Financial Accounting Ch #3 vocabulary

Unearned revenues (deferred)

$ Received but not yet earned. first: debit cash, unearned revenue; later: debit unearned revenue, credit revenue

current ratio

(current ratio = total current assets/total current liabilities.) This measures the company's ability to pay current liabilities with current assets. a company prefers a HIGH current ratio, which means the business has plenty of current assets to pay current liabilities. an increasing current ratio from period to period indicates improvement in financial position. rule of thumb, 1.50 is strong. most successful companies operate with ratios between 1.20 and 1.50. a current ratio of 1.00 is considered quite low.

debt ratio

(debt ratio = total liabilities/total assets) Debt ratio indicates the proportion of a company's assets that is financed with debt. This ratio measures a business's ability to pay both current and long-term debts (total liabilities). Low debt ratio is safer than a high debt ratio. normal debt ratio in US is 60% to 70%

contra account

2 characteristics: 1) always has a companion account. 2) normal balance is opposite that of the companion account. ex) accumulated depreciation is the contra account to (equipment), and appears directly after equipment on the balance sheet

which accounts NEED to be updated (adjusted)?

Accounts receivable, Supplies, Prepaid Rent, and the other accounts are another story. Not yet up-to-date, because certain transactions have not yet been recorded.

3 Categories of Adjusting entries

Deferrals, Depreciation, Accruals

Accrual accounting

Records the impact of a business transaction (cash or noncash) as it occurs, even if it isn't complete. When the business performs a service, makes a sale, or incurs an expense, the accountant records the transaction even if it receives or pays no cash.

Generally accepted accounting principles (GAAP) REQUIRE this more complex form of accounting that best represents economic reality

accrual accounting

Accounting is based on either the

accrual basis, or the cash basis

Depreciation

allocates the cost of a plant asset to expenses over the asset's useful life. Companies buy buildings and equipment. As the companies use these assets, they record depreciation for wear-and-tear and obsolescence. The accounting adjustment records depreciation expense and decreases the asset's book value over its life.

Deferrals

an adjustment for an item in which the company already paid for (Ex: supplies) or received cash in advanced for (Ex: prepaid rent, prepaid insurance). At the end of the period, a company's adjustment decreases the liability and increases the revenue for the revenue earned. Think of the money I received in advance for mowing lawns throughout a month. At the end of that month or period, I would adjust my accounts.

2 questions

are you talking about income or expense? is cash involved?

long-term assets

assets not classified as current assets. (land, buildings, furniture and fixtures, and equipment are plant assets)

permanent accounts

assets, liabilities, & stockholders' equity. these accounts carry over to the next period (cash, receivables, equipment, accounts payable, common stock, and retained earnings

Matching Principle (AKA Expense Recognition Principle)

basis for recording expenses. Expenses are the cost of assets used up, and of Liabilities created, in earning revenue. Expenses have no future benefit too the company. 2 steps: identity all the expenses incurred during the accounting period, and measure the expenses, and match (recognize) expenses against the related revenues earned.

Which accounts do NOT need to be updated

cash, equipment, accounts payable, common stock, and dividends, because the day to day transactions are up-to-date & provide all the data for theses accounts.

book value

cost - depreciation = asset's book value

Revenue Principle

deals with 2 issues: when to record (make journal entry) & the amount of revenue to record. revenue should be recorded after it has been EARNED - not before. Most cases, this is when a company has delivered a good or service. The amount of revenue to record is the cash value of the goods or services transfered to the customer.

Ratios

decision makers analyze a companies financial position using ratios computed form various items in the financial statements.

fiscal year

ends on a date other than December 31. Most retailers (J. Crew, Wal-mart, JCPenny) use a fiscal year that ends January 31, because the low point in their business activity falls in January, After Christmas.

The Time-Period Concept

ensures that accounting information is reported at regular intervals (progress reports to measure business income). Basic accounting period is one year (calendar year usually January 1 through December 31)

semiannual period

every six months financial statements created

quarter period

every three months financial statements recorded

prepaid expense

expense paid in advance and is therefore an ASSET, because it provides a future benefit for the owner.

Accruals

for an accrued expense, a company records the expense before paying cash. For accrued revenue, a company records the revenue before collecting cash. ex) salary expense, interest expense, income tax expense.

accrued expense posting process

incur expense, but have not yet paid for it. first: debit expense, credit payable. later: debit payable, credit cash.

trial balance

is unadjusted, which means its not completely up-to-date. not quite ready for preparing the financial statements for presentation to the public.

single-step income statement (format)

lists all the revenues together under a heading such as revenues, or revenues and gains. the expenses are listed together in a single category titled expenses or expenses and losses. only one step: subtract expenses and losses from revenues and gain = net income

report format (balance sheet)

lists assets at the top, followed by liabilities and stockholders' equity below. most popular format. 60% of large companies use this format.

account format (balance sheet)

lists the assets on the left and the liabilities and stockholders' equity on the right in the same way that a t-account appears: (assets (debits) on the left and liabilities and equity (credits) on the right.

long-term liability

many notes payable are long-term. some notes payable are paid in installments, with the 1st installment due within one yr, the second installment due the second yr, an so on. the 1st installment is a current liability, and the remainder is long-term.

liquidity

measure how quickly an item can be converted to cash. Cash is the most liquid asset. a balance sheet lists assets and liabilities in the order of relative liquidity.

accrued revenue

money earned, but not yet received. first: debit receivable, credit revenue. later: debit cash, credit receivable

Current assets

most liquid assets. will be converted cash, sold, or consumed during the next 12 months or within the business's normal operating cycle if longer than a year. (cash, short-term investments, accounts receivable, merchandise inventory, and prepaid expenses are current assets)

unadjusted

not yet ready for financial statements - coined in term trial balance.

prepaid expenses

pay $ for future asset. first: debit prepaid asset, credit cash; later: debit expense, credit prepaid expense

Cash-basis Accounting

records ONLY cash transactions - cash receipts and cash payments. Cash receipts are treated as revenues, and cash payments are handled as expenses.

accrued expense

refers to a liability that arises from an expense that has not yet been paid ex) payroll. this increases a liability and decreases stockholders' equity

multi-step income statement (format)

reports a number of subtotals to highlight important relationships between revenues and expenses.

temporary accounts

revenues and expenses are related to a limited period, this makes them temporary accounts, as well as the dividends account. closing process only applies to temporary accounts (revenues, expenses, dividends) `

accrual accounting records these noncash transactions

sales on account, purchases of inventory on account, Accrual of expenses incurred but not yet paid, Depreciation expense, Usage of prepaid rent, insurance, and supplies, as well as earnings of revenue when cash was collected in advance.

to RECOGNIZE (match) expenses along w/related revenues means to

subtract expenses from related revenues to compute net income or net loss

accumulated depreciation

this account shows the sum of all depreciation expense from using the asset. This account will therefore increase over the asset's life.

closing the books

to prepare the accounts for the next period's transactions. the closing entries set the revenue, expense, and dividends balances back to zero at the end of the period. closing entries transfer the revenue, expense, and dividends balances to retained earnings.

Adjusting process summary

two purposes: measure income & update balance sheet. every adjusting entry affects at least one of the following: revenue or expense - to measure income. Asset or liability - to update balance sheet.

unearned sales revenue

when a company collects cash from customers before earning the revenue (Ex: Starbucks receives cash up front from grocery-store chain in advance of earning the revenue & has a liability to provide coffee for the customer) **When Starbucks delivers the coffee to customer, it earns SALES REVENUE; this earning process requires an adjustment at the end of the period.

accrued revenue

when a company earns revenue before they receive cash. (its earned, but not yet collected) (debit receivable, credit a revenue)

liquidation

when a company shuts down, sells its assets, pays the liabilities, and returns any leftover cash to the owners (go out of business); only way for a business to know for certain how well it performed