Business Background Management is responsible for preparing...
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1 Business Background Management is responsible for preparing... Financial Statements High Quality = Relevance + Reliability... Are useful to investors and creditors.
2 Business Background Revenues are recorded when earned. Expenses are recorded when incurred. Because transactions occur over time, ADJUSTMENTS are required at the end of each fiscal period to get the revenues and expenses into the right period.
3 Accounting Cycle During the period: Analyze transactions. Record journal entries. Post amounts to general ledger. Close revenues, gains, expenses, and losses to Retained Earnings. At the end of the period: Adjust revenues and expenses. Prepare financial statements. Disseminate statements to users.
4 Learning Objectives Purpose of a trial balance.
5 Unadjusted Trial Balance A listing of individual accounts, usually in financial statement order. Ending debit or credit balances are listed in two separate columns. Total debit account balances should equal total credit account balances.
6 Note that total debits = total credits
7 Accumulated depreciation is a contra-asset account. It is directly related to an asset account but has the opposite balance.
8 Cost - Accumulated depreciation = BOOK VALUE.
9 Learning Objectives Analyze the adjustments necessary at the end of the period to update balance sheet and income statement accounts.
10 Adjusting Entries There are two types of adjusting entries. ACCRUALS Revenues earned or expenses incurred that have not been previously recorded. DEFERRALS Receipts of assets or payments of cash in advance of revenue or expense recognition.
11 Chart for Deferred and Accrued Revenues During the period Cash received before revenue earned Deferred Revenue Cash (+A) Unearned revenue (+L) Accrued Revenue None End of the period Company has earned revenue Unearned revenue (-L) Revenue receivable (+A) Revenue (+R, + SE) Revenue (+R, +SE) Next period Cash is received None Cash (+A) Revenue receivable (-A) Income Statement R-COGS-Exp= Net Income Balance Sheet A = L + SE
12 Chart for Deferred and Accrued Expenses During the period Cash paid before expense incurred Deferred Expense Prepaid asset (+A) Cash (-A) Accrued Expense None End of the period Company must recognize expense Expense (+E) Expense (+E) Prepaid asset ((-A) Liability (+L) Next period Cash is paid after expense incurred None Liability (-L) Cash (-A) Income Statement R-COGS-Exp= Net Income Balance Sheet A = L + SE
13 Adjustments Involving Estimates Certain circumstances require adjusting entries to record accounting estimates. Examples include... Depreciation Bad debts Income taxes $$$
14 Depreciation Adjustment The accounting concept of depreciation involves the systematic and rational allocation of the cost of a longlived asset over multiple accounting periods it is used to generate revenue. This is a cost allocation concept, not a valuation concept.
15 Depreciation Adjustment The journal entry required is to debit Depreciation Expense and to credit an account called Accumulated Depreciation. This is called a Contra-Asset account.
16 Depreciation Adjustment At January 1, 2008, Solar System s trial balance showed Accumulated Depreciation of $149,000 (in thousands of dollars). For the month of January, Solar System s needs to recognize $2,500 in depreciation.
17 Depreciation Adjustment After we post the entry to the T-accounts, the account balances look like this (in thousands of dollars): 1/31 2,500 Bal. 2,500 Depreciation Expense Accumulated Depreciation 1/1 149,000 1/31 2,500 Bal. 151,500
18 Learning Objectives Income statement with earnings per share Statement of stockholders equity Balance sheet Supplemental cash flow information.
19 Financial Statement Relationships Net The income income increases statement retained is created earnings first (a net loss by determining decreases retained the difference earnings). Dividends between decrease revenues retained and expenses. earnings. DIVIDENDS Decrease RETAINED EARNINGS Increase NET INCOME = REVENUES EXPENSES
20 Financial Statement Relationships Contributed Capital and Retained Earnings make up Stockholders Equity. STOCKHOLDERS EQUITY Increase CONTRIBUTED CAPITAL RETAINED EARNINGS Increase NET INCOME = REVENUES EXPENSES
21 Financial Statement Relationships ASSETS = LIABILITIES + STOCKHOLDERS EQUITY Increase CONTRIBUTED CAPITAL RETAINED EARNINGS Increase NET INCOME = REVENUES EXPENSES
22 Learning Objectives Compute and interpret the net profit margin.
23 Key Ratio Analysis Net Profit Margin indicates how effective management is at generating profit on every dollar of sales. Net Profit Margin = Net Income Net Sales Net profit margin for January 2004 is: $7,241,000 $69,800,000 = 10.37%
24 Learning Objectives Explain the closing process.
25 Closing the Books Balance sheet account balances carry forward from period to period Income statement accounts do not. Closing entries: 1. Transfer net income (or loss) to Retained Earnings. 1. Establish a zero balance in each of the temporary accounts to start the next accounting period.
26 Closing the Books The following accounts are called temporary or nominal accounts and are closed at the end of the period... Revenues. Expenses. Gains. Losses. Dividends declared. $ 0
27 Closing the Books Assets, liabilities, and stockholders equity are permanent, or real accounts, and are never closed. Assets. Liabilities. Stockholders Equity. Period End Balances
28 Closing the Books Two steps are used in the closing process Close revenues and gains to Retained Earnings. 1. Close expenses and losses to Retained Earnings. How to Close the Books!
29 Post-Closing Trial Balance Let s take a look at the adjusted trial balance of Matrix, Inc. at December 31, We want to see the difference between the adjusted trial balance and the post-closing trial balance.
30 Post-Closing Trial Balance Close these accounts. Net income is $1,200
31 Post-Closing Trial Balance Retained earnings $2,960 ($1,760 + $1,200 net income).
32 Judging Earnings Reporting Quality Companies that make relatively pessimistic estimates that reduce current income are judged to follow conservative financial reporting strategies Experienced analysts give these reports more credence. These companies are viewed as having higher quality reporting of earnings.
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