Accounting

Taxing authorities

(IRS) want to know whether the company complies with tax laws.

Deferrals

1. Prepaid Expenses 2. Unearned Revenues

A dishonored note receivable

A dishonored note receivable is no longer negotiable.

The Basic Accounting Equation

Assets = Liabilities + Stockholders' Equity

__________ and ___________ is a required step in the accounting cycle

Journalizing and posting closing entries

the accounting equation applies to

all economic entities regardless of sieze, nature of business, or form of business organization.

The purchase of supplies results

in an increase (a debit) to an asset account.

Debit

left side of an account (Dr.)

Retained Earnings is the

net income that is kept (retained) in the business

Current Liabilities

obligations that the company is to pay within the coming year to its operating cycle, whichever is longer

The company carries forward the balances of

permanent accounts into the next accounting period.

Liability accounts normally

show credit balances • Credits to a liability account should exceed debits to that account

Valuing Accounts Receivable

• Determining the amount to report is sometimes difficult because some receivables will become uncollectible. • Some accounts receivable become uncollectible

Transactions

→(business transactions) a business's economic events recorded by accountants

3 parts of an Account

1. A title 2. A left or debit side 3. A right or credit side

A complete entry consists of

1. Date of the transaction 2. The accounts and amounts to be debited and credited. 3. A brief explanation of the transaction.

Sale of Receivables

A common sale of receivables is to a factor

What is Accounting?

Accounting exists of three basic activities—it identifies, records, and communicates the economic events of an organization to interested users

Unearned revenues

Cash received before services are performed

Income Summary

Companies close the revenue and expense accounts to another temporary account Income Summary

Recording Estimated Uncollectibles

Companies do not close Allowance for Doubtful Accounts at the end of the fiscal year.

Companies generally journalize and post closing entries

Companies generally journalize and post closing entries only at the end of the annual accounting period. Thus all temporary accounts will contain data for the entire year.

Stockholders' Equity Relationships

Companies report common stock and retained earnings in the stockholders' equity section of the balance sheet

Correcting Entries—An Avoidable Step

Companies should correct errors, as soon as they discover them.

Debits ________ revenue accounts

Debits decrease revenue accounts

Dishonor of Notes Receivable

Dishonored (defaulted) note→a note that is not paid in full at maturity

Dollar signs

Dollar signs are typically only used in the trial balance and the financial statements

The Summary of Basic Relationships

Each adjusting entry affects one balance sheet account and one income statement account.

Internal Transactions

Economic events that occur entirely within a company • Ie, the use of cooking and cleaning supplies

Expenses Recognition Principle

Expense recognition principle (aka matching principle)→efforts (expenses) be matched with results (revenues)

Expenses

Expenses decrease stockholders' equity

Accrued Expenses

Expenses incurred but not yet paid in cash or recorded

amount due at maturity

For each interest-bearing note, the amount due at maturity is the face value of the note plus interest for the length of time specified on the note.

The Journal

For each transaction the journal shows the debt and credit effects on specific accounts.

Computing Interest

Interest = (face value of note) * (annual interest rate) * (time in terms of one year)

common examples of accrued expenses

Interest, taxes, and salaries

accounts receivable turnover

Investors and corporate managers compute financial ratios to evaluate the liquidity of a company's accounts receivable. They use accounts receivable turnover to asses the liquidity of the receivables. • = net credit sales (net sales - cash sales)/average net accounts receivable during the year

Chart of accounts

Lists the accounts and the account numbers that identify their location in the ledger

Recovery of an Uncollectible Account

Occasionally a company collects from a customer after it has written off the account as uncollectible.

Permanent Accounts

Relate to one or more future accounting periods. They consist of all balance sheet accounts, including stockholders' equity accounts.

the capacity to provide future services of benefits.

The common characteristic possessed by all assets is the capacity to provide future services of benefits.

Depreciation is the practice of

allocating the cost of assets to a number of year o Companies do this by systematically assigning a portion of an asset's cost as an expense each year (rather than expensing the full purchase price in the year of purchase).

Accounting time periods

are generally a month, a quarter, or a year

Current Assets

assets that a company expects to convert to cash or use up within one year of its operating cycle (whichever is longer) • For most the cutoff is one year.

The company recognizes the supplies expense

at the end of the accounting period.

Short-term investments appear

before short-term receivables because these investments are more liquid (nearer to cash).

Common Stock normally has a ____ balance

credit

A company wants

current assets > current liabilities

Adjusting entries

ensure that the revenue recognition and expense recognition principles are followed

Journalizing

entering transaction data in the journal.

Accrued Expenses

expenses incurred but not yet paid or recorded at the statement date

Companies apply the fair value principle extensively

extensively only in situations where assets are actively traded

Closing Entries

formally recognize in the ledger the transfer of net income (or net loss) and Dividends to Retained Earnings • Produce a zero balance in each temporary account.

Classified Balance Sheet

groups together similar assets and similar liabilities, using a number of standard classifications and sections

Credit balance

if the credit amounts exceed the debits

Debit balance

if the total of the debit amounts exceeds the credits

Credits (net income) ______ the Retained Earnings account

increase

Credits _____ the Common stock account

increase

Factor

is a finance company or bank that buys receivables from businesses and then collects the payments directly from customers.

The purpose of depreciation

is not valuation but a means of cost allocation

Retained Earnings represents the

portion of stockholders' equity that the company has accumulated through the profitable operation of the business

Financial Accounting

provides economic and financial information for investors, creditors, and other external users.

Dividends _____ the stockholders' claims on retained earnings

reduce

Monetary Unit Assumption

requires that companies include in the accounting records only transaction data that can be expressed in money terms. • This assumption enables accounting to quantify (measure) economic events) • It is vital to applying the historical cost principle. • It prevents the inclusion of some relevant information in the accounting records (ie, the health of the company's owner)

Compound Entry

requires three or more accounts

Labor unions

such as the MLB Players Assoc want to know whether the owners have the ability to pay increased wages and benefits.

Statement of cash flows

summarizes information about the cash inflows (receipts) and outflows (payments) for a specific period of time.

Generally Accepted Accounting Principles (GAAP)

the common set of standards that indicate how to report economic events

Closing the Books

the company makes the accounts ready for the next period at the end of an accounting period

Expenses

the cost of assets consumed or services used in the process of earning revenue o Decreases in stockholder's equity that result from operating the business

International Financial Reporting Standards (IFRS)

the standards set by the IASB

Common Stock

the total amount paid in by stockholders for the shares they purchase.

Adjusting entries are necessary because

the trial balance may not contain up-to-date and complete data. • Adjusting entries are required every time a company prepares financial statements. • Every adjusting entry will include one income statement account and one balance sheet account.

Promissory notes are negotiable instruments (as are checks)which means

they can be transferred to another party by endorsement.

In general, most companies choose

to use cost

Accruals

1. Accrued Revenue 2. Accrued Expenses

Summary of Transactions

1. Each transaction must be analyzed in terms of its effect on: a. The three componenets of the basic accounting equation. b. Specific types (kinds) of items within each component. 2. The two sides of the equation must always be equal. 3. The Common Stock and Retained Earnings columns indicated the causes of each change in the stockholders' claim on assets.

Posting

1. In the ledger, in the appropriate columns of the accounts debited, enter the date, journal page, and debit amount shown in the journal. 2. In the reference column of the journal, write the account number to which the debit amount was posted. 3. In the ledger, in the appropriate columns of the accounts credited, enter the date, journal page, and credit amount shown in the journal

Long Term Investments are generally

1. Investments in stocks and bonds of other companies that are normally held for many years 2. Long-term assets such as land or buildings tat a company is not currently using in its operating activities 3. Long-term notes receivable

2 bases are used to determine the amount of the expected uncollectibles

1. Percentage of Sales 2. Percentage of Receivables

These groupings help financial statement readers determine such things as

1. Whether the company has enough assets to pay its debts as they come due 2. The claims of short-term and long-term creditors on the company's total assets

The notes receivable allowance account is

Allowance for Doubtful Accounts.

Under the Direct Write-Off Method

Bad Debt Expense will only show actual losses from uncollectibnles. The company will report accounts receivable as its gross amount

Prepaid expenses

Expenses paid in cash before they are used or consumed.

Accumulated Depreciation

account that shows the total amount of depreciation

Depreciation is

an allocation concept, not a valuation concept. Depreciation allocates an asset's cost to the period in which it is used. Depreciation does not attempt to report the actual change in the value of the asset.

Liabilities must appear

before stockholders' equity because they are paid first if a business is liquidated.

There is no legal distinction

between the business as an economic unit and the owner, but the accounting records of the business activities are kept separate from the personal records and activities of the owner.

Credits ______ expenses

decrease

Convergence

in recent years the two standard-setting bodies have made efforts to reduce the difference between US GAAP and IFRS • Someday there will likely be a single set of high-quality accounting standards that are used by companies around the world

When a merchandiser sells goods, it ______ Accounts Receivable and _______ Sales Revenue.

increases (debits) increases (credits)

The normal balance of an account

is on the side where an increase in the account is recorded

Decreases in liabilities

must be entered on the left or debit side

Increases in assets

must be entered on the left or debit side

Balance Sheet

reports the assets, liabilities, and stockholders' equity of a company at a specific date.

Retained earnings statement

summarizes the changes in retained earnings for a specific period of time

The note holder usually transfers dishonored note

the Notes Receivable account to an Accounts Receivable account.

Depreciation

the process of allocating the cost of an asset to expense over its useful life.

Assets

the resources a business owns

No interest revenue is reported when the note is accepted because

the revenue recognition principle does not recognize revenue until the performance obligation is satisfied. Interest is earned (accrued) as time passes.

Regulatory agencies

(SEC or FTC) want to know whether the company is operating within prescribed rules

Investors

(owners) use accounting information to decide whether to buy, hold, or sell ownership shares of a company • Ie, Is General Electric earning satisfactory income? • How does Disney compare in size and profitability with Time Warner?

Creditors

(such as suppliers and bankers) use accounting information to evaluate the risks of granting credit or lending money • Will United Airlines be able to pay its debts as they come due?

Steps in the Recording Process

1. Analyze each transaction for its effect on the accounts. 2. Enter the transaction information in a journal. 3. Transfer the journal information to the appropriate accounts in the ledger.

Common Types of Current Assets

1. Cash 2. Investments (such as short term US government securities) 3. Receivables (notes receivable, accounts receivable, and interest receivable) 4. Inventories 5.Prepaid Expenses (supplies and insurance)

GAAP requires the allowance method. 3 essential features

1. Companies estimate uncollectible accounts receivable. They match this estimated expense against revenues in the same accounting period in which they record the revenues. 2. Companies debit estimated uncollectibles to Bad Debt Expense and credit them to Allowance for Doubtful Accounts through an adjusting entry at the end of each period. Allowance for Doubtful Accounts is a contra account to Accounts Receivable. 3. When companies write off a specific account they debit actual uncollectibles to Allowance for Doubtful Accounts and credit that amount to Accounts Receivable

A general journal

1. Discloses in one place the complete effects of a transaction. 2. Provides a chronological record of transactions. 3. Helps to prevent or locate errors because the debit and credit amounts for each entry can be easily compared.

Steps in Preparing a Worksheet

1. Prepare a Trial Balance on the Worksheet 2. Enter the Adjustments in the Adjustments Columns • Companies do not journalize the adjustments until after they complete the worksheet and prepare the financial statements. 3. Enter Adjusted Balances in the Adjusted Trial Balance Columns • For each account the amount in the adjusted trial balance columns is the balance that will appear in the ledger after journalizing and posting the adjusting entries. 4. Extend Adjusted Trial Balance Amounts to Appropriate Financial Statement Columns 5. Total the Statement Columns, Compute the Net Income (or Net Loss), and Complete the Worksheet • The debit amount balances the income statement columns; the credit amount balances the balance sheet columns.

3 accounting issues associated with accounts receivable are:

1. Recognizing accounts receivable. 2. Valuing accounts receivable. 3. Disposing of accounts receivable.

The basic issues for notes receivable

1. Recognizing notes receivable 2. Valuing notes receivable 3. Disposing of notes receivable

The company makes two entries to record the recovery of a bad debt:

1. Reverses the entry made in writing off the account. This reinstates the customer's account. 2. It journalizes the collection in the usual manner.

Arrangement of the Ledger

1. The Asset Accounts 2. Liability Accounts 3. Stockholders' Equity Accounts 4. Revenues 5. Expenses

The statement of cash flows reports

1. The cash effects of a company's operation during a period 2. Its investing activities 3. Its financing activities 4. The net increase or decrease in cash during the period 5. The cash amount at the end of the period

3 parties are involved when credit cards are used in retail sales

1. The credit card issuer, who is independent of the retailer 2. The retailer 3. The customer

The amount of interest recorded is determined by three factors

1. The face value of the note. 2. The interest rate, which is always expressed as an annual rate 3. The length of time the note is outstanding

Companies sell receivables for 2 major reasons

1. They may be the only reasonable source of cash. 2. Billing and collections are often time-consuming and costly.

Promissory notes may be used

1. When individuals and companies lend to borrow money 2. When the amount of the transaction and the credit period exceed normal limits 3. In settlement of accounts receivable.

The statement of cash flows provides answer to the following questions

1. Where did cash come from during the period? 2. What was cash used for during the period? 3. What was the change in the cash imbalance during the period?

Dividends

A dividend is a company's distribution to its stockholders on a pro rata (equal) basis

Expanded Accounting Equation

Assets = Liabilities + Stockholder's Equity Assets = Liabilties + (Common Stock + Retained Earnings) Assets = Liabilties + (Common Stock + (Revenues - Expenses -Dividends)) Cash + Accounts Receivable + Supplies + Equipment = Accounts Payable + (Common Stock + (Revenues - Expenses -Dividends))

At the financial statement date, companies ________ Insurance Expense and __________ Prepaid Insurance for the cost of insurance that has expired during the period.

At the financial statement date, companies increase (debit) Insurance Expense and decrease (credit) Prepaid Insurance for the cost of insurance that has expired during the period.

Accrued Revenue

Revenues for services performed but not yet received in cash or recorded.

aging the accounts receivable

The company prepares an aging schedule in which it classifies customer balances by the length of time they have been unpaid

face value

The company records the notes receivable at its face value, the amount shown on the face of the note.

The payee still

The payee still has a claim against the maker of the note for both the note and the interest

Determining the Maturity Date

When the life of a note is expressed in terms of months, you find the date when it matures by counting the months from the date of issue. When the due date is stated in terms od days, you need to count the exact number of days to determine the maturity date.

Corporation

a business organized as a separate legal entity under state corporation law and having ownership divided into transferable shares of stock. • the holders of shares (stockholders) enjoy limited liability. • Stockholders may transfer all or part of their ownership shares to toehr investors at any time • b/c ownership can be transferred without dissolving the corpotation, the orporation enjoys and unlimited life

Propreitorship

a business owned by one person • The owner is often the manager/operator of the business. • Small service-type businesses, farms, small retail stores • Usually only a relatively small amount of money (capital) is necessary to start in business as a proprietorship. The owner (proprietor) receives any profits, suffers any losses, and is personally liable to all debts of the business.

Partnership

a business owned by two or more persons • Like a proprietorship except more than one owner is involved • Retail and service-type businesses, esp professional practices • A partnership agreement sets forth such terms as an initial investment, duties of each partner, division of net income, and settlement to be made upon death or withdrawal of a partner. • Each partner general has unlimited personal liability of the debts of the partnership. • Like a proprietorship, for accounting purposes the partnership transactions must be kept separate from the personal activities of the partners.

Communicates

a company communicates the collected information to interested by means of accounting reports. • The most common of these reports are called financial statements. • Data is reported in the aggregate.

Records

a company records those events in order to provide a history of its financial activities • recording is keeping a systematic, chronological diary of events, measured in dollars and cents.

If a company lends money using a note, the entry is

a debit to Notes Receivable and a credit to Cash in the amount of the loan.

Companies may also grant credit in exchange for

a formal credit instrument known as a promissory note.

Notes receivable gives the holder

a stronger legal claim to assets than do accounts receivable.

Notes Receivable

a written promise for amounts to be received. The note normally requires the collection of interest and extends for time period of 60-90 days or longer

Accounts Receivables

amounts customers owe on account. They result from the sale of goods and services o Companies generally expect to collect accounts receivable within 30 to 60 days.

Fiscal Year

an accounting time period that is one year in length • Begins on the first day of a month and ends 12 months later • Most businesses January 1 to December 30

When expenses are prepaid

an asset account is increased (debited) to show the service or benefit that the company will receive in the future.

An adjusting entry for accrued expenses results in _________ to an expense account and ________ to a liability account

an increase (a debit) an increase (a credit)

An adjusting entry for accrued revenues results in __________ to an asset account and ________ to a revenue account.

an increase (a debit) an increase (a credit)

An adjusting entry for prepaid expenses results in

an increase (a debit) to an expense account and a decrease (a credit) to an asset account.

Customers

are interested in whether a company like General Motors will continue to honor product warranties and support its product lines

The principal sources (increases) of stockholder's equity

are investments by stockholders and revenues from business operation

Identifies

as a starting point to the accounting process, a company identifies the economic events relevant to its business

In the account form we record the increases in cash

as debits and the decreases in cash as credits

Property, Plant, and Equipment

assets with relatively long useful lives that a company is currently using in operating the business.

A merchandiser records accounts receivable

at the point of sale of merchandise on account.

The law requires that creditor claims

be paid before ownership claims • Because creditors may legally force the liquidation of a business that does not pay its debts

T account

because the form of the account resembles the letter T we refer to it as a T account

Economic Entity Assumption

can be any organization or unit in society • Can be a company, governmental unti, municipality, school district, church • It requires that the activies of the entitity be kept separate and distinct from the activities of its owner and all other economic entities

Stockholder's Equity is equal to

claim total assets minus total liabilities.

Liabilities

claims against assets—existing debts and obligations.

Stockholder's Equity

claims of owners

Liabilities

claims of those to whom the company owes money (creditors)

General Ledger

contains all the asset, liability, and stockholders' equity accounts

Retained earnings normally has a _____ balance

credit

Revenues normally has a _____ balance

credit

Users of financial statements look closely at the relationship between

current assets and current liabilities. This relationship is important in evaluating a company's liquidity (its ability to pay obligations expected to be due within the next year

Companies frequently accept notes receivable from

customers who need to extend the payment of an outstanding account receivable • Often require such notes from high-risk customers

Dividends normally has a _____ balance

debit

Expenses normally has a _____ balance

debit

Credits ______ the Dividends account

decrease

Debits (dividends or net losses) _____ the Retained Earnings account

decrease

Debits ______ the Common stock account

decrease

The adjusting entry for unearned revenues results in a _________ to a liability account and an ________ to a revenue account

decrease (a debit) increase (a credit)

Bad Debt Expense _____ increase when the write-off occurs.

does not

Ledger

entire group of accounts maintained by a company

A business uses its assets

in carrying out such activities as production and sales

Short-term receivables appear

in the current assets section of the balance sheet.

Companies record closing entries

in the general journal.

Other Receivables

include non-trade receivables such as interest receivable, loans to company officers, advances to employees and income taxes refundable. o These do not generally results form the operations of the business so they are generally classified and reported as separate items in the balance sheet

Credits _______ revenue accounts

increase

Debits _____ the Dividends account

increase

Debits _______ expenses

increase

The adjusting entry to record the estimated uncollectibles _________ Bad Debts Expense and ________ Allowance for Doubtful Accounts.

increases (debits) increases (credits)

External Users

individuals and organizations outside a company who want financial information about the company

Revenues provides

information as to why the stockholders' equity increases

Most common form of dividends

is a cash dividend

Worksheet

is a multiple column form used in the adjustment process and in preparing financial statements • It is a working tool. • Not a permanent accounting record. • It is merely a device used in preparing adjusting entries and financial statements.

The cost of insurance (premiums) paid in advance

is recorded as an increase (a debit) in the asset account Prepaid Insurance.

Valuing short-term notes receivable

is the same as valuing accounts receivable. o Companies report short-term notes receivable at their cash (net) realizable value.

Ethics

is the standards of conduct by which actions are judged as right/wrong, honest/dishonest, fair/not fair

When the company makes the adjusting entry for Percentage of Sales

it disregards the existing balance in Allowance for Doubtful Accounts.

Intangible Assets

long-lived assets that do not have physical substance yet but are very valuable o Goodwill, patents, copyrights, trademarks, trade names that give companies exclusive right

Relevance

means that financial information is capable of making a difference in a decision.

Faithful representation

means that the numbers and descriptions match what really existed or happened—they are factual.

Interim Periods

monthly and quarterly time periods

Decreases in assets

must be entered on the right or credit side

Increases in liabilities

must be entered on the right or credit side

Preparing Adjusting Entries From a Worksheet

o A worksheet is not a journal, and it cannot be used as a basis for posting to ledger accounts. o The adjusting entries are prepared from the adjustment columns of the worksheet.

Prepaid expenses are

o Costs that expire with the passage of time (rent, insurance, etc.) or through use (supplies)

Three Column Form of Account

o debit o credit o balance

Long-Term Liabilities

obligations that a company expects to pay after one year o Bonds payable, mortgages payable, long-term notes payable, lease liabilities, and pension liabilities. o Many companies report long-term debt maturing after one year as a single amount in the balance sheet and show the details of the debt in notes that accompany the financial statements

Stockholders' Equity is the combination

of Common Stock and Retained Earnings, and is how they are reported on the balance sheet

In counting

omit the date the note is issued but include the due date.

Businesses of all sizes usually borrow money and purchase merchandise

on credit.

The recovery of a bad debt affects

only balance sheet accounts.

A write-off affects

only balance sheet accounts—not income statement accounts.

Simple Entry

only involves two accounts, one debit and one credit

Income Statement

presents the revenues and expenses and resulting net income or net loss for a specific period of time.

Managerial accounting

provides internal reports to help users make decisions about their companies

With prepaid expenses, companies

record payments of expenses that will benefit more than one accounting period

Receivables

refers to amounts due from individuals and companies • Claims that are expected to be collected in cash

Temporary Accounts

relate only to a given accounting period. They include all income statement accounts and the Dividends account.

The revenue recognition principle

requires that companies recognize revenue, in the accounting period in which the performance obligation is satisfied

Reductions (decreases) in stockholder's equity

result from expenses and dividends

Accrued Revenues

revenues for services performed but not yet recorded at the statement date

Retained Earnings

revenues, expenses, and dividends.

Credit

right side of an account (Cr.)

Asset accounts normally

show debit balances • Debits to a specific asset account should exceed credits to that account

Adjusted Trial Balance

shows the balance of all accounts, including those adjusted, at the end of the accounting period.

Fair Value Principle

states that assets and liabilities should be reported at the fair value (the price received to sell and asset or settle a liability) • Fair value information may be more useful than historical cost for certain types of assets and liabilities. • Ie, certain investment securities are reported at fair value because market price information is usually readily available for these types of assets.

The company closes all ______ accounts at the end of the period.

temporary

In the credit card industry it is standard practice to write off accounts

that are 210 days past due

Allowance Method ensures

that companies state receivables on the balance sheet at their cash (net) realizable value.

Allowance for Doubtful Accounts shows the estimated amount of claims on customers

that the company expects will become uncollectible in the future.

International Accounting Standards Board (IASB)

the accounting standards that most countries outside of the US follow

Securities and Exchange Commission (SEC)

the agency of the US government that oversees US financial markets and accounting standard-setting bodies o The SEC relies on the FASB to develop accounting standards, which public companies much follow

Under the allowance method, companies debit every bad debt write-off to

the allowance account rather than to Bad Debt Expense.

maturity value

the amount due

Operating Cycle

the average time that it takes to purchase inventory, sell it on account, and then collect cash from customers. • For most businesses this cycle takes less than a year, so they use a one-year cutoff o But for some businesses (vineyards, airplane manufacturers, etc.) this period may be longer than year

Book Value

the difference between the cost of any depreciable asset and its related accumulated depreciation

Unless bad debt losses are insignificant

the direct write-off method is not acceptable for financial reporting purposes.

Dividends

the distribution of cash or other assets to stockholders o Reduce retained earnings but are not an expense o If a corporation has net income and decides it has no better use for that income, a corporation may decide to distribute a dividend to its owners (the stockholders)

Reversing Entry

the exact opposite of the adjusting entry made in the previous period • An optional bookkeeping procedure; it is not a required step

Companies report both

the gross amount of receivables and the allowance for doubtful accounts.

Revenues

the gross increases in stockholders' equity resulting from business activities entered into for the purpose of earning income.

Internal Users

the managers who plan, organize, and run the business • This includes marketing managers, production supervisors, finance directors, and company officers • Internal users need detailed information on a timely basis

Maker

the party making the promise to pay

Payee

the party to whom the payment is to be made

Financial Accounting Standards Board (FASB)

the primary accounting standard-setting body in the United States

Purpose of Adjusted Trial Balance

to prove the equality of the total debit balances and the total credit balances in the ledger after all adjustments. • It is the primary basis for the preparation of financial statements.

Without the adjusting entry, assets and stockholders' equity on the balance sheet and revenues and net income on the income statement are

understated.

Cash (net) realizable value

value is the net amount the company expects to receive in cash o Excludes amounts that the company will not

To find out what belongs to stockholders

we subtract creditor's claims (the liabilities) from the assets. Residual Equity (the equity left over after creditors' claims are satisfied)

Performance obligation

when a company agrees to perform a service or sell a product to a customer • When the company meets the performance obligation it recognizes revenue.

Direct Write-Off Method

when a company determines a particular account to be uncollectible, it charges the loss to Bad Debt Expense

Unearned Revenues

when companies receive cash before services are performed, they record a liability by increasing (crediting) a liability account called unearned revenues.

Net Loss

when expenses exceed revenues

A service organization records a receivable when

when it performs a service on account.

Net Income

when revenues exceed expenses

The adjusting entry for accruals

will increase both a balance sheet and an income statement account

US regulators and lawmakers were very concerned that the economy

would suffer if investors lost confidence in corporate accounting because of unethical financial reporting

3 steps to help analyze ethics cases

• 1. Recognize an ethical situation and the ethical issues involved. • 2. Identify and analyze the principal elements in the situation. • 3. Identify the alternatives, and weigh the impact of each alternative on various stakeholders.

Accumulated Depreciation is a

• Accumulated Depreciation is a contra asset account→it is offset against an account on the balance sheet. • Accumulated Depreciation-Equipment amount offsets the asset account Equipment

Permanent (these accounts are not closed):

• All asset accounts • All liability accounts • Stockholders' equity

Temporary (these accounts are closed):

• All revenue accounts • All expense accounts • Dividends

Preparing Financial Statements

• Companies can prepare financial statements directly from the adjusted trial balance.

Common Stock

• Companies issue common stock in exchange for the owners' investment paid into the corporation

Disposing of Accounts Receivable

• Companies now frequently sell their receivables to another company for cash, thereby shortening the cash-to-cash operating cycle

Bad Debts Expense

• Companies record credit losses as debits to Bad Debts Expense (or Uncollectible Accounts Expense). Such losses are a normal and necessary risk of doing business on a credit basis.

Cash Basis Accounting

• Companies record revenue when they receive cash • They record an expense when they pay out cash. • Fails to record revenue for a company that has performed services but for which it has not received the cash • Does not match expenses with revenues. • Not in accordance with generally accepted accounting principles (GAAP). • Individuals and some small companies do use cash-basis accounting • The cash basis is justified for small businesses because they often have few receivables and payables.

Accrual Basis Accounting

• Companies record transactions that change a company's financial statements in the period in which the events occur. • Companies recognize revenues when they perform service rather than when they receive cash • Recognizing expenses when incurred rather than when paid • Medium and large companies use accrual-basis accounting.

In a multiple-step income statement

• Companies report bad debt expense and service charge expense as selling expenses in the operating expenses section. • Interest revenues appears under "Other revenues and gains" in the non-operating activities section of the income statement.

In response congress passed the Sarbanes-Oxley Act (SOX)

• Its intent is to reduce unethical corporate behavior and decrease the likelihood of future corporate scandals • As a result, top management must now certify the accuracy of financial information • Penalties for fraudulent financial activity are much more severe • SOX increased the independence required of the outside auditors who review the accuracy of corporate financial statements and increased the oversight role of boards of directors

trade receivables

• Notes and accounts receivable that result from sales transactions are often called trade receivables.

Occasionally the allowance account will have a debit balance prior to adjustment

• Occurs when write-offs during the year have exceed previous provisions for bad debts • The company adds the debit balance to the required balance when it makes the adjusting entry

Percentage of Receivables

• Results in a better estimate of cash realizable value • Emphasis on Balance Sheet Relationships • Accounts Receivable←→Allowance for Doubtful Accounts

Percentage of sales

• Results in a better matching of expenses with revenues • Emphasis on Income Statement Relationships • Sales Revenue←→Bad Debts Expense

Bookkeeping

• The accounting process includes bookkeeping. • It usually involves only the recording of economic events

The double entry system of recording transactions

• The dual (two-sided) effect of each transaction is recorded in appropriate accounts • Helps ensure the accuracy of the recorded amounts as well as the detection of errors

Accounting for Credit Card Sales

• The retailer generally considers sales from the use of national credit card sales as cash sales. • The retailer must pay to the bank that issues the card a fee for processing the transactions • The retailer then records the credit card slips in a similar manner as checks deposited from a cash sales.

Limitations of a Trial Balance

• The trial balance may balance even when: 1. A transaction is not journalized. 2. A correct journal entry is not posted. 3. A journal entry is posted twice 4. Incorrect accounts are used in journalizing or posting. 5. Offsetting errors are made in recording the amount of a transaction.

5 subdivisions of stockholders' equity:

• common stock • retained earnings • dividends • revenues •expenses

Account

→ an account is an individual accounting record of increases and decreases in a specific asset, liability, or stockholder's equity item

External Transactions

→ involve economic events between the company and some outside enterprise • Ie, purchase of cooking supplies

Historical Cost Principle

→(cost principle) dictates that companies record assets at their cost • This is true not only at the time the asset is purchased but also over the time the asset is held.

Honor of Notes Receivable

A note is honored when its maker pays in full at its maturity date.

promissory note

A promissory note is a written promise to pay a specified amount of money on demand or at a definite time.

average collection period

A variant of the accounts receivable turnover that makes the liquidity even more evident is its conversion into an average collection period in terms of days. • Average collection period in days= days in year/accounts receivable turnover • Used to asses the effectiveness of a company's credit and collection policies • The general rule is that the collection period should not greatly exceed the credit term period.

Allowance Method

Allowance Method of accounting for bad debts involves estimating uncollectible accounts at the end of each period. oThis provides better matching on the income statement