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This 13 page Class Notes was uploaded by Petey Martin on Monday September 28, 2015. The Class Notes belongs to ACC 201 at University of Rochester taught by WOJDAT K in Summer 2015. Since its upload, it has received 41 views. For similar materials see FINANCIAL ACCOUNTING in Accounting at University of Rochester.
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Date Created: 09/28/15
Petey Martin Notes 92215 Unadjusted Statements 0 Journal entries combined with beginning account balances and other journal entries give rise to account totals as of the end ofjanuary 0 These totals can be used to create unadjusted nancial statements 0 Considered unadjusted because period end adjusting entries are still needed to record some revenues expenses asset changes liability changes income taxes etc Need to determine unearned revenue earned prepaid expense used depreciation etc 0 Pro t margin net income net sales 0 High Level is good 0 Assets increase revenue Assets are both variable and xed 0 Furthermore even rms in the quotsamequot industry may face natural differences in their pro t margins due to normal differences in the nature of their products and of their competitive environment Chapter 4 Introductory Accounting 0 Throughout the accounting period transactions associated with exchanges between the accounting entity and other entities are recorded in the accounts 0 Journal entries for the period are not complete at this time 0 At the end of the accounting cycle a number of steps are performed before the nancial statements are distributed 0 Account balances as of the period end are calculated by using T accounts or automation to combine beginning balances with the journal entries that have been recorded up to the end of the period 0 An unadjusted trial balance is prepared to make sure that debits edual credits for all entries made prior to the nal adjusting entries 0 Adjusting entries are made at the end of the accounting period which need not be 1231XX to record economic events not yet recorded in the accounts as of that time 0 Two basic kinds of adjustment Deferral Adjustments Adjust the accounts that were previously established to account for cash received prior to revenue being earned or cash paid prior to expenses being incurred 0 Reduce a liability m record a revenue 0 Reduce an asset m record an expense to record use of an asset to generate revenue Accruals Recognize revenue earned or expenses incurred during the accounting period that have not yet been recognized and for which cash will respectively be received or paid in a later accounting pedod 0 Record revenue and a receivable asset 0 When cash is received in the future period revenue is not recognized at that time instead receivable is reduced via a credit Record expense and a payable liability 0 When cash is paid in the future period expense is not recognized at that time instead the payable is reduced via a debit Note both the accruals and the deferrals serve to record revenue and expense in the proper period 0 The auditors must then evaluate the appropriateness of account balances after all adiusting entries have been made Adjusting previously booked unearned revenue and prepaid expense 0 Unearned Revenue also called Deferred Revenue is a previously booked liability that must be adjusted to recognize revenue earned through the end of the accounting period 0 Prepaid Expense a deferred expense is a previously booked asset that must be adjusted to re ect the expense incurred through the end of the accounting period Purchases of supplies inventory and longlived assets are also deferred expenses previously booked as assets that must be adjusted to re ect expense incurred through the end of the accounting period similar to prepaid expenses 0 Cash goes out rst to buy inventory supplies or PPampE 0 Adjust entry records portion of asset used up 0 Examples Inventory In chapter 3 the example showed the accounting for the purchase of inventory with the inventory account adjusted and COGS recognized i the time of sale 0 A year end adjustment is also needed to account for errors in original accounting and for losses and theft of inventory 0 Some companies simply adjust inventory at year end without accounting for COGS throughout the year although losses and thefts are then unknown quantities Supplies Tracking supplies usage would be tedious and potentially expensive Often supplies expense is calculated only at period end by comparing tota supplies available for use beginning and purchases to the total remaining at year end Plant Property and Equipment Can provide service for many years An estimate of the total cost of using PPampE over its entire estimated useful life is the asset s cost less an estimate of the value it will have at the end of its estimate useful life 0 Depreciation is calculated at the end of each period Depreciation is used to assign a portion of the above cost as an expense of each year the asset is expected to be in service 0 The credit reducing the PPampE asset goes to an accumulated depreciated account not the asset account Accumulated depreciation is a contra asset account 0 The Net book value of PPampE is the original cost captured in the asset account less accumulated depreciation captured in the contra asset account 0 Year end adjusting entries to accruals o Accrue revenue earned for which cash has not yet been received 0 Accrue expenses incurred but not yet paid 0 In the case of accruals the cash transactions occurs second for deferrals it occurrs rst Petey Martin Notes 92415 0 Chipotle s Example 0 A review of the balance sheet indicates a number of accounts that require year end adjustment Inventorv and Supplies both require a period end counts and adjustment of the asset balance Prepaid Expense requires determination of any used up Property and Equipment requires depreciation entry Unearned Revenue requires determining services provided Accounts Receivable indicates that revenue had been accrued in prior periods and may need to be again Accounts and Accrued Expenses Payable indicate that expense had been accrued in prior periods and may need to be again Long Term Notes Receivable indicates that interest revenue may need to be accrued Long Term Notes Payable indicates that interest expense may need to be accrued Income Taxes Pavable accrua needed in past and needed currently At the end of the quarter Chipotles makes the following year end adjusting entries 0 At the end ofjanuary Chipotle s counts 10000 worth of supplies on hand but the balance in the supplies account is 216600 Supplies Expense E SE 206600 Supplies A 206600 Inventory works the same way 0 During the quarter Chipotle uses up three months of the 32000 in insurance coverage that covered 12 months Insurance Expense E SE 8000 Prepaid Insurance A 8000 Prepaid Insurance asset balance is 24000 after Chipotle uses term occupancy expense 0 During the quarter Chipotle used up three months of the 36000 in prepaid rental that covered 6 months Rental Expense E SE 18000 Prepaid Rental A 18000 Prepaid Rental asset balance is 18000 after Chipotle uses term occupancy expense During the quarter Chipotle used up the 18000 of advertising purchased at the beginning of the quarter Advertising Expense E SE 18000 Prepaid Advertising A 18000 Chipotle uses term occupancy expense During the quarter Chipotle has depreciation of 20100 Depreciation Expense E SE 20100 Accumulated Dep XA 20100 Accumulated depreciation increases from 370000 to 390100 reducing net book value of PPampE by 20100 During the quarter Chipotle s customers redeemed 21300 worth of gift cards for food Unearned Franchise Fees L 21300 Franchise Revenue R SE 21300 Chipotle s employees earned 13400 in salaries or the last two days of the quarter which will be paid next quarter Salary Expense E SE 13400 Salary Payable L 13400 Chipotle receives a 4400 utility bill for gas and electricity used in during the quarter Utility Expense E SE 4400 Utilities Payable L 4400 Would accrual be needed if bill had not been received YES Chipotle owed 233200 in notes payable during the quarter Interest on the borrowing was approximately 77 Interest for the quarter was 223200 x 077 x 14 rounded to nearest 100 Interest Expense E SE 4500 lnterest Payable L 4500 Investments owned by Chipotle earned 200 in investment income interest for which the cash had not been received by Chipotle as of the end of the quarter lnterest Receivable A 200 lnterest Revenue R SE 200 Chipotle calculates pretax income of 102700 after all adjustments other than income tax Chipotle s tax rate of approximately 389 No tax pavments have been made Income Tax Expense E SE 40000 Income Tax Payable L 40000 0 Once all adjustments have been made rm prepares an adjusted trial balance to verify that debits equal credits 0 O O 0 Adjusted Trial Balance Account Unadjusted Adjustments Adjusted Name Debit Credit Debit Credit Debit Credit Cash 25 25 NR 30 30 Interest Rec a 10 10 Inventory 30 30 PPampE 30 3O Accum Dep 5 b 5 5 Accounts Payable 2O 20 Notes Payable 3O 30 Common Stock 2 2 Additional PIC 28 28 Beginning RE 30 30 Dividends 10 10 Revenue 55 a 10 65 COGS 15 15 Selling Expenses 20 b 5 25 Income Taxes 5 5 Gain on Sale PPampE 5 5 Interest Expense 10 Totals 175 175 15 15 190 190 Total of debit balance equals total of credit balances before and after adjustments Adjusted debit and credit balances are accumulated into categories for nancial statement presentation Note Even though revenue and expenses are of the balancing in the trial balance we will still end up with Assets Liabilities Stockholders Equity because revenue and expense balances will become part of retained earnings 0 From adjusted trial balance nancial statements are prepared 0 Prepare the income statement rst as it is needed to calculate ending retained earnings adjusted trial balance does not show ending retained earnings as revenue and expenses are shown in separate accounts From above adjusted trial balance 0 Income Statement Revenue 65 Cost of Goods Sold Q Gross Margin 50 Sell Gen Admin Expenses 25 Operating Income 25 Gains 5 Interest Expense IQ Income before Taxes 20 Income Taxes 5 Net Income 15 0 Prepare the Statement of Retained Earnings or Consolidated Statement of Stockholders Equity next to get ending retained earnings for the balance sheet Ending Retained Earnings credit balance Beginning Retained Earnings Net Income Dividends From trial balance income statement and other sources 0 Consolidated Statement of Stockholders Egu y Common Add Retained Total Stock PIC Earnings SE Beg Balance 1 14 30 45 Stock Issued 1 14 15 Net Income 15 15 Stock Redeemed 0 0 Dividends 10 1amp1 End Balance 2 28 35 65 0 Prepare the balance sheet Get retained earnings from the statement of retained earnings From above adjusted trial balance and Statement of Retained Earnings Assets Liabilities Cash 25 NP 20 NR 30 Notes Payable Interest Rec 10 Total Liabilities 50 Inventory 30 Net PPampE 20 Stockholders Equity Total Assets 115 Common Stock 2 Add PIC 28 Retained Earnings g Total SE 65 0 One Last Element is the closing process Before the closing entries the balance in the Retained Earnings account does not include any income from the yearjust nished Also at this point the revenue expense and dividend accounts have balances equal to the total revenue expense and dividends from the next yearjust nished Closing entries at the end of each period address both issues by O transferring revenue expense and dividend account balances from those accounts to the retained earnings account Establishing a zero balance in the income statement and dividends accounts to start the accumulation for the next period 0 Normal closing entries look as follows Revenue Debit to zero Expense Credit to zero Retained Earnings Credit to net income Retained Earnings Debit to dividends Dividends Credit to zero unless dividends are debited to retained earnings immediately when declared 0 Closing entries for the above trial balance Revenue 65 Gain on Sale of PPampE 5 o COGS 15 0 Selling Expenses 25 0 Income Tax Expenses 5 0 Interest Expense 10 o Retained Earnings 15 Retained Earnings 10 o Dividends 10 0 After the closing entries Revenue and Expense and Dividends accounts are zero ready for entries ensuing years Revenue and Expense and Dividends accounts are called temporary or nominal accounts because their balances reset to zero at the beginning of each yeah 0 At end of each accounting period their balances are transferred to retained earnings 0 Therefore these accounts accumulate data for one accounting period only 0 After the closing entries the Retained Earnings account total equals the amount on the balance sheet just as all other balance sheet accounts do Balance sheet accounts are called permanent accounts because their account balances consist of all transactions affecting the account since the inception of the rm Ending balance in balance sheet accounts for one period is carried over as beginning balance of the following period 0 Overall Example 0 Balance Sheet Beginning of Year Cash 5000 Inventory 5000 Total Assets 10000 Liabilities 0 Common Stock 100 Contributed Capital 4900 Retained Earnings 5000 Total Stockholder s Equity 10000 Total Liabilities and SE 10000 0 Transactions During the year Firm sells one half the inventory for 5000 in cash 0 Cash 5000 Cost of Goods Sold 2500 Inventory 2500 Revenue 5000 Firm declares a 3000 dividend at year end Dividends Declared 3000 Dividends Payable 3000 o Adjusting Entry Firm s salesmen and executives earn 1000 for current year s service payable beginning of next year Wage Expense SGampA expense 1000 Wages Payable 1000 0 At this point Cash bb 5000 a 5000 10000 Inventory bb 5000 I a 2500 2500 Div Payable l b 3000 3000 Wages Payable l c 1000 1000 Common Stock 0 I bb 100 100 Add PIC I bb 4900 4900 Retained Earnings I bb 5000 5000 Revenue I a 5000 5000 COGS a 2500 2500 Wage Expense c 1000 1000 Dividends a 3000 3000 bb are beginning balances from balance sheet 5 beginning of year 0 c is an adjusting entry and would not be included on the unadjusted trial balance 0 Trial Balances created from account totals Unadjusted TB Adi Entries Adjusted Account Debit Credit Debit Credit Debit Credit Cash 10000 10000 inventory 2500 2500 Wages Payable 1000 1000 Dividend Payable 3000 3000 Common Stock i100 i00 Additional PIC 4900 4900 Beginning RE 5000 5000 Revenue 5000 5000 Cost of Goods Sold 2500 2500 Wage Expense 1000 1000 Dividends 3000 3000 Total i1 8000 1 8000 1000 11000 19000 I 19000 Income Statement Revenue 5000 Cost of Goods Sold 2500 Selling Gen and Admin 1 000 Net Income 1500 Assumes no other income or expenses and no income tax Statement of Retained Earnings Beginning Balance RE 5000 Plus Net Income 1500 Less Dividends Declared 3000 Ending Retained Earnings 3500 Balance Sheet End of Year Cash 10000 5000 5000 Inventory 2500 5000 2500 Total Assets 12000 Wages Payable 1000 0 1000 Dividends Payable 3 000 0 3000 Total Liabilities 4000 Common Stock 100 100 0 Additional PIC 4900 4900 0 Retained Earnings 3500 from RE state Total Stockholder s Equity 8500 Total Liabilities and SE 12500 Need following closind entrv ce Revenue 5000 COGS 2500 Wage Expense 1000 Retained Earnings 1500 Retained Earnings 3000 Dividends 3000 Retained Earnings ce 1000 bb 5000 ce 2500 ce 5000 ce 3000 I 3500 Revenue ce 5000 I a 5000 0 COGS a 2500 ce 2500 0 Wage Expense c 1000 Ice 1000 0 Dividends b 3000 Ice 3000 0 Incentives to Misrepresent Revenue and Expense O O 0 Managers bonuses are often paid based on reported earnings earnings shortfalls can cost managers money Further Investment analysts have expectations of a firm s future net income These factors can motivate managers to try to increase reported revenue or decrease reported expense 0 Opportunities to Misrepresent Revenue and Expense O 0 Earnings can be manipulated or in error through the misreporting of assets and or liabilities Sales may be overstated resulting in higher reported accounts receivable and higher reported revenue than actual Eg there may be cut off manipulations or errors where end of period transactions are recorded in the wrong period 0 Revenue may be recorded before it is truly earned resulting in overstated receivables and overstated revenue in the current period lower revenue in later periods when the error unwinds 0 Many SEC enforcement actions involve the accrual of revenue that should not be recognized until a later period Liabilities may be understated by lowballing liability estimates resulting in understated expenses reported in the current period and higher eXDenses reported in later periods when the insufficiency of the accrual becomes evident Inventory values may be overstated resulting in lower current period expense and higher later period expenses when the true value become evident