Mod 3 - Accounting 250 chapter 3

A couple of cautions about preparing closing entries.

(1) Avoid unintentionally doubling the revenue and expense balances rather than zeroing them. (2) Do not close Dividends through the Income Summary account. Dividends are not expenses, and they are not a factor in determining net income.

Temporary Accounts consist of

"RED" REVENUE EXPENSE DIVIDEND

book value of any depreciable asset is the

difference between its cost and its related accumulated depreciation -asset's book value generally differs from its fair value. The reason: Depreciation is an allocation concept, not a valuation concept. That is, depreciation allocates an asset's cost to the periods in which it is used. Depreciation does not attempt to report the actual change in the value of the asset.

accrued expenses

expenses incurred but not yet paid in cash or recorded -Interest, rent, taxes, and salaries are common example

general journal chronologically lists transactions and other events,

expressed in terms of debits and credits to accounts.

chart of accounts

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

Transferring journal entries to the ledger accounts is called

posting.

temporary accounts—

revenues, expenses, and dividends

prepaid expenses.

the costs of assets acquired in one period that will be expensed in a future period -insurance, supplies, advertising, and rent -an adjusting entry for prepaid expenses results in a debit to an expense account and a credit to an asset account.

Cash Basis Accounting - Revenues are recorded when cash is received and expenses are recorded when cash is disbursed.

Accrual Basis Accounting - Revenues are recorded when earned (performance obligation is satisfied) and expenses are recorded in the period incurred. -Example: JB Accounting Firm completed tax returns for clients in the month of April, billing clients $10,000 on April 30th. The firm is paid $8,000 in May and $2,000 in June from the clients billed. Determine the month and the dollar amount of revenue recorded under the cash basis and accrual basis.

Special journals summarize transactions possessing a common characteristic (e.g., cash receipts, sales, purchases, cash payments).

As a result, using them reduces bookkeeping time.

Accrued Salaries and Wages

Debit -Wage and Salary Expense Credit - Wages and Salary Payable To record wages and salaries owed.

What is an accounting information system?

Is a system that is used to • Collects and processes transactions • Converts them into a useable format - the financial statements.

Accruals

NO CASH is received or paid •Revenues earned during the period but no cash has been received (interest, or service revenue). •Expenses were incurred but not yet paid out in cash or recorded (interest, wages).

Transactions are types of external events. They may be an exchange between two entities where each receives and sacrifices value, such as purchases and sales of goods or services.

Or, transactions may be transfers in one direction only. For example, an entity may incur a liability without directly receiving value in exchange, such as charitable contributions -In short, a company records as many events as possible that affect its financial position.

Real and Nominal Accounts.

Real (permanent) accounts are asset, liability, and equity accounts; they appear on the balance sheet. Nominal (temporary) accounts are revenue, expense, and dividend accounts; except for dividends, they appear on the income statement. Companies periodically close nominal accounts; they do not close real accounts.

Accrued Revenues

Revenues earned in a period that are both unrecorded and not yet received in cash (or other assets); adjusting entries for recording accrued revenues involve increasing assets and increasing revenues. -an adjusting entry for accrued revenues results in a debit (increase) to an asset account and a credit (increase) to a revenue account.

Expense recognition principle - expenses are recognized in the same period as the revenues to which they relate. "Match efforts (expenses) with accomplishments (revenues)"

Revenues recognition principle - revenues are recorded when the performance obligation is satisfied or in the period in which they are "earned."

Merchandising Income Statement

Sales Revenue less contra revenue accounts equals Net Sales -Contra Revenue Accounts (have a debit balance): • Sales Returns & Allowances - occur when customers return merchandise or are granted a reduction in sales price due to quality issue or a similar concern. • Sales Discounts - are awarded to customers for prompt payment -(2/10, n/30). -Cost of Goods Sold is an expense account, has a debit balance. It represents the cost of the merchandise sold to the customer.

A company records in accounts those transactions and events that affect its assets, liabilities, and equities.

The general ledger contains all the asset, liability, and stockholders' equity accounts.

Insurance Most companies maintain fire and theft insurance on merchandise and equipment, personal liability insurance for accidents suffered by customers, and automobile insurance on company cars and trucks. The extent of protection against loss determines the cost of the insurance (the amount of the premium to be paid).

The insurance policy specifies the term and coverage. The minimum term usually covers one year, but three- to five-year terms are available and may offer lower annual premiums. A company usually debits insurance premiums to the asset account Prepaid Insurance when paid. At the financial statement date, it then debits Insurance Expense and credits Prepaid Insurance for the cost that expired during the period.

useful life

The period of time over which an asset contributes to the earnings of a business.

When preparing closing journal entries, there are typically ___________ entries.

There are four typical closing journal entries, revenue is closed to income summary, expenses are closed to income summary as well and to the retained earnings, and dividends to retained earnings. The other choices do not describe closing journal entries.

adjusting entry for accruals will increase both a balance sheet and an income statement account.

second category of adjusting entries is accruals. Companies make adjusting entries for accruals to record revenues for services performed and expenses incurred in the current accounting period. Without an accrual adjustment, the revenue account (and the related asset account) or the expense account (and the related liability account) are understated.

On June 30, 2019 Martin Corp.'s balance sheet included a 10%, $3,000,000 note payable. The note is dated October 1, 2017, and is payable in three equal annual payments of $1,000,000 plus interest. The first interest and principal payment was made on October 1, 2018. In Martin's June 30, 2019 balance sheet, the accrued interest payable for this note will be

$2,000,000 × 9/12 × 10% = $150,000The other choices are incorrect for recording will cause a misstatement.

Cybercrime is committed by many different offenders with diverse motives, such as

(1) insiders who have authorized access and then abuse this access for personal gain, (2) competitors seeking unfair advantage, (3) foreign governments committing espionage for political or economic gain, (4) transnational criminal enterprises stealing or extorting information to generate income, and (5) activists protesting organizational actions or policies.

Merchandising Companies Buy and Sell Goods

-The primary source of revenues is referred to as sales revenue or sales.

he owner of a store selling used CDs wants one account that summarizes all sales to customers and another that summarizes all purchases from individuals. What should the owner use for each purpose?

A special journal is used to record only specific types of transactions. Therefore, a special journal should be used to record specific transactions related to sales vs. purchases.A journal is a detailed account that records all the financial transactions.The standard account form is part of the general ledger.The special ledger would be used to post the special journal.

double-entry accounting system

A system of accounting for recording transactions, based on recording increases and decreases in accounts so that debits equal credits - a company records the dual (two-sided) effect of each transaction in appropriate accounts.

Event.

A happening of consequence. An event generally is the source or cause of changes in assets, liabilities, and equity. Events may be external or internal.

Identifying and Recording Transactions and Other Events

The first step in the accounting cycle is analysis of transactions and selected other events.

After adjustment, the asset account Supplies shows a balance of $10,000, which equals the cost of supplies on hand at the statement date. In addition, Supplies Expense shows a balance of $15,000, which equals the cost of supplies used in October.

Without an adjusting entry, October expenses are understated and net income overstated by $15,000. Moreover, both assets and stockholders' equity are overstated by $15,000 on the October 31 balance sheet.

Depreciation expense identifies that portion of the asset's cost that expired during the period (in this case, October).

Without this adjusting entry, total assets, total stockholders' equity, and net income are overstated, and depreciation expense is understated.

the number in the posting reference column serves two purposes.

(1) It indicates the ledger account number of the account involved. (2) It indicates the completion of posting for the particular item.

Accruals:

1. Accrued revenues: Revenues for services performed but not yet received in cash or recorded. 2. Accrued expenses: Expenses incurred but not yet paid in cash or recorded.

Depreciation is

the process of allocating the cost of an asset to expense over its useful life in a rational and systematic manner. -epreciation is an estimate rather than a factual measurement of the expired cost.

FASB uses the phrase "transactions and other events and circumstances that affect a business enterprise" to describe the sources or causes of changes in an entity's assets, liabilities, and equity. Events are of two types.

(1) External events involve interaction between an entity and its environment, such as a transaction with another entity, a change in the price of a good or service that an entity buys or sells, a flood or earthquake, or an improvement in technology by a competitor. (2) Internal events occur within an entity, such as using buildings and machinery in operations, or transferring or consuming raw materials in production processes.

A trial balance does not prove that a company recorded all transactions or that the ledger is correct. Numerous errors may exist even though the trial balance columns agree. For example, the trial balance may balance even when a company

(1) fails to journalize a transaction, (2) omits posting a correct journal entry, (3) posts a journal entry twice, (4) uses incorrect accounts in journalizing or posting, or (5) makes offsetting errors in recording the amount of a transaction. In other words, as long as a company posts equal debits and credits, even to the wrong account or in the wrong amount, the total debits will equal the total credits.

general journal entry consists of four parts:

(1) the accounts and amounts to be debited (Dr.), (2) the accounts and amounts to be credited (Cr.), (3) a date, and (4) an explanation. A company enters debits first, followed by credits (slightly indented).

Accounting Cycle Steps

1. Analyze business transactions 2. Journalize the transactions 3. Post to ledger accounts 4. Prepare a trial balance 5. Journalize and post adjusting entries 6. Prepare an adjusted trial balance 7. Prepare financial statements 8. Journalize and post closing entries 9. Prepare a post-closing trial balance

Steps in the recording process

1. Analyze each transaction in terms of its effect on the accounts 2. Enter the transaction in the general journal. Journal entry format: Debit: Account $xxxxxxCredit: Account $xxxxxx 3. Transfer (post) information to the appropriate account in general ledger (T-account) 4. Prepare an unadjusted trial balance 5. Prepare adjusting journal entries 6. Prepare adjusted trial balance 7. Prepare financial statements 8. Close the temporary (nominal) accounts 9. Prepare post-closing trial balance

The Recording Process Steps:

1. Analyze each transaction in terms of its effects on the accounts.2. Enter the transaction in the general journal. 3. Post information to the appropriate account in general ledger (T-account)4. Prepare an unadjusted trial balance

The Closing Entry - four steps 1-2

1. Close out Revenue Accounts to the Income Summary Account: Debit: Revenue XXXX Credit: Income Summary Account XXXX The Income Summary Account is a temporary Account only used during the closing process. 2. Close out Expense Accounts to the Income Summary Account: Debit: Income Summary Account XXXX Credit: All Expense Accounts XXXX Transfer Expense Account Balances Transfer Revenue Account Balances After these steps, all revenue and expense accounts have now have a zero balance

The Accounting Cycle Summarized

1. Enter the transactions of the period in appropriate journals. 2. Post from the journals to the ledger (or ledgers). 3. Prepare an unadjusted trial balance (trial balance). 4. Prepare adjusting journal entries and post to the ledger(s). 5. Prepare a trial balance after adjusting (adjusted trial balance). 6. Prepare the financial statements from the adjusted trial balance. 7. Prepare closing journal entries and post to the ledger(s). 8. Prepare a post-closing trial balance (optional). 9. Prepare reversing entries (optional) and post to the ledger(s). A company normally completes all of these steps in every fiscal period.

Posting involves the following steps.

1. In the ledger, in the appropriate columns of the account(s) 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 account(s) credited, enter the date, journal page, and credit amount shown in the journal. 4. In the reference column of the journal, write the account number to which the credit amount was posted.

The procedures for preparing a trial balance consist of:

1. Listing the account titles and their balances. 2. Totaling the debit and credit columns. 3. Proving the equality of the two columns.

Deferrals:

1. Prepaid expenses: Expenses paid in cash before they are used or consumed. 2. Unearned revenues: Cash received before services are performed.

The Closing Entry - four steps 3-4

3. Close out the Income Summary Account to Retained Earnings. • If ending balance of Income Summary Account is a Credit: Debit: Income Summary and Credit: Retained Earnings for the balance. • If ending balance of Income Summary Account is a Debit: Credit: Income Summary and Debit: Retained Earnings for the balance. Credit balance in Income Summary represents net income Debit balance in Income Summary represents net loss 4. Close out the Dividend Account to Retained Earnings. Debit: Retained Earnings XXXX Credit: Dividends XXXX

trial balance is a list of accounts and their balances at a given time.

A company usually prepares a trial balance at the end of an accounting period. The trial balance lists the accounts in the order in which they appear in the ledger, with debit balances listed in the left column and credit balances in the right column. The totals of the two columns must agree.

The company's ownership structure dictates the types of accounts that are part of or affect the equity section.

A corporation commonly uses Common Stock, Paid-in Capital in Excess of Par, Dividends, and Retained Earnings accounts. A proprietorship or a partnership uses an Owner's Capital account and an Owner's Drawings account. An Owner's Capital account indicates the owner's or owners' investment in the company. An Owner's Drawings account tracks withdrawals by the owner(s).

post-closing trial balance

A list of permanent accounts and their balances after a company has journalized and posted closing entries. -purpose of the post-closing trial balance is to prove the equality of the permanent account balances that the company carries forward into the next accounting period -the post-closing trial balance will contain only permanent (real)—balance sheet—accounts.

modified cash basis

A mixture of the accrual basis and cash basis, with modifications that have substantial support, such as capitalizing and depreciating plant assets or recording inventory.

closing process

A step in the accounting cycle that occurs at the end of the period. The closing process consists of journalizing and posting the closing entries to set the balances of the revenues, expenses, Income Summary, and Dividends accounts to zero for the next period. -reduces the balance of nominal (temporary) accounts to zero in order to prepare the accounts for the next period's transactions. In the closing process, Pioneer Advertising transfers all of the revenue and expense account balances (income statement items) to a clearing or suspense account called Income Summary.

Account.

A systematic arrangement that shows the effect of transactions and other events on a specific element (asset, liability, and so on). Companies keep a separate account for each asset, liability, revenue, and expense, and for capital (stockholders' equity). Because the format of an account often resembles the letter T, it is sometimes referred to as a T-account (see Illustration 3.3).

Bad Debts

Accounts of customers who do not pay what they have promised to pay; an expense of selling on credit; also called uncollectible accounts. -Companies estimate uncollectible accounts at the end of each period. This ensures that receivables are reported on the balance sheet at their net realizable value. As a result, proper valuation of the receivable balance requires recognition of uncollectible receivables and an adjusting entry for bad debt expense.

contra asset account offsets an asset account on the balance sheet

Accumulated Depreciation—Equipment account offsets the Equipment account on the balance sheet. Its normal balance is a credit.

reversing entry

An entry made at the beginning of the next accounting period; the exact opposite of the adjusting entry made in the previous period. -optional bookkeeping procedure; it is not a required step in the accounting cycle

Transaction.

An external event involving a transfer or exchange between two or more entities.

The Basic Accounting Equation

Assets = Liabilities + Stockholders' Equity

Gina is attempting to complete Briar Books' statement of retained earnings for the year. She knows Briar's retained earnings as of January 1 of last year, as well as the firm's net income for the year. What other information will Gina need to complete the statement of retained earnings?

Briar's dividends paid during the prior year, as listed on its adjusted trial balance.

Deferrals

CASH is received or paid •Cash is received before the performance obligation is complete (unearned revenues). •Cash is paid out before expense is incurred (prepaids).

The board declares a $200 dividend to be payed in FEB

Debit: Dividends Credit: Dividends payable

closing entries

Entries at the end of an accounting period to transfer the balances of temporary accounts to a permanent stockholders' equity account, Retained Earnings.

Adjusting Entries.

Entries made at the end of an accounting period to bring all accounts up to date on an accrual basis, so that the company can prepare correct financial statements.

if the adjusting entry for an accrued revenue is not made

If a company fails to adjust for accrued revenues: assets will be understated and revenues will be understated, stockholders' equity will be understated. -no impact on liabilites

Revenues and Expenses are closed out to the Income Summary Account and Dividends are closed out directly to Retained Earnings.

Income Tax Expense is closed out to Income Summary during the closing process

If Jackson Enterprises recorded journal entries for the issuance of common stock for $160,000, a payment of $52,000 on accounts payable, and a payment of salaries and wages expense of $84,000, the net effect of these entries on stockholder's equity would be an

Issuing common stock would increase equity by $160,000 and paying salary expenses would decrease equity by $84,000. Payment of accounts payable would have no effect on equity. Therefore, owners' equity would increase by $76,000 ($160,000 -$84,000). The other choices would cause an improperly recorded transaction

If Nation's Best Chocolate recorded journal entries for the declaration of $150,000 of dividends, a $96,000 increase in accounts receivable for services rendered, and the purchase of equipment for $63,000, then the net effect of these entries on stockholder's equity would be

Paying dividends would decrease equity by $150,000 and increasing accounts receivable would increase equity by $96,000 for the revenue earned. Equipment purchases would have no effect on equity. Therefore, stockholder's equity would decrease by $54,000 ($150,000 -$96,000). The other choices would result in the transaction being improperly recorded.

Financial Statements.

Statements that reflect the collection, tabulation, and final summarization of the accounting data. Four statements are involved. (1) The balance sheet shows the financial condition of the enterprise at the end of a period. (2) The income statement measures the results of operations during the period. (3) The statement of cash flows reports the cash provided and used by operating, investing, and financing activities during the period. (4) The retained earnings statement reconciles the balance of the retained earnings account from the beginning to the end of the period.

Why are personnel changes, such as the resignation or retirement of employees, not reflected in the accounting cycle?

Such events do not affect the assets, liabilities, or equity of a company, making their financial impacts difficult to measure.

Supplies A business may use several different types of supplies. For example, a CPA firm will use office supplies such as stationery, envelopes, and accounting paper. An advertising firm will stock advertising supplies such as whiteboard markers and printer cartridges.

Supplies are generally debited to an asset account when they are acquired. Recognition of supplies used is generally deferred until the adjustment process. At that time, a physical inventory (count) of supplies is taken. The difference between the balance in the Supplies (asset) account and the cost of supplies on hand represents the supplies used (an expense) for the period.

The terms debit (Dr.) and credit (Cr.) mean left and right, respectively. These terms do not mean increase or decrease, but instead describe where a company makes entries in the recording process.

That is, when a company enters an amount on the left side of an account, it debits the account. When it makes an entry on the right side, it credits the account. When comparing the totals of the two sides, an account shows a debit balance if the total of the debit amounts exceeds the credits. An account shows a credit balance if the credit amounts exceed the debits.

Journal.

The "book of original entry" where the company initially records transactions and selected other events. Various amounts are transferred from the book of original entry, the journal, to the ledger. Entering transaction data in the journal is known as journalizing.

ASSETS = LIABILITES + STOCKHOLDERS' EQUITY

The Accounting Equation must always balance -the accounting equation must always balance. Each transaction has a dual (double sided) effect on the equation. -EXAMPLE: If Assets increase, there must be a corresponding: (1) Increase in specific liability or (2) Increase in stockholders' equity or a (3) decrease in asset (exchange one asset for another).

Ledger.

The book (or computer printouts) containing the accounts. A general ledger is a collection of all the asset, liability, stockholders' equity, revenue, and expense accounts. A subsidiary ledger contains the details related to a given general ledger account.

In order for an event or item to be recorded for accounting purposes, which of the following must be true?

The event or item affects an element.

Closing Entries.

The formal process by which the enterprise reduces all nominal accounts to zero and determines and transfers the net income or net loss to a stockholders' equity account. Also known as "closing the ledger," "closing the books," or merely "closing."

Trial Balance.

The list of all open accounts in the ledger and their balances. The trial balance prepared immediately after all adjustments have been posted is called an adjusted trial balance. A trial balance prepared immediately after closing entries have been posted is called a post-closing (or after-closing) trial balance. Companies may prepare a trial balance at any time.

The number and type of accounts differ for each company.

The number of accounts depends on the amount of detail management desires

Posting.

The process of transferring the essential facts and figures from the book of original entry to the ledger accounts.

____________ is (are) generally only prepared at the end of a company's annual accounting period.

The trial balance after closing is called the post-closing trial balance. Since all temporary accounts will have zero balances, the post-closing trial balance will contain only permanent (real)—balance sheet—accounts. The other choices would occur prior to the post-closing trial balance.

Deferrals are expenses or revenues that are recognized at a date later than the point when cash was originally exchanged.

The two types of deferrals are prepaid expenses and unearned revenues. -If a company does not make an adjustment for these deferrals, the asset and liability are overstated, and the related expense and revenue are understated.

Financial StatementsWhat is the Objective of Financial Reporting?Provide decision useful financial information about the reporting entity to present and potential equity investors and creditors.

What is the principal means through which financial information is communicated? Financial Statements• Balance Sheet• Income Statement• Statement of Stockholders' Equity (Retained Earnings Statement) • Statement of Cash Flows

The purpose of transaction analysis is first to identify the type of account involved, and then to determine whether to make a debit or a credit to the account.

You should always perform this type of analysis before preparing a journal entry.

to have a complete record of each transaction or other event in one place,

a company uses a journal

Adjusted Trial Balance

a list of all accounts and their balances after we have updated account balances for adjusting entries

Accounting transaction -

an economic event that impacts the assets, liabilities or stockholders' equity (accounting equation) of an organization.

Account -

an individual accounting record of increases and decreases in a specific asset, liability, or stockholders' equity item. Each account appears in the general ledger.

permanent accounts—

assets, liabilities, and stockholders' equity (Common Stock and Retained Earnings)

unearned revenues

cash received and a liability recorded before services are performed record a liability by increasing (crediting)

accounting information system

collects and processes transaction data and then disseminates the financial information to interested parties

strict cash basis,

companies record revenue only when they receive cash. They record expenses only when they disperse cash. Determining income on the cash basis rests upon collecting revenue and paying expenses. The cash basis ignores two principles: the revenue recognition principle and the expense recognition principle. -NOT GAAP

adjusting entries

journal entries recorded to update general ledger accounts at the end of a fiscal period

If an adjusting entry is not made for a deferred revenue which was initally creditd to an unearned revenue account, which of the following results?

liabilites are overstated, revenues are understated, and assets are unaffected

accrual-basis accounting:

recognize revenue when the performance obligation is satisfied and expenses in the period incurred, without regard to the time of receipt or payment of cash.