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Chapter 3

Lecture 4 - chapter 3.docx

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University of Toronto Mississauga
Catherine Seguin

AccrualAccounting and Income : Chapter 3 Learning objective 1: relate accrual accounting and cash flows The Business cycle: entity 1 has cash: purchase inventory, entity 2 holds inventory: sale of inventory on account, entity 3 has a receivable: collection of receivable Accounting Cycle (for a fiscal year): transaction occurs  transaction analyzed  transaction entered in journal  amounts posted to the ledger  trial balance  adjust records to make sure all income and expenses are reported for the period, journalize in general journal, post to individual accounts  adjusted trial balance  prepare financial statements  close income statements  prepare a post-closing trial balance Accrual Basis ofAccounting (non cash transactions): Revenue recorded when earned, expenses recorded when incurred regardless when cash received • E.g. purchase of inventory on account, depreciation expense, usage of prepaid rent Cash Basis of Accounting: transactions recorded when cash received/paid Time Period Concept: business need regular progress reports, so accountants prepare financial statements for specific periods and at regular intervals (monthly, quarterly and yearly) Learning Objective 2: recognize revenue and record expenses Revenue Principle: governs when to record revenue and amount of revenue to record Recording Expenses: as revenue earned, firm incurs expenses  identify all expenses incurred during the period and measure the expenses and record Ethical Issues in accrual Accounting • “Managing” earnings to meet / beat bay street forecasts • Questionable timing of recognizing revenues, and expenses; affects quality of earnings Learning Objective 3: adjust accounts Updating the accounts: adjustment process - begins with trial balance The unadjusted trial balance lists the accounts and their balances after the period’s transactions have been recorded Categories of AccountingAdjustments: • Deferrals : expenses paid in advance, not yet incurred OR revenue collected in advance but not yet earned o “On May 01 Falk Consulting Inc. paid 3 months’ rent” = DR prepaid rent (3,000)& CR cash (3,000) ADJUSTMENT ENTRY: on May 31 record rent expense for may = DR Rent Expense (1000) & CR Prepaid Rent (1000) o Inventory count at month end indicated that 350 in supplies remained  Supplies beg balance : 530  530 – 350 = 180 therefore CR 180 and DR supplies expense 180 o On may 1 2011 falk consulting had received 5,300 for future services  CR Unearned Revenue 5300 and DR 5,300Cash  On may 31, $1,325 of revenue has now been earned • DR Unearned revenue = 1,325 and CR Revenue = 1,325 • Depreciation: allocation of cost of property, plant and equipment to expense over asset’s useful life • Accruals: expenses incurred but not recorded/paid OR revenues earned but not recorded/collected Depreciation of property, plant and equipment • Spread cost of property, plant and equipment over useful life AccrualAccounting and Income : Chapter 3 • Company buys buildings, equipment and furniture for use in business • As company uses these assets, it records depreciation for their wear and tear o E.g. on may 1, Firm purchases furniture for 16,500 cash. Furniture expected to last 4 years.  DR furniture 16500 & CR Cash 16500. Therfore depreciation is: $16,500 / 4 years = $4,125/12 months = 344 (rounded)  When depreciates use following accounts  depreciation expense (DR) and accumulated depreciation (CR)  Depreciation expense DR ($344) &Accumulated depreciation CR ($344)  On balance sheet, it is the reported as its carrying amount • Furniture $16,500 • Less:Accumulated depreciation 344 16,156 Accrued Expenses = liability that arises from expense that has not yet been paid • E.g. on may 1firm signed note payable due in 2 years w/ interest on note of 10% and is paid yearly – yet are preparing a monthly statement o On May 31, interest has been accrued for one month yet not paid  $10,200 x 10% = 1,020 x (1/12) = 85  DR interest expense ($85) & CR interest payable ($85) • E.g. employees paid every Friday, statements are made monthly. This month the 31 falls on a Tuesday therefore you have incurred salaries e
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