Chapter 8 Receivables, Chapter 6, Chapter 5, Chapter 4, ACCOUNTING 1

Comparison of Accounting for Uncollectibles

Income Statement approach: percentage of sales: net credit sales*% Balance Sheet approach: percentage of receivable method aging-of-receivables method

Balance Sheet

reports assets, liabilities, and stockholders' equity as of the last day of the accounting period (balance sheet recorded at the point of time)

What is a balance sheet? How is it structured?

reports on assets, liabilities, and stockholders' equity of the business as of a specific date (point of time).

Income Statement

reports revenues and expenses and calculates net income or net loss for the period

Statement of Retained Earnings

shows how retained earnings changed during the period due to net income (or net loss) and dividends

Which organization oversees creation and governance of accounting standards?

Financial Accounting Standards Board (FASB)

What does GAAP stand for?

Generally Accepted Accounting Principles (GAAP)

Credit terms (on invoice) 3/15, net 30 days or "3/15, n/30" 1/10, net EOM n/30

3/15, net 30 days or "3/15, n/30" 3% discount if paid within 15 days, balance due within 30 days 1/10, net EOM 1% discount if paid within 10 days, balance due by the end of the month n/30 No discount offered, balance due within 30 days

Which accounts have a normal balance on the debit side (i.e. any increases are recorded as debits)?

Assets, Expenses, Dividends

What is a chart of accounts?

A chart of account is a list of accounts used by a company

Classified Balance Sheet

A classified balance sheet places each asset and each liability into a specific category. Assets are shown in order of liquidity (liquidity measures how quickly and easily an account can be converted to cash) Liabilities are classified as current (due within one year) or long term (due after one year)

Merchandiser

A merchandiser is a business that sells merchandise, or goods, to customers. The merchandise that this type of business sells is called merchandise inventory. A merchandiser could be retailer or a wholesaler.

What is a T-account?

A shortened form of the ledger left side: debit right side: credit

Retailer vs. Wholesaler

A wholesaler buys goods from a manufacturer and sells them to retailers. A retailer buys merchandise from manufacturers or a wholesaler and then sells the goods to consumers.

What are source documents?

Accountants record the transactions after reviewing source documents. Example of source documents: sales invoices, loan certificates, etc.

Why is accounting important?

Accounting is the information system that: measures business activities processes the information into reports communicate the results to decision makers

Examples of Liabilities Accounts

Accounts Payable, Notes Payable, Accrued Liabilities (such as Salaries Payables, Utilities Payable, Interest Payable), Unearned Revenue Unearned revenue is a liability account! Differences between Accounts Payable and Notes Payable? Notes Payable is WRITTEN promise to pay in the future.

Accounts Receivable

Accounts receivable, also called trade receivables, represents the right to receive cash in the future from customers for goods or services performed. Generally collected within 30 to 60 days Reported as a current asset on the balance sheet

Examples of Accrued Expenses

Accrued Expenses are expenses a business has incurred but has not yet paid. 1. Salaries Expense AJE to record the salaries expense incurred but has not paid: Salaries Expense (debit) Salaries Payable (credit) JE to record the payment for salaries payable Salaries Payable (debit) Cash (credit) 2. Interest Expense AJE to record the interest expense incurred but has not paid: Interest Expense (debit) Interest Payable (credit) JE to record the payment for Interest payable Interest Payable (debit) Cash (credit) 3. Utilities Expense AJE to record the utilities expense incurred but has not paid: Utilities Expense (debit) Utilities Payable (credit) JE to record the payment for Utilities payable Utilities Payable (debit) Cash (credit)

Accruing Interest Revenue and Recording Honored Notes Receivable

Adjusting JE for the accrual of interest revenue: Dr. Interest Receivable Cr. Interest Revenue

What is an income statement? How is it structured?

All revenues- All expenses=Net Income (if positive)/ Net Loss (if negative) Income statement covers a period of time.

Computing Interest on a Note

Amount of Interest = Principal x Interest Rate x Time In the formula, time represents the portion of a year that interest has accrued on the note. It may be expressed as a fraction of a year in months (number of months/12) Or a fraction of a year in days (number of days/365) or (number of days/360) Interest rates are always annual. Time is always a fraction of a year.

What are the effects of merchandise inventory errors on the financial statements?

An error in inventory can lead to errors in other related accounts. Because the ending inventory number is used in other computations when ending inventory is incorrect, other numbers will also be incorrect, such as: Cost of goods sold (=Beginning Inventory+ Purchases - Ending Inventory) Gross profit (=Net Sales - COGS) Net income An inventory error cancels out after two periods. The overstatement of cost of goods sold in Period 2 counterbalances the understatement for Period 1. Remember the formula: Beginning Inventory + Purchases during the period - Ending Inventory = COGS or re-write as: Beginning Inventory + Purchases during the period=Cost of Goods Available for Sale =Ending Inventory+ COGS Also, remember, as a permanent account, the current period ending balance equals next period's beginning balance.

inventory costing method

An inventory costing method approximates the flow of inventory costs in a business that is used to determine the amount of cost of goods sold and ending merchandise inventory. Four basic inventory costing methods are allowable by GAAP: Specific identification First-in, first-out (FIFO) Last-in, first-out (LIFO) Weighted-average

What's a transaction?

Any event that affects the financial position of the business Affect any least two accounts (you can make a JE out of a transaction)

What is the purpose of the adjusted trial balance, and how do we prepare it?

At the end of the fiscal period, an adjusted trial balance is prepared. An adjusted trial balance is a list of all the accounts with their adjusted balances. The purpose is to ensure total debits equal total credits

Examples of Asset Accounts

Cash, Accounts Receivable, Short-term Notes Receivable, Prepaid Expenses, Inventory (above are current assets) Land, Building, Equipment, Furniture, Fixtures, Computer, long-term investments, long-term Notes Receivables (above are long-term assets) Prepaid Expenses is an ASSET account!

What does CPA and CMA stand for?

Certified Public Accounts (CPAs) serve the general public. Certified Management Accounts (CMAs) often works for a single company.

Examples of Equity Accounts

Common Stock, Preferred Stock, Additional Paid in Capital of Common Stock, Additional Paid in Capital of Preferred Stock, Dividends, Revenues, Expenses Remember: Dividends, and Expenses are subtractions (they decrease stockholders' equity)

Cost of Goods Available for Sale

Cost of goods available for sale is the total cost spent on inventory that was available to be sold during a period.

Current Assets VS. Long-term Assets

Current Assets will be converted to cash, sold, or used up during the next 12 months or within the business operating cycle if the cycle is longer than a year. Examples of current assets listed in order of liquidity: cash, accounts receivable, inventory, supplies, prepaid expenses Long-term assets are all the assets that will not converted to cash or used up within the business's operating cycle or one year, whichever is greater.

Current Liabilities VS. Long-term Liabilities

Current liabilities must be paid either with cash or with goods and services within one year or within the entity's operating cycle. Examples of current liabilities: Accounts Payable, Salaries Payable, Unearned Revenues. Long-term liabilities are liabilities that do not need to be paid within one year or within the operating cycle.

Adjusting JE of merchandiser to account for inventory shrinkage

Debit COGS Credit Inventory (when the inventory on books (T-account balance) is higher than the actual physical count at the end of the accounting period, the inventory on books is the ending balance in inventory before the adjusting journal entry)

Assume we are doing JE for the buyer journal entry to record the purchase of inventory journal entry to record the return of inventory journal entry to record the payment

Debit Inventory Credit Accounts Payable (the amount could include the shipping if buyer pays for shipping, the amount should NOT be the discounted amount: i.e. assume not taking the discount) Debit Accounts Payable Credit Inventory (return of the inventory will reduce the bill amount, and reduce the inventory on hand) If there is a purchase allowance: the buyer receives a reduction in bill amount but does not need to return the inventory: The JE should be the same with the return of the inventory! Why? Because the Inventory account should reflect the actual cost/dollar amount of the inventory. Even though there is no physical reduction in inventory, the cost of inventory reduces, which should be reflected by crediting inventory account. Debit Accounts Payable Credit Cash Credit Inventory (if the actual cash payment is lower than the amount recorded in Accounts Payable (i.e. the buyer takes advantage of the discount), the inventory account is reduced/credited to reflect the lower cost that actually being incurred)

Definition of Liability

Debts owned to the creditors

What are the 4 rules that govern accounting studied in Chapter 1?

Economic entity assumption Going concern assumption Cost principle Monetary unit assumption

FOB Shipping point vs. FOB Destination

FOB Shipping Point: ownership transfers from seller to buyer at shipping point, buyer pays for shipping as buyer has ownership during shipping Buyer's entry for payment of shipping: Debit Inventory Credit Cash FOB Destination: ownership transfers from seller to buyer at destination, buyer pays for shipping as seller still has ownership during shipping Seller's JE for payment of shipping Debit Delivery Expense (part of operating expense) Credit Cash

Accounting information should be faithful represented. What does faithful representation mean?

Faithful representation means being completed, neutrual, and free from error.

Who are users of accounting information?

Financial accounting provides information to EXTERNAL users such as creditors, and investors Managerial accounting provides information to INTERNAL users such as managers, employees

Fiscal Year

Fiscal year is an accounting year of any 12 consecutive months that may or may not coincide with the calendar year: Example of the fiscal year: Jan-Dec (coincides with the calendar year); Feb-Jan of next year (12 consecutive months starting from Feb, often used by retailer companies such Macy's)

Control Over Merchandise Inventory

Good inventory controls ensure that inventory purchases and sales are properly authorized and accounted for by the accounting system by: Ensuring inventory is purchased with proper authorization. Tracking and documenting receipt of inventory. Recording damaged inventory properly. Performing physical counts of inventory annually. Recording and removing inventory from Merchandise Inventory when sold.

Gross Profit

Gross profit is a measure of a business's success. It is the markup on the merchandise inventory. It indicates the amount available to cover operating expenses. Gross Profit= Net Sales Revenue- COGS

How are financial statements affected by using different inventory costing methods?

Income statement Cost of Goods Sold is higher under LIFO than under FIFO when costs are rising. Net income is lower under LIFO than under FIFO when costs are rising. Balance sheet When costs are increasing, FIFO inventory will be the highest, and LIFO inventory will be the lowest.

What are the four financial statements? In what order are they prepared?

Income statement, statement of retained earnings, balance sheet, statement of cash flows. We first prepare the income statement. After we get the net income/loss from income statement, we prepare the statement of retained earnings. Then, with the ending balance of retained earnings, we prepare the balance sheet (we also use the adjusted trial balance to prepare balance sheet). In the end, we use the balance of cash in the balance sheet to prepare the statement of cash flows.

Sales Discount Forfeited

It is other income for the seller(NOT part of the sales revenue). It is the discount forfeited by the buyer when they pay beyond the discount period.

How are uncollectible accounted for when using the allowance method?

JE for write-off under allowance method: Dr. Allowance for Bad Debt Cr. Accounts Receivable The Allowance account is a contra-asset account for the Accounts Receivable Instead of recording a debit to Bad Debts Expense (as in the Direct Method), the company records a debit to Allowance for Bad Debts. The entry to write off a receivable reduces the amount of the Allowance for Bad Debts account and also the Accounts Receivable account, but it does not affect the net realizable value (balance sheet) nor does it effect net income (income statement).

Which accounts have a normal balance on the credit side (i.e. any increases are recorded as credits)?

Liabilities, Common Stock, Revenues

What are the characteristics of a corporation?

Owners of a corporation: shareholders/stockholders: they are not personally liable for the company debt Corporations are managed by managers/executives The managers and executives are appointed by board of directors. A corporation is a separate legal entity that pays tax (double tax: corporation pays corporate taxes if there is a profit; if corporation pays out dividends to shareholders, shareholders pay individual tax on the dividends)

Definition of equity

Owners' claims to the assets of the business increases in equity result from: contributed capital (also called owner contribution/paid in capital), revenues decreases in equity result from: dividends (also called owner distribution), expenses

How are notes receivable accounted for? -continued from last flashcard

Principal —The amount loaned by the payee and borrowed by the maker of the note. Interest —The revenue to the payee for loaning money. Interest is an expense to the debtor and revenue to the creditor. Interest period —The period of time during which interest is computed. It extends from the original date of the note to the maturity date. Also called the note term. Interest rate —The percentage rate of interest specified by the note. Interest rates are almost always stated for a period of one year. Maturity date —As stated earlier, this is the date when final payment of the note is due. Also called the due date. Maturity value —The sum of the principal plus interest due at maturity. Maturity value is the total amount that will be paid back.

Accounting information should be relevant. What does relevant mean?

Relevant means users should be able to make a decision based on the accounting information.

Which organization oversees the US financial markets?

Securities and Exchange Commission (SEC)

Identifying Maturity Date

Some notes specify the maturity date. Other notes state the period of the note in days or months. When the period is given in months, the note's maturity date falls on the same day of the month as the date the note was issued. When the period is given in days, the maturity date is determined by counting the actual days from the date of issue. Count the maturity date Omit the issue date

Stockholders' Equity

Stockholders' equity represents the stockholders' claims to the assets of the business. Reflects the stockholders' contributions through common stock Represents the amount of assets left over after the corporation has paid its liabilities

Monetary unit assumption

The assumption that requires the items on the financial statements to be measured in terms of a monetary unit (dollar amount)

Going concern assumption

The assumption that the company will continue in operation for the foreseeable future.

Differences of the balance sheet between a merchandiser and a service company

The balance sheet for a merchandiser is very similar, except for two new assets accounts: Merchandise Inventory Estimated Returns Inventory And one new liability account: - Refunds Payable Bonus Question: differences of the income statement between a merchandise and a service company: -sales revenue vs. service revenue -COGS is a new account in a merchandiser -Sales discount forfeited is new other income account in a merchandiser Also pay attention to diferences between balance sheet account and income statement account

What is the closing process, and how do we close the accounts?

The closing process zeroes out all revenue and expense accounts in order to measure each period's net income separately from all other periods. Temporary accounts relate to a particular accounting period and are closed at the end of that period Revenues, Expenses, Income Summary, and Dividends accounts are temporary accounts. Permanent accounts are not closed at the end of the period Asset, Liability, Common Stock, and Retained Earnings accounts are permanent accounts.

Purchase returns vs. Purchase Allowances

The invoice price for a purchaser may need to be adjusted for purchase returns or purchase allowances. Purchase returns exist when sellers allow purchasers to return merchandise that is defective, damaged, or otherwise unsuitable. Purchase allowances are amounts granted to purchasers as an incentive to keep goods that are not "as ordered."

How is merchandise inventory valued when using the lower-of-or-market rule?

The lower-of-cost-or-market (LCM) rule requires that inventory be reported in the financial statements at the lower of the inventory's historical cost or its market value. Market value generally means the current replacement cost.

Matching Principle

The matching principle guides accounting for expenses and ensures: All expenses are recorded when they are incurred during the period. Expenses are matched against the revenues of the period. The goal is to compute an accurate net income or net loss for the time period. Examples of applications of matching principle: depreciation/amortization/depletion expense: matching depreciation expense when using the asset; accrued liabilities: interest payable/expense, salaries payable/expense allowance for bad debt is based on matching principle, the direct write-off violates the matching principle The matching principle requires businesses to record Warranty Expense in the same period that the company records the revenue related to the warranty.

Materiality Concept

The materiality concept states that a company must perform strictly proper accounting only for items that are significant to the business's financial situation. Information is significant when it would cause someone to change a decision.

What is a journal?

The record of the transactions in date order

Single-step income statement vs. Multi-step income statement

The single-step income statement groups all revenues together and then lists and deducts all expenses together without calculating any subtotals. The multi-step income statement contains subtotals to highlight significant relationships. In addition to net income, it reports gross profit and operating income. Operating expenses are reported in two categories: 1. Selling expenses are related to marketing and selling the company's goods and services. 2. Administrative expenses include expenses not related to marketing the company's goods and services. Gross profit minus operating expenses equals operating income. Other income and expenses reports revenues or expenses that are outside the normal, day-to-day operations of a business, such as a gain or loss on the sale of plant assets, interest expense/revenue, or sales discounts forfeited. Income tax expense reports the federal and state income taxes that are incurred by the corporation.

What is a statement of cash flows? How is it structured?

The statememt of cash flows reports the changes in Cash account during period. Net Cash flows of operating activities (net means cash inflows minus cash outflows) +Net Cash flows of investing activities +Net Cash flows of financing activities =Net Increase/Decrease in Cash account during the period which equals ending balance of cash minus beginning balance of cash The balances of cash are acquired from balance sheet.

What is a statement of retained earnings? How is it structured?

The statement of retained earnings informs the users about how much of the earnings were kept and reinvested in the company. Retained Earning Beginning Balance +Net Income/Net Loss(from Income Statement) -Dividends =Retained Earning Ending Balance

Cost principle

Transactions are recorded at the ACTUAL amount paid

Recording Dishonored Notes Receivable

When a maker dishonors a note, the dishonored note and the unpaid interest are transferred to Accounts Receivable. Later, the Accounts Receivable can be written off under the direct write-off method or the allowance method.

journal entry for shipping charges when the buyer pays for shipping (FOB destination)

When buyers pays for shipping, the shipping cost is considered part of the inventory. Journal Entry: Debit: Inventory Credit: Cash (if pay shipping with cash)

journal entry for shipping charges when the seller pays for shipping (FOB Shipping Point)

When seller pays for shipping, the shipping cost is considered as delivery expense which is part of the operating expenses (NOT part of cost of goods sold) Journal Entry: Debit: Delivery Expense Credit: Cash (if pay shipping with cash)

Time Period Concept

assumes that business activities are sliced into small time segments and that financial statements can be prepared for specific periods, such as a month, quarter, or year

cash basis vs accrual basis accounting

cash basis: revenues/expenses recorded when cash is received/paid; not allowed under GAAP; easier to follow accrual basis: revenue recorded when earned; expenses recorded when incurred; provide a better picture of a business's net income or loss; used by most business

Direct write-off method vs. Allowance method

write-off of an uncollectible account: Direct write off: Dr. Bad Debt Expense Cr. Accounts Receivable Allowance method: Dr. Allowance for Bad Debt Cr. Accounts Receivable Recovery of accounts previously written off: Direct write off: Dr. Accounts Receivable Cr. Bad Debt Expense Allowance method: Dr. Accounts Receivable Cr. Allowance for Bad Debt both methods will also record the receipt of cash, and reduce in A/R as follows: Dr. Cash Cr. Accounts Receivable Adjusting entry to recognize bad debts; direct write-off: No adjusting entry recorded. allowance method: Dr. Bad Debt Expense Cr. Allowance for Bad Debt

Example of Accrued Revenue

Accrued revenue arise when: a company performs a service but has not yet collected/received cash or a company delivers a product but has not yet collected/received cash AJE to record the revenue earned but has not received payment: Accounts Receivable (debit) Revenue (credit) JE to record the receipt of payment for Accounts Receivable Cash (debit) Accounts Receivable(credit)

Adjusting Entries

Adjusting entries are made at the end of the accounting period to record revenues to the period in which they are earned and expenses to the period in which they occur. Adjusting entries also update asset and liability accounts. The two basic categories are deferrals and accruals.

Adjusting JE of seller to estimate the returns of inventory

Debit Sales Revenue Credit Refunds Payable Debit Estimated Returns Inventory Credit COGS The amount of estimation is based on historical data in the business.

Deferrals and Accruals

Deferrals: defer the recognition of revenues or expenses to a date after the cash is received or paid. Two types of deferrals: deferred expenses (prepaid expenses, office supplies, depreciation expense); deferred revenues: unearned revenue Accruals: record an expense before the cash is paid, or records revenue before the cash is received Two types of accruals: accrued expenses (salaries expense, interest expense, utilities expense); accrual revenues: debit to accounts receivable, credit to cash

How do we record the issue of notes receivable?

Dr. Notes Receivable Cr. Cash the amount would be at its principal amount

Recovery of Accounts Previously Written Off—Allowance Method

JE for recovery of accounts previously written off under allowance method: Dr. Allowance for Bad Debt Cr. Bad Debt Expense (reverse the accounts for writing off the account, the reverse reestablish the customer's accounts receivable) Since the recovery requires the customer paying us back, another JE associated with recovery would be: Dr. Cash Cr. Accounts Receivable

Last-In, First-Out (LIFO) Method

Last-in, first-out (LIFO) method is the opposite of FIFO. As inventory is sold, the cost of the newest item in inventory is assigned to each unit as Cost of Goods Sold. Cost of Goods Sold closely reflects current replacement cost. Ending Inventory contains the oldest costing units.

Cost of Inventory Purchased

Net cost of inventory purchased = Purchase cost of inventory - purchase returns and allowances - purchase discounts + freight in (if buyers pays for shipping) The discount is applied to the amount of (Purchase cost of inventory - purchase returns and allowances). Example: 2/15, n EOM If the buyer pays the bill within the discount period (15 days after purchase date) Net cost of inventory purchased = (100% -2%)*(Purchase cost of inventory - purchase returns and allowances) + freight in

Revenue Recognition Principle

The revenue recognition principle tells accountants when to record revenue and requires companies follow a five step process: Step 1: Identify the contract with the customer. Step 2: Identify the performance obligations in the contract. Step 3: Determine the transaction price. Step 4: Allocate the transaction price to the performance obligations in the contract. Step 5: Recognize revenue when (or as) the entity satisfies each performance obligation.

Specific Identification Method

The specific identification method is an inventory costing method based on the specific cost of particular units of inventory.

Maturity value of Notes Receivable

The sum of the principal plus interest due at maturity.

Weighted-Average Method

The weighted-average method computes a new weighted-average cost per unit after each purchase. Weighted-average cost per unit is determined by dividing the cost of goods available for sale by the number of units available. Ending Inventory and Cost of Goods Sold are based on the same weighted-average cost per unit. Weighted-average method produces COGS, and Ending Inventory amount in between the amounts produced by LIFO and FIFO.

Examples of Long-term Assets

There are three types of long-term assets: 1. long-term investments: investments in bonds or stocks that the company intends to hold for longer than one year 2. Property, Plant, and Equipment (PPE): long-lived, tangible assets, used in the operation of a business 3. Intangible Assets: are assets with no physical form that are valuable because of special rights carried

What is a contra-account? What are the characteristics of a contra-asset account?

A contra-account has two main traits: 1. it is paired with and is listed immediately after its related account in the chart of accounts and associated financial statement 2. its normal balance is the opposite to the normal balance of the related account Example: Accumulated Depreciation: is a contra-asset account it has a normal balance of credit (opposite to asset's normal balance of debit) Examples of contra-accounts from later chapters: contra-asset account: allowance for bad debt (its main account is accounts receivable) contra-liability account: discount on bonds payable adjunct-liability account: premium on bonds payable

What are common types of receivables, and how are credit sales recorded?

A receivable occurs when a business sells goods or services to another party on account (on credit). A receivable is a monetary claim against a business or an individual. A receivable is a right to receive cash in the future from a current transaction. A creditor is the party who receives a receivable. A debtor is the party to a credit transaction who is obligated to pay later. There are 3 types of receivables: Accounts Receivable, Notes Receivable, and Other Receivables

Recovery of Accounts Previously Written Off—Direct Write-off Method

After the company has written off an account, it is possible the customer will still make a payment on their account. In this case, the company needs to: (1) reverse the earlier write-off and (2) record the cash collection. Reestablishing the A/R and then recording the payment provides accurate records and restores the customer's credit history. JE for recovery of accounts previously written off: Dr. Accounts Receivable Cr. Bad Debt Expense (reverse the accounts for writing off the account, the reverse reestablish the customer's accounts receivable) Since the recovery requires the customer paying us back, another JE associated with recovery would be: Dr. Cash Cr. Accounts Receivable

How to determine the balance of a T-account?

All debits -All credits if positive, ending balance is a debit if negative, ending balance is a credit remember, if the account has an ending balance from last account period, need to carry over to the current period's T-account beginning balance

How to determine the balance of a T-account?

All debits -All credits if positive, ending balance is a debit if negative, ending balance is a credit remember, if the account has an ending balance from last accounting period, need to carry over to the current period's T-account beginning balance In later chapters, we learn that only permanent account (assets, liabilities, equity accounts) are carried over from last period to the next period, the temporary accounts (revenues, expenses, dividends, income summary accounts) are closed to zero at the end of each period.

Other Receivables

Any other type of receivable is considered other receivables. Receivables are classified as either current or long-term, depending on whether they will be received in one year or less. Examples include: Dividends receivable Interest receivable Taxes receivable

Control account and Subsidiary accounts of Accounts Receivable

Businesses maintain different A/R accounts (called subsidiary accounts) for each customer. The control account, Accounts Receivable, shows a balance which should be equal to (and on the same side) the total of the individual customer accounts in the subsidiary ledger.

Closing entries

Closing entries transfer revenues, expenses, and Dividends to Retained Earnings. Revenues and expenses may be transferred first to an account titled Income Summary. Income Summary is a temporary account that summarizes the net income (or net loss) for the period. Closing entries are prepared after the financial statements are prepared. To close revenues accounts: Debit Revenue Credit Income Summary To close expense accounts: Debit Income Summary Credit Expense To close Income Summary account, the debit or credit depends on whether there is a net income or net loss Net Income: Debit Retained Earnings Credit Income Summary Net Loss: Debit Income Summary Credit Retained Earnings To close dividends: Debit Retained Earnings Credit Dividend

Estimating and Recording Bad Debts Expense—Allowance Method

Companies estimate bad debts expense based upon: Past experience The industry in which they operate Other variables There are three methods to estimate uncollectibles using the allowance method: Percent-of-sales Percent-of-receivables Aging-of-receivables Adjusting JE for estimation: Dr. Bad Debt Expesne Cr. Allowance for Bad Debt

Conservatism

Conservatism means a business should report the least favorable figures in the financial statements when two or more possible options are presented. Anticipate no gains, but provide for all probable losses. Record an asset at the lowest reasonable amount and a liability at the highest reasonable amount. When there's a question, record an expense rather than an asset. Choose the option that undervalues, rather than overvalues, your business. Example: lower of cost or market (LCM), record sales revenue at the net amount (assuming the buyer takes advantage of the discount)

Options to decrease collection time while transferring the risk of noncollection on Accounts Receivable to a third party include:

Credit Card and Debit Card Sales Factoring (selling) and Pledging (using as collateral on a loan) Receivables

Assume we are doing JE for the seller journal entry to record the sale of inventory journal entry to record the payment of shipping journal entry to record the return of inventory journal entry to record the sales allowances journal entry to record the receipt of payment

Debit COGS Credit Inventory Debit Accounts Receivable Credit Sales Revenue (Accounts Receivable and Sales Revenue is recorded as net of discount, assuming the buyer always takes the discount if given the option: conservative accounting) Debit Delivery Expense (part of operating expenses) Credit Cash (if pay with cash) Actual return of inventory: Debit Refunds Payable Credit Accounts Receivable Debit Inventory Credit Estimated Returns of Inventory Sales Allowance: Debit Refunds Payable Credit Accounts Receivable (there is no entry related to inventory, as sales allowance receives no inventory back; note when there is a purchase allowance, buyer's JE is the same as a purchase return!) Receipt of Payment: debit Cash credit Accounts Receivable credit Sales Discount Forfeited (other income, if the buyer did not pay within discount period)

Relationship Among the Financial Statements

Net income or net loss from the income statement flows to the Statement of Retained Earnings. Ending balance of Retained Earnings (=Beginning Balance + Revenue - Expenses - Dividends) from the Statement of Retained Earnings flows to the Balance Sheet. Ending balance of all other accounts except for Retained Earnings are acquired from adjusted trial balance. Ending balance of cash is used to prepare statement of cash flows (total change of cash account=ending balance of cash in the current period - ending balance of cash in the prior period=change of cash from operating+change of cash from investing+change of cash from financing activities)

What is net realizable value of Accounts Receivable?

Net realizable value is the net value the company expects to collect from its accounts receivable. NRV=A/R-Allowance for Bad Debt

Notes Receivable

Notes receivable usually have longer terms than accounts receivable. Notes receivable are sometimes called promissory notes. A note receivable represents a promise to pay a fixed amount of principle plus interest by a certain due date. The maturity date is the date on which a note receivable is due. Reported as a current asset if due within one year. Reported as a long-term asset if due beyond one year.

How are notes receivable accounted for?

Promissory note — A written promise to pay a specified amount of money at a particular future date, usually with interest. Maker of the note (debtor) — The entity that signs the note and promises to pay the required amount. The maker of the note is the debtor. Payee of the note (creditor) — The entity to whom the maker promises future payment; the payee of the note is the creditor. The creditor is the company that loans the money.

Post-closing trial balance

The accounting cycle ends with a post-closing trial balance: A list of the accounts and their balances at the end of the period, after journalizing and posting the closing entries Includes only permanent accounts Differences between Post-closing Trial Balance and Adjusted Trial Balance: All accounts before Retained Earnings (include Assets, Liabilities, and Common Stock) have the same balance; Retained Earnings is updated to ending balance in post-closing trial balance (adjusted trial balance has a beginning balance in Retained Earnings); All the temporary accounts (revenue, expenses, dividends) are removed or have zero balances in the post-closing trial balance

What is the accounting cycle?

The accounting cycle is the process by which companies produce their financial statements for a specific period. It is the steps that are followed throughout the time period. It starts with the beginning asset, liability, and stockholders' equity account balances left over from the preceding period.

What is an account

The accounting equation contains three categories of accounts: assets, liabilities, and equity. Each part contains accounts. An account is the detailed record of all increases, and decreases that have occurred in an account during a specified period.

Aging-of-Receivables Method

The aging-of-receivables method is similar to the percent-of-receivables method. In the aging method, businesses group individual accounts based on how long the receivable has been outstanding. Different percentages are applied to each category. The procedure for recording the year-end adjusting entry under the aging-of-receivables method is similar to the percent-of-receivables method.

Consistency Principle

The consistency principle states that a business should use the same accounting methods and procedures from period to period. Consistency helps investors and creditors compare financial statements from one period to the next. Example: keep the accounting method the same from period to period

Recording and Writing Off Uncollectible Accounts—Direct Write-off Method

The direct write-off method is a method of accounting for uncollectible receivables in which the company records bad debts expense when a customer's account receivable is uncollectible. Primarily used by small, nonpublic companies. Accounts receivable are written off when the business determines that it will never collect from a specific customer. Once an account receivable is written off, the company stops pursuing the collection. JE for write-off under direct write off method: Dr. Bad Debt Expense Cr. Accounts Receivable

Limitations of the Direct Write-off Method

The direct write-off method violates the matching principle Example: A company records sales revenue in 2017 and related bad debts expense in 2018. This results in: Overstated net income in 2017 Understated net income in 2018 Overstated Accounts Receivable in 2017 Not GAAP (the direct write-off method is only acceptable for companies that have very few uncollectible receivables).

Disclosure Principle

The disclosure principle states that financial statements should report enough information for outsiders to make knowledgeable decisions about the company. Information should be relevant and have faithful representation. Example: disclose the accounting method in the footnotes of the financial statements As we learned in Chapter 15, we disclose accounting policies, and principals, in the footnotes of financial statements (consistent with disclosure principle)

First-In, First-Out (FIFO) Method

The first-in, first-out method (FIFO) assumes the first units purchased are the first to be sold. Cost of Goods Sold is based on the oldest purchases. Ending Inventory closely reflects current replacement cost. For most companies, FIFO is consistent with the actual physical movement of inventory (companies want to sell the oldest purchases first)

Closing the Accounts of a Merchandiser

The four-step closing process for a merchandising company follows: Step 1: Make the revenue accounts equal zero via the Income Summary account. Step 2: Make expense accounts equal zero via the Income Summary account. Step 3: Make the Income Summary account equal zero via the Retained Earnings account. This closing entry transfers net income (or net loss) to Retained Earnings. Step 4: Make the Dividends account equal zero via the Retained Earnings account.

Operating Cycle of a Merchandising Business

The operating cycle: It begins when the company purchases inventory from an individual or a business, called a vendor. The company then sells the inventory to a customer. Finally, the company collects cash from customers

Percent-of-Receivables Method

The percent-of-receivables method computes bad debts expense as a percentage of accounts receivable.

Percent-of-Sales Method

The percent-of-sales method computes bad debts expense as a percentage of net credit sales. Some companies use all sales, not just credit sales. This method is also called the income-statement approach.

Operating Cycle

The period of time between the purchase of inventory and the collection of any receivable from the sale of the inventory. The cycle is a 3-step cycle: 1. cash is used to acquire goods and services 2. these goods and services are sold to customers 3. the business collects cash from customers

What is a transaction?

Transactions always involve at least two accounts (you should be able to make a Journal Entry out of it). A transaction is any event that affects the financial position of the business and can be measured with faithful representation.

What is posting?

Transferring data from the journal to the ledger is called posting.

Examples of Deferred Expenses

advance payments of future expenses, also called prepaid expenses treated as assets until used recognizes as an expense by an adjusting journal entry when the prepayment is used 1. Prepaid Rent Prepaid Rent (debit) Cash(credit) when the rent expense incurred at the end of each month Rent Expense (debit) Prepaid Rent (credit) 2. Office Supplies Office Supplies beginning balance + Purchase of Supplies during the period if any - Office Supplies Used=Office Supplies on Hand When purchased office supplies: Office Supplies (debit) Cash(credit) Adjusting journal entry at the end of accounting period (some of all the of supplies purchased are used): Supplies Expense (debit) Office Supplies (credit) 3. Depreciation when purchased property, plant, and equipment: Computer (or other long-lived asset) (debit) Cash(credit) Adjusting journal entry to record the depreciation at end of accounting period: Depreciation Expense-Computer (debit) Accumulated Depreciation-Computer (credit)

Example of Deferred Revenue

deferred revenue occurs when a company receives cash before it performs the service or delivers the product; deferred revenue is a liability because the business owes the customer the product, the service Deferred revenue is also called unearned revenue. Upon performance or delivery, deferred revenue is converted to earned revenue JE to record the upfront payment from customer for services not performed yet Cash (debit) Unearned Revenue (credit) AJE (Adjusting Journal Entry) to record the partial or total completion of the service: Unearned Revenue (debit) Service Revenue(credit)

What are the two ways of accounting for uncollectibles on Accounts Receivable?

direct write-off method (not allowed under GAAP, violates matching principal): Allowance method (GAAP method)