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Recognition and Measurement Concepts
ELEMENTS 1. Assets 2. Liabilities 3. Equity 4. Investment by owners 5. Distribution to owners /
dividends 6. Comprehensive
income 7. Revenues 8. Expenses 9. Gains 10. Losses
OBJECTIVES
Provide information:
1. Useful in investment and credit decisions.
2. Useful in assessing future cash flows.
3. About the financial position, performance, and changes in financial position.
PRINCIPLES
1. Historical cost 2. Revenue recognition 3. Matching 4. Full disclosure
CONSTRAINTS
1. Cost-benefit 2. Materiality 3. Industry Practice 4. Conservatism 5. Balance between Qualitative Characteristics
ASSUMPTIONS
1. Economic entity 2. Going concern 3. Monetary unit 4. Periodicity
First level: The “why” – goals and purposes of accounting.
Second level: Bridge between levels 1 and 3
Third level: The “how” – implementation
QUALITATIVE CHARACTERISTICS
1. Understandability 2. Relevance (Feedback
value, Predictive value and Materiality)
3. Reliability (Faithful Representation, Substance over Form, Neutrality, Prudence, and Completeness)
4. Comparability
Generally Accepted Accounting Principles
The Accounting CycleIdentification and Measurement of
Transactions and Other Events
Identification and Measurement of Transactions and Other Events
Reversing entries(optional)
Reversing entries(optional)
Post-closing trial balance
(optional)
Post-closing trial balance
(optional)
Closing(nominal accounts)
Closing(nominal accounts)
Statement preparationIncome statement Retained earnings Balance sheetCash Flows
Statement preparationIncome statement Retained earnings Balance sheetCash Flows
JournalizationGeneral journalCash receipt journalCash disbursements journalPurchases journalSales journalOther special journals
JournalizationGeneral journalCash receipt journalCash disbursements journalPurchases journalSales journalOther special journals
Posting General ledger (usually monthly)Subsidiary ledgers (usually daily)
Posting General ledger (usually monthly)Subsidiary ledgers (usually daily)
Trial Balance Preparation
Trial Balance Preparation
AdjustmentsAccruals
PrepaymentsEstimated items
AdjustmentsAccruals
PrepaymentsEstimated items
Work Sheet(optional)
Work Sheet(optional)
Adjusted Trial BalanceAdjusted Trial Balance
Accounting Process
Prepare accounting reports
Analyze and interpret for users
Record, classify, and summarize
Select economic events (transactions)
IdentificationIdentificationRecordingRecording
CommunicationCommunication
Transaction Identification
1. Each transaction must be analyzed in terms of its effect on:
(a) the three components of the basic accounting equation (i.e. ASSETS, LIABILITIES & CAPITAL)
(b) specific types (kinds) of items within each component (i.e. Account Titles as indicated in the CHART OF ACCOUNTS)
2. The equality of the equation must be maintained for every transaction.
Discuss services offered with potential client
Purchase supplies
CriterionCriterion
Pay rent
Record
EventsEvents
RecordDon’t
Record
Record/ Record/ Don’t RecordDon’t Record
Is the financial position (assets, liabilities, and owner’s equity) of the company changed?
Yes No Yes
CHART OF ACCOUNTS
Assets Owner’s Equity
101 Cash 301 E. Fernandez, Capital
112 Accounts Receivable 306 E. Fernandez, Drawing
113 Inventory 350 Income Summary
130 Prepaid Insurance
157 Equipment Revenues
158 Accumulated Depreciation—Office Equipment
400 Service Revenue
Liabilities Expenses
200 Notes Payable 501 Advertising Expense
201 Accounts Payable 502 Depreciation Expense
209 Unearned Revenue210 Accrued Revenue
503 Supplies Expense504 Insurance Expense
212 Salaries Payable 505 Salaries Expense
230 Interest Payable 506 Rent Expense
507 Utilities Expense
Revenues/Gains
Withdrawals by owner
Expenses/Losses
Investments by ownerOwner’s Equity
INCREASES DECREASES
Transaction Analysis
TRANSACTION (1). INVESTMENT BY OWNER. Eric Fernandez decides to open a clinic which he names Caring Hands. On September 1, 2007, he invests $15,000 cash in the business.
Assets = Liabilities +
E. Fernandez
Capital(1) 15,000 = 15,000
Capital
Cash
Transaction Analysis
TRANSACTION (2). PURCHASE OF EQUIPMENT FOR CASH. Caring Hands purchases equipment for $7,000 cash.
Liabilities + Capital
E. Fernandez
CapitalOld Bal. 15,000 15,000
(2) -7,000 7,000 _______New Bal. P8,000 7,000 = 15,000
15,000
=
Assets
EquipmentCash
Transaction Analysis
TRANSACTION (3). PURCHASE OF SUPPLIES ON CREDIT. Caring Hands purchases supplies for $1,600, expected to be paid next month.
Liabilities + Capital
Old Bal. 8,000 7,000 15,0001,600 -1,600
New Bal. 8,000 + 7,000 = 1,600 + 13,400
=
15,000
+
Assets
EquipmentCash
15,000
+Accounts Payable
E. Fernandez, Capital
Old Bal. 8,000 7,000 1,600 13,400(4) 1,200 1,200
New Bal. 9,200 + 7,000 = 1,600 + 14,600
Accounts Payable
E. Fernandez, Capital
=EquipmentCash + +
Transaction Analysis
TRANSACTION (4). SERVICES PROVIDED FOR CASH. Caring Hands receives $1,200 cash from customers for professional services it has provided.
Service Revenue
16,20016,200
Transaction Analysis
TRANSACTION (5). PURCHASE OF ADVERTISING ON CREDIT. Receives a bill for $250 from the Rural News for advertising but postpones payment of the bill until a later date.
Old Bal. 9,200 7,000 1,600 14,600(5) 250 -250
New Bal. 9,200 + 7,000 = 1,850 + 14,350
Accounts Payable
E. Fernandez, Capital
EquipmentCash + +=
Advertising Expense
16,200 16,200
Transaction Analysis
TRANSACTION (6). SERVICES PROVIDED FOR CASH AND CREDIT. Caring Hands provides $3,500 of medical services for customers. Cash of $1,500 is received from customers, and the balance of $2,000 is billed on account.
Liabilities + Capital
Old Bal. 9,200 7,000 1,850 14,350(6) 1,500 2,000 3,500
New Bal. 10,700 + 2,000 + 7,000 = 1,850 + 17,850
19,750
Assets
EquipmentCash
19,700
+ +Accounts Payable
E. Fernandez, Capital
=+Accounts
Receivable
Service Revenue
Transaction Analysis
TRANSACTION (7). PAYMENT OF EXPENSES. Expenses paid in cash for September are rent $600, salaries of employees $900, and utilities $200.
Liabilities + Capital
Old Bal. 10,700 2,000 7,000 1,850 17,850-1,700 -600
-900(7) -200
New Bal. 9,000 + 2,000 + 7,000 = 1,850 + 16,150
Accounts Payable
E. Fernandez, Capital
=+Accounts
Receivable
18,000
Assets
EquipmentCash
18,000
+ +
Rent Expense
Salaries Expense
Utilities Expense
Transaction Analysis
TRANSACTION (8). PAYMENT OF A LIABILITY. Caring Hands pays its $250 Rural News advertising bill in cash.
Old Bal. 9,000 2,000 7,000 1,850 16,150(8) -250 -250
New Bal. 8,750 + 2,000 + 7,000 = 1,600 + 16,150
17,750
EquipmentCash
17,750
+ +Accounts Payable
E. Fernandez, Capital
=+Accounts
Receivable
Transaction Analysis
TRANSACTION (9). COLLECTION OF A RECEIVABLE. The sum of $600 in cash is received from customers who have previously been billed for services [in Transaction 6].
Old Bal. 8,750 2,000 7,000 1,600 16,150(9) 600 -600
New Bal. 9,350 + 1,400 + 7,000 = 1,600 + 16,150
Accounts Payable
E. Fernandez, Capital
=+Accounts
Receivable
17750
EquipmentCash
17,750
+ +
Transaction Analysis
TRANSACTION (10). WITHDRAWAL OF CASH BY OWNER. Erik Fernandez withdraws $1,300 in cash from the business for his personal use.
Old Bal. 9,350 1,400 7,000 1,600 16,150(10) -1,300 -1,300
New Bal. 8,050 + 1,400 + 7,000 = 1,600 + 14,850
Accounts Payable
E. Fernandez, Capital
=+Accounts
Receivable
16,450
EquipmentCash
16,450
+ +
Drawings
Liabilities +
(1) 15,000 15,000 Investment
(2) -7,000 7,0008,000 + 7,000 = 15,000
(3) 1,600 -1,600 Supplies Expense
8,000 + 7,000 = 1,600 13,400(4) 1,200 1,200 Service Revenue
9,200 + 7,000 = 1,600 14,600(5) 250 -250 Advertising Expense
9,200 + 7,000 = 1,850 14,350(6) 1,500 2,000 3,500 Service Revenue
10,700 + 2,000 + 7,000 = 1,850 17,850(7) -1,700 -600 Rent Expense
-900 Salaries Expense
-200 Utilities Expense
9,000 + 2,000 + 7,000 = 1,850 16,150(8) -250 -250
8,750 + 2,000 + 7,000 = 1,600 16,150(9) +600 -600
9,350 + 1,400 + 7,000 = 1,600 16,150(10) -1,300 -1,300 Drawings
8,050 + 1,400 + 7,000 = 1,600 + 14,850
+
Transaction
Accounts Payable
=+Accounts
Receivable
Owner's Equity
E. Fernandez, Capital
16450
Assets
EquipmentCash
16,450
+
Tabular Summary of Caring Hands Transactions
Accounting Process
Prepare accounting reports
Analyze and interpret for users
Record, classify, and summarize
Select economic events (transactions)
IdentificationIdentificationRecordingRecording
CommunicationCommunication
The Recording Process (Bookkeeping)
Transaction Identification
Enter transaction
in a JOURNAL using the rules of
DEBIT and CREDIT
Transfer journal
information to the LEDGER ACCOUNTS
REGULAR BOOKS OF ACCOUNTS
JOURNALS Record of transactions in chronological order
Cash Book – record all receipts and payments for the period
Sales Journal – record all sales on credit Purchases Journal – record all purchases on credit General Journal – record of all transactions
GENERAL LEDGER Classifies the transactions as they affect the
different accounts for the period (usually one year)
SUBSIDIARYBOOKS OF ACCOUNTS
Receivables (Customers) Ledger Payables (Suppliers) Ledger Payroll Register Stock (Inventory) Records Equipment Ledgers or Asset
Inventory Rcords
Title of Account
Left or debit sideRight or credit
side
Debit Balance Credit balance
Basic Form of Account
Sept 30 Balance CB1 18 3 0 0 00 18 3 0 0 0030 Balance CB1 10 2 5 0 00 8 0 5 0 00
Debit
ACCOUNT Cash ACCOUNT NO. 101
CreditPost. Ref. Debit Credit
BalanceItemDate
SAMPLE ACCOUNT
recorded inrecorded in
recorded inrecorded in
RECEIPT and PAYMENT of CASH from any source
Cash Book
Other transactions
General Journal
The JOURNALS
Account Titles F
Sept 1 15 0 0 0 00 E. Fernandez, capital 15 0 0 0 002 7 0 0 0 00 Equipment 7 0 0 0 004 1 2 0 0 00 1 2 0 0 006 1 5 0 0 00 2 0 0 0 00 3 5 0 0 007 1 7 0 0 00 9 0 0 00 2 0 0 00 Rent Expense 6 0 0 008 2 5 0 00 2 5 0 009 6 0 0 00 ( 6 0 0 00 )
10 1 3 0 0 00 E. Fernandez, drawing 1 3 0 0 0018 3 0 0 00 10 2 5 0 00 2 5 0 00 9 0 0 00 2 0 0 00 1 4 0 0 00 4 7 0 0 00 8 9 0 0 00 15 0 0 0 00
29 9 5 0 00 29 9 5 0 00Debits
ParticularsAccounts Payable
Debit
Salaries Expense
Debit
=
Cash Book page 1
Cash
Debit Credit
Utilities Expense
DebitDate
Accounts Receivable Debit (Credit)
Service Revenue
Credit
Credits
Debit Credit
Sundry
Description F
1 Sept 3 Supplies Expense 1 6 0 0 00 1
2 Accounts Payable 1 6 0 0 00 2
3 Purchase supplies on credit. 3
4 4
5 5 Advertising Expense 2 5 0 00 5
6 Accounts Payable 2 5 0 00 6
7 Incurred advertising expense 7
8 on credit. 8
9 9
GENERAL JOURNAL Page 1Date Debit Credit
Equipment
Supplies
The General Ledger
Individual
Assets
Accounts Receivable
Cash
Interest Payable
Salaries Payable
Individual
Liabilities
Accounts Payable
Notes Payable
Salaries Expense
Service Revenue
Individual
Owner’s Equity
E. Fernandez, Drawing
E. Fernandez, Capital
CHART OF ACCOUNTS
Assets Owner’s Equity
101 Cash 301 E. Fernandez, Capital
112 Accounts Receivable 306 E. Fernandez, Drawing
113 Inventory 350 Income Summary
130 Prepaid Insurance
157 Equipment Revenues
158 Accumulated Depreciation—Office Equipment
400 Service Revenue
Liabilities Expenses
200 Notes Payable 501 Advertising Expense
201 Accounts Payable 502 Depreciation Expense
209 Unearned Revenue210 Accrued Revenue
503 Supplies Expense504 Insurance Expense
212 Salaries Payable 505 Salaries Expense
230 Interest Payable 506 Rent Expense
507 Utilities Expense
Sept 30 Balance CB1 18 3 0 0 00 18 3 0 0 0030 Balance CB1 10 2 5 0 00 8 0 5 0 00
Debit
ACCOUNT Cash ACCOUNT NO. 101
CreditPost. Ref. Debit Credit
BalanceItemDate
Sept 6 CB1 2 0 0 0 00 2 0 0 0 009 CB1 6 0 0 00 1 4 0 0 00
Debit
ACCOUNT Accounts Receivable ACCOUNT NO. 112
CreditPost. Ref. Debit Credit
BalanceItemDate
Sept 2 CB1 7 0 0 0 00 7 0 0 0 00
Date Debit
ACCOUNT Equipment ACCOUNT NO. 157
CreditPost. Ref. Debit Credit
BalanceItem
Sept 3 GJ1 1 6 0 0 00 1 6 0 0 005 GJ1 2 5 0 00 1 8 5 0 00
30 CB1 2 5 0 00 1 6 0 0 00
Debit
ACCOUNT Accounts Payable ACCOUNT NO. 201
CreditPost. Ref. Debit Credit
BalanceItemDate
Sept 1 CB1 15 0 0 0 15 0 0 0
Debit
ACCOUNT E. Fernandez, Capital ACCOUNT NO. 301
CreditPost. Ref. Debit Credit
BalanceItemDate
Sept 10 CB1 1 3 0 0 0 1 3 0 0 00
ACCOUNT E. Fernandez, Drawing ACCOUNT NO. 306
CreditPost. Ref. Debit Credit
BalanceItemDate Debit
Sept 30 Balance CB1 4 7 0 0 4 7 0 0
Debit
ACCOUNT Service Revenue ACCOUNT NO. 400
CreditPost. Ref. Debit Credit
BalanceItemDate
Sept 5 GJ1 2 5 0 00 2 5 0 00
Debit
ACCOUNT Advertising Expense ACCOUNT NO. 501
CreditPost. Ref. Debit Credit
BalanceItemDate
Sept 3 GJ1 1 6 0 0 00 1 6 0 0 00
ACCOUNT Supplies Expense ACCOUNT NO. 503
CreditPost. Ref. Debit Credit
BalanceItemDate Debit
Sept 30 Balance CB1 9 0 0 00 9 0 0 00
ACCOUNT Salaries Expense ACCOUNT NO. 505
CreditPost. Ref. Debit Credit
BalanceItemDate Debit
Sept 6 CB1 6 0 0 00 6 0 0 00
Date Debit
ACCOUNT Rent Expense ACCOUNT NO. 506
CreditPost. Ref. Debit Credit
BalanceItem
Sept 30 CB1 2 0 0 00 2 0 0 00
Date Debit
ACCOUNT Utilities Expense ACCOUNT NO. 507
CreditPost. Ref. Debit Credit
BalanceItem
Cash 8 0 5 0 00Accounts Receivable 1 4 0 0 00Equipment 7 0 0 0 00Accounts Payable 1 6 0 0 00E. Fernandez, Capital 15 0 0 0 00E. Fernandez, Drawing 1 3 0 0 00Service Revenue 4 7 0 0 00Supplies Expense 1 6 0 0 00Advertising Expense 2 5 0 00Salaries Expense 9 0 0 00Rent Expense 6 0 0 00Utilities Expense 2 0 0 00
21 3 0 0 00 21 3 0 0 00
CARING HANDSTrial Balance
30-Sep-07
Adjusting Entries
1. ACCRUALS1.1. Accruals of Expenses – expenses incurred
but not paid.Expenses
XX Payable (Accrued Expense) XX
1.2. Accruals of Revenue – revenue earned but not collected.
Receivable (Accrued Revenue) XX Revenue XX
Adjusting Entries
2. DEFERRALS2.1. Deferrals of Expenses – expenditures paid but
not incurred.ASSET METHODExpense XX Asset (Prepaid/Deferred Expense)XXEXPENSE METHODAsset (Prepaid/Deferred Expense) XX Expense
XX
Adjusting Entries
2. DEFERRALS2.2. Deferrals of Revenue – receipts collected but
not earned.LIABILITY METHODLiability (Deferred Revenue) XX Revenue XXREVENUE METHODRevenue XX Liability (Deferred Revenue)XX
Adjusting Entries
3. DEPRECIATIONDepreciation Expense – Asset XX Accumulated Depreciation – Asset
XX
Formula: Cost – Salvage Value Useful life
Adjusting Entries
4. BAD DEBTSBad Debts Expense XX Allowance for Bad Debts XX
Formula: % of Outstanding Receivables
Revenue Service revenue $4,700Expenses Supplies Expense $1,600 Salaries Expense 900 Rent Expense 600 Advertising expense 250 Utilities expense 200 Total expenses 3,550Net income $1,150
CARING HANDSIncome Statement
For the Month Ended September 30, 2007
E. Fernandez, Capital - September 1 $ --0--Add: Investments $15,000 Net income 1,150 16,150
16,150Less: Drawings 1,300E. Fernandez, Capital - September 30 $14,850
CARING HANDSOwner's Equity Statement
For the Month Ended September 30, 2007
Cash $8,050Accounts receivable 1,400Equipment 7,000 Total assets $16,450
Liabilities Accounts payable $1,600Owner's equity E. Fernadez, Capital 14,850 Total liabilities and owner's equity $16,450
Liabilities and Owner's Equity
CARING HANDSBalance Sheet
As of September 30, 2007Assets
Cash flows from operating activities Cash receipts from revenues $ 3,300 Cash payments for expenses (1,950) Net cash provided by operating activities 1,350Cash flows from investing activities Purchase of equipment (7,000)Cash flows from financing activities Investments by owner $15,000 Drawings by owner (1,300) 13,700Net increase in cash 8,050Cash at the beginning of the period 0Cash at the end of the period $ 8,050
CARING HANDSStatement of Cash Flows
For the Month Ended September 30, 2007