Financial Accounting MidTerm I. Debit vs. Credit. Debit Debit = left side of T-accountOn the Balance Sheet a debit indicates: 1. An increase in an asset 2. A decrease in a liability 3. A decrease in shareholders' equity items. Credit Credit = Right side of T-accountOn the Balance Sheet a credit indicates: 1.
A decrease in an asset 2. An increase in a liability 3. An increase in shareholders' equity item HINT - Identify two components of each transaction: 1.) what did you get; 2.) where did it come from. The debit is what you got, and the credit is the source of the item you received. For instance, let's imagine that you purchase a computer with your credit card. Since the computer is what you received it's going to result in a debit to the asset account for your computer.
The credit will be applied to the credit card liability account for the same amount. II. What accounts Increase / Decrease with debits and credits Account Type Debit Credit Balance Sheet Assets Increase Decrease Balance Sheet Liabilities Decrease Increase Balance Sheet Owner's Equity Decrease Increase Income Statement Revenue Decrease Increase Income Statement Cost of goods sold Increase Decrease Income Statement Expenses Increase Decrease. Typical Accounts A. Assets Cash Marketable Securities Accounts receivable Notes receivable Interest Receivable Merchandise inventory Raw materials inventory Supplies inventory Work-in-progress inventory Finished goods inventory Advances to suppliers Prepaid rent Prepaid insurance Investment in securities Land Buildings Equipment Furniture Accumulated depreciation Leasehold Organization costs Patents Good will B. Liabilities Accounts payable Notes payable Interest payable Income taxes payable Advances from customers Advances from tenants; rent received in advance Mortgage payable Bonds payable Convertible bonds Capitalized lease obligations Deferred income tax C. Shareholders' Equity Common stock Preferred stock Additional paid-in capital Retained earnings Treasury shares IV. Purpose of 3 Main Financial Statements A. Balance Sheet Statement of financial position Snapshot at a specific point in time Date is last day of accompanying income statement period Valued at historical or current value so Includes assets (investing); liabilities (financing); and owners' equity (financing) o Picture of financial health of a company - GOAL of BALANCE SHEET. Income Statemento Shows net income and earning so Covers a period of time Reflects revenues (inflows of assets or reductions of liabilities) from selling goods / services and expenses (outflows of assets or increases of liabilities) used in generating revenue Net income increases retained earnings on balance sheet o Shows how profitable a company is - GOAL of INCOME STATEMENT.
Cash Flow Statemento Explains change in cash from one balance sheet date to the nex to Groups activity as operating, investing, or financing o Covers a period of time Shows sources and uses of cash and if we have enough cash to continue in business - GOAL of CFS V. Accrual vs. Cash Basis Accounting. Cash Basis Accounts for cash in and cash out Easy to use Drawbacks 1) Ignores cash received from owners or from borrowing 2) Does not match effort of generating inflows with the inflows themselves 3) Unnecessarily postpones the time to recognize revenues 4) Can distort measurement of operating performance by managing the timing of cash receipts and disbursements B. Accrual Basis 1.) Revenue Recognitiono Recognize revenue at sale if, a. All or most of the services expected to be provided have been performed b. Received cash or a promise to pay (accounts receivable) c. An exchange with an outside entity has occurred Adjust revenue recognized for d.
Any amounts not expected to be collected e. Sales discounts and allowances f. Sales returns 2.) Expense Recognitiono Assets = unexpired cost so Expenses = expired cost so Recognize costs as expenses in the period when recognizing the revenue it helped produce - Matching Principle Match cost expirations caused by revenue (inventory) - Product Costs Cost expiration occurs when the benefits of the asset are consumed in operations (marketing, sales and administrative costs) - Period Cost sVI. Adjusting Entries Adjusting entries are journal entries made at the end of the accounting period to allocate revenue and expenses to the period in which they actually are applicable. o Two major types of adjusting entries are: o Accruals: for revenues and expenses that are matched to dates before the transaction has been recorded. o Deferrals: for revenues and expenses that are matched to dates after the transaction has been recorded. A. Accruals o Some accrued items for which adjusting entries may be made include: - Salaries- Past-due expenses- Income tax expense - Interest income- Unfilled revenue. Deferral so Some deferred items for which adjusting entries would be made include: - Prepaid insurance- Prepaid rent- Office supplies- Depreciation- Unearned revenue (in this case, a liability account is credited when the cash is received. An adjusting entry is made once the service has been rendered or the product has been shipped, thus realizing the revenue.) C. Effect of adjusting entries Debit Credit Asset account Revenue account Liability account Revenue account Expense account Asset account Expense account Contra-asset account Expense account Liability account Revenue contra-account Contra-asset account Contra account: An account, such as accumulated depreciation, that accumulates subtractions from another account, such as machinery.
VII. Cash Flow Statemento The cash flow statement explains the reasons for changes in the cash balance, showing sources and uses of cash in the operating, financing, and investing activities of the firm. o The cash flow statement is derived by converting the accrual information to a cash-basis using one the following two methods: Direct Method: cash flow information is derived by directly subtracting cash disbursements from cash receipts Indirect Method: cash flow information is derived by adding or subtracting non-cash items from net income. A. Classifying Cash Flows 1.) Operating Relates to selling goods and services (income statement, current assets and current liabilities.) Indicates cash received from the sale of goods and services and cash paid for operating goods and services. 2.) Investing Relates to acquisition and sale of non-current assets Indicates cash received fro m sales of investments and property and equipment; and cash paid for acquisition of investments and property and equipment 3.) Financing Relates to increases and decreases in debt and owners' equity Indicates cash received from the issue of debt and capital stock; and cash paid for reacquisition of debt and capital stock and the payment of dividends. 4.) Ambiguities in Classifying cash flows a.) classifying cash received from interest and dividend revenues generated by investments in securities as operating activity. FASB Rule: classify the receipt of cash from interest and dividend revenues as an operating activity but the cash related to the purchase and sale of investments in securities as an investing activity. b.) Same thing with interest on debt-should it appear on statement as operating or financing activity?
FASB Rule: classify interest expense as an operating activity but the issue or redemption of debt as a financing activity. B. How Can a Profitable Firm Run Out of Cash? 1.) Net income for a particular period does not equal cash flow from operations 2.) Firms experience cash inflows and outflows from investing and financing activities that do not appear directly on the income statement. C. Columnar Worksheet 1.) Step 1: Compute the change in each balance sheet account between the beginning and the end of the year. Enter the changes in the non cash balance sheet accounts in the first column of the work sheet using the following rules: Increases in non cash assets reduce cash and therefore appear with negative signs. Decreases in non cash assets increase cash and therefore appear with positive signs Increases in liability and shareholders' equity accounts increase cash and appear with positive signs Decreases in liability and shareholders' equity accounts decrease cash and appear with negative signs. 2) Step 2: Classify the change in each balance sheet account as an operating, or investing, or financing activity and enter it in the appropriate column of the work sheet using the same sign as the first column. 3.) Step 3: Sum the entries in the Operations, Investing, and Financing Columns and net the 3 sums to ensure that they equal the net change in cash.
Things to Remember In T-accounts the balance are as follows: Asset: balance on the left Liability: balance on the right Stockholders' equity: balance on the right Balance Sheet is written as follows: Assets Liabilities Stockholders' equity Income Statement is written as follows: Sales Other Revenue Cost of Goods Sold Expenses Net Income Statement of Cash Flows (Indirect Method) is written as follows: Operations Investing Financing.