PROFESSOR S CLASS NOTES COB 241 Sections 13, 14, 15 Class on September 17, 2018

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1 PROFESSOR S CLASS NOTES COB 241 Sections 13, 14, 15 Class on September 17, 2018 Administrative Items Re-do Seating Chart for Sections 14 and 15 Reminder of correct usage of Self-Assessments Reminder of correct usage of Professor s Class Notes Quick Review Chart of Accounts vs. General Ledger Closing Process important to learn the steps in this process Journal: the practical way to record business events Journal Entry: a two-line entry, a debit and a credit, recording the effect of a business event Second Major Accounting Equation: Debits = Credits -- for every journal entry Specialty Journals: a journal containing entries for one type of event General Journal: the single journal usually containing all entries made to the ledger Examples of Specialty Journals: Cash Disbursements, Cash Receipts, Sales, etc. Posting : the activity whereby journal entries are copied to the ledger T-accounts Adjusting Entries: the debits and credits required for accrual accounting Closing Entries: the debits and credits required to close out Income and Expense to Retained Earmings Striking : the term used to indicate creation of a Trial Balance or Financial Statements Some Formal Definitions Accrual: A revenue or expense event (entry) that is recognized (recorded) before cash is exchanged. Deferral: A revenue or expense event (entry) that is recognized (recorded) after cash has been exchanged. Receivables: The shortened form of Accounts Receivable, the money owed to the company by its customers. Payables: The shortened form of Accounts Payable, the money owed by the company to its vendors/suppliers. Prepaids: The shortened form of Prepaid Expenses, where the company has deferred the expense recognition. Unearned Revenue: A liability which the company owes (performance or a refund) a customer who paid in advance. TODAY S MATERIAL Short-Term vs. Long-Term Assets On the Balance Sheet, assets are classified as either Short Term or Long Term assets, depending on when the company plans to use up or convert to the asset to cash.

2 Definitions Short-Term Asset: an asset the company plans to use up or convert the asset to cash within the upcoming year. Long-Term Asset: an asset the company plans to continue owning for longer than the upcoming year. In the case of physical assets such as buildings, land, plant, property, and equipment, even if the company plans to liquidate or dispose of the asset in the next year, most of the time it is still considered a long-term asset until it is actually sold or disposed of. Examples Examples of Short Term Assets: Cash (is always considered a short-term asset) Accounts Receivable (companies hope to collect within the next year) Inventories (companies hope to sell these within the next year) Supplies (companies plan to use these within the next year) Prepaids (companies plan to expense these, or obtain a refund, within the next year) Short-term investments (investments the company plans to hold less than a year) Examples of Long-Term Assets: Land (will exist for longer than 1 year) Buildings, Property, Plant (these will last longer than 1 year) Equipment (machinery, furniture, fixtures, designed to last longer than 1 year Long-term loans made to other companies and organizations Long-Term Investments the company owns and intends to hold for longer than 1 year Sequence of Appearance on the Balance Sheet The order in which assets appear on the Balance Sheet is standardized by GAAP. Balance sheets using this sequence are said to be in proper form or good form. The general rule is: Assets are listed in decreasing order of liquidity. (Liquidity is the ease with which the asset can be converted to cash). The required order for short-term assets: Cash (is always liquid, and is always the first account listed) Cash Equivalents (CD s, savings accounts, etc. can be converted to cash almost instantly) Accounts Receivable (the company has already done all the work except collection) Inventories (the company must first sell the inventory, then collect) Supplies (might not be saleable at full value, but can be used at full value) Prepaids (many prepaids are non-refundable by contract, and can only be used over time) Short-Term Investments (these must be sold, and might have to be sold at a loss)

3 Physical vs. Intangible Assets Physical assets can be touched, transported, installed, moved, and/or must be maintained. Examples include land, plant, property, equipment, furniture and fixtures, etc. Intangible Assets are usually long-term assets, and consist of rights which cannot be touched, but have value and can be sold. Intangible assets include things such as patents, brands, trademarks, logos, copyrights, mineral rights, exclusivity agreements, and other rights which have value. Depreciation of Physical Assets Definition of Depreciation : an adjusting entry made to recognize the reduction in value of a long-term physical asset caused by usage and/or the passage of time. Why We Have Depreciation We all know that a used car is not worth as much as a new car. As a long-term asset is used, and even simply with the passage of time, almost all physical long-term assets depreciate in value. For this reason, we must adjust the accounting records to reflect this reduction in value. Accounting for Depreciation There are two parts to depreciation, and they correspond to the debit and the credit made in the adjusting entry. Depreciation Expense: The amount by which the asset value is reduced (or used up) in the current period is debited to the Depreciation Expense account. Accumulated Depreciation: The amount by which the asset value is reduced in the current period is credited to the Accumulated Depreciation account for the asset which is being reduced in value. Note that accumulated depreciation is recorded by asset. In practice, each asset will have its own Accumulated Depreciation account. However, at the present time, we will use only one Accumulated Depreciation account for the entire collection of physical long-term assets. Also note that the Depreciation Expense account, being an expense account, is closed to Retained Earnings at the end of every accounting period, whereas the Accumulated Depreciation account is carried forward on the balance sheet from period to period. As the asset ages, the amount in the Accumulated Depreciation account continues to accumulate credit entries. These credits are a reduction the asset s value.

4 Calculating the Amount of the Depreciation Entry There are numerous ways of determining the amount of reduction in value of an asset. At the present time, we will not go into those ways, but will cover them at a later point in the course. For now, all depreciation amounts will be provided. Reporting Depreciation Depreciation Expense is reported on the Income Statement for each period. Depreciation is usually reported separately from all other expenses. As an income statement account, it is closed out to Retained Earnings as part of the closing entries at the end of each period. Accumulated Depreciation is a credit-balance account, but is reported under the Asset to which it applies. Since the credit balance is reducing the value of the asset, Accumulated Depreciation is called a Contra-Asset account. Accumulated Depreciation is carried forward from period to period, and once a physical asset is first depreciated, the account will have an opening balance at the beginning of each period. Relationship Between Acquisition Cost and Depreciation Under GAAp, all Long-Term Assets are kept on the books and reported on the Balance Sheet at their original Acquisition Cost. Acquisition cost is a historical fact and does not change over time. As long as the company owns the asset, the asset will appear on the Balance Sheet at its acquisition cost. However, directly underneath the asset s acquisition cost is where Accumulated Depreciation is reported. Thus, by seeing the original acquisition cost and the accumulated depreciation, a financial statement user can see how much of the asset has been used up since it was acquired, and how much usability remains. Exception for Land Land is generally reported separately from plant, property, and equipment. If a company owns a factory which is located on a 100-acre parcel of land, the company s Balance Sheet will report the value of the 100-acre parcel as Land, and will separately report the value of the factory and its equipment as Plant, Property, and Equipment (PPE). Land does not depreciate. Land rarely if ever loses value. To the contrary, most land appreciates and becomes more valuable over time. But under the conservativeness principle, accountants always report asset at the Lower of Cost or Market. Since cost of land is usually lower than its market value, we always report land at its acquisition cost, without depreciation.

5 Example of Depreciation Journal Entry Date Account Debit Credit 13-Jan Depreciation Expense $ 1, Accumulated Depreciation $ 1, The above entry shows that the long-term asset has reduced in value by $2500. The using up of part of this asset s value is an expense. The accumulated depreciation will be shown on the Balance Sheet to inform the balance sheet user that the asset is not Presentation of Long-Term Assets on the Balance Sheet LONG TERM ASSETS Land $ 450,000 Plant, Property and Equipment $ 1,600,000 Less Accumulated Depreciation on PPE $ -450,000 Plant, Property and Equipment net of depreciation $ 1,150,000 Vehicles (Truck Fleet) $ 1,000,000 Less Accumulated Depreciation on Vehicles $ -300,000 Vehicles net of depreciation $ 700,000 TOTAL LONG-TERM ASSETS $ 2,300,000