COB 241: Ch 2 - Accounting for Accruals and Deferrals

On 6/1 of Year 1, a law firm collected $1800 in exchange for an agreement to provide legal services for one year term beginning immediately. Services will be provided evenly over the 12 month period. The amount of earned revenue recognized in Year 1 is ... and the amt in Y2 is ....

$1050 $750 1800/12 = 150 7 months until Dec = 7 x 150 = 1050 1800 - 1050 = 750

Accounting Cycle Steps (4)

1) recording transactions 2) adjusting the accounts 3) preparing financial statements 4) closing the temporary accounts the first step occurs continually throughout the acc period. 2, 3, and 4 normally occur at the end of the accounting period

A company borrowed 10,000 from the State Bank on 4/1, Y1. The one-year note carried a 6% of interest. The amount of interest expense that Gomez would report on its Y2 income statement would be

10,000 x .06 = 600 annual interest 600/12 = 50 per month 50 x 3 = 150 in year 2

A company borrowed 10K from the State Bank on 4/1, y1. The one-year note carried a 6% rate of interest. The amount of interest expense that the company would report on its Year 1 income statement would be

10,000 x .06 = 600 annual interest 600/12 = 50 per month 50 x 9 = 450 in Yr 1

A company borrowed 10K from the State Bank on 4/1, y1. The one-year note carried a 6% rate of interest. The amount of cash outflow from operating activities that the company would report on its Year 2 statement of cash flows would be

10,000 x .06 x 12/12 = 600 The total amount of cash is paid at the maturity date 3/31, Y2

On 4/1 of Year 1, a law firm collected $1200 in exchange for providing services for a one year term beginning immediately. The amt of earned revenue recognized in Y1 is

12 - 3 = 9 (excludes Jan, Feb, Mar) 1200/12 = 100 9 x 100 = 900 900

On 9/1 of y1, a company paid $1800 cash to rent office space for one year beginning immediately. the amt of rent expense recognized in Y1 is ... and the amt in Y2 is ...

12 - 8 = 4 (discrete stats) 1800/12 = 150 per month 150 x 4 = 600 in Y1 1800 - 600 = 1200 in Y2

... salary expense is normally recorded in a year-end ... entry

Accrued adjusting

Types of transactions (4)

Asset source transactions - an asset account increases, and a corresponding claims account increases Asset use transactions - an asset account decreases, and a corresponding claims account decreases Asset exchange transactions - one asset account increases, and another asset account decreases Claims exchange transactions - one claims account increases, and another claims account decreases

Unearned revenue appears on which of the following statements?

Balance sheet even though the term rev is included in the account title, UR represents a liability (obligation) to provide goods/services to customers

Paying cash to purchase a truck affects which financial statement?

Balance sheet - paying cash to purchase it is an asset exchange trans. that does not affect the total amt of assets shown on BS. however, it does affect the BS because it affecs the balance of cash and the balance of the truck acc shown on the BS Statement of cash flows - shows a cash outflow from investing activities

The entry to record the cash purchase of prepaid insurance will affect what statements?

Balance sheet - while the amt of total ass is not affected, the amt of the Cash acc decreases and the amount of the Prepaid insurance acc increases Statement of Cash flows - there is a cash outflow from operating activities at the time the insurance is purchased

which formula may be used to determine the amount of supplies expense to recognize at the end of an acc period?

Beginning balance of supplies Plus: Supplies purchase = Supplies available for use Less: Ending balance of Supplies = Supplies used

... expenses are expenses that have not been recognized even though the associated cash payments have been exchanged

Deferred

Expense

Instead of a decrease in assets, a company may record an increase in liabilities (salaries payable) Therefore, an expense can be more broadly defined as an economic sacrifice (a decrease in assets or an increase in liabilities) resulting from operating activities undertaken to generate revenue

Company recognizes 33K of salary expense in Y1. Cash payments to settle salaries payable amt to 28K in Y1, with the remainder being paid in Y2. the company's financial statements would show a

Net loss of 33K and cash outlfow from operating activities of 28K in Y1

when an entity collects cash for services to be provided in the future, which section of the Statement of Cash flows is impacted?

Operating activities section

If a company recognizes an accrued salary expense in Y1 and pays its employees in Y2, which financial statements will be affected in Y2

Statement of cash flows - cash outlfow to payoff the salaries payable acc is hsown on the Y2 statement of cf Balance sheet - affected by the Y2 cash payment to settle the salaries payable. specifically, both the cash and salaries payable accounts decrease NOT income sheet

Elements that are typically present when fraud occurs (3)

The availability of an OPPORTUNITY The existence of some form of PRESSURE leading to an incentive The capacity to RATIONALIZE These three elements are frequently arranged in the shape of a triangle

What occurs when a company recognizes an expense?

Total liabilities increase AND

A company borrowed 10K from the State Bank on 4/1, y1. The one-year note carried a 6% rate of interest. The amount of cash outflow from operating activities that the company would report on its Year 1 statement of cash flows would be

Zero. The total amount of cash is paid at the maturity date 3/31, YEAR 2. Accordingly, zero would be paid in Yr 1

when a company purchases supplies on account, the balance in the

accounts payable acc increases supplies acc increases cash acc is not affected (asset source transaction)

When a company recognizes depreciation expense on a truck, the balance in the (2)

accumulated depreciation account increases (when recognized) truck acc is not affected

Prepaid items

aka deferred expenses other commonly deferred expenses include prepaid insurance, prepaid taxes, and unused office space with its expenses deferred until it begins to generate revenue

Carrying value

aka the book value of an asset

Difference between liabilities and expenses

although liabilities may increase when a company recognizes expenses, liabilities are NOT expenses. They are OBLIGATIONS, and can arise from acquiring assets as well as recognizing expenses

Expense

an economic sacrifice incurred in the process of generating revenue. Its recognition is accompanied by a decrease in assets or an increase in liabilities resulting from consuming assets and services in an effort to produce revenue

Account receivable

an expectation to collect cash in the future asset acc

Account payable

an expectation to pay cash in the future liability acc

When a company pays cash to purchase supplies, the total amount of assets and liabilities

are not affected the Supplies account (in assets) increases and another asset acc, Cash, decreases; hence, nothing happens

recognizing revenue on account is a

asset source transaction

On 1/1 of Y1, a company paid 2400 cash for an insurance policy. The policy protects the company from losses due to fire for the coming year, beginning immediately. On 1/1, Y1, the company should report a

asset titled prepaid insurance a cost is not always an expense. if a company buys something that it will use in the future to gain revenue, then it is an asset

Accounts Receivable

balance in AR represents the amount of cash the company expects to collect in the future revenue is an economic benefit that increases this specific asset

Salaries Payable

balance in this account represents the amount of cash the company is obligated to pay in the future specifically increases when there is a claims exchange transaction recognizing salary expense decreases net income and ultimately retained earnings

When a company pays cash to settle an account payable

both accounts decrease

When a company borrows money by issuing a note, the balance in the

cash acc increases - inflow of cash is a financing activity notes payable acc increases - notes payable represents obligation (liability) to return the principal balance to the lender in the future. recognizing the obligation requires an increase in the notes payable acc

What show how recognizing accrued interest expense affects financial statements?

cash flow is not affected - recognizing it causes the balance in the expense acc to increase and the balance in the interest payable acc to increase. the cash acc is not affected. Accrual occurs when an expense is recognized before cash is paid liabilities increase - recognizaing it caues the balance in the expense acc to increase and the balance in the interest payable (liability) acc to increase

Asset use transaction

cash payment for salary expense; (decrease in cash means decrease in stockholders' equity) on the balance sheet, assets and stockholders' equity decrease; decreases net income on the income statement and ultimately retained earnings on the balance sheet

Assume a beginning balance in the supplies acc of 300. During the acc period, the company purchases 1700 of supplies on acc. Supplies on hand at the end of the acc period is 400. The adjusting entry to recognize supplies expense will

cause net income to decrease by 1600 have no affect on the statement of cash flows cause total assets to decrease by 1600

What does accrual accounting do to income statements and statements of cash flow?

causes the amount of revenues and expenses reported on the income statement to differ significantly from the amount of cash flow from operating activities reported on the statement of cash flows because of timing differences

Code of Professional Conduct and its 6 principles

code that members of the AICPA must follow 6 principles: Responsibilities Public Interest Integrity Objectivity and Independence Due Care Scope and Nature of Services

Asset exchange transaction

collection of an account receivable; the amount of total assets is not affected (+60 in cash, but -60 in acc receivable), and the income statement is unaffected i.e. a company does not recognize revenue when the cash is collect, only when the work was done

Vertical statements model

concurrent representation of several financial statements to significant totals

The book value of a long-term asset is equal to the

cost of the asset - accumulated depreciation difference between the balances in the item acc and the related Accumulated Depreciation acc

on 5/1 of Y1, a company paid cash to purchase prepaid rent. the yr end adjust entry required to recognize rent expense would ... the prepaid acc and ... the balance in the rent expense acc

decrease increase

On 5/1 of Y1, a company paid cash to purchase prepaid rent. Based on this info, the year-end adjusting entry required to recognize rent expense would ... the Prepaid Rent acc and ... the balance in the Rent Expense acc

decrease increase the expense reduces net income shown on the income statement and ultimately the amt of stockholders' equity (retained earnings) on the BS

On 6/1 of Y1, an accountant collected cash in exchange for an agreement to provide consulting services for one year beginning immediately. The year end adjusting entry required to recognize earned revenue would

decrease the balance in the Unearned Rev acc and increase the balance in the earned Rev acc adjusting entry is a claims exchange event. Assets are not affected. On the BS, liabilities decrease and stock. equity (ret earn) increases. cash flow is not affected.

the adjusting entry to recognize supplies expense ... the supplies acc balance and ... the supplies expense acc balance

decreases increases

the adjusting entry to recognize supplies expense

decreases the Supplies acc balance increases the balance in the Supplies Expense acc

cost

either an asset or expense if a company has already consumed a purchased resource in the process of earning revenue, the cost of the resource is an expense in contrast, if a company purchases a resource it will use in the future to generate revenue, the cost of the resource represents an asset

Adjusting entry

entry required to update the account balances

What does double-entry accounting system affect?

every event affects at least two ledger accounts at the end of the acc period, the info that has been collected in the ledger accounts is used to prepare financial statements

useful life

expected period of use of an asset

a company paid 120 cash for lawn care service that had been consumed. the company should report a

expense titled lawn service expense

Period costs

expenses that are matched with the period in which they are incurred

Accrued expenses

expenses that are recognized before cash is paid

Deferral

feature of accrual accounting describes a revenue or an expense event that is recognized AFTER cash has been exchanged. i.e. suppose J pays cash in Y1 to purchase office supplies it uses in Y2. In this case, the cash payment occurs in Y1, although supplies expense is recognized in Y2.

Accrual

feature of accrual accounting describes a revenue or an expense event that is recognized BEFORE cash is exchanged. i.e. Johnson's recognition of revenue in Year 1 that is related to cash collected in Year 2

Features required by the Sarbanes-Oxley Act

firms that provide public audits are prohibited from providing a variety of other non audit services independent auditors conducting audtis of public companies must reigster with Public Company Accounting Oversight Board (PCAOB)

Supplies available for sale amounts to 1700 and supplies on hand at the end of the acc period is 400. the adjusting entry to recognize supplies expense will

have no affect on the statement of cash flows cause net income to decrease by 1300

Recognizing accrued salary expense will

have no effect on the statement of cash flows

Recognizing revenue on account will

have no effect on the statement of cash flows

General ledger

holds asset acc, liability acc, and stock. equity acc

On 8/1 of Y1, a company paid cash to purchase prepaid rent. The year end adjusting entry required to recognize rent expense would

increase the balance in the Rent expense acc decrease the balance in the Prepaid Rent acc NOT AFFECT the balance in the cash acc

When a company records the cash purchase of prepaid rent, the balance in the Prepaid Rent acc ... and the amt in the Cash acc ...

increases decreases

When a company collects cash for services to be provided in the future, the balance in the Unearned Revenue account ... and the amt in the Cash acc ...

increases increases

When a company borrows money by issuing a note, the balance in the cash account...

increases and the balance in the notes payable account increases

Pressure

key ingredient of misconduct; can cause employees to commit fraud but remain honest pressure can come from a variety of sources, like: - personal vices - intimidation from superiors - personal debt - family expectations - business failure - loyalty

When a company collects cash for services to be performed in the future, the company should recognize a

liability called unearned revenue

Straight-line depreciation

method for computing depreciation expense produce equal amts of depreciation to allocate to expense each period over an asset's life; computed by subtracting the salvage value from the asset's cost and then dividing by the number of yrs of useful life

What does an accountant require in order to function in society?

needs to have trust and credibility accounting info is worthless if the accountant is not trustworthy; tax and consulting advice is useless if it comes from an incompetent person

A company earned 5000 of rev on acc during Y1, but collected the cash associated with the receivables in Y2. under accrual acc, the company would report

net income of 5K and cash inflow from operations of zero in Y1

On 8/1 of Y2, a company paid cash to purchase prepaid rent. How would the 12/31, a year-end adjusting entry to recognize rent expense, affect Y2 IS and the Y2 St. of cash flows?

net income would decrease - rent expense would be recognized, causing net income to decrease cash flow from operating activities would not be affected - cash flow would be affected when the prepaid rent was purchased, not when the year end adjustment is made

notes payable

obligation (liability) to return the principal balance to the lender in the future. recognizing the obligation requires an increase in the notes payable acc

Sarbanes-Oxley Act

passed by Congress due to audit failures of major companies in 2001. Established several regulations to improve how the audit system works and to hold companies and auditors more accountable and responsible for their actions

Internal controls

policies and procedures that a business implements to reduce opp for fraud and to assure that its objectives will be accomplished specific controls are tailored to meet the individual needs of particular businesses

Depreciation expense

portion of the cost that represents the use of the asset recognizing this is an asset use transaction, meaning assets and equity decrease

the ... acc is an asset acc, while the ... acc is a liability acc

prepaid rent unearned revenue

Revenue's Relationship with Unearned Revenue

previously defined as an economic benefit a company obtains by providing customers with goods and services. in one case, the economic benefit is a DECREASE in the liability account of Unearned Revenue Revenue can therefore be more precisely defined as an increase in assets or a decrease in liabilities that a company obtains by providing customers with goods or services

Matching concept

primary goal of accrual accounting is to appropriately match expenses with revenues matching is not perfect, so there may be time when there is no traceable connection between expenses and revenue

Claims exchange transaction

recognizing accrued expense the claims of creditors increase and the claims of stockholders decrease. total claims remain unchanged

Accrual accounting

recognizing revenue when it is earned and expenses when they are incurred, regardless of when cash changes hands requires companies to recognize revenue in the period in which the work is done regardless of when cash is collected. 2 features: accruals and deferrals

American Institute of Certified Public Accountants (AICPA)

requires its members to comply with the Code of Professional Conduct to ensure that accountants hold themselves to the highest ethical standards possible

Accrued revenue

revenue that has been recognized but the associated cash has not been collected

When a company purchases supplies on account, the balance in the

supplies account increases Cash account is not affected Accounts Payable account increases

Salvage value

the amount someone expects to receive from the sale of the asset at the end of its useful life

Revenue

the economic benefit derived from operating the business. Its recognition is accompanied by an increase in assets or a decrease in liabilities resulting from providing products or services to customers

Which financial statement reflects accrual accounting?

the income statement

Asset source transaction

the issue of stock for cash (cash and common stock increase) on the balance sheet, assets and stockholders' equity increase; the transaction does NOT affect the income statement ex. because the revenue recognition causes assets (accounts receivable) to increase, it is classified as this

The cost of supplies should be expensed in the period

the supplies are used

common misconception held by students about revenue and expense items

they are cash equivalents. this is not true. a company may recognize a revenue or expense without a corresponding cash collection or payment in the same accounting period

Opportunity

top of fraud elements triangle because without opp, fraud could not exist most effective way to reduce opp for ethical or criminal misconduct is to implement an effective set of internal controls

What may occur when a company recognizes an expense?

total assets decrease total liabilities increase

When company pays cash to purchase a truck, the balance in the

truck acc increases cash acc decreases this is an asset exchange transaction. total assets are unaffected

T/F: The closing process occurs at the end of each acc cycle

true

Unearned revenue

when deferred revenue is a liability because a company is obligated to perform services in the future

Rationalization

when people develop rationalizations to justify their conduct; they don't believe themselves to be evil or doing the wrong thing common rationalizations: - everybody does it - i'm taking what i deserve - i'm borrowing it - the company can afford it - i'm doing this for my family