Turn in your homework assignment

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• Turn in your homework assignment

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CHAPTER 3

• Accrual Accounting and the Financial Statements

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Keeping Score

• Why accountants record transactions?
• To determine net income for firm!

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Two Bases of Accounting (1) Cash Basis
Accounting

• Records business transactions only when cash
  received or paid
• Easy way to record business transactions but not
  always accurate nor objective. Not GAAP!
• No Accounts Receivable or Accounts Payable

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(2) Accrual Basis Accounting

• GAAP (generally accepted accounting principles -
  Chapter 1) method for recording business
  transactions
• Recognizes revenues when earned
• Recognizes expenses when incurred
• Three concepts in accrual
• Time period
• Revenue
• Matching

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The Time Period Concept

• Companies want to provide users with relevant,
  timely information for business decisions
• At a minimum, companies calculate net income and
  report once each year (quarterly estimates are
  also provided).

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The Revenue Principle

• WHEN TO RECOGNIZE REVENUE need both
• (1) When to record revenue ( i.e. make a journal
  entry, After it has been earned and NOT BEFORE.
• (2) The amount of revenue to record? The cash
  value of the goods transferred to the customer.

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The Matching Principle

• Recognizes expenses in period when company uses
  its resources or other entities services to
  generate sales revenues
• Best determination of period net income is to
  match
• expenses, and
• revenues generated as a result of the expenses.

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Measuring a Businesss Net Income (Most
Important)

• Because its so important, before net income is
  calculated ...
• Additional steps taken at period-end to make net
  income more representative of companys
  income-generating activities
• This is the adjusting entries process

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Categories of Adjusting Entries

• Deferrals an adjustment for which the business
  paid or received cash in advance. For e.g.,
  prepaid expenses, unearned subscription revenue.
• Depreciation adjustment that reduces the book
  value of an asset over its life.
• Accruals An accrual is the opposite of a
  deferral. For e.g., Salary expense, interest
  revenue

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Prepaid Expenses Rent Note Prepaid expense is
an asset and not an expense

• On April 1, 2004, Air Sea Travel prepays three
  months office rent in cash

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Prepaid Expenses Rent

• What is the adjusting entry on April 30?

April 30 Rent Expense 1,000 Prepaid
Rent 1,000 To record rent expense
(3,000 x 1/3)
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Prepaid Expenses Supplies

• On April 2, 2004, Air Sea Travel paid cash of
  700 for office supplies.

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Prepaid Expenses Supplies

• An inventory at month end indicated that 400 in
  office supplies remained.

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Depreciation

• Allocation of the cost of a plant asset to
  expense over the assets useful life

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Depreciation of Plant Assets

• On April 3, the business purchased furniture on
  account for 16,000. The furniture is expected to
  last 5 years.

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Depreciation of Plant Assets

• Straight-line method of depreciation allocates
  equal amounts each accounting period.
• 16,000 5 years 3,200 per year
• 3,200 12 months 266 per month

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Depreciation of Plant Assets

• What is the adjusting entry on April 30?

April 30 Depreciation Expense,
Furniture 266 Accumulated Depreciation, Furni
ture 266 To record depreciation
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Accrued Expense

• A liability that arises from an expense that has
  not yet been paid.
• Air Sea Travel pays its employees a monthly
  salary of 1,900, half on the 15th and half on
  the last day of the month. If a payday falls on
  the weekend, Air Sea pays the employee on the
  following Monday.

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Accrued Expenses
Salary Expense
Cash
4/15 950
4/15 950
4/30 950
Bal. 1,900
Salary Payable
4/30 950
Bal. 950
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Accrued Revenue

• A revenue that has been earned but not received
  in cash.
• Bank One hires Air Sea Travel on April 15 to
  arrange travel services on a monthly basis. Bank
  One will pay the travel agency 500 monthly, with
  the first payment on May 15.

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Accrued Revenues

• Adjusting entry

April 30 Accounts Receivable 250 Service
Revenue 250 To accrue service revenue
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Adjusting Entries - A Summary

• Adjusting entries ALWAYS affect
• One income statement account (expenses or
  revenues)
• One balance sheet account (assets or liabilities)
• Never involve cash!

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The Adjusted Trial Balance

• Prepared after recording/posting all adjusting
  entries
• Adjusted trial balance data used to prepare
  financial statements

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Preparing Financial Statements from the Adjusted
Trial Balance

• Financials prepared in following order
• 1. Income Statement
• 2. Statement of Retained Earnings
• 3. Balance Sheet
• 4. Statement of Cash Flows

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Closing Entries

• Prepare the accounts for the next periods
  transactions.
• Transfer the revenue, expense, and dividends
  balances to Retained Earnings.

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Which AccountsNeed To Be Closed?

• Temporary accounts are closed
• Revenue
• Expense
• Dividends
• Permanent accounts are not closed
• Assets
• Liabilities
• Stockholders equity

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Journalizing the Closing Entries
April 30 Service Revenue 7,400 Retained
Earnings 7,400 April 30 Retained
Earnings 4,415 Rent Expense 1,000 Salary
Expense 1,900 Supplies Expense
300 Depreciation Expense 275 Utilities
Expense 400 Income Tax Expense 540 April 30
Retained Earnings 3,200 Dividends 3,200
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Posting the Closing Entries
Service Revenue
7,400
7,000 250 150 7,400
Retained Earnings
4,415 3,200
11,250 7,400 11,035
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The Accounting Cycle

• Journalize-daily
• Post-weekly
• Trial balance-monthly
• End of year
• Adjusting entries
• Adjusted trial balance
• Closing entries
• Financial Statements

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THE END of the Lecture on Chapter 3!
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First Exam Review

• Accounting Equation All combinations,
  Classification of assets and liabilities and
  owners equity what falls under which category
• Rules of Dr. and Cr. (ADELCR.) MEMORIZE
• Items that go to the balance sheet versus items
  that go to the income statements

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First Exam Review

• Go over slides and lecture notes carefully and
  understand them.
• Be clear about the effect of transactions on
  increases and decreases in assets, liabilities,
  and owners equity . Note revenues increase
  stockholders equity and expenses decrease
  stockholders equity.
• Revenue and Matching principles of accrual
  accounting.
• Adjusting entries (Chap. 3).
• Go over Homework problems.
• Read questions on the exam very carefully