Introduction to Accounting Day 2

Based on Alison Online October 2015

Accounting Day 2 TopicsDebit and Credit Quiz Review Introduction to Financial Statements• Income Statement• Balance Sheet• Retained Earnings• Cash flow Statement

Transactions Affecting Income Statements and the Balance Sheets

Cash vs Accrual Based AccountingAdjustments for Financial Accounting

Debit and Credit Quiz Review

Quiz Review

Quiz Review

Quiz Review

Quiz Review

Quiz Review

Quiz Review

Quiz Review

Quiz Review

Financial Statements Of Business Organizations

Financial StatementsFinancial information comes in many forms, but

the most important are the Financial Statements. They summarize relevant financial information in a format that is useful in making important business decisions.

Too much information may be equally useless. Financial statements summarize a large number of Transactions into a small number of significant categories. To be useful, information must be organized.

Quick Quiz (Preview of Concepts) The financial statements of a business entity:

A. Include the balance sheet, income statement, and income tax return.B. Provide information about the profitability and financial position of the company.C. Are the first step in the accounting process.D. Are prepared for a fee by the Financial Accounting Standards Board.

The correct answer is B. An income tax return is not one of the financial statements. Income tax returns contain confidential information and follow tax law, not accounting principles. The three required financial statements include the: balance sheet income statement cash flow statement Many companies also include a statement of owner's equity or retained earning

Preparing the financial statements is the LAST step in the accounting process. They are generally prepared by accountants working for the company, but small companies often have their financial statements prepared by a Certified Public Accountant (CPA). The FASB is a government-endorsed non-profit organization responsible for establishing WHAT information is contained in financial statements and HOW it is presented. This is referred to as Generally Accepted Accounting Principles (GAAP) and revolves around the principles of "adequate disclosure" and "fair presentation."

Financial Statements of Business Organizations

1. The Income Statement is the Financial Statement that reflects a company’s profitability

2. The Statement of Retained Earnings show the change in retained earnings between the beginning and end of a period (not required by GAAP)

3. The Balance Sheet reflects a company’s solvency and financial position4. The Statement of Cash Flow shows the cash inflows and outflows for a

company over a period of time.

Financial Statements

The Relationship Between the Financial Statements

The Relationship Between the Financial Statements (Expanded)

Income StatementThe income statement is sometimes

referred to as the profit and loss statement (P&L), statement of operations, or statement of income.

The income statement is important because it shows the profitability or net income of a company during the time interval specified in its heading.

Net Income= Revenues - Expenses

Here's a Tip

Net income is often called the earnings of the company. When expenses exceed revenues, the business has a net loss.

Here's a Tip

Parts of the Income StatementThe format of the income statement or the profit and loss statement will vary according to the complexity of the business activities. However, most companies will have the following elements in their income statements:

A. Revenues and Gains1. Revenues from primary activities2. Revenues or income from secondary

activities B. Expenses and Losses

1. Expenses involved in primary activities2. Expenses from secondary activities 3. Losses (e.g., loss on the sale of long-term

assets etc.)C. Net Income

1. Revenues-Expenses

Under the accrual basis of accounting, the cost of goods sold and expenses are matched to sales and/or the accounting period when they are used, not the period in which they are paid.

Here's a Tip

Don't confuse revenues with receipts—Revenues (operating and nonoperation) occur when a sale is made or when they are earned. Revenues are frequently earned and reported on the income statement prior to receiving the cash.Receipts occur when cash is received/collected.

Here's a TipThe income statement or

profit and loss statement shows revenues, expenses, gains, and losses.The income statement does not show cash receipts and cash disbursements.

Here's a Tip

Example of a Income Statement

The Balance SheetThe accounting balance sheet is one of the major

financial statements used by accountants and business owners. The balance sheet is also referred to as the statement of financial position.

The balance sheet presents a company's financial position at the end of a specified date. Some describe the balance sheet as a "snapshot" of the company's financial position at a point (a moment or an instant) in time. For example, the amounts reported on a balance sheet

dated December 31, 2014 reflect that instant when all the transactions through December 31 have been recorded.

The Uses of the Balance Sheet Because the balance sheet informs the

reader of a company's financial position as of one moment in time, it allows someone—like a creditor—to see what a company owns as well as what it owes to other parties as of the date indicated in the heading.

This is valuable information to the banker who wants to determine whether or not a company qualifies for additional credit or loans.

Others who would be interested in the balance sheet include current investors, potential investors, company management, suppliers, some customers, competitors, government agencies, and labor unions.

Parts of the Balance Sheet

Assets

• Assets are things that the company owns. They are the resources of the company that have been acquired through transactions, and have future economic value that can be measured and expressed in dollars.

Liabilities

• Liabilities are obligations of the company; they are amounts owed to creditors for a past transaction and they usually have the word "payable" in their account title. Along with owner's equity, liabilities can be thought of as a source of the company's assets. They can also be thought of as a claim against a company's assets.

Owner's (Stockholders') Equity

• Owner's Equity—along with liabilities—can be thought of as a source of the company's assets. Owner's equity is sometimes referred to as the book value of the company, because owner's equity is equal to the reported asset amounts minus the reported liability amounts.

• Owner's equity may also be referred to as the residual of assets minus liabilities.

Balance Sheet Accounts Cash Petty Cash Temporary Investments Accounts Receivable Inventory Supplies Prepaid Insurance Land Land Improvements Buildings Equipment Goodwill Bond Issue CostsUsually asset accounts will have debit balances.

Contra assets are asset accounts with credit balances. (A credit balance in an asset account is contrary—or contra—to an asset account's usual debit balance.) Examples of contra asset accounts include: Allowance for Doubtful Accounts Accumulated Depreciation-Land Improvements Accumulated Depreciation-Buildings Accumulated Depreciation-Equipment Accumulated Depletion Etc.

Notes Payable Accounts Payable Salaries Payable Wages Payable Interest Payable Other Accrued Expenses Payable Income Taxes Payable Customer Deposits Warranty Liability Lawsuits Payable Unearned Revenues Bonds Payable Etc.Liability accounts will normally have credit balances.

Contra liabilities are liability accounts with debit balances. (A debit balance in a liability account is contrary—or contra—to a liability account's usual credit balance.) Examples of contra liability accounts include:

Discount on Notes Payable Discount on Bonds Payable Etc.

Assets Liabilities

Outline of Classifications on a Balance Sheet

Example Balance Sheet

Retained EarningsRetained earnings are

usually considered part of the balance sheet (another basic financial statement) under "stockholders equity (shareholders' equity)”

The statement is mostly affected by net income earned during a period of time by the company less any dividends paid to the company's owners / stockholders.

Cash Flow StatementA cash flow statement,

also known as statement of cash flows, is a financial statement that shows how changes in balance sheet accounts and income affect cash and cash equivalents

It breaks the analysis down to operating, investing and financing activities.

Day two quiz: Financial StatementsBalance Sheet1. Another name for the balance sheet is Statement Of Operations

Statement Of Financial Position

2. The balance sheet heading will specify a Period Of Time Point In Time

3. Which of the following is a category or element of the balance sheet? Expenses Gains Liabilities Losses

4. Which of the following is an asset account? Accounts Payable Prepaid Insurance Unearned Revenue

5. What is the normal balance for an asset account? Debit Credit

6. What is the normal balance for liability accounts? Debit Credit

Day two quiz: Financial StatementsIncome Statement1. Which of the following names is NOT associated with the income statement?

P & L Statement Of Financial Position Statement Of Operations

2. The income statement heading will specify which of the following? A POINT In Time A PERIOD Of Time

3. Amounts earned by a company in its main operating activities are Revenues Gains

4. A company disposes of equipment that it no longer uses in its business. The amount received by the company is more than the amount the asset is carried at in the accounting records. The company will report a(n) Expense Gain Loss Revenue

5. On December 1 a company borrowed $100,000 at 12% per year. The interest will be paid quarterly, with the first payment due on March 1. What should the company report on its income statement for December? Nothing

Interest Expense Of $1,000

6. Is a retailer's Interest Expense an operating expense or a non-operating expense? Operating Expense Non-operating Expense

Day two quiz: Financial StatementsBalance Sheet1. Another name for the balance sheet is Statement Of Operations

Statement Of Financial Position

2. The balance sheet heading will specify a Period Of Time Point In Time

3. Which of the following is a category or element of the balance sheet? Expenses Gains Liabilities Losses

4. Which of the following is an asset account? Accounts Payable Prepaid Insurance Unearned Revenue

5. What is the normal balance for an asset account? Debit Credit

6. What is the normal balance for liability accounts? Debit Credit

Day two quiz: Financial StatementsIncome Statement1. Which of the following names is NOT associated with the income statement?

P & L Statement Of Financial Position Statement Of Operations

2. The income statement heading will specify which of the following? A POINT In Time A PERIOD Of Time

3. Amounts earned by a company in its main operating activities are Revenues Gains

4. A company disposes of equipment that it no longer uses in its business. The amount received by the company is more than the amount the asset is carried at in the accounting records. The company will report a(n) Expense Gain Loss Revenue

5. On December 1 a company borrowed $100,000 at 12% per year. The interest will be paid quarterly, with the first payment due on March 1. What should the company report on its income statement for December? Nothing

Interest Expense Of $1,000

6. Is a retailer's Interest Expense an operating expense or a non-operating expense? Operating Expense Non-operating Expense

Financial Statements QuizzesBalance Sheet Quiz

http://www.accountingcoach.com/balance-sheet/quizIncome Statement Quiz

http://www.accountingcoach.com/income-statement/quiz

Cashflow Statementhttp

://www.accountingcoach.com/cash-flow-statement/quiz

Transactions Affecting Income Statements and the Balance Sheets

Transactions Affecting Only Balance SheetSince each transaction affecting a business entity

must be recorded in the accounting records, analyzing a transaction before actually recording it is an important part of financial accounting.

An error in transaction analysis results in incorrect financial statements

Transactions Affecting Only Balance SheetTo illustrate the analysis of transactions and their

effects on the basic accounting equation, the activities of Metro Courier, Inc., and the resulting statements are shown.

Two exercises and the resulting balance sheets are shown.

Owners invested Cash When Metro Courier, Inc., was organized as a corporation on 2010

June 1, the company issued shares of capital stock for USD 30,000 cash to Ron Chaney, his wife, and their son.

This transaction increased assets (cash) of Metro by USD 30,000 and increased equities (the capital stock element of stockholders’ equity) by USD 30,000. The basic accounting equation is demonstrated below.

Owners Borrowed Money The company borrowed USD 6,000 from Chaney’s father. Chaney signed

the note for the company. The note bore no interest and the company promised to repay (recorded

as a note payable) the amount borrowed within one year. After including the effects of this transaction, the basic accounting equation is:

Purchased trucks and office equipment for cash Metro paid USD 20,000 cash for two used delivery trucks and USD 1,500 for office

equipment. Trucks and office equipment are assets because the company uses them to earn revenues in the future.

Note that this transaction does not change the total amount of assets in the basic equation but only changes the composition of the assets.

The transaction decreased cash and increased trucks and office equipment (assets) by the total amount of the cash decrease.

Metro receive two assets and gave up one asset of equal value. Total assets are still USD 36,000. The accounting equation now is:

Purchased office equipment on account (for credit) Metro purchased an additional USD 1,000 of office equipment on

account, agreeing to pay within 10 days after receiving the bill. (To purchase an item on account means to buy it on credit.)

This transaction increased assets (office equipment) and liabilities (accounts payable) by USD 1,000. As stated earlier, accounts payable are amounts owed to suppliers for items purchased on credit. No you can see USD 1,000 increase in assets and liabilities as follows:

Paid and account payableEight days after receiving the bill, Metro Paid USD 1,000 for

the office equipment purchased on account (transaction 4a). This transaction reduced cash by USD 1,000 and reduced

accounts payable by USD 1,000. Thus, the assets and liabilities both are reduced by USD 1,000 and the equation again balances as follows.

Transactions affecting only the balance sheet-summary A summary of transaction is a teaching tool used to show the effects of

transactions on the accounting equation. Note that the stockholders’ equity has remained at USD 30,000. This amount

changes as the business begins to earn revenues or incur expenses. You can see how the totals tie into the balance sheet. The date on the balance

sheet is 2010 June 30. These totals become the beginning balances for July 2010. Thus far, all transactions have consisted of exchanges or acquisitions of assets

either by borrowing or by owner investment. We used this procedure to help you focus on the accounting equation as it relates to the balance sheet.

However, people do not form a business only to hold existing assets. They form businesses so their assets can generate greater amounts of assets. Thus, a business only to hold existing assets. They form businesses so their assets can generate greater amounts of assets.

Thus, a business increases its assets by providing goods or services to customers. The results of these activities appear in the income statement. The section that follows shows more of Metro’s transactions as it began earning revenues and incurring expenses.

Transactions effecting the income statement

Transactions effecting the income statements—Earned service revenue and received cash

As its first transaction in July, Metro performed delivery services for customers and received USD 4,800 cash. This transaction increased and asset (cash) by USD 4,800. Stockholders’ equity (retained earnings) also increased by USD 4,800, and the accounting equation was in balance.

The USD 4,800 is a revenue earned by the business and, as such, increases stockholders’ equity (in the form of retained earnings) because stockholders prosper when the business earns profits. Likewise, if the corporation sustains a loss, the loss would reduce retained earnings.

Revenues increase the amount of retained earnings while expenses and dividends decrease them. Right now, we show all of these items as immediately affecting retained earnings. Usually, the revenues, expenses, and dividends are accounted for separately from retained earnings during the accounting period and are transferred to retained earnings only at the end of the account period as part of the closing process.

The effects of this are USD 4,800 transaction on the financial position of Metro are as follows.

Earned Service Revenue and Received Cash—Retained earnings Metro would record the increase in stockholders’ equity brought about by

the revenue transaction as a separate account, retained earnings. This does not increase capital stock because the Capital Stock account

increases only when the company issues share of stock. The expectation is that revenues transaction will exceed expenses and yield net income.

If net income is not distributed to stockholders, it is in fact retained. Later modules show that because of complexities in handling large numbers of transactions, revenues and expenses affect retained earnings only at the end of an accounting equation remains in balance.

Service revenue earned on account (for credit) Metro performed courier delivery services for a customer who agreed to pay USD

900 at a later date. The company granted credit rather than requiring the customer to pay cash immediately. This is called earning revenue on account.

The transaction consists of exchanging services for the customer’s promise to pay later. This transaction is similar to the previous transaction.

However, the transaction differs because the company has not received cash. Instead, the company has received another asset, and account receivable.

As noted earlier, an account receivable is the amount due from a customer for goods or services already provided, The company as a legal right to collect from the customer in the future. Accounting recognizes such claims as assets. The accounting equation, including this USD 900 item, is as follows.

Collected cash on accounts receivable Metro collected USD 200 on account in the last transaction. The

customer will pay the remaining USD 700 later. This transaction affects only the balance sheet and consists of giving up a claim on a customer in exchange for cash. The transaction increases cash by USD 200 and decreases accounts receivable by USD 200.

Note that this transaction consists solely of a change in the composition of the assets. When the company performed the services, it recorded the revenue. Therefore, the company does note record the revenue again when collecting the cash.

Paid salaries Metro paid employees USD 2,600 in salaries. This transaction is an

exchange of cash for employee services. Typically, companies pay employees for their services after they perform their work. Salaries (or wages) are costs companies incur to produce revenues, and companies consider them an expense.

Thus, the accountant treats the transaction as a decrease in an asset (cash) and a decrease in stockholders’ equity (retained earnings) because the company has incurred an expense. Expense transactions reduce net income. Since net income becomes a part of the retained earnings balance, expense transactions also reduce the retained earnings.

Paid Rent In July, Metro paid USD 400 cash for office space rental.

This transaction causes a decrease in cash of USD 400 and a decrease in retained earnings of USD 400 because of the incurrence of rent expense. The previous transaction had the following effects on the amounts in the accounting equation.

Received bill for gas and oil usedAt the end of the month, Metro received a USD 600 bill

for gas and oil consumed during the month. This transaction involves an increase in accounts payable (a liability) because Metro has not yet paid the bill and decrease in retained earnings because Metro has incurred and expense. Metro’s accounting equation now reads:

Summary of balance sheet and income statement transactions

Exercise Income Statement

Exercise Balance Sheet

Summary of Transactions

Balance Sheet Stockholders’ Equity

Balance Sheet Stockholders’ Equity—Summary of Transactions

Income Statement

Balance Sheet

Cash versus Accrual Basis Accounting

Cash versus Accrual based Accounting

Cash versus Accrual based Accounting

Cash and Accrual Based Accounting Compared

Cash Versus Accrual based Accounting

Adjustments for Financial Accounting

The need for adjusting entries

The need for adjusting entries

The need for adjusting entries

The need for adjusting entries

Adjusting Entries

Deffered Items

Accrued Items

Summary of Adjustments

Quiz #2 Adjusting EntriesUse the following information to answer questions 1 - 6:A company borrowed $100,000 on December 1 by signing a six-month note that specifies interest at an annual percentage rate (APR) of 12%. No interest or principal payment is due until the note matures on May 31. The company prepares financial statements at the end of each calendar month. The following questions pertain to the adjusting entry that should be entered in the company's records.1. What date should be used to record the December adjusting entry? 2. How many accounts are involved in the adjusting entry? 3. What is the name of the account that will be debited? 4. What is the name of the account that will be credited? 5. What is the amount of the debit and the credit? 6. What would be the effect on the financial statements if the company fails

to make the adjusting entry on December 31?

Quiz #2 Adjusting Entries (Answers)Use the following information to answer questions 1 - 6:A company borrowed $100,000 on December 1 by signing a six-month note that specifies interest at an annual percentage rate (APR) of 12%. No interest or principal payment is due until the note matures on May 31. The company prepares financial statements at the end of each calendar month. The following questions pertain to the adjusting entry that should be entered in the company's records.1. What date should be used to record the December adjusting entry?

December 31 (the last day of the accounting period) 2. How many accounts are involved in the adjusting entry?

Two3. What is the name of the account that will be debited?

Interest Expense (an income statement account)

4. What is the name of the account that will be credited?Interest Payable (a balance sheet account)

5. What is the amount of the debit and the credit?$1,000. Computation: 12% per year is 1% per month X $100,000 = $1,000 per month.

6. What would be the effect on the financial statements if the company fails to make the adjusting entry on December 31?

If the company fails to make the December 31 adjusting entry there will be four consequences: 1) Interest Expense will be understated (too little expense being reported) by $1,000. 2) Net Income will be overstated (too much net income being reported) by $1,000. 3) Owner's equity will be overstated by $1,000. 4) Interest Payable will be understated by $1,000.

The accounting equation and balance sheet will show liabilities (Interest Payable) understated by $1,000 and owner's equity overstated by $1,000.