Transaction Analysis Cash vs Accrual Accounting Accrual accounting based on GAAP Realization principle o Record revenue when 1 The earnings process is complete or virtually when goods are sold services performed complete 2 There is reasonable certainty as to the collectability of the asset received o It is not necessary to receive cash in order to record revenue o The receipt of cash doesn t always indicate that a revenue has been earned o Record revenue independent of exchange of cash o It is required that the receipt of cash be relatively assured in order to record revenue Problem 1 The Matching Principle o Record expenses when 1 The same accounting period that the related revenue is earned in The determining factor in the timing of recording expenses is the generation of revenue not the payment of cash For most expenses it is difficult to trace to a specific revenue so they recorded when they are incurred Problem 2 Cash accounting does not follow GAAP o Record revenues when cash is received o Record expenses when cash is paid Problem 3 Accrual accounting must be used by all companies who sell stock to the public Cash accounting can be used by any company who doesn t sell stock to the public Cash accounting is also used by individuals to account for their personal finances If a company who does not sell stock to the public attempts to a get a bank loan they are typically required to present their financial statements using accrual accounting This is usually required because cash accounting can be easily manipulated and thus could lead to misleading financial statements place where all increases and decreases in financial statement are recorded Account Analyze accounts using a T account o 1 Top heading place account name o 2 Left side debit o 3 Right side credit Example 4 Accounting transactions economic events that require recording in the financial statements o Transactions are recorded in the financial statements because they result in a change to assets liabilities and or equity accounts o Not all activities represent transactions all the accounts of the company taken together think of the ledger as all the T Ledger accounts of the company Journal Journal entry Notice debts always credits Double entry accounting the place where all accounting transactions are initially recorded the means used to record transactions in the journal one debit with the total dollar debits total dollar credits Posting process of transferring credit and debit accounts from the journal ledger every transaction must be recorded with at least one credit and o Posting the T accounts allows us to determine the ending balance in each account Double entry system Example 5 Gains effects two or more accounts a gain is recorded when you sell an asset other than inventory for more than it cost o You are not in the business of selling these assets they are not part of your Losses a loss is recorded when you sell an asset other than inventory for less than it cost o You are not in the business of selling these assets they are not part of your inventory o The gain selling price cost o A gain is classified as a revenue account inventory o The loss cost selling price o A loss is classified as an expense account New account dividends o Payments by corporation to stockholders o Not an expense account o Dividends are classified as a contra equity account since it reduces equity Accounting Cycle Basic Steps 1 Record transactions in the journal use journal entries 2 Post debit and credit amounts from the journal to the ledger 3 Prepare a trial balance o Trial balance a list of accounts and their balances at a given time The primary purpose of a trial balance is to prove debits credits after posting If debits and credits do not agree the trial balance can be used to uncover errors in journalizing a post o The total debits must equal the total credits Errors can occur and trial balance agrees o Incorrect accounts or amounts used in journalizing or posting o A journal entry is not recorded 4 From trial balance prepare financial statements Financial statement analysis financial statement numbers and the trends in those numbers over time involves the examination of both the relationships among o Purposes o 1 Use the past performance of a company to predict how it will do in the future o 2 Evaluate the performance of a company with an eye toward identifying problem areas Financial ratios relationships between financial statements amounts o Ratios are used by creditors and investors to help them make decisions o Specifically these ratios aid users in deciding whether or not to invest in or loan money to a company a single ratio by itself is not very meaningful they provide meaningful information Note when they can be compared with same bench mark needs to be a comparison o Typical benchmarks or Comparison Points 1 Other companies that operate in the same industry 2 Industry averages 3 Past years trend analysis Two ratios to be discussed o 1 Working capital current assets current liabilities o 2 Current ratio currents assets current liabilities Both of these are referred to as liquidity ratios Liquidity ratios due measure the short term ability of the company to its debts as they come o Who cares Short term creditors such as bankers and suppliers Both ratios give a user a feel for the company s ability to pay their debts when their due one ratio is in the form of a dollar and the other in form of of times Effects of transactions on the liquidity ratios o Assume working capital is positive and the current ratio is greater than 1 Transaction purchased supplies costing 200 on account o We are increasing assets and current liabilities by 200 Adjusting and Closing Process Accounting Cycle Basic steps 1 Record transactions in the journal 2 Post from the journal to the ledger 3 Prepare an unadjusted trial balance 4 Record past year end adjusting entries 5 Prepare an adjusted trial balance 6 From the adjusted trial balance prepare financial statements Revenues recorded when earned Expenses are recorded in the same period they help to earn revenues Accrual Accounting o Realization principle o Matching concept Adjusting entries are followed are needed to ensure that the realization principle and matching concept o 1 Revenues are recorded in the period earned o 2 Expenses are recognized in the period incurred Regardless as to when cash is received or paid Adjusting entries account balances journal entries made at the end of the