Intermediate Accounting Chapter 2

Deferral Revenue

A deferral of revenue is the accounting process of recognizing deferred revenue (such as a contract liability) at the time of the cash inflow.

Accrual-basis accounting (required under GAAP) demands the

Accrual-basis accounting (required under GAAP) demands the recording of deferrals and accruals at the end of each accounting period using revenue and expense recognition principles

Identify, Record, and Post Adjusting Journal Entries—Step 5

Adjusting journal entries are used to record resource changes that span more than one time period to ensure the accuracy of financial statements. Adjusting journal entries generally record a resource or obligation change and usually involve both a permanent and a temporary account. Adjusting journal entries are recorded and dated as of the last day of the accounting period.

ledger

All accounts, such as cash, payables, and common stock, are organized in an accounting system using a ledger, also called a general ledger. The begin- ning balance, increases, decreases, and an ending balance are maintained and continually updated in the ledger for each account.

accounting information system

An accounting information system is designed to record accurate financial data in a timely and chronological manner, facilitate retrieval of financial data in a form useful to management, and simplify periodic preparation of financial statements for external use. An accounting information system uses debits and credits to record transactions and events

Consult Inc. borrowed $10,000 from a bank by signing a note payable

Analysis: Assets (cash) increase and liabilities (note payable) increase when Consult Inc. incurs an obligation to repay in the future the cash received now.

Consult Inc. purchased $4,000 of supplies on account from Office Gear Inc

Analysis: Assets (supplies) increase when Consult Inc. purchases supplies with an obligation to pay an amount at a later date, which is a liability (accounts payable)

Consult Inc. declared a cash dividend of $500 payable to shareholders

Analysis: Consult Inc. declares a dividend (but has not yet paid the dividend), which causes liabilities to increase (dividends payable) and stockholders' equity to decrease through a reduc‑ tion in retained earnings. Dividends are not an expense but rather a direct reduction to retained earnings.

Consult Inc. paid $3,000 on account to Office Gear Inc

Analysis: Consult Inc. decreases assets (cash) when it makes a payment on account, which causes its obligations (liabilities) to decrease

Consult Inc. performed consulting services for $2,000 cash.

Analysis: Consult Inc. performs services for cash, resulting in an increase in assets (cash) and an increase in stockholders' equity through the recognition of revenue

Owners invested $25,000 in Consult Inc. in exchange for shares of common stock

Analysis: From the company perspective, assets (cash) increase as stockholders' equity increases (common stock) with the latter reflecting the increase in owners' claims on assets contributed

Consult Inc. paid $1,000 in attorney fees to help launch the business.

Analysis: The decrease in assets (cash) causes stockholders' equity to decrease through the recognition of legal expense

External events

External events include the exchange of resources and obligations between the reporting company and outside parties.These exchanges are either reciprocal transfers or nonreciprocal transfers. In a reciprocal transfer, the company both transfers and receives resources (such as a sale of goods). In a non-reciprocal transfer, the company either transfers or receives resources (such as a payment of cash dividends). External events also include economic and environmental events beyond the control of the company, including casualty losses and changes in the market value of assets and liabilities. External events generally require a journal entry.

Accounting Cycle Step 1: Identify transactions

The purposes of the first step in the accounting cycle are to identify the transactions and events that cause a change in the company's resources, obligations, and equity, and to collect relevant economic data about those transactions. Events that change a company's resources, obligations, and equity are categorized as external, internal, or some combination of both. Transactions are types of external event

Internal events

occur within the company, affecting its resources or obligations, and do not involve outside parties. Examples are recognition of depreciation of long-lived assets and the use of inventory for production. These events generally require a journal entry. However, a number of events, such as increases in the value of a brand name, are not recorded. GAAP provides guidelines on which transactions should be recorded in the accounting information system.

The category of stockholders' equity is further divided into two main components

paid-in capital and retained capital, usually called retained earnings in practice. Paid-in capital is the amount in- vested by shareholders into the corporation, while retained earnings is the amount of income (reve- nue less expenses) recognized by the corporation (net of dividends) since the inception of the company.

Assets

probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events Examples cash, accounts receivable, prepaid expense, supplies, inventory, equipment, building, intangible assets

Liabilities

probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events Examples accounts payable, salaries payable, accrued expenses, notes payable, bonds payable, deferred revenue

double-entry system

Economic transactions or events are recorded in an accounting system in such a way as to affect at least two accounts. For the accounting equation to stay in balance, a change in one amount in the equation requires an offsetting change in another amount in the equation. This duality is called the double-entry system. The double-entry system ensures that the accounting equation remains in balance

__________rules complement the double-entry system

Debit and credit rules complement the double-entry system. The debit and credit system is used as a recording and balancing procedure. This system divides accounts into two sides. The debit (Dr.) side is always the left side, and the credit (Cr.) side is always the right side. These terms carry no further meaning. The T-account is a form of a ledger used for summarizing transactions; it takes the form of the letter T. In the accounting equation (Assets = Liabilities + Stockholders' Equity), the accounts on the left side of the equation (assets) usually have a net normal debit balance and the accounts on the right side of the equation (liabilities and stockholders' equity) usually have a net normal credit balance. To ensure that the accounting equation is always in balance, the left side (debit accounts) must always equal the right side (credit accounts). This means that each transaction in a double-entry accounting system consists of at least one debit amount and one credit amount.

Deferral

Deferral is concerned with past cash receipts and payments—with prepayments received (often described as collected in advance) or paid: it is the accounting process of recognizing a liability resulting from a current cash receipt (or the equivalent) or an asset resulting from a current cash payment (or the equiva-lent) with deferred recognition of revenues, expenses, gains, or losses. Their recognition is deferred until the obligation underlying the liability is partly or wholly satisfied or until the future economic benefit underlying the asset is partly or wholly used or lost.

Adjusting journal entries are classified into two categories

Deferrals of expense and revenue Accruals of expense and revenue For deferrals, recognition of revenues and expenses is delayed to future periods, even though the cash flows occur now. A deferral of revenue is recorded as a liability while a deferral of expense is recorded as an asset. Revenue and expense recognition take place in a future period. For accruals, recognition of revenues and expenses occurs in the current accounting period while the cash flows occur in the future. An accrual of revenue is recorded as an asset while an accrual of expenses is recorded as a liability. The recording of cash flows takes place in a future period

chart of accounts

Each account in the ledger is assigned a unique account number in a chart of accounts. Accounts are typically numbered by the order of the balance sheet: asset accounts, liability accounts, stockholders' equity accounts. Having a master set of account names with identification numbers allows for consistent recording by all departments and segments of the company. The number of accounts in a chart of accounts varies by the size and complexity of the transactions of a company. The chart of accounts is tailored for a company's industry and specific needs Identify, Record, and Post Transactions Identify the accounts affected by a transaction Record the impact on the accounts in a journal Post the impact to individual account balances in a ledge

Permanent accounts

Permanent accounts are those appearing in the balance sheet: assets, liabilities, and stockholders' equity. The term permanent means that balances in these accounts are carried over from one period to the next

Issuances of common stock and revenue

increase stockholders' equity while expenses and dividends decrease stock- holders' equity. Any change in a stockholders' equity account must be offset by another account to assure that the accounting equation remains in balance.

recording to general journal-step 3

Step 2: Record transactions Step 2 measures and records the economic effect of transactions in a journal. A general journal is a chronological record of transactions, or- ganized in a debit-credit format. A general journal includes the (1) date, (2) debited accounts listed first (positioned at the far left) and credited accounts listed next (slightly indented to the right), (3) account num- bers, (4) dollar amounts (debits in the first column and credits in the next column), and (5) a brief, optional explanation. Companies may also use special journals to record multiple transactions of a similar type, such as for sales, cash receipts, purchases, and cash payments

Stockholders' equity

Stockholders' equity, also called shareholders 'equity, is the residual interest in assets of a corporation after deducting liabilities. Examples paid‑in capital: common stock; retained earnings: revenue, expense, dividends

Temporary accounts

Temporary accounts report changes in Retained Earnings (a permanent account) from dividends and income-generating activities that appear in the income statement: revenues, expenses, gains, and losses. For example, when a bill for utilities is paid, the Utilities Expense account describes the reason for the decrease in cash. Temporary accounts are closed (meaning set to zero) and their balances transferred to the permanent account (Retained Earnings) at the end of each accounting period.

The accounting equation reflects

The accounting equation reflects the basic identity of a corporation. Assets of a corporation are claimed by creditors (liabilities) and by owners (stockholders' equity). Stockholders' equity, also called shareholders'equity, is the residual interest in assets of a corporation after deducting liabilities

Analyze the effects of economic transactions using the accounting equation

The accounting process begins with an economic transaction or event that has a direct impact on the financial position of a company. The effects of a transaction or event are recorded in accounts, which describe specific re-sources, obligations, and their changes. Accounts are organized into one of three categories of assets, liabilities, and stockholders' equity. The relation of these categories of accounts is expressed in the following equa-tion, which reflects assets (resources) on the left and the financing of those resources on the right.

contract liability

The basis for revenue recognition under the revenue recognition accounting standard (ASC 606) is the existence of a contract (a legally enforceable agreement) between two entities. This means that when cash is received in exchange for a company's obligation to transfer goods or services in the future under a revenue contract, a liability is created called a contract liability

accounting cycle

The first three steps in the accounting cycle require the most time and effort and take place during the accounting period. Steps 4 through 7 occur at the end of each accounting period (monthly, quarterly, and/or yearly). Steps 8 and 9 take place at the end of the accounting period with the fiscal year-end

unadjusted trial balance-step 4

The unadjusted trial balance is a list of general ledger accounts and their account balances in the following order: assets, liabilities, stockholders' equity, revenues, expenses, gains, and losses. The unadjusted trial balance is prepared before the adjusting entries are recorded In step 4, an unadjusted trial balance is typically prepared at the end of the reporting period, after all transaction entries are recorded in the journals and posted to the ledger. The debit balances are listed in the left column and the credit balances in the right column, with the totals of the two columns in agreement.The unadjusted trial balance is a means for checking that the sum of debit account balances equals the sum of credit account balances. If the sums of debit and credit balances are not equal, the error must be found and corrected. A reexamination of source documents and postings is one way to discover the source of an error. Equality of debits and credits does not, however, imply that the accounts are error-free. An unposted journal entry, an incorrectly classified account, and an erroneous journal entry amount are errors that are not revealed through an inequality of debits and credits

contra account

The use of a contra account provides financial statement users both the original cost and net book value of the asset

source document

Transactions are often accompanied by a source document, generally a record (electronic or paper) that describes the exchange, the parties involved, the date, and the amount. Examples are sales invoices, freight bills, and cash register receipts. Certain events (such as the accrual of inter- est) are not signaled by a separate transaction or source document. Recording these transactions requires reference to the underlying contract supporting the original exchange of resources. Source documents are essential for the initial recording of transactions in a journal and are also used for subsequent tracing and verification, for evidence in legal proceedings, and for audits of financial statements.

Posting to ledger-step 3

Transferring transaction data from the journal to the ledger is called posting. Posting reclassifies the data from the journal's chronological format to an account classification format in the ledger. Recall that a ledger holds individual accounts, grouped according to account type. A T-account was introduced previously as a form of a ledger. In a computerized accounting system, a journal entry automatically generates a posting to the corresponding ledger accounts

Accounting systems usually have two types of ledgers

the general ledger and subsidiary ledgers. The general ledger holds the control accounts. Subsidiary ledgers support general ledger accounts that consist of many separate individual accounts. For example, a company with a substantial number of customer accounts receivable maintains one ledger account per customer, stored in an accounts receivable subsidiary ledger. The individual customer account is called the subsidiary account. The general ledger holds only the control account, the balance of which reflects the sum of all the individual customer account balances. Only control accounts are used in preparing financial statements Cross-referencing (matching journal page number where both are found in journal) is important when posting large numbers of transactions, detecting and correcting errors, and maintaining an audit trail.