Accounting Midterm 2 Study Guide Transaction Analysis Accrual Accounting Based on GAAP Required for companies that sell stock Not easily manipulated Revenues REALIZATION PRINCIPLE Independent of the exchange of cash Costs MATCHING CONCEPT Record in the same accounting period that revenue is earned Cash Accounting Does not follow GAAP Used by private companies Easily manipulated Must prepare FS with accrual accounting if they want a bank loan Record Revenues and Expenses when CASH Received Paid Accounts Place where all increases and decreases in FS are recorded Analyze with a T Account Debits LEFT Credits RIGHT Account Name Asset Liability Equity Revenu e Expense Increase Normal Balance Debit Credit Credit Credit Decrease Credit Debit Debit Debit Debit Credit Account Transactions economic event that requires recording in the financial statement BECAUSE they change Assets Liabilities or Equity Ledger All accounts of the company put together all T accounts Journal Place where all accounting transactions are initially recorded Journal Entry How each transaction is recorded in the journal Double Entry Recording add two entries together but they still have to balance Posting Transferring debit and credit amounts from Journal to Ledger Analyzing Transactions Process of identifying the specific effects of economic effects on Accounting Assets Liabilities and Equity Unique Transaction Gains Sell an asset other than inventory for more than you bought it for Considered a revenue account Losses Sell an asset other than inventory for less than what you bought it for Considered an expense account Dividends Ownership Withdrawals Not an expense account No effect on Income Statement Contra Equity Account Reducing effect on equity therefore behaves the opposite of equity Sole Proprietors have these instead of Dividends Not an expense account Are also Contra Equity Accounts Just reduce Contributes Capital Adjusting Closing Process The Accounting Cycle 1 Record Transactions in the Journal using Journal Entries 2 Post Debit Credit amounts from Journal to the Ledger in order to determine ending balance 3 Prepare an Unadjusted Trial Balance Primary Purpose Prove Debits Credits Use it to uncover errors However does not mean there are no errors if trial balance is in balance Ex Incorrect accounts incorrect amounts journal entry not recorded 4 Record and post Year End Adjusting Entries 5 Prepare an Adjusted Trial Balance 6 Prepare a Financial Statement from the Adjusted Trial Balance Adjusting Entries Ensure that the Realization Principle and the Matching Concept are followed 2 Main Types Deferrals Accruals Deferrals Deferred Expenses Prepaid Expenses Recorded as an asset Becomes an expense when item is used up Deferred Revenue Unearned Revenue Recorded as a liability Becomes a revenue when service is performed Depreciation Accruals Allocation of the cost of a PLANT ASSET over the cost of its useful life Record because of the Matching Concept Has nothing to do with the change of value of an asset DEBIT Depreciation Expense CREDIT Accumulated Depreciation Contra Asset Account Accrued Revenues Accrued Expenses Revenues earned but not received in cash Ex Sale of merchandise on account Expenses incurred but not yet paid for Ex Salaries Payable Interest Principal x Rate x Time Rate always annual Time x 12 Never computed for 1 year These adjusting entries happen FIRST Closing Entries 2 Types of Accounts Closing Entries Purpose Transfer Net Income or loss to Retained Earnings 3 Closing Entries to be made Permanent Real Assets Liabilities Equity NEVER closed to 0 at end of every year Nominal Temporary Revenues Expenses Dividends ALWAYS closed to 0 at end of every year After Closing Entries All Nominal Accounts must have a 0 balance Retained Earnings now represents the Net Income that is not paid as Dividends Revenues Expenses Dividends Debit Revenues Retained Earnings Retained Earnings Credit Retained Earnings Expenses Dividends Statement of Cash Flows Statement of Cash Flows Shows changes in cash for the same time that the Income Statement covers Provides information about Cash Receipts Inflows Cash Payments Outflows Cash Flows shows the Increase and Decrease of cash VERSUS Major Financial Statements Accrual Accounting Help users asses 1 Ability to generate future cash flows 2 Ability to pay dividends meet obligations 3 Why net income is different from operating cash flows 4 Cash investing and financing transactions Operating Activities Represent the cash effect of Revenues and Expenses that appear on the Income Statement Inflow Examples Sale of goods Interest received dividends from another company Outflow Examples Cash to the supplier for inventory to employee for services Investing Activities Cash relating to the selling of long term assets PP E Investments Intangibles Inflow Examples Cash from selling assets cash from principal on a loan you gave to another company Outflow Examples Purchasing an asset a loan you give to another company Financing Activities Cash paid or received from creditors or owners Involve all interest bearing Liabilities and Stockholder s Equity items Inflow Examples Sale of stock Money from loans received Outflow Examples Dividends Principal payment of a loan Creating the Operating Activities Section Purpose Convert Net Income to a Cash Basis of accounting Can be done by 2 ways Direct Method FASB prefers Indirect Method Companies prefer easier Reveals less about the company Direct Method 1 For each item of the Income Statement match it to an item on the Balance Sheet 2 Draw T accounts for Balance Sheet item and determine the amount of cash that the Income Statement item used Some accounts on the Income Statement have NO CASH effect Ignore them Depreciation Expense Losses Gains For Cost of Goods Sold 2 T account will need to be used Inventory Accounts Payable Exclusively used for Inventory Indirect Method Net Income Depreciation Expense noncash expense Gains Losses Decreases in Current Assets Except Cash Investments Increases in Current Assets Except Cash Investments Decreases in Current Liabilities Except Notes Payable Increases In Current Liabilities Except Notes Payable Net Cash from Operating Activities Explanations Depreciation Expense Gains and Losses eliminates effects of noncash Income Statement accounts Cash is represented in all the sections Investments are investing activities Notes Payable are financing activities Significant Noncash Activities Definition Financing and