Accounting Chapter 3

GIRLS

Generally these types of accounts are increased with a credit: Gains Income Revenues Liabilities Stockholders' (Owner's) Equity

DEAL

Generally these types of accounts are increased with a debit: Dividends (Draws) Expenses Assets Losses

Accounting/Reporting/Periods

Length of time covered by financial statements

natural business year

Twelve month period that ends when the company's sales activities are at its lowest point

Current Ratio

A measure of liquidity calculated by dividing the firm's current assets by its current liabilities.

Current Liabilities Examples

Accounts Payable, Unearned Service Revenue

Accumulated Depreciation

Accumulated Depreciation has a normal credit balance; it decreases the asset's reported value

Compute Chavez Company's current ratio using this information.

Answer: 2.93

Current Asset Examples

Cash, Accounts Receivable, Office Supplies, Prepaid Insurance

fiscal year

Consecutive 12-month period chosen as the annual accounting period

Types Of Adjustments

Prepaid (deferred) expenses, unearned (deferred) revenues, accrued expenses, accrued revenues

Adjusting Entry Types

Prepaid expense, unearned revenues, accrued expenses, accrued revenues

Time Period Assumption

Presumes that an organizations activities can be divided into specific time periods such as a month, three-month quarter, a six-month intervals or a year

accrued interest formula

Principal amount owed × Annual interest rate × Fraction of year since last payment date

Annual financial statements

Reports covering a one-year period

Closing Accounts

Step 1: Close Credit Balances in Revenue and Fees Earned Accounts to Income Summary Step 2: Close Debit Balances in Expense Accounts to Income Summary Step 3: Close Income Summary to Retained Earnings Step 4: Close Dividends Account to Retained Earnings

Preparing Financial Statements

We prepare financial statements in the following order: income statement, statement of retained earnings, and balance sheet.

adjusted trial balance

a list of accounts and balances prepared after adjusting entries have been recorded and posted to the ledger.

unadjusted trial balance

a list of accounts and balances prepared before adjustments are recorded.

post-closing trial balance

a list of permanent accounts and their balances from the ledger after all closing entries have been journalized and posted. It lists the balances for all accounts not closed. The aim of a post-closing trial balance is to verify that (1) total debits equal total credits for permanent accounts and (2) all temporary accounts have zero balances.

Income Summary

a temporary account (only used for the closing process) that contains a credit for the sum of all revenues (and gains) and a debit for the sum of all expenses (and losses).

Temporary (or nominal) accounts

accumulate data related to one accounting period. They include all income statement accounts, the Dividends account, and the Income Summary account. The closing process applies only to temporary accounts.

expense recognition (or matching) principle

aims to record expenses in the same accounting period as the revenues that are earned as a result of those expenses. Recording revenue early overstates current-period revenue and income; recording it late understates current-period revenue and income.

straight-line depreciation

allocates equal amounts of the asset's net cost to depreciation during its useful life.

contra account

an account linked with another account, it has an opposite normal balance, and it is reported as a subtraction from that other account's balance.

Accrued expenses

costs that are incurred in a period but are both unpaid and unrecorded. Accrued expenses must be reported on the income statement for the period when incurred. Adjusting entries for recording accrued expenses increase the expense (income statement) account, and increase a liability (balance sheet) account

interim financial statements

covering one, three, or six months of activity.

book value / net amount

equals the asset's costs less its accumulated depreciation

adjusting entry

made at the end of an accounting period to reflect a transaction or event that is not yet recorded. Each adjusting entry affects one or more income statement accounts and one or more balance sheet accounts (but never the Cash account)

unclassified balance sheet

one whose items are broadly grouped into assets, liabilities, and equity.

classified balance sheet

organizes assets and liabilities into important subgroups that provide more information to decision makers

closing process

prepares accounts for recording the transactions and the events of the next period. In the closing process we must (1) identify accounts for closing, (2) record and post the closing entries, and (3) prepare a post-closing trial balance.

Accrual basis accounting

process to recognize revenues when earned and expenses when incurred (matched with revenues). Accrual accounting also increases the comparability of financial statements from one period to another.

Cash basis accounting

recognizes revenues when cash is received and records expenses when cash is paid. Cash basis accounting is not consistent with generally accepted accounting principles

Prepaid expenses (decrease an asset and record an expense)

refer to items paid for in advance of receiving their benefits. Prepaid expenses are assets. When these assets are used, their costs become expenses. Adjusting entries for prepaids increase expenses and decrease assets. (debit insurance expense, credit prepaid insurance)

unearned revenues

refers to cash received in advance of providing products and services. Unearned revenues, also called deferred revenues, are liabilities.

plant assets

refers to long-term tangible assets used to produce and sell products and services. They are gradually reported as expenses in the income statement over the assets' useful lives (benefit periods)

prepaid expenses (including depreciation) & unearned revenues (both also called deferrals)

reflect transactions when cash is paid or received before a related expense or revenue is recognized

Permanent (or real) accounts

report on activities related to one or more future accounting periods. They carry their ending balances into the next period and generally consist of all balance sheet accounts. These asset, liability, and equity accounts are not closed

revenue recognition principle

requires that revenue be recorded when earned, not before and not after.

accrued revenues

revenues earned in a period that are both unrecorded and not yet received in cash (or other assets). Paid when job is finished. The adjusting entries for accrued revenues increase a revenue (income statement) account, and increase an asset (balance sheet) account

Depreciation

the process of allocating the costs of these assets over their expected useful lives.

accounting cycle

the steps in preparing financial statements. It is called a cycle because the steps are repeated each reporting period.

closing entries

transfer the end-of-period balances in revenue, expense, and dividends accounts to the permanent Retained Earnings account

accrued expenses & accrued revenues

which reflect transactions when cash is paid or received after a related expense or revenue is recognized.