Important Terminology

Transcription

1 Important Terminology Recognition When we "recognize" a revenue or expense, it means that we record the amount in our general ledger and the amount is included in our income statement. Deferral When we "defer" recognition of a revenue or expense, it means that the amount does not appear in our income statement in the current period. Instead, the amount will appear in the income statement in a future period. Example: When we purchase a fixed asset, we defer the recognition of the expense. Instead, the amount will be recognized over the life of the asset (through depreciation). Accrual Something that accumulates over the passage of time or comes into being as an enforceable right. Example: Interest "accrues" on a loan.

2 The Accounting Process Important Points: The only way to change a general ledger balance is by recording a journal entry. Journal entries must balance; debits must equal credits. Recording Transactions Journal entries to record contracts, purchases, sales, payments, etc. Adjusting Entries Prepayments-cash flow precedes either expense or revenue recognition Examples: Purchases of supplies before they are used or the receipt of subscription payments. Accruals-cash flow comes after either expense or revenue recognition Examples: Using utilities and being billed later, or providing a service and billing your client later. Estimates-estimating future effects of past transactions, such as future sales returns.

3 Example: E 2-8 Prepare the adjusting entries at 12/31/00 for the Falwell Company. Assume that no financial statements were prepared during the year and no adjusting entries were recorded. 1. A three-year insurance policy was purchased on 7/1/00 for $6,000. The company debited insurance expense for the entire amount. Dr./Cr. Account Name Amount 2. Depreciation on equipment totaled $15,000 for the year. 3. The company determined that accounts receivable in the amount of $6,500 will probably not be collected. The allowance for uncollectible accounts account has a credit balance of $2,000 before any adjustment.

4 4. Employee salaries of $18,000for the month of December will be paid in early January Dr./Cr. Account Name Amount 5. On November 1, 2000 the company borrowed $100,000 from a bank. The note requires principal an interest at 12% to be paid on 4/30/ On 12/1/00, the company received $3,000 in cash from another company that is renting office space in Falwell's building. The payment, representing rent for December and January, was credited to unearned rent revenue.

5 Now for Something a Little More Challenging (All $s in Millions) Part 1 In the motion picture industry, the term "gross" refers to the amount of box office receipts for a particular movie. Those receipts are shared between the producer of the film and the theater (typically, the producer receives 70-80%). Sometimes the theater will pay a guaranteed amount upfront to be offset by the gross. For example, if a theater pays a $1 guaranteed advance against 80% of the gross, the theater pays the producer $1. If the gross is over $1.25 the producer keeps the $1 and receives 80% of the box office receipts in excess of $1.25. If the gross turns out to be less than $1.25, the producer just keeps the $1. XYZ Movies, Inc. produces a movie. The movie is produced in 1998 at a cost of $80. During 1998, XYZ negotiates a contract with ABC Theatre Co. for a guarantee of $60 as an advance against 75% of the gross.

6 1. Assume that the contract is signed in 1998, the $60 is received in 1999, but due to production delays, the film is released in In what year should XYZ recognize the revenue? Why? 2. When should XYZ recognize the expense for the $80? Explain. 3. When should the theater recognize the expense for the $60? Explain

7 Part 2: Assume XYZ Movies pays $30 in cash in 1998 to produce the movie and owes an additional $10 to be paid in ABC Theatres agrees to pay XYZ a $25 guaranteed advance against 70% of the gross. The $25 is paid in 1999 and the movie is shown in In addition, XYZ expects to receive $14 from video and other sales in Prepare the entries for 1998 and XYZ ABC Dr./Cr. Account Name Amount Dr./Cr. Account Name Amount 1999 XYZ ABC Dr./Cr. Account Name Amount Dr./Cr. Account Name Amount

8 Assume that the movie is a success. The film grosses $150 in Prepare the entries for XYZ ABC Dr./Cr. Account Name Amount Dr./Cr. Account Name Amount Assume that the film is a flop. The film grosses $40 in Prepare the entries for XYZ ABC Dr./Cr. Account Name Amount Dr./Cr. Account Name Amount

9 Part 3: Movie producers also receive additional revenue from video sales and royalties. How would this fact affect the journal entries recorded in 2000? Suggested Textbook Problems for Chapter 2 P2-1, P2-2, P2-3, P2-11.