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THE ACCTG INFO SYSTEMTHE ACCTG INFO SYSTEMAND THE ACCTG CYCLEAND THE ACCTG CYCLE (1 of (1 of
2)2)
Learning objectivesMeasuring income—recording reven
ues and expenses Timing differences Adjusting entries and preparing
financial statements
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THE ACCTG INFO SYSTEMTHE ACCTG INFO SYSTEMAND THE ACCTG CYCLEAND THE ACCTG CYCLE (2 of (2 of
2)2)
Closing revenue and expense accounts
Financial statement analysis Business risk, control, and ethics
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Learning ObjectivesLearning Objectives(1 of 2)(1 of 2)
Define accrual accounting and explain how income is measured
Explain accruals and deferrals and how they affect financial statements
Make adjusting entries and prepare the four financial statements
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Learning ObjectivesLearning Objectives(2 of 2)(2 of 2)
Explain closing the books, and why it is done
Compute and explain the debt-to-total-assets ratio
Identify the five essential components of an internal control system
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Measuring Income—Measuring Income—Recording Revenues and Recording Revenues and
Expenses Expenses (1 of 3)(1 of 3)
Accrual accountingRevenue
Earned when company delivers a product or performs a service
ExpensesIncurred when company uses resources or
services to help generate revenueReceipt or payment of cash does not
affect revenue or expense recognition
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Measuring Income—Measuring Income—Recording Revenues and Recording Revenues and
Expenses Expenses (2 of 3)(2 of 3)
Cash accountingRevenue earned when cash is
receivedExpenses incurred when cash is paidDoes not require expenses to be
reported in same period related revenue earned
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Measuring Income—Measuring Income—Recording Revenues and Recording Revenues and
Expenses Expenses (3 of 3)(3 of 3)
Time period assumptionBusiness activities evaluated using
specific time periodsE.g., months, quarters, years
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Timing DifferencesTiming Differences(1 of 3)(1 of 3)
Difference between when item is recognized and actual cash flowCash received/paid before
revenue/expense recognizedRecognition deferred (postponed)
Cash received/paid after revenue/expense recognizedRecognition accrued
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Timing DifferencesTiming Differences(2 of 3)(2 of 3)
Difference between recognition and cash flow (continued)No timing difference when cash
received/paid at same time revenue/expense is recognizedRecognition occurs when cash flow occurs
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Timing DifferencesTiming Differences(3 of 3)(3 of 3)
Rev/Exp
Cash
Cash Rev/Exp
Accural
Action Before $$
Deferral
$$ Before Action
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Adjusting Entries and Adjusting Entries and Preparing Financial Preparing Financial
StatementsStatements
The accounting cycleAdjusting entriesFinancial statements
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The Accounting Cycle(1 of 2)
Steps in the accounting cycle1. Analyze and record transactions in
journal2. Post journal entries to general ledger3. Prepare unadjusted trial balance
At end of the accounting period
4. Prepare adjusting journal entries Post them to general ledger
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The Accounting Cycle(2 of 2)
Steps in the accounting cycle (cont’d)5. Prepare an adjusted trial balance 6. Prepare the financial statements7. Prepare closing entries
Close temporary accounts Post temporary accounts to general ledger
8. Prepare post-closing trial balance sheet
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Adjusting Entries
Accrued revenuesAccrued expensesDeferred revenuesDeferred expenses
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Accrued RevenuesAccrued Revenues
Revenue earned but not yet Received in cashPreviously recorded
Types of accrued revenue adjustmentsInterest RevenueReceivables with interest Other accrued revenue
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Interest Revenue
Income earned from letting someone else use your money
Time passing is the action related to interest income
Interest = Principal x Rate x Time Principal - amount loanedRate - annual interest rateTime - portion of year loan outstanding
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Receivables with Interest(1 of 3)
On 10/1/08 SpongeCo loaned an employee $4,000 at 5%, for 3months
Date Transaction Debit Credit
Assets = Liab. + Cont. Cap. + R/E
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Receivables with Interest(2 of 3)
Record the adjusting entry on 12/31/08 to accrue 3 months of Interest Revenue
Date Transaction Debit Credit
Assets = Liab. + Cont. Cap. + R/E
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Receivables with Interest(3 of 3)
Record receiving repayment of principal and interest on 1/1/09
Date Transaction Debit Credit
Assets = Liab. + Cont. Cap. + R/E
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Other Accrued Revenue
Companies need to accrue revenue for income that has been earned from providing goods and/or servicesEven though the customer has not yet
been billed for the goods/services, orThe customer has received the bill, but
the company has not yet received payment
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Accrued ExpensesAccrued Expenses
Expenses incurred but not yetPaid in cashPreviously recorded
Types of accrued expense adjustmentsInterest ExpenseOther accrued expenses
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Accrued Interest Expense(1 of 3)
On 5/1/08 SpongeCo borrowed $20,000 from Shark Bank at 6%, for 8 months
Date Transaction Debit Credit
Assets = Liab. + Cont. Cap. + R/E
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Accrued Interest Expense(2 of 3)
Record the adjusting entry on 12/31/08 to accrue 8 months of Interest Expense
Date Transaction Debit Credit
Assets = Liab. + Cont. Cap. + R/E
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Accrued Interest Expense(3 of 3)
Record repayment of principal and interest on 1/1/09
Date Transaction Debit Credit
Assets = Liab. + Cont. Cap. + R/E
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Other Accrued Expenses(1 of 2)
Some expenses are recorded at the end of the year because the accounting period ends after the expense was incurred and before it has been paid
Salary expense is one of the most common year-end accrued expenses
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Other Accrued Expenses(2 of 2)
SpongeCo employees are paid a total of $20,000 per week for a 5-day week. 12/31 is a Thurs. Accrue the salary expense on 12/31.
Date Transaction Debit Credit
Assets = Liab. + Cont. Cap. + R/E
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Deferred RevenuesDeferred Revenues(1 of 3)(1 of 3)
Deferred revenuesDollars have been received in a prior
transactionAdjustment made for revenue earned
related to cash previously receivedOften called unearned revenue
Is unearned revenue an asset, liability, revenue, or expense?
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Deferred RevenuesDeferred Revenues(2 of 3)(2 of 3)
On 7/1/08 SpongeCo received $72,000 from customers for 24-month subscriptions to Square Pants Magazine
Date Transaction Debit Credit
Assets = Liab. + Cont. Cap. + R/E
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Deferred RevenuesDeferred Revenues(3 of 3)(3 of 3)
Record the adjusting entry on 12/31/08 to recognize 6 months of subscription revenue
Date Transaction Debit Credit
Assets = Liab. + Cont. Cap. + R/E
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Deferred ExpensesDeferred Expenses(1 of 2)(1 of 2)
Deferred expensesDollars were paid in a prior transactionAdjustment made for expense incurred
in current accounting period related to cash previously received
Often called prepaid expensesAre prepaid expenses assets,
liabilities, revenues, or expenses?
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Deferred ExpensesDeferred Expenses(2 of 2)(2 of 2)
Common prepaid expensesInsuranceRentSuppliesEquipment (depreciation)
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Prepaid Insurance(1 of 2)
On 4/1/08, SpongeCo purchased a 1-year flood insurance policy
Date Transaction Debit Credit
Assets = Liab. + Cont. Cap. + R/E
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Prepaid Insurance(2 of 2)
12/31/08: Recognize the expense for the portion of insurance policy used up during 2008.
Date Transaction Debit Credit
Assets = Liab. + Cont. Cap. + R/E
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Supplies(1 of 4)
Purchase of supplies is an asset exchangeSupplies Expense should reflect only
supplies used up during the periodSupplies on hand at the end of the period
should be recorded as an assetAre supplies a current or non-current asset?
Why don’t we record Supplies Expense when we purchase them?
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Supplies(2 of 4)
Supplies Expense computation
Beginning Balance+ Purchases- Ending Balance _
Supplies Used (expense)
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Supplies(3 of 4)
During May, SpongeCo purchases $800 of supplies. It had a beginning balance of $200.
Date Transaction Debit Credit
Assets = Liab. + Cont. Cap. + R/E
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Supplies(4 of 4)
On May 31, SpongeCo had $225 of supplies on hand. Record the adjusting entry
Date Transaction Debit Credit
Assets = Liab. + Cont. Cap. + R/E
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Depreciation(1 of 5)
Equipment that lasts longer than one year should be treated like any other prepaid expenseWe should allocate the cost of the asset
to the periods that benefit from the use of the assetThis is called depreciation
Depreciation has NOTHING to do with the FAIR MARKET VALUE of an asset
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Depreciation(2 of 5)
A separate account is used to accumulate all depreciation related to an assetAccumulated Depreciation is a contra-asset
because it reduces the value of the asset on the booksBook value is the cost of an asset less
Accumulated DepreciationWhy don’t we reduce the asset account
directly for depreciation?
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Depreciation(3 of 5)
Straight-line depreciationAllocates an equal amount of the
cost of the asset to each accounting period.
Annual depreciation formula Asset cost _ useful life (in years)
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Depreciation(4 of 5)
On 1/1/08, SpongeCo purchased a new machine w/ a useful life of 3 yrs for $60,000
Date Transaction Debit Credit
Assets = Liab. + Cont. Cap. + R/E
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Depreciation(5 of 5)
12/31/08: Record the depreciation expense for 2008
Date Transaction Debit Credit
Assets = Liab. + Cont. Cap. + R/E
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Preparing Financial Statements
Prior to preparing financial statements, the steps below in the accounting cycle are performed
1. Record transactions2. Posting transactions to the general
ledger3. Prepare an unadjusted trial balance4. Prepare and post adjusting entries5. Prepare an adjusted trial balance
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Closing Revenue and Closing Revenue and Expense AccountsExpense Accounts (1 of 5) (1 of 5)
After preparing the financial statements, revenues and expenses as well as dividends have to be transferred from those temporary accounts to retained earnings.
After this process, the income stmt. and div. accounts are reset to zero.
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Closing Revenue and Closing Revenue and Expense AccountsExpense Accounts (2 of 5) (2 of 5)
1. Revenue accounts are reset to zero. Since they have credit balances, we
use a DEBIT to decrease the accounts to zero (a zero balance).
The retained earnings account is CREDITED because revenues increase retained earnings.
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Closing Revenue and Closing Revenue and Expense AccountsExpense Accounts (3 of 5) (3 of 5)
2. Expense accounts are reset to zero. Since they have DEBIT balances, we
use a CREDIT to decrease the accounts to zero (a zero balance).
The retained earnings account is DEBITED because expenses decrease retained earnings.
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Closing Revenue and Closing Revenue and Expense AccountsExpense Accounts (4 of 5) (4 of 5)
3. Dividends account is reset to zero. Since it has a DEBIT balance, we use a
CREDIT to decrease the account to zero (a zero balance).
The retained earnings account is DEBITED because dividends decrease retained earnings.
A post-closing trial balance is prepared, showing only permanent accounts.
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Closing Revenue and Closing Revenue and Expense AccountsExpense Accounts (5 of 5) (5 of 5)
Prepare closing entries for the following accounts.
Retained Earnings
Dr. Cr.500 beg bal
Service RevenueDr. Cr.
100
Rent ExpenseDr. Cr.20
Wage ExpenseDr. Cr.40
DividendsDr. Cr.10
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Financial Statement Financial Statement AnalysisAnalysis
Debt-to-assets ratioMeasure of long-term liquidity
What are two measures of short-term liquidity?
Also called a solvency ratio
Total LiabilitiesTotal Assets
Is a higher or lower ratio desirable?
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Business Risk, Control, Business Risk, Control, and Ethicsand Ethics
Controls that help a firm make sure all of its transactions are recordedPre-numbered documentsSegregation of duties
The person who does the record-keeping for an asset does not have control of the asset
How can the segregation of duties control be circumvented?
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