SET 3 - Lecture notes 3 PDF

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Foundations of Accounting class from Fall 2017. Taught by Professor Jane Sarvalegam., Foundations of Accounting class from Fall 2017. Taught by Professor Jane Sarvalegam....

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SET 3 Accrual-basis accounting Recording revenues when earned (the revenue recognition principle) and expenses with related revenues (the matching principle)

the revenue recognition principle requires that revenue be recognize in the accounting period when it is earned

the matching principle match expenses against the revenues earned in the SAME period. in a given period, we report revenue as it is earned, according to the revenue recognition principle. It's only logical, then, that in the same period we should also record all expenses incurred to generate that revenue. The result is a measure—net income—that matches current period revenues and expenses. That's the matching principle in a nutshell.

Accruals occur when the cash flow occurs after either the expense is incurred or the revenue is earned. Accruals are the opposite of prepayments.

Accrued expense When a company has incurred an expense but hasn't yet paid cash or recorded an obligation to pay.In the case of accrued expenses, we paid cash after we incurred the expense and recorded a liability. The adjusting entry for an accrued expense always includes a debit to an expense account (increase an expense) and a credit to a liability account (increase a liability).

accrued revenue when a company has earned revenue but hasn't yet received cash or recorded an amount receivable In the case of accrued revenues, we receive cash after we earned the revenue and recorded an asset. The adjusting entry for an accrued revenue always includes a debit to an asset account (increase an asset) and a credit to a revenue account (increase a revenue).

Adjusted trial balance

A list of all accounts and their balances after we have updated account balances for adjusting entries

Adjusting entries Entries used to record events that occur during the period but that have not yet been recorded by the end of that period

Cash-basis accounting Record revenues at the time cash is received and expenses at the time cash is paid

Classified balance sheet B/S that groups a company's assets into current assets and long-term assets and that separates liabilities into current liabilities and long-term liabilities

Closing entries Entries that transfer the balances of all temporary accounts (revenues, expenses, and dividends) to the balance of the Retained Earnings account

Contra account An account with a balance that is opposite, or "contra," to that of its related accounts

Matching principle Recognize expenses in the same period as the revenues they help generate

Operating cycle The average time between purchasing or acquiring inventory and receiving cash proceeds from its sale

Permanent accounts

All accounts that appear in the balance sheet. Account balances are carried forward from period to period

Post-closing trial balance A list of all accounts and their balances at a particular date after we have updated account balances for closing entries

Prepaid expenses The costs of assets acquired in one period that will be expensed in a future period.

Revenue recognition principle Record revenue in the period in which it's earned

Temporary accounts All revenue, expense, and dividend accounts. Account balances are maintained for a single period and then closed (or zeroed out) and transferred to the balance of the Retained Earnings account at the end of the period

Unearned revenues When a company receives cash in advance from a customer for products or services to be provided in the future. Example-When customers pay cash in advance, we debit cash and credit a liability. This liability reflects the company's obligation to provide goods or services to the customer in the future. After the company has provided these products or services, the company can record revenue earned and reduce its obligation to the customer. The adjusting entry for an unearned revenue always includes a debit to a liability account and a credit to a revenue account.

During a discount sale, Larry buys a CD from Best Buy. Rather than paying cash, Larry uses his Best Buy card to buy the CD on account. When will Best Buy record revenue from this sale? at the time of sale, The revenue recognition principle states that we should recognize revenue in the period in which we earn it, not necessarily in the period in which we receive cash.

Which relationship between revenue and expense recognition is implied in the matching principle? Cause and Effect

A publisher sends magazines on a monthly basis to a customer throughout 2013. The customer had paid for this subscription in December 2012. For the February edition of the magazine, the publisher purchases paper in January by issuing a notes payable. The note is paid in March 2013. When should the company report the costs associated with the purchase of paper?

December 2012 January 2013 March 2013 February 2013 February 2013, We match expenses to the revenues they help to generate.

A publisher sends magazines on a monthly basis to a customer in 2013. According to the revenue recognition principle, it should report this revenue in its 2012 income statement, if it received cash for the magazine subscription in 2012.

True False False, Think about when the company earns this revenue.

On January 4, a company purchases supplies worth $1,500. Suppose that at the end of January, a count of supplies reveals that only $1,000 of supplies remains. This means that $500 worth of supplies were used during this period. How would you record this? We make a single adjusting entry at the end of the month for the total amount used during the period. To record one month of the cost of supplies as an expense in January, we increase the expense account Supplies Expense by debiting it. Supplies, which are assets, are reduced by $500 with a credit entry. Notice that the adjusting entry includes a $500 expense.

January 31 Debit Credit

Supplies Expense 500 Supplies 500

indicate the accounts that will be debited and credited when the adjusting entries are made at the end of the month. On February 1, an insurance company receives a premium of $4,000 cash from another company in an agreement to provide insurance of $1,000 each month for the next four months, beginning in February. Think from the insurance company's perspective. Debit- Unearned Revenue ,Credit Service Revenue (The adjusting entry for an unearned revenue always includes a debit to a liability account and a credit to a revenue account.)

indicate the accounts that will be debited and credited when the adjusting entries are made at the end of the month. At the end of May, a company receives a utility bill for $500 associated with operations in May. The company plans to pay the bill on June 10. Debit- Utilities Expense, Credit-Utilities Payable ( The adjusting entry for an accrued expense always includes a debit to an expense account (increase an expense) and a credit to a liability account (increase a liability). )

indicate the accounts that will be debited and credited when the adjusting entries are made at the end of the month. A company provides tutoring services to customers during two weeks in April. Customers pay cash in April. No entry required (This transaction involves the recognition of revenues and therefore will not require month-end adjusting entries. )

indicate the accounts that will be debited and credited when the adjusting entries are made at the end of the month. On August 1, a bank lends $5,000 to a company at an annual interest of 12% on the borrowed amount. Think from the bank's perspective. Debit-Interest Receivable, Credit- Interest Revenue [The adjusting entry for an accrued revenue always includes a debit to an asset account (increase an asset) and a credit to a revenue account (increase a revenue).]

indicate the accounts that will be debited and credited when the adjusting entries are made at the end of the month. On January 1, a company pays one year of rent in advance for $12,000 ($1,000 per month). Debit- Rent Expense, Credit-Prepaid Rent [The adjusting entry for a prepaid expense always includes a debit to an expense account (increase an expense) and a credit to an asset account (decrease an asset).]

Posting an adjusting entry On January 4, a company purchases supplies worth $1,500. Suppose that at the end of January, a count of supplies reveals that only $1,000 of supplies remains. Supplies, an asset, has to be reduced by $500 and supplies expense has to be increased. The adjusting entry involves a debit to Supplies Expense and a credit to Supplies. This adjusting entry is then posted to the company's General Ledger accounts. As shown, supplies are reduced by $500, and the ending balance is $1,000. This entry does not affect any liabilities. Stockholder's equity decreases by $500 as expenses increase.

Posting an adjusting entry On January 15, a company receives $2,000 in advance from customers who will record 5 audio lectures in the future. Assume that by the end of January, the company has recorded 1 audio lecture paid in advance. One-fifth of the work is now complete. This requires an adjusting entry for the $400 that the company has already earned for providing the service. Let's look at the adjusting entry now. Unearned Revenue, a liability account, is debited by $400, and the Service Revenue account is credited for the same amount. This adjusting entry is then posted to the company's General Ledger accounts. This entry does not affect any assets. As shown, unearned revenues are reduced by $400, and the ending balance is $1,600. Stockholders' equity increases as revenues increase. Note that the company had other revenues of $7,200 during the month before this adjustment. The ending balance in the Service Revenue account is now $7,600.

Post adjusting entry Assume that a company pays total salaries to its employees of $150 per day. For the first four weeks (28 days), the company pays $4,200 cash to employees. For the remaining three days in January, employees earn additional salaries of $450, but the company doesn't plan to pay the

employees until the end of the week, February 4. However, it must record the $450 salaries expense in January, the month in which the employees worked. The adjusting entry involves a debit to an expense account, which in this case is Salaries Expense, and a credit to a liability account, which is Salaries Payable. The net effect is an increase in both expenses and liabilities. This adjusting entry is then posted to the company's General Ledger accounts. This entry does not affect assets. As shown, Salaries Payable are increased by $450, and the ending balance in this account is $450. Now let us look at stockholders' equity. Before adjustment, the Salaries Expense account had a debit balance of $4,200 to account for expenses incurred for the first 28 days. This adjustment increases salaries expense by $450. The balance in the Salaries Expense account is now $4,650.

Post Adjusting Entry A company provides $800 of recording services to customers from January 28 to January 31. However, it usually takes the company one week to mail bills to customers and another week for customers to pay. Therefore, it expects to receive cash from these customers during February 814. Because the company earned the revenue in January (regardless of when cash receipt takes place), it should recognize in January the service revenue and the amount receivable from the customers. The adjusting entry would increase an asset—Accounts Receivable—by debiting $800 and will also increase Service Revenue by crediting it. Now, let's post this adjusting entry to the company's General Ledger accounts. Assume that before adjustments, the Accounts Receivable account had a balance of $2,900. The adjusting entry increases Accounts Receivable by $800. The balance including other receivables for January is now $3,700. This entry does not affect any liability. Now let's look at the Stockholders' Equity section. Before adjustments, this account had a balance of $7,200. Notice that we had credited $400 from an earlier transaction when the company performed $400 worth of recording services. Now we credit the Service Revenue Taccount by $800. Notice that the new balance in the Service Revenue account is $8,400.

Adjusted Trial Balance a list of all accounts and their balances after we have updated account balances for adjusting entries. Let us look at the relationship between an unadjusted trial balance (before adjustments) and an adjusted trial balance (after adjustments). Recall that in our first adjusting entry, we adjusted the Supplies account from $1,500 to $1,000 by reducing its balance by $500. The adjustment to supplies also resulted in Supplies Expense of $500 recorded. The other three adjustments are for revenue earned from previously unearned amounts, employee salaries owed but not paid, and revenue earned with no cash collection yet. These adjustments are included in

the adjusted trial balance the same way. After any other adjustments are made—for example, assume that we also adjust for rent, depreciation, utilities, and interest—the adjusted trial balance is complete.

A company is in its first month of operations. Post the adjusting entries for each of the scenarios provided. Make sure that you provide the correct account name. If nothing is needed choose no entry.

Supplies worth $4000 were purchased on January 5. At the end of the month, supplies worth $3000 were in hand.

A company is in its first month of operations. Post the adjusting entries for each of the scenarios provided. Make sure that you provide the correct account name. If nothing is needed choose no entry.

On January 1, the company paid $2100 as rent for 3 months in advance.

A company is in its first month of operations. Post the adjusting entries for each of the scenarios provided. Make sure that you provide the correct account name. If nothing is needed choose no entry.

On January 1, the company borrows $10,000 from the bank. The bank charges annual interest of 12% on the borrowed amount. Interest is due by the end of the year.

A company is in its first month of operations. Post the adjusting entries for each of the scenarios provided. Make sure that you provide the correct account name. If nothing is needed choose no entry.

The company performed $2000 worth of services in January. The company expects payments to come in by February 15.

current liabilities those due during the next year

Long-Term Liabilities those due in more than one year

In the adjusted trial balance, the balance of the Retained Earnings account is its balance at the end of the accounting period—the balance after all revenue, expense, and dividend transactions.

True False False, Think of why we would need a post-closing trial balance.

The _____ is the average time between purchasing inventory and receiving cash proceeds from its sale. operating cycle

Which of the following is an example of a current asset?

Equipment Common stock Accounts Payable Supplies Supplies, Some examples of current assets are cash, accounts receivable, supplies, and prepaid rent.

Which of the following provides the balance of retained earnings to be used in a classified balance sheet?

Statement of stockholders' equity Adjusted trial balance Income Statement Statement of Cash flows Statement of stockholders' equity, For the classified balance sheet, we need the ending balance of retained earnings.

Which financial statement reports revenue and expense accounts? Income Statement

Prepaid insurance Provides a benefit for how long? These provide a benefit over the next year.

Property and Equipment Provides a benefit for how long? These provide a benefit for more than one operating cycle.

Notes Payable are typically due..... These are typically due in more than one year.

Salaries Payable are due.... These are due during the next year.

Closing Entries, Revenues All revenue accounts have credit balances. To transfer these balances to the Retained Earnings account, we debit each of these revenue accounts for its balance and credit Retained Earnings for the total.

Closing Entries, Expenses and Dividends all expense and dividend accounts have debit balances. So, we credit each of these accounts for its balance and debit Retained Earnings for the total.

Closing Entries, Retained Earnings Retained Earnings is credited or increased in the first entry and then debited or decreased in the second and third entries.

Which of the following is a temporary account?

Retained Earnings Salaries Expense Accounts Receivable Cash Salaries Expense (Revenues, expenses, and dividends are termed temporary accounts.)

All accounts that appear in the balance sheet, including Retained Earnings, are permanent accounts, and we carry forward their balances from period to period.

True False True, Think of accounts that permanently appear in a balance sheet.

Which of the following is an objective for preparing closing entries?

a. To record the exact balances of all accounts and prepare them for measuring activity in the next period. b. To make sure that proper adjustments are made before preparing an adjusted trial balance. c. To reverse the effects of double-entry bookkeeping and ensure that the accounting equation is in balance.

d. To transfer the balances of temporary accounts to the Retained Earnings account. d. To transfer the balances of temporary accounts to the Retained Earnings account. (Note that closing entries "close out" certain accounts.)

The balance of which permanent account is affected by closing entries? Retained Earnings (Think of the account to which we transfer the balance of all revenue, expense, and dividend accounts.)

The closing entry for which of the following accounts will result in an increase in retained earnings? Revenues, Think of a closing entry in which retained earnings is credited.

Once we have prepared the closing entries, the balance of each revenue, expense, and dividend account equals... Zero

post-closing trial balance a list of all accounts and their balances at a particular date after we have updated account balances for closing entries. The post-closing trial balance helps to verify that we prepared and posted closing entries correctly and that the accounts are now ready for the next period's transactions. Notice that the post-closing trial balance does not include any revenues, expenses, or dividends, because these accounts all have zero balances after closing entries. The balance of Retained Earnings has been updated from the adjusted trial balance to include all revenues, expenses, and dividends for the period.

Which of the accounts are lsited in a Post-closing Trial balance? Select all that apply.

Salaries Expense Supplies Retained Earnings Dividens Service Revenue

Unearned Revenue Supplies, Retained Earnings, Unearned Revenue (think of accounts that are closed out to retained earnings)

The post-closing trial balance does not include any revenues, expenses, or dividends, because these accounts are permanent accounts.

True False False, The post-closing trial balance does not include any revenues, expenses, or dividends, because these accounts all have zero balances after closing entries.

The balance of Retained Earnings account in the post-closing trial balance will be different from that of the adjusted trial balance.

True False True, Adjusted trial balance contains the beginning balance of retained ...