Acct 2301 cumulative notes week 7
Acct 2301 cumulative notes week 7 acct 2301
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Nebin Mathew Luke
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This 60 page Class Notes was uploaded by Nebin Mathew Luke on Saturday October 8, 2016. The Class Notes belongs to acct 2301 at University of Texas at Dallas taught by bo liu in Fall 2016. Since its upload, it has received 2 views. For similar materials see Intro to Financial Accounting 1 in Accounting (ACCT) at University of Texas at Dallas.
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Date Created: 10/08/16
Chapter 1 Equity- Money that belongs to the owner(s) of the company. (also known as invested money) -equity=owner. -doesn’t have to be paid back. -permanent financing. -usually the owner or the shareholders. (example-capital from the owner) Liabilities- Money that doesn’t belong to the company. -liability=creditor. -has to be paid back. -borrowed from creditors. -not permanent financing. (Example- money from the bank) Creditors- people who lend money to the company. -they are a liability. (example- the bank) Assets- resources that belong to the company and will help in the economic growth of the company or develop revenue. (example- land, machinery, cash at hand, cash in bank, pens etc) Long term assets-buildings, computers etc Short term assets- pens, pencils etc Revenue- the inflow of assets like cash or accounts receivable because of providing a service. -this is before money is reduced for expenses. -revenue is also a/r because there was a service done. Expense- cost of generating income. (example- salary, shipping, electricity, etc) FORMULA: assets = liabilities + equity Resources = Debt + contributed equity + earned equity -contributed equity and earned equity are the sources of resources in a company. Four financial statements- 1. Income Statement 2. Statement of retained earnings 3. Balance sheet 4. Statement of cash flows Income Statement- summary of the revenues and expenses of a period of time. -Revenues – expense = net income Statement of retained earnings- Summary of all income earned since the beginning of business without the small dividends that where being paid from the beginning of business. Dividends: small amounts paid to shareholders of profits. -beginning R.E. + Net income – dividends = retained earnings. -income that is retained not paid as dividend. -Dividend isn’t expense because it doesn’t cause revenue. Balance Sheet- summary of assets, liabilities and owner’s equity at a specific time. -fundamental equation -Assets liability Cash A/P (after a service) A/R Notes payable (mortgage, bank loans etc) Inventory S.H.E.(Shareholder Equity) Building Stock Land End retained earnings Equipment Statement of cash flows- Summary of cash inflow and outflow in a specific period of time. -Operating section -investing section - all these activities are the basic activities of a company -financing section Solving questions- Identify the category each account belongs to- -assets, lia., SHE, stocks etc Put the identified account to the corresponding financial statement. 1. The following information is available from the records of Prestige Landscape Design Inc. at the end of 2009 calendar year: (a little background of double entry might help students why certain items (supply) belongs to certain category (assets)) Accounts Payable $5,000 Office Equipment $7,500 Accounts receivable 4,000 Rent expense 6,500 Capital stock 8,000 Cash 13,000 Beginning of the year 8,500 Dividends 3,000 Salary Expense 12,000 Landscaping Revenues 25,000 Supplies 500 Required: 1. What was prestige’s Net Income for the year ended Dec 31, 2009? 25,000-(6500)-(12,000) = 6500 2. What is Prestige’s Retained Earnings balance at the end of the year? 8500+6500-(3000)=12000 3. Prepare Prestige’s Balance Sheet as of December 31, 2009. Assets lia 4000 5000 13000 SHE 7500 8000 500 12000 Assets=25000 total= 25000 Chapter 2 Income statement components- Revenues- inflow of assets as a result of delivering goods or performing a service. Expense- using a resource to help generate revenue Gains and losses- incidental or peripheral transactions as a result of sales of assets. Eg- selling a food truck (not the core of the business transaction) (remember profitandloss through depreciation Multi-step Income Statement- Net Sales - Cost of Goods Sold (COGS) – cost of merch sold i.e buns, burgers (even electricity bill to be used to make the burger. = Gross Profit - Operating Expenses Selling Expenses - Cost of salesmen, advertising ) day to General & Administrative – Salaries of administrative staff, rent, utilit) day activities = Income from Operations ± Other revenues and expenses – gains and losses, interest Expense = Income before income taxes - Income Tax Expense = Net Income Divided by core business activities and other activities Recognizing the multi-step income statement- words like gross profit, income from operations Statement of Retained Earnings Statement of Stockholder’s Equity Beginning R.E beginning S.H.E. +issuance of common stock (if more stocks were added) Net income +Net income -dividend -dividend End R.E End S.H.E In the Statement of stockholder’s equity stock and R.E is included. It is the main header both accounts come under. Only necessary when new stock was added. Balance sheet classifactions- Current assets- Converted to cash, sold, or able to consume in a year. Eg- Cash, Market securities (investment(stocks) by the business in another business), A/R (Amount customer owes for the product or service), Inventory (Goods held for Resale, core activity, for selling, generates cash) Supplies (costs of supplies on hand like paper, cartridges; can be consumed in a year) Difference from supplies expense which is after you end up using the asset(supply) will be an expense. Prepaid expense (expenses paid beforehand) Prepaid Insurance Prepaid rent Long term assets- longer than a year to use up Long term investments- held of future expansion, machines not used, stocks (not using atm) Plant, property and equipment (aka fixed assets)- productive assets used for business operations Land – doesn’t have a limited useful life appreciation(maybe?) Building ) Equipment ) subject to Depreciation Furniture ) Depreciation – total depreciation- constant throughout the years. Eg- 10000 every year accumulative depreciation- increases every year. Eg- 10,000 year 1, 20,000 year 2 and so on. Contra asset Contra asset- depreciation is there on one of the sides of the balance sheet but is negative(left hand side). Depreciation takes away from the asset. Depreciation in accounting is because we use the resource to generate revenue, which is expense. It is necessary for the matching concept. Matching concept- Assets should have an equal expense. Fundamental accounting equation. Accumulated depreciation is not a real cash amount. Reality might be different. Intangable assets- lack of a physical form but an asset. Trademark Copyrights Franchise rights Patents Goodwill- purchase price paid for the market value of net assets when a business is purchased. Amortize if limited life – like depreciation Liabilities Current liabilities- Obligations that will be satisfied in one year. A/P- the company owes for items Wages/ salaries payable- The service is done but not paid, making it payable Interest payable Tax payable Notes payable- promissory notes that have been written and need to be given by the company. Unearned Revenue- didn’t do the service yet, was paid in advance. Still to be earned. It is an expense. Opposite of prepaid expense. Long term Liabilities- longer than a year. Notes payable Bonds payable- always long term. Result of bonds issued by a company. Bonds are supposed to be paid back with interest. Financing activity. Shareholders’ equity Liquidity measures- ability to pay liabilities within the next year i.e. how much cash you could use to settle debts atm. Working capital- current assets-current liabilities too little- may not able to pay liabilities too much- not effective use of cash. Could be invested. Current ratio- current assets/current liabilities Allows comparison between companies by omitting amounts. Sometimes the person with more money isn’t more liquidified (or better off in terms) When comparing a company’s ratio, you need to look at the make-up (form) of current assets how liquid they are Liquid current assets- Cash + market sec. + A.I.R more liquid than Inventory + prep. Exp. (both are still current cash) Rule of thumb for a good ratio- 2/1 Limits and uses of balance sheet- Historical cost- the cost paid for it by the business when purchased. (used by GAAP) Fair market value- the actual value of the asset on the market. (IFRS uses fair market value(international)) Omissions- things that can’t go on the balance sheet- skills, intelligence and loyalty of employees. (very valuable and hard to measure). This cannot be measured so business could potentially be manupilated to show a better balance sheet. Trademark- the trademark on the balance sheet is not the trademark of the company itself but trademark of another company when you buy it out (the extra money other than its net worth). When doing a multi step income statements- -expenses go to the left side and subtracted from sales revenue -first take out cost of goods sold = gross profit/loss -subtract expenses = net loss/profit On retained earnings, First retained earnings = end retained earnings On balance sheet, Left Current assets = C.A total Long term assets (don’t forget depreciation) = total assets Chapter 3 Business transactions are transformed into quantifiable figures through their effects on the equation. The accounting equation always stays in balance after each transaction. T transactions accounts Debit the good stuff credit the bad stuff Debit credit T accounts- summarize the transactions that effect just one account Assets should have a debit balance after all transactions for a good business. 1. Journal entries 2. T accounts (general ledger) 3. Trial balance (all accounts) Journal entries – the first thing done in accounting Writing journal entries First write the date Then the accounts First account should always be the debit account/s. Indent for the credit account/s. Lastly the values. (debit should = credit) Ledger – collection of t accounts. Trial balance - A snapshot of all the accounts and their balances. Trial balance faults- Transactions that are not journalized are not picked up. A correct journal was not posted. Incorrect accounts are used in jounal entry. Chapter 4 Cash basis- record revenue and expense only when cash is involved. Accural basis (GAAP) - record revenue and expense when service is performed even without cash. (includes cash too) Transactions are recorded in the period when the event occurred. Revenue recognition principle (GAAP) – revenue is counted as earned when the service has been completed or satisfied. Matching principle (GAAP) – match expenses with revenue that in generated in that time period. Even though there is no cash based transactions in the period, there are still revenue and expenses that needs to be recognized. Indirect matching The cost is estimated therefore t is an indirect matching but still matched with the same period. Eg- depreciation Adjusting entries Needed in the end of the accounting period to match expenses and revenue. Check to see how much expense(incurred) and how much revenue(earned). It is done in the end of the accounting period. Correcting all prepaid, unearned, accrued income and expense by turning then=m into assets or liabilities. 4 types- Prepaid expense- will become expense either with the passage of time or through use(used up). Agj. Entry- Increase expense (debit) Decrease prepaid asset (credit) Unearned revenue- received cash before the service and service is done with the passing of time. Adj. entry- Increase revenue (credit) Reduce unearned revenue (debit) Accrued revenue- Revenue comes later but service was provided before. Adj. entry- Increase revenue (debit) Decrease accrued revenue(a/r) (credit) Accrued expense- expense that happened but haven’t come around to paying it but with the passing of time it will be (in the same period). Adj. entry- decrease accrued expense (a/p) Decrease expense (credit) Adjusting entries tips- cash is never a part of the entry one account will always be from the income statement (either revenue or expense) one account will always be from the balance sheet. (either assets or liabilities) Interest = face value * interest rate * time elapsed If you don’t do accounting adjusting entries, the assets or expense are overstated or understated. Fake image for a business, tricks consumers. Deprociation- because fixed assets have a useful life longer than 1 year, we want to spread put the original cost of the asset to expense over each year the asset helped to generate the revenue Type of adj. entry- prepaid expense Original entry- purchace of asset Depreciation forula(for a year)- (cost – salvage value)/# years of useful life Journal entry- dep. Exp. Accum. Dep.(contra asset) Balance sheet p.p.&e less: accum. Dep. Depreciation is cost allocation technique, not a valuation technique *advance means unearned revenue Adjusting trial balance – with adjusting entries Closing entry Closing temporary accounts and transfer profit or loss to retained earnings. 2 accounts Permanent- balance sheet accounts Temporary- income statement accounts and dividends Eg- Income statement for period ending at (date) Income statement is non- accumulative. Balance sheet is accumulative Revenues and expenses go into income summary and income summary goes to retained earnings Dividends go into retained earnings Unit 5 Accounting for inventory Perpetual method Continuously records both changes in inventory quality and COGS. Missing items are not included in COGS For every purchase: Inventory $xx (# purchased * purchase cost) Accounts payable $xx For every sale: Cash or A/R $xx (# sold * retail price)Sales Revenue $xx COGS $xx (# sold * original cost) Inventory $xx This is the matching concept. We have to record the sales and reduce inventory. Both entries are to be made if inventory is used. INVENTORY ) COGS ) always effected during inventory transactions COGS shows the actual sales that happened rather than any missing item included Inventory can be lost or stolen or unaccounted for. To record this transcation after checking inventory and finding it lesser than calculated inventory- Loss on inventory decline xx Inventory xx This goes to gains and losses. Loss on inventory is a temporary account. Periodic method Beginning inv. + purchase = end inv. + COGS This is basically the t account and calculated the same way supply expense is calculated. End inventory is found through physical count. Done at the end of every accounting period. Doesn’t account for missing items making COGS more than the actual sales that occurs. Matching concept isn’t violated because the expenses are updated at the end of the periods in periodic method Inventory is only effected in the end. Step one Record inventory purchase Purchase Csh/A/p Step two Sale of merch Cash Sales Step 3 Take a physical count of inventory and update losses 2 methods perpetual Loss on inventory Inventory Periodic Inventory identification Dealing with the quantity of item that are items in question whether to include or not like goods in transit. Included in ending inventory- All goods that have a legal title by the business should be included in inventory Goods on transit- goods are on the way. Matters because weather to include in E.I or nah Terms of sale- decides who has the legal title FOB shipping point- legal title passed on to buyer at the shipping point. Buyer pays shipping. Buyer includes in ending inventory. FOB destination- legal title passed on to the buyer at the destination. Seller pays shipping. Cosigned Goods- owner transfers physical goods to agent (cosignee) for the purposes of selling without giving up legal rights. The legal title doesn’t transfer over so it cannot be put in E.I by the medium to sell. Key facts to differentiate for E.I- Buyer or seller Terms of sale Inventory errors- their impact on financial statements COGS and E.I are inversely related COGS and net income are inversely related Inventory costing method (periodic method) Dealing with the amount for item that are items in question whether to include or not like goods in transit. The question is whether to use the selling price or buying price for the unit Specific identification method- puts a specific value for the unit item Very costly method for large scale Made for Small quantities or luxury items Cost flow assumption- (unrelated to the physical count/flow) First in, first out(FIFO) oldest goods are assumed to be sold first. The ending inventory is assumed as the oldest. GAS- goods available for sale Calculated with the unit price bought first (assumed to sell first) Example: As of December 31, ABC Corp. took a physical count of its inventory and determined they had 30 units of their product still on hand. ABC’s accounting records provided the following information about their inventory: Goods Available for Sale during the year: # Units Unit Cost Total Cost Beginning Inventory 20 $ 4 $ 80 Purchase, February 15 40 $ 5 $ 200 Purchase, May 10 50 $ 6 $ 300 Purchase, Nov. 19 60 $ 7 $ 420 Total GAS during the year 170 units $1,000 E.I Newest 30 units 30x7=210 COGS cosg CAS – E.I 20x4=80 =790 40x5=200 50x6=300 30x7=210 Advantages Assigns current cost to inventory With prices rising, income is higher With prices rising, assets are higher Disadvantages Matching cost with revenue Net income is overstated and income taxes are higher Last in, first out(LIFO) Inventory on hand is the oldest Example: As of December 31, ABC Corp. took a physical count of its inventory and determined they had 30 units of their product still on hand. ABC’s accounting records provided the following information about their inventory: Goods Available for Sale during the year: # Units Unit Cost Total Cost Beginning Inventory 20 $ 4 $ 80 Purchase, February 15 40 $ 5 $ 200 Purchase, May 10 50 $ 6 $ 300 Purchase, Nov. 19 60 $ 7 $ 420 Total GAS during the year 170 units $1,000 E.I (Oldest 30 units) 20x4=80 10x5=50 =130 COGS CAS – E.I =870 COGS 60x7=420 50x6=300 30x5=150 =870 Advantages Matching costs with revenue Prices rising, income is less, taxes are less Disadvantages Non current value to inventory on balance sheet Prices rising, income is less Prices rising, assets are lower Weighted average- assumes all inventory cost the same. Total Cost of Goods Available for Sale (GAS) / Weighted Average Method = Total # of Units available for sale Lower cost or market (LCM) When the market value of inventory is lower than its original purchase cost, companies need to write down the inventory cost to the market value. This is a conservative inventory validation approach that is an attempt to anticipate the declines in the value of the inventory before its actual sale Record loss is the year the decline of value actually happens Market value is defined as current replacement cost Journal entry: Loss on deduction in inventory (temporary account) Inventory CHAPTER 6 NOTES Reporting and Analyzing Inventory Learning Objectives 1. Determine how to determine the ending inventory quantities. 2. Indicate the effects of inventory errors on the financial statements. 3. Apply the inventory cost flow methods under a periodic inventory system to determine the total cost of the ending inventory. 4. Understand the financial statement and tax effects of each of the inventory cost flow assumptions. 5. Understand the lower-of-cost-or-market basis of accounting for inventories. I. Goods to Include in Ending Inventory All goods for which the company has legal title (regardless of location) 1. Goods in Transit – goods ordered but not yet received Goods in transit should be included in the inventory of the company that has legal title to the goods. Legal title is determined by the terms of sale. FOB Shipping Point – title transfers to buyer when the public carrier accepts the goods from the seller. Buyer pays the shipping costs. FOB Destination – title transfers when goods are delivered to destination of buyer. Seller pays the shipping costs. 1 2. Consigned Goods – the owner (consignor) transfers physical goods to agent (consignee) for purposes of selling without giving up legal title. Example Problem 1 – First Bank and Trust is considering giving Novotna Company a loan. Before doing so, they decide that further discussions with Novotna's accountant may be desirable. One area of particular concern is the inventory account, which has a year-end balance of $295,000. Discussions with the accountant reveal the following: 1. Novotna sold goods costing $35,000 to Moghul Company FOB Shipping Point on December 28. The goods have been shipped but are not expected to arrive in India until Jan. 12. The goods were not included in the physical inventory because they were not in the warehouse. 2. The physical count of the inventory did not include goods costing $95,000 that were shipped to Novotna FOB destination on December 27 and were still in transit at year-end. 3. Novotna received goods costing $25,000 on January 2. The goods were shipped FOB shipping point on December 26 by Cellar Co. The goods were not included in the physical count. 4. Novotna sold goods costing $40,000 to Sterling of Canada FOB destination on December 30. The goods were received in Canada on January 8. They were not included in Novotna's physical inventory. 5. Novotna received goods costing $44,000 on January 2 that were shipped FOB destination on December 29. The shipment was a rush order that was supposed to arrive December 31. This purchase was included in the ending inventory of $295,000. REQUIRED: Determine the correct ending inventory amount on December 31. 2 II. Inventory Errors – their impact on the financial statements (see Appendix 6B) If ending inventory is overstated, COGS is understated (Balance Sheet and Income Statement would be wrong!) If ending inventory is misstated, beginning inventory the next period is also misstated. A condensed income statement for the year ended December 31, 2008 for Murcer Products shows the following: Sales................................................................................... $80,000 Cost of goods sold ............................................................... 50,000 Gross profit on sales.......................................................... $30,000 Expenses.............................................................................. 20,000 Net income........................................................................ $10,000 An investigation of the records discloses the following error in summarizing transactions for 2008: Ending inventory was overstated by $3,100. 3 III. Inventory Costing Methods (Periodic Method) After a company has determined the quantity of units of ending inventory, it applies unit costs to the quantities to determine the total cost of the ending inventory and the cost of goods sold Inventory is purchased at different times, and at different prices; these costs must be allocated correctly when items are sold. Some rational system must be used. Several options available under GAAP: Actual Flow of Goods: 1. Specific Identification Method – only practical for businesses with small quantity of inventory or high priced items a. Ex: car dealership, antique store, jewelry store 4 Cost Flow Assumptions Made: 2. First-In, First-Out (FIFO) – Assumes the oldest items are sold first and ending inventory is our newest items. Example: As of December 31, ABC Corp. took a physical count of its inventory and determined they had 30 units of their product still on hand. ABC’s accounting records provided the following information about their inventory: Goods Available for Sale during the year: # Units Unit Cost Total Cost Beginning Inventory 20 $ 4 $ 80 Purchase, February 15 40 $ 5 $ 200 Purchase, May 10 50 $ 6 $ 300 Purchase, Nov. 19 60 $ 7 $ 420 Total GAS during the year 170 units $1,000 Determine $ COGS and $ Inventory based on FIFO method: Advantages of FIFO: o Assigns current cost to inventory (end inventory = most recent purchases) o When prices are rising, income is higher o When prices are rising, assets are higher Disadvantages of FIFO: o Fails to match most recent costs with revenues o When prices are rising, net income is overstated and income taxes are higher! 5 3. Last-In, First-Out (LIFO) – Assumes the newest items are sold first and ending inventory is our oldest items. Example: As of December 31, ABC Corp. took a physical count of its inventory and determined they had 30 units of their product still on hand. ABC’s accounting records provided the following information about their inventory: Goods Available for Sale during the year: # Units Unit Cost Total Cost Beginning Inventory 20 $ 4 $ 80 Purchase, February 15 40 $ 5 $ 200 Purchase, May 10 50 $ 6 $ 300 Purchase, Nov. 19 60 $ 7 $ 420 Total GAS during the year 170 units $1,000 Determine $ COGS and $ Inventory based on LIFO method: Advantages of LIFO: o Matches current cost with current revenue o When prices are rising, income is less, which makes taxes less Disadvantages of LIFO: o Gives a non-current value to inventory on the balance sheet o When prices are rising, income is less o When prices are rising, assets are lower 6 4. Weighted Average Method – assumes all inventory costs the same; assigns average cost to both Ending Inventory and COGS Example: As of December 31, ABC Corp. took a physical count of its inventory and determined they had 30 units of their product still on hand. ABC’s accounting records provided the following information about their inventory: Goods Available for Sale during the year: # Units Unit Cost Total Cost Beginning Inventory 20 $ 4 $ 80 Purchase, February 15 40 $ 5 $ 200 Purchase, May 10 50 $ 6 $ 300 Purchase, Nov. 19 60 $ 7 $ 420 Total GAS during the year 170 units $1,000 Step 1: Determine Average Cost per Unit: Total Cost of Goods Available for Sale (GAS) Weighted Average Method = Total # of Units available for sale Step 2: Based on Average Cost, determine $ COGS and $ Ending Inventory: Advantage: Assigns cost on an equal unit basis to both End Inventory and COGS 7 EXAMPLE: Units Cost per unit Total Cost Beginning inventory 10,000 $4.00 $40,000 Purchase, Jan. 10 8,000 4.20 33,600 Purchase, Jan. 30 6,000 4.25 25,500 Purchase, Feb. 11 9,000 4.30 38,700 Purchase, Mar. 17 11,000 4.40 48,400 30,000 units were sold during the period for $7.00 each. Calculate the company’s ending inventory and COGS under each inventory methods. 8 5. Lower-of-Cost-or-Market (LCM) – “Market value” is defined as _______________________________________ If the LCM rule applies, we record the following journal entry: BE6-7 (pg. 305): O’Conner Video Center accumulates the following cost and market data at December 31. Inventory Categories Cost Data Market Data Cameras $12,500 $13,400 Camcorders $9,000 $9,500 DVDs $13,000 $12,800 Compute the lower-of-cost-or-market valuation for O’Conner’s inventory. 9 CHAPTER 5 NOTES Recording Inventory Course objectives: 1. Explain the recording of purchases under a perpetual inventory system. 2. Explain the recording of sales under a perpetual inventory system. 3. Determine cost of goods sold under a periodic system. 4. Explain the recording of purchases and sales of inventory under a periodic inventory system. 5. Explain that perpetual method gives more information to determine missing inventory. I. Review A. Inventory (Merchandising Inventory) a. b. B. COGS – Cost of Goods Sold a. b. II. Accounting for Inventories – 2 methods (need to know both of them!) 1. Perpetual Method: a perpetual accounting system continuously records both changes in inventory quantity and COGS. Missing items are not included in COGS. For every purchase: Inventory $xx (# purchased * purchase cost) Accounts payable $xx For every sale: Cash or A/R $xx (# sold * retail price) Sales Revenue $xx COGS $xx (# sold * original cost) Inventory $xx 1 If a physical count of inventory at the end of the period reveals a difference between what should be on hand and what in reality is, the difference is recorded as: Loss on Inventory decline $xx Inventory $xx 2. Periodic Method: A periodic inventory system adjusts inventory and records COGS only at the end of each reporting period. All items purchased for resale during the period are debited to a “PURCHASES” account. Missing items are included in the COGS. Use the COGS Formula with the Periodic Method: Cost of goods sold calculation: Beg. Inventory + Net purchases* = Goods available for sale - Ending inventory = Cost of goods sold *Net Purchases = Total Purchases + (transportation & taxes) 2 Example of Periodic vs. Perpetual Method: Periodic Perpetual (All items purchased for resale are debited to (All items purchased for resale go directly into a PURCHASES account. Rely on physical count & inventory. This method keeps a running total COGS formula at year-end to determine COGS. of COGS and updates inventory. When sale is Requires adj. entry at year-end to record COGS) made, requires (2) entries…one to record sale, one to reduce inventory. This method gives more info to determine inventory losses. To Record Purchase of Inventory: Purchased 50 tennis racquets for the Pro Shop at $10 each, on account. To Record Sale of Merchandise: Sold 40 racquets at $50 each, receiving cash. 3 End of Year Adjustments: Take a physical count of inventory. Eight racquets are on hand. 4 CHAPTER 4 NOTES Accrual Accounting The Accounting Cycle Ch. 3 Review Record transactions in the general journal, which is just a chronological list of transactions. Post the transactions to the general ledger accounts (“T-accounts”). Prepare a trial balance before adjustment, which is just a check to make sure debits=credits. It’s just a list of accounts, not an actual financial statement. Ch. 4 Record adjusting entries in the general journal. Post adjusting entries to the “T-accounts”. Prepare an adjusted trial balance. Record the closing entries to the general journal and then post to the “T-accounts”. I. Cash vs. Accrual Basis of Accounting a. Cash Basis – b. ***Accrual Basis – The basic difference between cash and accrual accounting is the timing of when revenue and expense are recorded. II. Accrual Basis (preferred method) 2 concepts: Revenue Recognition Principle and Matching Concept The accrual basis of accounting tells us when to record revenues and when to record expenses. 1 A. Revenue Recognition Principle (GAAP): tells us when to record revenues Recognize revenue in the accounting period in which the performance obligation is satisfied. B. Matching Concept (GAAP): tells us when to record expenses Match expenses with revenues in the period when the company makes effort to generate those revenues. III. Adjusting Entries Because Accrual Accounting is based on timing and not when cash is received or paid, it will require Adjusting Entries at the end of every accounting period in order to update all revenues (if now earned) and all expenses (if now “used up”). Necessary entries that update all unrecorded Revenues and Expenses due to the passage of time Four types of adjusting entries: Deferrals (prepayments) = CASH COMES FIRST 1. Prepaid Expenses – Cash is paid before expenses are incurred a. Ex: Rent, Insurance, Supplies, Advertising, Depreciation 2. Unearned Revenue – Cash is received before services are performed. a. Ex: Magazine subscriptions, Airline tickets, Rent, Customer deposits for future service 2 Accruals = CASH COMES LATER 3. Accrued Revenue – Revenue for services performed before cash is received; both revenue and asset accounts are increased a. Ex: Interest, Services performed but not collected 4. Accrued Expense – Expense is incurred before cash is paid; both expense and liability accounts are increased a. Ex: Wages/Salaries, Utilities, Interest, Taxes HINTS for ADJUSTING ENTRIES: 1) 2) 3) Adjusting Entry Examples: 1. On Nov 1, $6,000 was paid for 3 months of rent. Record the adjusting entry for Dec. 31. What type of adjusting entry? ______________________ 2. On May 1, $300 is received from a customer for 3 lawns to be cut during the month at $100 each. By May 31, two of the three have been done. What type of adjusting entry? _____________________ 3. An attorney works on a client’s legal brief for 8 hours on the last day of the month. The attorney’s fee is $200/hour. Client invoices will not be mailed until the 3 of the following month. What type of adjusting entry? ______________________ 3 4. Employees earn wages of $1,000/week ($200/day) and are paid on Friday. Dec. 31 (the company’s year-end) falls on a Wednesday. What type of adjusting entry? _______________________ 5. On Jan. 1, purchase $500 of supplies using cash. Supplies on hand at Jan. 31 are $200. What type of adjusting entry? ____________________ 6. Comet Pride, Inc. signed a twelve-month, 12% note payable in the amount of $10,000 on Oct. 1. Comet’s year end is Dec. 31. What type of adjusting entry? _____________________ 7. Boyd Co. purchased a two-year insurance policy on June 30 for $960 and recorded the transaction with a debit to “prepaid insurance”. Boyd’s year end is Dec. 31. What type of adjusting entry? _______________________ What is the effect if you failed to record this adjusting entry? 4 8. Depreciation – 5 Example Problem Water Corporation prepares monthly financial statements and therefore adjusts its accounts at the end of every month. The following information is available for March 2007: a) Water Corporation takes out a 90-day, 8%, $15,000 note on March 1, 2007, with interest and principle to be paid at maturity. b) The asset account Office Supplies on Hand has a balance of $1,280 on March 1, 2007. During March, Water adds $750 to the account for the purchases of the period. A count of the supplies on hand at the end of March indicates a balance of $1,370. c) The company purchased office equipment last year for $62,600. The equipment has an estimated useful life of six years and an estimated salvage value of $5,000. d) The company’s plant operates seven days per week with a daily payroll of $950. Wage earners are paid every Sunday. The last day of the month is Saturday, March 31. e) The company rented an idle warehouse to a neighboring business on Feb. 1, 2007, at a rate of $2,500 per month. On this date, Water Corporation credited Rent Collected in Advance for six month’s rent received in advance. f) On March 1, 2007, Water Corporation credited a liability account, Customer Deposits, for $4,800. This sum represents an amount that a customer paid in advance and that will be earned evenly by Water over a four-month period. g) Based on its income for the month, Water Corporation estimates that federal income taxes for March amount to $3,900. Required: For each of the preceding situations, prepare in general journal form the appropriate adjusting entry to be recorded on March 31, 2007. 6 IV. Post Adjusting Entries to Ledger & Prepare Adjusted Trial Balance Adjusted Trial Balance – Include the effects of adjusting entries (All ending balances are now up-to-date) The Adjusted Trial Balance again shows debits=credits V. Closing Entries Two types of accounts: Permanent = balance sheet accounts Temporary = income statement accounts and dividends Purpose of closing entries: 1. Close temporary accounts (revenue, expense, dividends) –return balances to ZERO 2. Transfer net income or loss to retained earnings How (pg. 185)? To close, create one more temporary account, the “Income Summary Account” 4 journal entries are involved 7 Example: Use the following information to prepare closing entries: Revenues $10,000 Beg. Retained Earnings $30,000 Rent expense 2,000 Dividends 1,000 Salary expense 5,000 1. Close all Revenue and Expense accounts to Income Summary. 2. Close Income Summary to Retained Earnings. 3. Close Dividends to Retained Earnings. (Don’t close Dividends to Income Summary!) 8 Below is the adjusted trial balance of the Nittany Lion Co. as of October 31, 2009. Cash $10,000 Accounts Receivable 4,000 Notes Receivable 2,500 Supplies 1,000 Accounts Payable $4,500 Note payable 3,000 Unearned Revenue 1,500 Common Stock 5,000 Retained Earnings 2,500 Dividends 500 Revenues 3,000 Insurance Expense 1,000 Wage Expense 500 $19,500 $19,500 Required: a. Prepare the closing entries as of October 31, 2009. 9 CHAPTER 3 NOTES The Accounting Information System Learning Objectives: Record transactions in the general journal, which is just a chronological list of transactions. Post the transactions to the general ledger accounts (“T-accounts”). Prepare a trial balance before adjustment, which is just a check to make sure debits=credits. It’s just a list of accounts, not an actual financial statement. I. The Effects of Business Transactions on the “Accounting Equation” Economic events are the basis for recording transactions in the accounting system. For every transaction, it is essential to analyze its effect on the accounting equation. 1 Example - Keeping the Accounting Equation in balance. 1. Owner invests $1,000 cash 2. Obtains loan from bank for $5,000. 3. Purchased supplies for $2,000, paid cash. 4. Received $3,000 cash from customer for 3 jobs to be performed in future. (Fee for each job is $1,000) 5. Owner withdrew $500 for personal use. 6. Performed a job for a fee of $700. Customer paid in cash. 7. Performed job for customer for a fee of $900. Customer will pay next month. 8. Paid employees wages of $1,500. 9. Completed one job for customer in #4 above. 10. Supplies on hand at the end of the month are $800. Assets Liabilities + Stockholder = Equity Retained Accounts Note Unearned Common Earnings = Cash Receivable Supplies = Payable Revenue Stock Revenue (Expense) (Dividend) 2 II. How to record business transactions in T-accounts: Double-Entry System a. The Rules: i. Each transaction must affect two or more accounts to keep the basic accounting equation in balance ii. Each individual transaction is recorded by debiting at least one account and crediting another. iii. For each individual transaction, the dollar amount of debits must equal the dollar amount of credits. iv. Debits on the left, Credits on the right Debits: Credits: Increase assets Increase liab & equity accts. Increase expenses Increase revenues Increase dividends Decrease assets Decrease liab. & equity accts. Decrease expenses Decrease revenues b. Illustration – T-accounts: Asset + - Increase an asset with a debit debit credit Decrease an asset with a credit Normal Balance Liability - + Increase a liability with a credit debit credit Decrease a liability with a debit Normal Balance 3 Stockholder's Equity - + Increase equity with a credit debit credit Decrease equity with a debit Normal Balance Revenue - + Increase revenue with a credit debit credit Decrease revenue with a debit Normal Balance Expense + - Increase an expense with a debit debit credit Decrease an expense with a credit Normal Balance c. Summarize Rules of Debits and Credits: 4 III. The Accounting Cycle STEP 1: RECORDING GENERAL JOURNAL ENTRIES All transactions are recorded in the general journal (chronological list of transactions) Example: Sept. 1 Owner invests $2,000 into company Sept. 3 Borrows $5,000 from local bank Sept. 5 Purchase $1,000 of supplies on account Sept. 7 Received $700 cash from customer for services performed. Sept.15 Paid employee wages of $500 To Record: STEP 2: POST TO LEDGER The general ledger is a collection of “T-accounts” which are used to group like transactions. 5 Exercise: Jane Feller opened a driving range and the following transactions took place in July, 2008. Date: July 1 Owner invested $10,000 in the common stock of the business. 5 Purchased equipment for $5,000; made a cash down payment of $2,000, and signed a 60-day note for the balance. 25 Dividends of $100 were paid. 31 Total revenue for the month was $1,500; $1,200 was collected in cash, and the balance was owed on account by customers. 31 Total expenses for the month were $1,100; $900 was paid in cash, and the balance was owed on account. REQUIRED: Record the journal entries for these transactions and post to t-accounts. 6 STEP 3: TRIAL BALANCE BEFORE ADJUSTMENT The trial balance is a list of all accounts in the general ledger and their balance (i.e. whether it is a debit or credit and what the dollar amount is). Purpose: 1. Prove that debits = credits 2. Catch some obvious errors (the trial balance will NOT catch all errors) Exercise (con’t): TRIAL BALANCE Account Title Debit Credit 7 Short Problem: Listed below are selected accounts from the financial statements of a company for the year ended December 31, 2007. In the blank space provided for each account, indicate what type of account it is, its normal balance, and the debit/credit rules for increasing and decreasing it. Use the following abbreviations for your answers: Rules to Increase or Decrease Type of Account Normal Account Balance the Account A = Asset Dr = Debit Dr = Debit L = Liability Cr = Credit Cr = Credit OE = Owner’s Equity R = Revenue E = Expense Type of Normal Rule to Rule to Account Balance Increase Decrease a) Cash _________ _______ _______ ______ b) Income Tax Expense _________ _______ _______ ______ c) Accounts Payable _________ _______ _______ ______ d) Retained Earnings _________ _______ _______ ______ e) Inventories _________ _______ _______ ______ f) Prepaid Expenses _________ _______ _______ ______ g) Sales Revenues _________ _______ _______ ______ h) Long term Debt _________ _______ _______ ______ i) Intangibles _________ _______ _______ ______ j) Common Stock _________ _______ _______ ______ k) Unearned Revenue _________ _______ _______ ______ 8 CHAPTER 2 NOTES I. In-Depth Look At The Income Statement A. Components of Income Statement: Revenues – inflow of assets (cash or A/R) as a result of delivering goods or performing a service Expenses – “using up” of a resource to help generate revenue Gains & Losses – B. Multi-step Income Statement (Ch. 5) Net Sales - Cost of Goods Sold (COGS) = Gross Profit - Operating Expenses Selling Expenses General & Administrative = Income from Operations ± Other revenues and expenses = Income before income taxes - Income Tax Expense = Net Income a. Identifying characteristics: Gross Profit, Income from Operations b. Highlights components of income based on operating vs. non-operating activities 1 II. In-Depth Look at the Statement of Stockholder’s Equity OR Statement of Retained Earnings Statement of Retained Earnings Statement of Stockholder’s Equity Statement of Stockholder’s Equity shows changes in both capital stock and retained earnings If there were no stock transactions, only a Statement of Retained Earnings is prepared III. In-Depth Look at The Classified Balance Sheet Current Assets – converted to cash, sold, or consumed within one year. o Some examples: Cash Short-term investments or “marketable securities” Investments made for the short-term (could be stocks, bonds, treasury bills, etc.) Accounts Receivable (A/R) Inventory Supplies Prepaid Expenses Don’t get tricked by the name…these are assets! Non-current Assets – anything that is not a current asset (longer than one year) o Some examples: Long-term Investments (stocks, land held for future expansion, machines not used for operations, etc.) 2 Plant, Property and Equipment (PP&E) – productive assets used in the operation of your business 1. Land 2. Building 3. Equipment 4. Furniture Everything in the PP&E category is subject to depreciation except land (Depreciation = allocating the cost of assets to expense over its useful life) 5. Accumulated Depreciation = contra-asset! Matching Concept = match revenues and expenses therefore, we want to match depreciation expense to each period over which the asset helps earn revenue Accumulated Depreciation is an “allocation of cost” – it is NOT REAL cash! Intangibles – lack physical substance Trademarks, copyrights, franchise rights, patents, goodwill Amortize if limited life Current Liabilities – obligations that will be satisfied within one year o Some examples: Accounts Payable (A/P) Wages/Salary Payable Interest Payable Taxes Payable Notes Payable (can also be a long-term liability…depends on the maturity date) Unearned Revenue Don’t get tricked by the name—these are liabilities! 3 Long-term Liabilities – anything that is not a current liability (longer than one year) o Some examples: Notes Payable Bonds Payable Stockholder’s Equity – owner’s claims to the assets of the company o Common Stock and Retained Earnings Balance Sheet Example Assets Liabilities: Current Assets: Current Liabilities: Cash $ xx Accounts Payable $ xx Accounts Receivable xx Notes Payable (short term) xx Inventory xx Wages Payable xx Supplies xx Unearned Revenues xx Prepaid Expenses xx Total Current Liabilities $ xx Total Current Assets $xx Long-Term Debt: Long Term Investments xx Notes Payable $ xx Fixed Assets: Bonds Payable xx Land $ xx Total Long-Term Debt $xx Building xx TOTAL LIABILITIES $xx Equipment xx Stockholders’ Equity: Less: Accum. Depr (xx) Common Stock $ xx Total Fixed Assets xx Retained Earnings xx Patents xx Total SHE $ xx Total Assets $XX Total Liabilities & SHE $ XX 4 IV. Uses and Limitations of Balance Sheet Uses – to analyze (pg. 59): Liquidity Measures –the ability to pay obligations expected to become due within the next year 1) Working Capital = (Current Assets – Current Liabilities) 2) Current Ratio = (Current Assets / Current Liabilities) Allows comparison of liquidity between companies by omitting $ amounts Limitations 1. Historical Cost vs. FMV 2. Omissions Example Problem 1: Landon Corporation was organized on January 2, 2005, with the investment of $100,000 by each of its two stockholders. Net income for its first year of business was $85,200. Net income increased during 2006 to $125,320 and $145,480 during 2007. Landon paid $20,000 in dividends to each of the two stockholders in each of the three years. Prepare a statement of retained earnings for the year ended December 31, 2007. 5 Example Problem 2: The balance sheet for Stevenson, Inc. includes the following items: Cash $23,000 Accounts receivable 58,000 Prepaid Insurance 800 Land 80,000 Accounts payable 54,900 Salaries payable 1,200 Capital stock 100,000 Retained earnings 5,700 1. Determine the current ratio and working capital. 2. Beyond the information provided in your answers to 1, what does the composition of the current assets tell you about Stevenson’s liquidity? 6 Example Problem 3: These financial statement items are for Batra Corporation at year-end, December 31, 2009: Salaries expense $20,000 Utilities expense 14,900 Equipment 15,900 Accounts Payable 6,220 Sales Revenue 69,600 Unearned rent revenue 1,800 Common stock 20,000 Cost of Goods Sold (COGS) 38,700 Cash 10,440 Accounts receivable 8,780 Accumulated depreciation 5,400 Dividends 14,000 Depreciation expense 4,000 Retained earnings (Jan. 1, 2009) 25,200 Prepaid Expenses 1,500 Required: a. Prepare a multi-step income statement and a Retained Earnings Statement for the year. Batra Corp. did not issue any new stock during the year. b. Prepare a classified balance sheet at December 31, 2009. 7 Chapter 1 Notes Introduction to Financial Statements Learning Objectives: 1. General knowledge about business activities 2. The fundamental balance equation of accounting 3. The basic formats of the four financial statements I. Business Activities - 3types A. Financing Activities: Raise money to start and continue business a. Invested money – is obtained by selling stock to investors. This is called **equity, which represents the owner’s share of the business. i. Permanent financing ii. Stockholders own the company b. Borrowed money – must be repaid. This is called **liability. i. Not permanent financing ii. Lenders called creditors B. Investing activities: money obtained from financing is used to acquire assets a. **assets = resources owned by a company that will generate future economic profits i. EX: land, building, machinery, patent, accounts receivable, inventory, etc. C. Operating Activities: Day-to-day business of producing and/or selling a product or performing a service which results in revenue and expenses a. **Revenue = inflow of assets (cash or A/R) as a result of: i. Performing a service OR ii. Delivering the goods
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