Chapter 3 - Adjusting Accounts for Financial Statements Flashcards
Depreciation
The process of allocating the costs of long-term tangible assets over their expected useful lives.
Plant assets
- A special category of PREPAID EXPENSES
- Costs of these assets are gradually reported as expenses on Income Statement over it’s useful life
- Long term tangible assets used to produce and sell products or services
- Provide benefits for more than one period
- Eventually wear out or decline in usefulness
- Ex: Buildings, machines, vehicles, fixtures
Accrual basis accounting
Applies adjustments so that revenues are recognized when services and products are delivered, and expenses are recognized when incurred.
Follows GAAP
Cash basis accounting
Recognizes revenue when cash is received and records expenses when cash is paid.
Does not follow GAAP
4 Types of Adjustments
- Prepaid Expenses
- Unearned Revenues
- Accrued Expenses
- Accrued Revenues
Adjusting entry
Made at the end of an accounting period, to reflect a transaction or event that is not yet recorded.
Always affects accounts on Income Statement and Balance Sheet. Never the cash account.
Accumulated depreciation
A CONTRA ASSET account that has a normal balance of CREDIT and it’s reported on the balance sheet.
Calculating deprecation
Total cost - salvage cost / useful life
Prepaid Expenses
Pay for something in advance of receiving. When used their costs become expenses.
Turning and asset into an expense.
DECREASE an Asset
INCREASE an Expense
Unearned Revenues
Received cash but have not provided service yet.
A liability because you OWE a service.
Adjusting the entry:
DECREASE a Lability
INCREASE the Revenue
Accrued Expenses
Incur an expense that is not yet paid for.
A liability because you OWE money for expense.
INCREASE a LIABILITY
INCREASE an EXPENSE
Ex - Wages expense, an account with supplier
Formula for computing accrued interest expense
Principle amount x Annual interest rate x Fraction of year since last payment date
Adjusted trial balance
List of accounts and balances prepared after adjusting entries have been recorded and posted to ledger
Can prepare financial statement directly from adjusted trial balance
Closing process
Done at the end of an accounting period and AFTER FINANCIAL statements
Prepares accounts for recording of the next period
Purpose of closing process
- Resets revenue, expense, and dividends accounts
2. Helps summarize a period’s revenues and expenses
Steps to close temporary accounts
Step 1 - Close credit balances in Revenue Accounts
Step 2 - Close debit balances in Expense Accounts
Step 3 - Close Income Summary to Retained Earnings
Step 4 - Close Dividends Accounts to Retained Earnings
Accrued Revenue
Provided a service but have not been paid.
An asset
INCREASE an Asset
INCREASE Revenue
Ex - Services revenue in accounts receivable
Profit Margin =
Net Income / Net Sales
Current Ratio =
Current Assets / Current Liabilities
Post closing trail balance
List of PERMANENT accounts after all closing entries have been journalists.
Aim:
- verify total debits equal total credits for permanent accounts
- verify all temporary accounts have zero balances
Closing entries
Transfer of the end-of-period balances in revenue, expense, and dividends account to the permanent Retained Earnings account.
Steps in Accounting Cycle
- Analyze transaction
- Journalize (or record accounts)
- Post to General Ledger
- Prepare unadjusted trial balance
- Adjust and pots accounts
- Prepare adjusted trail balance
- Prepare financial statements
- Close accounts
- Prepare post closing trial balance
- Reverse and post (optional)
Unclassified Balance Sheet
Broadly groups accounts into assets, liabilities, and equity.
Classified Balance Sheet
Organizes assets and liabilities into sub groups.
These sub groups provide more information to decision makers.
“Current” items on classified balance sheet
Either collected or owed within one year or the company’s operating cycle
Assets on Classified Balance Sheet
- Current Assets (always listed first)
- Long term investments
- Plant assets
- Intangible assets
Liabilities on a Classified Balance Sheet
- Current liabilities (always listed first)
- Long Term liabilities
Prepaid Alternative Adjustment
Recording entire expense as debit to expense account.
ADJUSTMENT - Any unexpired or unused cost must be transferred to Prepaid Expense (asset) account.
Unearned Revenue Alternative Adjustment
Recording entire amount earned with a credit to revenue account.
ADJUSTMENT - Any unearned revenue must be transferred to Unearned Revenue (liability) account.
