Survey
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
Sustainability accounting wikipedia , lookup
Factoring (finance) wikipedia , lookup
Microsoft Dynamics GP wikipedia , lookup
International Financial Reporting Standards wikipedia , lookup
Mergers and acquisitions wikipedia , lookup
Mark-to-market accounting wikipedia , lookup
Edward P. Moxey wikipedia , lookup
Natural capital accounting wikipedia , lookup
Accounting Zoubida SAMLAL - MBA , CFA Member, PHD candidate for HBS program 1 PLAN Module chapter Part I Introduction to accounting Types of Accounting and Regulators Part II Accounting and financial systems Recording transactions Part III Closing Process Introduction to Accounting and Regulators 3 Fundamental concepts What is accounting? • the language of business • a process of identifying, recording, summarizing, and reporting economic information to decision makers in the form of financial statements • a mean to communicate financial information. • a way to convey information about a business to users. 4 Definitions of Accounting • “The process of identifying, measuring, and communicating economic information to permit informed judgements and decisions by users of the information.” —American Accounting Association (AAA) • “A service activity whose function is to provide quantitative information, primarily financial in nature, about economic entities that is intended to be useful in making economic decisions.” —American Institute of Certified Public Accountants (AICPA) 5 Primary Functions of Accounting 1. Recording data about business transactions 2. Summarizing results of business activity into useful report- However, managers in today's environment demand more detailed reports like sales by district or sales by product type. 3. Providing assurances that the business is operating as intended and that the assets of the organization are protected 6 Accounting as an Aid to Decision Making • Accounting helps in decision making by showing where and when money has been spent, by evaluating performance, and by showing the implications of choosing one plan instead of another. • Fundamental relationships in the decision-making process: Event Accountant’s analysis and recording Financial statements Users Fundamental concepts Who uses accounting information? • Owners • Managers • Investors (including potential) – Analysts on their behalf • Creditors (including potential) • Government (tax assessment) • Regulators • Customers 8 Fundamental concepts • Accounting has two main divisions: 1- Financial accounting Primarily prepared for users external to the company: Revenues, earnings, assets, etc. 2- Management accounting Primarily for internal purposes : Costing, budgeting, net present value, etc. 9 Fundamental concepts There are several ways that cash gets into a company: • Investment by owners • Investment by creditors (loans) • Payments from customers • Repayment of amounts loaned to other entities • Return on investments (interest and dividend) • Proceeds from selling assets 10 Fundamental concepts Cash going in can be organized into three categories: Operations • Payments from customers • Refunds from suppliers Financing • Investment by owners • Investment by creditors (loans) Investing • Return on investments (interest and dividend) • Proceeds from selling assets • Repayment of amounts loaned to other entities 11 Fundamental concepts Similarly, money going out of an entity can be categorized: Operations • Payments to suppliers • Refunds to customers Financing • Payment of dividends or capital to owners • Repayment of creditors Investing • Purchase of assets • Amounts invested in other entities (debt or equity) 12 Fundamental concepts Financial accounting categorizes all transactions and events based on their substance because the users of the information are using it with the assumption that these categorizations are being made accurately. If money invested by owners was reported as revenue, this would be counter to the fundamental definition of revenue (i.e. that it results from the operations of the company). The separation of income and capital is a fundamental concept of financial accounting. 13 Standards and Regulatory bodies 14 Securities and Exchange Commission Established by federal government Accounting and reporting for public companies Securities Act of 1933 Securities Act of 1934 Encouraged private standard-setting body SEC requires public companies to adhere to GAAP aka IFRS Oversight Enforcement Authority Financial Accounting Standards Board Wheat Committee’s recommendations resulted in the creation of a the Financial Accounting Standards Board (FASB) in 1973. Financial Accounting Foundation Selects members of the FASB Funds their activities Exercises general oversight. Financial Accounting Standards Board Mission to establish and improve standards of financial accounting and reporting. Financial Accounting Standards Advisory Council Consult on major policy issues. Financial Accounting Standards Board Missions is to establish and improve standards of financial accounting and reporting. Differences between FASB and APB include: Full-time, Remunerated Membership Greater Autonomy Increased Independence Broader Representation Standard-Setting Organizations • Generally accepted accounting principles (GAAP) encompass the conventions, rules, and procedures for determining acceptable accounting practices at a particular time. • Financial Accounting Standards Board (FASB) is primarily responsible for evaluating, setting, or modifying GAAP in the U.S. • Sarbanes-Oxley Act responded to cases of accounting fraud. – Created the Public Accounting Oversight Board, which sets audit standards and investigates and sanctions accounting firms that certify the books of publicly traded firms. – Senior executives must personally certify that the financial information reported by the company is correct. – Resulted in increase in demand for accountants. Financial Reporting Challenges IFRS in a Political Environment Financial Reporting Challenges The Expectations Gap What the public thinks accountants should do vs. what accountants think they can do. Significant Financial Reporting Issues Non-financial measurements Forward-looking information Sort assets Timeliness Financial Reporting Challenges Ethics in the Environment of Financial Accounting Companies that concentrate on “maximizing the bottom line,” “facing the challenges of competition,” and “stressing short-term results” place accountants in an environment of conflict and pressure. IFRS does not always provide an answer. Doing the right thing is not always easy or obvious. Financial Reporting Challenges International Convergence In 2002 the IASB and the FASB formalized their commitment to the convergence of U.S. GAAP and international standards. The Boards agreed to: 1. Make their existing financial reporting standards fully converged as soon as practicable, and 2. Coordinate their future work programs to ensure that once achieved, convergence is maintained. 12 Fundamental concepts 24 1) BUSINESS ENTITY CONCEPT • Business is treated as separate & distinct from its members • Separate set of books are prepared. • Proprietor is treated as creditor of the business. • For other business of proprietor different books are prepared. 25 2) MONEY MEASUREMENT CONCEPT • Transactions of monetary nature are recorded. • Transactions of qualitative nature, even though of great importance to business are not considered. 26 3) GOING CONCERN CONCEPT • Business will continue for a long period. • As per this concept, fixed assets are recorded at their original cost & depreciation is charged on these assets. • Because of this concept, outside parties enter into long term contracts with the enterprise. 27 4) ACCOUNTING PERIOD CONCEPT • Entire life of the firm is divided into time intervals for ascertaining the profits/losses are known as accounting periods. • Accounting period is of two types- financial year(1st Apr to 31st March) & calendar year(1st Jan to 31st Dec). • For taxation purposes financial year is adopted as prescribed by the Govt. • Companies having their shares listed on stock exchange publishes their quarterly results. 28 5) HISTORICAL COST CONCEPT • Assets are recorded at their original price. • This cost serves the basis for further accounting treatment of the asset. • Acquisition cost relates to the past i.e. it is known as historical cost. 29 JUSTIFICATION FOR HISTORICAL COST CONCEPT • This cost is objectively verifiable. • Justified by going concern concept. • Current values are difficult to determine. • Difficult to keep track of up down of the market price. 30 DRAWBACKS OF HISTORICAL CONCEPT • Assets for which nothing is paid will not be recorded like reputation, brand value, etc. • Information based on historical cost may not be useful to its members. 31 6) DUAL ASPECT CONCEPT • Every transaction recorded in books affects at least two accounts. • If one is debited then the other one is credited with same amount. • This system of recording is known as “DOUBLE ENTRY SYSTEM”. • ASSETS = LIABILITIES + CAPITAL 32 7) REVENUE RECOGNITION/REALISATION CONCEPT • Revenue means the addition to the capital as a result of business operations. • Revenue is realized on three basis-: 1. Basis of cash 2. Basis of sale 3. Basis of production 33 8) MATCHING CONCEPT • All the revenue of a particular period will be matched with the cost of that period for determining the net profits of that period. • Accordingly, for matching costs with revenue, first revenue should be recognized & then costs incurred for generating that revenue should be recognized. 34 Following points must be considered while matching costs with revenue • Outstanding expenses though not paid in cash are shown in the P&L a/c. • Prepaid expenses are not shown in the P&L a/c. • Closing stock should be carried over to the next period as opening stock. • Income receivable should be added in the revenue & income received in advance should be deducted from revenue. 35 9) ACCRUAL CONCEPT • In this concept revenue is recorded when sales are made or services are rendered it is immaterial whether cash is received or not. • Same with the expenses i.e. they are recorded in the accounting period in which they assist in earning the revenues whether the cash is paid for them or not. 36 10) OBJECTIVITY CONCEPT • Accounting transactions should be recorded in an objective manner, free from the personal bias of either management or the accountant who prepares the accounts. • It is possible only when each transaction is supported by verifiable documents & vouchers such as cash memos, invoices. 37 11) TIMELINESS • This principle states that the information should be provided to the users at right time for the purpose of decision making. • Delay in providing accounts serves no usefulness for the users for decision making. 38 12) COST BENEFIT PRINCIPLE • This principle states that the cost incurred in applying the principles should be less than the profits derived from them. 39 ACCOUNTING CONVENTIONS ACCOUNTING CONVENTIONS • An accounting convention may be defined as a custom or generally accepted practice which is adopted either by general agreement or common consent among accountants. 1) CONVENTION OF FULL DICLOSURE • Information relating to the economic affairs of the enterprise should be completely disclosed which are of material interest to the users. • Proforma & contents of balance sheet & P&L a/c are prescribed by Companies Act. • It does not mean that leaking out the secrets of the business. 2) CONVENTION OF CONSISTENCY • Accounting method should remain consistent year by year. • This facilitates comparison in both directions i.e. intra firm & inter firm. • This does not mean that a firm cannot change the accounting methods according to the changed circumstances of the business. 3) CONVENTION OF CONSERVATISM • All anticipated losses should be recorded but all anticipated gains should be ignored. • It is a policy of playing safe. • Provisions is made for all losses even though the amount cannot be determined with certainty 4) CONVENTION OF MATERIALITY • According to American Accounting Association, “An item should be regarded as material if there is reason to believe that knowledge of it would influence decision of informed investor.” • It is an exception to the convention of full disclosure. • Items having an insignificant effect to the user need not to be disclosed. DIFFERENCE B/W CONCEPTS & CONVENTIONS BASIS Established Biasness Uniformity ACCOUNTING CONCEPTS By law ACCOUNTING CONVENTIONS Guidelines based upon customs or usage No space for Biasness in adoption personal biasness in the adoption Uniform adoption No uniform adoption Accounting and Financial Statements The Nature of Accounting • The accounting system is a series of steps performed to analyze, record, quantify, accumulate, summarize, classify, report, and interpret economic events and their effects on an organization and to prepare the financial statements. Accounting as an Aid to Decision Making • Fundamental relationships in the decisionmaking process: Event Accountant’s analysis & recording Financial Statements Users Financial and Management Accounting • The major distinction between financial and management accounting is the users of the information. – Financial accounting serves external users. – Management accounting serves internal users, such as top executives, management, and administrators within organizations. Financial and Management Accounting The primary questions about an organization’s success that decision makers want to know are: What is the financial picture of the organization on a given day? How well did the organization do during a given period? CHART OF ACCOUNTS The Chart of Accounts is organized using three different methods. 1. First: Accounting Types 2. Second: Order of Liquidity - the ease of converting to cash without loss of value 3. Third: Account Numbers 52 7 TYPES OF ACCOUNTS 1. 2. 3. 4. Assets - Things you own Liabilities - Things you owe Equity - Owners Stake in Company Revenue - Income through Sales of the Products of the Business 5. Costs of Goods Sold - Costs to provide the service or to manufacture or acquire the product the business sells 6. Expenses - Things that are paid for that are consumable and are part of the cost of running a business 7. Other Revenue and Expenses - Revenue and Expenses that are unusual cases and are not directly related to the business product and are not usual costs of running a business. 53 ORDER OF LIQUIDITY • The Chart of Accounts’ second method of organization is Order of Liquidity. Liquidity refers to the expectation that the item can be converted to cash at least close to its current value within one year. • Accounts are listed in descending order of liquidity within their accounting types, with cash at the top of the list for Assets. • The liquidity classification is so important that Assets and Liabilities are divided into the Subtypes of Current and Long Term/Fixed to group items of similar liquidity together. 54 ACCOUNT NUMBERS • Assigning Account numbers starts by assigning a range of numbers to each Accounting Type. • The number of digits will be important in your software system so when using ranges in the 1000’s there are 4 digits, and the Account Numbers would range from 1000 to 9999. 55 ACCOUNT NUMBERS • Assets: 1000’s – Current Assets 1000 – 1499; Fixed Assets 1500 -1999 • Liabilities: 2000’s – Current Liabilities 2000 – 2499; Long Term Liabilities 2500 2999 • Equity: 3000’s • Revenue: 4000’s • Costs of Goods Sold: 5000’s • Expenses: 7000’s • Other Revenue: 8000’s • Other Expenses: 9000’s 56 Use of Funds (Debit) Accounting Types • Each Accounting Type under the “Funds/Use of Funds” Category increases in value or balance with each debit (Use of Funds) transaction entry and decreases in value or balance with each credit (Source of Funds) transaction entry. Use of Funds Accounts are sometimes referred to as Debit Accounts. 57 Use of Funds (Debit) Accounting Types Positive balances for these accounts are balances where total debits > total credits to the account and their balances should show in the Debit Column. 1. Assets 2. Costs of Goods Sold 3. Expenses 4. Other Expenses 58 Source of Funds (Credit) Accounting Types • Each Accounting Type under the “Source of Funds” Category increases in value or balance with each credit (Source of Funds) transaction entry and decreases in value or balance with each debit (Use of Funds) transaction entry. Source of Funds Accounts are sometimes referred to as Credit Accounts. 59 Source of Funds (Credit) Accounting Types Positive balances for these accounts are balances where total credits > total debits to the account and their balances should show in the Credit Column. 1. Liabilities - Things you owe 2. Equity - Owners’ Stake in Company 3. Revenue - Income through Sales of the Products of the Business 4. Other Revenues - Revenues that are unusual cases and are not directly related to the business product and are not usual revenues from running a business. 60 FINANACIAL STATEMENTS ANNUAL REPORT • Financial Statements – Income Statement – Statement of Retained Earnings – Balance Sheet – Statement of Cash Flows • Management Discussion and Analysis • Notes to Financial Statements • Auditor's Report Financial Accounting Statements • Income Statement - reports the results of operations for a specific period of time • Retained Earnings Statement - reports the changes in retained earnings for a specific period of time • Balance Sheet - reports the assets, liabilities, and stockholders’ equity at a specific date • Statement of Cash Flows - reports the cash receipts and payments for a specific period of time 63 Management Discussion and Analysis Covers three aspects of a company: – liquidity - ability to pay near term obligations – capital resources - fund operations and expansions – results of operation 64 Notes to Financial Statements • Provide additional information not included in body of statements • Describe accounting policies or explain uncertainties and contingencies 65 Auditor's Report • Auditor, a professional accountant who conducts an independent examination of the financial accounting data presented by a company. • Auditor gives an unqualified opinion if the financial statements present the financial position, results of operations, and cash flows in accordance with GAAP. 66 Statement of Cash Flows 67 Statement of Cash Flows The Cash Flow Statement (Statement of Cash Flows) provides an overview of the way Funds move through an Entity, how they impact Overall Value and eventually reconcile with Cash Balances and determine Net Cash Flow in any given year. 68 3 Types of Business Activity • Financing • Investing • Operating 69 Investing Activities Obtaining the Resources or Assets needed to operate the business Examples of assets... • • • • Cash Accounts Receivable Prepaid Rent Buildings, Equipment, Furniture 70 Investing Activities - Examples • Purchase or Sale of computers, delivery trucks, furniture, buildings • Purchase or Sale of investments 71 Cash flow statement 1. Operating Activities Net Income + Depreciation Expense (+ Increase and -Decrease in Accumulated Depreciation) + Increases in Current Liabilities + Decreases in Current Assets - Increases in Current Assets - Decreases in Current Liabilities Cash flow statement 2. Investing Activities + Decreases in Long Term/Fixed Assets (Independent of Accumulated Depreciation) - Increases in Long Term/Fixed Assets (Independent of Accumulated Depreciation) Cash flow statement 3. Financing Activities + Increases in Long Term Liabilities/Debt - Decreases in Long Term Liabilities/Debt + Increases in Owners’ Capital - Decreases in Owners’ Capital - Increases in Dividends Beginning Cash Balance - Net Increase/Decrease = Ending Cash Balance Statement of Cash Flows Cash Flows From Operating Activities Net Income Depreciation Increase in Payables Net Cash Provided by Operating Activities Cash Flows From Investing Activities Increase in Fixed Assets Net Cash Used by Investing Activities $45,104 $496 $1,700 ———— $47,300 ———— $2,950 ———— -$2,950 ———— Cash Flows From Financing Activities Net Cash Provided by Financing Activities Increase in Cash and Cash Equivalents (Net Cash Flow) Cash and Cash Equivalents at Beginning of Year Cash and Cash Equivalents at End of Year $0 ———— $0 ———— $44,350 $0 ———— $44,350 Income Statement Income Statement • The Income Statement Accounting Types are Revenue, Cost of Goods Sold and Expenses. The Accounts that are not on the Income Statement are on the Balance Sheet. • As its name suggests, the purpose of the Income Statement is to report Income. Income = Revenue - Expenses. It is almost that simple, but there is more to the Income Statement than a simple calculation. Income Statement Revenue -Cost of Goods Sold —————=Gross Margin -Expenses —————=Operating Income +Other Revenue -Other Expenses —————=Net Income CSU CORPORATION Income Statement For the Year Ended December 31, 2008 1st- head up the statement •name of company •name of statement •period of time covered CSU CORPORATION Income Statement For the Year Ended December 31, 2008 Revenues Service revenue 2nd - List the revenues $17,000 CSU CORPORATION Income Statement For the Year Ended December 31, 2008 Revenues Service revenue Expenses Rent expense Insurance expense Supplies expense Total expenses $17,000 $9,000 1,000 200 10,200 3rd - List and total the expenses CSU CORPORATION Income Statement For the Year Ended December 31, 2008 Revenues Service revenue Expenses Rent expense Insurance expense Supplies expense Total expenses Net Income $17,000 $9,000 1,000 200 10,200 $ 6,800 4th - Subtract expenses from revenues to obtain net income. Retained Earnings CSU CORPORATION Retained Earnings Statement For the Year Ended December 31, 2008 1st- head up the statement •name of company •name of statement •period of time covered CSU CORPORATION Retained Earnings Statement For the Year Ended December 31, 2008 Retained earnings, January 1 $ 2nd - Start with beginning retained earnings 0 CSU CORPORATION Retained Earnings Statement For the Year Ended December 31, 2008 Retained earnings, January 1 Add: Net Income $ 0 6,800 6,800 3rd - Add net income from the current year - subtotal CSU CORPORATION Retained Earnings Statement For the Year Ended December 31, 1998 Retained earnings, January 1 Add: Net Income $ Less: Dividends Retained earnings, December 31 $ 6,800 0 6,800 6,800 0 4th - Subtract current year’s dividends and total Balance Sheet The Balance Sheet The balance sheet equation: Assets = Liabilities + Owners’ Equity or Owners’ Equity = Assets - Liabilities CSU CORPORATION Balance Sheet December 31, 2008 1st- head up the statement •name of company •name of statement •date CSU CORPORATION Balance Sheet December 31, 2008 Assets Cash Accounts receivable Supplies Equipment Total assets $ 2,000 4,000 1,800 16,000 $23,800 2nd - list the assets and total CSU CORPORATION Balance Sheet December 31, 2008 Assets Cash Accounts receivable Supplies Equipment Total assets Liabilities and Stockholders’ Equity Liabilities Accounts payable Notes payable Total liabilities $ 2,000 4,000 1,800 16,000 $23,800 $ 2,000 5,000 7,000 3rd - list the liabilities and subtotal CSU CORPORATION Balance Sheet December 31, 2008 4th - list stockholders’ equity subtotal. Add to liabilities, Total CSU CORPORATION Balance Sheet December 31, 2008 Assets Cash Accounts receivable Supplies Equipment Total assets Liabilities and Stockholders’ Equity Liabilities Accounts payable Notes payable Total liabilities Stockholders’ equity Common stock Retained earnings Total Stockholders’ equity Total liabilities and stockholders’ equity $ 2,000 4,000 1,800 16,000 $23,800 $ 2,000 5,000 7,000 10,000 6,800 16,800 $23,800 CSU CORPORATION Balance Sheet December 31, 2008 Assets Cash Accounts receivable Supplies Equipment Total assets Liabilities and Stockholders’ Equity Liabilities Accounts payable Notes payable Total liabilities $ 2,000 4,000 1,800 16,000 $23,800 $ 2,000 5,000 7,000 3rd - list the liabilities and subtotal CSU CORPORATION Balance Sheet December 31, 1998 4th - list stockholders’ equity subtotal. Add to liabilities, Total In what order are financial statements prepared? WHY? CSU CORPORATION Income Statement For the Year Ended December 31, 2008 Revenues Service revenue Expenses Rent expense Insurance expense Supplies expense Total expenses Net Income $17,000 $9,000 1,000 200 10,200 $ 6,800 Net Income is needed for the Statement of Retained Earnings. CSU CORPORATION Retained Earnings Statement For the Year Ended December 31, 2008 Retained earnings, January 1 Add: Net Income $ Less: Dividends Retained earnings, December 31 $ 6,800 0 6,800 6,800 0 Ending Retained Earnings is needed for the balance sheet. CSU CORPORATION Balance Sheet December 31, 2008 Assets Cash Accounts receivable Supplies Equipment Total assets Liabilities and Stockholders’ Equity Liabilities Accounts payable Notes payable Total liabilities Stockholders’ equity Common stock Retained earnings Total Stockholders’ equity Total liabilities and stockholders’ equity $ 2,000 4,000 1,800 16,000 $23,800 $ 2,000 5,000 7,000 10,000 6,800 16,800 $23,800 Analyzing and Recording Transactions Analyzing and Recording Process Exchanges of economic consideration between two parties. External Transactions occur between the organization and an outside party. Internal Transactions occur within the organization. Analyzing and Recording Process Accounting process: -Identifies business transactions and events, -Analyzes and records their effects, and -Summarizes and presents information in reports and financial statements. Steps in accounts process that focus on analyzing and recording transactions and events are: (1)Record relevant transactions and events in a journal, (2) Post journal information to ledger accounts, and (3) Prepare a trial balance. Accounting records are informally referred as the accounting books, or simply the books. Analyzing and Recording Process Analyze each transaction and event from source documents Prepare and analyze the trial balance Record relevant transactions and events in a journal Post journal information to ledger (T) accounts Source Documents Checks Employee Earnings Records Bills from Suppliers Purchase Orders Bank Statements Sales Tickets The Account and its Analysis An account is a record of increases and decreases in a specific asset, liability, equity, revenue, or expense item. The general ledger is a record containing all accounts used by the company. The Account and its Analysis Assets Assets Asset Accounts Accounts Accounts = Liability Liability Liability Accounts Accounts Accounts + Equity Equity Equity Accounts Accounts Accounts Asset Accounts Cash Land Buildings Asset Accounts Accounts Receivable Notes Receivable Prepaid Accounts Equipment Supplies Liability Accounts Accounts Payable Notes Payable Liability Accounts Accrued Liabilities Unearned Revenue Dividends Payable Equity Accounts Retained Earnings Common Stock Dividends Declared Equity Accounts Revenues Expenses The Account and its Analysis Assets = Liabilities + – Common Stock Dividends + + Revenues Equity – Expenses Ledger and Chart of Accounts The ledger is a collection of all accounts for an information system. A company’s size and diversity of operations affect the number of accounts needed. The chart of accounts is a list of all accounts and includes an identifying number for each account. 101 106 126 128 167 201 236 307 318 Cash Accounts receivable Supplies Prepaid insurance Equipment Accounts payable Unearned revenue Common stock Retained Earnings 319 403 406 622 637 640 652 690 Dividends Consulting Revenues Rental revenue Salaries expense Insurance expense Rent expense Supplies expense Utilities expense Debits and Credits A T-account represents a ledger account and is a tool used to understand the effects of one or more transactions. T- Account (Left side) (Right side) Debit Credit Double-Entry Accounting NORMAL Balance ASSETS = LIABILITIES + EQUITY DR = CR CR Assets are on the left side of the equation; therefore, the left, or debit side is the normal balance side for assets. Liabilities and equities are on the right side; therefore, the right, or credit side is the normal balance side for liabilities and equity. Double-Entry Accounting ASSETS = LIABILITIES + EQUITY || ASSETS = LIABILITIES + Common Stock – DIV + REV - EXP Total amount that is debited to accounts must equal the total amount credited to accounts for each transaction. Sum of debit account balances in the ledger must equal the sum of credit account balances. Double-Entry Accounting NORMAL Balance Assets ASSETS Debit + = Liabilities - Debit - Equity EQUITIES LIABILITIES Credit + Credit + Debit - Credit + Whether a debit or a credit is an increase or decrease depends on the NORMAL Balance of the account. Double-Entry Accounting NORMAL Balance Equity _ Common Stock Stock Dividends Debit Credit - Dividends + Revenues Revenues Debit Credit + + - Expenses Expenses Debit Credit - _ + Debit Credit + - Double-Entry Accounting NORMAL Balance An account balance is the difference between the increases and decreases in an account. Notice the T-Account Cash Investment by owner for stock Consulting services revenues earned Collection of accounts receivable Total increases Balance 30,000 Purchase of supplies 4,200 Purchase of equipment 1,900 Payment of rent Payment of salary Payment of accounts payable Payment of cash dividend 36,100 Total decreases 4,800 2,500 26,000 1,000 700 900 200 31,300 Journalizing & Posting Transactions Assets = Liabilities + Equity T- Account (Left side) (Right side) Debit Credit Step 1: Analyze transactions and source documents. ACCOUNT NAME: Date Step 2: Apply doubleentry accounting GENERAL JOURNAL ACCOUNT No. Description PR Debit Credit Balance Step 4: Post entry to ledger Date Description Page Post. Ref. Debit 123 Credit Step 3: Record journal entry Journalizing Transactions Transaction Date Titles of Affected Accounts GENERAL JOURNAL Account Titles and Explanations PR Date 2009 Dec. 1 Cash Common stock Investment by shareholders 2 Supplies Dec.Transaction explanation Cash Page 1 Debit Credit 30,000 30,000 Dollar amount of debits and credits 2,500 2,500 Balance Column Account T-accounts are useful illustrations, but balance column accounts are used in practice. CASH Date ACCOUNT No. 101 Explanation PR Debit Credit Balance 2,500 26,000 30,000 27,500 1,500 5,700 2009 Dec. 1 Dec. 2 Dec. 3 Dec. 10 Initial investment Purchased supplies Purchased equipment Collection from customer 30,000 4,200 Posting Journal Entries GENERAL JOURNAL Date Account Titles and Explanation 2009 Dec. 1 Cash Common stock Investment by shareholders Dec. 2 Supplies Cash 1 Identify the debit account Purchased store supplies for cash Page 1 PR Explanation Credit 30,000 30,000 2,500 2,500 in ledger. CASH Date Debit ACCOUNT No. PR Debit Credit 101 Balance 2009 Dec. 3 Purchased equipment G1 20,000.00 ######## Posting Journal Entries GENERAL JOURNAL Date Account Titles and Explanation 2009 Dec. 1 Cash Common stock Investment by shareholders Page 1 PR Explanation Credit 30,000 30,000 Dec. 2 Supplies 2 Enter the date. Cash Purchased store supplies CASH for cash Date Debit 2,500 2,500 ACCOUNT No. PR Debit 101 Credit Balance 20,000.00 ######## 2009 Dec. 1 Dec. 3 Purchased equipment G1 Posting Journal Entries GENERAL JOURNAL Page 1 Date Account Titles & Elxplanations PR 2009 Dec. 1 Cash Common stock Investment by shareholders Dec. 2 Supplies 3 Enter theCash amount and description. Purchased store supplies CASH for cash Date Explanation PR Debit Credit 30,000 30,000 2,500 2,500 ACCOUNT No. Debit Credit 101 Balance 2009 30,000 Dec. 1 Dec. 3 Purchased equipment G1 20,000 (20,000) Posting Journal Entries GENERAL JOURNAL Page 1 Date Account Titles and Explanation PR 2009 Dec. 1 Cash Common stock Investment by shareholders 2Enter Supplies the journal reference. Cash Purchased store supplies CASH for cash Debit 30,000 30,000 Dec. 4 Date Explanation 2,500 2,500 ACCOUNT No. PR Debit G1 30,000 2009 Dec. 1 Credit Credit 101 Balance Posting Journal Entries GENERAL JOURNAL Date Account Titles & Elxplanations 2009 Dec. 1 Cash Common stock Investment by shareholders Page 1 PR Debit 30,000 30,000 Dec. 2 Compute Supplies the balance. Cash Purchased store supplies CASH for cash 2,500 5 Date Explanation Credit 2,500 ACCOUNT No. PR Debit G1 30,000 Credit 101 Balance 2009 Dec. 1 Dec. 3 Purchased equipment G1 30,000 20,000 (20,000) Posting Journal Entries GENERAL JOURNAL Date Account Titles and Explanation 2009 Dec. 1 Cash Common stock Investment by shareholders Page 1 PR Debit 101 2 Supplies Enter the ledger reference. Cash Purchased store supplies CASH for cash 2,500 6 Explanation 30,000 30,000 Dec. Date Credit 2,500 ACCOUNT No. PR Debit G1 30,000 Credit 101 Balance 2009 Dec. 1 Dec. 3 Purchased equipment G1 30,000 20,000 (20,000) Analyzing Transactions Shareholders invested $30,000 in FastForward on Dec. 1. Transaction:1 Analysis: Assets = Liabilities Cash 30,000 + Equity Common Stock 30,000 Double entry: (1) Cash 101 301 Common stock 30,000 30,000 Posting: (1) Cash 30,000 101 Common Stock (1) 301 30,000 Analyzing Transactions Transaction:2 FastForward purchases supplies by paying $2,500 cash. Analysis: Cash (2,500) Assets Supplies = Liabilities + Equity Common Stock 2,500 Double entry: (2) Supplies Cash 126 101 2,500 2,500 Posting: (2) Supplies 2,500 126 (1) Cash 30,000 101 (2) 2,500 Analyzing Transactions Transaction:3 FastForward purchases equipment by paying $26,000 cash. Analysis: Assets Cash Equipment (26,000) = Liabilities + Equity Common Stock 26,000 Double entry: (3) Equipment Cash 167 101 26,000 26,000 Posting: (3) Equipment 26,000 167 (1) Cash 30,000 101 (2) (3) 2,500 26,000 Analyzing Transactions Transaction:4 FastForward purchases $7,100 of supplies on credit. Analysis: Assets = Supplies Liabilities Accounts Payable 7,100 + Equity Common Stock 7,100 Double entry: (4) Supplies Accounts payable 126 201 7,100 7,100 Posting: (4) Supplies 2,500 7,100 126 Accounts Payable (4) 201 7,100 Analyzing Transactions FastForward provides consulting services and Transaction:5 immediately collects $4,200 cash. Analysis: Assets = + Liabilities Cash 4,200 Equity Revenue 4,200 Double entry: (5) Cash 101 403 Consulting Revenue 4,200 4,200 Posting: 403 Consulting Revenue (5) 4,200 (1) (5) Cash 30,000 4,200 101 (2) (3) 2,500 26,000 Analyzing Transactions Transaction: 6 FastForward pays $1,000 cash for December rent. Analysis: Assets = + Liabilities Cash (1,000) Equity (Expense) (1,000) Double entry: (6) Rent Expense Cash 640 101 1,000 1,000 Posting: Rent Expense (6) 1,000 640 (1) (5) Cash 30,000 4,200 101 (2) (3) (6) 2,500 26,000 1,000 Analyzing Transactions Transactions 7: Payment of Salaries expenses in cash Analysis: - Assets (Cash) = – Equity (Expenses) Double entry: Debit Salaries Expenses and credit Cash Transaction 8: Provide services and rents test facilities for credit Analysis: + Assets (Accts Receivable) = + Equity (Revenues) Double entry: Debit Accounts Receivable and Credit Consulting Revenue and Credit Rental Revenue Transaction 9: Receipt of cash from accounts receivable Analysis: + Assets (Cash) = – Assets (Accounts Receivable) Double entry: Debit Cash and credit Accounts Receivable Analyzing Transactions Transaction 10: Payment of accounts payable Analysis: – Assets (Cash) = – Liability (Accounts Payable) Double entry: Debit Accounts Payable and credit Cash Transaction 11: Payment of cash dividend Analysis: – Assets (Cash) = – Equity (Dividends) Double entry: Debit Dividends and credit Cash Transaction 12: Receipts of cash from a customer for future consulting services Analysis: + Assets (Cash) = + Liabilities (Unearned Revenue) Double entry: Debit Cash and credit Unearned Consulting Revenue Analyzing Transactions Transaction 13: Pay cash for future insurance coverage Analysis: – Assets (Cash) = + Assets (Prepaid Insurance) Double entry: Debit Prepaid Insurance and credit Cash Transaction 14: Purchase supplies for cash Analysis: - Assets (Cash) = + Assets (Supplies) Double entry: Debit Supplies and credit Cash Transactions 15: Payment of utilities expenses in cash Analysis: – Assets (Cash) = – Equity (Expenses) Double entry: Debit Utilities Expense and credit Cash Transactions 16: Payment of salaries expenses in cash Analysis: – Assets (Cash) = – Equity (Expenses) Double entry: Debit Salaries Expense and credit Cash After processing its remaining transactions for December, FastForward’s Trial Balance is prepared. FastForward Trial Balance December 31, 2009 Cash Accounts receivable Supplies Prepaid Insurance Equipment Accounts payable Unearned consulting revenue Common stock Dividends Consulting revenue Rental revenue Salaries expense Rent expense Utilities expense Total Debits $ 4,350 9,720 2,400 26,000 Credits $ 6,200 3,000 30,000 200 5,800 300 1,400 1,000 230 $ 45,300 $ 45,300 The trial balance lists all account balances in the general ledger. If the books are in balance, the total debits will equal the total credits. Six Steps for Searching for and Correcting Errors If the trial balance does not balance, the error(s) must be found and corrected. Make sure the trial balance columns are correctly added. Recompute each account balance in the ledger. Make sure account balances are correctly entered from the ledger. Verify that each journal entry is posted correctly. See if debit or credit accounts are mistakenly placed on the trial balance. Verify that each original journal entry has equal debits and credits. Using a Trial Balance to Prepare Financial Statements Point in Time Period of Time Point in Time Income Statement Statement of Retained Earnings Statement of Cash Flows Beginning Balance Sheet Ending Balance Sheet Income Statement FASTFORWARD Income Statement For the Month Ended December 31, 2009 Revenues: Consulting revenue $ 5,800 Rental revenue 300 Total revenues $ 6,100 Expenses: Salaries expense 1,400 Rent Expense 1,000 Utilities Expense 230 Total expenses 2,630 Net income $ 3,470 Statement of Retained Earnings FASTFORWARD Statement of Retained Earnings For the Month Ended December 31, 2009 Balance, 12/1/09 $ Net income for December 3,470 3,470 Less: Dividends (200) Balance, 12/31/09 $ 3,270 FASTFORWARD Income Statement For the Month Ended December 31, 2009 Revenues: Consulting revenue $ 5,800 Rental revenue 300 Total revenues $ 6,100 Expenses: Rent expense 1,000 Salaries expense 1,400 Utilities expense 230 Total expenses 2,630 Net income $ 3,470 Balance Sheet FASTFORWARD Statement of Retained Earnings For the Month Ended December 31, 2009 Balance, 12/1/09 $ Net income for December 3,470 3,470 Less: Dividends 200 Balance, 12/31/09 $ 3,270 FASTFORWARD Balance Sheet December 31, 2009 Assets Cash Supplies Prepaid insurance Equipment Total assets Liabilities Accounts payable Unearned revenue Total liabilities Equity Common stock Retained earnings Total equity Total liabilities and equity $ 4,350 9,720 2,400 26,000 $ 42,470 $ 6,200 3,000 9,200 30,000 3,270 33,270 $ 42,470 Completing the Accounting Cycle What is a Worksheet? • multiple-column form used for the adjustment process and preparing financial statements • working tool for the accountant • not a permanent accounting record • Eases preparation of adjusting entries and financial statements Example of a Work Sheet Remember: • A work sheet is not a permanent accounting record • When it is used: – financial statements are prepared from the work sheet – adjustments are journalized and posted from the work sheet after financial statements, so management can receive the financial statements more quickly To Prepare A Work Sheet: 1 Prepare the trial balance 2 Enter adjustments in the adjustments columns 3 Enter adjusted balances in adjusted trial balance columns 4 Extend adjusted trial balance amounts to the appropriate financial statement columns 5 Total the statement columns, compute net income (loss), and complete the work sheet FastForward Work Sheet For Month Ended December 31, 2011 Cash Accounts receivable Supplies Prepaid insurance Equipment Accum. depr. - Equip. Accounts payable Salaries payable Unearned revenue C. Taylor, Capital C. Taylor, Withdrawals Consulting revenue Rental revenue Depr. expense Salaries expense Insurance expense Rent expense Supplies expense Utilities expense Totals Unadjusted Trial Balance Dr. Cr. 3,950 9,720 2,400 26,000 Adjustments Dr. 6,200 3,000 30,000 600 5,800 300 1,400 1,000 230 45,300 45,300 Cr. First, enter the unadjusted trial balance amounts to the worksheet! Adjusted Trial Balance Dr. Cr. Here are our adjusting entries for December a) Insurance expense 100 Prepaid insurance 100 b) Supplies expense 1050 Supplies 1050 c) Depreciation expense 375 Accum. Depr. – Equip. 375 Here Are More Adjusting Entries for December d) Unearned revenue 250 Consulting Revenue e) Salaries Expense 210 Salaries Payable f) Accounts Receivable 1,800 Consulting Revenue 250 210 1,800 FastForward Work Sheet For Month Ended December 31, 2011 Cash Accounts receivable Supplies Prepaid insurance Equipment Accum. depr. - Equip. Accounts payable Salaries payable Unearned revenue C. Taylor, Capital C. Taylor, Withdrawals Consulting revenue Rental revenue Depr. expense Salaries expense Insurance expense Rent expense Supplies expense Utilities expense Totals Unadjusted Trial Balance Dr. Cr. 3,950 9,720 2,400 26,000 Adjustments Dr. f 6,200 3,000 d 30,000 Adjusted Trial Balance Dr. Cr. Cr. Next, enter the adjustments! 1,800 b a 1,050 100 c 375 e 210 d f 250 1,800 250 600 5,800 300 1,400 1,000 230 45,300 45,300 c e a 375 210 100 b 1,050 3,785 3,785 Prepare the adjusted trial balance! Cash Accounts receivable Supplies Prepaid insurance Equipment Accum. depr. - Equip. Accounts payable Salaries payable Unearned revenue C. Taylor, Capital C. Taylor, Withdrawals Consulting revenue Rental revenue Depr. expense Salaries expense Insurance expense Rent expense Supplies expense Utilities expense Totals FastForward Work Sheet For Month Ended December 31, 2011 Unadjusted Trial Balance Dr. Cr. 3,950 9,720 2,400 26,000 Adjustments Dr. f 6,200 3,000 d 30,000 Cr. 1,800 b a 1,050 100 c 375 e 210 Adjusted Trial Balance Dr. Cr. 3,950 1,800 8,670 2,300 26,000 250 600 600 5,800 d f 250 1,800 7,850 300 1,400 1,000 230 45,300 45,300 375 6,200 210 2,750 30,000 300 c e a 375 210 100 b 1,050 3,785 3,785 375 1,610 100 1,000 1,050 230 47,685 47,685 Then, extend theFastForward adjusted trial balance Work Sheet amounts theEnded financial For to Month Decemberstatements! 31, 2004 Cash Accounts receivable Supplies Prepaid insurance Equipment Accum. depr. - Equip. Accounts payable Salaries payable Unearned revenue C. Taylor, Capital C. Taylor, Withdrawals Consulting revenue Rental revenue Depr. expense Salaries expense Insurance expense Rent expense Supplies expense Utilities expense Totals Adjusted Trial Balance Dr. Cr. 3,950 1,800 8,670 2,300 26,000 Income Statement Dr. Cr. Balance Sheet & Statement of Equity Dr. Cr. 3,950 1,800 8,670 2,300 26,000 375 6,200 210 2,750 30,000 375 6,200 210 2,750 30,000 600 600 7,850 300 7,850 300 375 1,610 100 1,000 1,050 230 47,685 47,685 375 1,610 100 1,000 1,050 230 4,365 8,150 43,320 39,535 FastForward Total statement columns, compute income or loss, Work Sheet and balance columns. For Month Ended December 31, 2004 Cash Accounts receivable Supplies Prepaid insurance Equipment Accum. depr. - Equip. Accounts payable Salaries payable Unearned revenue C. Taylor, Capital C. Taylor, Withdrawals Consulting revenue Rental revenue Depr. expense Salaries expense Insurance expense Rent expense Supplies expense Utilities expense Totals Net income Adjusted Trial Balance Dr. Cr. 3,950 1,800 8,670 2,300 26,000 Income Statement Dr. Cr. Balance Sheet & Statement of Equity Dr. Cr. 3,950 1,800 8,670 2,300 26,000 375 6,200 210 2,750 30,000 375 6,200 210 2,750 30,000 600 600 7,850 300 7,850 300 375 1,610 100 1,000 1,050 230 47,685 47,685 375 1,610 100 1,000 1,050 230 4,365 3,785 8,150 8,150 8,150 43,320 39,535 43,320 3,785 43,320 Prepare the Financial Statements FastForward Income Statement For the Month Ended December 31, 2011 Revenues: Consulting revenue $ 7 850 Rental revenue 300 Total revenues 8 150 Operating expenses: Depr. expense - Equip. $ 375 Salaries expense 1 610 Insurance expense 100 Rent expense 1 000 Supplies expense 1 050 Utilities expense 230 Total expenses 4 365 Net income $ 3 785 Prepare the Income Statement. A work sheet does not substitute for financial statements. FastForward Income Statement For the Month Ended December 31, 2011 Revenues: Consulting revenue $ 7 850 Rental revenue 300 Total revenues 8 150 Operating expenses: Depr. expense - Equip. $ 375 Salaries expense 1 610 Insurance expense 100 Rent expense 1 000 Supplies expense 1 050 Utilities expense 230 Total expenses 4 365 Net income $ 3 785 Prepare the Statement of Changes in Owner’s Equity. FastForward Statement of Changes in Owner's Equity For the Month Ended December 31, 2011 C. Taylor, Capital 12/1/04 Add: Net income $ Investment by owner Total Less: Withdrawal by owner C. Taylor, Capital 12/31/04 $ 3 785 30 000 $ -033 785 33 785 600 33 185 FastForward Statement of Changes in Owner's Equity For the Month Ended December 31, 2011 C. Taylor, Capital 12/1/04 Add: Net income $ Investment by owner Total Less: Withdrawal by owner C. Taylor, Capital 12/31/04 $ 3 785 30 000 $ -0- Prepare the Balance Sheet. 33 785 33 785 600 33 185 FastForward Balance Sheet December 31, 2011 Assets Cash Accounts receivable Supplies Prepaid insurance Equipment Less: accum. depr. Total assets $ $ 26 000 (375) 3 950 1 800 8 670 2 300 $ 25 625 42 345 $ 9 160 $ 33 185 42 345 Liabilities Accounts payable $ Salaries payable Unearned consulting revenues Total liabilities 6 200 210 2 750 Owner's Equity C.Taylor, Capital Total liabilities and equity Which of these characteristics are true about a work sheet? – – – – a permanent accounting record an optional device used by accountants a part of the general ledger a part of the journal Answer! – – – – permanent accounting record optional device used by accountants part of the general ledger part of the journal Although it’s optional, the work sheet is a very useful tool! TEMPORARY VS. PERMANENT ACCOUNTS TEMPORARY (NOMINAL) PERMANENT (REAL) These accounts are closed These accounts are not closed All revenue accounts All asset accounts All expense accounts All liability accounts Owner’s drawing Owner’s capital account Now, let’s talk about closing entries and income summary! CLOSING ENTRIES • Closing entries – Transfer net income (loss) and owner’s drawings to owner’s capital – Journalizing and posting is a required step in the accounting cycle • Income Summary – A temporary account – Used in closing revenue and expense accounts – Minimizes the details in the permanent owner’s capital account Closing Process • Resets revenue, expense and withdrawal account balances to zero at the end of the period. • Helps summarize a period’s revenues and expenses in the Income Summary account. Identify accounts for closing. Record and post closing entries. Prepare post-closing trial balance. Temporary and Permanent Accounts Income Summary Liabilities Permanent Accounts The closing process applies only to temporary accounts. Owner’s Capital Temporary Accounts Assets Withdrawals Expenses Revenues Recording Closing Entries Close Revenue accounts to Income Summary. Close Expense accounts to Income Summary. Close Income Summary account to Owner’s Capital. Close Withdrawals to Owner’s Capital. Let’s see how the closing process works! Closing Process Revenue Accounts 25,000 Expense Accounts 10,000 25,000 10,000 Income Summary Withdrawals Account 5,000 Owner's Capital 30,000 30,000 Balances before closing. 5,000 Closing Process Expense Accounts 10,000 Close Revenue accounts to Income Summary. Revenue Accounts 25,000 25,000 - 10,000 Income Summary 25,000 Owner's Capital 30,000 30,000 25,000 Withdrawals Account 5,000 5,000 Closing Process Expense Accounts 10,000 10,000 Close Expense accounts to Income Summary. Revenue Accounts 25,000 25,000 - - Income Summary 10,000 25,000 Owner's Capital 30,000 30,000 15,000 The balance in Income Summary equals net income. Withdrawals Account 5,000 5,000 Closing Process Expense Accounts 10,000 10,000 Close Income Summary to Owner’s Capital. Revenue Accounts 25,000 25,000 - - Income Summary 10,000 25,000 15,000 Owner's Capital 30,000 15,000 45,000 - Withdrawals Account 5,000 5,000 Closing Process Expense Accounts 10,000 10,000 Revenue Accounts 25,000 25,000 - - Income Summary 10,000 25,000 15,000 Owner's Capital 5,000 30,000 15,000 45,000 40,000 - Close Withdrawals account to Owner’s Capital. Withdrawals Account 5,000 5,000 5,000 - FastForward Adjusted Trial Balance December 31, 2011 Cash $ 3 950 Accounts receivable 1 800 Supplies 8 670 Prepaid insurance 2 300 Equipment 26 000 Accumulated depreciation-Equip. $ Accounts payable Salaries payable Unearned consulting revenue C. Taylor, Capital C. Taylor, Withdrawals 600 Consulting revenue Rental revenue Depreciation expense-Equipment 375 Salaries expense 1 610 Insurance expense 100 Rent expense 1 000 Supplies expense 1 050 Utilities expense 230 Totals $ 47 685 $ 375 6 200 210 2 750 30 000 7 850 300 47 685 Using the adjusted trial balance, let’s prepare the closing entries for FastForward. FastForward Adjusted Trial Balance December 31, 2011 Cash $ 3 950 Accounts receivable 1 800 Supplies 8 670 Prepaid insurance 2 300 Equipment 26 000 Accumulated depreciation-Equip. $ Accounts payable Salaries payable Unearned consulting revenue C. Taylor, Capital C. Taylor, Withdrawals 600 Consulting revenue Rental revenue Depreciation expense-Equipment 375 Salaries expense 1 610 Insurance expense 100 Rent expense 1 000 Supplies expense 1 050 Utilities expense 230 Totals $ 47 685 $ 375 6 200 210 2 750 30 000 7 850 300 47 685 Close Revenue accounts to Income Summary. Close Revenue Accounts to Income Summary Dec. 31 Consulting revenue Rental revenue Income summary 7,850 300 8,150 Now, let’s look at the ledger accounts after posting this closing entry. Close Expense Accounts to Income Summary Dec. 31 Income summary Depreciation expense-Equipment Salaries expense Insurance expense Rent expense Supplies expense Utilities expense 4,365 375 1,610 100 1,000 1,050 230 Now, let’s look at the ledger accounts after posting this closing entry. Close Expense Accounts to Income Summary Depreciation Expense- Eq. 375 375 - Rent Expense 1,000 1,000 - Salaries Expense 1,610 1,610 - Supplies Expense 1,050 1,050 - Insurance Expense 100 100 - Utilities Expense 230 230 - Income Summary 4,365 7,850 300 3,785 Net Income FastForward Adjusted Trial Balance December 31, 2011 Cash $ 3 950 Accounts receivable 1 800 Supplies 8 670 Prepaid insurance 2 300 Equipment 26 000 Accumulated depreciation-Equip. $ Accounts payable Salaries payable Unearned consulting revenue C. Taylor, Capital C. Taylor, Withdrawals 600 Consulting revenue Rental revenue Depreciation expense-Equipment 375 Salaries expense 1 610 Insurance expense 100 Rent expense 1 000 Supplies expense 1 050 Utilities expense 230 Totals $ 47 685 $ 375 6 200 210 2 750 30 000 7 850 300 47 685 Close Income Summary to Owner’s Capital. Close Income Summary to Owner’s Capital Dec. 31 Income summary C. Taylor, Capital 3,785 3,785 Now, let’s look at the ledger accounts after posting this closing entry. Close Income Summary to Owner’s Capital Close Income Summary to Owner’s Capital C. Taylor, Capital 30,000 3,785 33,785 Income Summary 4,365 7,850 3,785 300 - FastForward Adjusted Trial Balance December 31, 2011 Cash $ 3 950 Accounts receivable 1 800 Supplies 8 670 Prepaid insurance 2 300 Equipment 26 000 Accumulated depreciation-Equip. $ Accounts payable Salaries payable Unearned consulting revenue C. Taylor, Capital C. Taylor, Withdrawals 600 Consulting revenue Rental revenue Depreciation expense-Equipment 375 Salaries expense 1 610 Insurance expense 100 Rent expense 1 000 Supplies expense 1 050 Utilities expense 230 Totals $ 47 685 $ 375 6 200 210Close Withdrawals 2 750 to Owner’s Capital. 30 000 7 850 300 47 685 Close Withdrawals to Owner’s Capital Dec. 31 C. Taylor, Capital 600 C. Taylor, Withdrawals 600 Now, let’s look at the ledger accounts after posting this closing entry. Close Withdrawals to Owner’s Capital C. Taylor, Withdrawals 600 600 - C. Taylor, Capital 600 30,000 3,785 33,185 ABOUT CLOSING ENTRIES Be Careful! •Avoid doubling revenue and expense balances – watch debits and credits •Remember: owner’s drawing does not move to the Income Summary account. Owner’s drawing is not an expense and it is not a factor in determining net income. RESULTS OF POSTING CLOSING ENTRIES • Temporary accounts – All temporary accounts will have zero balances after posting the closing entries – Temporary accounts (revenues and expenses) are totaled, balanced and double ruled • Owner’s capital – Total equity of the owner at the end of the accounting period – No entries are journalized and posted to owner’s capital during the year • Permanent accounts (assets, liabilities, and owner’s capital) are not closed POST-CLOSING TRIAL BALANCE After all closing entries have been journalized the post-closing trial balance is prepared from the ledger. The purpose of this trial balance is to prove the equality of the permanent account balances that are carried forward into the next accounting period. Post-Closing Trial Balance • List of permanent accounts and their balances after posting closing entries. • Total debits and credits must be equal. Let’s look at FastForward’s postclosing trial balance. Post-Closing Trial Balance FastForward Post-Closing Trial Balance December 31, 2011 Cash $ 3 950 Accounts receivable 1 800 Supplies 8 670 Prepaid insurance 2 300 Equipment 26 000 Accumulated depreciation-Equipment $ Accounts payable Salaries payable Unearned consulting revenue C.Taylor, Capital Totals $ 42 720 $ 375 6 200 210 2 750 33 185 42 720 Post-closing Trial Balance Summary of Steps in the Accounting Cycle 1 Analyze business transactions 2 Journalize the transactions 3 Post to ledger accounts 4 Prepare a trial balance 5 Journalize and post adjusting entries STEPS IN THE ACCOUNTING CYCLE 6 Prepare an adjusted trial balance 7 Prepare financial statements: Income Statement, Owner’s Equity Statement, Balance Sheet 8 Journalize and post closing entries 9 Prepare a post-closing trial balance 1. Correcting Entries • Correcting Entries – errors should be corrected as soon as discovered – correcting entries are unnecessary if records are free of errors – can be journalized and posted whenever an error is discovered – involve any combination of balance sheet and income statement accounts Illustrative Example Of Correcting Entry May 10 10 20 Incorrect Entry Cash Service Revenue (To record collection from customer an account) Correct Entry Cash Accounts Receivable (To record collection from customer an account) Correcting Entry Service Revenue Accounts Receivable (To correct entry of May 10) 50 50 50 50 50 50 Another Illustrative Example Of Correcting Entry May 18 18 June 3 Incorrect Entry Delivery Equipment Accounts Payable (To record purchase of equipment on account) Correct Entry Office Equipment Accounts Payable (To record purchase of equipment on account) Correcting Entry Office Equipment Delivery Equipment Accounts Payable (To correct entry of May 18) 45 45 450 450 450 45 405 Question: The closing entry process consists of closing: all asset and liability accounts – out the owner's capital account – all permanent accounts – all temporary accounts – Which answer is correct? The closing entry process consists of closing all asset and liability accounts – out the owner's capital account – all permanent accounts – all temporary accounts – Standard Balance Sheet Classifications • Financial statements become more useful when the elements are classified into significant subgroups. • A classified balance sheet generally has the following standard classifications (see next slide): Classified Balance Sheet Categories of a Classified Balance Sheet Assets Liabilities and Equity Current Assets Current Liabilities Noncurrent Assets Noncurrent Liabilities Long-Term Investments Equity Plant Assets Intangible Assets Current items are those expected to come due (both collected and owed) within the longer of one year or the company’s normal operating cycle. Snowboarding Components Balance Sheet December 31, 2011 ASSETS Current assets Cash $ 6 500 Short-term investments 2 100 Accounts receivable 4 400 Merchandise inventory 27 500 Prepaid expenses 2 400 Total current assets $ Long-term investments Notes receivable 1 500 Investments in stocks and bonds 18 000 Land held for future expansion 48 000 Total investments Plant assets Store equipment $ 33 200 Less accumulated depreciation 8 000 25 200 Buildings 170 000 Less accumulated depreciation 45 000 125 000 Land 73 200 Total plant assets Intangible assets Total assets $ 42 900 Current assets are expected to be sold, collected, or used within one year or the 67 500 company’s operating cycle. 223 400 10 000 343 800 Snowboarding Components Balance Sheet December 31, 2011 ASSETS Current assets Cash Short-term investments Accounts receivable Merchandise inventory Prepaid expenses Total current assets Long-term investments Notes receivable Investments in stocks and bonds Land held for future expansion Total investments Plant assets Store equipment Less accumulated depreciation Buildings Less accumulated depreciation Land Total plant assets Intangible assets Total assets $ 6 500 2 100 4 400 27 500 2 400 $ 42 900 1 500 18 000 48 000 67 500 $ 33 200 Long-term investments are expected to 8 000 25 200 be held for the longer170of 000 one year or the 45 000 125 000 operating cycle. 73 200 $ 223 400 10 000 343 800 Snowboarding Components Balance Sheet December 31, 2011 ASSETS Current assets Cash Short-term investments Accounts receivable Merchandise inventory Prepaid expenses Total current assets Long-term investments Notes receivable Investments in stocks and bonds Land held for future expansion Total investments Plant assets Store equipment Less accumulated depreciation Buildings Less accumulated depreciation Land Total plant assets Intangible assets Total assets $ 6 500 2 100 4 400 27 500 2 400 $ 42 900 $ 223 400 10 000 343 800 Plant assets are tangible long-lived 1 500 assets used to produce or sell products 18 000 and services. 48 000 67 500 $ 33 200 8 000 170 000 45 000 25 200 125 000 73 200 Snowboarding Components Balance Sheet December 31, 2011 ASSETS Current assets Cash Short-term investments Accounts receivable Merchandise inventory Prepaid expenses Total current assets Long-term investments Notes receivable Investments in stocks and bonds Land held for future expansion Total investments Plant assets Store equipment Less accumulated depreciation Buildings Less accumulated depreciation Land Total plant assets Intangible assets Total assets $ 6 500 2 100 4 400 27 500 2 400 $ 42 900 1 500 18 000 48 000 67 500 Intangible assets are long-term $ 33 200 resources used to produce or sell 8 000 25 200 170 000 products and services and125that lack 45 000 000 physical form. 73 200 223 400 $ 10 000 343 800 Snowboarding Components Balance Sheet December 31, 2011 LIABILITIES Current liabilities Accounts payable Wages payable Notes payable Current portion of long-term liabilities Total current liabilities Long-term liabilities: Notes payable (net of current portion) Total liabilities EQUITY T. Hawk, Capital Total liabilities and equity $ 15 300 3 200 3 000 7 500 $ 29 000 $ 150 000 179 000 $ 164 800 343 800 Current liabilities are obligations due within the longer of one year or the company’s operating cycle. Snowboarding Components Balance Sheet December 31, 2011 LIABILITIES Current liabilities Accounts payable Wages payable Notes payable Current portion of long-term liabilities Total current liabilities Long-term liabilities: Notes payable (net of current portion) Total liabilities EQUITY T. Hawk, Capital Total liabilities and equity $ 15 300 3 200 3 000 7 500 $ 29 000 $ 150 000 179 000 $ 164 800 343 800 Long-term liabilities are obligations not due within the longer of one year or the company’s operating cycle. Snowboarding Components Balance Sheet December 31, 2011 LIABILITIES Current liabilities Accounts payable Wages payable Notes payable Current portion of long-term liabilities Total current liabilities Long-term liabilities: Notes payable (net of current portion) Total liabilities EQUITY T. Hawk, Capital Total liabilities and equity $ 15 300 3 200 3 000 7 500 $ 29 000 $ 150 000 179 000 $ 164 800 343 800 Equity is the owner’s claim on the assets. Cash Flow and Financial Planning Learning Goals 1. Tax depreciation procedures and the effect of depreciation on the firm’s cash flows. 2. Firm’s statement of cash flows, operating cash flow, and free cash flow. 3. The financial planning process, 1. long-term (strategic) financial plans 2. short-term (operating) plans. 4. Cash-planning process and the cash budget. 5. Pro forma income statement and balance sheet Analyzing the Firm’s Cash Flows • Cash flow is the primary focus of the financial manager. • An important factor affecting cash flow is depreciation. • From an accounting perspective - statement of cash flows. • From a financial perspective, – Managerial decision-making - operating cash flow – Participants in the capital market - free cash flow Depreciation • Depreciation is the systematic charging of a portion of the costs of fixed assets against annual revenues over time. • Depreciation for tax purposes - the modified accelerated cost recovery system (MACRS). • Other depreciation methods are often used for reporting purposes. Depreciation: Depreciation & Cash Flow • Financial managers are much more concerned with cash flows rather than profits. • To adjust the income statement to show cash flows from operations, all non-cash charges should be added back to net profit after taxes. • By lowering taxable income, depreciation and other non-cash expenses create a tax shield and enhance cash flow. Depreciation: MACRS Depreciable Value & Depreciable Life • The depreciable value of an asset is its full cost, including outlays for installation. • No adjustment is required for expected salvage value. • For tax purposes, the depreciable life of an asset is determined by its MACRS recovery predetermined period. • MACRS property classes and rates are shown in Table 3.1 and Table 3.2 on the following slides. Depreciation First Four Property Classes under MACRS Rounded Depreciation Percentages by Recovery Year Using MACRS for First Four Property Classes Depreciation: An Example • Baker Corporation acquired, for an installed cost of $40,000, a machine having a recovery period of 5 years. Using the applicable MACRS rates, the depreciation expense each year is as follows: Depreciation • Question: – If as a business owner you could design a depreciation schedule to look the way you wanted it to, what would it look like? Developing the Statement of Cash Flows • The statement of cash flows summarizes the firm’s cash flow over a given period of time. • The statement of cash flows is divided into three sections: – Operating flows – Investment flows – Financing flows Developing the Statement of Cash Flows: Classifying Inflows and Outflows of Cash • The statement of cash flows essentially summarizes the inflows and outflows of cash during a given period. Inflows and Outflows of Cash Baker Corporation Income Statement ($000) for the Year Ended December 31, 2009 Baker Corporation Balance Sheets ($000) (cont.) Baker Corporation Balance Sheets ($000) Baker Corporation Statement of Cash Flows ($000) for the Year Ended December 31, 2009 Interpreting Statement of Cash Flows • The net increase (or decrease) in cash and marketable securities should be equivalent to the difference between the cash and marketable securities on the balance sheet at the beginning of the year and the end of the year. Operating Cash Flow • A firm’s Operating Cash Flow (OCF) is the cash flow a firm generates from normal operations—from the production and sale of its goods and services. • OCF may be calculated as follows: NOPAT = EBIT x (1 – T) OCF = NOPAT + Depreciation OCF = [EBIT x (1 – T)] + Depreciation Operating Cash Flow (cont.) • Substituting for Baker Corporation, we get: OCF = [$370 x (1 - .40) + $100 = $322 • Thus, we can conclude that Baker’s operations are generating positive operating cash flows. Free Cash Flow • Free Cash Flow (FCF) is the amount of cash flow available to debt and equity holders after meeting all operating needs and paying for its net fixed asset investments (NFAI) and net current asset investments (NCAI). FCF = OCF – NFAI - NCAI • Where: NFAI = Change in net fixed assets + Depreciation NCAI = Change in CA – Change in A/P and Accruals Free Cash Flow (cont.) • Using Baker Corporation we get: NFAI = [($1,200 - $1,000) + $100] = $300 NCAI = [($2,000 - $1,900) + ($800 - $700)] = $0 FCF = $322 – $300 - $0 = $22 • This FCF can be used to pay its creditors and equity holders. The Financial Planning Process • Financial planning involves guiding, coordinating, and controlling the firm’s actions to achieve its objectives. – cash planning and profit planning. • Cash planning involves the preparation of the firm’s cash budget. • Profit planning involves the preparation of both cash budgets and pro forma financial statements. The Financial Planning Process: Long-Term (Strategic) Financial Plans • Long-term strategic financial plans lay out a company’s planned financial actions and the anticipated impact of those actions over periods ranging from 2 to 10 years. The Financial Planning Process: Long-Term (Strategic) Financial Plans (cont.) • Long-term financial plans consider a number of financial activities including: – – – – – Proposed fixed asset investments Research and development activities Marketing and product development Capital structure Sources of financing • These plans are generally supported by a series of annual budgets and profit plans. Short-Term Financial Planning Cash Planning: Cash Budgets • The cash budget or cash forecast is a statement of the firm’s planned inflows and outflows of cash. • It is used to estimate short-term cash requirements with particular attention to anticipated cash surpluses and shortfalls. • Surpluses must be invested and deficits must be funded. Cash Planning: Cash Budgets (cont.) • The cash budget begins with a sales forecast, which is simply a prediction of the sales activity during a given period. Cash Planning: Cash Budgets (cont.) The General Format of the Cash Budget Cash Planning: Cash Budgets An Example: Coulson Industries • Coulson Industries, a defense contractor, is developing a cash budget for October, November, and December. Halley’s sales in August and September were $100,000 and $200,000 respectively. Sales of $400,000, $300,000 and $200,000 have been forecast for October, November, and December. Historically, 20% of the firm’s sales have been for cash, 50% have been collected after 1 month, and the remaining 30% after 2 months. In December, Coulson will receive a $30,000 dividend from stock in a subsidiary. Cash Planning: Cash Budgets An Example: Coulson Industries (cont.) • Based on this information, we are able to develop the following schedule of cash receipts for Coulson Industries. A Schedule of Projected Cash Receipts for Coulson Industries ($000) Cash Planning: Cash Budgets An Example: Coulson Industries (cont.) • Coulson Company has also gathered the relevant information for the development of a cash disbursement schedule. Purchases will represent 70% of sales—10% will be paid immediately in cash, 70% is paid the month following the purchase, and the remaining 20% is paid two months following the purchase. The firm will also expend cash on rent, wages and salaries, taxes, capital assets, interest, dividends, and a portion of the principal on its loans. The resulting disbursement schedule thus follows. Schedule of Projected Cash Disbursements for Coulson Industries ($000) Cash Planning: Cash Budgets An Example: Coulson Industries (cont.) • The Cash Budget for Coulson Industries can be derived by combining the receipts budget with the disbursements budget. At the end of September, Coulson’s cash balance was $50,000, notes payable was $0, and marketable securities balance was $0. Coulson also wishes to maintain a minimum cash balance of $25,000. As a result, it will have excess cash in October, and a deficit of cash in November and December. The resulting cash budget follows. A Cash Budget for Coulson Industries ($000) Profit Planning: Pro Forma Statements • Pro forma financial statements are projected, or forecast, financial statements – income statements and balance sheets. Profit Planning: Pro Forma Financial Statements Profit Planning: Pro Forma Financial Statements (cont.) Vectra Manufacturing’s Balance Sheet, December 31, 2009 Profit Planning: Pro Forma Financial Statements (cont.) • Step 1: Start with a Sales Forecast – The first and key input for developing pro forma financial statements is the sales forecast for Vectra Manufacturing. 2010 Sales Forecast for Vectra Manufacturing Profit Planning: Pro Forma Financial Statements (cont.) • Step 1: Start with a Sales Forecast (cont.) – The previous sales forecast is based on an increase in price from $20 to $25 per unit for Model X and from $40 to $50 per unit for Model Y. – These increases are required to cover anticipated increases in various costs, including labor, materials, & overhead. Profit Planning: Pro Forma Financial Statements (cont.) • Step 2: Preparing the Pro Forma Income Statement – A simple method for developing a pro forma income statement is the “percent-of-sales” method. Profit Planning: Pro Forma Financial Statements (cont.) A Pro Forma Income Statement, Using the Percent-of-Sales Method, for Vectra Manufacturing for the Year Ended December 31, 2010 Profit Planning: Pro Forma Financial Statements (cont.) • Step 2: Preparing the Pro Forma Income Statement (cont.) – Clearly, some of the firm’s expenses will increase with the level of sales while others will not. – As a result, the strict application of the percent-of-sales method is a bit naïve. – The best way to generate a more realistic pro forma income statement is to segment the firm’s expenses into fixed and variable components. – This may be demonstrated as follows. Profit Planning: Pro Forma Financial Statements (cont.) Profit Planning: Pro Forma Financial Statements (cont.) • Step 3: Preparing the Pro Forma Balance Sheet – Probably the best approach to use in developing the pro forma balance sheet is the judgmental approach. – Under this simple method, the values of some balance sheet accounts are estimated and the company’s external financing requirement is used as the balancing account. Profit Planning: Pro Forma Financial Statements (cont.) • Step 3: Preparing the Pro Forma Balance Sheet (cont.) 1. A minimum cash balance of $6,000 is desired. 2. Marketable securities will remain at their current level of $4,000. 3. Accounts receivable will be approximately $16,875 which represents 45 days of sales on average [(45/365) x $135,000]. 4. Ending inventory will remain at about $16,000. 25% ($4,000) represents raw materials and 75% ($12,000) is finished goods. 5. A new machine costing $20,000 will be purchased. Total depreciation will be $8,000. Adding $20,000 to existing net fixed assets of $51,000 and subtracting the $8,000 depreciation yields a net fixed assets figure of $63,000. Profit Planning: Pro Forma Financial Statements (cont.) • Step 3: Preparing the Pro Forma Balance Sheet (cont.) 6. Purchases will be $40,500 which represents 30% of annual sales (30% x $135,000). Vectra takes about 73 days to pay on its accounts payable. As a result, accounts payable will equal $8,100 [(73/365) x $40,500]. 7. Taxes payable will be $455 which represents one-fourth of the 1998 tax liability. 8. Notes payable will remain unchanged at $8,300. 9. There will be no change in other current liabilities, long-term debt, and common stock. 10. Retained earnings will change in accordance with the pro forma income statement. Profit Planning: Pro Forma Financial Statements (cont.) A Pro Forma Balance Sheet, Using the Judgmental Approach, for Vectra Manufacturing (December 31, 2010)