Chapter 3 - BookNotes

Highlights the adjustment for prepaid insurance:

After adjusting and posting, the $100 balance in Insurance Expense and the $2,300 balance in Prepaid Insurance are ready for reporting in financial statements.

Highlights the adjustment for depreciation:

After posting the adjustment, the Equipment account ($26,000) minus its Accumulated Depreciation ($300) account equals the $25,700 net cost. The $300 balance in the Depreciation Expense account is reported in the December income statement.

An organization can use a fiscal year consisting of:

any 12 consecutive months or 52 week period (chosen as the organizations annual accoutning period). For example, Gap's fiscal year consistently ends the final week of January or the first week of February each year.

Prepaid expenses, or deferred expenses, are:

are assets paid for in advance of receiving their benefits. When these assets are used, those advance payments become expenses.

Profit margin or return on sales is computed as

in Exhibit 3.15. This ratio shows the percent of profit in each dollar of sales.

Contra account

is 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. For exam: FastForward's contra account of Accumulated Depreciation—Equipment is subtracted from the Equipment account in the balance sheet.

Many organizations also prepare interim financial statements covering ?

one, three, or six months of activity.

Each adjusting entry affects one or more income statement (revenue or expense) accounts and one or more balance sheet (asset or liability) accounts, but never______________________.

the Cash account.

If a company is holding notes receivable that produce interest revenue, we must adjust

the accounts to record any earned and yet uncollected interest revenue. The adjusting entry is similar to the one for accruing services revenue. Specifically, debit Interest Receivable (asset) and credit Interest Revenue.

Accrued interest expense

usually have this on notes payable and other long term liabilities at the end of a period. Interest expense is incurred as time passes. Unless interest is paid on the last day of an accounting period, we need to adjust for interest expense incurred but not yet paid. This means we must accrue interest cost from the most recent payment date up to the end of the period.

If a company has a $6,000 loan from a bank at 5% annual interest, then 30 days' accrued interest expense is

$25—computed as $6,000 × 0.05 × 30∕360. The adjusting entry debits Interest Expense for $25 and credits Interest Payable for $25.**--

In what order we prepare financial statements?

(1) income statement (2) Statement of owner's (3) Balance sheet This order makes sense because the balance sheet uses information from the statement of owner's equity, which in turn uses information from the income statement. The statement of cash flows is usually the final statement prepared.

What is the two accounts that require adjustments before their balances appear in finanlcial statemts after external transactions and events are recorded but is needed because internal transactions and events are not yet recorded?

- Accrual basis accounting - Cash basis accounting

As products or services are provided, the liability ________________and the unearned revenues become ______________.

1. Decreases 2.revenues

The adjusting entries for accrued revenues _____________________ a revenue (income statement) account and _______________ an asset (balance sheet) account.

1. Increase 2.increase

Adjusting entries for unearned revenue ________________ the unearned revenue (balance sheet) account and ______________________ the revenue (income statement) account.

1. decrease 2. increase

Adjusting entries for prepaid expenses _____________ expenses and ___________ assets, as shown in the T-accounts.

1. increase 2. decrease To demonstrate accounting for prepaid expenses, we look at prepaid insurance, supplies, and depreciation. In each case we decrease an asset (balance sheet) account and increase an expense (income statement) account.

Adjusting entries for recording accrued expenses___________ the expense (income statement) account and _______________ a liability (balance sheet) account.

1. increase 2. increase

Example of Cash Basis

A cash basis income statement for December 2021 reports insurance expense of $2,400. The cash basis income statements for years 2022 and 2023 report no insurance expense. The cash basis balance sheet never reports a prepaid insurance asset because it is immediately expensed. Also, cash basis income for 2021-2023 does not match the cost of insurance with the insurance benefits received for those years.

Cash basis accounting

Accounting system that recognizes or record revenues when cash is received and records expenses when cash is paid. Cash basis income is cash receipts minus cash payments.

Accrual basis accounting

Accounting system that recognizes or records revenues when goods (products) or services are provided or delivered and records expenses when incurred (matched with revenues).

straight line depreciation

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

Accrued expenses or accrued liabilities

Are costs incurred in a period that are both unpaid and unrecorded. adjusting entries for recording accrued expenses involve increasing expenses and increasing liabilities. Accrued expenses are reported on the income statement for the period when incurred.

Plant assets

Are long term tangible assets used to produce and sell products and services. also called property, plant and equipment (PP&E) or fixed assets. And provide benefits for more than one period. Examples include buildings, machines, vehicles, and equipment. All plant assets (excluding land) eventually wear out or become less useful.

Monthly

Bold center timeline contains 12 segments with the moths of the year listed.

Annual Timeline

Contains all 12 months in one period.

Accumulated depreciation

Cumulative sum of all depreciation expense recorded for an asset. And is a separate contra account and has a normal credit balance.

The annual reporting period is always a calendar year ending on December 31? True or False

False

Example of Unearned Consulting Revenue

FastForward has unearned revenues. The company agreed on December 26 to provide consulting services to a client for 60 days for a fixed fee of $3,000. Step 1: On December 26, the client paid the 60-day fee in advance, covering the period December 27 to February 24. The entry to record the cash received in advance is

Example of Accrual Basis

FastForward paid $2,400 for 24 months of insurance coverage that began on December 1, 2021. Accrual accounting requires that $100 of insurance expense be reported each month, from December 2021 through November 2023. (This means expenses are $100 in 2021, $1,200 in 2022, and $1,100 in 2023.)

Example of Depreciation

For the journal entry dated December 31, Depreciation Expense is debited for $300 and Accumulated Depreciation--Equipment is credited for $300. The description reads: Record monthly equipment depreciation. Arrows point from the $300 debit in the journal entry to a debit entry in the Depreciation Expense--Equipment T-account and from the $300 credit in the journal entry to a credit in the Accumulated Depreciation--Equipment T-account. The Equipment T-Account remains the same with a $26,000 debit balance.

Example of Prepaid insurance in Journal Entry:

For the journal entry dated December 31, Insurance Expense is debited for $100 and Prepaid Insurance is credited for $100. The description reads: Record first month's expired insurance. Arrows point from the $100 debit in the journal entry to a debit entry in the Insurance Expense T-account and from the $100 credit in the journal entry to a credit in the Prepaid Insurance T-account. Assets = Liabilities + Equity -100 -100

Example of Supplies in Journal Entry:

For the journal entry dated December 31, Supplies Expense is debited for $1,050 and Supplies is credited for $1,050. The description reads: Record supplies used. Arrows point from the $1,050 debit in the journal entry to a debit entry in the Supplies Expense T-account and from the $1,050 credit in the journal entry to a credit in the Supplies T-account Assets = Liabilities + Equity -1,050 -1,050

We can prepare financial statements directly from information in the adjusted trial balance.? True or False

True

The value of informations is linked to ?

Is linked to its timeliness.

Depreciation What is the special category of prepaid expenses ?

Is plants assets, also called Property,Plant & Equipment (PP&E).

Depreciation

Is the allocating the costs of these assets over their expected useful lives. but it does not necessarily measure decline in market value.

Accounting Period

Length of time covered by financial statements; also called reporting period.

Another prepaid expenses that are accounted for exactly as insurance and supplies are:

Prepaid Rent and Prepaid Advertising.

The formula for computing accrued interest is

Principal amount owed x annual interest rate x fraction of the year since last payment.

A useful measure of a company's operating results is the ratio of its net income to net sales. This ratio is called ?

Profit margin or return on sales.

Quarterly Timeline

Shows four divisions, each with three months.

Semiannual Timeline

Shows two divisions: JAnuary through June, and July through December.

Supplies We count supplies at period-end and make an adjusting entry. What are the three step activities listed?

Step 1: December 2, 6, and 26: Purchase supplies and record asset. FastForward purchased $9,720 of supplies in December, some of which were used during that same month. When financial statements are prepared at December 31, the cost of supplies used during December is expensed. Step 2: December 31: Physical count. When FastForward computes (physically counts) its remaining unused supplies at December 31, it finds $8,670 of supplies remaining of the $9,720 total supplies. The $1,050 difference between these two amounts is December's supplies expense. Step 3: December 31: Record expense. The adjusting entry to record this expense and reduce the Supplies asset account, along with T-account postings, follows.

Adjustments are made using a 3-step process. What are thos 3 step?

Step 1: Determine what the current account balance equals. Step 2: Determine what the current account balance should equal. Step 3: Record an adjusting entry to get from step 1 to step 2.

Prepaid Insurance What are the three-step to adjusting an account?

Step 1: Determine what the current balance equals. For example: FastForward's prepaid insurance is equal to its $2,400 payment for 24 months of insurance benefits that began on December 1, 2021. Step 2: Determine what the current balance account should equal. The benefits of the insurance expire over time and a portion of the Prepaid Insurance asset becomes expense. For FastForward, one month's insurance coverage expires by December 31, 2021. This expense is $100, or 1/24 of $2,400, which leaves $2,300. Step 3: Record a adjusting entry to get from step 1 to step 2. The adjusting entry to record this expense and reduce the asset, along with T-account postings, follows.

Depreciation expense is recorded with adjusting entry similar to that for other prepaid expenses, the three steps are:

Step 1: FastForward purchased equipment for $26,000 in early December to use in earning revenue. This equipment cost must be depreciated. Step 2: The equipment is expected to have a useful life (benefit period) of five years and to be worth about $8,000 at the end of five years. This means the net cost of this equipment over its useful life is $18,000 ($26000-$8000).FastForward depreciates it using straight-line depreciation, Which allocates equal amounts of the asest's net cost to depreciation during its useful life. Dividing the $18,000 net cost by the 60 months (5 years) in the asset's useful life gives a monthly cost of $300 ($18,000∕60). Step 3: The adjusting entry to record monthly depreciation expense, along with T-account postings, follows.

A highlight of the adjustment for unearned revenue:

The adjusting entry transfers $250 from unearned revenue (a liability account) to a revenue account.

Highlights the adjustment for supplies:

The balance of the Supplies account is $8,670 after posting—equaling the cost of the remaining supplies

Examples od accrued Expenses

This adjustment recognizes expenses incurred in a period but not yet paid. Common examples of accrued expenses are salaries, interest, rent, and taxes. We use salaries and interest to show how to adjust accounts for accrued expenses.

Is accrual accounting better reflects business performance than cash basis accounting? True or False

True

Natural business year

Twelve-month period that ends when a company's sales activities are at their lowest point. for the year for retailers usually ends around January 31st

shows both the unadjusted and the adjusted trial balances for FastForward at December 31, 2021. The order of accounts in the trial balance usually matches the order in the chart of accounts. Several new accounts usually arise from adjusting entries.

Unadjusted and Adjusted Trial Balances

Companies that have seasonal variations in sales often use?

Used a natural business year end, which is when sales are at their lowest level for the year. For the year for retailers such as Target usually ends around January 31st after holidays.

Companies with little seasonal variation in sales often use?

Used the calendar year as their fiscal year. For example: Netflix uses calendar-year reporting.

An adjusted trial balance is

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

An unadjusted trial balance

a list of accounts and balances before adjustments are recorded.

Accrued revenues are recorded when

are recorded when adjusting entries are made at the end of the accounting period. These accrued revenues are earned but unrecorded because either the buyer has not yet paid or the seller has not yet billed the buyer.

Accrued Revenues also called accrued assets.

are revenues earned in a period that are both unrecorded and not yet received in cash (or other assets). An example is a technician who bills customers after the job is done. If one-third of a job is complete by the end of a period, then the technician must record one-third of the expected billing as revenue in that period—even though there is no billing or collection. .

Accrued expenses at the end of one accounting period result in

cash payment in a future period(s).

Accrued revenues at the end of one accounting period result in

cash receipts in a future period(s).

Accrual accounting also increases the?

comparability of financial statements from period to period.

Book Value

equals the assets cost less (minus) its accumulated depreciation. Example:The $900 balance in the Accumulated Depreciation account is subtracted from its related $26,000 asset cost. The difference ($25,100) between these two balances is called book value, or net amount, which is the asset's costs minus its accumulated depreciation.

When the Boston Celtics receive cash from advance ticket sales, they record it in an unearned revenue account called Deferred Game Revenues. And the Celtics record revenue as games are played is a ?

example of a Unerarned revenue that are common in sporting and concert events:

The costs of plant assets are gradually reported as?

expenses in the income statement over the assets' useful lives (benefit periods).

Unearned revenue

is cash received in advance of providing products and services. Unearned revenues, or deferred revenues, are liabilities. When cash is accepted, an obligation to provide products or services is accepted. We defer, or postpone, reporting amounts received as revenues until the product or service is provided.

adjusting entry

made at the end of an accounting period to reflect a transaction or even that is not yet recording, effects one or more income statement accounts and one ore more balance sheet accounts but never the cash account.

Some prepaid expenses are both ______________________________________________.

paid for and fully used up within a single period. One example is when a company pays monthly rent on the first day of each month. In this case, we record the cash paid with a debit to Rent Expense instead of an asset account.

To provide timely information, accounting systems prepare reports at regular intervals. Time period assumption

presumes that an organizations activities can be divided into specific time periods such as a month, a three month quarter, a six month interval or a year.

Most organizations use a year as their ?

primary accounting period.

Annual financial statements

reports covering a one-year period.

Expense recognition (or matching) principle

requires that expenses be recorded in the same accounting period as the revenues that are recognized (earned)as a result of those expenses.

Revenue recognition principle

requires that revenue be recorded when goods or services are provided to customers and at an amount expected to be received from customers. Adjustments ensure revenue is recognized (reported) in the time period when those services and products are provided.

What are the two principles in the adjusting process:

revenue recognition and expense recognition.

Accrued revenues usually come from

services, products, interest, and rent. We use services and interest to show how to adjust for accrued revenues.