4-1 ©2006 Prentice Hall, Inc.. 4-2 ©2006 Prentice Hall, Inc. THE ACCTG INFO SYSTEM AND THE ACCTG...


THE ACCTG INFO SYSTEMTHE ACCTG INFO SYSTEMAND THE ACCTG CYCLEAND THE ACCTG CYCLE (1 of (1 of

2)2)

Learning objectivesMeasuring income—recording reven

ues and expenses Timing differences Adjusting entries and preparing

financial statements


THE ACCTG INFO SYSTEMTHE ACCTG INFO SYSTEMAND THE ACCTG CYCLEAND THE ACCTG CYCLE (2 of (2 of

2)2)

Closing revenue and expense accounts

Financial statement analysis Business risk, control, and ethics


Learning ObjectivesLearning Objectives(1 of 2)(1 of 2)

Define accrual accounting and explain how income is measured

Explain accruals and deferrals and how they affect financial statements

Make adjusting entries and prepare the four financial statements


Learning ObjectivesLearning Objectives(2 of 2)(2 of 2)

Explain closing the books, and why it is done

Compute and explain the debt-to-total-assets ratio

Identify the five essential components of an internal control system


Measuring Income—Measuring Income—Recording Revenues and Recording Revenues and

Expenses Expenses (1 of 3)(1 of 3)

Accrual accountingRevenue

Earned when company delivers a product or performs a service

ExpensesIncurred when company uses resources or

services to help generate revenueReceipt or payment of cash does not

affect revenue or expense recognition




Cash accountingRevenue earned when cash is

receivedExpenses incurred when cash is paidDoes not require expenses to be

reported in same period related revenue earned




Time period assumptionBusiness activities evaluated using

specific time periodsE.g., months, quarters, years


Timing DifferencesTiming Differences(1 of 3)(1 of 3)

Difference between when item is recognized and actual cash flowCash received/paid before

revenue/expense recognizedRecognition deferred (postponed)

Cash received/paid after revenue/expense recognizedRecognition accrued

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©2006 Prentice Hall, Inc.


Difference between recognition and cash flow (continued)No timing difference when cash

received/paid at same time revenue/expense is recognizedRecognition occurs when cash flow occurs

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Rev/Exp

Cash

Cash Rev/Exp

Accural

Action Before $$

Deferral

$$ Before Action

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Adjusting Entries and Adjusting Entries and Preparing Financial Preparing Financial

StatementsStatements

The accounting cycleAdjusting entriesFinancial statements

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The Accounting Cycle(1 of 2)

Steps in the accounting cycle1. Analyze and record transactions in

journal2. Post journal entries to general ledger3. Prepare unadjusted trial balance

At end of the accounting period

4. Prepare adjusting journal entries Post them to general ledger

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The Accounting Cycle(2 of 2)

Steps in the accounting cycle (cont’d)5. Prepare an adjusted trial balance 6. Prepare the financial statements7. Prepare closing entries

Close temporary accounts Post temporary accounts to general ledger

8. Prepare post-closing trial balance sheet

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Adjusting Entries

Accrued revenuesAccrued expensesDeferred revenuesDeferred expenses

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Accrued RevenuesAccrued Revenues

Revenue earned but not yet Received in cashPreviously recorded

Types of accrued revenue adjustmentsInterest RevenueReceivables with interest Other accrued revenue

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Interest Revenue

Income earned from letting someone else use your money

Time passing is the action related to interest income

Interest = Principal x Rate x Time Principal - amount loanedRate - annual interest rateTime - portion of year loan outstanding

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Receivables with Interest(1 of 3)

On 10/1/08 SpongeCo loaned an employee $4,000 at 5%, for 3months

Date Transaction Debit Credit

Assets = Liab. + Cont. Cap. + R/E

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Record the adjusting entry on 12/31/08 to accrue 3 months of Interest Revenue



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Record receiving repayment of principal and interest on 1/1/09



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Other Accrued Revenue

Companies need to accrue revenue for income that has been earned from providing goods and/or servicesEven though the customer has not yet

been billed for the goods/services, orThe customer has received the bill, but

the company has not yet received payment

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Accrued ExpensesAccrued Expenses

Expenses incurred but not yetPaid in cashPreviously recorded

Types of accrued expense adjustmentsInterest ExpenseOther accrued expenses

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Accrued Interest Expense(1 of 3)

On 5/1/08 SpongeCo borrowed $20,000 from Shark Bank at 6%, for 8 months



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Record the adjusting entry on 12/31/08 to accrue 8 months of Interest Expense



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Record repayment of principal and interest on 1/1/09



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Other Accrued Expenses(1 of 2)

Some expenses are recorded at the end of the year because the accounting period ends after the expense was incurred and before it has been paid

Salary expense is one of the most common year-end accrued expenses

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Other Accrued Expenses(2 of 2)

SpongeCo employees are paid a total of $20,000 per week for a 5-day week. 12/31 is a Thurs. Accrue the salary expense on 12/31.



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Deferred RevenuesDeferred Revenues(1 of 3)(1 of 3)

Deferred revenuesDollars have been received in a prior

transactionAdjustment made for revenue earned

related to cash previously receivedOften called unearned revenue

Is unearned revenue an asset, liability, revenue, or expense?

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On 7/1/08 SpongeCo received $72,000 from customers for 24-month subscriptions to Square Pants Magazine



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Record the adjusting entry on 12/31/08 to recognize 6 months of subscription revenue



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Deferred ExpensesDeferred Expenses(1 of 2)(1 of 2)

Deferred expensesDollars were paid in a prior transactionAdjustment made for expense incurred

in current accounting period related to cash previously received

Often called prepaid expensesAre prepaid expenses assets,

liabilities, revenues, or expenses?

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Deferred ExpensesDeferred Expenses(2 of 2)(2 of 2)

Common prepaid expensesInsuranceRentSuppliesEquipment (depreciation)

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Prepaid Insurance(1 of 2)

On 4/1/08, SpongeCo purchased a 1-year flood insurance policy



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Prepaid Insurance(2 of 2)

12/31/08: Recognize the expense for the portion of insurance policy used up during 2008.



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Supplies(1 of 4)

Purchase of supplies is an asset exchangeSupplies Expense should reflect only

supplies used up during the periodSupplies on hand at the end of the period

should be recorded as an assetAre supplies a current or non-current asset?

Why don’t we record Supplies Expense when we purchase them?

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Supplies(2 of 4)

Supplies Expense computation

Beginning Balance+ Purchases- Ending Balance _

Supplies Used (expense)

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Supplies(3 of 4)

During May, SpongeCo purchases $800 of supplies. It had a beginning balance of $200.



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Supplies(4 of 4)

On May 31, SpongeCo had $225 of supplies on hand. Record the adjusting entry



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Depreciation(1 of 5)

Equipment that lasts longer than one year should be treated like any other prepaid expenseWe should allocate the cost of the asset

to the periods that benefit from the use of the assetThis is called depreciation

Depreciation has NOTHING to do with the FAIR MARKET VALUE of an asset

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A separate account is used to accumulate all depreciation related to an assetAccumulated Depreciation is a contra-asset

because it reduces the value of the asset on the booksBook value is the cost of an asset less

Accumulated DepreciationWhy don’t we reduce the asset account

directly for depreciation?

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Straight-line depreciationAllocates an equal amount of the

cost of the asset to each accounting period.

Annual depreciation formula Asset cost _ useful life (in years)

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On 1/1/08, SpongeCo purchased a new machine w/ a useful life of 3 yrs for $60,000



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12/31/08: Record the depreciation expense for 2008



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Preparing Financial Statements

Prior to preparing financial statements, the steps below in the accounting cycle are performed

1. Record transactions2. Posting transactions to the general

ledger3. Prepare an unadjusted trial balance4. Prepare and post adjusting entries5. Prepare an adjusted trial balance

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Closing Revenue and Closing Revenue and Expense AccountsExpense Accounts (1 of 5) (1 of 5)

After preparing the financial statements, revenues and expenses as well as dividends have to be transferred from those temporary accounts to retained earnings.

After this process, the income stmt. and div. accounts are reset to zero.

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1. Revenue accounts are reset to zero. Since they have credit balances, we

use a DEBIT to decrease the accounts to zero (a zero balance).

The retained earnings account is CREDITED because revenues increase retained earnings.

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2. Expense accounts are reset to zero. Since they have DEBIT balances, we

use a CREDIT to decrease the accounts to zero (a zero balance).

The retained earnings account is DEBITED because expenses decrease retained earnings.

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3. Dividends account is reset to zero. Since it has a DEBIT balance, we use a

CREDIT to decrease the account to zero (a zero balance).

The retained earnings account is DEBITED because dividends decrease retained earnings.

A post-closing trial balance is prepared, showing only permanent accounts.

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Prepare closing entries for the following accounts.

Retained Earnings

Dr. Cr.500 beg bal

Service RevenueDr. Cr.

100

Rent ExpenseDr. Cr.20

Wage ExpenseDr. Cr.40

DividendsDr. Cr.10

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Financial Statement Financial Statement AnalysisAnalysis

Debt-to-assets ratioMeasure of long-term liquidity

What are two measures of short-term liquidity?

Also called a solvency ratio

Total LiabilitiesTotal Assets

Is a higher or lower ratio desirable?

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Business Risk, Control, Business Risk, Control, and Ethicsand Ethics

Controls that help a firm make sure all of its transactions are recordedPre-numbered documentsSegregation of duties

The person who does the record-keeping for an asset does not have control of the asset

How can the segregation of duties control be circumvented?

Comments or questions about PowerPoint Slides?Contact Dr. Richard Newmark atUniversity of Northern Colorado’s

Kenneth W. Monfort College of [email protected] 4-

52©2006 Prentice Hall, Inc.

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