ACCT Exam 2

All adjusting entries will affect at least one ___ account and one ______ account

income statement balance sheet

all adjusting entries will affect at least one _____ account and one ____ account

income statement balance sheet

an expense is recorded when it is ______, regardless of when cash is payed

incurred

expense recognition is delayed or deferred until the expense is ____

incurred

for accounting purposes, the selling or ___ price is usually assumed to be the price after adjustment for the trade or quantity discounts. accordingly, trade and quantity discounts are not recorded separately in the accounting records.

invoice

the closing process is accomplished through a series of ____ that are dated as of the last day of the accounting period

journal entries

deferred (unearned) revenues

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

net profit margin=

net income/net sales

on the income statement, sales returns and allowances, like sales discounts, are subtracted from gross sales revenue to produce ___

net sales revenue

operating margin=

operating income/net sales

under the allowance procedure, two methods commonly used to estimate bad debt expense are :

percentage of credit sales method aging method

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 been received

securitization

process when large businesses/financial institutions frequently package factored receivables as financial instruments or securities and sell them to investors

long-lived assets

property, plant, equipment

a reduction in the selling price granted by the seller because selling costs per unit are less when larger quantities are ordered

quantity discount

profitability ratios

ratios that incorporate sales that attempt to measure the return the company is earning on sals

money due from another business or individual

receivable

depreciation expense

represents the portion of the cost of the long-lived asset that is matched against the revenues that the asset helped to generate

the adjusting entry for an accrued revenue will result in an increase to a ____ account and an increase to an ___ account

revenue asset

the adjusting entry for deferred revenue will result in an increase to a ___ account and decrease to a ____ account

revenue liability

cash-basis accounting

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

net income

revenues-expenses

when goods or services arrive late, or in some other way are rendered less valuable, a customer may be induced to accept the goods/services if a price reduction called a ___ is offered by the seller

sales allowance

a contra-revenue account called ___ is used to record the price reduction

sales returns and allowances

Common prepaid expenses

supplies, prepaid rent, prepaid advertising, and prepaid insurance

Estimated bad debt expense

total credit sales x percentage of credit sales estimated to default

a reduction in the selling price granted by the seller to a particular class of customers (Ex: to customers who purchase goods for resale rather than use)

trade discount

after a company has journalized and posted all of the adjusting entries, it updates the ____ to reflect the adjusments that have been made

trial balance

the ____ delays or defers the recognition of revenue by recording the revenue as liability until it is earned

unearned revenue account

the gross method

when most companies record the sale and associated receivable at the gross (pre-discount) amount of the invoice

means that noncash resources (such as inventory) have been exchanged for cash or near cash (accounts receivable)

"realized"

accounts receivable turnover

- one of the most widely used asset management ratios -provides a measure of how many times average trade receivables are collected during the period

revenue-recognition principle

-Determines when revenue is recorded and reported -Revenue is recorded when the 2 conditions are met, regardless of when cash is received

Since sales revenues have a significant effect on a company's net income, internal control procedures must be established to ensure the amounts reported for these item are correct. For sales revenues these controls involve the following documents and procedures:

-accounting for a sail begins with a receipt of a purchase order or some similar document from a customer. the document is necessary for the buyer to be obligated to accept and pay for the ordered goods -shipping/billing documents are prepared based on the order document. Billing documents are usually called INVOICES -a sale and its associated receivable are recorded only when the order, shipping, and billing documents are all present

Contra accounts

-accounts that have a balance that is opposite of the balance in a related account

accrual accounting

-an alternative to cash-basis accounting that is required by Generally Accepted Accounting Principles -through the application of the revenue recognition and expense recognition principles links income recognition to the principal activity of the company, selling goods and services -therefore provides a better estimate of future cash flows than cash-basis accounting

permanent accounts

-assets, liabilities, and stockholder's equity -their balances are carried forward from the current accounting period to future accounting periods

debit cards

-authorize a bank to make an immediate electronic withdrawal (debit) from the holder's bank account -used like a credit card except that a bank electronically reduces (debits) the holders bank account and increases (credits) the merchant's bank account for the amount of a sale made

aging method

-bad debt expense is estimated by determining the collectability of the accounts receivable rather than by taking a percentage of total credit sales -at end of each accounting period, the individual accounts receivable are categorized by age -then an estimate is made of the amount expected to default in each age category based on past experience and expectations about how the future may differ from the past -the overdue accounts are more likely to default than the currently due accoutns

allowance method

-bad debt expense is recorded in the period of sale, which allows it to properly be matched with revenues -result is that bad debt expense is recognized before the actual default

depreciation

-because property, plant, and equipment helps to produce revenue over a number of years (instead of just one period), the expense recognition/matching principle requires companies to systematically assign the asset's cost as an expense to each period in which the asset is used -requires an adjustment to recognize the expense incurred during the period and reduce the long-lived asset -the unused portion of the asset is reported as property, plant, and equipment on the balance sheet -the process reduces the asset

sales discount

-discount offered by businesses that is a reduction of the normal selling price and is attractive to both the seller and the buyer -for seller, the cash is more quickly available and collection costs are reduced -for buyer, it is a reduction to the cost of the goods and services

adjusting entries

-journal entries made at the end of an accounting period to record the completed portion of partially completed transactions -necessary to apply the revenue recognition and expense recognition principles and ensure a company's financial statements include the proper amount for revenues, expenses, assets, liabilities, and stockholder equity -required for continuous transactions that are partially complete at the end of an accounting period -internal events that do not involve another company

adjusted trial balance

-lists all of the active accounts and proves the equality of debits and credits -primary source of information needed to prepare the financial statements

the Securities and Exchange Commision (SEC) maintains that revenue is realized or realizable and earned when they following criteria are met:

-persuasive evidence of an arrangement exists -delivery has occurred or services have been provided -the seller's price to the buyer is fixed and determinable -collectability is reasonably assured

Deferred (Prepaid) Expenses

-prepayments for companies to acquire goods/services before they are used -recorded as assets -used to generate revenue -an adjustment is necessary to reduce the previously recorded prepaid asset and recognize the related expense -the portion of the prepaid asset that has not been used represents the unexpired benefits and remains in the asset account until it is used

Accrued expenses

-previously unrecorded expenses that have been incurred but not yet paid in cash -an adjustment is necessary to record the expense and the associated increase in a company's liabilities, usually a PAYABLE -expenses are recorded as they are incurred, regardless when cash is paid

expense recognition

-process of identifying an expense with a particular time period -the key is to match the expense with revenue

notes receivable

-receivables that generally specify an interest rate and a maturity date at which any interest and principal must be repaid -recognized for the amount of cash loaned or goods/services sold

Expense Recognition (Matching) Principle

-requires that expenses be recorded and reported in the same period as the revenue that it helped to generate -expenses for an accounting period should EXCLUDE those costs used to earn revenue in an earlier period and those costs that will be used to earn revenue in a later period

temporary accounts

-revenues, expenses, and dividends -collect the activities of only one period

percentage of credit sales method

-simpler of the two methods to estimate bad debt expense -using past experience and managements views of how the future may differ from the past, it is possible to estimate the percentage of the current period's credit sales that will eventually become uncollectible -this percentage is multiplied by the total credit sales for the period to calculate the estimated bad debt expense for the period

Income Summary

-temporary account used to aid the closing process -allows the company to easily identify net income or net loss for the period

key elements of accrual accounting

-time period assumption -revenue recognition principle -expense recognition (matching) principle

accrual-basis accounting

-transactions are recorded when they occur -superior to cash-basis because it links income measurement to selling, the principle activity of the company -revenue is recognized as it is earned and expenses are recognized when they are incurred -records both cash and non-cash transactions

Deferred (Unearned) Revenues

-transactions for which a company has received cash but has not yet earned the revenue -Ex: rent received in advance, magazine subscriptions received in advance, concert tickets -as the goods are delievered, adjustment is necessary to reduce the previously recorded liability and to recognize the portion of the revenue that has been earned -the portion of money that has not been earned remains in the liability account, unearned revenue, until it is earned

accrued revenues

-transactions that have earned revenue but not received the cash -an adjustment is necessary to record the revenue and the associated increase in a company's assets , usually a receivable Ex: interest on a loan

closing the accounts is done to:

-transfer the effects of revenues, expenses, and dividends to the permanent stockholder's equity account, Retained earnings -Clear the revenue, expenses, and dividends (reduce their balances to zero) so they are ready to accumulate the business activities of the next accounting period

direct write off method

-waits until an account is deemed uncollectible before reducing accounts receivable and recording the bad debt expense -inconsistent with the matching concept and can only be used if bad debts are immaterial under GAAP

types of adjusting entries

1. Accruals 2. Deferrals

Steps in the Accounting Cycle

1. Analyze transactions 2. Journalize transactions 3. Post to ledger 4. Prepare Trial Balance 5. Adjust the accounts 6. Prepare financial statements 7. Close the Accounts

while cash basis accounting recognizes revenue in the period payment is received ( as on your tax return), accrual basis accounting recognizes revenue when it is: 1. 2.

1. Realized and realizable 2. Earned

Receivables are typically categorized along three different dimensions:

1. accounts receivable or notes receivable 2. current or noncurrent receivables 3. trade or nontrade receivables

4 step closing procedure:

1. close revenues to Income Summary 2. close expenses to Income Summary (at this point the balance in the Income Summary account should be equal to net income) 3. close Income Summary to retained earnings 4. close dividends to Retained Earnings

two methods to record bad debt expense:

1. direct write off method 2. allowance method

3 stepsfor making adjusting journal entries

1. identify pairs of income statement and balance sheet accounts that require adjustment 2. calculate the amount of the adjustment based on the amount of revenue that was earned or the amount of expense that was incurred during the accounting period 3. Record adjusting journal entry

Order to prepare financial statements

1. the income statement is prepared from the revenue and expense accounts 2. net income (obtained from income statement) and dividends are used to prepare the retained earnings statement 3. the balance sheet is prepared using the ending balance of retained earnings from the retained earnings statement

Conditions of revenue-recognition principle

1. the revenue has to be earned 2. the collection of cash is reasonably assured (these requirements are usually met when goods have been delivered to a customer or when services have been performed for a customer)

in the allowance method, because defaults for the current period's sales have not actually occurred, the specific accounts recievable are not lowered; instead an account called ____ is established to "store" the estimate until specific accounts are identified as uncollectible

Allowance for Doubtful Accounts

Interest=

Principal x Annual Interest Rate x Fraction of 1 Year

notes receivable

a is a legal document given by a borrower to a lender stating the timing of repayment and the amount (principal/interest) to be repaid

when the revenue is earned or the expense is incurred BEFORE the associated cash flow occurs, an ___ adjusting entry is necessary

accrual

time-period assumption

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

principal

amount lent

nontrade receivables

arise from transactions not involving inventory (such as interest receivable or cash advances to employees)

deferred (prepaid) expenses

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

Contra accounts are deducted from the balance of the related asset account in the financial statements, and the resulting difference is known as the ____

book value of the asset

most companies do not use cash-basis accounting because...

by recording only the cash effect of transactions, cash-basis financial statements may not reflect all of the assets and liabilities of a company at a particular date

___ is NEVER affected by adjustments

cash

_____ is NEVER affected by adjustments because revenue and expense recognition does not depend on cash receipt or cash payment.

cash

the appropriate amount of revenue to recognize is generally the ___ or ___ of the receivable

cash received or cash equivalent

without _____, the temporary accounts would accumulate the business activities of ALL accounting periods, not just the current one

closing entries

final step of accounting

closing the accounts

if the bill has already been paid, the seller can either refund a portion of the purchase price and record a ___ to cash or apply the allowances against future purchases by the customer by recording a ___ to accounts receivable

credit; credit

although in practice both accounts and notes receivable are typically classified as ___, accounts receivable are typically due in 30-60 days and do not have interest while notes receivable have interest and are typically due in anywhere from 3-12 months. if the due date is over one year, the note receivable typically will be classified as ____

current noncurrent

Sales discounts offered to encourage prompt payment are recorded at the gross (pre-discount) amount of the invoice. if the discount IS taken, a ___ is made to Sales Discounts at the time of the payment

debit

when a specific account is ultimately determined to be uncollectible under the allowance method, it is written off by a ___ to the allowance account and ____ to accounts receivable

debit credit

while the asset has a normal ___ balance, the contra account has a normal ____ balance

debit credit

when the revenue is earned or the expense is incurred AFTER the associated cash flow occurs, a _____ adjusting entry is necessary

deferral

accounts receivable

do not have a formal note. for example, while yo likely signed a formal agreement to rent your apartment, you probably did not sign a formal agreement for utilities

trade recievables

due from customers purchasing inventory in the ordinary course of business

interest

excess of the total amount of money collected over the amount lent

the adjusting entry for deferred expenses will result in an increase to an ___ account and a decrease to an ___ account

expense asset

the adjusting entry for an accrued expense will result in an INCREASE to an ___ account and an INCREASE to a ____ account

expense liability

the buyer of the receivables who acquires the right to collect the receivables and the risk of uncollectibilty

factor

when receivables are ____, the seller receives an immediate cash payment reduced by the factor's fees

factored

credit cards are just a special form of ___. the issuer (bank) of the card pays the seller the amount of each sale minus a service charge (on date of purchase) and then collects the full amount of the sale from the buyer (at a later date)

factoring

gross profit margin=

gross profit/net sales

Accounting for notes receivable: any excess of the amount received over principal is recognized as ____ in the period the interest was earned

income interest