Study Guides (248,578)
Canada (121,621)
Administration (1,205)
ADM1340 (89)

ADM1340 Midterm Review

50 Pages
Unlock Document

Marc Tasse

Chapter  1         The  Purpose  and  Use  of  Financial  Stateme   Users  and  Uses  of  Accounting   Accounting  is  the  information  system  that  identifies  and  records  the  economic   events  of  an  organization,  and  then  communicates  them  to  a  wide  variety  of   interested  users.     Internal  Users   • Plan,  organize,  and  run  companies.   • Financial  directors,  marketing  managers,  human  resource  personnel,   production  supervisors,  and  company  officers.     External  Users   • Investors  à  to  make  decisions  to  buy,  hold,  or  sell  their  ownership  interest.   • Lenders  à  to  evaluate  the  risks  of  lending  money.     • Creditors  à  to  decide  whether  or  not  to  grant  credit.   • Customers,  employees,  labour  unions,  taxing  authorities  and  regulators.   Ethical  Behaviour  By  Users   • For  accounting  information  to  have  value,  preparers  must  have  high  ethical   standards:   – Actions  are  legal  and  responsible   – Consider  organization’s  interests   • Accountants,  other  professionals,  and  most  companies  have  rules  or  codes  of   conduct  to  guide  ethical  behaviour     • Companies  have  rules  of  conduct   1.  Recognize  an  ethical   2.  Identify  and  analyze  the 3.  Identify  the  alternative,  and   situation  and  the  ethical  issues   main  elements  in  the  situation.   weigh  the  impact  of  each   involved.   alternative  on  various   stakeholders.   Forms  of  Business  Organization   Proprietorships   • Owned  by  one  person   • Simple  to  set  up   • Owner  has  control  over  business   • Unlimited  liability  (owner  receives  any  profits,  suffers  any    es) • Life  of  the  proprietorship  is  limited  to  the  life  of  the  owner.   • The  business  profits  are  reported  as  self-­‐employment  income  and  taxed  on   the  owner’s  personal  income  tax  return.   • Business  records  must  be  kept  separate  from  those  related  to  the  owner’s   personal  activities.  (Reporting  entity  concept)   ADM1340  MIDTERM  REVIEW   1     CHAPTER  1   Partnership   • Similar  to  proprietorship  except  owned  by  more  than  one  person   • Formalized  in  a  written  agreement   o Formation  of  the  partnership   o Partners’  contributions   o How  profits  and  losses  are  shared   o Provisions  for  withdrawals  of  assets  and/or  partners   o Dispute  resolution   o Partnership  liquidation   • Each  partner  has  unlimited  liability   • The  business  profits  are  reported  as  self-­‐employment  income  and  taxed  on   each  partner’s  personal  income  tax  return.   • Business  records  must  be  kept  separate  from  those  related  to  the  partners’   personal  activities. (Reporting  entity  concept)   Corporations   • Separate  legal  entity  owned  by  shareholders  (owners  of  shares)   • Indefinite  life   • Owners  enjoy  limited  liability   • May  be  public  or  private:   o Depends  on  whether  shares  are  publicly  traded   • Proprietors  and  partners  pay  personal  income  tax  on  their  respective  shares   of  the  profits.   • Corporations  pay  income  tax  as  separate  legal  entities  on  any  corporate   profits.     Public  corporations   distribute  their  financial  statements  to  investors,  lenders,  other   creditors,  other  interested  parties,  and  the  general  lic.   Private  corporations   issue  shares,  but  they  do  not  make  them  available  to  the  general   public.  They  almost  never  distribute  their  financial  statements  pub  lly. Business  Activities   Financing  Activities   • Obtaining  (and  repaying)  funds  to  finance  the  operations  of  the  business:   o Borrowing  money  or  repaying  loans  (debt  financing)   o Selling  or  repurchasing  shares  (equity  financing)   • Forms  of  debt:   o Bank  indebtedness   [Pre-­‐arranged  bank  loan,  company  draws  more  money  than   cash  on  hand]     o Bank  loans   [Money  borrowed]   o Noncurrent  debt  such  as  mortgages,  bonds,  leases       2   ADM1340  MIDTERM  REVIEW     CHAPTER  1   Investing  Activities   • Purchase  or  sale  of  long-­‐lived  assets  needed  to  operate  the  company   • Examples:   – Purchase  or  sale  of  long-­‐term  investments   – Purchase  or  sale  of  long-­‐lived  assets  such  as  property,  plant  and   equipment  and  intangible  assets   Assets  are  resources  that  a  company  owns  or  controls.   Operating  Activities   • Operating  activities  are  the  main  day-­‐to-­‐day  activities  of  the  business   • Examples:   o Revenues   o Expenses   o Related  accounts  such  as  accounts  receivable  and  accounts  payable   Financial  Statements   Income  statement:   An  income  statement  reports  revenues  and  expenses  to  show  how   successfully  a  company  performed  during  a  period  of  time   Statement  of  changes  in  equity:   A  statement  of  changes  in  equity  shows  the  changes  i n   each  component  of  shareholders’  equity,  as  well  as  total  equity,  during  a  period    time. Statement  of  financial  position  [Balance  Sheet]:   A  statement  of  financial  position   presents  a  picture  of  what  a  company  owns  (its  assets),  what  it  owns  (its  liabili ties),  and  its   net  worth  (its  shareholders’  equity)  at  a  specific  point      time. Statement  of  cash  flows:   A  statement  of  cash  flows  shows  where  a  company  obtained   cash  during  a  period  of  time  and  how  that  cash  was  used.   Income  Statement   • Revenues:   o Arise  from  the  sale  of  a  product  or  service   o Result  in  an  inflow  of  assets   • Expenses:   o Costs  of  assets  consumed  or  services  used  to  generate  revenues   Profit  (loss)  =  Revenues  -­‐  expenses   Amounts  received  from  issuing  shares  are  not  revenues,  and  amounts  paid  out   as  dividends  are  not  expenses.     Statement  Of  Changes  In  Equity   Shareholders’  equity  includes  (1)  share  capital  and  (2)  retained  earnings.     • Share  capital:  amounts  contributed  by  shareholders.   • Retained  earnings:  cumulative  profit  retained  in  the  corporation.   o Deficit:  negative  retained  earnings.     Beginning  balance  of  share  capital  à  adds  any  changes  (new  shares,  repurchased  shares)         ADM1340  MIDTERM  REVIEW   3     CHAPTER  1   Statement  Of  Financial  Position  (Balance  Sheet)   Assets  =  Liabilities  +  Shareholders’  Equity   • Assets:  Resources  owned  by  a  business   • Liabilities:  Obligations  of  the  business   • Shareholders’  equity:  Share  capital  and  retained  earnings   Statement  Of  Cash  Flows   • Reports  the  effect  on  cash  of  the  company’s:   o Operating  activities   o Investing  activities   o Financing  activities   • Shows  net  increase  or  decrease  in  cash  for  the  period     Relationships  between  the  Statements   • Profit  from  income  statement  is  reported  in  statement  of  changes  in  equity   • Ending  balances  of  shareholders’  equity  is  reported  in  both  statements  of   financial  position  and  changes  in  equity   • Statement  of  cash  flows  is  related  to  statement  of  financial  position   Annual  Report   • Publicly  traded  companies  must  prepare  an  annual  report  each  year   • Includes  financial  and  nonfinancial  information  about  the  company:   o Financial:  management  discussion  and  analysis  (“MD&A”)  statement   of  management  responsibility,  auditors’  report,  financial  statements   and  notes   o Nonfinancial:  company’s  mission  and  goals,  products,  people   Generally  Accepted  Accounting  Principles  (GAAP)   • Rules  and  practices  for  the  preparation  of  financial  statements   • Different  for  publicly-­‐traded  and  private  corporations:   – Publicly-­‐traded  corporations  use  International  Financial  Reporting   Standards  (IFRS)   – Private  corporations  may  use  IFRS  or  Accounting  Standards  for   Private  Enterprises  (ASPE)   • Proprietorships  and  partnerships  do  not  have  to  use  IFRS  or  ASPE  as   statements  are  prepared  for  internal  users  only   4   ADM1340  MIDTERM  REVIEW       Chapter  2             A  Further  Look  at  Financial  Statements   The  Classified  Statement  of  Financial  Position   (Balance  Sheet)   A  classified  statement  of  financial  position  generally  contains  the  following  standard   classifications:   Assets   Liabilities  and  Shareholders’  Equity   Current  assets   Current  liabilities   Investments     Non-­‐current  liabilities     Property,  plant,  and  equipment   Shareholders’  equity   Goodwill     Share  capital       Retained  earnings   Assets   Current  Assets   • Assets  expected  to  be  converted  to  cash  or  used  in  the  business  within  one   year  or  one  operating  cycle:   o Operating  cycle  is  the  average  time  it  takes  to  go  from  cash  to  cash  in   producing  revenue   • Usually  listed  in  order  of  liquidity   (Reverse  order  of  liquidity  also  possible)   Common  types  of  current  assets  include:   1. Cash   2. Short-­‐term  investments  -­‐   investments  in  debt  securities  (shares  of  another  company)   3. Accounts  receivable  –   amounts  owed  to  the  company  by  customers   4. Accrued  receivables  –   amounts  owed  to  the  company  for  interest,  sales  tax,  rent. ..   5. Notes  receivable  –   amounts  owed  to  a  company  supported  by  a  promise  to  repay   6. Inventory  –   goods  held  for  sale  to  customers   7. Supplies  –   consumable  items   8. Prepaid  expenses  –   expenses  paid  in  advance     Non-­‐Current  Assets   • Assets  not  expected  to  be  converted  to  cash  or  used  in  the  business  within   one  year  or  one  operating  cycle   Common  types  of  non-­‐current  assets  include:   1. Investments  –   long  term  investments  (loans,  mortgages,  bonds)   2. Property,  plant,  and  equipment  –   tangible  assets  with  long  useful  lives   3. Intangible  assets  and  goodwill  –   assets  that  do  not  have  a  physical  substance   Liabilities   Current  Liabilities   • Obligations  that  are  to  be  paid  within  the  coming  year  or  one  operating  cycle   Common  examples  of  current  liabilities  include:   1. Bank  indebtedness  –   short-­‐term  loan  from  a  bank  (line  of  credit)   2. Accounts  payable  –   amounts  owed  by  the  company  to  suppliers  for  purchases  made  on  credit   3. Accrued  liabilities  –   amounts  owed  by  the  company  salaries,  rent,  sales  tax…   ADM1340  MIDTERM  REVIEW   5     CHAPTER  2   4. Notes  payable  –   amounts  owed  supported  by  a  promise  to  repay   5. Current  maturities  of  long-­‐term  debt  –   portion  of  the  payment  due  within  the  current  ear Non-­‐Current  Liabilities   • Debts  expected  to  be  paid  or  settled  after  one  year   • Usually  accompanied  by  extensive  notes  to  the  financial  statements   Common  examples  of  non-­‐current  liabilities  include:   1. Notes  payable  –   including  bank  loans  payable,  mortgages  payable,  and  bonds  payable.     2. Lease  obligations  –   amounts  to  be  paid  in  th e  future  on  long-­‐term  rental  cont  s 3. Pension  and  benefit  obligations  –   amounts  owed  to  employees  for  retirement  benefits   4. Deferred  income  tax  liabilities  –   income  tax  that  is  expected  to  be  payable  l   Shareholders’  Equity   Share  capital   • Investment  of  cash  (or  other  assets)  in  the  company  by  shareholders  in   exchange  for  preferred  or  common  shares   Retained  earnings   • Cumulative  profits  kept  for  use  in  the  company   Using  the  Financial  Statements   • Ratio  analysis  expresses  the  relationships  between  selected  items  of  financial   statement  data.   • Use  comparisons  to  aid  in  analyses:   o Intracompany  comparisons   covering  two  years  for  the  same  company   o Intercompany  comparisons   based  on  comparisons  with  a  competitor  in   the  same  industry   o Industry  average  comparisons   based  on  average  ratios  for  particular   industries   Using  The  Statement  Of  Financial  Position   (Balance  Sheet)     Liquidity   • Measure  a  company’s  short-­‐term  ability  of  to  pay  its  obligations  that  will   come  due  within  the  next  year   Working  Capital:  difference  between  current  assets  and  current  liabilities.   Working  Capital   =  Current  Assets  –  Current  Liabilities   Current  Ratio:  dividing  current  assets  and  current  liabilities.            Current  Assets         Current  Ratio   = Current  Liabilities     HIGHER  IS  GENERALLY  BETTER       6   ADM1340  MIDTERM  REVIEW     CHAPTER  2   Solvency   • Measure  a  company’s  ability  to  survive  over  a  long  period  of  time:   o The  higher  the  percentage  of  debt  to  total  assets,  the  greater  the  risk   that  debts  cannot  be  repaid  when  they  are  due   Debt  to  Total  Assets:  measures  the  percentage  of  assets  that  is  financed  by  lenders   and  other  creditors  rather  than  by  shareholders.              Total  Liabilities           Debt  to  Total  Assets     =     Total  Assets   LOWER  IS  GENERALLY  BETTER   Using  The  Income  Statement   Profitability   • Measure  a  company’s  operating  success  for  a  given  period  of  time   Earnings  per  Share:  measures  the  profit  earned  on  each  common  share.   Profit  Available  to  Common  Shareholders Earnings  per  Share     =              Weighted  Average  Number  of  Common  Shares     Price-­‐Earnings  Ratio:  ratio  of  the  stock  market  price  of  each  common  share  to  its   earnings  per  share.    Market  Price  per  Share Price Earnings  Ratio     =   Earnings  per  Share   HIGHER  IS  GENERALLY  BETTER   Framework  for  the  Preparation  and  Presentation  of  Financial  Statements   Conceptual  Framework  For  Financial  Reporting   Objective  of  financial  reporting   • To  provide  financial  information  that  is  useful  to  existing  and  potential   investors,  lenders  and  other  creditors   • Who  are  making  decisions  about  providing  resources  to  a  company:   o Buying,  selling,  holding  equity  and  debt     o Providing  or  settling  loans  or  other  credit   • Financial  information  is  provided  by  general  purpose  financial  statements   using  accrual  accounting   Qualitative  characteristics  of  useful  financial  information   • Identify  the  types  of  information  that  are  likely  to  be  most  useful  to  existing   and  potential  investors.     Fundamental  Qualitative  Characteristics   Relevance   • Information  has  relevance  if  it  makes  a  difference  in  users’  decisions   ADM1340  MIDTERM  REVIEW   7     CHAPTER  2   • May  have  predictive  value  and/or  confirmatory  value   o Predictive:  if  it  helps  make  predictions  about  future  events.   o Confirmatory:  if  it  helps  confirm  or  correct  their  previous  predictions.     • Materiality  is  important:  will  information  influence  the  decisions  of  users?   Faithful  representation   • Information  should  reflect  economic  reality   • It  must  be  complete,  verifiable  and  free  from  material  error   Enhancing  Qualitative  Characteristics   • Comparability   o Users  can  identify  and  understand  similarities  and  differences  in  items   • Verifiability   o Independent  consensus  that  information  is  faithfully  represented   • Timeliness   o Available  before  it  loses  its  usefulness  in  decision-­‐making   • Understandability   o Classified,  characterized  and  presented  clearly  and  concisely   Cost  Constraint   • Ensures  that  the  value  of  the  information  provided  by  financial  reporting  is   greater  than  the  cost  of  providing  it   • The  benefits  of  financial  reporting  should  justify  the  costs  of  providing  and   using  it   Underlying  Assumption     • The  going  concern  assumption  assumes  that  a  company  will  continue  in   operation  for  the  foreseeable  future.     Elements  of  financial  statements   • Assets   • Liabilities   • Equity   • Income   • Expenses   Measurements  of  the  elements  of  financial  statements   • Accountants  have  developed  principles  that  describe  when  and  how  the   elements  of  financial  statements  should  be:   o Recognized   o Measured,  and   o Reported   • Historical  cost   o Assets  and  liabilities  should  be  recorded  at  their  cost  when  acquired   o Not  only  at  time  of  purchase,  but  throughout  the  life  of  each  asset  and   liability   • Fair  value   o Certain  assets  and  liabilities  should  be  recorded  and  reported  at  fair   value   • In  choosing  between  these  two,  apply  the  concepts  of  relevance  and   representational  faithfulness   8   ADM1340  MIDTERM  REVIEW       Chapter  3           The  Accounting  Information  System   Accounting  Transactions   • Accounting  information  system:  the  system  of  collecting  and  processing   transaction  data  and  communicating  financial  information   • Can  vary  widely  based  on  factors  such  as:   o Type  of  business  and  its  transactions   o Size  of  company   o Amount  of  data   o Information  requirements   • An  accounting  transaction  occurs  when  assets,  liabilities,  or  shareholders’   equity  items  change  as  a  result  of  some  economic  event.     Analyzing  Transactions   • Transaction  analysis  determines  impact  on  the  accounting  equation   Assets  =  Liabilities  +  Shareholders’  Equity   • The  accounting  equation  must  always  balance   o Therefore,  each  transaction  has  a  dual  (double-­‐sided)  effect  on  the   equation   Sierra  Corporation  Example:       Transaction  (1):  Investment  by  Shareholders.     On  October  1,  cash  of   $10,000  was  invested  in  Sierra  Corporation  in  exchange  for  10,000  common  shares.       Transaction  (2):  Issue  of  Note  Payable.     Also  on  October  1,  Sierra   borrowed  $5,000  from  Scotiabank  by  signing  a  note  payable.  It  promised  to  repay   the  note,  plus  6%  interest,  in  three  months.     Transaction  (3):  Purchase  of  Equipment.     On  October  1,  Sierra  acquired   equipment  by  paying  $5,000  cash  to  Superior  Equipment.       Transaction  (4):  Receipt  of  Cash  in  Advance  from  Customer.   On  October  2,   Sierra  received  a  $1,200  cash  advance  from  R.  Knox,  a  client,  for  advertising  services   that  are  expected  to  be  completed  before  November  15.     Revenue  should  not  be  recorded  until  the  work  has  been  performed.  However,  since  cash  was   received  before  performing  the  advertising  services,  Sierra  has  a  liability  for  the  work  due.  We  call   this  liability  unearned  revenue.     Transaction  (5):  Payment  of  Rent.   Also  on  October  2,  Sierra  Corporation   paid  its  office  rent  for  the  month  of  October  in  cash,  $900.      nses  decrease  retained  earnings,  which  in  turn  decreases  shareholders’  equity.   Transaction  (6):  Purchase  of  Insurance.   On  October  3,  Sierra  paid  $600  for  a   one-­‐year  insurance  policy  effective  October  1  that  expires  next  year  on  September  30.     Payments  of  expenses  that  will  benefit  more  than  one  accounting  period  are  identified  as  prepaid   expenses  or  prepayments.     ADM1340  MIDTERM  REVIEW   9     CHAPTER  3   Transaction  (7):  Hiring  of  New  Employees.   On  October  4,  Sierra  hired  four   new  employees  to  begin  work  on  Monday,  October  8.  Each  employee  will  receive  a   weekly  salary  of  $500  for  a  five-­‐day  workweek,  payable  every  two  weeks.   Employees  will  receive  their  first  paycheques  on  Friday,  October  19.     There  is  no  effect  on  the  accounting  equation  because  the  company’s  assets,  liabilities,  and   shareholders  equity  have  not  changed.     Transaction  (8):  Purchase  of  Supplies  on  Account.   On  October  9,  Sierra   purchased  advertising  materials  on  account  from  Aero  Supply  Corp.  for  $2,500.  The   account  is  due  in  30  days.     This  transaction  is  referred  to  as  a  purchase  “o n  account.”     Transaction  (9):  Services  performed  on  Account.            On  October  13,  Sierra   performed  $10,000  of  advertising  services  for  Copa  Ltd.  Sierra  sent  Copa  a  bill  for   these  services  asking  for  payment  before  the  end  of  the  month.     Revenue  is  earned  when  services  are  performed.     Transaction  (10):  Payment  of  Salaries.     Employees  worked  two  weeks,   earning  $4,000  in  salaries,  and  were  paid  on  October  19.       Transaction  (11):  Payment  of  Dividend.   On  October  26,  Sierra  paid  a  $500   cash  dividend.     Dividends  are  a  distribution  of  retained  earnings  rather  than  an  expense.     Transaction  (12):  Collection  of  Account.   On  October  30,  Copa  paid  Sierra   the  amount  owing  on  its  account.                                                                                                                      Liabilities                                                      Shareholders’  Equity                        .                       Retained  Earnings     Cash        +   A/R      +   Sup.    +   Pre.   Equip.    =   A/P          +   N/P      +   Unearned   Common   Rev.            -­Exp.            -­‐ Div.   Ins.      +   Revenue  +   Shares  +   (1)   +$10,000                 +10,000         (2)   +5,000             +5,000             (3)   -­‐5,000         +5,000                 (4)   +1,200               +1,2000           (5)   -­‐900                     -­‐900     (6)   -­‐600       +600                   (8)       +2,500       +2,500               (9)     +10,000                 +10,000       (10)   -­‐4,000                     -­‐4,000     (11)   -­‐500                       -­‐500   (12)   +10,000   -­‐10,000                         $15,200   $0   $2,500   $600   $5,000   $2,500   $5,500   $1,200   $10,000   $10,000   $4,900   $500     The  Account   • An  individual  accounting  record  of  increases  and  decreases  in  a  specific   asset,  liability,  or  shareholders’  equity  item   • Three  parts:   1) The  title  of  the  account   2) A  left  or  debit  side   3) A  right  or  credit  side   10   ADM1340  MIDTERM  REVIEW     CHAPTER  3   Debits  and  Credits   • Describe  where  entries  are  made  in  the  accounts:   o Debiting:  entering  an  amount  on  the  left  side   o Crediting:  entering  an  amount  on  the  right  side   • Add  up  each  side:   o If  the  greater  sum  is  on  the  left,  the  account  has  a  debit  balance.   o If  the  greater  sum  is  on  the  right,  the  account  has  a  credit  balance.   Normal  Balances       Steps  in  the  Recording  Process   Step  1 :  Each  transaction  is  analyzed  to  determine  if  it   has  an  effect  on  the  account.  Evidence  of  the  transaction   comes  from  a  source  document.     Step  2:  The  transaction  information  is  recorded  as  a   journal  entry  in  the  general  journal.   Step  3:  The  information  is  transferred  from  the  general   journal  to  the  appropriate  accounts  in  the  general   ledger.         THE  JOURNAL   • Transactions  are  recorded  in  chronological  order  in  the  journal  and  then   transferred  to  the  accounts.     • For  each  transaction,  the  journal  shows  the  debit  and  credit  effects  on   specific  accounts.   • The  general  journal  makes  several  contributions  to  the  recording  process:   ADM1340  MIDTERM  REVIEW   11     CHAPTER  3   1. It  discloses  the  complete  effect  of  a  transaction  in  one  place,  including  an   explanation  and,  where  applicable,  identification  of  the  source  document.   2. It  provides  a  chronological  record  of  transactions.   3. It  helps  to  prevent  and  locate  errors,  because  the  debit  and  credit   amounts  for  each  entry  can  be  quickly  compared.       General  Journal   Date   Account  Titles  and  Explanations   Debit   Credit   2012         Oct.  1   Cash   10,000                  Common  Shares   10,000                            (Issued  common  shares)     Note  the  following  features  of  the  journal  entry:     1. The  date  of  the  transaction  is  entered  in  the  Date  column.   2. The  account  to  be  debited  is  entered  first  at  the  left.  The  account  to  be   credited  is  then  entered  on  the  next  line,  indented  under  the  line  above.  The   indentation  differentiates  debits  from  credits  and  decreases  the  chance  of   switching  the  debit  and  credit  amounts  by  mistake.     3. The  amounts  for  the  debits  are  recorded  in  the  Debit  (left)  column,  and  the   amounts  for  the  credits  are  recorded  in  the  Credit  (right)  column.   4. A  brief  explanation  of  the  transaction  is  given.   THE  LEDGER   • Entire  group  of  accounts  maintained  by  a  company   o List  of  accounts  is  called  a  chart  of  accounts   • Contains  all  the  asset,  liability,  and  shareholders’  equity  accounts   • Posting  is  the  process  of  transferring  information  from  the  general  journal  to   the  general  ledger  accounts     THE  RECORDING  PROCESS  ILLUSTRATED     SIERRA  CORPORATION   General  Journal   Date   Account  Titles  and  Explanations   Debit   Credit   2012         Oct.  1   Cash   10,000                    Common  Shares   10,000           (Issued  common  shares)         1   Cash   5,000                  Notes  Payable   5,000         (Issued  three-­‐months,  6%  note  payable  for  cash)   1   Equipment   5,000                  Cash   5,000         (Purchased  equipment  for  cash)     12   ADM1340  MIDTERM  REVIEW     CHAPTER  3   2   Cash   1,200                  Unearned  Revenue   1,200           (Received  advance  from  R.  Knox  for  future  service)     2   Rent  Expense   900                  Cash   900           ( Paid  cash  for  October  office  rent)   3   Prepaid  Insurance     600                  Cash   600           (Paid  one-­‐year  insurance  policy;  effective  October  1)   9   Supplies   2,500                  Accounts  Payable   2,500           (Purchased  supplies  on  account  from  Aero  Supply)   13   Accounts  Receivable   10,000                  Service  Revenue   10,000           (Performed  services  on  account  for  Copa)   19   Salaries  Expense   4,000                  Cash   4,000           (Paid  salaries  for  Oct  8-­‐19)   26   Dividends   500                  Cash   500           (Paid  cash  dividends)         30   Cash   10,000                  Accounts  Receivable   10,000           (Received  cash  on  account  from  Copa)       SIERRA  CORPORATION   General  Ledger   Cash     Unearned  Revenue   Oct.  1   10,000   Oct.  1   5,000         Oct.  2   1,200   1   5,000   2   900         Bal.   1,200   2   1,200   3   600             30   10,000   19   4,000     Notes  Payable       26   500         Oct.  1   5,000   Bal.   15,200             Bal.   5,000                     Accounts  Receivable     Common  Shares   Oct  13   10,000   Oct.  30   10,000         Oct.  1   10,000   Bal.   0             Bal.   10,000                     Supplies     Dividends   Oct.  9   2,500         Oct.  26   500       Bal.   2,500         Bal.     500                                           ADM1340  MIDTERM  REVIEW   13     CHAPTER  3     Prepaid  Insurance       Service  Revenue   Oct.  3   600             Oct.  13   10,000   Bal.     600             Bal.   10,000                     Equipment     Salaries  Expense   Oct.  1   5,000         Oct.  19   4,000       Bal.   5,000         Bal.   4,000                         Accounts  Payable     Rent  Expense       Oct.  9   2,500     Oct.  2   900           Bal.   2,500     Bal.   900       The  Trial  Balance   Step  4 :  Prepare  a  trial  balance.     • List  of  all  the  accounts  and  their  balances  at  a  specific  time   • Serves  to  prove  the  mathematical  equality  of  debits  and  credits  after  posting   Sum  of  debits  =  sum  of  credits   • Aids  in  the  preparation  of  financial  statements   The  procedure  for  preparing  a  trial  balance  is  as  follows:   1. List  the  account  titles  and  their  balances  in  the  same  order  as  the  chart  of   accounts.  Debit  balances  should  be  entered  in  the  debit  column  and  credit   balances  in  the  credit  column.   2. Total  the  debit  column  and  the  credit  column.   3. Ensure  that  the  debit  and  credit  column  totals  are  equal.         14   ADM1340  MIDTERM  REVIEW       Chapter  4             Accrual  Accounting  Concep ts   Timing  Issues   • Companies  need  immediate  feedback  on  how  well  they  are  doing   • Accounting  divides  the  economic  life  of  a  business  into  artificial  time  periods   o Month,  quarter,  year   o Many  transactions  affect  more  than  one  time  period   Revenue  Recognition   • Revenue  is  recognized  when:   o Sales  or  performance  effort  is  substantially  complete   o Amount  is  determinable  (measureable)   o Collection  is  reasonably  assured   • In  a  merchandising  company:   o When  merchandise  is  sold  (point  of  sale)   • In  a  service  company:   o When  the  service  is  performed   Expense  Recognition   • Expenses  are  recognized  when:   o Due  to  ordinary  activity,  a  decrease  in  future  economic  benefits  occurs   § Related  to  a  decrease  in  an  asset  or  an  increase  in  a  liability   o It  can  be  measured  reliably   • Tied  to  changes  in  assets  and  liabilities   • Often  (but  not  always)  coincides  with  revenue  recognition     Accrual  Versus  Cash  Basis  of  Accounting   Accrual   • Transactions  affecting  a  company’s  financial  statements  are  recorded  in  the   period  the  events  occur,  rather  than  when  cash  is  received  or  paid   o Revenue  is  recorded  when  earned,  rather  than  when  cash  is  received   o Expenses  are  recorded  when  goods  or  services  are  consumed,  rather   than  when  cash  is  paid   Cash   • Revenue  is  recorded  only  when  cash  is  received   • Expenses  are  recorded  only  when  cash  is  paid   • Can  lead  to  misleading  financial  statements:   o Revenue  and  expenses  can  be  manipulated  by  timing  the  receipt  and   payment  of  cash   o Can  increase  or  decrease  profit     ADM1340  MIDTERM  REVIEW   15     CHAPTER  4   The  Basics  of  Adjusting  Entries   • Adjusting  entries  are  made  to  adjust  or  update  accounts  at  the  end  of  the   accounting  period   • Required  because  the  trial  balance  may  not  contain  complete  and  up-­‐to-­‐date  data   o Some  items  are  not  recorded  daily   o Some  costs  are  not  recorded  during  the  accounting  period,  as  they   expire  due  to  the  passage  of  time   o Some  items  may  be  unrecorded   Types  of  Adjusting  Entries   Prepayments   • Prepaid  expenses:   Expenses  paid  in  cash  and  recorded  as  assets  before  they  are   used  or  consumed.   • Unearned  revenues:   Cash  received  and  recorded  as  liabilities  before  revenue  is   earned.   Accruals   • Accrued  revenues:   Revenues  earned  but  not  yet  received  in  cash  or    rded. • Accrued  expenses:   Expenses  incurred  but  not  yet  paid  in  cash  or  recorded.   Adjusting  Entries  for  Prepayments   • Prepayments  increase  current  assets  such  as  prepaid  expenses  and  certain   types  of  non-­‐current  assets.   • Adjusting  entries  for  prepayments  allocate  a  cost  from  an  asset  or  liability   account  to  an  expense  or  revenue  account.     Prepayments  made:   • The  adjusting  entry  records  the  expense  that  applies  to  the  current  period   and  reduces  the  asset  account  that  was  originally  recorded.   Prepayments  received:   • The  adjusting  entry  records  the  revenue  earned  in  the  period  and  reduces   the  liability  account  where  the  unearned  revenue  was  originally  recorded.   Prepaid  Expenses   • Costs  that  are  paid  for  in  cash  before  they  are  used   o When  the  cost  is  incurred,  an  asset  (prepaid)  is  increased  (to  show  the   future  service  or  benefit)  and  cash  is  decreased   • Expire  with  the  passage  of  time  or  through  use   o Not  practical  to  record  this  expiration  on  a  daily  basis,  so  done  when   statements  are  prepared   • Adjusting  entry  increases  an  expense  account  and  decreases  the  asset   (prepaid)  account   Depreciation   • The  process  of  allocating  the  cost  of  a  long-­‐lived  or  non-­‐current  asset  to   expense  over  its  useful  life.     Depreciation:  normally  used  in  relation  to  property,  plant,  and  equipment.   Amortization:  used  in  relation  to  intangible  assets.   Depletion:  used  in  relation  to  natural  resources.   16   ADM1340  MIDTERM  REVIEW     CHAPTER  4   • Depreciation  is  an  allocation  concept,  not  a  valuation  concept.   o We  depreciate  an  asset  to  allocate  its  cost  to  the  periods  over  which   we  use  it.   o Not  recording  a  change  in  the  actual  value  of  the  asset.   Calculation  of  Depreciation   • Straight-­‐line  method  of  depreciation:  divide  the  cost  of  the  asset  by  its  useful   life.   • At  the  time  an  asset  is  acquired,  its  useful  life  is  not  known  with  any   certainty.     o It  must  be  estimated   o Depreciation  is  an  estimate  rather  than  a  factual  measurement  of  the   cost  that  has  expired.   Unearned  Revenue   • Cash  that  has  been  received  before  revenue  is  earned   o When  the  cash  is  received,  a  liability  account  (unearned  revenue)  is   increased  and  cash  is  increased   • The  opposite  of  prepaid  expenses   • Adjusting  entry  decreases  the  liability  (unearned  revenue)  account  and   increases  a  revenue  account   o Reflects  the  amount  of  revenue  earned  in  the  period  and  the   remaining  liability  at  the  end  of  the  period   Adjusting  Entries  for  Accruals   • Accruals  have  not  been  recognized  at  all  until  an  adjustment  is  made   • Revenues  that  have  been  earned,  but  not  received  in  cash  (accrued  revenues)   o Adjusting  entry  results  in  an  increase  to  both  an  asset  and  a  revenue   account   • Expenses  that  have  been  incurred,  but  not  yet  paid  or  recorded  (accrued   expenses)   o Adjusting  entry  results  in  an  increase  to  both  an  expense  and  a   liability  account   Accrued  Revenues   • Accrued  revenues  may  accumulate  (accrue)  with  the  passing  of  time,  as  in   the  case  of  interest  revenues.   • They  may  result  from  services  that  have  been  performed  but  not  yet  billed  or   collected,  such  as  fees.   An  adjusting  entry  is  required  for  two  purposes:   1. To  show  the  receivable  that  exists  at  the  statement  of  financial  position  date.   2. To  record  the  revenue  that  has  been  earned  during  the  period.   Accrued  Expenses   • Interest,  rent,  salaries,  property  tax,  and  income  tax  are  common  examples.   • Accrued  expenses  result  from  the  same  factors  as  accrued  revenues.   Adjustments  for  accrued  expenses  are  necessary  to:   1. Record  obligations  that  exist  at  the  statement  of  financial  position  date.   2. Recognize  the  expenses  that  apply  to  the  current  accounting  period.   ADM1340  MIDTERM  REVIEW   17     CHAPTER  4   Adjusting  entries  illustrated     Adjustment  (1):  Prepaid  expenses  –  supplies.       A  count  at  the  close  of   business  on  October  31  reveals  that  $1,000  of  supplies  are  still  on  hand.   Adjustment  (2):  Prepaid  expenses  –  insurance.     On  October  3,  Sierra   Corporation  paid  $600  for  a  one-­‐year  insurance  policy.  Coverage  began  on  October  1.   Adjustment  (3):  Prepaid  expenses  –  depreciation.   The  $5000  equipment   purchased  on  October  1  is  expected  to  have  a  useful  life  of  5  years.   Adjustment  (4):  Unearned  revenues.   R.  Knox  paid  $1,200  on  October  2  for   advertising  services  expected  to  be  completed  by  November  15.  From  an  evaluation   of  the  work  performed  by  Sierra  for  Knox  during  October,  it  is  determined  that  $400   worth  of  work  was  done  in  October.     Adjustment  (5):  Accrued  revenues  –  accounts  receivable.   In  October,  Sierra   Corporation  earned  $200  for  advertising  services  that  were  not  billed  to  the  clients   before  October  31.     Adjustment  (6):  Accrued  expenses  –  interest.     Sierra  Corporation  signed  a   three-­‐month  note  payable  for  $5000  on  October  1.  The  note  bears  interest  at  an   annual  rate  of  6%.  ($5,000  X  6%  X  3/12)     Adjustment  (7):  Accrued  expenses  –  salaries.     Salaries  are  paid  every  two   weeks.  Sierra’s  four  employees  were  last  paid  on  October  19.  The  next  payment  of   salaries  will  not  occur  until  November  2.  The  four  employees  each  receive  a  salary   of  $100  a  day.  (8  days  X  $100/day  X  4  employees)   Adjustment  (8):  Accrued  expenses  –  income  tax.   For  accounting  purposes,   corporate  income  tax  must  be  accrued  based  on  the  current  year’s  estimated  profit.   Sierra’s  monthly  income  tax  expense  is  estimated  to  be  $200.       SIERRA  CORPORATION   General  Journal   Date   Account  Titles  and  Explanations   Debit   Credit   2012         Oct.  31   Supplies  Expense   1,500                  Supplies   1,500             (To  record  supplies  used)      31   Insurance  Expense   50                  Prepaid  Insurance   50         (To  record  insurance  expired )     31   Depreciation  Expense   83                  Accumulated  Depreciation  -­‐  Equipment   83         (To  record  monthly  depreciation)    31   Unearned  Revenue   400                  Service  Revenue   400         (To  record  revenue  earned )       31   Accounts  Receivable     200                  Service  Revenue   200         (To  accrue  revenue  earned  but  not  billed  or  collected )   18   ADM1340  MIDTERM  REVIEW     CHAPTER  4   31   Interest  Expense   25                  Interest  Payable   25           (To  accrue  interest  on  note  pay able)   31   Salaries  Expense   3,200                  Salaries  Payable   3,200             To  record  accrued  salaries( )   31   Income  Tax  Expense   200                  Income  Tax  Payable   200             To  record  accrued  income  tax )       SIERRA  CORPORATION   General  Ledger   Cash     Unearned  Revenue   Oct.  1   10,000   Oct.  1   5,000         Oct.  2   1,200   1   5,000   2   900         Oct.  31     Bal.   1,200   2   1,200   3   600             30   10,000   19   4,000     Notes  Payable       26   500         Oct.  1   5,000   Oct.  31      Bal.   15,200             Oct.  31     Bal.   5,000                     Accounts  Receivable     Common  Shares   Oct  1.   10,000   Oct.  30   10,000         Oct.  1   10,000             Adj, 31           200   Oct  31       Bal.   200             Oct.  31     Bal.   10,000                     Supplies     Dividends   Oct.  9   2,500   Oct.  31         Adj.   1,500     Oct.  26   500       Oct.  31      Bal.   2,500         Oct.  31       Bal.     500                           Prepaid  Insurance       Service  Revenue   Oct.  3   600   Oct.  31         Adj.   50         Oct.  13   10,000   31       Adj.       400   31       Adj.      200   Oct.  31      Bal.     600             Oct.  31     Bal.   10,600                     Equipment     Salaries  Expense   Oct.  1   5,000         Oct.  19   4,000                 Adj.      3,200     Oct.  31      Bal.   5,000         Oct.  31       Bal.   7,200                         Accounts  Payable     Rent  Expense       Oct.  9   2,500     Oct.  2   900           Oct.  31      Bal.   2,500     Oct.  31       Bal.   900             ADM1340  MIDTERM  REVIEW   19     CHAPTER  4   Accumulated  Depreciation  -­‐  Equipment     Depreciation  Expense       Oct.  31     Adj.   83     Oct.  31       Adj.   83           Oct.  31     Bal.     83     Oct.  31       Bal.   83                         Salaries  Payable       Supplies  Expense       Oct.  31     Adj.   3,200     Oct.  31       Adj.   1,500           Oct.  31     Adj.   3,200     Oct.  31       Bal.   1,500                         Income  Tax  Payable     Insurance  Expense       Oct.  31     Adj.   200     Oct.  31       Adj.   50           Oct.  31     Bal.   200     Oct.  31       Bal.   50                         Interest  Payable     Interest  Expense       Oct.  31     Adj.   25     Oct.  31       Adj.   25           Oct.  31     Bal.   25     Oct.  31       Adj.   25                         Unearned  Revenue  
More Less

Related notes for ADM1340

Log In


Join OneClass

Access over 10 million pages of study
documents for 1.3 million courses.

Sign up

Join to view


By registering, I agree to the Terms and Privacy Policies
Already have an account?
Just a few more details

So we can recommend you notes for your school.

Reset Password

Please enter below the email address you registered with and we will send you a link to reset your password.

Add your courses

Get notes from the top students in your class.