Accounting Reading and Vocabulary

7/27/2019 Accounting Reading and Vocabulary

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A CCOUNTING

Readings and vocabulary in English


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David Smith Murphy Zoila Gallardo Hernndez

Jaime Sanchis Cuevas

A C C O U N T I N G

Readings and Vocabulary in English

I NSTITUTO P OLITCNICO N ACIONAL

M X I C O


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Primera edicin:

D.R. 1998, INSTITUTO POLITCNICO NACIONAL

Direccin de Publicaciones y Materiales Educativos

Tresguerras 27, 06040, Mxico, D.F.

ISBN:

Impreso en Mxico /Printed in Mexico


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INTRODUCTION

This book is not designed to teach accounting concepts; the students

are assumed to a have firm grasp of accounting. The purpose of this

book is to provide Spanish-speaking students and professionals, at

intermediate and advanced English levels, with the vocabulary that is

necessary for them to be able to discuss accounting concepts in English.

Each chapter contains a short description of several related concepts

based on specialized literature. The topics have been chosen within

the realm of the accounting world to help students analyze and discuss

these matters in English. The text in each chapter is followed by

exercises which are suitable for self-study and class discussion. The

great majority of the questions, except those exercises where discussion

is involved, have keyed answers at the back of the book.


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CHAPTER 1ACCOUNTING: THE LANGUAGE OF BUSINESS

INTRODUCTORY VOCABULARY

Study the following terms before the reading.

INTRODUCTION

Accounting is often referred to as the language of business and is a

necessary and important part of our day-to-day economic activities.

Many people view accounting as an exact science which is only

practiced by well-trained specialists. However, almost everyoneengages in accounting activities. For example, the preparation of a

family budget requires accounting skills as does paying bills and filling

out tax forms. This chapter reviews the nature and functions of

accounting in our complex world.

Accounting has been defined as the art of providing quantitative

information, which is primarily financial in nature, about economic

Accounting Contabilidad

Auditing Auditora

Budget Presupuesto

Investors Inversionistas

Material Material

Qualitative Cualitativo

Quantitative Cuantitativo

System Sistema

Tax Impuesto

Transactions Transacciones

Profitability Rentabilidad

Profit Utilidad


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events and transactions that is intended to be useful in making

economic resource allocation decisions. Others believe that accounting

is a process that involves (1) the observation and selection of relevant

types of data about an organizations activities, (2) the measurement

of that data, (3) the processing and analysis of the selected data so

that it can be used in decision making and (4) the disclosure or

presentation of that information to decision makers. In both cases

an accounting system is used to record, summarize, and report the

selected information.

QUALITATIVE CHARACTERISTICS

The information that is selected for presentation by an accounting

system should exhibit several qualitative characteristics. The

characteristics are summarized in figure 1.1 below.

FIGURE1.1Qualitative information characteristics

MATERIAL

COST EFFECTIVE

UNDERSTANDABLE

USEFUL

DECISION RELEVANT COMPARABLE RELIABLE

TIMELY PREDICTIVE

FEEDBACK

NEUTRAL VERIFIABLE


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The first requirement or objective of an accounting system is that it

produces information that is material. This means that the

information will make a difference to a decision maker. If information

will not affect the decision made by an individual then the information

has no value. The accounting system must also be cost effective.

This means that the cost of the information generated by the

accounting system must be less than or equal to the value of the

information generated. It is not rational to produce information if

the cost of the information exceeds its value. The information must

also be understandable because decision makers will not be able to

make effective use of information that they can not understand.

Information must also be useful. Accounting information is useful

if it is relevant, comparable, and reliable. Information is relevant

when it is received before a decision is made, not after, and when it

has either predictive value or feedback value. Predictive information

can be used to project future events. Feedback information can be

used to control current operations. Information is comparable when

similar information exists from past periods. Accountants and

managers are able to use information produced in several different

time periods to analyze trends and to see how a business is changing

over time. Finally, information should be reliable. Information is

reliable when it is free from bias and when it is verifiable, when other

accountants would come to the same conclusions given the same

situation and the same facts.

USERS OF ACCOUNTING INFORMATION

Accounting information is prepared for two important groups: (1)

external users, and (2) internal users. External users are decision makers

outside of the organization while the internal users are the managers


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of the organization. External users include investors and potential

investors, governmental agencies, and the general public.

Investors and potential investors need information about the

profitability of the organization. Stockholders and potential

stockholders are concerned with the growth in stock prices and the

firms ability to pay dividends. Creditors and potential creditors are

concerned with the organizations ability to pay its current and future

debt obligations.

Governmental agencies are concerned with the taxes that anorganization should pay, the contribution that the organization makes

to the economic well being of the country, and organizations

compliance with applicable laws andregulations.

Managers, the internal users of accounting information, are

responsible for planning and controlling the operations of the

organization. They use accounting information to determine how

well the organization is meeting its goals and objectives and to control

or direct the future course of the organization. Accountants play a

critical role in providing information to all of these groups of

individuals.

ACCOUNTANTS ROLES AND RESPONSABILITIES

Accountants play three important roles with respect to accounting systems.

Accountants are the primary users of accounting systems. This means that

the accountants provide input to the accounting system and receive and

evaluate the systems outputs. Accountants are also responsible for the design

of accounting system and for auditing accounting systems to make sure that

the information produced by the system is relevant and reliable.


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d. Design

e. Manager

f. Profitability

g. Relevant

h. Reliable

i. Resource

j. Stockholders

k. Trend

3.MATCHINGMatch first column with the best definition from

the second column.

a. Accounting 1. A plan that shows expected revenues and

expenses

b. Auditing 2.The head of a department or organizational

unit

c. Budget 3. A process which includes transaction

recording

d. Creditor 4.The process of verifying reported results

e. Manager 5. An individual or entity to whom money is

owed

4. FILL-INFill in the blanks using the vocabulary words from this

chapter.

a. _______________ and _______________ are two

different types of investors.

b. Managers use accounting information to help them

_______________ and _______________ business operations.


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c. Accounting information is used to make ________________

_____________ decisions.

d. Information is _______________ when it makes a difference to

a decision maker.

e. Information must be timely and either have ___________

value or ___________ value to be relevant to a decision maker.

5. DISCUSSIONQUESTIONS Answer the following questions and

discuss them in class.

a. Why is accounting called the language of business?

b. Why do you think that accounting is so important in

todays business enviroment ?

c. In addition to the qualitative characteristics of information

discussed in this chapter, what other attributes should

accounting information have?

d. What different decisions do you think that external users

of financial information make? What kind of information

would help them make those decisions?

e. What different decisions do you think that internal usersof financial information make? What kind of information

would help them make those decisions? Why are the

information needs of external and internal users different?

f. Which of the three roles that accountants play with respect to

information systems do you think is most important? Why?


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CHAPTER 2

THE ACCOUNTING EQUATION

INITIAL VOCABULARY

Asset ActivoBalance sheet Hoja del balance

Income Ingreso

Income statement Estado de Resultados

Liability Pasivos

Stockholders equity Patrimonio

INTRODUCTION

Individuals invest their resources in a business when they create a

new business and when they purchase an interest in an existing

business. The owners and managers of the business use these resources

along with funds borrowed from creditors to acquire economic

resources. The amount of economic resources held by a business are

always equal to the sum of the owner and creditor investments. This

relationship is represented matematically in the accounting equation:

Assets = Liabilities + Stockholders Equity

Assume that the owners of a business invested $100 000 in the

business and that they borrowed an additional $50 000 from a large

bank. Their accounting equation would show:


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$150 000 = $50 000 + $100 000

ASSETS

Assets are the economic resources that an organization holds and

controls. These economic resources are assumed to be capable of

providing future economic benefits. An item is considered to be an

asset when (1) it resulted from a past transaction, (2) it has an historicalcost, (3) it is expected to provide future economic benefits, and (4) it

is controlled or owned by the organization.

There are many different types of assets in most organizations.

Common assets include cash, accounts receivable, inventory, and

property, plant and equipment or fixed assets. Most assets, but not

all, have physical substance. For example, cash and inventory are

both physical assets. Accounts receivable on the other hand does nothave a physical substance, it can not be physically counted or touched,

nevertheless it represents a future economic benefit and so it is classified

as an asset.

Assets are usually classified in decreasing order of liquidity. Current

assets include cash and all other assets which will either be converted

into cash or used by operations during the current year. Accounts

receivable and inventory are other examples of current assets.

LIABILITIES

Liabilities are expected future sacrifices of economic resources resulting

from present obligations or exchanges. For example, when a firm

borrows money from a bank, as in the example above, it receives an


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economic resource (cash) from the bank and incurs an obligation to

pay for that resource in the future by sacrificing an economic resource

in the future.

Liabilities are usually classified in terms of their expected payment

date. Obligations that will be paid within one year are usually classified

as current liabilities while obligations which will be due in more

than one year are classified as long-term liabilities. Accounts payable

and wages payable are examples of common current liabilities.

Mortgages and long-term loans are examples of long-term liabilities.

OWNERS EQUITY

Owners equity, or stockholders equity in a corporation, represents

the owners residual interests in the assets of a business after all of the

liabilities have been paid. Owners equity is sometimes called the net

asset value of the business.

Two common classifications of owners equity in a corporation are

capital stock and retained earnings. Capital stock represents the

amount that the owners have invested in the business. Retained

earnings represents the profits of the business (the difference between

revenues and expenses) that has not been distributed to the owners.

BALANCE SHEET

The relationship between assets, liabilities, and owners equity are

shown on a financial statement called the balance sheet. A balance

sheet provides a picture of a firms financial position at a point in

time. Assume that Holly and Jack decide to start a new business,

Holly Togs, Inc. on January 1. They complete the following three

transactions during the month of January: (1) Holly and Jack each

invest $5 000 in the business in exchange for capital stock, (2) they


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obtain a $3 000, 3 year loan from their friend Kimberly, and (3)

purchase equipment for $4 000, paying cash. Their accounting

equation would show the following changes:

ASSETS = LIABILITIES + OWNERS EQUITY

TRANSACTION CASH + EQUIPMENT = LOAN PAYABLE + CAPITAL STOCK

1 $10 000 $10 000

2 3 000 $ 3 000

3 - 4 000 $ 4 000 ______ _______

Balances $ 9 000 + $ 4 000 = $ 3 000 + $10 000

======== ====== ====== =======

Their balance sheet at January 31 would show:

HOLLY TOGS, INC.BALANCE SHEETJanuary 31, 1998

ASSETSCash $ 9 000Equipment 4 000

Total Assets $13 000=======

LIABILITIES AND STOCKHOLDERS EQUITY

Loan payable $ 3 000Total Liabilities $ 3 000

Capital Stock $10 000Total Stockholders Equity 10 000

Total Liabilities and Equity $13 000=======

Notice that total assets on the balance sheet are equal to the sum of

total liabilities and stockholders equity. This should always be true.


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EXERCISES

1.VOCABULARY.Translate the following terms into Spanish.

2. FILL-IN. Fill in the blanks with the appropriate accounting term.

a. The ______________ is a financial statement that provides

a picture of a firms financial position at a point in time.

b. The _______________ shows the equality of assets, and

liabilities and owners equity.

c. Cash, inventories and accounts receivable are all examples

of _______________.

d. A(n) _______________ is an example of a current

liability.

e. The difference between revenues and _______________

is called _______________.

f. Two components of owners equity are _______________

and _______________.

accounts payable

accounts receivable

asset

balance sheet

capital stock

cash

current asset

current liability

expense

income statement

inventory

liability

long-term liability

owners equity

prepaid expenses

property

retained earnings

revenue


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g. _______________ obligations that will be paid within

one year.

h. The financial statement which shows the results of operations,

the differences between revenues and expenses, is the _______.

i. Goods and merchandise held for resale are called __________.

j. Long-term loans and _______________ are examples of

long-term liabilities.

3. MATCHING. Match each English word with its Spanish equivalent.

a. asset 1. ingreso

b. balance sheet 2. pasivo

c. expense 3. estado de resultados

d. income statement 4. activo

e. liability 5. hoja de balance

f. owners equity 6. gastos

g. revenue 7. patrimonio

4. TRUEORFALSE Indicate whether each of the following statement

is true or false. If the statement is false, then explain why.

a. The balance sheet shows the difference between revenuesand expenses over the course of an accounting period.

b. The sum of assets and liabilities should always be equal to

stockholders equity in the accounting equation.

c. The difference between total assets and total liabilities is

sometimes called the net asset value of a company.


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d. Assets are resources which are expected to provide future

economic benefits and which are owned or controlled byan organization.

e. Assets are reported on the income statement in decreasing

order of liquidity.

f. The two common classifications of stockholders equity

are capital stock and retained earnings.

g. Total assets should always equal total liabilities on a

balance sheet.

h. All business transactions affect at least two different

accounts.

5. DISCUSSIONQUESTIONS. Write answers to the following questions

and be ready to discuss them in class.

a. What is the importance of the accounting equation?

b. Define asset and provide examples of assets which were

not identified in this chapter.

c. What kinds of assets would provide future economic

benefits without having physical substance in addition to

accounts receivable?

d. Why are liabilities and owners equity sometimes both

referred to as equities?


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CHAPTER 3

TRANSACTION CYCLES FOR MERCHANDISING FIRMS

INITIAL VOCABULARY

INTRODUCTION

There are many different ways to differentiate or classify business

firms. One common approach is to classify firms according to the

type of activity in which they are engaged. Using this approach, firms

can be classified as either service firms, merchandising firms, or

manufacturing firms. Aservice firmis one that provides a service to

its clients but which does not, in the normal course of its business,

maintain inventory or sell products to its clients. Advertising agencies,travel agencies, and accounting firms are examples of service businesses.

Amerchandising firmpurchases and holds inventory for resale to its

customers. Clothing stores and grocery stores are examples of

merchandising firms. Amanufacturing firmpurchases raw materials

and then converts those production inputs into finished goods which

are then sold to the firms customers.

Finished Goods Productos terminadosFirm Empresa

Inventory Inventario

Merchandising Empresa

Firm comercial

Order Pedido

Production FabricacinRaw Material Materias primas

Journal Entry Partida

General Ledger Libro Mayor

Revenue cycle Ciclo de ingresos

Expenditure cycle Ciclo de egresos


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A transaction cycle is a series of processing steps that common

business transactions follow. The transaction cycle is used by auditors

to understand the flow of information and transactions through a

clients accounting system. Transaction cycles are used by systems

analysts to identify the types of transaction processing systems that

should be found within an organization and the interfaces between

those systems. We will examine the computer-based transaction cycles

used by merchandising firms in this chapter. In chapter 12 we will

study a manufacturing firms transaction cycles.

TRANSACTION CYCLES

Figure 3.1 illustrates the two transaction cycles found in merchandising firms.

The first transaction cycle is the Revenue Cycle. This cycle processes customer

orders and accounts for the payment of goods purchased by customers. The

second transaction cycle, the Expenditure Cycle, processes the business

transactions used to purchase inventory, and pays the firms expenses.

FIGURE3.1Transaction cycles-Merchandising firm

REVENUE

CYCLE

EXPENDITURE

CYCLE

ORDERENTRYSYSTEM

ACCOUNTSRECEIVABLE

SYSTEM

INVENTORYSYSTEM

PURCHASING

SYSTEM

RECEIVING

SYSTEM

ACCOUNTSPAYABLESYSTEM

SHIPPING

SYSTEM

GENERALLEDGERSYSTEM


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Revenue Cycle

The Revenue Cycle usually consists of four different systems: Order

Entry, Inventory, Shipping, and Accounts Receivable. Processing inthe Revenue Cycle begins when a customer order is entered into the

Order Entry System. The Order Entry System makes sure that the

customers order can be filled by comparing the quantities ordered for

the items on the order with their respective quantities on hand. To do

this, the order entry system must access information contained in the

inventory file. The order entry system must also check the customers

credit status and decide whether or not to accept the customers order.Accepted orders are written to an Open Order File. Some customers

may have a history of slow or nonpayment of their accounts. In these

cases the order entry system may decide to reject the order or require

that the customer pay for the goods before they are shipped.

The inventory system acts as an interface between the Revenue Cycle

and the Expenditure Cycle. The inventory system substracts the quantity

ordered from the quantity on hand in the inventory master file when acustomers order is accepted. This way managers and sales representatives

always know how many units of an item are available for sale; they also

can decide when to purchase more inventory.

The shipping system receives the items that have been withdrawn

from inventory, packages them, and sends them to the customer. This

systemchanges the status of the order in the open order file from

open to filled. This system also sends information to the accounts

receivable system so that the customer can be billed for the goods

that have been shipped.

The Accounts Receivable System has four primary functions. First,

the Accounts Receivable System prints invoices which are sent to

customers when goods are shipped, it also prints monthly statements


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showing the unpaid balances on their accounts. Second, the Accounts

Receivable System maintains the accounts receivable master file. This file

replaces the accounts receivable subsidiary ledger in a manual accountingsystem. Third, it receives and processes customer payments on their accounts.

Finally, this system generates journal entries to record the sale of merchandise,

the cost of goods sold, and the receipt of payments on account. These

journal entries are processed by the general ledger system.

Expenditure Cycle

The Expenditure Cycle processes the transactions that are required to acquire

and pay for the goods and services that a firm requires. The Purchasing

System prints purchase orders which are sent to vendors. Vendors fill the

orders and send the requested goods back to the firm. The goods are

processed by the Receiving System which verifies that the received goods

were actually ordered and that the quantity and quality of the goods received

are appropriate. The vendor usually sends an invoice to the company

which ordered the goods at the time that the goods are shipped. Thisinvoice is received by the Accounts Payable System which records the liability

to pay for the goods. The Accounts Payble System eventually writes a check

to pay or liquidate the liability. This system also generates the journal

entries required to record the recognition of a liability when the goods are

received and the liquidation of the liability when the invoice is paid.

The Inventory System is the interface between the Revenue Cycle and

the Expenditure Cycle. Inventory quantities are added to inventory by theExpenditure Cycle and are subtracted from inventory by the Revenue Cycle.

All merchandising firms have a Revenue Cycle and an ExpenditureCycle. The systems found within each cycle are designed to meet theneeds of the company. For example, a retail store may replace theOrder Entry and Shipping Systems with a Point-of-Sale System.

Nevertheless, the same basic functions are always performed.


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EXERCISES

1. DEFINITION. Write definitions in English for the following terms.

Service Firm

Merchandising Firm

Manufacturing FirmTransaction Cycle

Vendor

2. FILL-IN. Fill in each of the following blanks with the appropiate term.

a. _______________ and _______________ are examples

of service businesses.

b. The Revenue Cycle consists of four different systems:

Order Entry, ________________ , ____________ and

Accounts Receivable.

c. Vendors ____________ the orders and _______ the

requested goods back to the firm.

d. The Inventory System is the ________________ between

the Revenue Cycle and the Expenditure Cycle.

e. All merchandising firms have a _______________ and an

Expediture Cycle.


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3. MATCHING. Match the term in the first column with the bestdefinition from the second column.

a. customer 1. buy

b. clothing stores and grocery stores. 2. unaccepted

c. purchase 3. goods

d. rejected 4. client

e. food, clothes, vehicles. 5. examples of

merchandising firm

4. FALSEORTRUE. Indicate whether each of the following statementsis true or false. If the statement is false, explain why.

a. The transaction cycle is used by system analysts to

understand the flow of information and transactions

through a clients accounting system.

b. The Revenue Cycle processes customer orders and accounts

for the payments of goods purchased by customer.

c. One of the primary functions of the Accounts Receivable

System is to receive the items that have been withdrawn

from inventory.

d. The Accounts Receivable System generates the journal

entries which would be recorded in accounts receivablesubsidiary ledger in a manual accounting system.

e. Journal entries are processed by the general ledger system.

f . The expenditure Cycle processes the transactions that are

required to acquire and pay for the goods and services that a

firm requires.


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g. The Receiving System prints purchase orders which are

sent to vendors.

h. The Purchasing System prints purchase orders which are

sent to vendors.



a. What are the ways to classify firms according to the type of

activity they are engaged in? Provide examples apart fromthose mentioned in this chapter.

b. For what do auditors and system analysts use the

transaction cycle ?

c. Explain in few words the difference between the Revenue

Cycle and the Expenditure Cycle.

d. Why is the Inventory System considered the interface

between the Revenue Cycle and the Expenditure Cycle?

e. Are the systems found within each cycle always the same?

Give examples of business which would have different

systems within the transaction cycles.


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CHAPTER 4

THE ACCOUNTING CYCLE


Balance Balance

Control Controlar

Credit Crdito/ abono

Debit Dbito/ cargo

Journal Diario

Record Registrar

Transaction Transaccin

Trial Balance Balanza de

comprobacin

Entry Asiento

INTRODUCTION

The accounting cycle consists of a series of steps which are followed

to capture, record and report financial information. The steps in this

cycle change little from organization to organization however the

technology used in the accounting cycle varies from unsophisticated

manual systems to very complex, on-line, integrated computer-based

systems. The process is cyclical because the same steps are repeated

every year. These steps are illustrated in figure 4.1 below.

The first four steps in the accounting cycle take place throughout

the accounting period, the remaining steps occur at the end of an

accounting period.


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DATA CAPTURE

The first step in the accounting cycle is to recognize that a business

transaction or event has occurred. Although businesses are engaged

in many different types of transactions and events, accountants are

interested in financial transactions, which usually result from an

exchange with a third party. The accountants capture data about the

monetary value of the transactions, the resources and obligations

affected by the transaction, the date of the transaction, and other

information which may be included on a source document.

FIGURE4.1The Accounting Cycle

1. Capture Transaction Data|

2. Analyze Data|

3. Record Transaction

|4. Post Transaction

|5. Prepare Trial Balance

|6. Prepare Adjusting Entries

|7. Prepare Adjusted Trial Balance

|8. Prepare Financial Statements

|9. Record and Post-Closing Entries

|10. Prepare Post-Closing Trial Balance

|11. Record and Post Reversing


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DATA ANALYSIS

The accountants analyze the data after it has been collected to

determine the effect of the transaction on specific general ledger

accounts. The accountants want to make sure that they are consistent,

that similar transactions are always treated the same way. They are

also concerned with objectivity and verifiability; they want to record

information which is free from bias and which is the same as that

which other accountants would record in the same situation.

TRANSACTION RECORDING

Accountants use journal entries to record business events. Every

journal entry affects at least two different accounts because a double-

entry accounting system is used. To maintain the equality of the

accounting equation the same amount must be (1) added to both

sides of the equation, (2) subtracted from both sides of the equation,

or (3) add and subtracted at the same time from one side of theequation. This is illustrated in figure 4.2.

FIGURE4.2Effect of transactions on the accounting equation


|___________________________________|(1) + +(2) - -(3) + - + -

Transactions are recorded using debits and credits. A debit represents

an entry on the left-hand side of a journal while a credit represents an

entry on the right-hand side of a journal. Debits and credits are used

to change accounts balances but their effect is determined by the type


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of account involved in the journal entry. Figure 4.3 below shows the

effects of debits and credits by major account type.

FIGURE4.3Effect of debits and credits

Account Type Debit Credit

Asset Increase Decrease

Liability Decrease Increase

Owners Equity Decrease Increase

Revenue Decrease Increase

Expense Increase Decrease

A $150 sales transaction on account would increase the balance in

the Accounts Receivable account by $150 (an asset account) and would

also increase the balance in the Sales (a revenue account) account.

Therefore this transaction would be recorded as:

Accounts Receivable 150.00Sales 150.00

POSTING TRANSACTIONS

The information contained in journal entries is transfered from the

journals (or books of original entry) to the general ledger (or book of

final entry). This process is called posting. The general ledgercontains a record for each general ledger account and all of the

transaction data that affect an account are summarized in that place.

The balance of each account is also maintained in the general ledger.

These balances are used to prepare the Trial Balance.


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TRIAL BALANCE PREPARATION

A trial balance is a report which lists every account in the general

ledger and its corresponding balance. The purpose of the trial balance

is to verify that the general ledger is in balance, that is, that debits

equal credit. A trial balance is used as a tool to control the general

ledger. It can not identify all errors in recording and posting

transactions, but it will indicate when debits do not equal credits.

The trial balance provides some of the information that is needed to

prepare adjusting journal entries and financial statements. These topicswill be discussed in the following chapter.

EXERCISES

1. VOCABULARY.-Translate the following terms into Spanish

a. General Ledger

b. Journal Entry

c. Trial Balance

d. Record Transaction

e. Post Transaction

f. Double-entry

2. MATCHING.- Match first column with the best definition from the

second column.

a. Cycle 1. Prejudice, predisposition.

b. Transaction 2. Growth

c. Process 3. Exchange


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d. Debit 4. Recurrent series

e. Increase 5. State of going or carried on

f. Bias 6. Entry in account of sum owing

3. Order the following steps of the Acounting Cycle in the correct

sequence.

a. Post transaction

b. Prepare Trial balance

c. Capture Transaction Data

d. Prepare Adjusting entriese. Record Transaction

f. Analyze Data

4.FILL-IN.- Fill in the blanks with the appropriate accounting term.

a. The accounting cycle consists of a series of steps which are

followed to _______________ , _______________ and

_______________.

b. ______________ , data analysis, ______________ and

posting transactions occur during the accounting period.

c. Accountants use _______________ _______________

to record bussiness events.

d. Transactions are recorded using _______________ and

________________.

e. Debits and Credits are used to change _______________

_______________.

f. The purpose of a trial balance is to ______________ that the

general ledger is in balance.


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g. The trial balance can not identify all errors in __________

and _______________ transactions.

h. The process of transfering the information contained in

journal entries from journals to the general ledger is called

_____________.



a. What are the steps in the accounting cycle that occur

during the accounting period?

b. What kind of data do accountants capture?

c. What is the purpose of analyzing data in the accounting

cycle?

d. How is the equality of the accounting equation

mantained?

e. How do accountants record transactions?

f. Explain the fourth step in the accounting cycle.

g. What is the purpose of a trial balance?

h. Why do you think that accountants use the double-entry

accounting system?


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CHAPTER 5

COMPLETING THE ACCOUNTING CYCLE


Accrued Devengado

Adjust Ajustar

Book keepers Tenedores de libro

Close Cerrar

Frequency Frequencia

Fiscal year Ao fiscal

Prepaid Gastos anticipados

expenses

Unearned Cobros anticipados

revenue

Accrual Gasto devengado

INTRODUCTION

The last chapter presented the first steps in the accounting cycle. These

steps are performed every day by accountants and bookkeepers as

they record business events and transactions. The remaining steps in

the accounting cycle are performed less frequently, often only once a

quarter or at the end of the fiscal year. The first of these steps is the

preparation of adjusting journal entries.

ADJUSTING JOURNAL ENTRIES

Adjusting journal entries are prepared to record events that occur

because of the passage of time. For example, interest income on an

investment may be earned continuously, however it is too difficult to

prepare a journal entry every hour or every day to record interest that


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ADJUSTED TRIAL BALANCE

An adjusted trial balance is prepared after all of the adjusting journal

entries have been posted to the general ledger. This trial balance

proves that the general ledger is still in balance after the transactions

have been posted.

FINANCIAL STATEMENT PREPARATION

Financial statements are prepared after all of the transactions for a

year have been recorded and posted and the accountants have verified

that the general ledger is in balance. Four financial statements are

prepared in the United States by organizations who conform to

Generally Accepted Accounting Principles (GAAP). These financial

statements are the (1) balance sheet, (2) income statement, (3)

statement of retained earnings, and (4) statement of cash flows.

CLOSING ENTRIES

Some general ledger accounts (assets, liabilities, and owners equity

accounts) are permanent accounts. The balances in these accounts

are carried forward from one year to the next. Other accounts (revenue

and expense accounts) are temporary accounts. The beginning

balances in these accounts are always zero. Closing entries are prepared

at the end of a fiscal year or accounting period to transfer the balancesin these accounts to the retained earnings account. These journal

entries are called closing entries. Some organizations use a special

account, income summary, as a flow-through account to aid in the

closing process. All of the revenue and expense accounts are closed

into the income summary account (at which time the balance in that

account should be the same as net income for the period) then the

income summary account is closed into the retained earnings account.


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Assume that a company had the following temporary account

balances:

Debit_________________Credit

Sales $ 35 000

Rent Expense $ 10 000

Salaries Expense 15 000

Utilities Expense 5 000

The closing entries for this company would be:

Sales 35 000

Rent Expense 10 000

Salaries Expense 15 000

Utilities Expense 5 000

Income Summary 5 000

andIncome Summary 5 000

Retained Earnings 5 000

POST-CLOSING TRIAL BALANCE

A post-closing trial balance is prepared after the closing entries have

been journalized (recorded in the journal) and posted. Once again,

this trial balance tests to make sure that the general ledger is in balance.

REVERSING ENTRIES

Some companies prepare reversing entries, as the first journal entries

of a new accounting period, to reverse the effect of accrual entries


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that were made during the adjustment process. Reversing entries are

not required but they make it easier to record subsequent transactions.

For example, assume that a companys payroll is $50 per day and that

all employes are paid every Friday. Further assume that Tuesday was

the last day of the fiscal year. On Tuesday the company had to prepare

the following journal entry to record accrued payroll:

Salaries and Wage Expense 100

Salaries and Wages Payable 100

After preparing closing entries on Tuesday the balance in the Salaries

and Wage Expense account was zero. If the company does not prepare

reversing entries then the journal entry to record payroll expense on

Friday will be:



Cash 250

On the other hand, to avoid making this complex journal entry,

the company could have prepared an entry on Wednesday (the first

day of the new fiscal year) to reverse the accrual entry that had been

made:




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Then journal entry on Friday would be:


Cash 250

The balances in the expense, liability and asset cash are the same in

either case after recording these transactions.

Now that you understand the basic vocabulary needed to discuss

the accounting cycle, we will look at accounting problems andvocabulary related to specific types of transactions in the following

chapters.


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EXERCISES

1. VOCABULARY. Give the best equivalent in Spanish for the following

terms.

a. Reversing Entries

b. Payroll

c. Unearned revenue

d. Statement of retained earnings

e. Statement of cash flows

f. Balance sheet

g. Income statement

2. MATCHING. Match the terms in the first column with the best

definition from the second column.

a. Bookkeeper 1. Money, currency

b. Accrue 2. Value

c. Cash 3. List of employees to be paid with the

amount due to each.

d. Invest 4. Who keeps a systematic record of

business transactions.

e. Worth 5. Accumulate periodically as an increase

f. Payroll 6. To put (money) into business, real

state. stocks, etc.


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3. Put the following steps in the accounting cycle, which are often performed

only once a quarter or at the end of the fiscal year, in the correct order.

a. Closing entries

b. Adjusted trial balance

c. Post-closing trial balance

d. Adjusting journal entries

e. Financial statement preparation

f. Reversing entries

4. FALSEORTRUE. Indicate whether each of the following statementsis true or false. If the statement is false, then explain why.

a. Prepaid items do not include unearned revenue.

b. Revenue and expenses accounts are permanent accounts.

c. It is not necessary that all of the adjusting journal entries have

been posted to the general ledger to prepare the trial balance.

d. Balances in permanent accounts are carried forward from

one year to the next.

e. It is important that the accountants have verified that the general

ledger is in balance before preparing the financial statements.

f. The income summary account is used by some organizations

as a flow-through account to aid in the closing process

g. A post-closing trial balance is prepared after the closing

entries have been recorded in the journal and posted.

h. Reversing entries are always required.


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CHAPTER 6

REVENUE CYCLE TRANSACTIONS

INITIAL VOCABULARY

Contra-account Contracuenta

Destination Destino

FOB LAB (Libre a bordo)

Liquidate Liquidar

Net Neto

Periodic inventory system Mtodo analtico o pormenorizado

de inventarios

Perpetual inventory system Mtodo de inventario perpetuo

Sales discount Descuento sobre ventas

Sales returns and allowances Devolucin y rebaja sobre ventas

Shipping point Punto de envo

Terms Trminos

INTRODUCTION

The transaction processing cycles found in most merchandising firms

were introduced in Chapter 3. In this chapter we will review the

accounting transactions or journal entries which are generated in the

Revenue Cycle. However, lets begin by reviewing the four systems

found within most revenue cycles.


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REVENUE CYCLE SYSTEMS

The revenue cycle processes customer orders, ensures that those orders

are filled in a timely fashion, bills the customer for the goods or services

provided, and processes customer payments. The four information

processing systems within the revenue cycle are: order entry, inventory

control, shipping, and accounts receivable. Usually all of the journal

entries required to record revenue cycle transactions are generated by

the accounts receivable system. Accountants usually do not record

transactions until there has been an arms-length (or fairly negociated

and completed) transaction between two or more parties. Journalentries are not generated by the order entry system because, although

an order has been received, it has not been filled and the customer

does not have an obligation to pay for goods and services ordered but

not yet received. The inventory control system keeps track of the

quantity of inventory items on hand and on order. However, an

arms-length transaction has not been completed when goods are

withdrawn from inventory.

In some cases an arms length transaction is complete when goods

are shipped. However, to facilitate the consistent preparation of journal

entries most shipping systems do not generate journal entries. The

critical issue in determining when a sales transaction has been

completed is the passage of title or ownership rights and risks from

the seller to the buyer.

This determination is normally made by the FOB terms of the

sale. FOB stands for Free On Board and is a term which has been

borrowed from the maretime shipping industry. The two most

common FOB terms are FOB Destination and FOB Shipping Point.

When goods are shipped FOB Destination they are free on board


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to the destination from the buyers point of view. This means that

the seller pays the transportation costs to the destination and that

title is not transfered to the buyer until the goods reach their

destination. Consequently it would be inappropriate to record a

sale at the time of shippment when goods are shipped FOB

Destination. When goods are shipped FOB Shipping Point they

are free on board to the shipping point and the buyer must pay all

transportation costs from the shipping point to the destination,

accept all risks of ownership from the shipping point on, and receives

title or ownership of the goods at the shipping point. It would be

appropriate to prepare the journal entries to record the sale ofmerchandise at the time of shippment when goods are shipped FOB

Shipping Point.

There is usually very little delay between the shippment of goods

by the shipping system and the preparation of the invoice by the

accounts receivable system so, in most companies, the sales journal

entries are prepared at the same time as the invoice.

SALES JOURNAL ENTRIES

Assume that a company sold goods which cost $2 000 to a customer

for $3 800. The accounts receivable system would generate two journal

entries to record this transaction. The first journal entry records the

sale of the goods:

Accounts Receivable 3 800

Sales 3 800

The asset account Accounts Receivable is debited and the revenue

account Sales is credited for the sales price of the goods sold. The


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Assume that the customer for the transaction above paid the

discount within the discount period. In that case the accounts

receivable system would generate the following journal entry:

Cash 3 724

Sales Discount 76


Notice that the entire receivable is liquidated because the customers

obligation has been met. The difference between the receivable

amount and the amount of cash received, $76 in this case, is debited

to Sales Discount. The sales discount account is a contra-revenue

account. If this were the only sales transaction for the company in an

accounting period then the revenue section of the income statement

would show:

Sales $3 800Less Sales Discounts _( 76)

Net Sales $3 724

======

MERCHANDISE RETURNS

The revenue cycle must also account for sales returns and allowances.Sales returns and allowances occur when a customer returns

merchandise to the seller or asks for a price reduction, usually because

the merchandise delivered did not conform to the customers

specifications. The journal entry to record sales returns and allowance

is similar to that used for sales discounts. Assume that a customer

purchased $ 4 000 worth of merchandise on account, returned $ 1000


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worth of the merchandise and paid for the balance within the discount

period (2/10, n/30). The journal entry to record this transaction

would be:

Cash 2 940

Sales Discount 60

Sales Returns and Allowances 1 000


The sales returns and allowances account, like the sales discount

account, is a contra-revenue account and would appear in the same

section of the income statement as sales discounts.

In the next chapter we will see how the same transactions are treated

when viewed from the buyers point of view.


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3.FILLIN. Fill in the blanks with the appropriate accounting term.

a. The journal entries required to record revenue cycle

transactions are generated by the _______________.

b. ______________ keeps tracks of the quantity of inventory

items on hand and _______________ .

c. A sales transaction has been completed when the

_______________ transfers the ownership rights and risks

to the _______________.

d. The customer _______________ is liquidated when

_______________ is received.

e. The accounts receivable system functions as a

_______________ and _______________ system.

f. The revenue cycle accounts for sales, _______________

and _______________.

4.FALSEORTRUE. Indicate whether each of the following statements


a. Journal entries are generated by the order entry system.

b. An arms length transaction is a fairly negociated andcompleted transaction.

c. An arms length transaction has been completed when goods

are withdrawn from inventory.

d. A sale transaction is completed when the seller transfers the

ownership rights and risks to the buyer.

e. It is appropriate to record a sale at the time of shippment

when goods are shipped FOB destination.


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f. It is appropriate to record a sale at the time of shippment

when goods are shipped FOB shipping point.

g. Companies often offer disccounts to their customers as a

way to encourage prompt payment.

h. The journal entry to record sales returns and allowances is

completely different from that used for sales disccounts.

5.DISCUSSIONQUESTIONS. Write answers to the following questions

and discuss them in class.

a. What does the revenue cycle process?

b. What does FOB destination mean?

c. What does FOB shipping point mean?

d. According to the reading what is the difference between

sales discounts and sales returns and allowances?

e. What does this written expression of a discount 2/10,

N/30 mean?

f. Give an example of a journal entry where a contra-revenue-

account is required.


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CHAPTER 7

EXPENDITURE CYCLE TRANSACTIONS


Invoice Factura

Offer Oferta

Purchase returns Devoluciones y re-

and allowances bajas sobre

compras

Purchase order Pedido / orden de

compra

Purchase Descuento de

discounts compra

Receiving Report Reporte de bienes

recibidos

Unit cost Costo unitario

INTRODUCTION

In the last chapter we looked at revenue cycle transactions. Revenue

cycle transactions show us the sequence of transactions from the sellers

point of view. For every revenue cycle transaction there must be a

corresponding expenditure cycle transaction within another company

because for every buyer there is a corresponding seller. Purchase

transactions are normally generated within the expenditure cycle.

EXPENDITURE CYCLE SYSTEMS

As in the revenue cycle, there are four systems within the expenditure

cycle: purchase order, receiving, accounts payable, and inventory.

Remember that the inventory system exists within both the revenue

cycle and the expenditure cycle because it is the interface between


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the two cycles. Inventory is purchased by the expenditure cycle

and sold by the revenue cycle. Consequently, inventory additions

are usually recorded by the expenditure cycle while inventory

reductions or withdrawls are recorded by the revenue cycle.

The purchase order system prepares purchase orders which are

mailed to vendors or sellers. No journal entry is prepared at this

time because the company has not incurred a liability. The purchase

order is only an offer to purchase and a liability will not exist until

the offer has been accepted by the seller and the goods have been

shipped or received by the buyer (depending of the FOB terms).

A liability does exist, and the corresponding journal entry should

be prepared, when goods are received by the receiving system.

However, two different pieces of information are needed before the

journal entry can be prepared, the quantity of goods received and the

unit cost of the goods. The receiving system has access to the quantity

information but not to the cost information so it is usually impossible

for that system to generate the journal entries.

The seller mails an invoice to the buyers accounts payable

department when the goods are shipped. The accounts payable system

matches that invoice with the corresponding receiving report, which

shows the actual quantity received, and a copy of the original purchase

order, to make sure that received goods were actually ordered. the

accounts payable system can generate the necessary journal entries,after any differences between the documents have been reconciled.

PURCHASE JOURNAL ENTRIES

Remember in Chapter 6 that a buyer purchased goods for $3 800 with

terms of 2/10, n/30. Lets examine the journal entries for this transaction


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in the purchasers accounting records. The first journal entry generated

by the expenditure cycle records the liability to pay for the goods which

have been received, assuming a perpetual inventory control system, is:

Inventory 3 800

Accounts Payable 3 800

If the liability is liquidated within the discount period then the

accounts payable system will generate the following journal entry:


Cash 3 724

Purchase Discounts 76

We will see how purchase discounts are treated in the financial

statements in the next chapter. If the liablity is liquidated after thediscount period then the corresponding journal entry would be:


Cash 3 800

In this example the initial transaction was recorded gross, that is, the

liability was recorded at its full amount. Some companies record purchasesusing the net method so that they can measure the cost of not taking

discounts. The same three transactions recorded net would be:

Inventory 3 800


Purchase Discounts 76


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(To record the purchase of merchandise 2/10, n/30)


Cash 3 724

(To record liability payment within the discount period)

Accounts Payable 3724

Discounts Lost 76

Cash 3 800

(To record liability payment after expiration of the discount period)

MERCHANDISE RETURNS

Merchandise returns and allowances are treated in almost the samefashion as are sales returns and allowances. A purchase returns and

allowance reduces the amount of a companys liability. Lets use the

same example that we used in Chapter 6, a $4 000 purchase with a

$1 000 purchase return. The journal entry to record the return and

payment of the balance within the discount period (initially recorded

gross) would be:


Cash 2 940

Purchase Discount 60

Purchase Returns and Allowance 1 000


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EXERCISES

1.VOCABULARY. Give the best equivalent in Spanish for the following

terms.

a. Revenue cycle

b. Expenditure cycle

c. Withdrawld. Accounts payable

e. Unit cost

f. Gross

g. Purchase transaction

2.MATCHING. Match the terms in the first column with their opposite

in the second column.

a. Revenue cycle 1. Asset

b. Buyer 2. Sell

c. Accounts payable 3. Debit

d. Additions 4. Expenditure cycle

e. Purchase 5. Accounts receivable

f. Credit 6. Seller

g. Liability 7. Reductions


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3.FILLIN. Fill in the blanks with the appropriate accounting term.

a. For every _______________ there must be a corresponding

_______________ within another company.

b. _______________ are normally generated within the

expenditure cycle.

c. Inventory is _______________ by the expenditure cycle

and _______________ by the revenue cycle.

d. Purchase orders are prepared by

_____________________________.

e. It is necessary to know _______________ of goods received

and the _______________ of the goods for the preparation

of the journal entry.

f. The accounts payable system matches _______________

with the corresponding _______________.

4. FALSEORTRUE. Indicate whether each of the following statements


a. There are three systems within the expenditure cycle.

b. Inventory is sold by the expenditure cycle.

c. Journal entries are prepared by the purchase order system.

d. The receiving system has access to the quantity information

but not to the cost information.


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e. The receiving system cannot generate journal entries.

f. Inventory is purchased by the expenditure cycle.

g. The receiving system matches the invoices with the

corresponding receiving report.

h. The accounts payables system can generate journal entries.

5. DICUSSIONQUESTIONS. Write answers to the following questionsand be ready to discuss them in class.

a. How does the inventory system work within both the

revenue cycle and the expenditure cycle?

b. When does a liability exist within the expenditure cycle?

c. What different kinds of information are needed before

preparing a journal entry?

d. How does the accounts payable system work?

f. Prepare the journal entries that would be required to record

the purchase and subsequent payment of $6 800 of

inventory with terms 5/10, n/30. You may assume that theliability was paid within the discount period.


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CHAPTER 8

INVENTORIES AND COST OF GOODS SOLD

INITIAL VOCABULARY

Cost of Goods Sold Costo de Ventas

Cost flow assumption Estimacin de Costos

FIFO (First In-First Out) PEPS (Primeras entradas-primeras

salidas)

Gross Profit Utilidad Bruta

LIFO (Last In-First Out) UEPS (Ultimas Entradas-Primeras

salidas)

Specific Identification Identificacin Especfica / Promedios

INTRODUCTION

Perpetual and periodic inventory systems were mentioned in the

previous two chapters. Both systems are used extensively in practice.

The perpetual inventory system provides better or more current

information for management. In this chapter we will review the

differences between perpetual and periodic inventory systems, the

calculation of cost of goods sold in periodic inventory systems, andinventory costing methods.

PERPETUAL VS. PERIODIC INVENTORY

As its name implies, the perpetual inventory system keeps a perpetual

or up-to-date record of inventory transactions. Under the perpetual


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Note also that:

Net Purchases = Purchases - Purchase Discounts - Purchase Returns and Allowances

Goods available for sale represents the cost of inventory that could

have been sold during the year. Ending inventory represents the

inventory that was not sold during the year and the difference between

goods available for sale and ending inventory is the cost of the goods

that were sold during the year.

INVENTORY COSTING

Accounting for inventory appears to be relatively straight forward

however accountants must also make a cost flow assumption. In

many cases inventory is not sold in the same physical sequence in

which it was purchased and so a valuation method must be used.

The three most common inventory costing techniques are (1) specific

identification, (2) FIFO and (3) LIFO.

The specific identification method is used when individual

inventory items have different costs and those items and their

corresponding costs can be identified at the time of sale. The best

example of a company that would use specific identification is an

automobile dealer. Every car on the car dealers lot will most likely

have a different cost and the specific car and its corresponding cost

can be identified at the time of sale. This cost matching would be

very difficult in, for example, a grocery store where it would be very

difficult to identify the cost of a specific head of lettuce. In those

cases it makes more sense to use FIFO or LIFO.

FIFO stands for First In First Out. FIFO assumes that items in

inventory are sold in the order in which they were purchased. LIFO


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stands for Last In First Out and assumes that the most recent purchases

are sold first. The following example will illustrate the differences

between FIFO and LIFO costing. Assume that a company made the

following purchases of an inventory item, and that no inventory existed

before the January purchase:

DATE QUANTITY UNIT COST TOTAL COST

Jan. 1 100 $1.10 $ 110

Feb. 15 100 $1.20 $ 120

Mar. 20 100 $1.25 $ 125

TOTAL 300 $ 355

=== ====

On March 31 the company counts its inventory and finds that ending

inventory consists of 110 units of inventory. This means that 190

(300-110) units of inventory were sold. Under the FIFO assumption

the units purchased on January 1 were sold first, followed by 90 of theunits purchased on February 15. Cost of goods sold would be (100 x

$1.10) + (90 x $1.20) = $218, and ending inventory would be $137.

Under LIFO the most recent purchases are assumed to have been sold

first. In this case the units purchased on March 20 were sold first,

followed by 90 of the units purchased on February 15. Cost of goods

sold would be calculated as (100 x $125) + (90 x $1.20) = $233, and

ending inventory would be $122. Assume that the goods were sold for

$2.00 each. In that case partial income statements would show:

FIFO LIFO

Sales (190 x $2.00) $ 380 $ 380

Cost of Goods Sold 218 233

Gross Profit $ 182 $ 167

=== ===


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During periods rising prices (inflationary periods) the LIFO method

has several advantages in spite of the lower gross profit and hence

lower net income which it produces. In this situation taxes based on

net income will be less under LIFO than under FIFO and cost of

goods sold will more closely approximate the cost of replacing the

inventory which was sold. For these two reasons most companies in

the United States use the LIFO method.


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EXERCISES

1.VOCABULARY. Give the best equivalent in Spanish for the following terms.

a. Perpetual Inventory System

b. Periodic Inventory System

c. Cost of goods sold

d. FIFO ( First In First Out)e. LIFO (Last In First Out)

f. Unit Cost

g. Gross Profit

2.MATCHING. Match the terms in the first column with the best definition

from the second column.

a. up to date 1. available or ready

b. quantity 2. carry out

c. rather than 3. state briefly

d. on hand 4. extending to the present time

e. perform 5. the exact number of a

particular thing.

f. summarize 6. for this reason, therefore.

g. straight forward 7. presumption

h. assumption 8. moving straight ahead, direct

i. hence 9. instead of

3.FILLIN. Fill in the blanks with the appropriate term.

a. The perpetual inventory system holds a(n) _____________

record of inventory transactions.


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b. Ending inventory is the _______________ that were

_______________ during the year.

c. ______________,________and_________are the three

most common inventory costing techniques.

d. Cost of goods sold is the difference between

_______________ ___________________ and

___________________ and _______________.

e. Net purchases = _______________-_______________-

_______________ _______________.

f. An automobile dealer is the best example of a company that

would use specific _______________.

g. FIFO assumes that _______________ in inventory are sold

in the order they ______________.

4.Write questions about the perpetual an periodic inventory systems

to which the following are the answers. Use the cue words.

a. Under the perpetual inventory system how often

_________ ______________________

__________________________?

The quantity on hand is changed every time there is aninventory transaction.

b. Which

_________________________________________?

The accounting system debits and credits the inventory account

everytime there is an inventory transaction.


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c. Which ________________________________________?

Companies that use peridic inventory system do not keep an up

to date record of inventory quantities.

d. Where ________________________________________?

The cost of goods sold calculation appears in the income

statement.

e. Why ________________________________________?

Because companies that use periodic inventory systems do not

record cost of goods sold at the time of sale.

5.DISCUSSIONQUESTIONS. Write answers to the following questions


a. What is the difference between perpetual and periodic

inventory systems?

b. Why is it necessary to make a cost flow assumption?

c. Explain the specific identification method and give an

example of a company that would use this method. The

example must be different from the one given in thischapter.

d. What is the difference between FIFO and LIFO?

e. Do you think that the LIFO method has advantages over

the FIFO method? Why?


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CHAPTER 9

FIXED ASSETS AND DEPRECIATION

INITIAL VOCABULARY

Accumulated depreciation Depreciacin acumulada

Book value Valor en libros

Commission Comisin

Depreciation expense Gasto de depreciacin

Double declining balance Clculo doble de depreciacin

depreciation

Fixed asset Activo fijo

Salvage Value Valor de salvamento

Straight line depreciation Depreciacin en lnea rectaSum-of-the-year digits depreciation Depreciacin por suma de dgitos

INTRODUCTION

Fixed assets represent the largest single investment that a firm

makes in its productive resources and this investment is expected

to provide economic value over a substantial period of time.Because the investment in fixed assets benefits many different

accounting periods it is necessary to find a way to allocate the

cost of the investment to the accounting periods which benefit

from it.

Accounting theory identifies three different ways to match costs with

the revenues which they produce in an accounting period. The first


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method is called direct matching. This approach is used when a direct

cause and effect relationship can be identified between a cost and the

corresponding revenue. For example, commissions paid to sales people

can be directly matched with their sales. Sometimes, as is the case with

fixed assets, it is difficult to identify a direct cause and effect relationship.

In those cases costs are allocated to accounting periods using systematic

and rational allocations. In the third situation, when both direct

matching and systematic and rational allocation are not possible

accountants usually record the expenditure as an expense in the period

in which it was incurred. In this chapter we will see how fixed assets are

depreciated using systematic and rational allocation.

DEPRECIATION

Depreciation is the process of allocating the cost of an asset to the

accounting periods which benefit from its use. The simplest form of

depreciation is called straight line depreciation. This form of

depreciation is called straight line because the annual depreciationamount is constant (a straight line) over time.

Straight Line Depreciation

Straight line depreciation is computed as:

Lets assume that a company purchased a piece of factory equipment

for $12 000 on January 1, 1994. The asset has a five year life and

Annual depreciation = .

Asset Cost - Salvage Value

Life (in years)


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management expects that the asset will have a sales value of $2 000 at

the end of its five-year life. Depreciation expense, for each of the

next five years is computed as:

Annual depreciation = .

= $2 000 per year.

Accelerated Depreciation

Two other common methods of accelerated depreciation are sum-of-

the-years digits and double declining balance. Both of these methods

are called accelerated depreciation methods because depreciation is

accelerated to the early years. This means that more depreciation is

charged in the early years of the assets life and less in the later years.

Annual sum-of-the-years (SYD) depreciation expense is computed as:

Annual depreciation = (Asset Cost - Salvage Value ) x SYD Factor

SYD Factor = -

The factor for 1994 for the asset described above is:

SYD Factor = 5 / (5 + 4 + 3 + 2 + 1) = 5/15,

and depreciation expense for 1994 would be:

5 years

$12 000 - $2 000

Remaining life at the beginning of the current year

Sum of the years in the assets life


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1994 Depreciation Expense = ($12 000 - $2 000) x 5/15

= $3 333.

Depreciation for 1995 would be:

1995 Depreciation Expense = ($12 000 - $2 000) x 4/15= $2 667.

Double declining balance (DDB) depreciation is computed as:

Annual DDB Depreciation Expense = Undepreciated balance x DDB Factor

DDB Factor = 2/Asset Life.

The DDB Factor for the asset purchased above is 2/5 or 40%,

twice, or double, the straight-line rate.

1994 DDB Depreciation Expense = $12 000 x 0.40

= $4 800

1995 DDB Depreciation Expense = ($12 000 - $4 800) x 0.40

= $2,880

Table 9.1 below summarizes depreciation expense under these

three methods. Notice in DDB depreciation that salvage valueis not considered until total depreciation approaches the

depreciable value of the asset. DDB depreciation of $592 was

taken in 1997 so that total or accumulated depreciation would

be $10 000. One of the problems with DDB depreciation is

that an asset may become fully depreciated before the end of its

useful life.


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TABLE9.1Depreciation comparison

YEAR___STRAIGHT LINE____ SYD _________DDB _

1994 $ 2 000 $ 3 333 $ 4 800

1995 $ 2 000 $ 2 667 $ 2 880

1996 $ 2 000 $ 2 000 $ 1 728

1997 $ 2 000 $ 1 333 $ 592

1998 $ 2 000 $ 677 $ __ 0

TOTAL $10 000 $10 000 $10 000

======= ======= =======

Every year, or whenever depreciation is computed, the accountants

prepare depreciation journal entries. This journal entry is easy to

make because the accounts involved never change. The journal entry

to record straight-line depreciation for 1994 for the above asset is:

Depreciation Expense 2 000

Accumulated DepreciationFactory Equipment 2 000

The credit account, accumulated depreciation, is a contra-asset account

which reduces the value of an asset on the balance sheet from its historical

acquisition cost to its book value (Cost - Accumulated Depreciation).

BETTERMENTS AND IMPROVEMENTS

Some maintenance-type expenditures greatly increase the productive

capacity or life of an asset. These expenditures are called betterments

and improvements. Normally maintenance-type expenditures are

recorded as expenses and are reported on the income statement. These

expenditures however increase the cost of the asset and may affect the


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remain life of the asset. Depreciation expense is recalculated from the

time of the expenditure forward using the revised asset cost and the

revised life when this occurs.

SALE OF ASSETS

Fixed assets may be sold on or before their projected retirement date.

If the proceeds of the sale of the asset are greater than the book value

of the asset then the account Gain on Sale of Assets is credited. If the

sales proceeds are less than the book value of the asset then the account

Loss on Sale of Assets is debited. The gain account is an income

accountwhich will increase net income on the income statement.

The loss account reduces net income.

Assume that the asset above is sold on December 31, 1996 for

$8 000. The journal entry to record the sale of the asset would be:

Cash 8 000

Accumulated Depreciation 6 000

Factory Equipment 12 000

Gain on Sale of Assets 2 000

Notice that the asset account and its corresponding accumualteddepreciation account are zeroed when the asset is sold.


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EXERCISES

1.VOCABULARY. Give the best equivalent in Spanish for the following

terms.

a. Salvage value

b. Straight line depreciation

c. Fixed assetd. Double declinig balance depreciation

e. Betterments and Improvements

f . Book value

g. Direct matching

h. Systematic and rational allocations

i. Contra-asset account

2. MATCHING. Match the terms in the first column with the best

definition from the second column.

a. Fixed asset 1. Contra-asset account that

reduces the value of an asset on

the balance sheet from its

historical acquisition cost to its

book value.

b. Depreciation. 2. Maintenance-type expenditures

that increase the productive

capacity or life of an asset.


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Annual depreciation = _________________________

f. A problem _______________ depreciation is that an

_______________ may become depreciated before the end

of its useful life.

g. Generally maintanance type expenditures are recorded as

_______________ and are reported on the

_______________ statement.

4.FALSEORTRUE. Indicate whether each of the following statementsis false or true. If the statement is false then explain why.

a. In DDB depreciation the salvage value is not considered until

total depreciation approaches the depreciable value of the asset.

b. Depreciation journal entries are difficult to make because

the accounts involved change constantly.

c. The credit account, accumulated depreciation is considered

a contra-asset account.

d. Betterments and improvements increase the cost of the asset

and may affect the remain life of the asset.

e. Maintenance type expenditures are not reported on theincome statement.

f. If sales proceeds are less than the book value of the asset

then the account Loss on Sale of Assets is credited.

g. The account Gain on sale of Assets will increase net income

on the income statement.


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CHAPTER 10

PRESENT VALUE AND INVESTMENTS

INITIAL VOCABULARY

Future value Valor futuro

Horizontal Integration Integracin Horizontal

Investment Inversin

Long-term A largo plazo

Present value Valor presente

Short-term A corto plazo

Time-value of money Valor del dinero a travs del tiempo

Vertical Integration Integracin Vertical

INTRODUCTION

Would you be willing to lend me $100 today if I promised to pay you

$100 back exactly one year from today? Most likely you would not.

We all realize, at least intuitively, that any sum of money today is

worth more than the same sum at any point in the future. There are

two reasons for this time-dependent change in value.

The purchasing power of money decreases over time because of

inflation or price increases. When I was in high school (more than

20 years ago, but I wont tell you how many more) I used to buy a

hamburger on my way home from school for $0.19. My senior year

in high school (12th grade) the price increased to $0.29 and we were

very upset. Sometimes today, with luck, I can buy a hamburger for


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$0.99, but not very often. I am purchasing the same good but its

cost has changed over time, because the value of one dollar has

decreased.

Not only will the $100 that I have promised to return to you one

year from now purchase less than $100 today you will also lose the

use of that money for one year. This loss of use is called opportunity

cost. You lose all of your opportunities to spend or invest that $100

for the one year that I hold it. If your are rational, and I assume that

you are, you want to be compensated for that opportunity loss and

for the purchasing power loss.

The time value of money concept, or the present value concept,

lets us view the effects of time on purchasing power but not the

economic value of the opportunity cost.

PRESENT VALUE

The present value concept lets us restate some future sum in terms of

current purchasing power so that we can see how much that sum in

the future would be worth if we paid or received it today. Three

values are required for present value analysis: the future sum, the

time period, and a discounting rate. The discounting rate is interest

rate that we think that we could earn (or pay) on an investment (loan)

today. This rate is sometimes called the cost of capital. Assume

that you could earn 4% for one year on the $100 that I want to

borrow from you. This is illustrated in the diagram below.


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FIGURE10.1Present Value

0 1

| |

$100

$100

|

? |

The present value factor for 4% for 1 year is 0.9615 (1/1.04) so

the present value of $100 discounted at 4% for one year is $96.15

($100 x 0.9615).

FUTURE VALUE

Future value is the inverse of the present value. Using future value

analysis you can answer questions like If I invest $100 today at 5%

for 2 years, how much money will I have in two years? Figure 10.2

illustrates future value analysis.

FIGURE10.2Future Value Analysis

0 1 2

$100

|

| ?

The future value factor for 5% for 2 years is 1.1025 (1.052) and the

future value of $100 invested at 5% for two years is $110.25 ($100 x

1.1025).


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INVESTMENTS

Managers use present and future value analysis to help them make

investment decisions. Once the investment decision has been made

the accountants must decide how to record the investment. Two

different investment accounts are often used to record investment

transactions. These accounts are the short-term investment account

and the long-term investment account. Managements intent in

making the investment is used to differentiate between short-term

and long-term investments.

Short-term investments represent the temporary investment of

excess cash in some investment vehicle (stocks, bonds, certificates of

deposit, etc.). Short-term investments are current assets because

management expects to convert the investment into cash within one

year or the current operating cycle. Long-term investments on the

other hand usually represent investments in other companies. These

investments are made to solidify relationships between a company

and its suppliers and/or customers. This is called vertical integration.Long-term investments are also made establish relationships between

companies at the same market level, for example manufacturers or

distributers, within a market or industry. This is called horizontal

integration. The accounting treatment of long-term investments, in

the United States at least, is determined by the degree of control that

the investing company can exercise over the company in which it has

invested.

Documents

Accounting Reading and Vocabulary