Ch.3 Flashcards
Revenue:
increase in net assets from day to day operations
Gain:
increase in net assets from peripheral or incidental transactions
Net assets formula:
Net Assets = Assets – Liabilities
How would you get an increase in Net assets?
either Assets increase or Liabilities decrease
Revenue Recognition Principle:
explains the timing and measurement of revenues and gains for firms
Timing definition:
when to recognize the revenue
When would you recognize revenue?
Recognize revenue when EARNED
Measurement:
is the amount of revenue to recognize
Realized:
cash has been received
Realizable:
cash is expected to be received and can be measured
Expense:
decrease in net assets from day to day operations
Loss:
decrease in net assets from peripheral or incidental transactions
How would you get a decrease in Net assets?
either Assets decrease or Liabilities increase
Matching Principle:
explains the timing and measurement of expenses and losses for firms.
Direct Matching:
match expenses with revenues recognized in the
same accounting period
Indirect Matching:
match expenses with a particular period instead of a revenue
Accrual basis accounting:
-Revenues are recognized when they meet revenue recognition principle
-Expenses are incurred when they meet matching principle.
Cash Basis accounting:
-Revenues are recognized when cash is
-Expenses are incurred when cash is
-Real accounts: Cash and Equity
-Nominal Accounts: Revenue, Expense, Withdrawal by owners (all close
to equity)
Which basis of accounting do we use most often?
In this class, we will ALWAYS USE ACCRUAL BASIS ACCOUNTING (which is in accordance with GAAP).
How many steps in accounting cycle?
12
What is step 5 of the accounting cycle?
Step 5. End of Period
End of Period:
artificial time period like end of quarter or fiscal year.
Going Concern Assumption:
assumes firm will have infinite life
Periodicity Assumption:
breaks life of firm into artificial time periods for the
purpose of creating financial statements.
What is step 6 of the accounting cycle?
Step 6. Record Adjusting Entries (AJE)
Adjusting Journal Entries:
journal entries made at the end of the accounting
period to bring all accounts up to date so that financial statements can be prepared on an accrual basis.
Rules of Adjusting Entries:
- Do not include cash in adjusting entry
- Every adjusting entry always affects:
-at least one account PERMANENT ACCOUNT/BALANCE SHEET (asset, liability, or equity account)
- and at least one account TEMPORARY ACCOUNT (revenue or expense account)
What are the types of Adjusting entries ?
Adjusting entries are either Accruals or Deferrals
Accruals:
when revenue recognized or expense incurred before cash
changes hands
Deferrals:
Cash changes hands before the revenue is recognized or the expense is
incurred
Accrued revenues (assets) definition:
revenue is recognized before cash is received
Accrued revenues (assets):
o Happens when
1) time has passed and customer has received some service/goods and
2) the customer intends to pay in the future
o At end of period, the adjusting entry will:
1) recognize the correct amount of revenue earned and
2) adjust the firm’s assets (increase receivables) to reflect how much
the firm will receive in the future from the customer.
Accrued expenses (liabilities) definition:
expenses incurred before cash is paid
Accrued expenses (liabilities):
o Happens when
1) time has passed and firm has received some service or goods
and 2) firm intends to pay in the future.
o At the end of the period, the adjusting entry will
1) incur the correct amount of expense due to the passage of time
and 2) adjust (increase) the firm’s liabilities to reflect how much it owes.
Deferred revenues (aka Unearned Revenues) definition:
cash is received before revenue is
recognized
Deferred revenues (aka Unearned Revenues):
o Happens when
1) customer prepays the firm for service or goods; creating a liability
(Unearned Revenue) on the firm’s books
and 2) time has passed and customer has received some or all of the
prepaid service or goods thus reducing the firm’s liability.
o At end of period, the adjusting entry will
1) recognize the correct amount of revenue earned due to passage of time
and 2) adjust the firm’s obligation (decrease liabilities) to provide
goods/services in the future.
Deferred expenses (aka Prepayments) definition:
cash is paid before the expense is
incurred
Deferred expenses (aka Prepayments):
Happens when
1) firm prepays for future service or goods
and 2) time has passed and firm has received some or all of the prepaid
service or goods.
o At the end of the period, the adjusting entry will
1) incur the correct amount of expense due to the passage of time
and 2) adjust the unexpired costs (decrease the prepaid asset) that will be used in future periods.
Depreciation:
When a fixed asset is acquired, its cost is recorded in an
asset account. As the asset helps to generate revenue, the cost is converted to an expense.
Straight Line Depreciation expense formula:
=Historical Cost – Est. Salvage Value/
Est. Useful Life
What is step 7 of accounting cycle?
Post AJE to the General Ledger
What is step 8 of accounting cycle?
Prepare an Adjusted Trial Balance
Adjusted Trial Balance:
a listing of all accounts (real and nominal) and their
balances at the end of the period after adjusting entries have been recorded.Goal is to ensure Debits = Credits
What is step 9 of accounting cycle?
Prepare financial statements
Classified Balance Sheet :
Splits Assets & Liabilities into Current & Long-term
(Classified Balance Sheet) Assets order:
1.Current assets
2. Long term investments
3. PPE
4.Intangible assets(or other assets)
(Classified Balance Sheet) Liabilities order:
1.Current Liabilities {Accounts Payable, Wages Payable, Unearned Revenues, Notes Payable}
2.Long term liabilities {Notes payable, Bonds payable}
Stockholders Equity:
claims of owners against the net assets of the firm. (Assets -
Liabilities = SHE)
What is step 10 of accounting cycle?
Record Closing Journal Entries (CJE)
Closing Journal Entries:
reduced all nominal (temporary) accounts to zero by
closing them through Retained Earnings (or Income Summary then RE)
Nominal (Temporary) accounts:
-Income Statement: all revenues, gains, expenses, losses, and their
contra and adjunct accounts
-Statement of RE: dividends declared
Why do closing entries?
-In preparation for recording the transactions of the next period, all the
nominal accounts must have a balance of zero.
- Net income (loss) for the period is transferred to owner’s equity (RE) by closing all Income Statement accounts into Retained Earnings
- 3 Closing Entries:
What is step 11 of accounting cycle?
Post-Closing Journal Entries to General Ledger
What is step 12 of accounting cycle?
Prepare a Post-Closing Trial Balance
