BUS 2101

Decision Making

Financial Information Business Activities

Financial Statement Analysis

Financial Statements

GAAP

Operating

Investing

Financing

Income Statement

Users

External

Internal

Statement of Cash Flow

Balance Sheet

Annual Reports

Management Discussion

Notes

Auditor’s Report

Statement of Retained Earnings

Ratios

Liquidity

Profitability

Solvency

Market

Preparation

The Big Picture…

Accrual Accounting Concepts

• Cash basis accounting• Accrual basis accounting• Matching principle• Adjusting entries

– Prepayments– Accruals

• Adjusted trial balance• Closing entries• Accounting cycle

Cash basis accounting• Revenue recorded when cash is received

– No revenue if customer doesn’t pay at time of transaction

• Expenses recorded when they are paid– No expense unless payment made in period

• Advantage– Simple

• Disadvantage– Useful information???

• Often used by small businesses• Used by individuals for income tax purposes

Accrual basis accounting• Revenue recognition principle: Revenue is

recorded when service is performed or goods are delivered– May not be in the same period cash is received

• Matching principle: Expenses are recorded in the period they help generate revenue– May not be in the same period payment is made

• Adjusting entries: Needed based on revenue recognition and matching principles

Adjusting entries– Prepayments

• Prepaid expenses– Purchased supplies on 1/10/10 of $680– As of 1/31/10, only $100 of supplies in closet

1/10/10

Supplies (asset) 680

A/P 680

1/31/10

Supplies expense

580

Supplies 580

Adjusting entries– Prepayments

• Prepaid expenses– Paid $4,800 for 2010 insurance policy on 1/5/10– As of 1/31/10, used one month of insurance coverage

1/5/10

Prepaid Insurance

4,800

Cash 4,800

1/31/10

Insurance expense

400

Prepaid Insurance

400

Adjusting entries– Prepayments

• Depreciation– Paid $480,000 on 1/2/10 for building expected to last 20 years– $480,000 / 20 years = $24,000 depreciation expense– As of 1/31/10, need to record one month’s depreciation expense

1/2/10

Building 480,000

Cash 480,000

1/31/10

Depreciation expense 2,000

Accumulated depreciation

2,000

Adjusting entries– Unearned revenue

• Received $600 on 1/2/10 to fly customer to L.A. on 2/16/10

• As of 2/16/10, need to record revenue

Cash 600

Unearned revenue 600

Unearned revenue 600

Revenue 600

Adjusting entries– Accrued revenue: revenue earned but no cash received

• On 2/12/10, performed surgery on patient. Sent patient bill for $73 on 2/17/10.

• As of 2/28/10 no payment has been received

If not on 2/12/10, then 2/28

A/R 73

Revenue 73

Adjusting entries– Accrued expenses: expense incurred but not paid

• On 1/01/10, borrowed $100,000 at 6%. Interest is payable on 2/1/10.

• As of 1/31/10, no interest has been paid

1/1/10

Cash 100,000

Notes Payable 100,000

1/31/10

Interest expense 500

Interest payable 500

2/1/10

Interest payable 500

Cash 500

Adjusting entries

• Never an entry to cash• Either

– Dr. Expense or– Cr. Revenue– Other side of entry is to an asset or

liability account

Adjusted Trial Balance

• See page 177

Closing Entries

• Must reset income and expenses to zero before next accounting period

• Income summary is the basket used to do this

Closing Entries

• Debit Revenue, dump into Income Summary (Credit)– Revenue

•Income Summary• Credit Expenses, dump into Income

Summary (Debit)– Income Summary

•Expenses

Closing Entries

• Dump Net Income into Retained Earnings– Income Summary (if revenue > expenses)

•Retained earnings

• Dump Dividends into Retained Earnings– Retained Earnings

•Dividends

Accounting Cycle

Journal entries

Closing entries

PCTB

Financial statements

Adjusting entries

Prepare trial balance

Post to ledger accounts

BUS 2101

Decision Making

Financial Information Business Activities

Financial Statement Analysis

Financial Statements

GAAP

Operating

Investing

Financing

Income Statement

Users

External

Internal

Statement of Cash Flow

Balance Sheet

Annual Reports

Management Discussion

Notes

Auditor’s Report

Statement of Retained Earnings

Ratios

Liquidity

Profitability

Solvency

Market

Preparation

The Big Picture…