ACCTG 211 1st Edition Lecture 4 Outline of Last Lecture I More Examples on how transactions affect the accounting equation II How to find the income statement III How to find the statement of changes in shareholder s equity IV How to calculate a balance sheet How to calculate cash flows V Examples of problems discussing cash flow Outline of Current Lecture I Short Term VS Long Term Accounting II Cash Basis Accounting III Accrual Accounting IV Accrual Accounts V Revenue Recognition Principle VI Expense Recognition Principle VII Matching Principle VIII There are 5 types of adjustments IX Examples of the 5 types of Adjustments X INTEREST EXPENSE XI DEPRECIATION Current Lecture XII XIII Short Term VS Long Term Accounting a Only assets and liabilities can be classified into short term or long term i Shareholder s Equity simply splits into the two separate parts of contributed capital and earned capital b Long Term i A liability or asset that will be in the company for more than one year c Short Term i A liability or asset that will be in the company for less than one year Cash Basis Accounting a Treats incoming cash as revenues and outgoing cash as expenses b The IRS uses this method for incomes and taxation rules c However we will not be using cash basis accounting in this class and it is not approved by GAAP These notes represent a detailed interpretation of the professor s lecture GradeBuddy is best used as a supplement to your own notes not as a substitute XIV XV XVI XVII XVIII XIX Accrual Accounting a The time of when an expense or revenue is recognized is separate from when the cash is actually received or disbursed i Recognize means to include on the financial statements 1 Usually speaking about the income statement here Accrual Accounts a Used in accrual accounting i Accounts Receivable Accounts Payable various Prepaid accounts and various Deferred accounts b It helps to think of accrual accounts as parking spots on the balance sheet which we can think of as the parking lot i You put money in one of these parking spots and it stays there until you have reason to increase or decrease it 1 Balance sheets are considered to be permanent accounts meaning that the account will remain from period to period ii Role Forward Approach is when people use prior data on assets and liabilities to start the next accounting period Revenue Recognition Principle a Revenue is only recognized when it is earned i To be earned means to do something to deserve it ii While you may not be immediately earning the cash you have done the task or delivered the item which you are going to get paid for b Although some companies use this method for accounting purposes they still receive their payment immediately i EX a cash only ice cream man Expense Recognition Principle a Expenses are recognized when they are incurred b Once an item has been used than it has been incurred i You buy a 12 month insurance policy but you are only 6 months into the term You have only incurred 6 months of that expense c Sometimes cash payment for our expenses happens as soon as an expense is incurred i EX paying an emergency tow truck Matching Principle a Expenses are matched to revenues in the period during which the expenses were incurred to generate the revenues b Helps businesses recognize how much they truly expended to earn the revenue during a certain period There are 5 types of adjustments a Accrued Revenue Think revenue now cash later b Accrued Expenses Think expense now cash later c Deferred Revenue Think cash now revenue later XX i Unearned Revenue d Deferred Expenses Think cash now expense later i Prepaid Expenses e Depreciation Think of this as a long term Deferred Expense adjustment i Depreciation is the transfer of a portion of the asset s cost from the balance sheet to the income statement during each year of the asset s life Examples of the 5 types of Adjustments a ACCRUED REVENUE i You have a consulting firm and you provide clients with 1000 worth of service 1 Increase accounts receivable by 1000 2 Increase revenue by 1000 b ACCRUED EXPENSE i You pay your employees 3 500 per work week M F ii However the accounting period ends on W iii Figure out that you pay your employees 7 000 per day iv By W you have had them work for 3 days 1 This means you have accrued 21 000 in salary expense v Increase salaries expense by 21 000 vi Increase Salaries payable by 21 000 c DEFERRED REVENUE i You collect 1 000 in advance for services you have not yet provided 1 Unearned revenue ii By the end of the period you have completed 250 worth of the job 1 Earned revenue 2 250 increase in earned revenue 3 250 increase in cash d DEFERRED EXPENSE i At beginning of month we purchase 2 400 of insurance that covers a period of 12 months ii The accounting period ends 6 months from this purchase iii Each month of insurance is costing you 200 iv By the end of the period you have used 1 200 worth of insurance 1 Increase 1 200 insurance expense 2 Decrease 1 200 cash e INTEREST EXPENSE i I P x R x T 1 I interest 2 P Principal amount borrowed 3 R rate of interest 4 T Time borrowed for a X months currently borrowed for f b Y months in total before you pay in full c T X Y ii When we sign a note note payable we need to adjust interest expense at the end of each accounting period DEPRECIATION i Increase Depreciation Expense Expense ii Increase Accumulated Depreciation Contra Asset iii Accumulated Depreciation is a contra asset account iv The amount of depreciation expense formula 1 Asset Cost Residual Value Useful Life 2 Straight Line Depreciation Expense per period of Useful Life