP paid $24,000 to lease a store location through the following July 30 . Thus, Z CORP prepaid the lease. Based on the information provided on the following slides, what are the appropriate adjusting, closing, and reversing entries? Note, there are two acceptable methods for recording the Aug. 1 cash payment for rent (i.e., the “original entry”) – Case A: Dr. Prepaid Rent $24,000 Cr. Cash $24,000 Case B: Dr. Rent Expense $24,000 5 Cr. Cash $24,000 CASE A At 12/31 (Z's fiscal year-end), a partial unadjusted trial balance for Z CORP shows: DR CR Prepaid Rent 24,000 Rent Expense 0 12/31 Adjusting Entry: Dr. Rent Expense 10,000 Cr. Prepaid Rent 10,000 12/31 Closing Entry: Dr. Income Summary 10,000 Cr. Rent Expense 10,000 1/1 Reversing Entry: N/A CASE B At 12/31 (Z's fiscal year-end), a partial unadjusted trial balance for Z CORP shows: DR CR Prepaid Rent 0 Rent Expense 24,000 6 12/31 Adjusting Entry: Dr. Prepaid Rent 14,000 Cr. Rent Expense 14,000 12/31 Closing Entry: Dr. Income Summary 10,000 Cr. Rent Expense 10,000 1/1 Reversing Entry: Dr. Rent Expense 14,000 Cr. Prepaid Rent 14,000 Returns, Allowances, Discounts Seller’s Perspective Sales return- customer receives refund for damaged goods returned Sales allowance- customer receives refund for damaged goods retained Ex: Customer returns goods: Dr. Sales Returns & Allowances (contra Sales Revenue account) Cr. Accounts Receivable Sales (cash) discount- discount is offered for prompt cash payment. The account is a contra-sales revenue account that reduces Net Sales Net sales- Sales less returns, allowances, and discounts Buyer’s Perspective Purchases return- customer receives refund for damaged goods returned Purchase allowance- customer receives refund for damaged goods retained Ex: Customer returns goods: Dr. Accounts Payable Cr. Purchase Returns and Allowances (contra Inventory account) 7 Purchases discount- discount is offered for prompt cash payment. This account is a contra- inventory account Periodic Inventory Systems Periodic inventory systems Cost of Goods Sold (COGS) computation: Beginning Inventory + Net Purchases – Ending Inventory COGS Where, Net Purchases = Purchases – Purchase Returns & Allowances – Purchase Discounts If you need additional practice distinguishing different types of accounts (i.e., Inc. Stmt., Balance Sheet, Stmt. of Changes in Equity), please review P4-2 (pg. 4-60). Also see Example 4.1 (pg. 4-15) and Example 5.2 (pg. 5-14).
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