Accounting Test #2 - Chp.4

Cash Basis Accounting

Companies only recognize revenue when cash is received and expenses when cash is paid. This approach of revenue and expense recognition only measures cash receipts and disbursements and does not accurately measure the economic activity underlying cash receipts and payments

Accrual Basis

Companies recognize revenues when earned and expenses when incurred, regardless of when cash is paid.

Contributed Capital

Consists primarily of owners' investments in the business

General Ledger

Contains all accounts maintained by the company, with each account reflecting its increases, decreases, and balance. Each account balance is maintained in a single location for management analysis. An account has a debit balance if debits exceed credits, and a credit balance when credits are greater than debits. The account has a zero balance if debits equal credits.

Post-Closing Trial Balance

Contains only permanent balance sheet accounts because all temporary accounts were closed out and have zero balances.

Journal Entry

Contains the following elements in the common format: a. The date the transaction occurred is in the first column b. Accounts debited are listed first and positioned at the left side. The dollar amount debited is placed in the debit column c. Accounts credited are recorded next and indented to the right a few spaces. The dollar amount credited is placed in the credit column. d. A brief explanation is frequently included below the entry

Expenses, losses, and distributions to owners (Dividends) __ Retained earnings

Decrease

Losses

Decreases in equity (net assets) from an entity's peripheral or incidental transactions and from all other transactions and other events and circumstances affecting the entity except those that result from expenses or distributions to owners.

Distributions to Owners (Dividends)

Decreases in equity of a particular business enterprise resulting from transferring assets, rendering services, or incurring liabilities by the enterprise to owners. Distributions to owners decrease ownership interest (or equity) in an enterprise. Dividends are common distributions to owners.

Accounting Cycle

Describes the process by which a company records business transactions and ultimately aggregates and summarizes them in the financial statements

Retained Earnings Equation

Ending RE = Beginning RE + Revenues + Gains - Expenses - Losses - Dividends Declared

Adjusting Journal Entries

Entries made to ensure that all revenues are recognized in the period earned and all expenses are recognized in the period incurred They are necessary because US GAAP requires that financial information must be reported using the accrual basis of accounting Every adjusting entry will impact one balance sheet account and one income statement account Adjusting journal entries involve accounting for both deferrals and accruals

Summary of Adjusting Journal Entries

Exhibit 4.14 pg 109

Retained Earnings

Generally, retained earnings is a corporation's cumulative earnings since the corporation was formed minus the dividends it has declared since it began. In other words, retained earnings represents the corporation's cumulative earnings that have not been distributed to its stockholders. The amount of retained earnings as of a balance sheet's date is reported as a separate line item in the stockholders' equity section of the balance sheet. A negative amount of retained earnings is reported as deficit or accumulated deficit. Retained earnings is the percentage of net earnings not paid out as dividends, but retained by the company to be reinvested in its core business, or to pay debt. It is recorded under shareholders' equity on the balance sheet.

Difference between income statement accounts and balance sheet accounts (Permanent accounts)

In contrast to the income statement temporary accounts, the balance sheet consists of permanent accounts, which are accounts with cumulative balances carried forward period after period. Closing

Revenue and Gains __ Retained earnings

Increase

Gains

Increases in equity (net assets) from an entity's peripheral or incidental transactions and from all other transactions and other events and circumstances affecting the entity except those that result from revenues or investments by owners

Revenues

Inflows or other enhancements of an entity's assets or settlements of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or other activities that constitute the entity's ongoing major or central operations.

Deferrals

Occur when a company receives or pays cash before recognizing the revenue or expense in the financial statements.

Deferred Revenues (unearned revenues or advance collections)

Occurs when a company receives cash before earning revenue and recognizes it on the financial statements under accrual basis accounting. Represents cash that has been received before the occurrence of the underlying economic event that generates revenue. Companies record unearned revenues as liabilities until they are earned. Therefore an adjusting journal entry for unearned revenues will cause a change in both a liability and a revenue account as the liability is derecognized and the revenue recognized Ex. of unearned revenues include advance collections of insurance, rent, and subscription If the company does not adjust unearned revenue, it overstates liabilities and understates revenues. The adjusting journal entry results in a debit to liability account and a credit to a revenue account.. It may be the case that the company initially records the cash receipt as revenue.

Expenses

Outflows or other consumption of assets or incurrences of liabilities (or a combination of both) from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity's ongoing major or central operations.

General journal

Presents transactions in chronological order with a column for the date, the account titles and explanations, reference number, debits and credits. The column for the reference number is left blank until the entries are posted to the general ledger accounts, at which the time the account number is included in the reference column. Because events are recorded in the general journal first, it is known as the book of original entry

Assets

Probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events Ex. Cash, receivables, inventory, buildings

Liabilities

Probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events Ex. Accounts Payable, Salaries Payable, Notes Payable, Bonds Payable

Stockholders' Equity (Equation form)

SE = Contributed Capital + Retained Earnings + Accumulated Other Comprehensive Income

T-Account

Simplified version of the ledger accounts 3 parts: 1. The account title 2. A left (debit) side 3. A right (credit) side

Debits and Credits

Simply mean the left and right side of the account (do not imply increases or decreases) Debits will always = credits

Double-Entry System

The fact that all transactions affect at least two accounts and that the accounting equation will always balance Ex. Asset(+A), then there must be a decrease in another asset, an increase in liabilities (+L), or an increase in stockholders' equity (+SE)

Adjusted Trial Balance

The listing of all accounts and their ending debit or credit balances after making the adjusting journal entries

Stockholders' Equity

The net assets or residual interest in the assets of an entity that remains after deducting its liabilities Ex. Contributed Capital, Retained Earnings, Accumulated Other Comprehensive Income

Trial Balance

a listing of the accounts and their ending debit or credit balances at a point in time The accounts are listed with the balance sheet accounts first (assets,liabilities, and stockholders' equity) followed by dividends and the income statement accounts (revenues, gains, expenses, and losses) Provides a check on the recording process by ensuring the equality of debits and credits

Contra-Asset account

an asset account that has a normal credit balance.

Account

an individual record of increases and decreases in specific asset, liability, and stockholder equity items.

Temporary Accounts

are all income statement accounts and dividends that must be reduced to a zero balance in order to report net income(or net loss) and dividends for the next accounting period. The temporary accounts begin the next period with a zero balance to ensure that prior-period revenues and expenses are not included in the computation of the next year's net income or loss.

Accumulated Other Comprehensive Income

- Increases or decreases with other comprehensive income - Other comprehensive income is an additional component of comprehensive income

Trial balances do not reveal the following errors

1. A transaction that is not journalized 2. A correct journal entry that is not posted 3. An entry that is posted twice 4. The debiting or crediting of incorrect accounts 5. Debiting and crediting incorrect dollar amounts

Accounting Cycle Steps (9)

1. Analyze the transaction 2. Journalize the transaction 3. Post to the General Ledger 4. Prepare the Unadjusted Trial Balance 5. Prepare Adjusting Journal Entries 6. Prepare the Adjusted Trial Balance 7. Prepare Financial Statements (Statement of Net Income, Statement of Stockholder's Equity, Balance Sheet, Statement of Cash Flows) 8. Close Temporary Accounts 9. Prepare Post-Closing Trial Balance

4 closing entries

1. Close out revenue accounts: debit all revenue and gain accounts and credit income summary for the total of the accounts debited. 2. Close out expense accounts: Debit income summary for total expenses and losses and credit each expense and loss account for its balance. 3. Close out income summary account: Debit income summary and credit retained earnings for the amount of net income; conversely, credit income summary and debit retained earnings in the event of a net loss. 4. Close out the dividends account: Debit retained earnings and credit the dividends account for the year

Order of Financial Statements

1. Statement of Net Income 2. Statement of Stockholders' Equity 3. Balance Sheet 4. Statement of Cash Flows Statement of Net Income is prepared first, using the revenue and expense accounts. The company uses the resulting net income for the period, along with the equity accounts, to prepare the statement of stockholders' equity. The balance sheet includes all assets, liabilities, common stock, and the ending retained earnings balance obtained from the statement of stockholders' equity. The final step is preparing the statement of cash flows.

Unearned Revenues

A liability account that reports amounts received in advance of providing goods or services. When the goods or services are provided, this account balance is decreased and a revenue account is increased.

Chart of Accounts

A numerical listing of the account names and numbers that assists in locating the account in the ledger

Incurred

A word used by accountants to communicate that an expense has occurred and needs to be recognized on the income statement even though no payment was made. The second part of the necessary entry will be a credit to a liability account.

Expanded Accounting Equation

A=L+CC+RE(Ending)+AOCI A=L+CC+(Beg RE + Net Income - Dividends Declared) + AOCI A=L+CC+Beg RE + Revenues & Gains - Expenses & Losses - Dividends Declared + AOCI

Transaction

An economic event that involves a change in an asset, a liability, or a stockholders' equity account that companies record in their accounting records.

Unadjusted trial balance

An initial listing of all accounts and their debt or credit balances. May not reflect all of a company's events and transactions because it has not made the adjusting journal entries at the time it prepares the unadjusted trial balance.

Accounting Equation

Assets = Liabilities + Stockholders' Equity A = L + E Assets - Liabilities = Stockholders' Equity

A negative balance in retained earnings is called a

deficit

Closing

is the process of bringing all temporary accounts to a zero balance

Depreciation

is the systematic and rational allocation of the cost of a long-term operating asset to expense over the asset's expected useful life. When a company purchases a long-term operating asset, it records the asset with a debit. As the company uses the asset over time, the company reports an expense on the income statement, debiting expense. It also reduces the carrying value of the asset by the same amount. In the case of depreciation, the credit to reduce the value of the asset is to an account referred to as accumulated depreciation. Accumulated depreciation is a contra-asset account . The contra-asset accumulated depreciation directly offsets the asset account, and the net value of the two accounts is the asset's net carrying value.

Amortization

is the systematic and rational allocation of the cost of an intangible asset to expense over the asset's expected useful life In the case of amortization, the company may credit an accumulated amortization account or the intangible asset account directly

When expenses, losses, and dividends exceed revenues and gains over time, retained earnings is

negative

Accrued revenues

occur when a company has earned revenues but has not yet received cash If the company does not adjust accrued revenue, then assets and revenues are both understated. The adjusting journal entry is needed to debit the asset account and credit the revenue account. One the cash is received, the company debits cash and credits the asset(receivable) account.

Accrued Expenses

occur when a company has incurred expenses but has not paid cash ex. utility expense, salaries & interest expense There is an unrecorded liability (payable) and an unrecognized expense. The company understates both liabilities and expenses until it makes the adjusting journal entry The adjusting journal entry debits the expense account and credits the liability account. Once cash is paid, the company debits the liability (payable) and credits cash

Accruals

occur when the economic event that gives rise to revenue and expenses before the cash is received or paid.

Deferred expenses (prepaid expenses)

occurs when a company making a cash payment before incurring an expense under accrual based accounting. Companies record deferred expenses as assets before they are used or consumed in operations. Therefore, an adjusting journal entry for deferred expenses will cause a change in both an asset and an expense account as the asset is derecognized and the expense recognized. ex. prepaid rent, prepaid insurance, supplies, depreciation If the company does not adjust the prepaid expense, it will overstate assets and understate expenses. The adjusting journal entry results in a debit to an expense account and a credit to an asset account It may be the case that the company initially records the cash payment as an expense Other types of deferred expense: depreciation & amortization

When revenues and gains exceed expenses, losses, and dividends over time, retained earnings is...

positive

Normal Balance

the expected balance in an account The side that increases the value of the account If the account increases with a debit, then its normal balance is a debit. Conversely, if an account increases by a credit, then its normal balance is a credit.

Journalizing

the process of entering a transaction in the general journal. To journalize a transaction, companies prepare a journal entry.

Posting

the process of transferring information contained in journal entries to the individual ledger accounts. Each general ledger account has a column for the date, explanation, reference, debit, credit, and balance. The reference is the general journal page number.