Ucf Acg2021 Ch 3 Ppt

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Chapter ThreeAccrual Accounting

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Accrual Accounting vs. Cash-BasisAccounting

Two alternative methods may be usedfor calculating a businesss net income:

Accrual Basis of Accounting

Cash Basis of Accounting

Cash Basis of Accounting Revenues are recorded when cash is

received.

Expenses are recorded when cash is paid. No notion of Accounts Receivable (A/R) or

Accounts Payable (A/P).

Nota GAAP method.

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Accrual Accounting vs. Cash-BasisAccounting

Two alternative methods may be used forcalculating a businesss net income:

Accrual Basis of Accounting

Cash Basis of Accounting

Accrual Basis of Accounting Revenues are recorded when they are earned

i.e., when the service is performed or thegoods are delivered.

Expenses are recorded when resources areutilized to use revenue i.e., when used orconsumed.

GAAP Method.

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Accrual Accounting Concepts

Revenue Principle governs that revenueshould be recognized when it is earned (i.e.,when performance has occurred).

Matching Principle governs the recognition

of expenses (i.e., that expenses should berecognized when they are incurred).

Time-Period Concept (Periodicity) governsthe reporting of accounting information

and/or financial statements at regularintervals.

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Adjustment Process

The calculation of Net Income (Revenues Expenses) at the end of a period is critical.

Accountants make certain adjustments at theend of the period in order to update records

and accurately reflect all revenues andexpenses.

The adjustment process involves recording allrevenues and expenses that have been earnedor incurred in the current period.

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Rules of Thumb on Adjusting Entries

Each adjusting entry will affect oneRevenue or Expense account and oneAsset or Liability account.

The key to figuring out the necessaryadjusting entries is to:

(1) Identify the revenue or expense thatneeds to be updated.

(2) Identify the corresponding asset orliability account affected by the transaction.

Adjusting entries neveraffect cash.

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Adjusting Entries Deferrals

Deferrals are when cash has beenreceived or paid in advance of actuallyrecognizing an expense or revenue.

Supplies (Asset) = purchased $500 worth of

office supplies. Prepaid Insurance (Asset) = paid $10,000 in

advance for a 6-month insurance premium.

Prepaid Rent (Asset) = paid $10,000 in

advance for 1 year of rent. Unearned Revenue (Liability)= received

$2,000 in advance to paint two houses in thefuture.

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Deferrals Initial Journal Entry

Since cash has been received or paid in advance, itmay be helpful to think of the original journal entry.This is notrequired unless the problem specifies it,but can be a helpful first step.

Supplies 500Cash (or A/R) 500

Prepaid Insurance/Prepaid Rent 10,000

Cash 10,000

Cash 2,000

Unearned Revenue 2,000

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Adjustments Deferrals

Example of the adjustment process for Prepaid Expenses(deferrals) Prepaid Rent, Prepaid Insurance, and Supplies

These are expenses recorded in advance, in an asset account.

Must properly allocate the expenses to the period during the

adjustment process.

Example: On December 1, 2005, Shilling Construction, Inc. pre-

pays 12 months of rent expense in the amount of $10,000.

10,000

Prepaid Rent

10,000

Cash

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What is the adjusting entry on December31, 2005 to record the proper amount ofRent Expense for the period?

General Journal

Date Accounts and Explanations Debit Credit

12/31 Rent Expense ($10,000/12) 833

Prepaid Rent 833

To record rent expense

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Example of the adjustment process for Unearned Revenue, inwhich Revenues (Cash) are received before they are earned.Unearned Revenue is a liability account.

Example: On December 1, 2005, Georgetown Painters received$2,000 to paint two houses. At the time of receiving the cash,Georgetown planned to perform the work in the future.

2,000

Cash

2,000

Unearned Revenue

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As of December 31, 2005, Georgetown hadpainted 1 of the two houses.

What is the adjusting entry on December 31,2005 to record the proper amount of revenue forthe month?

General Journal


12/31 Unearned Revenue 1,000

Service Revenue ($2,000/2) 1,000To record rent revenue

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Adjustments Depreciation

Depreciation is the allocation of the cost of a plant assetto expense over the plants useful life.

Long-lived plant assets (buildings, equipment, etc.)are not expensed when purchased; rather, suchassets are expensed as they are used or consumed.

Depreciation expense is recorded in each accountingperiod in which the asset is used.

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Adjusting Entry Depreciation Expense

Calculating depreciation expense: Using the straight-line depreciation method,

allocate an equal amount each accountingperiod in which the asset is expected to benefit(the useful life).

Land is never depreciated.

Depreciation expense = Cost of the Asset

Useful Life

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Adjusting Entry Depreciation Expense

Accumulated DepreciationThe cumulative total ofall depreciation

expense relating to a particular plant asset.

It is a contra asset. This means it is ananti-asset, meaning it is presented with acompanion asset account, but it has anormal balance that is opposite thecompanion account.

Accumulated Depreciation has a credit

balance and increases with a credit. Book Value

Asset Accumulated Depreciation =Book Value

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Example of the adjustment process fordepreciation:

On December 1, 2005, Shilling Construction purchases

new office furniture on account for $20,000. The

furniture is expected to last 5 years.

20,000

Furniture Accounts Payable

20,000

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Depreciation Expense = Cost of the Asset

Useful Life

Depreciation Expense=$20,000=$4,000/year

5 years

Depreciation Expense=$4,000/yr=$333/month

12 months

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What is the adjusting entry on December31, 2005 to record the proper amount ofDepreciation Expense for the period?

General Journal


12/31 Depreciation Expense - Furniture 333

Accumulated Depreciation - Furniture 333

To record depreciation expense for furniture

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Book Value (or carrying amount) is the netamount of the plant asset, calculated bynetting the cost of the asset minus therelated accumulated depreciation. Book value is notthe same as fair market value.

Book value represents the amount left to beallocated to depreciation expense in futureperiods.

Furniture 20,000$

Less Accumulated Depreciation (333) 19,667$

Book value of plant assets 19,667$

Plant Assets of Shilling Construction at 12/13/05

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Adjustments Accrued Expenses

Salary Payable

12/31 950Bal. 950

Bal. 1,90012/31 950

Salary Expense

12/15 950

Cash

12/15 950

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Adjustments Accrued Revenues

Example of the adjustment process for Accrued Revenues,which are revenues that have been earned but notyet paidin cash.

Example: Towne East hires Air & Sea Travel on April 15th toprovide travel services on a monthly basis. Towne East will

pay Air & Sea Travel $500 monthly, with the first paymenton May 15th .

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Adjustments Accrued Revenues

Adjusting Entry:

General Journal

Date Accounts and Explanations PR Debit Credit

4/15 Accounts Receivable ($500 * 1/2) 250

Service Revenue 250To accrue service revenue.

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Summary of Adjusting Entries

Adjusting entries always affect at least: One Revenue or Expense account which

measure net income.

One Asset or Liability account which

update the Balance Sheet.

Adjusting entries neverinvolve cash.

**Exhibit 3-7 on page 121 has a useful chart regarding thecategory of adjusting entries and the types of accountsaffected.

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Adjusted Trial Balance

The Adjusted Trial Balance is a list of all of theledger accounts (i.e., all of the T-accounts)with their adjusted balances.

The Adjusted Trial Balance is used to preparethe financial statements.

Trial Balance Adjustments Adjusted TrialBalance

Debit Credit Debit Credit Debit Credit

Refer to Exhibit 3-9, page 123, for format.

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Preparation of Financial Statements

Using the Adjusted Trial Balance, the financialstatements must be prepared in the following order:

(1) Income Statement Single step All Revenues, followed by all Expenses.

Multi-step Subtotals (such as COGS and Gross Profit).

(2) Statement of Retained Earnings(3) Balance Sheet Assets Current Assets first (in order of liquidity), followed

by Long-Term Assets.

Liabilities Current Liabilities, then Long-Term Liabilities.

Note: theStatement of Cash Flows does not need to be

prepared in a particular order, but it is typically prepared last.

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Closing the Books

Closing the books is the process at the endof the period that journalizes and posts theclosing entries to set the balances of thetemporary or nominal accounts to zero.

Prepares the account for the next periodstransaction.

Transfers the temporary or nominal accountbalances to Retained Earnings.

What are temporary or nominal accounts??

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Closing the Books

Temporary or Nominal Accounts areclosed

Revenues

Expenses

Dividends

Permanent Accounts are not closed

Assets

Liabilities

Stockholders Equity

Do you notice any patterns?

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Closing the Books

Rules for closing Revenue accounts: DebitRevenue accounts and Credit RetainedEarnings.

4/30 Service Revenue 2,500

Retained Earnings 2,500

Rules for closing Expense accounts: DebitRetained Earnings and Credit the Expenseaccounts.

4/30 Retained Earnings 1,000

Rent Expense 1,000 Rules for closing Dividend accounts: DebitRetained Earnings and Credit Dividends.

4/30 Retained Earnings 500

Dividends 500

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Current Ratio and Debt Ratio

Current Ratio: Measures a companysability to pay current liabilities withcurrent assets.

Rule of thumb: a strong current ratio is around1.50-2.00.

High ratio: can pay current debts as they comedue, but too high may signify too many low-earning current assets.

Total Current AssetsTotal Current Liabilities

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Current Ratio and Debt Ratio

Debt Ratio: Measures a businesss abilityto pay total liabilities. Signifies theproportion of assets that is financed withdebt.

Total LiabilitiesTotal Assets

A low debt ratio is safer than a high debt ratio;this also signifies lower interest expense.

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Questions?

Any questions or concerns?

Documents

Ucf Acg2021 Ch 3 Ppt