ACCT 2110 Ch. 3 & 4

accrual accounting system rests on 3 elements:

1. time-period assumption 2. revenue recognition principle 3. expense recognition (matching) principle

calculating interest example: principal amount 3,000 8% interest annually calculate interest for on month

3,000 x .08 x 1/12 = $20

revenue recognition principle

determines when revenue is recorded and reported

the deferral of the expense is necessary because the initial cash payment

did not result in an expense

inventory does/does not require adjustment

does not

operating cycle

elapsed time between the purchase of goods for resale and the collection of cash from customers

cash-basis accounting does NOT link recognition of revenues and expenses to the actual business activity but rather to the

exchange of cash

the key to expense recognition is matching the _________ to the ____________

expense revenue

service charges

fees charged by the bank for checking account services

all adjusting entries will affect at least one ______________ account and one _______________ account

income statement balance sheet

deferred (prepaid) expenses

assets arising from the payment of cash which have not been used or consumed by the end of the period

bank reconciliation: how to find adjusted cash balance from BANK

cash balance from bank statement + deposit in transit - outstanding checks (on business records but not bank statements) = adjusted cash balance

how to find adjusted cash balance from COMPANY

cash balance from company records + error in recording check + interest - service charge - NSF check - electric bill (debit memo) = adjusted cash balance (should equal other adjusted cash balance)

most companies do not use cash-bases accounting because

cash-basis financial statements may not reflect all of the assets and liabilities of a company at a particular date

non-sufficient funds

check that has been returned to the depositor bc funds in the issuer's account are not sufficient to pay the check

If a company has prepaid insurance of $1200 for a 6-month plan, and they need to record that after one month it has partially expired, what should they credit and what should they debit?

debit insurance expense for $200 credit prepaid insurance for $200

accounting petty cash

debit petty cash, credit cash debit all expenses, credit cash total

step 4 of closing accounts

debit retained earnings credit dividends

step 1 of closing accounts

debit service revenue credit income summary

If a company has $6,000 in supplies and uses $4,500 of it, what would they credit and what would they debit?

debit supplies expense for $4500 credit supplies for $4500

If a company has $10,000 in unearned service revenue and calculates at the end of a period they have earned $4,000, what would they debit and what would they credit?

debit unearned service revenue for $4,000 credit service revenue for $4,000

effects of adjusting entries on the financial statements: deferred expense

decreases asset, stockholders equity increases expense

effects of adjusting entries on the financial statements: deferred revenue

decreases liability increases stockholder's equity and revenue

the adjusting entry for a deferred revenue will result in an ____________ to a revenue account and a ____________ to a liability account

increase decrease

effects of adjusting entries on the financial statements: accrued expense

increase liability and expense decreases stockholder's equity

effects of adjusting entries on the financial statements: accrued revenue

increases asset, stockholders equity, revenue

the formula for interest is:

interest = principal x interest rate x time

outstanding check

issued and recorded by the business that has not been cashed by recipient of the check

accrual is better than cash-basis because

it links income measurement to selling, the principle activity of the company

adjusting entries

journal entries made at the end of an accounting period to recorn the completed portion of partially completed transactions

deferred (unearned) revenues

liabilities arising from the receipt of cash for which revenue has not yet been earned

the deferral of revenue is necessary because the revenue was

not earned at the time of cash reciept

safeguarding

physical protection of assets

control activities

policies and procedures top management establishes to help ensure that objectives are met

accrued expenses

previously unrecorded expenses that have been incurred but not yet paid in cash

accrued revenues

previously unrecorded revenues that have been earned but for which no cash has yet been received earned revenue but has not received cash interest earned, but not yet received

the accrual of the expense is necessary because the expense was incurred

prior to the payment of cash

the accrual of revenue is necessary because the revenue was earned

prior to the receipt of cash

If a company rents out office space, they would debit _____________ and credit ______________

rent receivable rent revenue

expense-recognition (matching) principle

required that expenses be recorded and reported in the same period as the revenue that it helped to generate

under the revenue recognition principle, revenue is recognized, or recorded, in the period in which both of the following conditions are met :

revenue had been earned & collection of cash is reasonably assured

cash-basis accounting

revenue is recorded when cash is received, regardless of when it is actually earned expense is recorded when cash is paid, regardless of when it is actually incurred

risk assessment: strategic risks business process risks

strategic- possible threats to the organization's success in accomplishing its objectives and are external to the organization business process - internal processes of the company, how it allocates its resources to meet its objectives

depreciation

systematically assigning the asset's cost as an expense to each period in which the asset is used

adjusting entries are necessary to apply the revenue recognition and expense recognition principles and ensure...

that a company's financial statements include the proper amount for revenues, expenses, assets, liabilities and stockholders equity

in short, the difference between cash-basis and accrual-basis accounting is a matter of

timing

bank reconcilliation

to ensure that the accounting records are consistent with the bank's accounting records, any differences must be "reconciled"

how to prepare a classified balance sheet

total current assets + total PPE = total assets total current liabilities + total S.E. = total current liabs. & S.E.

accrual-basis accounting

transactions are recorded when they occur: revenue is recognized as it is earned and expenses are recognized when they are incurred

how would a company account for the use of office supplies?

treat as a continuous transaction and recognize through adjusting entries supplies used will be reported as an expense, unused portion of supplies will be reported as an asset

temporary accounts

used to collect the activities of only one period revenues, expenses, dividends

what organization has recently conducted numerous investigations involving the abuse of both revenue and expense recognition

Securities Exchange Commission (SEC)

segregation of duties

accounting and administrative duties should be performed by different people

If a company earns revenue and has not been paid, they would debit ________ and credit ________

accounts receivable revenue

contra-accounts

accounts that have a balance that is opposite of the balance in a related account ex: accumulated depreciation would be a contra-account to a building

which system of accounting records both cash and non-cash transactions?

accrual

the timing differences between when a revenue or expense is recognized and cash is received or paid give rise to two categories of adjusting entries :

accruals and deferrals

how to prepare a single-step income statement

add up all expenses and subtract from service revenue to get net income

without closing entries, the temporary accounts would accumulate the business activities of

all accounting periods, not just the current time period

cash equivalents

all highly liquid investments with an original maturity of 3 months or less at date of inception

internal control

all policies and procedures established by top management and board of directors to provide reasonable assurance that the company's objectives are being met

time-period assumption

allows companies to artificially divide their operations into time periods so they can satisfy users' demands for information

deposit in transit

an amount received and recorded by the business, but which has not been recorded by the bank in time to appear on the current bank statement

permanent accounts

balances are carried forward from the current accounting period to future accounting periods assets, liabilities, S.E.

how to prepare a retained earnings statement

beginning retained earnings + net income - dividends = ending retained earnings

_________ is never affected by adjustments

cash

step 3 of closing accounts

debit income summary credit retained earnings

control enviornment

collection of environmental factors that influence the effectiveness of control procedures

accounting system

consists of methods and records used to identify, measure, record and communicate financial information about a business

expenses are a normal

debit

step 2 of closing accounts

debit income summary credit expenses