Intermed Acc 1 Ppt Ch03

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Prepared by Coby Harmon

University of California, Santa Barbara

Intermediate Accounting

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Intermediate Accounting

14th Edition

3The Accounting

Information System

Kieso, Weygandt, and Warfield

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1. Understand basic accounting terminology.

2. Explain double-entry rules.

3. Identify steps in the accounting cycle.

4. Record transactions in journals, post to ledger accounts,

and prepare a trial balance.

5. Explain the reasons for preparing adjusting entries.

6. Prepare financial statement from the adjusted trial balance.

7. Prepare closing entries.

Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives

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Identifying and recording

Journalizing

Posting

Trial balance

Adjusting entries

Adjusted trial balance

Preparing financial statements

Closing

Post-closing trial balance

Reversing entries

Accounting Information System

The Accounting Cycle

Financial Statements for Merchandisers

Basic terminology

Debits and credits

Accounting equation

Financial statements and ownership structure

Income statement

Statement of retained earnings

Balance sheet

Closing entries

The Accounting Information SystemThe Accounting Information SystemThe Accounting Information SystemThe Accounting Information System

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Collects and processes transaction data.

Disseminates the information to interested parties.

Accounting Information SystemAccounting Information SystemAccounting Information SystemAccounting Information System

Accounting Information System (AIS)

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How much and what kind of debt is outstanding?

Were sales higher this period than last?

What assets do we have?

What were our cash inflows and outflows?

Did we make a profit last period?

Are any of our product lines or divisions operating at a loss?

Can we safely increase our dividends to stockholders?

Is our rate of return on net assets increasing?


Helps management answer such questions as:

3-7 LO 1 Understand basic accounting terminology.

Journal

Posting

Trial Balance

Adjusting Entries

Financial Statements

Closing Entries

Basic Terminology


Event

Transaction

Account

Real Account

Nominal Account

Ledger

3-8


LO 2 Explain double-entry rules.

An Account shows the effect of transactions on a

given asset, liability, equity, revenue, or expense

account.

Double-entry accounting system (two-sided effect).

Recording done by debiting at least one account and

crediting another.

DEBITS must equal CREDITS.

Debits and Credits

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Account Name

Debit / Dr. Credit / Cr.

Debits and CreditsDebits and CreditsDebits and CreditsDebits and Credits

An arrangement that shows the effect of transactions on an account.

Debit = “Left”

Credit = “Right”

AccountAccount


An Account can An Account can be illustrated in a be illustrated in a T-Account form.T-Account form.

3-10

Account Name




$10,000 Transaction #2$3,000

$15,000$15,000

8,000

Balance

Transaction #1

Transaction #3

If Debit entries are greater than Credit entries, the account will have a debit balance.

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Account Name



If Credit entries are greater than Debit entries, the account will have a credit balance.


$10,000 Transaction #2$3,000

$1,000$1,000

8,000 Transaction #3

Balance

Transaction #1

3-12

Chapter 3-23

AssetsAssets


Normal BalanceNormal Balance

Chapter 3-27



ExpenseExpense

Chapter 3-24

LiabilitiesLiabilities



Chapter 3-25



EquityEquity

Chapter 3-26



RevenueRevenue

Normal Balance Credit

Normal Balance Credit

Normal Balance

Debit

Normal Balance

Debit

Debits and Credits SummaryDebits and Credits SummaryDebits and Credits SummaryDebits and Credits Summary


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Balance Sheet Balance Sheet Income StatementIncome Statement

= + =-Asset Liability Equity Revenue Expense

Debit

Credit

Debits and Credits SummaryDebits and Credits SummaryDebits and Credits SummaryDebits and Credits Summary


3-14

The Accounting EquationThe Accounting EquationThe Accounting EquationThe Accounting Equation


Relationship among the assets, liabilities and stockholders’

equity of a business:

The equation must be in balance after every transaction.

For every Debit there must be a Credit.

Illustration 3-3

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Double-Entry System IllustrationDouble-Entry System IllustrationDouble-Entry System IllustrationDouble-Entry System Illustration

AssetsAssets LiabilitiesLiabilitiesStockholders’

Equity

Stockholders’ Equity

= +

1. Owners invest $40,000 in exchange for common stock.

+ 40,000 + 40,000


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AssetsAssets LiabilitiesLiabilities= +

2. Disburse $600 cash for secretarial wages.

- 600 - 600 (expense)





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3. Purchase office equipment priced at $5,200, giving a 10 percent promissory note in exchange.

+ 5,200 + 5,200




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4. Received $4,000 cash for services rendered.

+ 4,000 + 4,000 (revenue)




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5. Pay off a short-term liability of $7,000.

- 7,000 - 7,000




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6. Declared a cash dividend of $5,000.

+ 5,000 - 5,000





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7. Convert a long-term liability of $80,000 into common stock.

- 80,000 + 80,000




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8. Pay cash of $16,000 for a delivery van.


- 16,000

+ 16,000

Note that the accounting equation equality is maintained after recording each transaction.

Note that the accounting equation equality is maintained after recording each transaction.



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Ownership structure dictates the types of accounts that are part of the equity section.

Proprietorship or Partnership

Proprietorship or Partnership CorporationCorporation

Capital Account Drawing Account

Common Stock Additional Paid-in

Capital Dividends Declared Retained Earnings

Financial Statements and Ownership StructureFinancial Statements and Ownership StructureFinancial Statements and Ownership StructureFinancial Statements and Ownership Structure


3-24

Financial Statements and Ownership StructureFinancial Statements and Ownership StructureFinancial Statements and Ownership StructureFinancial Statements and Ownership Structure


Stockholders’ EquityStockholders’ Equity

Balance Sheet

Statement of Retained Earnings

Net income or Net loss (Revenues less expenses)(Revenues less expenses)

Income StatementIncome Statement

Net income or Net loss (Revenues less expenses)(Revenues less expenses)

Income StatementIncome StatementDividendsDividends

Retained Earnings Retained Earnings (Net income retained in business)(Net income retained in business)

Retained Earnings Retained Earnings (Net income retained in business)(Net income retained in business)

Common Stock Common Stock (Investment by stockholders)(Investment by stockholders)

Common Stock Common Stock (Investment by stockholders)(Investment by stockholders)

Illustration 3-4

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The Accounting CycleThe Accounting CycleThe Accounting CycleThe Accounting Cycle

LO 3 Identify steps in the accounting cycle.

TransactionsTransactions

1. Journalization1. Journalization

6. Financial Statements6. Financial Statements

7. Closing entries7. Closing entries

8. Post-closing trail balance8. Post-closing trail balance

9. Reversing entries9. Reversing entries

3. Trial balance3. Trial balance

2. Posting2. Posting

5. Adjusted trial balance5. Adjusted trial balance

4. Adjustments4. AdjustmentsWork SheetWork Sheet

Illustration 3-6

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Identify and Recording TransactionsIdentify and Recording TransactionsIdentify and Recording TransactionsIdentify and Recording Transactions

What to Record?

FASB states, “transactions and other events and

circumstances that affect a business enterprise.”

LO 3 Identify steps in the accounting cycle.

Types of Events:

External – between a business and its environment.

Internal – event occurring entirely within a business.

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General Journal – a chronological record of transactions. Journal Entries are recorded in the journal.

1. Journalizing1. Journalizing1. Journalizing1. Journalizing

LO 4 Record transactions in journals, post to ledger accounts, and prepare a trial balance.

September 1: Stockholders invested $15,000 cash in the corporation in exchange for shares of stock.

Illustration 3-7

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Posting – the process of transferring amounts from the journal to the ledger accounts.

2. Posting2. Posting2. Posting2. Posting


Illustration 3-7

Illustration 3-8

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Posting – Transferring amounts from journal to ledger.


LO 4

Illustration 3-8

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Expanded Example



The purpose of transaction analysis is

(1) to identify the type of account involved, and

(2) to determine whether a debit or a credit is required.

Keep in mind that every journal entry affects one or more of the following items: assets, liabilities, stockholders’ equity, revenues, or expense.

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1. October 1: Stockholders invest $100,000 cash in an advertising venture to be known as Pioneer Advertising Agency Inc.

Common stock 100,000

Cash 100,000Oct. 1

Debit Credit

Cash

100,000100,000 100,000100,000

Debit Credit

Common Stock



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2. October 1: Pioneer Advertising purchases office equipment costing $50,000 by signing a 3-month, 12%, $50,000 note payable.

Notes payable 50,000

Equipment 50,000Oct. 1

Debit Credit

Equipment

50,00050,000 50,00050,000

Debit Credit

Notes Payable



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3. October 2: Pioneer Advertising receives a $12,000 cash advance from KC, a client, for advertising services that are expected to be completed by December 31.

Unearned service revenue 12,000

Cash 12,000Oct. 2

Debit Credit

Cash

100,000100,000 12,00012,000

Debit Credit

Unearned Service Revenue


12,00012,000


3-34

4. October 3: Pioneer Advertising pays $9,000 office rent, in cash, for October.

Cash 9,000

Rent expense 9,000Oct. 3

Debit Credit

Cash

100,000100,000 9,0009,000

Debit Credit

Rent Expense


12,00012,0009,0009,000


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5. October 4: Pioneer Advertising pays $6,000 for a one-year insurance policy that will expire next year on September 30.

Cash 6,000

Prepaid insurance 6,000Oct. 4

Debit Credit

Cash

100,000100,000 6,0006,000

Debit Credit

Prepaid Insurance


12,00012,0009,0009,000

6,0006,000


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6. October 5: Pioneer Advertising purchases, for $25,000 on account, an estimated 3-month supply of advertising materials from Aero Supply.

Accounts payable 25,000

Supplies 25,000Oct. 5

Debit Credit

Supplies

25,00025,000 25,00025,000

Debit Credit

Accounts Payable



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7. October 9: Pioneer Advertising signs a contract with a local newspaper for advertising inserts (flyers) to be distributed starting the last Sunday in November. Pioneer will start work on the content of the flyers in November. Payment of $7,000 is due following delivery of the Sunday papers containing the flyers.



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8. October 20: Pioneer Advertising’s board of directors declares and pays a $5,000 cash dividend to stockholders.

Cash 5,000

Dividends 5,000Oct. 20

Debit Credit

Cash

100,000100,000 5,0005,000

Debit Credit

Dividends


12,00012,0009,0009,000

6,0006,000

5,0005,000


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9. October 26: Employees are paid every four weeks. The total payroll is $2,000 per day. The pay period ended on Friday, October 26, with salaries of $40,000 being paid.

Cash 40,000

Salaries expense 40,000Oct. 26

Debit Credit

Cash

100,000100,000 40,00040,000

Debit Credit

Salaries Expense


12,00012,0009,0009,000

6,0006,000

5,0005,000

40,00040,000


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10. October 31: Pioneer Advertising receives $28,000 in cash and bills Copa Company $72,000 for advertising services of $100,000 provided in October.

Accounts receivable 72,000Cash 28,000Oct. 31

Debit Credit

Cash

100,000100,000 72,00072,000

Debit Credit

Accounts Receivable


12,00012,0009,0009,000

6,0006,000

5,0005,000

40,00040,000

Service revenue 100,000

100,000100,000

Debit Credit

Service Revenue

28,00028,000

80,00080,000

3-41

Trial BalanceTrial Balance – A list of each account and its balance; used to prove equality of debit and credit balances.

3. Trial Balance3. Trial Balance3. Trial Balance3. Trial Balance

LO 4

Illustration 3-19

3-42

4. Adjusting Entries4. Adjusting Entries4. Adjusting Entries4. Adjusting Entries

LO 5 Explain the reasons for preparing adjusting entries.

Makes it possible to:

Report on the statement of financial position the appropriate assets, liabilities, and equity at the statement date.

Report on the income statement the proper revenues and expenses for the period.

► Revenues are recorded in the period in which they are earned.

► Expenses are recognized in the period in which they are incurred.

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Types of Adjusting EntriesTypes of Adjusting EntriesTypes of Adjusting EntriesTypes of Adjusting Entries

1. Prepaid Expenses. Expenses paid in cash and recorded as assets before they are used or consumed.

Prepayments

3. Accrued Revenues. Revenues earned but not yet received in cash or recorded.

4. Accrued Expenses. Expenses incurred but not yet paid in cash or recorded.

2. Unearned Revenues. Revenues received in cash and recorded as liabilities before they are earned.

Accruals


Illustration 3-20

3-44

Deferrals are either prepaid

expenses or

unearned revenues.

Adjusting Entries for DeferralsAdjusting Entries for DeferralsAdjusting Entries for DeferralsAdjusting Entries for Deferrals

Illustration 3-21


3-45

Payment of cash that is recorded as an asset because service or benefit will be received in the future.

Adjusting Entries for “Prepaid Expenses”Adjusting Entries for “Prepaid Expenses”Adjusting Entries for “Prepaid Expenses”Adjusting Entries for “Prepaid Expenses”

insurance

supplies

advertising

Cash PaymentCash Payment Expense RecordedExpense RecordedBEFORE


rent

buildings and equipment

Prepayments often occur in regard to:

3-46

Supplies.Supplies. Pioneer purchased advertising supplies costing$25,000 on October 5. Prepare the journal entry to record the purchase of the supplies.

Cash 25,000

Supplies 25,000Oct. 5

Debit Credit

Supplies

25,00025,000 25,00025,000

Debit Credit

Cash



3-47

Supplies. An inventory count at the close of business on October 31 reveals that $10,000 of the advertising supplies are still on hand.

Supplies 15,000

Supplies expense 15,000Oct. 31

Debit Credit

Supplies

25,00025,000 15,00015,000

Debit Credit

Supplies Expense

15,00015,000


10,00010,000


3-48

Statement

Presentation:

Supplies identifies that

portion of the asset’s

cost that will provide

future economic benefit.

Adjusting Entries Adjusting Entries for “Prepaid for “Prepaid Expenses”Expenses”


Illustration 3-35

Illustration 3-35

3-49

Statement

Presentation:

Supplies expense

identifies that portion of

the asset’s cost that

expired in October.

Illustration 3-35



3-50

Insurance. On Oct. 4th, Pioneer paid $6,000 for a one-year fire insurance policy, beginning October 1. Show the entry to record the purchase of the insurance.

Cash 6,000

Prepaid insurance 6,000Oct. 4

Debit Credit

Prepaid Insurance

6,0006,000 6,0006,000

Debit Credit

Cash



3-51

Insurance. An analysis of the policy reveals that $500 ($6,000 / 12) of insurance expires each month. Thus, Pioneer makes the following adjusting entry.

Prepaid insurance 500

Insurance expense 500Oct. 31

Debit Credit

Prepaid Insurance

6,0006,000 500500

Debit Credit

Insurance Expense


500500

5,5005,500


3-52

Statement

Presentation:

Prepaid insurance


the asset’s cost that will

provide future economic

benefit.



Illustration 3-35

Illustration 3-35

3-53

Statement

Presentation:

Insurance expense



expired in October.

Illustration 3-35



3-54

Depreciation. Pioneer Advertising estimates depreciation on its office equipment to be $400 per month. Accordingly, Pioneer recognizes depreciation for October by the following adjusting entry.

Accumulated depreciation 400

Depreciation expense 400Oct. 31

Debit Credit

Depreciation Expense

400400 400400

Debit Credit

Accumulated Depreciation



3-55

Statement

Presentation:

Accumulated Depreciation—is a contra asset account.



Illustration 3-35

Illustration 3-35

3-56

Statement

Presentation:

Depreciation expense



expired in October.

Illustration 3-35



3-57

Receipt of cash that is recorded as a liability because the revenue has not been earned.

Adjusting Entries for “Unearned Revenues”Adjusting Entries for “Unearned Revenues”Adjusting Entries for “Unearned Revenues”Adjusting Entries for “Unearned Revenues”

rent

airline tickets

school tuition

Cash ReceiptCash Receipt Revenue RecordedRevenue RecordedBEFORE

magazine subscriptions

customer deposits

Unearned revenues often occur in regard to:


3-58

Unearned Revenue. Pioneer Advertising received $12,000 on October 2 from KC for advertising services expected to be completed by December 31. Show the journal entry to record the receipt on Oct. 2nd.

Unearned advertising revenue 12,000

Cash 12,000Oct. 2

Debit Credit

Cash

12,00012,000 12,00012,000

Debit Credit

Unearned Rent Revenue



3-59

Debit Credit

Service Revenue

100,000100,000 12,00012,000

Debit Credit

Unearned Service Revenue

4,0004,000

8,0008,000


Unearned Revenues. Analysis reveals that Pioneer earned $4,000 of the advertising services in October. Thus, Pioneer makes the following adjusting entry.


Unearned service revenue 4,000Oct. 31

4,0004,000


3-60

Statement

Presentation:

Unearned service revenue identifies that portion of the liability that has not been earned.

Adjusting Entries Adjusting Entries for “Unearned for “Unearned

Revenues”Revenues”

Adjusting Entries Adjusting Entries for “Unearned for “Unearned

Revenues”Revenues”Illustration 3-35

Illustration 3-35

3-61

Statement

Presentation:

Service Revenue

includes the portion of

unearned service

revenue earned in

October.

Illustration 3-35



3-62

Adjusting Entries for AccrualsAdjusting Entries for AccrualsAdjusting Entries for AccrualsAdjusting Entries for Accruals

Illustration 3-27

Accruals are either accrued

revenues or

accrued expenses.


3-63

Revenues earned but not yet received in cash or recorded.

Adjusting Entries for “Accrued Revenues”Adjusting Entries for “Accrued Revenues”Adjusting Entries for “Accrued Revenues”Adjusting Entries for “Accrued Revenues”

rent

interest

services performed

BEFORE

Accrued revenues often occur in regard to:

Cash ReceiptCash ReceiptRevenue RecordedRevenue Recorded

Adjusting entry results in:


3-64

Accrued Revenues. In October Pioneer earned $2,000 for

advertising services that it did not bill to clients before October

31. Thus, Pioneer makes the following adjusting entry.


Accounts receivable 2,000Oct. 31

Debit Credit

Accounts Receivable

72,00072,000

Adjusting Entries for “Accrued Revenues”Adjusting Entries for “Accrued Revenues”Adjusting Entries for “Accrued Revenues”Adjusting Entries for “Accrued Revenues”

Debit Credit

Service Revenue

100,000100,000

4,0004,000

2,0002,000

106,000106,000

2,0002,000

74,00074,000

LO 5

3-65 LO 5

Adjusting Entries Adjusting Entries for “Accrued for “Accrued Revenues”Revenues”

Adjusting Entries Adjusting Entries for “Accrued for “Accrued Revenues”Revenues” Illustration 3-35

Illustration 3-35

3-66

Expenses incurred but not yet paid in cash or recorded.

Adjusting Entries for “Accrued Expenses”Adjusting Entries for “Accrued Expenses”Adjusting Entries for “Accrued Expenses”Adjusting Entries for “Accrued Expenses”

rent

interest

taxes

BEFORE

Accrued expenses often occur in regard to:

Cash Payment, if any*Cash Payment, if any*Expense RecordedExpense Recorded

salaries

bad debts*

Adjusting entry results in:


3-67


Accrued Interest. Pioneer signed a three-month, 12%, note payable in the amount of $50,000 on October 1. The note requires interest at an annual rate of 12 percent. Three factors determine the amount of the interest accumulation:

1 2 3 Illustration 3-29


3-68

Interest payable 500

Interest expense 500Oct. 31

Debit Credit

Interest Expense

500500 500500

Debit Credit

Interest Payable


Accrued Interest. Pioneer signed a three-month, 12%, note payable in the amount of $50,000 on October 1. Prepare the adjusting entry on Oct. 31 to record the accrual of interest.


3-69 LO 5

Adjusting Entries Adjusting Entries for “Accrued for “Accrued Expenses”Expenses”

Adjusting Entries Adjusting Entries for “Accrued for “Accrued Expenses”Expenses” Illustration 3-35

Illustration 3-35

3-70


Accrued Salaries. At October 31, the salaries for these days

represent an accrued expense and a related liability to Pioneer.

The employees receive total salaries of $10,000 for a five-day

work week, or $2,000 per day.


3-71

Salaries payable 6,000

Salaries expense 6,000Oct. 31

Debit Credit

Salaries Expense

40,00040,000 6,0006,000

Debit Credit

Salaries Payable


Accrued Salaries. Employees receive total salaries of $10,000

for a five-day work week, or $2,000 per day. Prepare the adjusting entry on Oct. 31 to record accrual for salaries.

6,0006,000

46,00046,000


3-72

Salaries expense 34,000

Salaries payable 6,000Nov. 23

Debit Credit

Salaries Expense

34,00034,000 6,0006,000

Debit Credit

Salaries Payable


Accrued Salaries. On November 23, Pioneer will again pay total salaries of $40,000. Prepare the entry to record the payment of salaries on November 23.

Cash 40,000

6,0006,000


3-73 LO 5



Illustration 3-35

3-74


Bad Debts. Assume Pioneer reasonably estimates a bad debt expense for the month of $1,600. It makes the adjusting entry for bad debts as follows.

Illustration 3-32


3-75 LO 5



Illustration 3-35

3-76

Shows the

balance of all

accounts, after

adjusting entries,

at the end of the

accounting period.

5. Adjusted Trial Balance5. Adjusted Trial Balance5. Adjusted Trial Balance5. Adjusted Trial Balance

Illustration 3-33

3-77

6. Preparing Financial Statements6. Preparing Financial Statements6. Preparing Financial Statements6. Preparing Financial Statements

LO 6 Prepare financial statement from the adjusted trial balance.

Financial Statements are prepared directly from the Adjusted Trial Balance.

Financial Statements are prepared directly from the Adjusted Trial Balance.

Balance Sheet

Income Statement

Retained Earnings

Statement

3-78


LO 6Illustration 3-34

3-79


Illustration 3-35

LO 6

3-80

7. Closing Entries7. Closing Entries7. Closing Entries7. Closing Entries

LO 7 Prepare closing entries.

To reduce the balance of the income statement (revenue and expense) accounts to zero.

To transfer net income or net loss to owner’s equity.

Balance sheet (asset, liability, and equity) accounts are not closed.

Dividends are closed directly to the Retained Earnings account.

3-81

7. Closing Entries7. Closing Entries7. Closing Entries7. Closing Entries


Retained earnings 5,000 Dividends

5,000


Salaries & wages expense46,000

Supplies expense15,000

Rent expense9,000

Insurance expense500

Interest expense500

Depreciation expense400

Bad debt expense1,600

Retained earnings33,000

Illustration 3-33

Closing Journal Entries:

3-82

7. Closing 7. Closing EntriesEntries

7. Closing 7. Closing EntriesEntries

Illustration 3-37

Illustration 3-37

3-83

8. Post-Closing Trial Balance8. Post-Closing Trial Balance8. Post-Closing Trial Balance8. Post-Closing Trial Balance

LO 7

Illustration 3-38

3-84

9. Reversing Entries9. Reversing Entries9. Reversing Entries9. Reversing Entries


After preparing the financial statements and closing

the books, a company may reverse some of the

adjusting entries before recording the regular

transactions of the next period.

3-85

Accounting Cycle SummarizedAccounting Cycle SummarizedAccounting Cycle SummarizedAccounting Cycle Summarized


1. Enter the transactions of the period in appropriate journals.

2. Post from the journals to the ledger (or ledgers).

3. Take an unadjusted trial balance (trial balance).

4. Prepare adjusting journal entries and post to the ledger(s).

5. Take a trial balance after adjusting (adjusted trial balance).

6. Prepare the financial statements from the second trial balance.

7. Prepare closing journal entries and post to the ledger(s).

8. Take a trial balance after closing (post-closing trial balance).

9. Prepare reversing entries (optional) and post to the ledger(s).

3-86

Financial Statements of a Merchandising CompanyFinancial Statements of a Merchandising CompanyFinancial Statements of a Merchandising CompanyFinancial Statements of a Merchandising Company

LO 7

Illustration 3-39

3-87

Financial Statements of a Merchandising CompanyFinancial Statements of a Merchandising CompanyFinancial Statements of a Merchandising CompanyFinancial Statements of a Merchandising Company

LO 7

Illustration 3-40

3-88

Financial Financial Statements of a Statements of a Merchandising Merchandising

CompanyCompany

Financial Financial Statements of a Statements of a Merchandising Merchandising

CompanyCompany

LO 7

Illustration 3-41

3-89

APPENDIXAPPENDIX 3A CASH-BASIS ACCOUNTING VERSUS ACCRUAL-BASIS ACCOUNTING

Most companies use accrual-basis accounting

recognize revenue when it is earned and

expenses in the period incurred,

without regard to the time of receipt or payment of cash.

Under the strict cash-basis, companies

record revenue only when they receive cash, and

record expenses only when they disperse cash.

Cash basis financial statements are not in conformity with GAAP.

LO 8 Differentiate the cash basis of accounting from the accrual basis of accounting.

3-90

Illustration: Quality Contractor signs an agreement to construct a

garage for $22,000. In January, Quality begins construction, incurs

costs of $18,000 on credit, and by the end of January delivers a

finished garage to the buyer. In February, Quality collects $22,000

cash from the customer. In March, Quality pays the $18,000 due the

creditors. Illustration 3A-1



3-91

Illustration: Quality Contractor signs an agreement to construct a

garage for $22,000. In January, Quality begins construction, incurs

costs of $18,000 on credit, and by the end of January delivers a

finished garage to the buyer. In February, Quality collects $22,000

cash from the customer. In March, Quality pays the $18,000 due the

creditors.Illustration 3A-2



3-92

Conversion From Cash Basis To Accrual Basis

Illustration: Dr. Diane Windsor, like many small business owners, keeps her accounting records on a cash basis. In the year 2010, Dr. Windsor received $300,000 from her patients and paid $170,000 for operating expenses, resulting in an excess of cash receipts over disbursements of $130,000 ($300,000 - $170,000). At January 1 and December 31, 2010, she has accounts receivable, unearned service revenue, accrued liabilities, and prepaid expenses as shown in Illustration 3A-5.

Illustration 3A-5



3-93

Illustration: Calculate service revenue on an accrual basis.

Illustration 3A-5

Illustration 3A-8




3-94

Illustration: Calculate operating expenses on an accrual basis.

Illustration 3A-5

Illustration 3A-11




3-95 LO 8

Illustration 3A-12



3-96LO 8 Differentiate the cash basis of accounting from

the accrual basis of accounting.

Theoretical Weaknesses of the Cash Basis

Today’s economy is considerably more lubricated by credit than by cash.

The accrual basis, not the cash basis, recognizes all aspects of the credit phenomenon.

Investors, creditors, and other decision makers seek timely information about an enterprise’s future cash flows.


3-97 LO 9 Identifying adjusting entries that may be reversed.

Illustration of Reversing Entries—AccrualsIllustration 3B-1

APPENDIXAPPENDIX 3B USING REVERSING ENTRIES


Illustration of Reversing Entries—Deferrals


Illustration 3B-2


Summary of Reversing Entries

1. All accruals should be reversed.

2. All deferrals for which a company debited or credited the

original cash transaction to an expense or revenue

account should be reversed.

3. Adjusting entries for depreciation and bad debts are not

reversed.

Recognize that reversing entries do not have to be used.

Therefore, some accountants avoid them entirely.


3-100 LO 10 Prepare a 10-column worksheet.

A company prepares a worksheet either on

columnar paper or

within an electronic spreadsheet.

A company uses the worksheet to adjust

account balances and

to prepare financial statements.

APPENDIXAPPENDIX 3C USING A WORKSHEET: THE ACCOUNTING CYCLE REVISITED

3-101 LO 10 Prepare a 10-column worksheet.

A company prepares a worksheet either on

columnar paper or

within an electronic spreadsheet.

Worksheet Columns


3-102 LO 10

Illustration 3C-1Worksheet


3-103

The Worksheet:

provides information needed for preparation of the

financial statements.

Sorts data into appropriate columns, which facilitates

the preparation of the statements.

LO 10 Prepare a 10-column worksheet.

Preparing Financial Statements from a Worksheet


3-104 LO 10

Illustration 3-39


3-105

Illustration 3-40


LO 10

3-106

Illustration 3-41

APPENDIXAPPENDIX 3C

USING A WORKSHEET: THE ACCOUNTING CYCLE REVISITED

LO 10

3-107

RELEVANT FACTS

International companies use the same set of procedures and records to keep track of transaction data. Thus, the material in Chapter 3 is the same under both GAAP and IFRS.

Transaction analysis is the same under IFRS and GAAP but, as you will see in later chapters, different standards sometimes impact how transactions are recorded.

Rules for accounting for specific events sometimes differ across countries. For example, European companies rely less on historical cost and more on fair value than U.S. companies. Despite the differences, the double-entry accounting system is the basis of accounting systems worldwide.

3-108

RELEVANT FACTS

Both the IASB and FASB go beyond the basic definitions provided in this textbook for the key elements of financial statements, that is, assets, liabilities, equity, revenues, and expenses.

A trial balance under IFRS follows the same format as shown in the textbook.

Internal controls are a system of checks and balances designed to prevent and detect fraud and errors. While most companies have these systems in place, many have never completely documented them nor had an independent auditor attest to their effectiveness. Both of these actions are required under SOX. Enhanced internal control standards apply only to large public companies listed on U.S. exchanges.

3-109

Information in a company’s first IFRS statements must:

a. have a cost that does not exceed the benefits.

b. be transparent.

c. provide a suitable starting point.

d. All the above.

IFRS SELF-TEST QUESTION

3-110

The transition date is the date:

a. when a company no longer reports under its national standards.

b. when the company issues its most recent financial statement

under IFRS.

c. three years prior to the reporting date.

d. None of the above.


3-111

When converting to IFRS, a company must:

a. recast previously issued financial statements in accordance

with IFRS.

b. use GAAP in the reporting period but subsequently use IFRS.

c. prepare at least three years of comparative statements.

d. use GAAP in the transition year but IFRS in the reporting year.


3-112

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