MGT 5000, Financial Management, Chapter 3
FASB and IASB way to recognize revenue.
The selling entity must do the following: (1) identify the contract with the customer, (2) identify the separate performance obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the separate performance obligations in the contract, and (5) recognize revenue when (or as) the entity satisfies the performance obligation.
Long-term assets
are all assets not classified as current assets. One category is plant assets, often labeled Property, Plant, and Equipment.
current liabilities
are debts that must be paid within one year after the balance sheet date or within the entity's operating cycle if longer than a year. Accounts Payable, Notes Payable due within one year, Salary Payable, Unearned Revenue, Interest Payable, and Income Tax Payable
Plant Assets
are long-lived tangible assets, such as land, buildings, furniture, and equipment. All assets except land decline in usefulness, and this decline is an expense.
current assets
are the most liquid assets. They will be converted to cash, sold, or consumed during the next 12 months after the balance sheet date or within the business's normal operating cycle if longer than a year.
permanent accounts:
assets, liabilities, and stockholders' equity. The permanent accounts are not closed at the end of the period because they carry over to the next period.
straight-line depreciation method
computes the amount of depreciation for each year by dividing the cost of the asset by its expected useful life
Current Ratio Formula
divides total current assets / total current liabilities.
The time-period concept
ensures that accounting information is reported at regular intervals.
deferral
is an adjustment for payment of an item or receipt of cash in advance.
prepaid expense
is an expense paid in advance. Therefore, are assets because they provide a future benefit for the owner.
Net working capital
is computational data that represents operating liquidity.
The expense recognition principle
is the basis for recording expenses. Expenses are the costs of assets used up and of liabilities created in earning revenue.
accrual
is the opposite of a deferral. For an expense, The Company records the expense before paying cash. For a revenue, the company records the revenue before collecting cash.
The operating cycle
is the time span during which cash is paid for goods and services, and these goods and services are sold to bring in cash.
A single-step income statement (statement of earnings)
lists all the revenues together under a heading such as Revenues, or Revenues and Gains.
The report format
lists the assets at the top, followed by the liabilities and stockholders' equity below.
Account Format
lists the assets on the left and the liabilities and stockholders' equity on the right in the same way that a T-account does, with assets (debits) on the left and liabilities and equity (credits) on the right.
Closing the books
means to prepare the accounts for the next period's transactions.
Liquidity
measures how quickly an item can be converted to cash.
Cash-basis accounting
records only cash transactions—cash receipts and cash payments. Cash receipts are treated as revenues, and cash payments are handled as expenses.
Accrual accounting
records the impact of a business transaction as it occurs. When the business performs a service, makes a sale, or incurs an expense, the accountant records the transaction, even if the business receives or pays no cash.
Accrued Expense
refers to a liability that arises from an expense that has not yet been paid.
multistep income statement
reports a number of subtotals to highlight important relationships between revenues and expenses.
Temporary Accounts
revenues and expenses. Because they relate to a limited period, The Dividends account is also temporary.
classified balance sheet
separates current assets from long-term assets and current liabilities from long-term liabilities.
The closing entries
set the revenue, expense, and dividends balances back to zero at the end of the period.
Accumulated Depreciation account
shows the sum of all depreciation expense from using the asset. Therefore, the balance increases over the asset's life.
steps to close the books of a company
1. Debit each revenue account for the amount of its credit balance. Credit Retained Earnings for the sum of the revenues. This process transfers the sum of all revenues into Retained Earnings, thereby increasing Retained Earnings. 2. Credit each expense account for the amount of its debit balance. Debit Retained Earnings for the sum of the expenses. This process transfers the sum of the expenses into Retained Earnings, thereby decreasing Retained Earnings. 3. Credit the Dividends account for the amount of its debit balance. Debit Retained Earnings. This entry places the dividends amount in the debit side of Retained Earnings. Remember that dividends are not expenses, but represent a permanent reduction of retained earnings.
The expense recognition principle includes two steps:
1. Identify all the expenses incurred during the accounting period. 2. Measure the expenses and recognize them in the same period in which any related revenues are earned.
contra account has two distinguishing characteristics:
1. It always has a companion account. 2. Its normal balance is opposite that of the companion account.
The revenue principle deals with two issues:
1. When to record (recognize) revenue 2. What amount of revenue to record
Accrued Revenue
A revenue that has been earned but not yet collected
Plant Assets List
Land, Buildings, Furniture and Fixtures, and Equipment
Net working Capital Formula
Net working capital = Total current assets - Total current liabilities
Unearned Revenue
Some businesses collect cash from customers before earning the revenue. This creates a liability
asset's book value (of a plant asset), or carrying amount.
The net amount of a plant asset (cost minus accumulated depreciation)
an adjusted trial balance.
This document lists all the accounts and their final balances in a single place.
Depreciation
allocates the cost of a plant asset to expense over the asset's useful life. Is the most common long-term deferral.
Debt Ratio
total liabilities / total assets.
Revenue is earned
when the business has delivered a good to, or has performed a service for, a customer.
Revenue is recognized
when the business transfers promised goods or services to a customer in an amount that reflects the cash (or fair market value of other consideration) that the entity expects to receive in exchange for those goods or services.
accrual accounting records cash transactions, such as the following:
■ Collecting cash from customers ■ Receiving cash from interest earned ■ Paying salaries, rent, and other expenses ■ Borrowing money ■ Paying off loans ■ Issuing stock
To help keep debt ratios within normal limits, companies might adopt one or more of the following strategies:
■ Increase revenue and decrease costs, thus increasing current assets, net income, and retained earnings without increasing liabilities ■ Sell stock, thus increasing cash and stockholders' equity ■ Choose to borrow less money
every adjusting entry affects both of the following:
■ Revenue or expense—to measure income ■ Asset or liability—to update the balance sheet
accrual accounting records noncash transactions, such as the following:
■ Sales on account ■ Purchases of inventory on account ■ Accrual of expenses incurred but not yet paid ■ Depreciation expense ■ Usage of prepaid rent, insurance, and supplies ■ Earning of revenue when cash was collected in advance
Two purposes of the adjusting process are to
■ measure income, and ■ update the balance sheet.
Income Statement Formats.
☺A single-step income statement (statement of earnings) ☺multistep income statement
Defects of Cash-Basis accounting
☺Balance-Sheet Defect. ☺Income Statement Defect.
Balance-Sheet Formats.
☺The report format ☺account format
Accounting adjustments fall into three basic categories:
☺deferrals, ☺depreciation, and ☺accruals.