Exam 2: Equations and Other Info Flashcards
(54 cards)
All about accrual-basis accounting
- Record economic events as they occur… assets at the time those resources are obtained, liabilities at the time those obligations occur, revenues at the time goods and services are provided to customers, and expenses at the time costs are used in running the company
- The intent is to provide accurate and timely information to financial statement users to make better decisions.
- Some costs, known as period costs, are more difficult to relate directly to a particular revenue activity, so we report those based on the period they occur (such as rent, advertising, or administrative salaries).
- Accrual-basis accounting is focused on the timing of transactions and events in the accounting cycle.
Similarities and differences between accrual-basis and cash-basis accounting
- Similarity:
– With both types, all revenues and expenses are eventually recorded for the same amount - Differences:
– The timing of when we record revenues and expenses is different (sometimes the timing is the same)
– Cash-basis accounting is not part of GAAP. All major companies use accrual-basis accounting to properly record revenues when goods and services are provided and record expenses in the period those costs have been used in company operations. Cash-basis accounting is not allowed for financial reporting purposes for most major companies.
When do you need adjusting entries?
When cash flows or obligations occur before the revenue-related or expense-related activity (prepayment) or when cash flows occur after the revenue-related or expense-related activity (accrual).
What are the categories of adjusting entries?
- Prepayments: prepaid expenses and deferred revenues
- Accurals: accrued expenses and accrued revenues
- Prepayments and accruals are opposites.
How do you do an adjusting entry for deferred revenue?
At the end of the reporting period, we determine the total amount of services provided and do a single adjusting entry to decrease the balance of Deferred Revenue to its remaining amount. We also recognize Service Revenue for the services provided during the period.
How do you do an adjusting entry for accrued expenses?
An adjusting entry is needed in the current period to record salaries payable (a liability) for the amount to be paid and to recognize salaries expense.
How do you do an adjusting entry for accrued revenues?
An adjusting entry is needed in the current period to record the amount receivable (an asset) and to recognize revenue, even though that cash won’t be received until a future period.
How do you do an adjusting entry for prepaid expenses?
- Common examples include the purchase of buildings, equipment, supplies, or prepaid rent. These payments are recorded as assets at the time of purchase.
- In the period these assets are used, an adjusting entry is needed to 1) decrease the asset’s balance to its remaining (unused) amount, and 2) recognize an expense for the cost of asset used.
All about depreciation
Depreciation is an estimate based on expected useful life and is an attempt to allocate the cost of the asset over its useful life. Depreciation is an internal calculation, and the book value doesn’t necessarily represent market value (what the asset could be sold for in the market).
All about deferred revenues
- Common examples include receiving cash in advance from customers for subscriptions, memberships, and gift cards.
- When a customer receives cash before providing services to customers, it owes the customer a service in return (this creates a liability).
- In the period those services are provided, the liability is settled, and adjusting entry is needed to 1) decrease the liability to its remaining amount owed, and 2) recognize revenue.
All about accrued expenses
- Common examples include the current cost of employee salaries, utilities, interest, and taxes that won’t be paid until the following period.
- Because the company has used these costs to operate the company in the current period and is obligated to pay them, an adjusting entry is needed to 1) record the liability to be paid, and 2) recognize the cost as an expense.
- There are 3 accrued expenses in the soccer example: employee salaries, utilities, and interest. Each represents costs used to operate the company during December, and the company is obligated to pay for these costs in the future.
All about accrued revenues
- Common examples include selling products and services to customers on account or being owed interest on amounts lent to others.
- Because the company has provided products and services in the current period and has the right to receive payment, an adjusting entry is needed to 1) record an asset for the amount expected to be received, and 2) recognize revenue.
Name 3 times when no adjustment is necessary.
- Transactions with owners do not involve the recognition of revenues or expenses.
- Transactions in which we receive cash at the same time we record revenue or in which we pay cash at the same time we record an expense do not require adjusting transactions (no timing differences).
Classified balance sheets separate assets and liabilities into what major categories?
Current assets and long-term assets // Current liabilities and long-term liabilities
How are current assets listed on a classified balance sheet?
Typically listed in order of liquidity…
- Cash is the most liquid of all assets, so it’s listed first.
- Accounts receivable (amounts owed by customers to the company) are generally collected within one month, so they are highly liquid assets and typically listed after cash.
- Prepaid expenses (such as supplies and prepaid rent) will not be converted to cash, but they are expected to be consumed within the next year, so they are included as current assets.
What are examples of current assets on a classified balance sheet?
-cash
- accounts receivable
- prepaid expenses (such as supplies and prepaid rent)
What are examples of long-term assets on a classified balance sheet?
- long-term investments
- property, plant, and equipment (such as land, buildings, equipment, machinery)
- intangible assets (such as patents, copyrights, trademarks, and franchises)
What are examples of current liabilities on a classified balance sheet?
- accounts payable
- deferred revenue
- salaries payable
- utilities payable
- interest payable
What is an example of a long-term liability on a classified balance sheet?
A loan that has a term longer than one year
How do you close revenue accounts?
Revenue accounts have credit balances, so we debit each revenue account for its balance and credit Retained Earnings for the total.
How do you close expense accounts?
Expense accounts have debit balances, so we credit each expense account for its balance and debit Retained Earnings for the total.
How do you close dividends accounts?
Dividends account has a debit balance, so we credit its balance and debit Retained Earnings for the same amount.
Which accounts should have a balance of $0 after closing entries?
All temporary accounts, so every revenue, expense, and dividend account. We start from scratch in measuring these the next period.
What is the ending balance of Retained Earnings after closing entries?
Ending Retained Earnings = Beginning Retained Earnings + net income - dividends
