Chapter 3: Accrual Accounting And Income Flashcards
Accrual Accounting
Records the impact of a business transaction as it occurs. When a business performs a service the accountant records the transaction even if the business receives or pays no cash
Cash-Basis Accounting
Records only cash transactions, cash receipts, and cash payments. Cash receipts are revenues and cash payments are expenses
GAAP
Requires accrual accounting
Balance Sheet Defect
If we fail to record a sale on account, the balance sheet reports no accounts receivable. Therefore assets are overstated
Income Statement Defect
A sale on account provides revenue that increases the company’s wealth. Ignoring that understates revenue and net income on the income statement
Cash transactions
Collecting cash from customers, receiving cash from interest earned, paying expenses, borrowing money, paying off loans, issuing stock
Non-Cash transactions
Sales on account, purchases of inventory on account, accrual of expenses incurred but not yet paid, depreciation expense, usage of prepaid rent, and earning of revenue when cash was collected in advance
Time Period Concept
Ensures that accounting information is reported at regular intervals. The basic accounting period is one year. A fiscal year ends any other date than December 31
Revenue Principle
Deals with when to record revenue (make a journal entry) and the amount of revenue to record. Revenue must be recorded after it is earned. The amount of revenue to record is the cash value of the goods or services transferred to the customer
Expense Recognition Principle
Deals with identifying all of the expenses incurred during the accounting period and measure the expenses, and recognize them in the same period in which any related revenues are earned
What accounts need to be adjusted?
Accounts receivable, supplies, and prepaid rent must be adjusted because certain transactions have not been recorded
Deferrals
Is an adjustment for payment of an item or receipt of cash in advance. Assets are used up and can become expensive. An adjusting entry is needed to update the asset account and the expense. There are also deferral adjustments for liabilities. A company may collect cash in advance of earning revenue which is called unearned service revenue
Depreciation
Allocates the cost of a plant asset to expense over the assets useful life. Depreciation is the most common long term deferral. Records wear and tear of assets
Accruals
Is the opposite of a deferral. An accrual is recording an expense or revenue before cash is collected.
Examples of Accruals
Income tax expense and interest expense
Prepaid Expenses
Is an expense that is paid in advance. Are assets because they provide a future benefit to the company
Plant Assets
Are long lived tangible assets, such as land, buildings, furniture, and equipment. All plant assets except for land decline in usefulness and this decline is an expense. Depreciation is the process of allocating cost to expense for a long term plant asset
Accumulated Depreciation
The account that shows the sum of all depreciation expense from using the asset. The balance increases over the useful life
Contra Account
Always has a companion account and its normal balance is opposite that of the companion account. Accumulated depreciation is the contra account to equipment
Book Value (of a plant asset)
The net amount of a plant asset (cost minus accumulated depreciation) is the assets carrying cost
Accrued Expense
Refers to a liability that arises from an expense that has not yet been paid. Companies don’t record accrued expenses daily or weekly. Instead, they wait until the end of the period and use an adjusting entry to update each expense
Accrued Revenues
Businesses often earn revenue before they receive the cash. A revenue that has been earned but not yet collected
Unearned Revenue
Some businesses collect cash from customers before earning the revenue. This creates a liability. Only when the job is completed does the business earn the revenue
Adjusted Trial Balance
Lists all of the accounts and their balances in a single place
Closing the Books
Means to prepare the accounts for the next periods transactions
Closing Entries
Set the revenue, expenses, and dividend balances back to 0 at the end of the period
Temporary Accounts
The closing process involves only revenues, expenses, and dividends
Permanent Accounts
Assets, liabilities, and stockholder’s equity are permanent accounts because they are the beginning balances of the next period
First Step to Close the Accounts
Debit each revenue account for the amount of its credit balance. Credit retained earnings
Second Step to Close the Accounts
Credit each expense account for the amount of the debit balance. Debit retained earnings
Third step to close the accounts
Credit the dividends account for the amount of the debit balance. Debit retained earnings
Liquidity
Measures how quickly an item can be converted to cash
Liquidity of Current Assets
Are the most liquid assets. They will be converted to cash, sold, or consumed during the next 12 months
Operating Cycle
Is the time span during which cash is paid for goods and services, and these goods and services are sold to bring in cash
Liquidity of Long Term Assets
Are all assets not classified as current assets. Plant assets is the most common with property and plant, land, and buildings
Liquidity of Current Liabilities
The sooner a liability must be paid l, the higher up the balance sheet it must be placed
Liquidity of Long Term Liabilities
Many notes payable are long term. Placed after current liabilities on the balance sheet
Balance Sheet Formats
Report format and account format
Report Format
Lists the assets at the top followed by liabilities and stockholder’s equity
Account Format
Lists the assets on the left and the liabilities and stockholder’s equity on the right side similar to t accounts
Income Statement Formats
Single step and multi step formats
Single Step Income Statement
Lists all of the revenues together under one heading and all of the expenses under another heading
Multi Step Income Statement
Reports a number of subtotals to highlight important relationships between revenues and expenses
Net Working Capital
Is computational data that represents operating liquidity.
Net Working Capital Formula
Net Working Capital = Total Current Assets - Total Current Liabilities
Current Ratio
Expressing operating data through the relationship between current assets and current liabilities
Current Ratio Formula
Current Ratio = Total Current Assets/ Total Current Liabilities
Debt Ratio
Includes the proportion of a company’s assets that is financed with debt. A lower debt ratio is better than a high debt ratio.
Debt Ratio Formula
Debt Ratio = Total Liabilities/ Total Assets
