ucf acg2021 ch 3 ppt
TRANSCRIPT
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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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Adjustments Deferrals
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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Adjustments Deferrals
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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Adjustments Deferrals
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
Date Accounts and Explanations Debit Credit
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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Adjustments Depreciation
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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Adjustments Depreciation
Depreciation Expense = Cost of the Asset
Useful Life
Depreciation Expense=$20,000=$4,000/year
5 years
Depreciation Expense=$4,000/yr=$333/month
12 months
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Adjustments Depreciation
What is the adjusting entry on December31, 2005 to record the proper amount ofDepreciation Expense for the period?
General Journal
Date Accounts and Explanations Debit Credit
12/31 Depreciation Expense - Furniture 333
Accumulated Depreciation - Furniture 333
To record depreciation expense for furniture
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Adjustments Depreciation
Book Value (or carrying amount) is the netamount of the plant asset, calculated bynetting the cost of the asset minus therelated accumulated depreciation. Book value is notthe same as fair market value.
Book value represents the amount left to beallocated to depreciation expense in futureperiods.
Furniture 20,000$
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?