CH 2- Accounting for Accruals
The statement of cash flows ______.
explains the change in cash from the beginning to the end of the accounting period
On the statement of cash flows, issuing stock for cash increases cash flow from ______ activities.
financing
Addison Company borrowed $6,000 from the State Bank on June 1, Year 1. The one-year note has an 8% rate of interest. On the Year 2 income statement, the amount of interest expense reported by Addison is ______.
$200 Reason: $6,000 principal ×.08 interest = $480 annual interest; $480 ÷ 12 months = $40 per month; $40 × 5 months = $200 in Year 2
Gomez Company has a December 31 year end. The company borrows $4,000 from the State Bank on December 1, Year 1. The one-year note has a 9% rate of interest. On the Year 2 income statement, the amount of interest expense reported by Gomez is ______.
$330 Reason: $4,000 principal ×.09 interest = $360 annual interest; $360 ÷ 12 months = $30 per month; $30 × 11 months = $330 in Year 2.
Which accounting organizations require their members to comply with a code of ethical conduct?
American Institute of Certified Public Accountants (AICPA) Institute of Internal Auditors (IIA) Institute of Management Accountants (IMA)
Issuing a note to borrow money affects the ______.
Balance sheet Statement of cash flows
Which of the following individuals must certify in writing that they have reviewed a company's financial reports and that the reports they reviewed present fairly the company's financial status?
Chief Executive Officer (CEO) Chief Financial Officer (CFO)
Which of the following are required by the Sarbanes Oxley Act?
Firms that provide public audits are prohibited from providing a variety of other nonaudit services. Independent auditors conducting audits of public companies must register with the Public Company Accounting Oversight Board (PCAOB).
Providing services on account affects the ______.
Income statement Balance sheet Statement of changes in stockholders equity
PREPARING FINANCIAL STATEMENTS Comparing Cash Flow from Operating Activities with Net Income The amount of net income measured using accrual accounting differs from the amount of cash flow from operating activities. For Cato Consulting in Year 1, the differences are summarized as follows:
Many students begin their first accounting class with the misconception that revenue and expense items are cash equivalents.
A cash payoff of an account payable is a(n) ______ transaction.
asset use
Issuing a note to borrow money increases ______.
assets liabilities
Providing services on account will ______.
cause an increase in the amount of net income shown on the income statement cause a increase in the amount of retained earnings shown on the statement of changes in stockholders equity
Decreases in accounts receivable are caused by ______.
collections of receivables
Opportunity, pressure and rationalization are the three components of the ____ ____.
fraud triangle
Recognizing an expense on account ______.
increases expenses decreases net income
Ethical standards ______.
promote trust improve credibility
Increases in accounts receivable are caused by ______.
sales on account
Incurring utility expense on account means the cash payment ______.
will be made in the future
During Year 1, Silver Sinks, Inc. earned $33,000 of revenue on account. Cash collections of receivables were $28,000. The remainer of the receivables were collected in Year 2. As a result of these transactions, Silver Sink will report Year 1 net income of ______.
$33,000 and cash inflow from operating activities of $28,000 in Year 1 and $5,000 in Year 2
Which of the following accounts are reported on the balance sheet?
Accounts receivable Salaries payable
Recognizing an expense on account affects the ______.
Balance sheet Statement of changes in stockholders equity Income statement
ACCOUNTING FOR NOTES PAYABLE EVENT 6 During Year 2, Cato Consultants provided $89,000 of consulting services on account. This event type was discussed previously. Its effects on the financial statements are shown in the following horizontal financial statements model:
Be careful not to confuse the terminology "provided service on account" in Event 6 with the terminology "incurred expense on account" in Event 3. The meaning of "on account" terminology depends on the business event. In Event 6, Cato provided services so Cato expected to receive money from its customers in the future. Therefore, Cato recorded Accounts Receivable and increased Retained Earnings. The increase in assets was an economic benefit and reported as revenue on the income statement. In Event 3, utility services were provided to Cato so Cato expected to pay money to the utility supplier in the future. Therefore, Cato increased Accounts Payable and decreased Retained Earnings. The increase in liabilities was an economic sacrifice and was reported as an expense on the Income Statement.
horizontal financial statements model
Concurrent representation of several financial statements horizontally across a page. The balance sheet is displayed first, adjacent to the income statement, and then the statement of cash flows. Due to space limitations, the statement of changes in stockholders' equity is not shown in the horizontal statements model.
True or false: A company recognized an accrued salary expense in Year 1 and paid its employees in Year 2. In Year 2 neither Salaries expense nor Salaries payable will change as a result of this transaction.
False Salaries expense will not change, but Cash and Salaries payable will.
ACCOUNTING FOR NOTES PAYABLE EVENT 5 On February 1, Year 2, Cato borrowed $5,000 cash from the State Bank. As evidence of the debt, Cato issues a promissory note that describes the company's obligations to the bank. The primary difference between notes payable and accounts payable is that notes generally have longer terms and usually require interest charges. In this case, the note stipulates a one-year term and an annual interest rate of 6 percent. Issuing the note is an asset source transaction. The asset account Cash increases and a new liability account called Notes Payable increases. The income statement is not affected. The statement of cash flows shows a $5,000 cash inflow from financing activities.
Notice that interest is not recognized on the day the money is borrowed. Interest expense is recognized after Cato has had access to the borrowed money. While interest accrues continuously, we will recognize it at the end of the accounting period.
PREPARING FINANCIAL STATEMENTS Balance Sheet
The balance sheet discloses an entity's assets, liabilities, and stockholders' equity at a particular point in time.
Income Statement
The income statement reflects accrual accounting. Recall that accrual accounting recognizes revenue in the accounting period in which it is earned even when the associated cash is collected in a subsequent accounting period. This is because the income statement shows the total benefits received from operating the business. Benefits include items in addition to cash. Accordingly, the total benefits (cash + increase in receivables) is reported as revenue on the income statement. Similarly, expenses include all sacrifices incurred to produce revenue regardless of whether cash has been paid. These accrual reporting practices will cause differences between the amount of net income shown on the income statement and the amount of cash flow from operating activities shown on the statement of cash flows.
PREPARING FINANCIAL STATEMENTS Statement of Cash Flows
The statement of cash flows explains the change in cash from the beginning to the end of the accounting period. It can be prepared by analyzing the Cash account.
Net income and cash flow from operating activities will ______.
differ due to accrual accounting used on the income statement
THE HORIZONTAL FINANCIAL STATEMENTS MODEL Recognize that horizontal financial statements models are learning tools. Because they are helpful in understanding how accounting events affect financial statements, they are used extensively in this book. However, the models omit many of the details used in published financial statements. For example, the horizontal model shows only a partial set of statements. Also, because the statements are presented in aggregate, the description of dates (i.e., "as of" versus "for the period ended") does not distinguish end of period data from during the period data.
To illustrate, we use it to display the seven accounting events that Master Builders experienced during its Year 1 operations. 1. Acquired $110,000 cash from the issuance of common stock. 2. Borrowed $400,000 cash. 3. Paid $500,000 cash to purchase land. 4. Received $85,000 cash from earning revenue. 5. Paid $50,000 cash for expenses. 6. Paid $4,000 of cash dividends to the owners. 7. The market value of the land was appraised at $525,000 on December 31, Year 1.
The horizontal financial statements model is ______.
a teaching tool used to show how transactions affect the income statement, balance sheet and statement of cash flows
When a company recognizes an expense on account, ______.
accounts payable and expenses increase
Revenue is recognized when it is earned and expenses when they are incurred, regardless of when cash changes hands when using _____ accounting.
accrual
Incurring a cash expense affects ______.
all of the financial statements
When an employee works in Year 1, but will be paid in Year 2, the employer will be required to record (recognize) _____.
an accrued expense in Year 1
Assets, liabilities and stockholders' equity at a particular point in time are reported on the ____ ____ .
balance sheet
Salaries payable is reported on the ______.
balance sheet
An accrued expense is the recognition of an expense ____ cash is paid.
before
Acquiring cash from the issue of common stock ______.
does not affect the income statement
When a company recognizes an accrued expense, the amount of ______.
cash is not affected expense increases
Recognizing a cash expense for advertising will ______.
cause the amount of assets shown on the balance sheet to decrease cause a decrease in the net cash flow from operations shown on the statement of cash flows
An account receivable is an expectation to ______ in the future.
collect cash
When a company incurs a cash expense, the balance in the cash account ______.
decreases and the balance in the expense account increases
The total benefits, both cash and other items, received from operating the business are shown on the ______.
income statement
Issuing stock in exchange for cash will ______.
increase stockholders' equity be reported on the statement of cash flows
A change in stockholders' equity is caused by ______.
incurring a cash expense earnings issuing stock
The horizontal financial statements model ______.
is a teaching tool
Accounts Payable is a(n) ______ account.
liability
Accrual accounting ______.
records expenses when incurred recognizes revenue only when earned
A company recognized an accrued salary expense in Year 1 and paid its employees in Year 2. In Year 2 ______.
salaries expense will not be affected salaries payable will decrease cash will decrease
When a company recognizes an accrued salary expense, ______.
salaries payable increases cash is not affected expenses increase
The change in cash is explained by the ______.
statement of cash flows
The financial statements affected when a company pays cash to settle an accounts payable are the ______,
statement of cash flows balance sheet
If a company has assets of $65,000 and liabilities of $30,000 then ______ must equal $35,000.
stockholders' equity
Issuing stock for cash increases ______.
stockholders' equity cash flow from financing activities common stock assets
Earning service revenue on account means cash ______.
will be collected in the future, even though the related service has been performed
Green Company incurred $5,000 of accrued expenses during Year 1, but paid the cash associated with the payables in Year 2. Based on this information alone, under accrual accounting, the company would report a net loss of ______.
zero and cash outflow from operations of $5,000 in Year 2 $5,000 and cash outflow from operations of zero in Year 1